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O2Micro International Limited (NASDAQ:OIIM)

Q3 2013 Results Earnings Call

October 30, 2013, 09:00 AM ET

Executives

Scott Anderson - Director of Investor Relations

Chuan Chiung "Perry" Kuo - Chief Financial Officer, Director and Secretary

James Keim - Head of Marketing and Sales and Director

Sterling Du - Chief Executive Officer and Chairman

Analysts

Tore Svanberg - Stifel Nicolaus

Vernon Essi - Needham & Company

Operator

Good day and thank you for joining us today to discuss O2Micro's financial results for the third quarter of the fiscal year 2013. If you would like a copy of the press release we issued this morning, please call Pamela Campbell at 408-987-5920, extension 8095, and we will fax you a copy immediately. It is also posted on the O2Micro's website at www.o2micro.com under the heading Investors.

There will be a replay available through November 6, 2013 at 9.00 AM Pacific time by calling 1-888-203-1112 or 1-719-457-0820 using pass code 1689610. Following the presentation by management the conference will be open for questions and answers as time permits. Gentlemen, you may begin.

Scott Anderson

Hi, good morning and thank you for dialing into O2Micro's financial results conference call for the third quarter of 2013 ending September 30, 2013. This is Scott Anderson, Director of Investor Relations.

I would like to remind listeners that the discussion of business outlook for O2Micro contains forward-looking statements. Statements made in this release that are not historical facts are forward-looking statements within the meaning of the Federal Securities laws. Actual results may differ materially due to numerous risk factors. Such risk factors are enumerated in the company's 20-F Annual Filings, our Annual Report and other documents filed with the SEC from time-to-time.

Listeners are referred to the O2Micro earnings press release and the documents filed with the SEC to understand these forward-looking statements and the associated risk factors. The statements made herein are dated information. The company assumes no responsibility to provide update to this information.

With me today are Perry Kuo, our CFO and Director; our Head of Marketing and Sales and Director, Jim Keim; and Sterling Du, O2Micro's Founder, CEO and Chairman. After the prepared remarks from these gentlemen the floor will be open to your questions.

Now I would like to introduce Perry Kuo, CFO of O2Micro for a discussion of the financial highlights of the third quarter ending September 30, 2013. Perry?

Chuan Chiung "Perry" Kuo

We will now review our financial results for Q3, 2013. Please note that financial results will be presented on a GAAP basis unless we state otherwise. The non-GAAP result is gross stock-based compensation expense, one-time charges, non-recurring debt and the losses from discontinued operations.

Our full GAAP results are available in our press release that was issued earlier today. GAAP revenue in the third quarter of 2013 was $18.6 million. GAAP net loss in the third quarter of 2013 was $4.5 million and we disclosed stock based compensation on $638,000, the non-GAAP net loss will be $3.9 million. GAAP net loss per ADS in the third quarter of 2013 was $0.16, non-GAAP net loss per ADS was $0.14.

Gross margin was 51.4% in Q3. The gross margin reflects the current revenue level and the product mix. R&D expense was $6.3 million or 34.1% of revenue. This amount excludes stock-based compensation expense of $173,000 in the quarter. SG&A expense was $7.3 million or 39% of revenue. This amount excludes stock-based compensation expense of $465,000 in this quarter.

Income tax was $247,000 in the third quarter and is mainly based on the estimated effective tax rate of each taxable location. In Q3, 2013, we repurchased 326,988 ADS units at a cost of $1.1 million. As of September 30, 2013 there was $19.45 million remaining in our authorization.

Q3, 2013 revenue by end market breakdown into the following percentages: consumer was 40% to 50% of revenue. Computer was 30% to 40% of revenue; industrial was 15% to 20% of revenue, communication was less than 5% of revenue.

At this moment I would like to provide some additional information. O2Micro finished the third quarter with $78.1 million in unrestricted cash and short term investment. This represents cash and cash equivalent of $2.77 per ADS. In addition O2Micro has no debt. Accounts receivable at the end of Q3 was $11.5 million. Our DSO is 55 days, is in our target range of 40 to 60 days. Inventory was $3.1 million at the end of the third quarter. This represents 80 days of inventory and inventory turnover was 4.5 times in Q3.

From a cash flow perspective we generated $2.8 million cash outflow from operating activities in Q3. Capital expenditure was about $129,000 in the third quarter for IT and R&D equipment. Depreciation and amortization was $1.1 million in Q3. At the end of the third quarter of 2013, O2Micro had 597 employees, 56% of which are engineers.

