Techwell, Inc. Q4 2008 Earnings Call Transcript

Techwell, Inc. (TWLL)

Q4 2008 Earnings Call

February 5, 2009 5:15 pm ET

Executives

Beverly Twing – Shelton Group Investor Relations

Mark Voll – Chief Financial Officer, Vice President Finance and Administration

Fumihiro Kozato – President, Chief Executive Officer & Director

Analysts

Quinn Bolton – Needham & Co.

Tore Svanberg – Thomas Weisel Partners

Christian Schwab – Craig-Hallum Capital Group

Chris Chaney – Stanford Group

Presentation

Operator

Welcome to Techwell’s fourth quarter and full year 2008 financial results conference call for the period ended December 31, 2008. My name is [Misal] and I will be your coordinator for today. At this time all participants are in listen only mode. We will be conducting a question and answer session towards the end of this conference. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Ms. Beverly Twing.

Beverly Twing

Welcome to Techwell’s fourth quarter and full year 2008 financial results conference call. The press release and financial tables associated with today’s conference call were distributed after the close of the market today. If you do not have a copy you may find them on the company’s website at www.TechwellInc.com. This call is being broadcast live over the Internet and may be accessed in the investor relations of Techwell’s website.

Before management begins the discussion of the fourth quarter’s results, I would like to remind you that this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which include without limitation statements that relate to future events and include but are not limited to the company’s belief that demand for its products will continue to grow, the company’s ability to better address customer requirements, leverage technology capabilities and to integrate additional functionality and achieve greater market share.

Statements relating to future opportunities, it’s anticipate revenue, gross margin and operating expenses for the first quarter of 2009, future operating trends and its operating performance in 2009, anticipate effective tax rate for the full year 2009, future product introductions, future objections and anticipated trends and growth in the company’s business and end markets in which it operates.

Any forward-looking statements made during this call are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information containing factors that could cause actual results to differ materially from any forward looking statements made during this call are contained in the company’s written earnings release and in the company’s quarterly report on Form 10Q filed with the Securities & Exchange Commission on November 6, 2008.

Techwell undertakes no obligation to publically update any forward-looking statement for any reason except as required by law even as new information becomes available or other events occur in the future. Thank you for your time and attention. I will now turn the call over to Mark Voll, Techwell’s Chief Financial Officer.

Mark Voll

Welcome to our fourth quarter and full year 2008 financial results conference call. With me today is our Chief Executive Officer Hiro Kozato. I will begin today’s call with a review of our quarterly financial results as well as provide a summary of our full year. We will then provide our business outlook for the first quarter of 2009. Following my remarks Hiro will provide an update on our business. We will then open the call for a question and answer session.

Please keep in mind that all reported financial results, unless otherwise noted are presented on a GAAP basis. For the fourth quarter ended December 31, 2008 we reported total net revenue of $16.5 million as we had projected in our revised guidance for the quarter. Total net revenue for the fourth quarter compares to $16.5 million in the same period a year ago.

Total net revenue in the fourth quarter of each of our product lines consisted of: security surveillance revenue of $13.8 million; representing 84% of total net revenue; LCD display revenue of $1.4 million or 8% of total net revenue; video decoder revenue of $1.3 million or 8% of total net revenue; and other revenue of approximately $9,000.

Security surveillance revenues grew 12% year-over-year and declined 4% sequentially. LCD display revenue declined 12% year-over-year and 30% when compared to the third quarter. Video decoder revenue declined 49% when compared to the same period last year and 39% sequentially. In the fourth quarter we had one customer that represented more than 10% of total net revenue.

Sales to our distributor in China represented 43% of revenue in the quarter which includes shipments to multiple end customers with no single end customer representing 10% or more of total net revenue. Combined, our 10 largest customers represented 83% of total net revenue in the quarter of which eight of these customers are distributors.

