O2micro International Ltd (OIIM) 2008 Q3 法說會逐字稿

Good day and thank you for joining us today to discuss O2Micro's earnings for the third quarter of fiscal year 2008. 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's also posted on O2Micro's website at www.O2Micro.com. There will be a replay of available through November 5, 2008 at 9.59 p.m. Pacific Time by calling 1-888-203-1112 or 1-719-457-0820 with a pass code of 7041539.

Following the presentation by management, the conference call will be open for questions and answers as time permits. Gentlemen, you may begin.

Good afternoon and thank you for dialing in to 02Micro's third-quarter financial results ended September 30, 2008 conference call. This is Gary Abbott, Director of Investor Relations. I would like to remind 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 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. Statements made herein are dated information. The Company assumes no responsibility to provide updates to this information.

With me today are Perry Kuo, our CFO; Jim Keim, our Head of Sales and Marketing and Director; and Sterling Du, O2's Founder, CEO and Chairman. After the report, the floor will open for questions as time permits. Today Mr. Kuo will highlight the operating results and projections followed by Mr. Keim. He will provide market highlights and closing comments will be made by Sterling Du.

Now I would like to introduce Perry Kuo, CFO of O2Micro for a discussion of the revenue income and financial highlights of the third quarter ended September 30. Perry?

Thank you and good afternoon. This is O2Micro's quarterly conference call. This call will cover our financial results for the third quarter of 2008. We will now review our financial results for Q3 2008. Please note that financial results will be presented on a non-GAAP basis unless we designate otherwise. The non-GAAP result is (inaudible) stock-based compensation expense and a one-time nonrecurring charges. Our full GAAP results are available in our press release that was issued moments ago.

GAAP revenue in the third quarter of 2008 was $37.8 million. This reflects a decrease of 16.3% from the comparable quarter of 2007. (inaudible) also, we think the $37 million to $38 million range of our preliminary result that we announced on October 1, 2008. We have begun to treat our security group separately in order to track its direct profitability and we will report more information on this in future quarters. However, we are in the position to tell you that our IC revenue was $36.8 million in the third quarter and our security revenue was $1.0 million.

GAAP net loss in the third quarter of 2008 was $12.6 million. If we exclude stock-based compensation of $713,000 and the one-time write-off related to the pre-paid services and our investment in Asia SinoMos which accounted for expense of $2.9 million and $13.1 million respectively. The non-GAAP net income will be $4.2 million.

GAAP loss for ADS in the third quarter of 2008 was $0.34. Non-GAAP net income for ADS was $0.11. Gross margin was 59.3% in Q3. The gross margin exceeded the 57% to 59% range than we expected due to a favorable product mix. The gross margin increased by 183 basis points from Q3 of 2007 due to our success with the -- of our China supply chain as well as efficient designs and the new product.

R&D expense was $9.5 million or 25.2% of revenue. This amount excludes stock-based compensation expense of $284,000 in the quarter. This was a slightly higher percentage than we expected because of lower revenue. SG&A expense was $8.5 million or 22.5% of revenue. This amount excludes stock-based compensation expense of $429,000 in the quarter. This was [roughly] in line with our expectations because we were able to manage expenses very tightly.

During Q3 SinoMos, it's foundry partner, they had a financial problem and they declared bankruptcy. We are happy to tell you that our operations are safe and margins are still good. We made a good decision to diversify our production and we are able to continue without problems. However, we are required to write off our $2.9 million of prepaid foundry service and also write off another $13.1 million for our long-term investment in SinoMos. Also this one-time expense is for O2Micro.

Income tax was $689 in the third quarter and is mainly based on the effective tax rate of each taxable location for the prior year and the normal annual tax accrual adjustments. This amount includes the withholding tax charge of interest reserve from Taiwan cobalt for $367.

In Q3 2008, we repurchased 936,269 ADS units at a cost of $4.8 million. As of September 30, 2008, there were more than [$2.3] million ADS remaining in our authorization. Q3 2008 revenue by end market breaks down into the following percentages. Consumer was 45% to 50% of revenue. Computer was 40% to 45% of revenue. Industrial and communications were both single-digit percentages respectively.

At this time I would like to provide some additional information. After our share buyback, O2Micro finished the third quarter with more than $97 million in unrestricted cash and short-term investments. This represents cash and equivalent of $2.59 for ADS. In addition, O2Micro has no debt.