At this time I would like to provide our financial guidance for the fourth quarter of fiscal year 2013. This guidance reflects our best estimate for the current environment and is subject to change. This is the only official guidance we will provide unless we update it with a public announcement in the future.

O2Micro expects Q4 revenues to be flat, plus or minus 3% sequentially. We are guiding the Q4 gross margin to be in the range of 50% to 52%. R&D expense excluding stock-based compensation should be $6 million to $7 million in Q4. SG&A should be $7 million to $8 million in Q4, including stock-based compensation expense. Stock-based compensation should be in the range of $600,000 to $700,000 in the fourth quarter.

Based on the service income of our subsidiaries in different countries we expect our tax amount to be in the range of $200,000 to $300,000 in the fourth quarter.

In closing, our top line results in the third quarter were in line with the guidance that we provided in July and continue to reflect a fairly weak end market demand environment. We will continue to invest in our carefully chosen growth drivers; General lighting, Intelligent Battery, Intelligent Power and Backlighting and we remain confident that the innovation and the investment we are making in this product segment, combined with strong design win activity and market share gain will lead to growth and a return to profitability in the near future.

We are now well underway in our [surprise] share management review and we expect to realize additional improvements to our gross margin profile in future quarters and we intend to provide additional details of this measure early next year.

Given the uncertain demand and the macro environment we will continue to aggressively manage cost. We are also very confident in our ability to control cost further as maybe required.

Lastly, regarding our share repurchase program we have been active in this program historically and we plan to be active going forward. At the end of Q3 we had $19.5 million remaining in our share buyback authorization returns to shareholders are very much on our mind and will continue to be a focus in the future.

I would like to thank everyone for participating and turn the call over to Jim Keim to tell more about our business. Jim?

James Keim

Thank you, Perry and good morning everyone. As we entered last quarter we stated that we faced difficult market conditions entering Q3 in notebook, monitor and TV and expected to see an increase in proportion of our revenues from new products directly resulting from major R&D investment in general lighting, intelligent lighting, intelligent battery, intelligent power products.

While the TV market remained relatively stable the monitor and notebook markets were weaker than expected in Q3. Lack luster sales in notebook and monitor markets were offset with new products sales and expansion of our industrial product sales. While this trend is slowing, notebook and monitor sales will continue from Q4 into 2014.

We are excited to see increasing opportunities in battery management, general lighting and industrial power. These product areas will continue to become an increasing portion of our revenue base and drive future growth while maintaining reasonable margin. We will place increasing emphasis into these markets which will consume more and more of our focus and energy going forward.

As we move forward and our new products and market base continues to grow we expect by the second half of 2014 to share more information in product sales break out information related to these new products with our investors. In the meantime we will continue to share some general highlights for products and market expansion.

In general lighting we continue to expand in three critical areas; patent portfolio, product offering and major account design wins. Most importantly the competitive nature of the LED general lighting business with traditional OEM lighting suppliers like General Electric, Osram and Philips competing with new market entrance for retail shelf base is resulting in rapidly dropping retail LED lighting prices. This will obviously drive much higher volumes as long lived LED bulbs and tubes become increasingly attractive to buyers.

Although we have stated in earlier investor calls that the general lighting market was fragmented we now see the situation stabilized and we have better market visibility. Based on our growing position in this market in both main brand OEMs and key supply chain ODMs revenue flows from this market will become an increasingly important revenue generator for us in 2014.

As noted previously we have a leading edge product line with our intelligent lighting group having being granted 36 patents with 649 patent claims in the first three quarters of this year. As announced in our press release our pre-dimming product line now includes three step dimming as well as continuous dimming products. The product-line feature include integrated MOSFETS, 110V-220V universal line input power factor correction circuitry for both isolated and non-isolated designs involving customers worldwide.

Applications include AC to DC products, for LED bulbs and T5 and T8 tubes, DC to DC for MR16 bulbs and street lighting. Besides general lighting we continue to be the investor leader in TVs and monitor backlight applications. We remain confident that we will continue to grow revenue in LED based products as these markets continue to expand to an increasingly broad application base, including industrial and automotive applications.

Our intelligent property in both Asian and Western countries continues to strengthen our market leadership position in all lighting areas and we are continuing to file additional patents to extend the slate.

Additionally we are pleased to see our intelligent battery design activity continue to gain momentum based on our creative design methodology. Our revenue base continues to grow in this product area and more design wins in industrial applications including power tools, vacuum cleaners, UPS systems, E-bike, and other light electric vehicles.

