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Advanced Analogic Technologies, Inc. (NASDAQ:AATI)

Q3 2008 Earnings Call Transcript

October 30, 2008, 4:30 pm ET

Executives

Lisa Laukkanen – The Blueshirt Group

Richard Williams – President, CEO and Chief Technical Officer

Brian McDonald –CFO, VP of Worldwide Finance and Secretary

Analysts

Tore Svanberg – Thomas Weisel Partners

Vernon Essi – Needham & Company

Rick Schafer – Oppenheimer

John Lau – Jefferies & Company

Frank Goodman – Merrill Lynch

Anthony Stoss – Craig-Hallum

Krishna Shankar – JMP Securities

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the AnalogicTech third quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. (Operator instructions) As a reminder, this conference is being recorded today, Thursday, October 30th, 2008. I would now like to turn the conference over to our host, Ms. Lisa Laukkanen with The Blueshirt Group. Please go ahead, ma’am.

Lisa Laukkanen

Good afternoon, and thank you for joining us on today’s conference call to discuss AnalogicTech’s third quarter 2008 results. This call is being broadcast live over the web and can be accessed for 90 days in the Investor Relations section of AnalogicTech's Web site at www.analogictech.com.

On today's call are Richard K. Williams, President, Chief Executive Officer, and Chief Technical Officer; and Brian McDonald, VP of Finance and Chief Financial Officer. After the market closed today, AnalogicTech issued a press release discussing the results for the third quarter ended September 30th, 2008. The press release is accessible online at the company's Web site, or you can call the Blueshirt Group at 415-217-4961, and we’ll fax or e-mail you a copy.

We would like to remind you that during the course of this conference call, AnalogicTech's management team may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are simply predictions, and actual results or events may differ materially. We refer you to the documents the company filed from time to time with the Securities and Exchange Commission, specifically the company's most recent 10-Q and 10-K. These documents identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

With that said, I’d now like to turn the call over to AnalogicTech's President, CEO and CTO, Richard Williams.

Richard Williams

Thank you for joining us today as AnalogicTech reports the third quarter 2008 results. During the call, I will provide a brief recap of the financial results and business highlights for the quarter. I will then turn the call over to Brian for a detailed financial review of our third quarter, followed by guidance for our fourth quarter. We will then open up your call to questions and your follow up questions.

Before we discuss our third quarter results, I would like to highlight that we announced today that the Board of Directors has authorized the repurchase of up to $30 million of our common stock. We believe the repurchase program underscores our confidence in the long term growth opportunities for the company. AnalogicTech will repurchase shares in the open market, which at current price levels, we believe, will be accretive to our long term financial results. The timing and actual number of shares repurchased will depend upon market conditions and other factors in accordance with Securities and Exchange Commission requirements.

Our third quarter results were inline with expectations. Revenue was $25.4 million, up 19.8% sequentially and down 17% year-over-year. Net loss from a GAAP basis was $0.6 million, or $0.01 per diluted share. As expected, we experienced a strong rebound in sales in China and Taiwan during the third quarter.

In China, reflecting the combination of aggressive inventory controls and improved demand, sales to our largest distributor, Chieftec, improved 5x sequentially. Inventories are now below two months.

In Taiwan, our 802.11n business recovered from a decline due to the model transition that occurred last quarter at Broadcom. We’re also experiencing increased revenue contributions from other customer applications, including memory cards and smart phones.

Sales in Korea increased 19% sequentially. Including subcontractors, sales at Samsung grew sequentially and accounted for approximately 41% of total revenue. As we’ve discussed previously, we’ve experienced strong design win traction in Samsung’s high end camera phones using modular BCD technology, especially in high current LU flash applications. Through our broad product offering, we have secured design wins in a growing number of premium Samsung models including Light Edge, Lucid, Omnia, Sole, Opus, Instinct, and Eureka. We also have recent design win traction in Samsung’s fast growing entry level phones, including their modern line.

Third quarter sales to LG accounted for 21% of total revenue. As expected, we experienced a decline in sales to LG during the quarter in part due to the flowing shipments at their entry level models and several models nearing end of lodge. Helping to offset this, new design wins of our high current camera flash products have begun to ramp in number of LG’s high end camera phones such Dare and Secret. We continue to experience solid revenue contributions from their Viewty and Chocolate models.

Broadcom related business returned to expected levels following their transition to their new generation chip sales. Broadcom and its distributors accounted for approximately 10% of total sales for the third quarter.

The migration to our low cost, higher margin LED drivers for mass market phones has been more complex than originally planned. Customers now have finally qualified the cost reductions. We shut off new wafer starts of the old material. And we are now burning off the remaining inventory of the higher cost part. At present run rates, we expect volume shipments from the new low cost part to transition in the first quarter of 2009. We expect this to have approximately 1% positive impact in the company’s aggregate margin in the first quarter.

Overall, 61% of revenues were from lighting and display products, 17% from voltage regulation and DC-to-DC converter products, and 22% from other power manager products, including port protection and battery management. Battery management, although still a small portion of total revenues, grew 76% sequentially, and has begun to show significant design win traction. Switching regulator revenue used in lighting solutions is reported in the lighting and display category.

