O2micro International Ltd (OIIM) 2006 Q3 法說會逐字稿

Good day and thank you for joining us to discuss O2Micro's earnings for the third quarter of the fiscal year 2006. If you would like a copy of the press release, please call Pamela Campbell at (408) 987-5920, extension 8095 and we will fax you a copy immediately. It is also posted on O2Micro's website at www.02Micro.com.

There will be a replay available through November 8th by calling 1-(888) 203-1112 or 1-(719) 457-0820, with pass code is 9974191. Following the presentation by management the conference call will be open for questions and answers as time permits. Gentlemen, you cam begin.

Thank you. Good afternoon and welcome to the O2Micro earnings report conference call for Q3 of the fiscal year 2006. My name is Mitchell Benus, I'm Director of Investor Relations. I would like to take this opportunity to remind the listeners that this discussion of business outlook for O2Micro contains forward-looking statements. Statements made in this release that are not historical facts are forward-looking statements within the meaning of the federal securities laws. Actual results may differ materially due to numerous risk factors. Such risk factors are enumerated in the Form F1, Form F3 and the 20F reports and other documents filed with the Securities and Exchange Commission from time to time.

Listeners are referred to the O2Micro earnings press release and the documents filed with the SEC to understand these forward-looking statements and their associated risk factors. The statements made herein are dated information. The Company assumes no responsibility to provide updates for this information.

With us on today's conference call are our CFO Perry Kuo, James Keim, Director, and Sterling Du, Chairman and CEO. After the reports, the floor will open for questions as time permits. Perry Kuo, CFO of O2Micro, will highlight operating results and projections, followed by James who will give market highlights, and closing comments will be made by Sterling Du, CEO and after we will take questions. Now may I introduce Perry Kuo, CFO of O2Micro, for a discussion of the revenue, income and financial highlights of the third quarter of fiscal 2006 ending September 30, 2006. Perry?

Thank you, Mitch, and good afternoon, everyone. This is O2Micro's earnings report announcement covering Q3 2006 ending September 30, 2006. As everyone has a copy of the earnings report we release I will be brief and report the highlights Revenue for Q3 was $31,452.000. This represents a increase of 12.2% from the preceding quarter and an increase of 12.2% from the comparable quarter of the prior year. Net income for Q3 was $550,000, compared to the preceding quarter of net loss $2,512,000. The net income for the comparable quarter of the prior year was $2,852,000.

If we exclude one time project expenses which include O2 Ocean One stock option expense of $442,000, [inaudible] $382,000, stock compensation $642,000, patent related litigation education $3,508,000 and take accrue reverse $2,551,000, the income would be $2,973,000.

Earnings per ADA fully diluted for Q3 ending September 30, 2006, was $0.01 for ADA compared to loss per ADA of $0.06 for the preceding quarter and $0.07 cents per ADA for the comparable quarter of the prior year. Gross profit margin for Q3 was 53.3% mainly due to product mix.

R&D expense, excluding stock-based compensation charge-offs $287,000 for Q3, or $7,497,000 or 23.8% of revenue. SG&A expense, including stock compensation charge off, $355,000 for Q3 was $6,896,000, or 21.9% of revenue not including the patent related expenses of $3,408,000. The total SG&A expense including litigation and stock based compensation charge was $10,759,000, or 34.2% of revenue. Income tax benefit for Q3 was $2,140,000 including reversal of taken accrual of $2,451,000 due to the [inaudible] of our 2001 income tax return filing of the O2Micro [inaudible] have been [inaudible] authorities to September, 2006.

Share repurchases in Q3 were 988,149 ADAs for a total of $5,891,501. Since Q1, a total of 1,468,949 ADAs have been repurchased to date which is about 2.98% of shares outstanding.

Revenue by end market as a percentage of total revenue for Q3 was consumer in the range of about middle 15 range, computer in the range of low 40% range, industrial and communications, each as more single digit percentage of revenue. In balance sheet, we are managing our cash and working capital. At the end of the third quarter, O2Micro hit over $64 million in cash and short term investments. Short term investments or money invested in corporate bonds of at least AA rating and government bonds of certain developed countries. This represents cash and equivalents of ADS shares of $1.16. In addition O2Micro has no debt.