We also continue to see growing opportunities in communication devices with our patented coolant counter technology. While the automotive market is slow to ramp in to high volume, smaller e-vehicles continue to gain market momentum and our technology leadership is enjoying revenue growth. With our increasing battery management activity opening new market opportunities we will focus on increasing amount of our energy and intelligent power products, including chargers and DC to DC into industrial market areas while our battery management is growing in success.

Our intelligent power products continue to enjoy broadening market acceptance in both Intel and AMD based platform in computer and industrial applications. This includes our highly integrated SMBus Programmable, Multi-Chemistry Battery Charger controller, providing complete battery charging control for single battery portable computer systems. It also features the hybrid power boost features to support the turbo boost mode of Intel CPUs.

To summarize our overall market activity we continue to see a rapid expansion of design activity into new markets that includes all product areas, notably intelligent battery, intelligent lighting and intelligent power. O2Micro is executing on the growth and diversification strategy built on product and technology leadership deliverable to the world's leading manufacturers.

At this time I will turn the call over to Sterling Du for some additional remarks.

Sterling Du

Thanks Jim. I am pleased to report Q3 revenue that was in line with the guidance we provided in July. We generated revenue of $18.6 million in the third quarter of 2013, a slight decrease of approximately 1% from $18.7 million that we reported in the second quarter of 2013. We reported a GAAP loss of $4.5 million in the third quarter of 2013 compared to the GAAP net loss of $4.4 million in the second quarter of 2013.

We reported gross margin of 51.4% in Q3, an increase from the 51.2% in Q2 and the 50% we reported in Q1 of 2013. The gradual improvement in our gross margin this year is the direct result of supply chain management review process which is ongoing, especially we have being working closely with our supply chain partners real life efficiency in wafer, assembly and testing processes.

We are also working with our vendor on pricing negotiation, the goal of this process is to streamline our current processes and increase the efficiencies to further improve our gross margin profile going forward. I am pleased with this progress so far and we expect to realize additional improvement in our gross margin throughout 2014.

Similar to last quarter, we saw a meaningful number of recent design wins, start plans and deliver the market share gains in the quarter. I am very pleased with the progress that we have been projecting in many of our long term growth drivers including general lighting, intelligent battery and intelligent power. Growth in this area was partially offset by weakness in our backlighting business into persistent weak end market demand in TV’s, Monitor and Notebooks.

We will continue to innovate carefully invest in order to spur the adoption of advanced [inaudible] product in a market we serve to clear competitive advantages. Our battery business of power tool and household plans continue to display a strong and lively momentum. We expect these design wins to translate into meaningful revenue in upcoming quarters. We are gaining share in this market and we expect to be one of the top supplier for battery management solution in the near future.

Depending of the type of the tool and appliance we generate between $0.50 and $1 of certain content and come with a high margin business. Many of the world top tier power tool vendors adopt O2Micro solutions.

Our LED general lighting business is growing significantly and we expect this business to increase for the remainder of 2013 and into 2014. We will continue our strategy to optimize the cost structure including a review our entire supply chain, combined power of the purchase and the vendor consolidation in general lighting in order to meet the requirements of our customers, specifically in the Chinese market, in addition to the active design win and business ramping up in Korea, Japan and U.S. marketplaces.

Regarding the backlighting we believe that we have improved our market share in our backlighting business due to the strength of the Chinese TV manufacturer versus Korea manufacturers as our attach rate is higher with Chinese manufacturers. So also very exciting to introduce a new market stream ICs for TV markets, our customer, and country sampling and is expect to reach the volume production early next year.

As we enter into Q4, we plan to continue focus the majority of investment resources on our priority chosen growth drivers, including LED general lighting, back lightening, battery management and power management. By implementing these strategy we are confident in our ability to drive growth in the future we remained focus on using new product innovation to drive our growth through significant design with activities and market share gains.

At this time I would like to thank you for listening to our conference call and I will turn it back to Scott. Scott please.

Scott Anderson

Thank you Sterling. Operator at this point we would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we’ll take our first question from Tore Svanberg with Stifel.

Tore Svanberg - Stifel Nicolaus

Yes, thank you and first question on the guidance, flat to up or down 2%, you just talked about some of the moving parts there and as part of that may be you could talk a little bit about your current visibility towards that number, thank you.

Chuan Chiung "Perry" Kuo

The current visibility towards the number Tore I think is quite good. The majority of the backlogs in places basically we're exceeding to enter November. So we feel quite good about the backlog positioning. As we mentioned on the call earlier we continue to see ongoing softness in the notebook area as well as the monitor area. I think Corning announced earlier today they actually glass production going down in the Q4 time frame and that’s a reflection into those markets.

