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GSI Technology (NASDAQ:GSIT)

Q3 2013 Earnings Call

January 31, 2013 4:30 pm ET

Executives

Lee-Lean Shu - Co-Founder, Chairman, Chief Executive Officer and President

Douglas M. Schirle - Chief Financial Officer and Principal Accounting Officer

Didier Lasserre - Vice President of Sales

Analysts

Daniel K. Marquardt - Robert W. Baird & Co. Incorporated, Research Division

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Michael Crawford - B. Riley & Co., LLC, Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to GSI Technology's Fiscal 2013 Third Quarter Conference Call. [Operator Instructions] Before we begin today's call, the company has requested that I read the following Safe Harbor statement: The matters discussed in this conference call may include forward-looking statements regarding future events and the future performance of GSI Technology that involve risks and uncertainties that could cause actual results to differ materially from those anticipated. These risks and uncertainties are described in the company's Form 10-K filed with the Securities and Exchange Commission. Additionally, I have also been asked to advise you that this conference is being recorded today, January 31, 2013, at the request of GSI Technology. Hosting the call today is Lee-Lean Shu, the company's Chairman, President and Chief Executive Officer. With him are Douglas Schirle, Chief Financial Officer; and Didier Lasserre, Vice President of Sales. I would now like to turn the conference over to Mr. Shu. Please go ahead, sir.

Lee-Lean Shu

Good afternoon, everyone and thank you for joining us. Due primarily to stronger sales to Cisco systems, which were $6.5 million compared to $4.9 million in the prior quarter, today we reported higher-than-anticipated third quarter net revenue of $17.5 million compared to our earlier estimate of $15 million to $16 million. Another factor in the increase was an uptick in military and defense sales, which were inherently lumpy and difficult to predict on a quarter-to-quarter basis. Gross margin of 41.9% was a little lower than anticipated, but still well within our target range. Year-to-date, we reported net revenue of just over $50 million and diluted earnings per share of $0.10. It is somewhat lower than the first 9 months of fiscal 2012 when we reported net revenues of almost $64 million and a diluted earnings per share of $0.20. Some of the dropoff in the net revenue can be attributed to Cypress Semiconductor's complaint before the ITC, which has occupied us since the summer of 2011 and which since the later part of fiscal 2012 has affected net revenue on a quarterly basis. The bottom line has also suffered, although not as much as in the prior fiscal year, but we continue to incur significant legal expenses related to the ITC litigation. I am optimistic that well before next year's first quarter earnings release, we will be able to report that the ITC litigation is behind us. An initial determination issued last October by the administrative law judge handling the case was overwhelmingly in GSI's favor, effectively ruling that GSI has not infringed anybody's service patents related to SRAM. As we previously announced, the administrative law judge handling the ITC case issued the initial determination on October 25, 2012 finding no infringement of the Cypress patents by the accused GSI products. Although the ITC has granted review of the judge's initial determination and remanded the case to the judge to consider our further claims that the patents are invalid and unenforceable, we believe that the full ITC will uphold the judge's favorable determination, with the final ruling now expected in June. Legal expenses could again become substantial; depends on the final outcome of the ITC proceeding and whether Cypress chooses to proceed with other patent litigation, which has been stayed during the ITC proceeding.

Whatever the outcome of the patent litigation with Cypress, we will continue to incur legal expenses, although to a lesser extent as we pursue our antitrust lawsuit against Cypress in which we have alleged that Cypress has conspired to monopolize the market for high-performance SRAMs. We have never shied away from competing with Cypress on the basis of technology and performance. Nor have we shied away from aggressively countering their baseless complaint before the ITC. Of course, their misleading and defamatory statement surrounding the complaint has presented a challenge -- and is clear that to some extent they have succeeded in intimidating existing and prospective GSI customers. Sales have been adversely affected and regaining that lost business will take time. With that, I'll now turn the call over to Doug.