Capital expenditures in Q3 was $3,602,000. Accounts receivable at the end of Q3 were $17,734,000, for a DSO of 48 days. This compares to a DSO of 42 days at the end of Q2, 2006. Our financial model is 45 to 55 days. Inventory turns ratio for Q3 were 3.7 compared to 3.4 for the previous quarter and the 3.2 for the comparable quarter of the prior year. Cash flow from operations for Q3 was negative, amount was 5,121,000.

O2Micro now has 1,012 employees, 62% of which are engineers. This positions us well for new product development and the continued introduction of new products and more customers in the future.

Now I move to the guidance for Q4, 2006. O2Micro estimates Q4 revenue compared to Q3 to be up in the range of 6% and 9%. R&D Q4 will be in 22% to 24%. We expect SG&A without litigation expense for Q4 to be in the range of 21% to 23%. We expect the litigation expense for Q4 to be in the range of 3.5 million to 4 million. Stock compensation expensing has begun in Q1 and we expect the stock compensation expense for Q4 to be in the range of $600,000 to $700,000. A fixed rate of 12% to 14% of pro forma income, the model will be in the area of 250,000. The gross profit margin target range of the company's financial model is 55% to 60% and we expect gross profit margin in Q4 to be in the rage of 52% to 55%, mainly based on the product mix. I will now pass the call to James Keim, Director.

Thank you, Perry. Q3 showed resumed growth as inventory corrections related to lower than expected sales at major customers during Q2 quickly reversed and we were challenged to keep up with demand from major customers in several product areas during the quarter. Fortunately, our investments in both wafer fab and back end processing enabled us to rapidly expand production. We have ongoing growth opportunities in all major market sectors, LCD monitor, LCD TV, Notebook and other consumer products.

We see our core markets being positioned for additional growth in Q4 and onward into 2007. Besides growth in core markets, we also believe 2 other factors will enhance our growth as we look to the future. Our expanding R&D efforts with ongoing intellectual property expansion will lead to a more broadly based portfolio of products over the next several years that can moderate the cyclical ups and downs that we've experienced. These products will include battery gauge, wide LED, power management units, DC to DC, and VPN/Firewall. Our IP will drive not only growth but profitability.

Secondly, we have established major operating activities in China leaving us better positioned for both lower cost production and improved supply support to our major customers most of whom base their production in China. Our Ocean One testing facility near Shanghai will be fully operational in the first half of 2007. This testing facility will reduce testing costs, improve our logistics, including turnaround time, and help protect proprietary information.

I will also comment briefly on our major product lines. Intelligent lighting continues to expand with new product design wins in all key market segments and an expanding customer base. Besides LCD display, O2Micro has developed a family of high efficiency LED controllers that are patent pending. These products have already begun to ship in volume for high volume portable applications. Intelligent power efforts continue to expand. Our power management units now have significant design wins, increasing revenue contribution.

Our system DC to DC products continue to win new notebook designs with increasing market penetration as new products continue to be introduced. Our processor DC to DC products now have major design wins for AMD based platforms and we expect increasing revenue in 2007. Additionally, our patented cool charge product is moving toward production after achieving initial design wins. This cool charge product enables higher performance from existing notebooks and helps pave the way for the next-generation of thinner and lighter notebooks.

Intelligent e-commerce has achieved significant revenue increases following design wins at a number of industry leading notebook OEMs. We continue to expand this product line with new and more cost effective products. Our intelligent battery product offering incorporates innovative intellectual property to more accurately control charging and discharging of batteries. This is essential in critical applications where safety and accuracy are required. We have multiple design wins in multiple market areas and have begun volume production. We expect increasing revenue contribution as we move through 2007.

As mentioned last time, our VPN/Firewall product has passed testing at IC SA labs where the O2Micro product was the first ever to meet all 1.0D log in requirement without any deficiencies. Sales are now ramping and we expect to see significant revenue contribution going forward into 2007.

To summarize, we expect to see ongoing growth opportunities in notebook, consumer and industrial business areas in Q4 and onward into 2007 as our broadening product lines enjoy a increasing number of design win opportunities. I will now pass the call on to Sterling Du, CEO and Chairman for closing remarks.