For the full year 2008, total net revenue increased 13% to $67.6 million compared to $59.9 million in 2007. Our revenue growth was driven by the strength of our security surveillance business which grew 30% during the year. Gross margin for the fourth quarter was 62% and continues to exceed our long term target of 55%. This compares to gross margin of 61% in the fourth quarter of 2007, 63% in the prior quarter.

During the fourth quarter 66% of our total net revenue came from products fabricated in .18 micron, up slightly from 65% in the prior quarter. We expect the percentage of our revenue fabricated in .18 micron will continue to increase throughout 2009. Total operating expenses for the fourth quarter of 2008 were approximately $8.5 million representing 52% of total net revenues.

This compares to operating expenses of $8 million or 43% of revenue in the third quarter of 2008 and $7.2 million or 44% of revenue in the fourth quarter of 2007. Of the $8.5 million of operating expenses in the quarter research and development expenses accounted for $4.9 million or 58% of our total operating expenses and included more than $1 million in tape out expenses for new product development. Operating expenses also include approximately $1.8 million of pre-tax stock-based compensation expenses.

Net income for the fourth quarter totaled $1.6 million or $0.07 earnings per diluted share. Net income includes pre-tax stock-based compensation expenses of approximately $1.9 million equating to a $0.09 per dilute share charge. Fully diluted earnings per share for the quarter were calculated using 22,050,000 shares. Earnings per diluted share of $0.07 for the fourth quarter compares to $0.19 in the fourth quarter of 2007 which included a tax benefit of $438,000.

The decline in our fourth quarter 2008 net income as compared to the prior year period was due to a decrease of more than $350,000 in non-operating income as we recorded $480,000 of interest income in the fourth quarter of 2008 compared to $854,000 of interest income in the same quarter last year. The reduction in non-operating income reflects lower interest rates available on cash, cash equivalents and investments.

Our tax rate for the fourth quarter was 30%. This tax rate was lower than in prior quarters during the year as we were able to realize all of our research and development tax credits for 2008 in the fourth quarter.

Now, turning to the balance sheet. Accounts receivable were $2 million at the end of the fourth quarter compared to $2.4 million at the end of the third quarter. Historically, we have sold on credit terms only to OEM customers and a result our accounts receivable balance has been low in comparison to overall revenue. In the fourth quarter revenue from direct sales to OEM represented 18% of our revenues while sales to distributors represented 82% of our revenue.

Inventory as December 31, 2008 was $4.8 million, decreasing from $6 million at the end of the third quarter 2008. Cash, cash equivalents in both short and long term investment balance as of December 31, 2008 was approximately $81.4 million compared to $77.3 million as of September 30, 2008 and $68.4 million as of December 31, 2007. The sequential increase in cash, cash equivalents and investments is a result of approximately $4.1 million in cash provided from operations in the fourth quarter.

Our cash, cash equivalents and investment balance at the end of the year of $81.4 million represents cash per diluted share of $3.69. At the end of the fourth quarter we had 165 employees, 78 of which are in research and development.

In terms of guidance for the first quarter of 2009 we expect the environment in each of our markets will remain challenging and as a result we expect total revenue to be in the range of $10 million to $11 million. We anticipate gross margins for the first quarter to remain comparable to our fourth quarter results although down slightly due to the lower sales volume. In response to the weakening economy, we have taken measures to reduce expenses which will result in operating expenses for the first quarter of between $5.75 and $6.25 million excluding stock-based compensation expenses.

We estimate that our effective tax rate throughout the full year of 2009 will be approximately 35%. As a result, we anticipate that we will continue to generate positive non-GAAP net income throughout 2009. This concludes my prepared remarks, now I will hand the call to Hiro for additional comments.

Fumihiro Kozato

As our results indicate, the first quarter was certainly challenged for Techwell. Based on the feedback we received, end customers have significantly cut back orders here in the first quarter and as a result there has been a buildup in inventory at our customers’ factories. The slowdown has been across all geographies but was most evident with our customers who target the [volume] segments of the market including retail and consumer.

