Silicon Image, Inc Q3 2009 Financial Results Conference Call

| About: Silicon Image, (SIMG)

Silicon Image, Inc. (NASDAQ:SIMG)

Q3 2009 Financial Results Call

October 22, 2009 5:00 p.m. ET

Executives

Mike Bishop - IR

Harold Covert - President and COO

Noland Granberry - VP of Finance and CAO

Analysts

Richard Shannon

Operator

Good day everyone and welcome to the Silicon Image's Third Quarter 2009 Financial Results Conference Call. Please note that today's call and question-and-answer session are being recorded. At this time I'd like to turn the call over to Mr. Mike Bishop. Please go ahead.

Mike Bishop

Good afternoon and welcome to the Silicon Images third quarter 2009 financial results conference call. I am Mike Bishop from Silicon Images Investor Relations. Joining me today is Harold Covert the company's President and COO and Noland Granberry the companies Vice President of Finance and Chief Accounting Officer.

The agenda for today's call includes a discussion of third quarter results and a company strategy from Hal and a more in debt discussion of financial results from Noland followed by a financial performance estimates for the fourth quarter.

We will then open the call for Q&A. Before I turn the call over to Hal let me remind the listeners that we will be making forward looking statements based on our current expectations during the call regarding many aspects of our business and the markets in which we operate.

Including but not limited to forward-looking statements about our operational infrastructure improvement efforts and the anticipated impacts of those efforts on our business going forward. Our future products and their anticipated benefit the timing of new product introductions average selling prices design wins market demand for our products and our financial results and performance. Our actual results may differ materially from our forward looking statements.

Moreover our forward looking statements and the company's future results are subject to certain risks and uncertainties which we described in today's press release as well as in our filings with the SEC including but not limited to our most recent periodic reports on forms 10-K and 10-Q. These documents describe certain relevant risk factors that could affect our future results.

I also want to mention that we have provided a financial metrics and a reconciliation of non-GAAP financial information to GAAP information in our third quarter 2009 financial results press release which is available on the investor relations section of our website at siliconimage.com.

I'll now turn the call over to Harold.

Harold Covert

Thanks, Mike. Good afternoon and thank you for participating in our conference call today. I will discuss the following topics before turning the call over to Noland to cover our financial results for the quarter.

First I'll provide an overview of our projective financial performance for 2009 and related actions at the company plans to take over the next 90 days. Second I'll discuss our preliminary financial goals for 2010 and finally I'll review our product strategy and market strategy.

2009 has been a challenging year for Silicon Image. Product mix changes in the DTV market, internal execution issues and the global economic slowdown have taken a toll on our ability to standardize and begin to improve the company's revenue profile and subsequently enhance shareholder value.

In an effort to position the company to enter 2010 with a sharper focus, on our core product strategy and related programs as well as continue to enhance the efficiency of our operational infrastructure. We plan to take or have already taken the following actions.

By the end of 2009 the company will close its two sites in Germany. We currently have approximately 150 employees in Germany that are primarily focused on R&D activities. In conjunction with these closures the company expects to incur a charge of approximately $15 million in Q4.

The company already took a restructuring charge in the second quarter of this year related to planned, downsizing of our employee base by the end of 2009. We expect a combined charge of $20 million, to have a cash impact of the same magnitude during the first half of 2010 and for this cash impact to be offset for the most part by related income tax refund.

Today the company has approximately 325 employees involved in R&D activities located in four sites, one in the United States, one in China and two in Germany. Starting in 2010, we intend to have R&D site in the United States and one R&D site in China with the combined total of approximately 250 employees by the end of 2010. We believe that this R&D site configuration will enable the company to improve execution, maximizing its overall return on R&D investment.

Next the company made a decision in Q4 to write off its investment in intellectual property acquired in 2007for the development of large scale integrated circuits. Given our current products strategy, which I will discuss shortly. This intellectual property no longer aligns with our product world map.

This decision was prompted by a change in our product strategy due to market place and related competitive dynamics. We expect to incur to non-cash charges of approximately $28 million in Q4 as a result of the slide off.

During Q3 the company incurred expenses of approximately $2 million for professional fees associated with evaluating a potential strategic acquisition which we decided not to pursue.