Thank you, James. Our third quarter 2006 finished with a record high revenue of 31.46 million, the highest recorded revenue since O2Micro went public in August 2000. Revenue of 31.46 million was an increase of 12.2% from the preceding quarter and an increase of 12.2% from the comparable quarter of the prior year. The earnings per ADS for third quarter 2006 fully diluted was $0.01 compared to the last per ADS years of $0.06 in the proceeding quarter and earnings per ADS of $0.07 in a comparable quarter of the prior year.

Our strong market share in the LCD display market also benefits our innovative LED driver product family. We introduced 3 exciting new LED ICs in the third quarter which attracts various customer needs in future trends. IC small to medium size panel will be the first segment to adopt our LED backlight technology. Our team will make sure we are one of the customers' preferred choices.

In the notebook computer area, our strategy is to place more power management capability in a smaller configuration. We have DC to DC for AMD microprocessors. This [inaudible] memory devices reside. Our [inaudible] technology portfolio includes state of the art cool charge conventional charger and a [inaudible]. We continue our leadership in PCI express product area by introducing the industry's first PCI express interface, 3094, integrated with a flash media controller for notebook. With our supreme battery gauge technology, as James indicated, we successfully achieved multiple design wins and have started volume production. These opportunities will be important to our 2007 and beyond.

We have established the foundation to accelerate the business growth of the internet security product in third quarter. We expect revenue ramping up in 2007. Our patent portfolio grew from 200 in Q2 2006 to 239 in Q3 2006 and the patent claims grew from 5,068 in Q2 2006, to 5,956 in quarter three 2006. Our China team grew from 491 in Q2 2006 to 634 in Q3 2006. We have been repurchasing shares of O2Micro stock and will continue to do so while incorporating our focused program to improve the shareholder value. Thank you for your continued support of O2.

Thank you, Mr. Du. Ladies and gentlemen, the conference is open for questions and answers as time permits. Operator, will you please take the first question?.

[OPERATOR INSTRUCTIONS] We'll go first to Tore Svanberg, Piper Jaffrey.

Yes, good afternoon. A couple of questions. First of all, based on our performance and guidance, it seems like you are potentially gaining some share. Could you elaborate a little bit on that, please?

I think based upon what we have seen in the market since last quarter, in fact we have begun to gain back market share in the notebook sector. Specifically, we've gained market share back in e-commerce product, we've gained market share in power products and we've gained market share in inverter product, by our own analysis. We also feel that there was reasonable growth in LCD monitors this past quarter and we have maintained our market share and perhaps grown some market share in that area. In LCD TV we continue to be the market leader and we see that market growing very rapidly.

Great, and based on your guidance, your guidance is significantly better than most analog companies. How much of that is attributed to share gains versus just some of your newer products really starting to ramp?

Well, it's a combination of both. We believe that the share gains that we have made, as we mentioned in the notebook area, we will maintain those share gains and perhaps even enhance them going forward. And we also, as we noted with the design wins, have many new products that are starting to ramp into production.

Very good. And a question on new products, both the VPN/Firewall and cool charge. You mentioned those products are now ready for ramp. Could you just add a little bit color there, please?

Pardon me, I heard cool charge. You mentioned one other product.

Yeah, the VPN/Firewall. Those are the 2 products specifically that I'm trying to understand how it would ramp in Q4 and into '07.

The cool charge has been working with one of the majors and [inaudible] design win and also this activity which are very close to the pre-production stage, they are most recently focused on mobile PC, we call it UNPC. That is ideally for the cool charge we have several majors working in that segment as the cool charge can help the thinner and lighter notebooks. And we feel that that will be one of the leading trends for 2007 in notebook when they go to light and thin and cool charge is one of the major selections. And we do see the activity with multiple times than the previous couple quarters.

And then second for the VPN, as we indicated, the VPN we laid out a very good foundation because VPN is the system business we're shipping to the enterprise consumers and we have shipping now for the sales to the application engineer and also the system to the logistic and the semiconductors. And at this moment we have been very successful to lay out a strong foundation and we are in the stage now that we can grow the business. And we also think the customer base so far to our major VPN product line has been quite satisfied and judge it to be time to penetrate to our enterprise in Asian based customers.

Great. And James, you mentioned you've been maybe a little bit constrained in the September quarter because demand is so strong. How does that look going into the fourth quarter?