In the third quarter, we remain focused on product development activities. We introduced a total of 17 new products, comprising four platforms and 13 derivative products, including a 28-volt high voltage buck converter, a high voltage PMU for routers, and our first 6-megahertz DC-to-DC converter. Modular BCD revenue in Q3 exceeded the 19%, one quarter ahead of our stated year-end goal. This revenue includes products for high current camera flash, a new generation of ultra compact smart switches, and our first generation of 28-volt over voltage protective safety switches. Third quarter shipments also included the PMU for Bluetooth hands-free car kits. To date, we have released 55 modular BCD-based products into production, and have 42 new products currently in development.

In the third quarter, we continued to accelerate modular BCD design activities, including the development of a new generation of LED flash drivers, comprising both boost and super cap based solutions, an extensive OVP product line, a novel two output dual polarity DC-to-DC converter for active matrix OLED displays that requires only one inductor, and a 40-volt LED backlight driver for notebook computers. We also successfully reported a number of circuit building blocks on the modular BCD, including a class D audio power output driver, a high speed spy bus interface, and a PLL needed for synchronizing backlighting in HDTVs.

In September of last year, the International Trade Commission issued a limited exclusion order to prevent AnalogicTech from directly importing one of its older switching regulator families in the United States. This limited exclusion order is currently of the subject of appeals by both Linear and AnalogicTech at the United States Court of Appeals for the Federal Circuit. In spite of the tendency of these appeals, Linear Technology has requested the International Trade Commission undertake an enforcement action based on alleged violations of the limited exclusion order.

Following normal procedure, the International Trade Commission has agreed to investigate Linear’s allegations, but several newer switching regulator families violate the claims of Linear’s fact. As a result, our legal expenses are expected to increase in the fourth quarter and for a portion of 2009. Regardless of the outcome of the enforcement action, we believe that based on a recent decision by the United States Federal Circuit Court of Appeals, this limited exclusion order cannot be used to bar importation of products by AnalogicTech’s customers.

AnalogicTech continues to secure new design wins by expanding its portfolio in the new application and diversifying the end markets it serves. Despite today’s economic uncertainties, we believe our expanding product portfolio will drive AnalogicTech’s revenue growth and profitability in 2009 and beyond. I will now turn the call over to Brian for a detailed financial review.

Brian McDonald

Thank you, Richard, and thank you everyone for attending our conference call. I will review our results for the quarter, and then briefly discuss our outlook for the fourth quarter of fiscal ’08. Please keep in mind that the financial data mentioned within this call will be on a GAAP basis unless otherwise noted.

Now let me outline the details. Revenue for Q3 ’08 was $25.4 million, compared to $21.2 million in Q2 of ’08, and $30.6 million in Q3 of ’07. Revenue increased by 19.8% sequentially, and decreased 17% from Q3 of ’07. Sales in Korea were $16.4 million, China, $3.8 million, Taiwan, $4.0 million, and all others at $1.2 million.

Sales in Korea increased primarily due to increased shipments to Samsung, partially offset by lower sales to LG. Direct sales to Samsung accounted for 26% of total revenue as compared to 19% in Q2 of ’08. Sales to Samsung, combined with its contract manufacturers, accounted for 41% of total revenue as compared to 37% in Q2 of ’08. Revenue growth in Samsung was driven by the ramp of higher content phone models. Sales to LG represented 21% of our total revenues, compared to 28% in Q2 of ’08. The softness in LG’s business is a result of the anticipated slowdown in their emerging market segment as expected for the second half of the year.

Sales in China regained momentum in the third quarter, and increased 74% sequentially in order to sustain increased distributor point of sale activity. Overall, distributor inventory level in China dropped significantly to below two-month target. Sales to Chieftec represented 5% of our total revenues, compared to 1% in Q2 of ’08.

Sales in Taiwan increased 36% sequentially, primarily due to higher Broadcom related shipments. Overall distributor inventory in Taiwan improved to below our two-month target.

GAAP gross margin was 50% for the quarter. This compares to 47.3% in the prior quarter and 53.6% in Q3 of ’07. Non-GAAP gross margin was 51.4%, compared to 48.9% last quarter and 54.6% in Q3 of ’07. Sequentially, gross margin increased primarily due to a lower excess inventory charge and partially due to improved product mix. Product mix was favorably impacted by higher sales in China, Taiwan, and Korea. We are expecting a decline in gross margin in Q4, primarily due to unfavorable product mix, one quarter delay of the low cost charge fund for pumping and volume, and higher E&O charges associated with the lower revenue.

R&D spending was 7.5 million or 29% of revenue for the quarter, a decrease of $0.3 million from the prior quarter, and a decrease of $0.5 million from Q3 of ’07. The sequential decrease in R&D expenses was a result of prior quarter IP R&D charges of $0.3 million related to the purchase of elite micro devices, lower personnel related expenses, offset by higher stock comp expense. Included in the R&D spending was $0.9 million of the stock-based compensation expense.