And finally, the company is evaluating the requirements to record a non-cash charge of approximately $29 million in Q4 to establish evaluation allowance for deferred tax assets currently carrying on our balance sheet. If recorded this charge will be in accordance with general accepted accounting principles and will be triggered to a large degree by the company’s projected GAAP net losses in the fourth quarter of 2009, rising from the fourth quarter actions just discussed.

Provided that this evaluation allowance is required our tax expense over the next few years will consist of foreign and withholding taxes that are projected to be in the range of approximately one to two percentage points of revenue.

In summary for the full year of 2009, the company expects a GAAP net loss in the range of approximately $145 million to $150 million. The following charges and expenses account for the majority of the projected GAAP net loss. $19 million for the write off of goodwill, $28 million to write off intangible assets, $29 million to establish deferred tax assets valuation allowance, $20 million for restructuring charges related to the shut down of our sites in Germany, $10 million for other restructuring charges, $18 million for stock based compensation, $4 million for the amortization of intangible assets and $2 million for professional fees.

All these charges and expenses which add up to a total of $130 million, the $30 million in restructuring charges and $2 million for profession fees will have a negative future cash impact.

From a cash standpoint the company started 2009 with a $185 million in cash and believes that it will end the year with approximately $150 million in cash.

The anticipated reduction in cash for 2009 is primarily due to an increase of approximately $14 million in working capital approximately, $15 million to fund non-GAAP operating losses and approximately $4 million for capital expenditures.

Moving on to 2010, before discussing our preliminary financial goals for 2010 I would like to point out that we are still in the process of developing our annual operating plan. We will complete our bottom of plan process in December and we will provide more definitive information about our 2010 financial goals during our Q4 earnings conference call in February.

Our preliminary financial goals for 2010 are first, establish a lower breakeven point, with the expense reduction activities that we plan on implementing in Q4, we expect to be able to breakeven with approximately $165 million in annual revenue with an overall gross margin of 55%. Our prior breakeven point was approximately 200 million in annual revenue.

Second to breakeven on a non-GAAP basis in Q2, 2010 and be profitable on a non GAAP basis starting in Q3, 2010. Finally to be profitable on a non-GAAP basis for the full year of 2010 and exit 2010 with more than a $150 million in cash. Now I would like to discuss our product and market strategy. Our mission is to develop and standardize technologies and related products that deliver digital contents securely anytime anywhere and on any device.

The company has consistently been recognized as an innovator of discrete solutions offering compelling differentiating functionality at a competitive price. In addition our standard activities help create synergistic eco-systems thereby reducing our customer's risk when adopting new technologies.

When we deliver our products to customers on a timely manner they have embraced our technology in a broad cross section of their overall product line up and the company has generated profit in line with or at the high end of our peer group.

With effective and consistent execution our product strategy is competitive and our business model is financially rewarding. Just as important, we are in a position today to leverage these attributes across our large base of tier one customers on a global basis as we enter into a new product cycle.

This opportunity will be our primary focus going forward in 2010 and 2011. We know that concerns have been raised about the company's product strategy and related business models. These concerns include issues such as lack of product breadth, ASP or average selling price compression, short product life cycles and a near term potential of our products being integrated into an SOC or system on the chip.

All of these concerns are valid at some level. The company has been taking concrete steps over the last two years to address each of these concerns and as a result we believe that we will enter 2010 a stronger company than in the recent past.

The following are highlights of the enhancements that we have made and are continuing to pursue to strengthen our business models. Let's start with products first. As the company enters 2010 we will be shipping four processors receivers and transmitters based on HDMI 1.4, the latest version of the HDMI standard.

The previous version of the HDMI standard was introduced in June of 2007. We believe that silicon image has an opportunity to drive meaningful revenue from HDMI 1.4 IC over next 18 to 24 months.

On September 28, 2009, the formation mobile high definition interface or MHDI working group was announced. The working group consists of Nokia, Samsung, Sony, Toshiba and Silicon Image. This working group is expected to launch the MHDI consortium and release the first version of the MHDI specification in early 2010.