Accounts receivable at the end of Q3 was $21.3 million. Our DSO is 57 days. This is the same as last quarter and it is [meeting] our target range of 40 to 60 days. Q3 inventory finished at 18.3 million. This was down from (inaudible) million in Q2. Days of inventory increased by one day from 113 days in Q2 to 114 days in Q3. Inventory turns remains consistent from Q2 to Q3 at 3.2 times.

Long-term investment were decreased by $9 million in Q3 primarily due to $13.1 million decrease in the investment in Asia SinoMos and a $1.6 million adjustment on mark-to-market revaluation provision and a $5.7 million increase in investment in [SicoChem].

From a cash flow perspective, we generated $12.8 million in cash inflow from operating activities in Q3. This was significantly ahead of our non-GAAP net income because of beneficial balance sheet changes such as decreases in accounts receivable, inventories, and the prepaid expenses during this quarter.

Capital expenditures were a mere $373,000 in the third quarter and were primarily driven by equipment purchases. Depreciation and amortization was $1.6 million in Q3. At the end of the third quarter of 2008, O2Micro has 943 employees, [67]% of which are engineers. This positions us well for new product development and allows us to maintain our technological advantage which leads into new design wins and high-margin business.

At this time, I would like to provide our financial guidance for the fourth quarter of fiscal 2008. This guidance reflects our best estimate for the current environment and is subject to change. This is the only [official] guidance we will provide unless we update it with a public announcement in the future.

O2Micro estimates that Q4 revenue should down 15% to 25% from Q3 levels. About half of this sequential decline is due to our low-margin PCI Express product. We are guiding the Q4 gross margin to a range of 57% to 59% to reflect a conservative product mix. Our expectation is that the gross margin will remain in the upper end of our 55% to 60% target range for all of 2008.

Given the weak global economy, we will continue to control our expenses. R&D expense excluding stock-based compensation should be $8.5 million to $9.0 million in Q4. SG&A should also be $8.5 million to $9.0 million in Q4 excluding stock-based compensation expense. Stock compensation should be in the range of $600,000 to $700,000 and the fourth quarter.

We expect our tax rate to be in the range of 7% to 10% of non-GAAP pretax income in the fourth quarter. As you can see from our cash flow in Q3, we have very strong cash management and we will continue to manage our inventory and accounts receivable to sustain a good cash position.

At this point I would like to remind everyone that we have strength in our balance sheet and the current cash flow to weather this storm however long it lasts. I would also like to thank everyone for participating and turn the call over to Jim Keim for more about our business.

Thank you, Perry. In July, we saw early signs of deteriorating market conditions and reported the following in our Q2 call on July 30. Samsung was significantly cutting inventories; Sony's weak demand for large screen LCD TVs was forcing it to cut production; LG Display had worst revenue than expected and was shifting to smaller LCD TV sizes due to the weak economy. Based on these deteriorating market conditions, we projected conservative Q3 revenues and kept a watchful eye for further market developments.

While Q3 followed our revenue projections closely, it is now clear that further market deterioration is occurring across global markets. Not only have major customer sales projections decreased but product sales have trended to the lower end of their product offering. Most notably, we see a trend or a significant portion of notebook sales are in reality net books which have minimal if any e-commerce content. Half of our Q4 sales reduction is due to reductions in sales of this low margin business.

Another significant trend is that many major customers have continued to cut inventories to minimize inventory carrying costs and prevent any potential inventory write-downs for products they are unable to sell in markets that are weak. We expect inventories that many of our customers by the end of Q4 to be lower than have existed in recent memory.

While we do not have exposure to distributors cutting inventory per se, the underlying trends driving the reductions notably weak end market sales is an issue that we must contend with. Based on these market conditions of ongoing inventory reductions, we expect Q4 revenues to be down across the industry. The good news is that these inventories should be abnormally low at our customers going into Q1 2009. This could minimize the effect of the seasonal adjustment that typically occurs in Q1 although it is too early to tell for sure.

We should also mention one very positive market trend. As a result of the recent global financial issues that were in part caused by the huge spike in energy costs, we now see many industries as well as governments focused on alternative energy sources and more efficient use of energy. This is opening new market opportunities for us with our leading edge power management solutions.