SG&A spending was approximately $6.1 million or 24% of revenue for the quarter. This represents a decrease of $0.1 million from the prior quarter and a decrease of $0.3 million from Q3 of ’07. The sequential decrease was primarily attributable to lower stock-based compensation, expense offset by higher personnel related expenses. Included in the SG&A spending was $0.7 million of stock-based compensation expense.

Litigation cost was $0.2 million for Q3 of ’08 as compared to $0.5 million in the prior quarter and $0.6 million in Q3 of ’07. Operating expenses in total were $13.8 million. This compares to $14.5 million in the prior quarter and $14.9 million in Q3 of ’07. Stock-based compensation expense was $1.7 million for Q3 of ’08, compared to $1.9 million in the prior quarter and $1.6 million in the prior year. Operating loss was $1.1 million for the quarter as compared to an operating loss of $4.4 million in the prior quarter and operating income of $1.5 million in Q3 of ’07. Other income net was $0.7 million or 2.8% of revenue for the quarter. This compares to $0.8 million in the prior quarter and $1.4 million in Q3 of ’07. The sequential decrease was primarily a result of lower interest income.

Tax expense was $0.3 million as compared to $0.1 million last quarter. Net loss for Q3 ’08 was $0.6 million or $0.01 per diluted share, compared to a net loss of $3.8 million or $0.08 per share in the prior quarter, and compared to net income of $2.6 million or $0.05 per share in Q3 of ’07.

Now moving on to the balance sheet, during the quarter, we maintained a solid debt free balance sheet. Cash, cash equivalents, and short term investments totaled a $111 million at the end of the quarter, an increase of $1 million from the prior quarter and a decrease of $3.3 million from the end of last year.

The decrease from last year was primarily attributable to the reclassification of certain short term investments to long term, and the purchase of elite micro devices. The increase from the prior quarter was primarily attributable to a $2 million note receivable collection. Net accounts receivable was $14.8 million at the end of the quarter, up by $3.6 million from the prior quarter and $0.4 million from last year, primarily due to higher sales and the timing of collections. The average day sales outstanding for the quarter were 53 days compared to 48 days in Q2, and 41 days at year-end. Net inventories were $12.4 million at the end of the quarter, down $1.3 million from the prior quarter, and up $0.2 million from last year. Inventory returns for the quarter were 4.1 as compared to 3.2 and 5.0 at the end of last year.

Now let me comment on Q4 of 2008. We expect Q4 ’08 revenues to be in the range of $19.5 million to $22.5 million, GAAP gross margin between 45% and 47%; R&D expenses in the range of $6.6 million and $6.8 million, exclusive of stock-based compensation expense; SG&A expense in the range of $5.3 million and $5.5 million exclusive of stock-based comp; litigation expense in the range of $1.7 million to $1.9 million; stock-based compensation expense in the range of $1.6 million to $1.8 million; other income in the range of $0.5 million to $0.7 million; amortization of intangible assets to be approximately $0.3 million; tax expense is expected to be zero; non-GAAP tax expense is expected to be in the range of $0.2 million to $0.4 million.

As a result, the GAAP EPS is expected to be a loss between $0.13 and $0.09. That concludes my remarks. Now I’d like to open the line for questions. Operator?

Question-and-Answer Session

Operator

Thank you sir. Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. (Operator instructions) One moment please for our first question. Our first question is from the line of Tore Svanberg with Thomas Weisel Partners. Please go ahead.

Tore Svanberg – Thomas Weisel Partners

Okay. My first question is on design wins. I mean obviously, you’ve seen a slowdown in bookings, but have you also seen now the push outs of certain key design wins?

Richard Williams

No. I don’t think we’ve seen that. In fact, what’s happened is that the design win fraction on the LED drivers have been pretty constant. And then, the securing of design wins in over voltage protected battery chargers has actually opened up the opportunity for increased content. So we think that the newer models that are coming will actually have an opportunity for greater content and higher margin contribution potentials because we have more valuable products in. So what we see is the push out, as you’re referring to, is that if those new models don’t ramp, then we just see the existing models last longer.

So the business isn’t going away. Of course, there are some volume fluctuations with the market and seasonality. But you see that the existing models will last longer, and the transition will happen maybe later in 2009 than it would normally. But we’re tuned up and ready for the next round. And that’s why we focus – continue to focus on cost reductions on the existing round because there’s still a lot of life in those older products.

Tore Svanberg – Thomas Weisel Partners

Sounds good. And then, I think you mentioned that 90% of your revenues now are from products with the modular BCD process. How much of that is cell phone–?

Richard Williams

Nineteen percent.

Brian McDonald

Nineteen.

Tore Svanberg – Thomas Weisel Partners

Or non-cell phone?

Brian McDonald

How much was the non-cell–?