Silicon Image is planning to introduce ICs that include mobile high definition link technology surely after the MHDI standard is announced. The Mobile market which includes smart and future cell phones, digital cell cameras and handy cams, as well as mobile devices is much larger than our current address market. We believe that Silicon Image will be in a position to start general mean for revenue from MHDI ICs starting in the second half of 2010.

The company will also begin shipping new low cost still buying series 3 ICs in 2010 for the PC storage market. In addition to these new products, Silicon Image will continue to expand the deployment of this InstaPort technology introduced in 2009. InstaPort technology has been developed and adopted on a broad range of products offered by most tier 1 HDTV manufacturers.

From a license revenue standpoint we expect to begin revenue from our SPMT or Serial Port Memory Technology that was announced in the second half of 2009 as well as the HDMI 1.4 and MHDMI technologies just discussed. Turning to ASPs and product lifecycles. With the innovator features that our new products provide to our customers we expect to see stabilization in our current ASPs.

We believe that we are well positioned competitively from both a features and price stand point and will continue to achieve our target product gross margin. These factors combined with continuing future price and product enhancements that we plan to provide put silicon image in the stronger position to combat ASP pressure and effectively address the length of our products life cycles on an aggregate basis.

Finally the integration threat. Integration is and always will be a principal attribute of the semi-conductor industry in our opinion, however with our port processor, we believe that we have established the defendable socket that will co-exist with the DTV SOC.

The DTV port processor as represented by latest SIL 9389 device which we are sampling with our customers now alters advanced HDMI connectivity with 5 HDMI ports with InstaPort. Support for the latest HDMI 1.4 features starts as HDMI Ethernet Channel or HEC, Audio Return Channel or ARC and 3D and cross effective solution.

In our view port processors are better suited then large SOC in delivering the latest HDMI innovations at a timely and cost effective manner. We believe that our port processors products will continue to be in place by DTV manufactures as the best solution for introducing differentiating connectivity features such as InstaPort in their latest DTV products.

Before I summarize my comments, I will like to say few words about LiquidHD, LiquidHD is the connectivity vision that the company has been talking about and pursuing for the last two years. This vision encompasses how high definition content will be displayed across personal and broadband entertainment networks in a seamless and simple manner.

We will continue to promote LiquidHD technology as the basis of an industry standard. However, in the near-term our primary focus will be on products that incorporate components of our LiquidHD technology for the DTV, home theater, mobile and PC markets. We expect our products that include LiquidHD technology will start shipping in 2011.

In summary we realize that our past few years, the company has not lived up to our shareholders expectations. We believe that Silicon Image is the much stronger company in our recent financial performance suggest. As we prepare if to move into 2010 we are on the front end of the new product introduction cycle that will serve the company well over the next 18 to 24 months.

In addition we have improved our ability to deliver products to our customers with a lower cost infrastructure. During the month of November we will arrange to meet with our shareholders and the investment community to address questions about our product strategy and financial goals discussed today. I'll now turn the call over to Noland.

Noland Granberry

Thanks, Hal. Good afternoon. I'll like to cover two topics. One, highlights of our financial results for Q3 '09, and two, our financial goals for Q4 '09. Unless otherwise indicated gross margin expenses and earning related items are repotted on a non-GAAP basis which excludes stock based compensation expense, amortization of intangible assets, restructuring charges and another non-recurring expenses.

Our GAAP financial result and a reconciliation of our non-GAAP measures reference in today's call are available on our investor relations page of our website www.siliconimage.com.

Revenue for Q3 '09 was $37.2 million compared to $37.3 million for Q2 '09, and $77.8 million for Q3 '08. On a year-over-year basis revenue was negatively impacted by the global economic slowdown in the impact of our product transition.

Product revenue totaled $30.7 million for Q3 '09 versus $29.4 million for Q2 '09 and $65 million for Q3 '08. License revenue for Q3 '09 was $6.4 million versus $7.9 million for Q2 '09 and $12.8 million for Q3 '08. CE continued to account for the majority of our total product revenue representing over 83% as compared to 87% for Q2 '09 and 71% for Q3 '08.