Most notably, our intelligent battery product offering continues to gain recognition and design wins in applications where advanced power management methodology is needed. This includes significant opportunities in industrial and automotive applications with new and more advanced energy efficient solutions are being rushed to the market by major OEMs. We see ourselves well positioned for outgoing growth in this dynamic market.

Our Intelligent power product line also offers unique power management capability and continues to gain market share with system and processor DC/DC and charger products. Our new generation of Intelligent power products are focused not only at next generation thin and light notebooks but also other markets where power management is becoming increasingly important.

We have completed development of new processes that will enable us to increase integration and innovatively address these rapidly expanding power management markets. This includes both consumer and industrial markets. Although our Intelligent Lighting growth and traditional LCD backlighting has been slowed by market conditions including a move to lower end products, our patent pending family of high-efficiency LED controllers continues to enjoy increasing design wins and revenue.

As previously announced, several top-tier notebook manufacturers chose O2Micro's LED backlight drivers for their new high-end models. As these design wins continue to grow in number, we have also expanded our focus on the broader LED market opportunities. These LED opportunities include new markets such as industrial where we have our first design win in an advanced street lighting system. We see the rapid expansion of LED lighting in DVD players, GPS systems, notebooks, industrial and automotive systems as offering significant growth opportunities for O2Micro.

We remain excited about the opportunity to expand our lead in backlighting based on our patent pending aerial lighting technology for LEDs which reduces motion blur in video and improves contrast ratio of the display. We would also highlight that in addition to our growth opportunities in lighting, 02Micro derives revenue from agreements with third-party LCD TV OEMs and IC suppliers based upon O2Micro's intellectual property and innovative products. We are hopeful to expand this revenue based on the issuance of significant new patents.

Our VPN security products are also growing both in terms of capability and market recognition. We are now shipping product to nine countries including China and the US and expect to see increasing contribution from the product line in the remainder of 2008 and 2009.

To summarize, while we see difficult market conditions near term, we see significant new opportunities for advanced power management and security products and our focused on long-term growth of our Company with a broad array of new and innovative products in ever broader markets.

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

Thank you, Jim. I'd like to discuss what we are seeing and especially what we are doing in this environment. First and foremost, I would like to say that O2Micro recognizes the need to balance the needs of customers, shareholders and employees. We will manage every aspect of business to achieve this important goal.

As Jim mentioned, the unit volume growth across our core notebook, LCD TV and LCD monitor market is coming from the low-cost models where we believe that low-cost mass market segments are very important and we have many products to address these opportunities. The mix in today's market reflects the current economic conditions more than long-term demand for our products. When the economy improves, any (inaudible) in mainstream or high-end product should benefit O2Micro.

In order to be sure O2Micro is able to capture share when the markets improve, we are maintaining our high investment in R&D. We will carefully watch the return on investment of our products and projects while we want to continue to introduce more powerful saving and better performance products and it will benefit everyone. Our customers will have better technologies to grow their business, our shareholders will see accelerating growth and increasing profitability, and our employees will have the satisfaction of having made a meaningful contribution while enjoying a mutual success.

On many occasions we have discussed the growth engines. Let me take a minute to reiterate them to tell you how we plan to grow O2Micro into a much larger company. First, our core markets will eventually resume a high-growth rate. This should allow our LCD TV, LCD monitor and our mainstream notebook computer business to resume a growth pattern. It is our expectation that these markets should be able to grow at low double-digit rates over the long term. If we succeed, we can grow faster and we are up to that challenge.

At the same time, the growth business that we talk about today consists of DC/DC, Security and Battery. These businesses are enjoying a major of success across the board even in this environment. This business could easily combine to be as large or even larger than the economy and the size of O2Micro today. Keeping this thought in mind, our business has a potential to eventually achieve the high growth in revenue and (inaudible) profit with a limited R&D expansion and it's easy to look at this environment and to be pessimistic. Nevertheless, we are encouraged by our new products group performance which no longer needs massive investment in R&D. We will continue to innovate and invent. We will be prudent with our spending and we will come out of this time as a stronger company.

I would like to thank you for everyone for attention and now return the call to Gary for questions. Gary?

Thank you, Sterling. I would now like to turn the call back over to the operator to begin the Q&A session.

(Operator Instructions) Tore Svanberg, Thomas Weisel.