Richard Williams

So the initial part is – of actual revenue is still handset related. So we would view that as a new application in the existing market. And we are just now sampling the products that expand into the non-handset, which is the routers, the LED backlight for notebooks. And we’re just very excited about a new chip that just came out. And the initial evaluations were very encouraging, which is the unique power supply that produces a positive and a negative voltage, two outlets from one inductor for AMOLED. And that one we’ll be sampling very soon, but we think the appetite for that product is quite great.

Tore Svanberg – Thomas Weisel Partners

Great. And then, I guess finally, you are trying to manage your expenses here next quarter. Now if we continue to see pretty severe downturn here, how are you going to manage your expenses relative to your revenues?

Brian McDonald

Currently, obviously we’re not hiring any folks at this point in time. And then we’ll just evaluate all the requirements, all the resource requirements that we have, and match that to the revenues.

Richard Williams

If we foresee extended durations of slow economic conditions, then we have to project what is the revenue growth that we’re going to be getting out of the new products and balance that against all of our expenses.

Tore Svanberg – Thomas Weisel Partners

I guess, just one more question, Brian, what are your expectations for inventories this quarter?

Brian McDonald

I would expect – on the lower end of the guidance, I would expect the inventories to be flattish, okay? And at the higher end of the guidance, I would expect it to come down.

Tore Svanberg – Thomas Weisel Partners

Great. Thank you very much.

Richard Williams

But we’re keeping a pretty tight reign on inventories.

Tore Svanberg – Thomas Weisel Partners

Okay. Thank you.

Richard Williams

Thank you.

Operator

Our next question is from the line of Vernon Essi with Needham & Company. Please go ahead, sir.

Vernon Essi – Needham & Company

Thank you. I’m just wondering if you could expand a little bit on the – you’ve got a big decline here in gross margin on the guidance, just talk about some of the moving parts there in the mix and – go ahead.

Brian McDonald

The big part, Vern, is one, with the declining revenue forecast we’re anticipating. An excess of obsolescence charge inventory reserve, which would drive the margin from the 50 down about two points – two percentage points. In addition to that, we see a slight mix deterioration in the fourth quarter, primarily because of the high end cell phones dropping off, and that’s where we have some of the high content phones. That’s about another 2%.

Richard Williams

So basically whatever the top line drops, the higher end portion that goes away and we’re left in an increase percentage of the lower margin business. And as soon as the revenues pick back up, then we get that back. So in that sense the margins do get modulated by the top line revenue.

Vernon Essi – Needham & Company

Okay. So just to put a sort of a little bit of a range around it, is that obsolescence charge then, Brian, probably – would be in the range of almost $0.5 million in that range?

Brian McDonald

No. The increment from the prior quarter’s a $0.5 million charge. We actually booked $0.5 million in the third quarter. So it will be about a $1 million charge.

Vernon Essi – Needham & Company

Okay. And then, on the SG&A side, it’s also ramping up. Is there any special item in there? Why would that – I guess usually that would be going down if your sales are going down from a commission perspective?

Brian McDonald

Yes. There were just some one time catch up expenses on some of the contractor cost, but I would expect that to drop back down next quarter.

Vernon Essi – Needham & Company

Okay. And then last, and I’ll get out of the queue here. If we were to look at your business in the Samsung and LG, can you give us an understanding of how much of it would be not specifically handset driven, in the sense that I know you’ve got flash functionality, you’re going to have OVP, you’re going to have some of these other features? One thing that would be helpful to us is to try to delineate what was the legacy revenue or sort of style or products you’re doing on the LG side versus these newer products.

Richard Williams

That’s kind of a mixed question. Let me see if I can decipher it a little bit. So the majority of the revenue today in Samsung and LG is related to handsets. There’s a little bit of business related to digital camera and some consumer products, but most of it is handset. In the past, it was mostly related to charge pumps and LED drivers primarily for backlighting. What has been a favorable shift for us is to move a greater percentage of that into the higher current camera flash. One of the reasons for this is that some of the LED backlight drives is pretty low quality and often times is getting integrated into the chip set PMU.

So in essence, it’s being commoditized away and gradually declining. But the high current camera flash is not something that is amenable towards integration into other chips. In fact, it’s a bad idea because it introduces noise and causes large chip sizes, and heating, and other types of problems. So we see that market as a very attractive market, and we’re continuing to invest in that. Both in ways of using up with boost converters, but also in super cap solutions, which we just start to see the industry are beginning to find acceptable solutions using super capacitors as an alternative to powering the flash from the battery. And that, of course, gets rid of the current spikes in the battery. So that’s what I would call new applications within a – it’s new applications within existing markets.

Now the high voltage LED driver is a totally new market for us. Okay. And that one is not handset related, and that includes – the 1408 is our first product that’s actually going after notebook backlighting. That’s our first generation product. We have, right behind it, a first generation television related backlight solution. And then we have another generation beyond that that will greatly improve power efficiency, and that will be for green TVs, where we can actually save additional power. So we have a whole road map planned out for that.

Vernon Essi – Needham & Company

Okay. If I could just ask though, those wouldn’t be – I assume, Samsung might be interested in those products, but I guess going back to the–?