We feel very good about our production capability moving forward into the fourth quarter. The issue we had in Q3 was a very sudden reversal of the market going from some inventory positioning in Q2 to very quickly adding to demand in Q3. We've not caught up with that demand and we see no issues in Q4.

Good, and final question, you have made some significant investments in your test facilities last couple of quarters. Where are we in that process and especially near term? Should we expect these investments to continue or will there be a little bit of a pause?

Yes, Tore, we will continue to invest several million in Q4 [inaudible]. As James mentioned, we are going to have a full operation in the first half of Q3, 2007, so we expect to have some gains on the cost savings.

So I think you spent about $3.5 million, $3.6 million on cap ex last quarter. Should we assume a similar range in Q4?

Q4 we expect 5 to 6 million.

5 to 6. Great. Thank you very much and great quarter.

Our next question comes from Quinn Bolton, Needham & Co.

Hey guys, congratulations on the strong results and the nice fourth quarter guidance. I first wanted to touch on the margins. It looks like margins were down to the 53 or just over 53% level. I'm trying to get a little bit more color there. Is this really a mix shift as the new e-commerce platforms ramp? And then it looks like the e-commerce saw some very strong revenue growth quarter over quarter and those products historically have carried slightly lower margins. So I'm wondering if that's really the main reason for the lower margins or are you still seeing sort of pricing pressure as you regain share, or I should say lower margins, as you regain share in the notebook inverter market?

Hi, Quinn, this is Perry. This is mainly due to the product mix. You are right, we continue to have more shipments in the e-commerce area, and e-commerce area has lower gross margin than the corporate average.

Are you seeing any abatement in the competitive landscape? I mean are TI and Ricoh backing off or are they still pretty aggressive with pricing in e-commerce?

We see, especially Ricoh, very price aggressive in the e-commerce area.

Do you think they've got the technical capabilities or the product to compete? Or do you think that they just have a lower end product and therefore have to compete on price?

We historically have seen them compete on price and our position will be to continue to take a technology edge in those product areas.

Okay, great. Then I wanted to touch on the legal. I think you guys had a hearing in the 722 case recently with MPS. Wondering if anything meaningful came out of that hearing. Also your competitor says that you've withdrawn the 129 patent from that suit. Wondering if you can comment as to why you might have done that and do you have plans to potentially bring that 129 patent back in another venue?

Well basically the 129 patent was a continuation of the 722 patent and our attorney simply felt it wasn't needed in this particular case. There's many, many hearings and filings that occur in any of these lengthy legal activities and basically there's nothing that we feel that's been major or significant enough to report this quarter versus last. If you would like any specific updates on some of the procedural events, you can certainly contact our general counsel, Joseph Lamb.

Okay, and then lastly, it sounds like a number of the new products and even some of the power products perhaps this quarter, have really stared to hit revenue production. I'm wondering if you might just be able to look out to 2007 and as a group, will the VPN/Firewall, the Cool Charge, the DC to DC, the power managements, I mean, could those products in aggregate say be 10 or 15% of revenues next year?

Yes.

Great. Okay, thanks guys.

Our next question comes from Bill Lu, Morgan Stanley.

Hi, good afternoon. A couple of questions for me. One is to just follow up on Quinn's question. I wonder if you can talk a little bit about, on the supply side, what you're getting from the foundries in terms of pricing? What progress are you making with moving some of the stuff to China? And then on the more digitally oriented parts, when can we expect margins to improve if you're getting some better pricing from the foundry partners?

I think, Bill, this depends on the product we are talking about. But in general, we have two sides, one is a wafer. Another one is assembly and testing. As we have a testing facility ourselves, we target for prices. We do believe we also have discussed that will be benefiting to our gross margin by the cost effective testing structure. Then assembly, that's the second one we are also trying to find out the goods of supply chain in China, not only to do a cost effective solution for the assembly, but also to enhance our logistic support. It also can increase our inventory days as their logistics would be easy if the areas are coming in China based. And a third area is the wafer. The wafer, the digital portion of course we are negotiating with our partner for a digital wafer. We do have some take down in pricing and that would be come out quarter by quarter. And we do see that as double digit savings for wafer. But as we know, the wafer is only maybe one third in general of the total cost. And the second for analog, we are doing two things. One is of course wafer pricing negotiation quarter by quarter, month by month. But also we try to shrink the design maybe from higher geometry to a smaller geometry so that could do more cost saving by design. So overall, we expect to see our savings for our cost should be either in line or hopefully we can get more benefit when we meet the challenge from [inaudible].