For Q3 '09 PC and storage revenues represented 6% and 11% of product revenues respectively. Average selling prices for product sales were the $1.54 per unit during Q3 '09 and were in line with our expectations. Our overall gross margin for Q3 '09 was inline with our goal of 55% at 55.3% versus 53.7% for Q2 '09 and 59.6% for Q3 '08.

Product gross margin for Q3 '09 was 46.5% compared to 42.2% in Q2 '09 and 52% in Q3 '08. While our license gross margin was 97.6% in Q3 '09, 96.5% in Q2 '09 and 98.3% in Q3 '08. Favorable product mix in Q3 '09 and the impact of unfavorable variances in Q2 '09 were the primary causes for our gross margin to turn higher sequentially.

On a year-over-year basis our gross margin declined as a result of lower revenues.

Operating expenses for Q3 '09 were $25.7 million compared to $26.3 million in Q2 '09 and $34.4 million in Q3 '08. The sequential and year-over-year decline in operating expenses was a result of our restructuring programs and tight expense controls. Headcount as of September 30 '09 was 560 compared to 574 as of June 30 '09 and 635 as of September 30 '08.

Our operating losses for Q3 '09 was 5.2 million compared to an operating loss of 6.3 million in Q2 '09 and an operating profit of 12 million for Q3 '08. Our operating loss improved sequentially as a result of higher gross margin and reduced operating expenses.

On a year-over-year basis the lower operating results were primarily driven by a decline in revenue and to a lesser extent a decrease in gross margin as a percent of revenue both of which were partially offset by lower operating expenses.

For Q3 '09, other income was $0.7 million compared to $0.6 million for Q2 '09 and $1.8 million for Q3 '08. Sequentially, other income is relatively unchanged while the year-over-year decrease is a result of lower interest income due to lower cash balances and a lower interest rate environment.

In Q3 '09 our non- GAAP effective income tax rate was 25%. For Q3 '09 we had a non-GAAP net loss of 3.4 million or $0.04 per share versus a non-GAAP net loss for Q2 '09 of $4.3 million or $0.06 per share.

In Q3 '08, we had non-GAAP income of 17.7 million or $0.23 per diluted share.

Our GAAP net loss was $15.5 million or $0.21 per share for Q3 '09 as compared to a GAAP net loss of 13.3 million or $0.18 per share for Q2 '09. Our GAAP net income for Q3 '08 was 6.1 million or $0.08 per share.

Our GAAP net loss increased sequentially primarily as a result of professional fees, stock based compensation and a lower net tax benefit realized during the quarter offset in part by restructuring charges recorded in Q2.

The decrease in net income from Q3 '08 is due to reduced revenues and gross margin also impart by lower operating overall operating cost.

Stock-based compensation which is not included in our non-GAAP net income was 7.6 million in Q3 '09 compared to 4.2 million in Q2 '09 and 4.1 million in Q3 '08. The sequential increase in stock based compensation is due to a multiyear adjustment related to the method use to calculate the expense.

Amortization of intangible assets which is not included in our non-GAAP results was 1.5 million in Q3 and Q2 '09 and 1.6 million in Q3 '08. As Hal mentioned earlier, we expect to record a charge of approximately $28 million in the fourth quarter to write off certain intangible assets due to the changes in the company’s product and market strategies.

During Q3 '09 the company incurred expenses of approximately 2 million for certain professional fees which are not included in our non-GAAP results.

So no restructuring activities during the third quarter. Weighted average share outstanding for Q3 '09 and Q2 '09 were $75.1 million and $74.8 million respectively. Diluted weighted average shares outstanding for Q3 '08 were 75.3 million. Moving to the balance sheet, cash and investments as of September 30, 2009 were $153.2 million compared to $163 million as of June 30 and $200.5 million as of September 30, '08.

The sequential and year-over-year decline is due to our operating losses, use of cash for working capital and capital expenditures. For Q3 '09 our accounts receivables totaled $24.5 million which equates to a DSO of 59 days as opposed to 46 days for Q2 and 27 days for Q3 '08. The increase in our DSO is due to the timing of shipments during the quarter.

Our target DSO based on customers paying within specified payment terms is approximately 55 days. Net inventory as of September 30, 2009 was $12.5 million which represents approximately 5.2 turns on an annualized basis. This compares to net inventory of 9.2 million as of June 30, 2009 and $16.5 million as of September 30, 2008.

