O2micro International Ltd (OIIM) 2007 Q1 法說會逐字稿

Good day, and thank you for joining us today to discuss O2Micro's earnings for the first quarter of the fiscal year of 2007. 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.o2micro.com. There will also be a replay available through May 10 by calling 1.888.203.1112 or 1.719.457.0820, and the pass code to access the replay will be 6475249. (OPERATOR INSTRUCTIONS).

At this time, I would like to turn the conference over to Mr. Benus. Please go ahead, sir.

Thank you, and good afternoon. Thank you very much for dialing into O2Micro's first quarter 2007 financial results conference call for the quarter ending March 31, 2007. This is Mitchell Benus, Director of IR.

I would like 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 fact 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 F-1, Form F-3 and the 20-F reports and other documents filed with the SEC 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 the associated risk factors. The statements made herein are dated information. The Company assumes no responsibility to provide updates to this information.

With me today are Perry Kuo, CFO; our Head of Marketing and Sales and our Director, Jim Keim; and Sterling Du, O2's founder, CEO and Chairman. After the report, the floor will be open for questions as time permits. Perry, the CFO of O2Micro, will highlight our operating results and projections, followed by Jim, and he will provide marketing highlights. And closing comments will be made by Sterling Du, CEO and Chairman, after which we will answer questions.

Now I would like to introduce Perry Kuo, CFO of O2Micro, for a discussion of the revenue, income and the financial highlights of the first quarter of fiscal 2007 ended March 31, 2007.

Thank you, and good afternoon, everyone. This is O2Micro's earnings report announcement covering Q1 2007, ending March 31, 2007. As everyone has a copy of the earnings report press release, I will be briefing and reporting the highlights.

Revenue for Q1 was $35,037,000, which represents a decrease of 3.5% from the preceding quarter and an increase of 20.4% from the comparable quarter of the prior year. Net income for Q1 was $99,000 compared to the preceding quarter of net profit $1,634,000. The net income for the comparable quarter of the prior year was $1,031,000. If we exclude stock compensation and the litigation, the non-GAAP income would be $3,956,000.

Earnings per ADS fully diluted for Q1 ended March 31, 2007 were $0.00 per ADS compared to $0.04 per ADS for the preceding quarter and $0.03 per ADS for the comparable quarter of the prior year.

Gross profit margin for Q1 was 54.6% compared to 53.9% for the preceding quarter and 56% for the comparable quarter of the prior year.

R&D expense, excluding stock-based compensation charge of $252,000, for Q1 was $7,702,000, or 22% of revenue. SG&A expense, excluding stock-based compensation charge of $350,000, for Q1 was $7,778,000, or 22.2% of revenue, not including the IP litigation expense of $3,255,000. The total SG&A expense, including litigation and stock-based compensation charge, was $11,383,000, or 32.5% of revenue.

Non-operating income was $560,000 for Q1. Interest income was $814,000, and foreign exchange loss was $256,000.

Income tax for Q1 was $239,000, mainly due to the income tax expense accrual for the first quarter.

In Q1 2007, 81,188 have been repurchased, which is 0.2% of shares outstanding.

Revenues by end market as a percentage of total revenue for Q1 was - consumer in the range of about high 40% range; computer in the range of high 40% range; industrial and communications each a small single digit percentage of revenue.

Balance sheet. O2Micro has over $61 million in cash and short term investments. This represents cash and equivalents per ADS shares of $1.61. In addition, O2Micro has no debt. Short term investments. Our money is invested in corporate bonds of at least AA rating and commonwealth bonds of certain developed countries.

Capital expenditure in Q1 was $2,589,000. Accounts receivable at the end of Q1 was $23,022,000 for a DSO of 54 days. Inventory turns ratio for Q1 was 4.4 compared to 4.5 for the previous quarter and 3.5 for the comparable quarter of the prior year. Cash outflow in operations for Q1 was $1,986,000.