While we believe the security surveillance market will outperform the broader economy in to ’09 due to its exposure to government infrastructure spending. It is clear the economic downturn is having an impact on our surveillance customer base especially as we look in to the first half of ’09. On a more positive note, in December we successfully launched our TW2880 multi-channel HD multiplexer and display controller at the China Public Security Show in Beijing.

Last week I had the opportunity to review a design in progress with ours sales team and I am very happy to report that we have already secured over 10 design wins with our leading surveillance customers. Although it is too early to quantify the exact impact of these design wins on our financial performance, this early success indicates our TW2880 will be well accepted in the market. It also shows that we can continue to successful leverage our leadership position in the mixed signal video decoding segment and integrate additional functionality.

This addition functionality allows us to raise our ASPs as well as address a larger portion of the security surveillance semiconductor market. The TW2880 should start shipping late in the third quarter and we anticipate customers commencing mass production in the fourth quarter. We also have an additional higher ASP product for the four and eight channel segments enter in the market early in the second quarter.

We would expect our ability to begin increasing ASPs for four, eight and 16 channel systems in the second half of the year which will allow us to partially offset the expected weakness in the surveillance market.

Due to the lack of visibility, we will not be providing full-year 2009 revenue guidance, however, I believe our security business should be roughly flat in to ’09 with the first half remaining very challenging but revenue growth occurring in the second half of the year due to the new products going in to mass productions combined with the strength from our customers in China.

With respect to our automotive entertainment business we saw a steep drop off in orders as automotive manufacturers significantly cut back on production. I think everyone is aware of the challenges facing the automotive manufacturers and it is safe to say that our business in this market will continue to be difficult until the market rebounds. However, the design win momentum we have achieved over the last year is beginning to turn in to volume shipments.

While we remain very cautious in light of the market conditions, initial estimates for 2009 from our sales team are that we should be able to sustain our automotive entertainment business at the same level achieved in 2008. This is largely based on the fact that more LCD displays are being added in to cars each year and we have a significant share of the new models. This is particularly evident in the front console and navigation units as well as rear seat entertainment displays and more recently with rear view mirror displays for back up camera applications.

Although automotive production volumes will likely be down 50% this year, touch rates are growing significantly offsetting a large portion of the current market construction. We look forward to announcing a number of these design wins throughout the year, once our customers are comfortable disclosing the projects.

Now, turning to our consumer business, we have largely executed this market and strategically chosen to focus on our two core markets security surveillance and automotive entertainment. As a result, we will expect revenues from legacy general purpose media decoder product that we sell in to advance TVs and other consumer electronic applications to continue to decline given market conditions in the consumer space, I would expect this business to be down significantly in 2009.

In closing, we expect our results in the first quarter of 2009 will reflect continued weakness in the global economic environment and as a result we have implemented strict controls over discretionary spending in order to maintain profitability during this time. We believe that revenues will improve beyond the first quarter as we expect demand to recover and our end customers’ inventories to be depleted.

We expect to be profitable in the first quarter on a non-GAAP basis and be able to grow the profits sequentially each quarter in 2009. In addition, we anticipate that we will maintain similar gross margin in 2009 as compared to 2008. To that end, we are working closely with our foundry partners on several fronts in order to keep our unit costs down. This will allow us to maintain high margins while passing along some savings to our customers.

In particular, we are taking advantage of the current environment to extract better wafer pricing. In addition, with our migration to .18 micron now largely complete we have turned our focus to migrating our mixed signal product to .13 micron and 90 nanometer. I believe that given our leadership positions in our two core markets and our robust product roadmap combined with our continued profitability and strong balance sheet will enable Techwell to weather this economic downturn and be well positioned when the markets recover.

That concludes my prepared remarks. Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Quinn Bolton – Needham & Co.

Quinn Bolton – Needham & Co.

I was just wondering if you could go in to a little more color if you have it on sort of where you think inventory levels are especially in the security surveillance channel it sounded like you felt that segment of the business would remain tough in the first half of the year so I’m just wondering if you have a sense of how much excess of inventory there is out in the channel and how long you think it takes to work off? Do you think we’re done by the end of the first quarter or do you think it’s going to continue in to the second quarter before that inventory is worked down?