Lower revenue than planned is the primary cause for the increase in inventory and low returns. Capital expenditures for Q3 '09 were $0.6 million compared to $1.6 million for Q2 '09 and $1 million for Q3 '08. We did not repurchase any of our common stock during Q3 '09. This completes my summary of our Q3 financial results.

Next I would like to discuss our financial goals for Q4 '09 which are as follows. Revenue $34 million to $37 million. Gross margins 54% to 55%. GAAP operating expenses approximately $71 million which includes stock based compensation of approximately $3 million write off from intangible assets of $28 million and restructuring charges of $15 million, all totaling approximately $46 million.

These expenses are not included in non GAAP expenses. Non-GAAP operating expenses approximately $25 million. Interest income approximately $0.7 million. Diluted shares outstanding, approximately $75 million. As Hal indicated earlier we may be required to record a non-cash text charge in Q4 to establish evaluation allowance against our deferred tax assets. The company will continue to evaluate the recoverability of the deferred tax assets considering its recent losses and should it be required a charge of up to $29 million may be necessary.

Should we record such evaluation allowance the company will record little or no additional tax expense in the fourth quarter. We do not anticipate using cash during Q4 as the majority of the restructuring costs to be incurred in Q4 will be paid in the first half of 2010 which will be offset to a large degree by an anticipated tax refund. This concludes my remarks. Operator we will now take questions.

Question-and-Answer Session

Operator

And at this time (Operation Instructions) we will take our first question from Richard Shannon. Please go ahead.

Richard Shannon

Hey, Hal how are you?

Harold Covert

Good.

Richard Shannon

Good, I apologize as some of my questions are repetitive compared to your script but I have bounced in to couple of calls here so they're with me here. I guess the first question I wanted to get into is regarding your design activity regarding HDMI version 1.4. We have seen the tech competitors come up with some chips that they may not have as many features as what you have implemented in your chips but they are roughly at the same time.

Can you tell us how the design win activity is going for you where you think you are going to have some success and can you compare it with what you are seeing your competitors doing in this environment?

Harold Covert

I think we started sampling in the same time frame as our competitors did, actually I think in some cases a little bit before. And as you indicated we believe that we have more functionality in our 1.4 version than they do in particular HEC for example. And I think just as an important, our 1.4 technology is going to be delivered via our port processor and included in the technology that we will deliver that port processor would be 1.4 InstaPort MHL as well as other features that we will come up within the future so we think that we are in a very solid position to compete we expect to get design wins with our tier 1 customers and going forward we think we have a major opportunity to take advantage again of the our port processor technology.

Richard Shannon

Okay. When do you expect to, what's the time frame, for hearing more about your design wins will it be sometime this quarter, next quarter, what's the time frame?

Harold Covert

I think on the call in February we will be able to fill you in more detail about. We are working on our annual operating plan now and we do have design wins at this point, but I think we have much clearer picture of 2010 and once we wrap up our planning process.

Richard Shannon

Okay. Can you give us a sense of what kind of price points on digital television we are talking about that would be more interested in your product because you have the incrementally greater number of features relative to your competition talking about $1000 price point $800, $1500 what, is there anyway we can think about this, Hal?

Harold Covert

Well, the way I think about it Richard is that I think it's I think everybody realizes that the top tier has been moving down into the mid tier TV range now but the TVs in the mid tier, are full featured TVs.

So we believe that our opportunity is going to continue to be in the high end because there will be a high end market. It's just not going to be as big as it was in the past. We think we have a major opportunity in the mid tier the 32 inch and above and if you take the combination of the high end and the mid tier as I just stated we think that represents around 60% of the market.

The space below that is below end is essentially an area that we don’t plan. It's SOC it's functionally is integrated there and it's few reports less functionality than the mid tier high-end lower focus.

The other key thing for us right now is that if you look at our ASPs, we believe that with our current ASP structure we are in a very competitive position to compete against the SOC providers trying to come up into our space as well as our primary competitors from a discreet standpoint.