Human resources. O2Micro now has 1,031 employees, 59% of which are engineers. This positions us well for new product development, the continuous introduction of new products and more customer design wins in the future.

Now, guidance for Q2 2007. O2Micro estimates Q2 revenues compared to Q1 to be an increase in the range of 6% to 10%; compared to the comparable quarter of the prior year, an increase in the range of 32% to 37%. Gross margin in Q2 will be in the area of 53% to 56%, mainly based on the product mix. R&D, excluding stock compensation in Q2, will be in the area of 21% to 24%. We expect SG&A, without litigation expense and stock-compensation expense, for Q2 to be in the range of 20% to 23%. Litigation expense for Q2 to be in the range of $3.1 million to $4.1 million. Stock compensation. We expect the stock-compensation expense for Q2 to be in the range of $600,000 to $700,000.

Litigation settlement of [$3,354,194] was received in April 2007. It is a one-time income booked in the [line] of operating income. We expect to have interest income in the area of $800,000 to $900,000 for Q2. Tax rate of 8% to 10% of pro forma income. Our tax amount will be $300,000. CapEx in Q2 is expected in the range of $1.5 million to $2.5 million.

So, in summary, with regard to the financial highlights of the quarter and our outlook for Q2, Q1 was a good quarter and largely as expected, given the normal seasonal conditions. We end the quarter with a strong balance sheet, sufficient cash for growing the business, no debt and authorization to buy back additional stock.

Our outlook for Q2 is very strong, especially when compared to many of larger peers. Based on our outlook, revenues for Q2 could be up more than 30% over the prior year second quarter. In addition, our gross margin is expected to improve as the year unfolds based on expected richer mix of the products in two years and in the [ramp of our Ocean 1] unit.

Regarding operating expense, our outlook is for some expansion in SG&A dollars spent tied to our new product ramp and the addition of more (inaudible). But SG&A should not expand as far as revenue, so some leverage. R&D spending will be largely stable at the current run rate, with some possible modest increase as a of result foreign exchange impact on our Chinese salary expense. In both cases, we are investing heavily in our business and are beginning to leverage our operating model.

I will now pass the call to Jim Keim, Director.

Thank you, Perry. Q1 reflected the normal market seasonality, including a significant slowdown in production for Chinese New Year. However, we expect Q2 to show solid growth over Q1, with very significant expansion over the prior year. Our projected Q2 reflects both core markets growth and expansion of revenue from new products.

Let me address both the markets and product expansion. The notebook market is now expanding after a noticeable seasonal slowdown in Q1. We believe that the notebook market will grow through the balance of the year, reaching an annualized growth of approximately 15%. The LCD monitor market was nearly flat in Q1 and now appears to be expanding with expected annualized growth similar to that of notebook. The LCD TV market was down in Q1 from a very high Q4 shipment rate. We expect a rapid increase in the LCD market for the remainder of the year, with growth exceeding 50%. Overall, the ongoing growth of our core markets in 2007, coupled with accelerating new product introductions, should result in another year of excellent growth for O2Micro.

I will also comment briefly on our major product lines. Intelligent lighting continues to expand with new product design wins in all key markets and an expanding customer base. Our family of high efficiency LED controllers that are patent pending continue to enjoy new design wins and increasing revenue.

Intelligent power. Our system DC/DC products continue to win new notebook designs with increasing market penetration. Our processor and system DC/DC product line is being expanded, and we expect increasing revenue in 2007. As our product offering continues to broaden, we expect increasing revenues from notebook as well as other markets.

Intelligent e-commerce is achieving significant increases in revenue in 2007 versus 2006, 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, and we'll also start focusing on other markets in 2007.

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 are now shipping production volumes into both notebook and industrial applications utilizing our advanced technology.

Our VPN security products are continuing to gain market recognition, and we expect to see good revenue growth as we move forward in 2007.

To summarize, we see ongoing growth opportunities in all our key markets in 2007. Additionally, we expect new products to enable us to expand both our market focus and our customer base.