Fumihiro Kozato

Regarding the security market we think the inventory level overall worldwide will be approximately two months and we think in China they’ll probably have a little less inventory compared with Taiwan and other territory. We think Taiwan has more inventory then other territories at this moment due to the exposure to more retail and consumer segments.

Quinn Bolton – Needham & Co.

Hiro, if there’s two months of inventory across the channel, how does that compare to normal? Is that two months of excess inventory or is it two months of inventory and usually there’s one month in the channel?

Fumihiro Kozato

Usually about one month but this time we’ve seen an extra two months in inventory.

Quinn Bolton – Needham & Co.

So it’s an excess of two months?

Fumihiro Kozato

Yes.

Quinn Bolton – Needham & Co.

So it’s unlikely then you’ll probably burn it all off in the first quarter?

Fumihiro Kozato

Yes, at the end of the first quarter we are seeing some forecast in Q2 of the new orders.

Quinn Bolton – Needham & Co.

So you start to see the order activity coming back in Q2?

Fumihiro Kozato

Yes.

Quinn Bolton – Needham & Co.

Then just sort of moving on, you had mentioned I believe some new four channel and eight channel parts entering the market in the second quarter. Are those just sort of slimmed down versions of the 16 channel?

Fumihiro Kozato

No, it’s totally a different chip. It’s specially designed for the low cost, low end four channel market.

Quinn Bolton – Needham & Co.

Are these video decoders or are these MUX parts?

Fumihiro Kozato

It’s decoder, MUX and VGA output graphics. So, it has additionally functionalities.

Quinn Bolton – Needham & Co.

And you said that with those new parts you think you get a bump in ASPs as they enter the market?

Fumihiro Kozato

Yes, for the four channel market.

Quinn Bolton – Needham & Co.

Then just lastly, with the gross margins obviously you’re seeing a pretty big drop in revenue from the September quarter down to the first quarter. It didn’t look like volume or absorption issues hit gross margin that much in Q1. When you say down slightly Mark, is that sort of 100 basis points or is there any more range you could put on the gross margin decline?

Mark Voll

I would say 100 to 200 basis points, somewhere in that range?

Quinn Bolton – Needham & Co.

Just the last one for me, I know tape out expenses were high, in the fourth quarter it looks like your taking the op ex down by about $500,000 at least in terms of the guidance last quarter to this quarter. Is that mostly tape out or can you just give us a sense of how much tape out is still in the first quarter guidance?

Mark Voll

A significant portion of that reduction will be in tape out so we expect that tape out expenses in the first quarter should be approximately $400,000.

Operator

Your next question comes from Tore Svanberg – Thomas Weisel Partners.

Tore Svanberg – Thomas Weisel Partners

Hiro, could you talk a little bit more about the 2880? You mentioned 10 design wins, can you just compare that with maybe some other major product introductions you’ve had historically just so we get a sense of how successful that product is so far?

Fumihiro Kozato

So far I think this is the biggest hit product we ever had before. It has lots of functionalities and of course, with much higher ASP. It’s a very powerful chip for 16 channel market. It has video decoders, MUX and many special features and [scale installations]. Basically it’s everything except backend codec compression chip.

Tore Svanberg – Thomas Weisel Partners

On the four and eight channel lower cost products coming out, since that’s going after the lower end part of the market in China, would you start to see some revenues already there by the end of the year or would it have to be 2010?

Fumihiro Kozato

We believe that we will see some revenue at the end of the year not only from China, we will see revenues from Korea and Taiwan too.

Tore Svanberg – Thomas Weisel Partners

So all the three higher ASP products will contribute to revenues by the end of the year?

Fumihiro Kozato

Yes.

Tore Svanberg – Thomas Weisel Partners

And you mentioned the consumer video business declining a lot this year, when does that business basically go away? Will it be near term or will it still generate revenues in Q4 of ’09?