Richard Shannon

Okay and finally on one of your quick comments Hal, you mentioned your port process will have MHL and you're running this out to across the gambit of a few TV guys here, I am curious to the extent of which you are seeing interest because of the MHL in there from vendors who are not officially a part of the MHL consortium at this time.

Harold Covert

Yeah, I think with our MHL technologies and in particular with the announcement of the working group on the 28, of this month or past month I should say I am sorry, there's been a lot of interest, in particular if you look at who has joined the working group, it's really the top tier players in the cell phone market base as well as some of those players have very broad lines of DTV too. So, that announcement I think has sparked a lot of interest and the desire to connect mobile devices to the bigger screen in the home environment is really a very key factor. I think everybody is focused on right now. So, there is a lot of interest by I think all players and the cell phone market as well as the HDTV market.

Richard Shannon

Okay. Continuing on the topic of HDMI version 1.4 in the licensing side. Can you give us an update on progress there in terms of engaging with or even signing up licensing deals? Have we seen some already, we see in the fourth quarter, it's kind of a time frame for thinking about that? So, once that can I really make an impact?

Harold Covert

Yeah, we are working on it right now and our outline is as we have done in the past the license that technology. My guess right now is, it will probably in the back half of the year before we would see any meaningful revenue opportunity. And it's probably more out in 2011 time frame before it really starts to ramp up any meaningful degree.

Richard Shannon

Okay. Couple of last quick questions from me Hal and I will jump out of line here, product gross margins spectacularly it crosses to the third quarter about 45% up quite nicely from previous quarter. You had mentioned last quarter some overhead variances that would wean its way out here (inaudible) holding, obviously they have come up nicely. Actually we think about our gross margins on the product side going forward both as revenues ramp in has 1.4 and perhaps that for and grasp other initiatives take hold here how should we think about this.

Harold Covert

I think, as we have been saying our target gross margin is 55% including the 85, 15 split that we have from a revenue standpoint, 85% product, 15 license. And our model heading into 2010 is designed around that and we think that we can maintain our ASPs as they are today, we don't believe there is a lot of upward potential but again we think we are in a sweet spot with the ASPs that we have and we plan on maintaining that level of ASPs going forward.

Which again then locks back into our 55% of overall gross margin target. So traditionally you would probably see an uptick when you roll out new products given the competitive nature of the market and the compression down into the mid tier we think it's more appropriate to maintain the level as opposed to try to move it up, but certainly if we couldn’t move it up, we would, but I don’t think that’s a high likelihood.

Richard Shannon

Okay. Great I think I will jump out of line thanks Hal.

Harold Covert

Thanks.

Operator

(Operator Instructions). And we will take our next question from Bill (inaudible) Please go ahead.

Unidentified Analyst

Good afternoon. Thank you for taking my call. For Q4 you described GAAP operating expenses $785 million and you said that will be a mixture of both cash and non-cash charges, is that correct?

Harold Covert

I outlined the GAAP expenses that we will be taking. The intangible asset write-off and so forth and the only real cash charge that we will have, I should say future cash charge it relates to the restructuring in the fourth quarter and as we indicated a large chunk of that restructuring expense is going to be offset by a tax refund that we find of getting.

Overall, I certainly realized that we are taking some very large charges but there are non-cash charges from a future standpoint and the cash charge that we do have will be offset by a tax refund.

Unidentified Analyst

Everything works according the plan. Do you anticipate earnings both this year and next was approximately 115 million in cash, is that?

Harold Covert

That’s what we stated and that is our plan.

Unidentified Analyst

Okay. And in terms of cash charges that have been kept out of non-GAAP what is the nature of those?

Harold Covert

Again I think we had two, we had the restructuring charge related to our shut down of our sites in Germany, which was $15 million and in the other charge that we had in Q3 was $2 million for professional fees. Sure to that those are the cash charges.

Unidentified Analyst

And those professional fees were related to a deal that you elected not to do.

Harold Covert

That’s correct.

Unidentified Analyst

Okay, very good, thank you.

Operator

And it appears that we have no further questions at this time. I will now turn the program back over to Mr. Covert.

Harold Covert

Okay, thank you and thank you for attending our call today. And we look forward to meeting with you in the month of November. Goodbye.

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