Before turning the call over to Sterling Du, our CEO, I'll give a brief update regarding our intellectual property protection program and the surrounding legal proceedings. We realize the issue of our intellectual property litigation is of interest to many of our investors.

O2Micro strategically defends its investment in intellectual property, including its patents. In the last few months, several favorable legal outcomes occurred. For the press release we issued on March 26, 2007, we announced an injunction and judgment against BiTek, SPI, FSP Group and Lien Chang. On April 5, 2007, O2Micro announced a settlement with Samsung. And on April 11, 2007, O2Micro's trade secret judgment was affirmed by an appeals court. These developments have helped validate what we believe will be near term and long term benefits of our intellectual property protection strategy.

Hopefully, our intellectual property litigation strategy does not distract investors from the solid sales growth we are now experiencing. We hope to see a decline in litigation expense in the second half of 2007. In addition, we expect to receive some cash payments that may offset legal expenses. Beyond these comments, we will not make any further comments regarding litigation issues.

I will now pass the call on to Sterling Du, CEO and Chairman, for closing remarks.

Thank you, Jim. Our first quarter 2007 finished with revenue of $35 million. This was a decrease of 4% from Q4 2006 but expected, given the rather high revenue we had in Q4 last year and the seasonal weakness that normally occurs in Q1. More importantly, Q1 revenues were up over 20% from the first quarter of 2006 last year.

Gross margin in Q1 was a respectable 54.6%, which was up 70 basis points from Q4. We expect gross margin to improve as the year progresses.

We had a very small amount of the net income in Q1, in part because of legal and stock-compensation expenses. As Perry mentioned, we expect to see some improvement in our operating model as the year goes on, and expanded sales and a higher gross margin should drive higher profit. We will also hope to see lower legal expenses once the current patent trial is complete.

After a seasonal slow Q1, we see good signs that LCD area is recovering rapidly in Q2 and expect an even stronger market in the second half of this year. The demand for the larger displays and LCD-based high definition TVs is growing rapidly, as Jim noted. The forecast for the LCD market is very strong. Our product portfolio fits well with this trend.

We are also pleased to have reached a settlement agreement with Samsung in April. Our LCD inverter-related patent portfolio grew to 68 granted patents, plus 116 pending patents. This is the result of investment to proprietary technologies and patent protection program.

In the notebook computer area, we introduced new DC/DC ICs for the Intel (inaudible). And our DC/DC for AMD microprocessors continue to penetrate the market, and shipments will grow in the second half of this year. Our battery [gas gauge] products are expanding to various applications, including notebook computers and industrial applications. I am pleased with our positioning in the notebook and handheld market. We expect this market to improve over the coming quarters.

While still a very small percentage of net sales, [DVM 5.0 system product] met our first quarter revenue goal as our channel business continued to expand. We expect ongoing revenue growth from our VPN product through the year. The revenue stream from this [box-level] solution provides a nice complement to our traditional IC product sales.

Our patent portfolio grew from 260 in Q4 last year to 289 in Q1 2007. Our patent [clients] grew from 6,451 in Q4 last year to 7,073 in Q1 2007.

With regards to talent, our China team grew from 624 people in Q4 last year to 651 in Q1 2007. Our worldwide R&D engineer pool now stands at 605 engineers, and this does not consider the additional application engineering talent which we have in sales and marketing.

In closing, and as we mentioned in our press release, the Company's long term strategy is clear - leverage our IP and use our large engineering pool to drive new products and to secure additional design wins. The majority of these design wins are likely to come from tier-one customers, many of which are based in Asia. We have the design, [applications] and the manufacturing resources located close to these OEMs to best support their needs. Finally, we are well positioned in several key end markets and positioned with leading products that expect to see solid growth through the year.

Your ongoing interest and support of O2 is highly appreciated. Thank you.

Before we take questions, I'd like to remind the listeners that we will be attending a number of investor conferences this quarter, including the Piper Jaffray Technology Conference, the Oppenheimer Tech Conference and Wedbush Morgan's Fifth Annual Institutional Investor Conference, all to be held in New York.