Richard Williams

It would be Samsung and LG.

Vernon Essi – Needham & Company

And LG. Okay.

Richard Williams

Because both, Samsung and LG, if you can check the statistics, but I think it’s probably – they comprise roughly 60% of the panel production in the world.

Vernon Essi – Needham & Company

Okay. So then if we back up and look at the snapshot of this quarter, we have a $16 million, in that range revenue from both of these customers, and you’re saying the majority, we should assume literally $15 million of that is still sort of your handset related and–?

Richard Williams

Yes. I would say that. And all that is the camera flash is increasing, battery chargers are in there, but haven’t started to ramp yet. So we probably will expect to see battery chargers start to show up more meaningfully in Q1, Q2 of next year. So some moving parts in there, but mostly handset related on that portion. And then the high voltage LED driver, we don’t think we’ll have meaningful revenue until the second half of next year.

Vernon Essi – Needham & Company

Okay. All right. Thank you very much. That’s helpful.

Operator

Thank you. Our next question is from the line of Rick Schafer with Oppenheimer. Please go ahead.

Rick Schafer – Oppenheimer

Hey, guys. I’ve got a couple of questions. I guess, the first is you mentioned coming into the quarter, you had a pretty solid backlog. Everything has kind of slowed down in the last couple of weeks. But could you kind of walk us through this really quick, couple of puts and takes maybe to get you the wide range that you’re giving for guidance? And then, maybe include sort of a turns number and how that compares for the last couple of quarters for you guys.

Richard Williams

Just read the newspaper, I’m certain.

Brian McDonald

Well that would be consistent with what you’ve heard on some other calls. But to give you anywhere – we’re very optimistic, actually, at the end of the quarter. We’ve actually about 55% coverage for the current mid point of the range. And that compared to numbers that were in the 30% range before. So we basically had 20% more backlog going into the quarter than we historically do. The September bookings were actually very strong for us, and they continued to be strong throughout September. And then October is when we really saw a slowdown. So that particular slowdown in the month of October has given us a concern and has caused us to broaden the range.

To give you an idea right now, the current backlog coverage to the mid point of the range is about 78%. So we’re still pretty well covered for this point in time in the quarter. But we’re waiting to see what these bookings do in October, November timeframe in light of all the chaos going on out there.

Richard Williams

Plus in the handset, we have another variable, which is that our major handset customers tend to have different strategies on how they control their inventory at year-end close. So depending on the year, we’ve seen LG and Samsung do different things about whether they continue to order through December or if they basically stop ordering in the middle of December. And where we fall within that range has a lot to do with what their December buying pattern will be, which is a normal yearly kind of uncertainty that we have to deal with.

Rick Schafer – Oppenheimer

So this is – I’m assuming, this is usually a pretty front and loaded quarter for you guys, fourth quarter? Is that right to assume that?

Brian McDonald

Typically, because of the holidays at the back end, we do see most of the shipments in the first two and a half months.

Rick Schafer – Oppenheimer

So how far, at the back end, if we get – let’s just say it’s roughly 20% turns from here until December 31st, I mean, is that – how would that compare with, I guess, past fourth quarters?

Brian McDonald

That’s actually a little bit higher than we have run at this point in time in historic quarters, about five plus percent.

Rick Schafer – Oppenheimer

Okay.

Richard Williams

So I guess you can say, we’re just being conservative because of the end market dynamics, not necessarily because of any one message that we got from any of our customers.

Rick Schafer – Oppenheimer

Okay. Great. And then, a follow up question on the China end of the business. Obviously, it rebounded really well. At least most of it is in some pent up demand, maybe after the Olympics and the earthquake, and everything. What’s the follow through business been like coming from China for handset so far in the fourth quarter?

Richard Williams

I would say the September – the August, September numbers were strong. The POS activity that we saw out of Chieftec was strong. We don’t have the final October numbers yet. I think the first indication is that they stopped in some, but we don’t think they stopped in – all that much, but down a little bit from the September timeframe.

Rick Schafer – Oppenheimer

Okay. And then just one last question, just going back to the two-channel LED driver, I know you mentioned that – I guess, you guys have stopped the wafer parts there and that basically the transition started to happen in the first quarter. I assume your biggest customer has finally called that part? And then secondly, are you branching – somebody mentioned it’s about 1% positive gross margin impact in the first quarter. Does that ramp up as the year goes on next year, I assume?

Brian McDonald

I wouldn’t expect that to improve. Once we get the cost reduction built in, it’ll be built in. It will take that one time effect on the gross margin.

Rick Schafer – Oppenheimer

Okay.

Brian McDonald

And we should be able to offset future price decreases or cost reductions. So I wouldn’t see that driving gross margin expansion.

Richard Williams

But there are other products that have better margin that could come into the mix other than that particular one. Remember, this is one where we basically got the wrong part designed in at the beginning. And then we got stuck with it. So we get a better part on those models, and then we try to launch some more of the multi-function products. And there are even further cost reductions in other models as well.