Fumihiro Kozato

It will not go away completely but I expect the revenue to drop more than 50% this year overall.

Operator

Your next question comes from Christian Schwab – Craig-Hallum Capital Group.

Christian Schwab – Craig-Hallum Capital Group

Hiro, I think you said earlier that although you weren’t providing yearly guidance, you expected the security and surveillance business to be flat on a year-over-year basis. Did I hear that correct?

Fumihiro Kozato

Yes.

Christian Schwab – Craig-Hallum Capital Group

So I’m just trying to figure out the math there given the economy and two months of excess inventory in security and surveillance sales that probably dropped to $8.5 to $9 million in March to come back and average in the next three quarters well above $13 million to get you back to almost $53 million in sales seems a significant stretch. What am I missing?

Fumihiro Kozato

First of all, we were told by many of our major customers that starting from Q2 the quantity, the unit shipment would increase starting from Q2. That’s one reason. Another reason is from second half of this year we’ll be shipping the much higher ASP product. These two reasons will offset the ASP drop.

Christian Schwab – Craig-Hallum Capital Group

Can you give us an apples-to-apples comparison then on the second half of ’08 to the second half of ’09, what you expect your average ASP to be per chip, the increase?

Fumihiro Kozato

We are not quoting the new products yet.

Christian Schwab – Craig-Hallum Capital Group

Just a broad directional range, is it going to be $4 more, $10 more?

Fumihiro Kozato

Overall, I would say 15% to 20% higher ASP overall.

Christian Schwab – Craig-Hallum Capital Group

In the second half of ’09 versus what you shipped in the second half of ’08?

Fumihiro Kozato

Yes.

Christian Schwab – Craig-Hallum Capital Group

So, if we look at that you think that quarterly revenues in security and surveillance will exit calendar 2009 high teens run rate?

Fumihiro Kozato

It’s difficult to say. We have many different products so overall I would say mid teens.

Christian Schwab – Craig-Hallum Capital Group

So exit the year at kind of $14 to $16 million quarterly run rate?

Fumihiro Kozato

You mean quarterly revenue?

Christian Schwab – Craig-Hallum Capital Group

Yes.

Fumihiro Kozato

Sorry, I thought you talking about the unit cost. Run rate we think we should go back to last year’s Q3 level.

Christian Schwab – Craig-Hallum Capital Group

So you think that you could exit December at kind of $14.4 million in quarterly revenue give or take?

Fumihiro Kozato

I believe it should be better than that?

Christian Schwab – Craig-Hallum Capital Group

So let me ask it again, so you would assume that you’re going to be at the high teens call it $16 to $19 million quarterly run rate in December?

Fumihiro Kozato

I believe so, yes. Between $16 to $19 million, yes.

Operator

Your next question comes from Chris Chaney – Stanford Group.

Chris Chaney – Stanford Group

On the ASP pressure I’m just wondering are you seeing pressure in the first half of the year on ASPs and when the 2880 begins to sell what is the relative price? When the ASPs go up will that unit be double what the others are on average?

Fumihiro Kozato

If you compare the chip to chip, the ASP would definitely double. But, the new 2880 will be also replacing our current chips so overall I would not say the ASP would double.

Chris Chaney – Stanford Group

Is there a danger of cannibalization then?

Fumihiro Kozato

Yes. But, at the same time we are attrition in the 16 channel market that we never really had before so it’s difficult to quantify the ASP at this moment.

Chris Chaney – Stanford Group

I guess kind of a follow on with that, on the automotive space my reckoning the gross margins for those devices were a little lower than the average for the company and with that being perhaps weaker this year would that actually help to boost gross margin a bit?

Mark Voll

The mix will be more positive from an overall gross margin standpoint, correct.

Chris Chaney – Stanford Group

Finally on the first quarter bookings, how much of that quarter do you think is booked? And then how do you feel about that $10 million to $11 million number?

Fumihiro Kozato

We feel comfortable in the $10 to $11 million range.

Chris Chaney – Stanford Group

How does the bookings for that quarter, the Q1 compared to past quarters for instance?