Ladies and gentlemen, the conference call is open for questions and answers as time permits. Operator, may we please take the first question.

Certainly. (OPERATOR INSTRUCTIONS). We'll take our first question from Tore Svanberg with Piper Jaffray.

A couple of questions. First of all, could you talk a little bit more qualitatively about your growth in the June quarter? You talked about notebooks coming back, displays coming back. But maybe you could just add a little bit more color on some programs that are giving you that confidence in growth.

Basically, we see the growth as being broad based. We see that the notebook activity is now picking up significantly as we move out of Q1. The LCD monitor activity is also now growing, and LCD TV now is growing very rapidly coming out of Q1. So we expect significant expansions in all three of these markets.

At the same time, we have a strong market position in all of these areas, and we're seeing increasing penetration, particularly in the notebook area with some of our new products, as we mentioned, including the e-commerce area, some of our intelligent power solutions. And then we also have new product lines, including the VPN security, which is now beginning to contribute revenue, and that will continue to expand into the Q2 time frame.

Very well. Then you also mentioned that you are in the developmental design stage for LED controllers for notebooks. Could you elaborate a little bit more on the Company's positioning there, and what are you seeing in the marketplace as far as LED backlit notebooks?

Tore, the LED product for O2 has been in the marketplace right now. We are engaged with our customer since a couple quarters ago, and we believe LED backlighted notebook providing battery operating longer time. But, however, the how much it's going to be LED versus traditional (inaudible) backlighting in the notebook area-- it's too early to make comments for the whole year long. But, we are one of the first providers to this LED backlighted notebook computer right now.

Very well. And in the power area, you said that you're now in production in the industrial market for battery management. Can you also maybe elaborate a little bit more on that and potentially talk about the market opportunity?

For the industrial, major we focus on the power tool for the professional usage, plus some of the transportation. There's no overall professional use power tool market statistic data at this moment. But while we are engaged with two of the top five worldwide top-tier professional power tool manufacturers right now. And we do see-- we initially already have some small production right now, and we do see the current production probably can escalate to some (inaudible) production by this year. We also see with the same manufacturer other product groups also have shown some interest into our ICs. (Inaudible), they can just using existing (inaudible) probably to do some semi-customized because some of the IC more with the (inaudible). We do see this as a very high growing market, given the power professional power tool going to convert to using (inaudible) battery. That is the trend. Secondly, because also involved with current they are solve the design (inaudible) API interface, and we are inside their socket and are probably also (inaudible) NG barrier. We probably can say that would be long term business revenue for us.

Secondly, for the transportation, that's many different areas of application, including power wheelchair, power golf cart, and some field vehicles and some of the small transportation powered by the battery. If we look in the opportunity that they convert from the traditional (inaudible) battery to the (inaudible) battery due to the (inaudible) batter, one, is lightweight. Second is the cost also effective compared to the nickel (inaudible), who are using precious metal. Now the pricings go up in the past couple years. So, for those markets, it's quite a spread over the different geographies, and it's spread over the different size of the customer. So we try to make use of our strong application support team in Asia, which is Taiwan, Japan and also China, to providing the best service and try to win this market in the long run.

Great. And a question for Perry. Perry, could you just give us an update on Ocean 1 - where you are as far as production is concerned right now?

Yes. Ocean 1. We move in mass production for the first quarter this year. It ramped up mostly Q1. Now it reaches up in the area of [15% to 60%] of the capacity, and we expect it will continue to ramp up in Q2. We expect the contribution of the Ocean 1 on gross margin in the second half of this year.

Great. Final question. You guided for $3.1 million to $4.1 million legal for Q2. Could you comment on where you see those numbers going for the second half?

Basically, what we indicated we are hopeful that our legal expenses will be less in the second half. Beyond that, we don't care to give additional guidance.

Fair enough. Thank you very much.

(OPERATOR INSTRUCTIONS). We'll hear next from Bill Lu with Morgan Stanley.