It looks like your cash now is actually higher than your market cap. What are you going to do with that cash during these times? Should we expect another buyback here pretty soon or maybe increase what you already have?

Tore, as you know, we have an ongoing buyback and we are planning to continue it. The environment is very unpredictable. So cash is king in this world. But we are well aware of that and we are going to put it to efficient use.

Okay. And you mentioned you expect SG&A to be almost flat to up even though sales are down quite a bit. Is there some legal expense in there? I am just wondering why it wouldn't be coming down more.

In Q4, we have some indication slightly up in the litigation expense. And for other areas in the Q3 area, we get some VAT sales tax return in China and in Q4, we don't get a return from China in Q4. So all in all, I think we would like to manage the expenses in the area of which is (technical difficulty) as flat as possible compared to Q3.

Okay. And on gross margin, you mentioned that a big bulk of your revenue decline in Q4 was because of PCI Express and obviously that is a lower-margin business. So why wouldn't gross margin be actually even higher sequentially given that big drop-off in PCI?

[That's] a portion of the higher gross margin (inaudible) is offset by the new product. We expect more new product ramp up in the Q4 with some new product which like our (inaudible) product and LED product. At the initial stage of the new product, we -- actually we will experience some low gross margin for the [year] improvement.

Okay. And then Jim, you talked about LED and you are certainly getting some more design wins there. Could you talk a little bit how you expect that business to ramp or maybe even that market to ramp as we now move into 2009?

Yes, we have actually seen an acceleration in the ramp especially in the notebook area and part of that I believe has to do with the success of some of the early notebooks that came out and LED. And we do see manufacturers now trying to enhance some of their offering by moving toward LED in the notebook area. So we have seen the acceleration there.

We are also beginning to see LED begin to enter other market areas and we did mention Street Lighting for instance. We are beginning to see that product now move toward the marketplace. So we do see more and more LED opportunity in the market.

Great, thank you.

Patrick Wang, Wedbush Morgan Securities.

So a couple of questions here. On the expense side, can you give us an idea of how much litigation expense is included in the third quarter?

We don't want to break that out, Patrick. You can see from the sequential change it is not that much. We actually had as Perry mentioned a little bit of a negative expense this quarter related to the tax return that we got. So the run rate is pretty close but I don't want to get in that habit. If it is a very large number at some point in the future, we will tell you but this isn't something that we want to do right now.

Okay, no, that is fair. In terms of R&D expense here, it's been on a decline -- I guess you guys are telling us $8.5 million to $9 million in the fourth quarter here. I'm just curious kind of what is behind that lower level R&D?

Lower level of the R&D, this is also a result from the [lower] -- new product nonrefundable engineering expenses. So we have some -- we do some projects and we are -- as Sterling just mentioned -- we advertise some project and also we do some account review in the Q3, Q4 timeframe.

Okay. So if we look at R&D going forward, is $8.5 million to $9 million range kind of a nice steady state level?

Yes, I think if the market continues to [deteriorate], we think probably in Q1 we will be bounce back -- we will bounce back. As Sterling mentioned, R&D is still very important for us to continue to grow as the momentum for the future grows in the power and energy sector. We actually would like to continue to invest in R&D area.

Okay, that is absolutely a good thing to do. Okay and then second, in terms of cash flow you guys generated some good cash flow this last quarter. I am just wondering, you guys have done any work in terms of figuring out where breakeven revenue level is for cash flow generation at least from operations?

For the cash management area, we will balance the accounts receivable and accounts payable area and also we will control the -- of course the profit and gross margin is very important for us. Some are prepay expense also are the area we like to monitor. So I think we actually we like to -- we control the cash ahead of profit. This is part of our (inaudible) of the finance area. However for the breakeven point actually, we like to try to do the most effort to manage the expenses and try to lower down the breakeven point if the market continues to be worse. So we will do everything possible. At this moment, I think $30 million to $35 million area is the area that we like to control.

Okay. So here in the fourth quarter here, if we look at the sequential decline of about 20% that gets us into that $30 million range here. Is that the right way to think about the fourth quarter that you guys may not be generating any cash flow?

We -- I think for the area we still can generate some cash flow based on current estimates because of the depreciation and also because of the non-cash stock-based compensation.

Got you. Do you guys have expectations for depreciation in the fourth quarter?

I would think in the area of the $1.6 million area.