Douglas M. Schirle

Thank you, Lee-Lean. The quarter ended December 31, 2012 was our 37th consecutive profitable quarter. We reported net income of $844,000 or $0.03 per diluted share and net revenues of $17.5 million for our third fiscal quarter ended December 31, 2012 compared to net income of $991,000, $0.03 per diluted share and net revenues of $20 million in the comparable period a year ago. In the prior quarter ended September 30, 2012, we earned $1.1 million or $0.04 per diluted share and net revenues of $16 million. For the 9 months ended December 31, 2012, net income was $2.9 million or $0.10 per diluted share, and net revenues were $50.3 million compared to net income of $5.9 million or $0.20 per diluted share and net revenues of $63.8 million the first 9 months of fiscal 2012. Gross margin was 42.4% compared to 43.9% for the comparable period of fiscal 2012. Third quarter direct and indirect sales to Cisco Systems were $6.5 million or 37% of net revenues compared to $4.9 million or 30.6% of net revenues in the prior quarter, and $9.9 million or 49.5% of net revenues in the same period a year ago. Military defense sales, 11% of shipments compared to 7.4% of shipments in the prior quarter, 6.3% of shipments in the comparable period a year ago. SigmaQuad sales were 33.7% of shipments compared to 33.9% in the prior quarter and 32.1% in the third quarter of fiscal 2012. Third Quarter Fiscal 2013 operating income was $595,000, or 3.4% of net revenues, compared to $1.5 million, or 9.4% of net revenues from the prior quarter and $683,000 -- $687,000 or 3.4% of net revenues a year ago. Total operating expenses were $6.7 million, compared to $5.7 million in the prior quarter, and $8.1 million a year ago. Research and development expenses of $2.9 million were unchanged from the prior quarter and slightly higher than the $2.6 million reported a year ago. Selling, general and administrative expenses was $3.9 million compared to $2.8 million in the prior quarter and $5.5 million in the third quarter of fiscal 2012. Included in SG&A during these periods were respectively $1.1 million, $323,000 and $2.9 million for litigation-related expenses. Total third quarter pretax stock-based compensation expense is $565,000 compared to $560,000 in the prior quarter and $532,000 in the comparable quarter a year ago. For the 9-month period, total pretax stock-based compensation was $1.7 million in fiscal 2013 compared to $1.6 million in fiscal 2012. At December 31, 2012, we had $65.6 million in cash, cash equivalents and short-term investments, $31.6 million in long-term investments, $87.8 million in working capital, no debt and stockholders' equity of $130.4 million. Accounts payable at December 31 was $3.7 million, down from $5.5 million at March 31. Net inventory was $15.2 million at December 31, down from $16.7 million at March 31. Inventory turns at December 31 were 2.7x compared to 2.4x at March 31. Depreciation and amortization expense was $576,000 for the quarter. Under our expanded repurchase program, we were authorized to repurchase up to a total of $20 million of our common stock from time to time on the open market or in private transactions. Specific timing and amount of the repurchases will be dependent on market conditions, the securities law limitations and other factors. The repurchase program may be suspended or terminated at any time without prior notice. During the quarter ended December 31, 2012, we repurchased 97,438 shares at an average cost of $4.84 per share. To date, we have repurchased a total of 3,631,230 shares at an average cost of $3.89 per share for a total cost of $14.1 million. We currently expect net revenues in the fourth quarter of fiscal 2013 to be in the range of $15.6 million to $16.6 million, with gross margin of approximately 43%. We also expect that ongoing legal expenses related to the patent litigation and antitrust litigation will continue to affect our operating income and our bottom line. These expenses are difficult to forecast, but we currently estimate that they will be approximately $750,000 in the fourth quarter. Operating expenses in total are expected to be approximately $6.5 million.

Operator, at this point, we'll open the call to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Tristan Gerra with Robert W. Baird.

Daniel K. Marquardt - Robert W. Baird & Co. Incorporated, Research Division

This is Daniel Marquardt on Tristan's behalf. I wanted to see if you can talk about the developments since last quarter with regard to opportunities from Samsung's exit from SRAM.

Didier Lasserre

We've kind of discussed this in the past, and it's going to be a similar story, which is, Samsung was shipping up until a few weeks ago and we certainly believe that there's -- parts are still being shipped and inventory out in the channels on the Samsung parts and certainly some of the larger OEM customers, from what we understand, are also getting extended terms as far as that goes. I have had some discussions actually with some of our -- I'll call them chip partners, other folks that sell chips into our OEMs that our parts interface with, and they have said that there's been some dialogue with those customers looking to second-source Samsung. So it looks like right now they -- they certainly still have enough Samsung inventory to carry them on, and my guess is, that we'll start seeing some of that business in the next few quarters ahead.

Daniel K. Marquardt - Robert W. Baird & Co. Incorporated, Research Division

All right. And then in terms of your primary competitor, Cypress, they had a pretty dismal quarter from a SRAM perspective, and you had 2 positive comps since going in military. Any sense that there's -- that, that could be share shift? Or is this just a timing thing?

Didier Lasserre

No. So certainly, if you look at Cisco, one of them was in an upside on a part that's a significant socket at Cisco that we actually do not share with Cypress, so it certainly wasn't any shift from anybody else to us. From everything we've gathered, it was just upside from Cisco, and I say upside; it was completely unforecasted, so it was a surprise to us in the quarter. The other bump that we got from Cisco during the quarter was a 90-day pull. So if you're familiar with the hub model, we can send material into the hubs and if they haven't been used within 90 days, the parts get pulled. So we've had actually a fairly significant 90-day pull that happened within the quarter, which had nothing to do with market shifts. And military, it was actually just a return to where we've been. We've historically run about 10%, 11%, 12% of our revenues in military. And in the September quarter, we had dropped down to 7.4%, so that was unusual. So again, I think the return to military is just where we have been in the past, and I don't see it being much of a share shift at this point.