A couple of questions from me. I know you don't want to talk too much about the litigations. I'm wondering if you could just comment on how that impacts your overall business and how-- whether you've seen a better pricing environment [influencing] the products and whether you're seeing a big opportunity in terms of market share and share gains.

At this point, I think we'll limit our comments, Bill, but, basically, what we can say is that we do develop products in our R&D that do have very significant intellectual property in them. Obviously, it's our intent to recoup that research and development cost through getting good margins for those products as we sell them. We do think that our intellectual property protection program has had an impact in terms of customer realization as well as some competitors realizing that we're serious about protecting our intellectual property. And we do think that that has helped us maintain better average selling prices in the marketplace, and it's also, in some instances, helped our market share position.

So would you say that the pricing the last couple of quarters has been better than, say, the last couple of years?

Well, I think that's difficult to make a blanket statement, Bill, because there's many different products in many different areas. But I do believe in the last several years that our intellectual property protection program has had a positive effect in terms of [depending] pricing in the marketplace in general.

Okay. Great. Thanks. Then, Jim, I think you have said in your prepared remarks that computing was in the high 40% of overall sales. Is that correct?

Could you repeat that, Bill? We had a little trouble hearing that.

In my notes, I've got your computing revenues in the low-- I'm sorry-- high 40% range in the quarter. I think last quarter was roughly 30%. Now you also said-- I would assume that PC monitors were flat to down sequentially, so most of that increase had to be from the new products. Right?

We have the consumer individual 40% range last quarter and computing ratio (inaudible).

What was computer in 4Q of last year?

In the March quarter.

Yes, but what was computing in the December quarter of '06?

'06, December-- computer (inaudible) in Q1. It depends on the product mix.

Right. That's mostly from the new products. Correct?

Yes. We indicated that we have captured significant design wins in the area of both e-commerce as well as power products.

Okay. Thanks. It looks like the line's not very good. I'm going to call back later. Thanks.

(OPERATOR INSTRUCTIONS). We will move next to Andrew Huang with American Technology.

Correct me if I'm wrong, but the payment you received in April-- is that the first check you've received from your litigation efforts after all these years?

(Inaudible).

Okay. Congratulations on that. I just wanted to get a feel for the September and December quarters. Given your recent success on the litigation front, would you expect to have similar type benefits in Q3 or Q4?

What type of benefit?

I guess, similar to the $3.4 million that you did receive in April?

Well, specifically, we can't comment relative to settlements. There have been past judgments that still are in the appellate process. Basically, until they get through the appellate process, they don't turn into finalized judgments that we collect on.

Okay. I guess as a follow-on question on your product front, can you talk a little bit more about VPN? You mentioned that sales of the VPN product in Q1 met your expectations. Can you give us a sense of what your expectations are for Q2 relative to Q1 for that business?

The medium security box solution-- that is back loaded through the year. So, the first half, we'll finish lower revenue than the second half. And, of course, Q1 (inaudible) because most enterprise buy the product back to Q4 last year. So, Q1 versus Q2, we believe our Q2 will be grow up from Q1. And for the whole year, second half will be higher revenue than the first half. That's the situation.

Okay. Can you give us a rough idea of maybe what percentage of revenue it is today or maybe exiting the year?

We didn't break down for that for Q1. For the whole year, probably right now it's probably too early also-- [internally] also too early to predict. So we didn't have breakdown. Sorry for that.

Okay. Maybe, can you answer a similar question for the DC/DC product, like how that should ramp throughout the year?

Andrew, we have disclosed this way. Our new product, including DC/DC and power tool, those gas gauge, plus VPN this year, altogether we expect that we can grow to $10 to $15 million range. Of course, it's a wide range, because it's still too early to narrow down to the narrow range. But that's how we try to give the sense how big our new products as a whole group contribute to the whole Company revenue.

Okay. That's $10 to $15 million for calendar '07?

Yes.

Okay. Thank you very much.