Rick Schafer – Oppenheimer

But it sounds like everybody has made the move to a two-channel now, it sounds like, right?

Richard Williams

No. No. No. That’s their ultra low cost. But on the performance base, if anything, the number of LEDs have gone up, not down.

Rick Schafer – Oppenheimer

Okay, okay. Thanks a lot.

Brian McDonald

Thank you.

Operator

Our next question is from the line of John Lau with Jefferies & Company. Please go ahead.

John Lau – Jefferies & Company

Great. Thank you. I wanted to follow up on some of the dynamics that you’re seeing out there, especially your comments with regards to the inventory at the end. Since a lot of the customers that you have are operating on a hub, what you’re seeing, it looks like the manufacturing is pulling back a lot now even for Christmas. So it looks like no one really knows what the end market’s doing. So I have a different question of you.

Richard Williams

Samsung doesn’t operate on a hub.

John Lau – Jefferies & Company

Okay.

Richard Williams

LG does, but Samsung does not. And Sony Ericsson does operate on a hub, but Samsung does not.

John Lau – Jefferies & Company

And their contract manufacturers? I know Samsung proper, but what about the other subcontractors that do their work? Are they on a hub or orders?

Brian McDonald

They’re direct shipping.

Richard Williams

They’re direct.

Brian McDonald

Direct shipped to a distributor.

Richard Williams

Yes. Distribution as a fulfillment agent.

John Lau – Jefferies & Company

Okay. So my question is, though, what is your – Let’s say for example, they’re shutting this down even before Christmas. They don’t really know what’s happening out there. What is your response time to ramp back up again, especially with distribution like LG Tech had less than two months. They’re coming back to you middle of the month, end of the month, and saying, “Oh my gosh, we need to make some more.” What is the typical response time at that point?

Richard Williams

We have phased manufacturing. So for example, we have some finished goods, but we also use wafer banking where we have wafers that we store in a partially manufactured state. And we’re able to change the characteristics of those products, and ship those products in a few weeks’ time from getting the purchase order. So that gives us quite a bit of flexibility. And we don’t get stuck with a lot of finished goods that have the wrong options or the wrong features. We can adjust to the business coming in and react pretty quickly. We also have products now that have – that have a one time programmable memory, OTP. And that allows us to actually change characteristics of the products even at final tests.

John Lau – Jefferies & Company

Okay. So–

Richard Williams

It’s not too bad for us.

John Lau – Jefferies & Company

Okay. So Samsung and their affiliated business is not on the hub, but there is still some variability from the LG side and Sony Ericsson, right?

Richard Williams

But the way I would see it, actually, every year-end, we sit here and guess what December is going to be like. Because all the purchasing agents, whether managing a hub or managing their inventories directly, all the purchasing agents tend to have a pattern on how to minimize their inventory and whip at year-end, just as a matter of practice for the big cell phone guys.

John Lau – Jefferies & Company

Great. Thank you very much.

Brian McDonald

Thanks, John.

Operator

Our next question is form the line of Srini Pajjuri with Merrill Lynch. Please go ahead.

Frank Goodman – Merrill Lynch

Hi, guys. This is Frank Goodman for Srini. Just have some questions on what you think – how you’re thinking about cash and how we should be modeling for free cash flow next year? And also, maybe just how you’re – what you’re thinking about doing with your cash? You have quite a bit. I know you’re probably looking at a little cash burn for over the next year and the remainder of this year. And you’ve announced that you have the buyback now. Maybe if you can add some color just for the timing that you see that playing out. And is there a certain dollar cash amount that you’re modeling towards? And what you would be doing with the remainder of that cash?

Richard Williams

We like the cash to go up. Yes.

Frank Goodman – Merrill Lynch

I guess, over the next year at least.

Brian McDonald

You do the straight math and you assume we got a – roughly $111 million in cash. We do expect that do go down to around $80 million. I would expect the cash flow to be relatively neutral next year. And we–

Richard Williams

That’s barring any future of any – of any non-handset business, which could drive it positive.

Brian McDonald

So it’s kind of a look at next year. The kind of the do me glasses that a lot of us are wearing these days. So kind of in the neutral range. And I think $80 million is more than enough for us. It gives us the ability to ramp if we have to and invest where we have to.

Frank Goodman – Merrill Lynch

Okay. Did you give an operating cash flow on CapEx for the current quarter?

Brian McDonald

No. But I thought you might ask. So it was about $1 million, right? Was it $900,000?

Frank Goodman – Merrill Lynch

Free cash flows?

Brian McDonald

Free cash flow’s about $900,000, $600,000 of that was operating income, and $400,000 on capital equipment purchases.

Frank Goodman – Merrill Lynch

Okay. And then just one follow up, this is more just a general question. So if we’re looking at the beginning of next year, maybe first half of next year, if we assume it’s kind of a weak hindsight, a weak consumer environment. I know you have a lot of exposure there, and a lot of your new products that you’ve talked about are- – they’re in those markets, but it’s more of a second half ’09 type story. I guess if you have to highlight one segment or one product area that you think would really be an area for share gains or for growth to offset some of the other weakness early next year. What would that be?