Operator

Our next question comes from Raji Gill with Needham and Company.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

The OpEx associated with the litigation -- the ongoing litigation, I know that you can't kind of specify a range, but it seems like you're kind of nearing completion. You only have maybe 4 or 5 months left. Should we expect kind of an additional $750,000 a quarter related to that, or should we kind of taper that legal expense down? Just curious to see how you think about that. And also, your lawsuit against them, what does that do to the overall legal expenses?

Douglas M. Schirle

Okay, so for the March quarter, where we're forecasting $750,000; almost all of that is related to our antitrust litigation. Very little of it is related to the ITC litigation with Cypress. The ITC litigation hit close to $3 million for a couple of quarters in the recent past and then you're right; that for the most part, it's behind us. We don't expect a lot of spending there. But the antitrust litigation is a much more lengthy process in terms of time than ITC activity. That could go on -- probably not hit trial until the first half of calendar 2014. So I wouldn't expect $3 million a quarter, but I certainly would expect something more than a few hundred thousand dollars. It all depends on the activity within a particular quarter; what activity is going on. Last 2 quarters have been more expensive than previously, because of the data gathering, going through analyzing our data. This quarter, it's deposition-related, but it really depends on the nature of the activity going on in any quarter. It really is hard to estimate what it is. I'd hate to throw a number out there, because even the attorneys can't tell me what to expect. But I can certainly tell you that it won't be $3 million a quarter, but I suspect it will be several hundred thousand dollars a quarter, potentially more.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

No, that was helpful. And Didier, on the common equipment market, there's been some relatively positive data points in the common equipment space whether it's semiconductor companies or actually service providers or other suppliers in this space. They're indicating some sort of rebound, perhaps, in the kind of U.S. carrier CapEx spend, Chinese spending, and even on the enterprise side. You're very tied to Cisco, and particularly on a certain program at Cisco, but any kind of insight on how you kind of look at the ramp at Cisco and the overall market going forward as we go into the second half?

Didier Lasserre

Yes. I've certainly heard similar rumblings, which is the rebound in the second half of the year, and we're certainly hoping to see that as well. Specifically, to talk about Cisco, or Huawei, or what have you, is difficult, but certainly where we see the most upside is from Alcatel. We've discussed in the past the 7750, which is their edge router and their 7950, their entry into the core routing business. We have significant content on both those platforms and those are platforms that really have not kicked in yet, though Alcatel has announced on the 7950, they've had 2 wins in Verizon and Telefonica most recently. And so we anticipate that, that should take off some time and we're certainly hoping it's going to take off sometime in the June quarter, but it's hard to anticipate if it's going to or not, but certainly by the second half of this year, we should see that take off. So in general, I do see the optimism as well in that market space certainly projecting our revenues for the second half of this year.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Now, the win in Alcatel Lucent, was that a market share gain? Or was that -- can you describe how you got the Alcatel Lucent? And if it was a market share gain, against who?

Didier Lasserre

Right.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Was it an existing program that they're ramping?

Didier Lasserre

No. So it's a new program, a new platform. It actually uses a few different SRAMs. But one of them is the SQ3, which is unique to GSI. We're the only one that offers it. There's also a few other sockets on there as well that we'll be sharing with other competitors. But on the SQ3, which is on both platforms, both the 7950 and the 7750, we are sole-source. So certainly that will be a new program, not a market shift.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

And on the ASPs, any range there you can provide?

Didier Lasserre

Certainly much higher than corporate average, which -- corporate average this past quarter was over $15, so we actually cracked $15 for the first time in the history of our company. In fact, if you track our ASPs, they pick up about $1 a year, and we're up to over $15 now and the ASPs on the families we're talking about for these platforms are much higher than that.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

And any update on the LLDRAM opportunity?

Didier Lasserre

So the LLDRAM, as we discussed last time, there was one last little fix that we're making, which has been made. We've actually closed our first major design win at 1 of our top 5 customers, which will start kicking in, in the June quarter. We've also had a few sockets that have opened up. Certainly, I think that some of the calls were being put on hold until some kind of feedback from the ITC course. Even though the LL has absolutely nothing to do with the case, it's not an SRAM, but some of the companies were still waiting to see what was coming back. And certainly with the very positive favorable ruling we got in October, some of those call sockets have been opened. In fact, our -- one of our single largest opportunities that we've been tracking for some time, the call window has just opened and we should start the call in April timeframe. It's not clear how long it'll take. It could take a couple of quarters, but it's going to be our -- certainly our single largest design win that will significantly increase the revenues of that family.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Just last question for me. You talked about the fact that you had lost some business because of the lawsuit and that you felt that Cypress might have hurt itself and its customer base due to the lawsuits. So I was just wondering if you're seeing any recovery in business from any of those customers that you supposedly said you lost business to?