Next we'll hear from [Tony Erps] with Goldsmith & Harris.

As a follow-up to Bill's litigation settlement question, what did the recent settlement with customers and potential future settlements with other customers imply with respect to your market share and pricing potential for the remainder of 2007 and beyond?

Again, we cannot speak to any specific settlement issues. We did speak earlier to the general effect of our intellectual property protection program and that we do feel that that has positive impact for us in terms of maintaining margins, our selling price in the marketplace and, obviously, in some areas, can also help us maintain market share.

Does that specifically result in an inflection point?

I don't think we can really talk about an inflection point. We basically in some of these areas are the market leader, and we're really not looking at an inflection point.

Fair enough. Thank you.

Next we'll hear from David Wu with Global Crown Capital.

I just wondered; given the revenue levels and pretty healthy gross margins, at what level of revenues would we get to a reasonable operating margin? I know there are litigation expenses. But if you take that out, it seems that we're not getting-- given how good the gross margin is, we're not getting very much in the pretax operating margin level at this revenue level. Is that a number that you could share with us what your goal is?

Our long term goal for the (inaudible) for the long term goal, like the second half of this year, we're talking in the area of 55% to 60%, based on our product mix.

Various products.

How much would that--? Forget about litigation expense or any checks you get from people, but if you take out the litigation expense, how much would that flow into the bottom line at the pretax operating margin level?

Our model for the-- excludes the stock compensation. Our model for the operating margin will be in the area of 15% to 20%.

Yes. So you need-- what kind of revenues do you need? The first quarter was obviously seasonally low. Do you need $50 million to get those kind of numbers per quarter?

$40 or $50 million or the annual $200 million model.

Yes. Right. Something like that.

Yes.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). We'll hear next from Vijay Rakesh with Oppenheimer.

Vijay Rakesh Just going back wondering what your breakdown by segment was for Q1. I don't know if you already went through it.

That was breakdown by segment?

Vijay Rakesh Yes.

Breakdown by segment. The consumer in the region of above high 40% range. Computer in the range of high 40% range. Industrial and communication is low single digits.

Vijay Rakesh Okay. Great. Sterling, as you look at the legal expenses here, obviously, you have Q2 probably kind of wrapping up some of the legal with Samsung and probably (inaudible) is going on now. How do you see the second half, Q3/Q4, just from the legal standpoint - legal expenses?

We did not put a specific number on them. We simply indicated we are hopeful that the legal expenses will be reduced in the second half.

Vijay Rakesh Reduced meaning $3 million or reduced meaning $1 million? We're not going to put a specific number on it.

Vijay Rakesh Okay. As you look at your gross margins in the second half, where do you see that trending? It looks like here Q1 had a very nice-- had a decent pick up on gross margins. Where do you see gross margins in the second half, in Q3/Q4?

We expect to be in the area of 55% to 60% based on the product mix.

Vijay Rakesh Okay. Any idea on--? The tax rate looks like it went down. Is that--? Is 8.8% to 10% the way to model for the rest of the year? I beg your pardon. Can you repeat the question again?

Vijay Rakesh What's your tax rate guidance for the second half through Q2? Tax rate for Q2 is 8% to 10%.

Vijay Rakesh Is that the same for the second half also? Yes.

Vijay Rakesh Okay. And what's your CapEx plans for the rest of the year? CapEx we guided quarter by quarter because based on the need of the [tests] and (inaudible) and also some testing purpose. In general, this year, we don't have a big project investment. (Inaudible). This year, I think the CapEx will be incremental increase for the rest of the quarters in the year. But we don't give out the quarter beyond the current quarter.

Vijay Rakesh Okay. Thanks.

That does conclude our question and answer session. Gentlemen, do you have any closing comments?

No. We'd just like to thank everyone for participating in the call. Thank you.

A replay will be available from now through May 10 by calling 1.888.203.1112 or 1.719.457.0820 and using pass code 6475249. We thank you for joining our conference. That does conclude our conference for today. Have a great day.