Okay, great. Thanks for the thorough answer. Second question is for Perry. I know you talked about legal expenses for the fourth quarter. Can you give me some guidance for how that's going to shape up in 1Q and 2Q of next year as well?

Bill, normally I give the guidance for the current quarter. So Q1, Q2, I think it will be more appropriate or more accurate when I do the next conference. Based on current status, I think the litigation expense will be in the similar area of the Q3/Q4 timeframe, Q3/Q4 level.

I'm sorry, what's going to be Q3/Q4 level?

3.5 to 4 million .

That's going to be 1Q as well?

Yes.

Okay.

This is a rough estimate but I think it will be better when I do it in the next conference.

Yeah, so Bill, so what Perry means, the Q1 legal forecast is too early, but we have reason to think that should be a similar level which is the 3.5 to 4 million. We're better to come out with more accurate number when the Q4 is approach to the end.

Okay, great. Lastly, it sounds like you're doing pretty well with the new products. I think before you said that you can get sort of 40, 50% market share for the PCI express products by sometime in 2007. Is that still kind of the target or what do you think there?

I don't believe we've ever given a market share estimate on that product. We obviously are gaining market share and obviously it's our intent to be a major factor in this marketplace.

Okay, great. Thanks very much.

[OPERATOR INSTRUCTIONS]. We'll go next to Craig Berger, Wedbush.

Good afternoon. I had a question on the gross margins. I understand you guys are ramping up the SmartCardBus products with lower margins, but is that really big enough to drive the magnitude of the margin decline that we've seen over the last couple of quarters? Or what other factors could be contributing to that reduced gross margin?

Well we also indicated in a prior call that there were some older products including in the inverter areas that had ramped very quickly and that in fact we have an aggressive cost reduction program on those products and will take place as we move to the end of Q4 and should rapidly begin to accelerate on into the first half of next year. So that is a very critical issue as well, some of the older products that we have.

And what are the cost reduction benefits you expect to realize and what portion of the inverter products does that comprise?

We expect the cost reduction on all products to be double digits. However, this is for the notebook area and we don't normally comment on specific product lines.

Got it. Can you comment on your 2007 design win activity within the LCD TV market for your lighting products?

We do not comment on specific customers in general, but nevertheless, we do have obviously an ongoing activity that's continually ongoing with the major TV manufacturers because they are bringing out many new models as they go forward. And we are actively working with virtually all of the TV manufacturers or in some cases their subcontractors.

Would you care to venture a guess as to what your market share might be for that market overall without discussing specific customers so that we can hone in what the potential opportunity is there for calendar next year?

No. We have not shared market information. We do believe we are the market leader though.

With respect to the litigation, I understand you guys are going to trial in late April and so the Q1/Q2 litigation should be higher. Are there any - - do you have any visibility into trials in the back half of '07 that may keep that spending at elevated levels? Or should we kind of model that to decline from these high levels?

Based on current status, I think 2007 will be at the same level as 2006.

Great. And then can you just comment on who else you are seeing out there in the LCD TV, CCFL market and what the competitive landscape looks like there?

We have seen a variety of competitors either enter or attempt to enter this marketplace. That's been ongoing for some period of time. We don't see any specific competitor that is evolving rapidly there.

And what's the competitive advantage your products offer in that area versus some of the competing products?

Well we have a greater variety of product that's available. We also have a very strong intellectual property position, as we've mentioned in the past, including phase ray technology that's been patented not only in the U.S., but a number of foreign countries including Japan and Korea.

And then very lastly on that same area, can you discuss the, how the transition to LED backlighting will impact your business in coming years?

The impact is from several fronts. The wide LED, as I mentioned, for the small to medium display for panel, has ability for conversion to LED. And so we come out with a solution and the LED design is quite variety compared to the CCFL. So for one is the LED [inaudible] gives us some room to do some innovation over there because the person to person, the device to device, custom to custom probably has a different philosophy in terms of system architecture. That's number one. So quite a variety of design [inaudible]. And number two, as this low voltage, or ED driver design, which is the current one we are using, of course we don't - - later on we probably have high voltage, but currently low, because then you have some extended possibility to integrate to some other devices which is a second challenge and also opportunity for us.