Fumihiro Kozato

Bookings is a little worse than our usual bookings.

Chris Chaney – Stanford Group

Any way to quantify that? Do you have 50% of it booked?

Fumihiro Kozato

It’s difficult to quantify that. Usually we’ll have something like one and a half months booking. We are seeing a little less in Q1 but we are very comfortable on the $10 to $11 million range.

Operator

Your next question comes from Christian Schwab – Craig-Hallum Capital Group.

Christian Schwab – Craig-Hallum Capital Group

Hiro, just a few follow ups to the gentlemen’s questions right before me, said another way, what type of turns do you typically have to have to hit the midpoint of your guidance, and what type of turns are you assuming this quarter?

Mark Voll

We typically have half of the business in backlog when we go in to a quarter and we have less than that now.

Christian Schwab – Craig-Hallum Capital Group

So you’re going to need increased turns to get to the midpoint?

Mark Voll

Right.

Christian Schwab – Craig-Hallum Capital Group

If the world goes exactly as you guys hope and the mix goes the way it would suggest being heavily dominated by security and surveillance exiting 2009, what would be your gross margin target?

Mark Voll

I would say that we would be approximately 60% overall gross margins?

Christian Schwab – Craig-Hallum Capital Group

60%?

Mark Voll

Yes.

Christian Schwab – Craig-Hallum Capital Group

So less than what we’re guiding for Q1?

Mark Voll

Yes.

Christian Schwab – Craig-Hallum Capital Group

Why would that be?

Mark Voll

We anticipate that we’ll have some ASP pressure throughout the year and that’s perhaps a little bit stronger than we’ve seen historically.

Christian Schwab – Craig-Hallum Capital Group

So we expect greater than historical pressures. So even though we’re selling a chip at initial introduction volume quotes would suggest a huge spike in ASP, you’re assuming that you’ll have to discount that meaningfully from initial introduction pricing to keep sockets in next generation products?

Fumihiro Kozato

Yes. And also, the ASPs for the old products will drop steeper.

Mark Voll

Right. So I don’t think it would be discounts on the new products, I think it will be discounts on the older products.

Operator

Your next question comes from Quinn Bolton – Needham & Co.

Quinn Bolton – Needham & Co.

I just wanted to come back to sort of the guidance for Q1. You’re saying that you’re less booked now for the midpoint of guidance and there’s two months of excess inventory in the channel which would leave me to believe that current order rates are probably pretty low. So, can you just kind of talk about what you’ve seen in terms of say monthly order patterns that give you confidence that you’ll be able to turn greater than 50% other revenue to hit the guidance?

Mark Voll

I think the issue is you’re not going to get orders from a customer if they’ve got some inventory so as they burn off that inventory we believe that based on their forecast, we’ll be able to get those orders in the quarter.

Quinn Bolton – Needham & Co.

So you’re not necessarily basing the guidance on current orders, you’re basing it on forecasts and your conversations?

Mark Voll

I would say forecast that we have sort of discounted heavily in the current environment. I think that we feel by putting in that margin we feel pretty comfortable with the guidance.

Fumihiro Kozato

Yes.

Quinn Bolton – Needham & Co.

Maybe I could just ask it coming at a different way, based on kind of the weekly turns business, you’re seeing today rather than looking at forecasts and things like that, are you kind of comfortable with the level of turns on a weekly or monthly basis that would kind of get you to the guidance range?

Fumihiro Kozato

Yes, we are.

Operator

At this time there are not additional questions in the queue. I will now pass the call over to Mr. Mark Voll for any closing remarks.

Mark Voll

We encourage you to visit our website at www.TechwellInc.com to view our latest announcements as well as our calendar of events. Later this month we will be presenting at the Thomas Weisel Technology Conference in San Francisco on the 10^th and on the 19^th and 20^th at the Oppenheimer Semiconductor Summit in Vale Colorado. Additionally, if you have questions or would like more information, please contact me directly. Thank you for joining us today.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect.

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