Didier Lasserre

Some yes and some no. So, some yes -- certainly I think even though the case isn't finalized; again, the initial determination was so one-sided, I think they feel comfortable going forward. And so those customers that are free to do so, I think are starting to make those decisions and we're starting to see the momentum. The ones that aren't are the ones that still have signed agreements with Cypress. And from what we gather -- and, again, we've not been privy to these agreements, but our understanding or certainly our belief is that these are -- these agreements are contingent on the final determination. And so those customers we won't see that return of revenue until the final determination comes out and obviously in our favor.

Operator

[Operator Instructions] We'll take our next question from Mike Crawford with B. Riley.

Michael Crawford - B. Riley & Co., LLC, Research Division

With the LLDRAM part that you're sampling now, does that already operate at 533 megahertz with 15-nanosecond latency, or is that something to come in the future?

Didier Lasserre

No, we have it now. So the family -- so there's 2 densities, the 288 meg and the 576 meg, and there's 4 different speed grades. You have the low-end, which is the 333 megahertz and the 400 megahertz at 20-nanosecond latency and you have the higher end, which is the 400 megahertz and the 533 megahertz at 15 nanosecond latency. So we offer all 4 of them. In fact, I believe we are the only 1 that have all 4 that have been shipping all along. So the answer is, we have them now and that single largest opportunity I mentioned earlier is the high-end 533 socket.

Michael Crawford - B. Riley & Co., LLC, Research Division

Didier, in the past you've talked about this product enabling as much as $10 million a quarter in revenues for GSIT. I'm wondering if that's -- continues to be the belief and if so, once customers start to take volume deliveries of production, is that something that could ramp up all in 1 quarter or is that going to take a couple of years to get to that level?

Didier Lasserre

No, it's going to take some time. Certainly that's still our goal, but it will take time. Again we've -- we started some of the calls now as I mentioned. A lot of them were on hold due to the ITC, and so some have been released now. So it will take a few quarters for some of them to happen. We still have a couple of large sockets out there that we haven't received a call window opening yet, and so those will take longer. So the answer is, we're going to have to build up to that, and it could take a little bit of time, but you'll start seeing -- as we exit this calendar year, you'll start seeing revenues coming from this family.

Michael Crawford - B. Riley & Co., LLC, Research Division

Okay. And then back to the SQ3. So that's being used for core router and edge router. And is there a way to quantify potential impact to GSIT based on the demand you see for those products?

Didier Lasserre

Yes. So we've been given forecasts in the past that certainly the deployment of these platforms have taken some time, and so I really don't want to go off those forecasts, because I don't want to lead you down a path that may not happen. And certainly, they're very rosy forecasts. And so the answer is, they -- when these kick in, as they kick in to the degree that we're being told from the OEM, it will be significant. It will be significant revenue for us. I just can't -- I can't or I don't want to share those forecasts because they're not hard orders yet, and until that happens, it's too dicey.

Michael Crawford - B. Riley & Co., LLC, Research Division

Okay, great. And then just to go back to Samsung one last time. So there's going to be Samsung SRAMs swimming around in the markets for you think, just a year ago or for several years? Or when do you think you're not going to see Samsung SRAMs really available in any meaningful amount for -- as an option for customers?

Didier Lasserre

So I think it depends on the customer and the socket. I think some sockets will use military, for instance, and maybe some automotive sockets, but certainly military where they tend to be single-source. But those customers, the qualification is so difficult that they will, instead of qualifying another supplier, they will do a lifetime buy. So there will be some sockets that none of us, the remaining SRAM suppliers will see. They'll do a lifetime buy and they're gone. The other portion of the market where they're going to continue to purchase -- it won't be years. No, I don't see that happening. But certainly, the shipment that Samsung made at the end of the year for the majority of the customers and the shipments they're still making for a small portion of their customer base will, I think, will keep Samsing material in the market, certainly for the next 2 to 3 quarters.

Operator

There are no further questions at this time. I'd like to turn the conference back to our speakers for any additional or closing remarks.

Lee-Lean Shu

Thank you all for joining us. We look forward to speaking with you in May when we will report our fourth quarter and year-end results. Thank you.

Operator

That concludes today's conference. Thank you for your participation.

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