And number three, our reputation in CCFL has been in the market for many, many years and the customer who is using our CCFL has both enjoyment of the ease of use experience and they like using those experience, and the benefit of leverage, we leverage those experience they like to talk to us and use our LED drivers. I think. So that's the third one we need to meet the demands of customer support, logistics of course, and also quickly come up with things which they prefer. So those are 3 opportunities/challenge.

Thank you. I am going to sneak one more in and then I will be finished. I understand you aren't guiding Q1, but given that you guys have seen some revenue re-acceleration here, is there any reason to believe that Q1 would be anything other than seasonal for you guys?

At this point, I think given the markets that we're in, we might expect some seasonality. But I think it's still too early to project that. Sometimes if some of the OEMs begin to see inventory build up in the channel, they pull back in Q4 some. If they don't, they continue to accelerate on into early Q1. So I think it's simply too early to tell.

Great. Thanks for taking my questions.

And again, that is star one for questions. We'll go next to Andrew Huang, American Technology Research.

Hi, congratulations on the good quarter. I was wondering if you could first comment on the increase in employees in China. It looks like it increased substantially and I was wondering what are all those people doing?

Well the most people we extend over there - - likely the past couple years which is mostly engineers. But right now we've also added application engineer and also for internet security which [inaudible] engineer. So we utilize this structure to begin to build the capability to initialize to do the start up of the China market and also to the product idea, some product which is ideally for the China market, a product manufactured in China by shipping to other place. And secondly, we are starting to gear up our testing facility in Ocean One and today we have close to 400 plus people. And we expect that will continue to grow when the quarter by quarter, it depends on the needs and also the machine purchase and also the operation and scale. So that was the second one. So the people we have increased major is proportionate.

Second question, I think you commented earlier that if you look at the DC to DC power management, AMD and then the cool charge product and the VPN/Firewall, that those could combine to be roughly potentially 10 to 15% of sales in calendar '07. I was just wondering if you can give us a rough idea of an ASP for each of those 3 products?

Yeah, I think to give you some idea, the system box is very different. It could be as high as like $6,000 U.S., and as low as like 2,000 U.S. to $2,500. So for the IC normally, every IC is either $0.50 to $0.80, but in some instance we're starting chips at maybe $1, $2.

Got it. And then last question, on the cool charge, I think you mentioned that you have some pretty good progress with one of the major notebook guys. And I was wondering have you gotten acceptance of the power supply manufacturers as well? Because my understanding is that you're going to need a different connector, and you're going to need an extra wire, and all of these kind of small changes to the power supply.

Yes.

Any other questions?

No, thank you.

Once again, that is star one for any questions. We'll take a follow up from Tore Svanberg. And Mr. Svanberg, if you'd still like to ask a question, please press star one.

And a final reminder, that is star one on your touchtone phone if you have any questions. And with no questions in our queue, that does conclude today's conference. I would like to remind our participants that a replay will be available through November 8th. You may reach this replay by calling 1-(888) 203-1112 or 1-(719) 457-0820 with the pass code is 9974191. And pardon me, gentlemen, Tore has re-queued.

Yeah, I don't know what happened there, can you hear me?

Please go ahead, Sir.

I was asking about China and maybe asking Andrew's question a little bit different. How much percentage of your business or your revenue is now generated from your China team? Just an approximate number.

Let me answer by this way. If we answer by the China team, and that would be one third today. So if the revenue by our Ocean One testing facility, as this is just beginning phase, right now is still very small. It's negligible but it will become significant next year, in '07.

So about one third of your revenues come from the engineering in China?

Yes.

Okay, very well. Also, Perry, the other income line has been volatile the last couple of quarters. What sort of interest income or expense should we expect next quarter?

Interest income for the coming quarter will be in the area of $700,000.

Great, thank you very much.

And gentlemen, we have no other questions in the queue. I would like to conclude today's conference. Again that replay will be available through November 8th. We do appreciate your participation in today's conference. You may now disconnect.