About $1.6 million again. Okay. And then just last question here. I know that you guys broke out revenues security products of about $1 million here. How should we think about that in the next couple of quarters here? I know that you guys said you are shipping to nine different countries but how -- when is that ramp potentially hit an inflection point and becoming a lot more meaningful?

I think at this moment we -- this quarter we just started to break it up and as I reported in the future quarter, we will give more details. At this moment, we don't care to disclose the details.

You know, Patrick, the environment is pretty unpredictable so we don't want to go give you sort of a line by line forecast of the guidance but it is Q4 so hopefully it has a good quarter.

Okay, great. Thanks very much.

Charlie Chan, Morgan Stanley.

(inaudible) said that we have some contribution from low cost models. I'm wondering if that including so-called notebooks like (inaudible) or (inaudible) EPC? What kind of product does O2Micro sell for this kind enabled product? Is that PCI Express or also LED backlighting driver?

Charlie, the netbooks most of the -- they probably utilize our lighting product and some of them probably utilize our power product and most of the UMPC or netbooks they are not using 1394 nor PCIe interface. And so that is our e-commerce product in this sector is very few presence. But for the lighting and also for power, we do have some presence.

Okay, so the backlighting should be LED form factor, right?

Either way, yes, both.

Both. Okay, so I'm wondering because it netbooks become more popular so what is the Company's strategy in the future to differentiate with your competitor to gain more market share in this segment?

Well we are continuing to expand product offering in our power area. So we intend to continue to offer more and more products that can be used even in the netbook type area. So basically we see ongoing expansion of the product line but at the same time, some of the traditional lower margin e-commerce products are not used in the netbooks.

Okay, thanks. My next question is on your first-quarter guidance. [Benjamin] said that half of the revenue [comes] is from shortfall of PCI Express. So I remember that the company also gave out some PCI interface business in the third quarter so should I assume that this business is going to decline quarter-over-quarter in the next year because of the margin is very low?

Yes. That business is continuing to decline from Q3 to Q4 and into Q1. At that point we do expect that the business probably will begin to level out but at a significantly lower level than it was early in 2008.

Okay. So excluding the PCI interface business, your other business only declined 7% to 12% in [first] quarter. So which is better than your competitors (inaudible) guidance of decline 12% to 20%. So do you think you are gaining market share versus your competitor?

I think we mentioned in the power area we definitely think we have gained market share because we are getting increased design wins. We obviously have indicated some strength in our new battery products and we definitely are seeing design wins and revenue increases in those areas. So with some of our core analog business, we are very pleased with our market position at this point.

Okay. My last question will be regarding balance sheet. With regards to this quarter the Company wrote off the investment from SinoMos. I am wondering is there any other long-term investment there also in danger like [CSMC] investment? How much downside should I look at your long-term investment or other assets on balance sheet? Thanks.

As the investor we are not the management (inaudible) of the company so we review carefully the financial statement. As of today, we got a report from the management teams of the investees. The company, most of the company are profitable and most of the company actually are supported by a very good parent company. So as of today, I think that is due to the [impairment] of the SinoMos.

Okay, thanks.

Vernon Essi, Needham & Company.

Thank you. I just wanted to follow on that exact last question there on the estimates and assets -- sort of your long term and kick the tires on those items. Just to be sure here and I understand the comments. You are now at it looks like about $28 million, $29 million. And you've checked in with all these investments and you are pretty certain that this is a fair reflection of book? I guess if things continue to worsen, what sort of risk should be looking at in those assets? How do we characterize that on this end of things?

Regarding the long-term investment, we do review on a quarterly basis and we will do the -- in general we are reviewing to the impairment notes on an annual base. And for the company investee up to now, most of the company they are a public company; some of the companies like [Express] are still private but very profitable currently and also supported by good investors.

Other companies, they are the public company so we do the quarterly mark-to-market so in our comprehensive loss area, we already booked the loss. So we have -- we actually reflected some potential loss in our book. But however for us to evaluate and to write down the impairment of this, we need to do it very carefully. When the material become (inaudible) and also it is reported by the company. So prior to this, I think we will give more close contact with the company we invest in. Hello?

Ladies and gentlemen, with no further questions in the queue, this does conclude today's conference. There will be a replay available by calling 1-888-203-1112 or 1-719-457-0820 and use the pass code 7041539. We thank you for your participation and you may now disconnect.