Richard Williams

It would be battery chargers in handsets. That would be the single biggest growth potential without opening up new markets.

Frank Goodman – Merrill Lynch

Okay. And you see that area as a growth opportunity even in a fairly weakened market just per share gain?

Richard Williams

Yes, because there’s been a complete change in the industry. All the battery chargers, the incumbent battery chargers no longer need these safety specifications of the customers because most of those chargers only operate up to 5.5 or 6.5, or maybe 7 volts. And now everyone’s moving toward an over voltage protected battery charger that can actually block input all the way up to 28 volts in case the voltages gets too high. This is really being driven by safety and liability risks. If somebody plugs in the wrong adapter and the lithium-ion battery catches on fire, then that’s a major risk factor for handset manufacturers. And they would like to eliminate that risk by being able to cut it off and protect all the way up to 28 volts.

Frank Goodman – Merrill Lynch

Okay. Thanks a lot.

Operator

Thank you. Our next question is from the line of Anthony Stoss with Craig-Hallum. Please go ahead.

Anthony Stoss – Craig-Hallum

Hi guys. Most of my questions have been answered other than, if you could highlight within your Q4 guidance, was there any one area that was perhaps more weaker than the rest? Was it the Korean folks, is it China?

Brian McDonald

Actually, China we’re still – because of the inventory situation there, we feel pretty good about it. Although, the overall economy drag is the problem, we still feel we’ll get flattish growth in China.

Richard Williams

And we normally assume seasonality in Korea.

Brian McDonald

So really Korea with the seasonality and Taiwan with seasonality on some of the notebook stuff, we expect that to be down. So those would be your two down areas.

Anthony Stoss – Craig-Hallum

Okay. Also, if you could give us a little bit more color on litigation and expenses, kind of go forward basis, you mentioned Q4. What are your thoughts Q1 and how long this plays out? And how much this cost you?

Richard Williams

This reinforcement action is kind of a red Harry. It’s not part of the normal ITC process. And as a result, it could kind of come and go in a hurry. But we haven’t really been able to fully scope it out yet, especially in light of that new federal court ruling that we talked about, which basically lenders – the whole discussion kind of lurid because we can argue all day about whether or not they can bar us from directly bringing some old products back in the United States. But that is not the basis of our new products. And our customers are, to our interpretation of the federal ruling, not subject to – I mean, their products being barred from importation in the United States. And we have almost no revenue from point of sale point of view in the US. So this thing seems to be an entirely academic argument as to whether or not this is a case or not because the products are still going to get sold and still get used.

Anthony Stoss – Craig-Hallum

How long do you think this goes on? And what your March quarter expenses might range?

Brian McDonald

Well to give you an idea, the enforcement action when it came up as quickly as it did, we did ramp up the legal bills in Q4, which I’m sure you noticed up into the $1.5 million to $1.8 million range. It is going to be a shorter term – it’s going to be a short term action. It will probably go two or three quarters. You could see it in – the Q1 range could be slightly higher than the Q4 range, but then we would expect it to start to ramp down pretty quickly after that.

Anthony Stoss – Craig-Hallum

Okay. And lastly then, what’s the pricing environment like? Can you give us a sense if anything’s changed in that regard?

Richard Williams

No. I think what we’ve seen is that the ultra low cost product line of cell phones is starting to have – getting in touch with reality that they will – that they will accept a lower set of standards on performance to get lower cost. And when they do that, then it actually makes it easier to make those products more profitable. The problem is always if you want superior performance at a very low cost. But if you’re willing to, for example, give up on controlling the LED brightness when the battery discharges, we can make the chips cheaper and still make good business from a lower ESP. So I’d say that what we’ve seen is the ultra low cost is starting to stabilize a bit, and the high end is still being driven by new features that are actually opening up new opportunities for us. So we’re not seeing nearly the erosion up there that we would see historically.

Brian McDonald

Yes. And we did do some – we did have some negations to some of the bigger customers recently. And the pricing declines were about consistent with what they had been the last six months, so no more aggressive than that.

Anthony Stoss – Craig-Hallum

Okay. And then lastly, I guess, any new comments on Sony Ericsson, your expectations from them as a customer, perhaps, ’09 or first half ’09?

Richard Williams

Sony Ericsson has been going through a lot of changes. They’ve been closing factories and moving people around, but they have a lot of design activities in other locations. And we’re pursuing them on a number of different applications more than we were before. So it’s kind of hard to say what their end volume as a company is going to be because I think that’s still in flux, but at the same time we’re seeing more types of opportunities than we did a year ago.

Anthony Stoss – Craig-Hallum

Okay. Thank you.

Richard Williams

Thank you.

Operator

(Operator instructions) Our next question is from the line of Krishna Shankar with JMP Securities. Please go ahead.

Krishna Shankar – JMP Securities

Yes. Can you give us some sense for how much of a lift you get on gross margins as a percent of your revenues from, I would say, BCD increases?

Brian McDonald

Well it’s – it’s a–

Richard Williams

It’s a complicated question.

Brian McDonald

It’s high. I think maybe a better way to answer it is that the margins on the BCD products are significantly above the corporate average. Okay. So we say – we typically would say north of 60% on the modular BCD set. And the modular BCD revenue was about 19% of revenue in the third quarter. So you can probably do the math from that.

Krishna Shankar – JMP Securities

Can you remind us again what it was at the beginning of the year, say Q1 ’08?

Brian McDonald

Q1 ’08, actually, I do have that information. BCD revenues was 4% – here it is. It was 4% in Q1, 15% in Q2, and 19% in Q3.

Krishna Shankar – JMP Securities

Okay. And as you look at some of these new products, the LCD TV, notebook backlighting, how quickly can they ramp and offset any macro weakness in the economy going into the first couple of quarters next year?

Brian McDonald

So we believe that there is another round – kind of the first opportunities for LCD TV would be in the second half of next year. And then, that would expand in the year after. So there is some opportunity in 2009. It’s still a little early to tell. But it doesn’t look like it’s all of 2010. It will have some business in 2009. The higher voltage battery chargers could start in the first half of the year, and have the potential of ramping throughout the year.

Krishna Shankar – JMP Securities

And what about notebook backlighting, LED notebook?

Richard Williams

I’m not really clear yet on what the cycle for the conversion is. I think if you read the press, a lot of the notebook designs are showing and talking up their LED backlight drive. But the number of units that are actually shipping is still very small. So it’s a little early to say, but it looks like that market – it’s an inevitability. It’s just a matter of the timing. And I don’t think we have a clear picture form the notebook guys yet as to when they’re going to do that conversion. But it is on the horizon. Because it definitely it will improve battery lives.

Krishna Shankar – JMP Securities

And Brian, the litigation expense, you said it’ll be north of $1.8 million in Q1, and then drop off rapidly after that. Can you give us a sense for kind of magnitude what – how it’ll drop off to beyond Q1?

Brian McDonald

So Q4 is going to be the acceleration of the bills on the enforcement action. That will play it through Q1. Then it’ll start to drop off, probably go – drop off by half in the second quarter. And then down about almost half of that in the subsequent quarter, and then drop off to zero in the fourth quarter.

Krishna Shankar – JMP Securities

Sounds good. Thank you.

Brian McDonald

Okay.

Operator

Our next question is a follow up question from the line of Tore Svanberg with Thomas Weisel Partners. Please go ahead.

Tore Svanberg – Thomas Weisel Partners

Yes. I have a few follow ups. So first of all on the gross margin, if we assume revenues are down again in Q1. Should we expect margins to continue to decline? Or will you finally get some benefits from mix at that point?

Brian McDonald

We’ll get some benefits from mix in Q1. Q4 should be the trough on the gross margin percentage because of the excess inventories. I think we’ve got a pretty good handle on the inventories. I can’t see the forecast coming down much beyond that at this point in time. So I think the E&O effect will go away. You’ll get a little bit – you’ll get some of the favorable effect on the low cost charge pump kicking in and for the newer products that Richard talked about. So you should start to see a pick up in Q1 from the Q4 range.

Tore Svanberg – Thomas Weisel Partners

Okay. And then on taxes for next year, should we model our rate or will it continue to be driven by dollar amounts?

Richard Williams

I think next year is going to be tough because, I think, when you model it, you’re going to see you’re close on a GAAP basis. It is going to be probably slightly unfavorable. And on a non-GAAP basis, it’s going to be slightly favorable. So I think this rule we’ve been telling you guys is 15% of income for $300 to $500, whichever is higher.

Tore Svanberg – Thomas Weisel Partners

Okay. And then lastly, I think you’ve mentioned the amortization intangibles next quarter is about $300,000. Is that amount constant? And for how many more quarters will you continue to have that charge?

Richard Williams

Yes. Up through Q3. Is it Q3 of–

Brian McDonald

Q4 of 2009.

Richard Williams

Q4 of 2009.

Brian McDonald

Throughout the rest of the remainder of 2009.

Tore Svanberg – Thomas Weisel Partners

And they will – that’s going to be $300,000?

Brian McDonald

It’ll be $300,000. Yes, our number expense.

Tore Svanberg – Thomas Weisel Partners

Okay. Thank you.

Operator

I’m sure there are no further questions at this time. I would like to turn it back to management. Please continue.

Brian McDonald

We have nothing else. We just like to thank everybody for attending the conference call. Thank you.

Operator

Ladies and gentlemen, this conference will be available for replay after 3:30 p.m. Pacific Standard Time, today, through November 5th, 2008, at midnight, Pacific Standard Time. You may access the AT&T replay system at any time by dialing 1-800-405-2236 or 303-590-3000, and entering the access code 11120755 and the pound sign. Thank you for your participation, and for using AT&T teleconference. You may now disconnect.

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Source: Advanced Analogic Technologies, Inc. Q3 2008 Earnings Call Transcript
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