TV remains little more stable but nevertheless is not expanding at this point in time. We did see ongoing growth for ourselves, certainly in the product areas we mentioned, mostly namely we expect to have reasonable growth in Q4 in the general lightening as well as the battery management areas.

Tore Svanberg - Stifel Nicolaus

Very good and if we look at the 15% to 20% that is non-industrial, is LED the highest sort of sub segment within there or is power tool right up there as well?

Sterling Du

Yeah, LED too.

Tore Svanberg - Stifel Nicolaus

And you have 80 days on inventory in the quarter, could you talk a little bit about your plans for Q4 please on inventories?

Chuan Chiung "Perry" Kuo

Q4 inventory I think in Q3 we are having some [light bank] to support the shorter cycle time. In Q4 the inventory would be probably a little bit late or the same day as our Q3 ended.

Tore Svanberg - Stifel Nicolaus

Okay. It just seems like it's lower levels than usual. So I am just wondering if you are choosing to keep at this low or...?

Chuan Chiung "Perry" Kuo

We actually we as Sterling mentioned that we have employed some turnkey solution of vendors. So it's also we can do a faster cycle time. The inventory level we have done some [counterlization]. But however we are having some light bank in Q3 to support dynamic event but we are having light banks we also cut final [inaudible] inventory in the stocks.

Tore Svanberg - Stifel Nicolaus

Sounds good. The last question, so you have done some cost down initiatives to try and get your gross margin back up, at what revenue level would you expect to be back within your target range of 55% to 60%?

Chuan Chiung "Perry" Kuo

I believe that in the area of $28 million to $30 million we may probably reach to 54%, 55% area, given the current situation of the competition.

Tore Svanberg - Stifel Nicolaus

Good. Thanks very much.

Operator

(Operator Instructions). We'll go next to Vernon Essi with Needham & Company.

Vernon Essi - Needham & Company

Thanks for taking my question. And I wanted to just dive into the gross margin point a little more here and I am just wondering, I guess you have $28 million to $30 million I guess revenue target on that. I am asking how you are going to get to that in some of the markets that you are in right now. It seems as though you are moving into these higher mix markets like battery charge and it's not really reflecting a positive gross margin traction. I mean I realize that your revenues are declining.

But with the profile in next be leaning a lot more towards those of products or would it be leaning more towards some of the traditional power products in the notebook and the backlighting products as well?

Sterling Du

We are moving up to a $28 million to $30 million, our gross margin was improved by the revenue level by 2% plus-minus and hopefully we can continue to improve in this area and also we can leverage our product in the cost saving program.

I'll comment on the market sector in force of some of the general lighting and also battery management area as we have higher gross margin in the corporate level. So we believe that we will continue to grow -- have growth over the area as well. And also in the backlight area also we have higher gross margin and in the corporate area.

That's why I think given the current competition area when we look up to the $28 million, $30 million area we can leverage this revenue level with the improvement in the gross margin by 2% area and also some better product mix.

Vernon Essi - Needham & Company

Okay. So I guess maybe let me rephrase this and I want to try you got to get some thinking around the construct to get to that. If you were to get to that revenue level in the high 20s, are you operating on the assumption that almost all the incremental growth would be in these newer products that are serving the industrial areas as well as that we see and with it I mean will we see a dramatic mix shift in sort of how Perry goes through the different buckets of revenue or would we still have kind of the same situation where are about two-third to 70% may be than 80% of revenue in sort of that notebook, computer/ consumer area?

Chuan Chiung "Perry" Kuo

Our notebook area is only 30% to 40% areas now and for TV area, actually for larger size TV area as the lighting we also enjoy higher growth margin in the corporate areas.

Vernon Essi - Needham & Company

Okay so, right, that’s helps a little bit there. And then just while, you sort of brought up the TV opportunity in China given at that time you already asked the question what are you hearing just generically speaking from the supply chain regarding Chinese New Year and what do you think is going to sort of not that it has to reflect upon your company directly but what seems to be chatter out there on goal points for Chinese New Year?

Sterling Du

Well although we’ve got a week Chinese holiday in the past and it's not -- it's a little disappointed. So we are carefully optimistic towards the Chinese New Year. There is some -- that you see the programs going to be coming up for the China, for the appliance but however that also come with some condition to certain consolidating.

So we believe that the TV marketing in China probably will be conservative optimistic. But at the same time what we commented inside this market Chinese manufacture the market share gains from Korea manufacturer and our attach rate in Chinese TV manufacturer higher than Korea. So that benefits us.

Vernon Essi - Needham & Company

Okay and just generically there it sounds as though there could be a conservative optimism in the consumer electronics market for the Chinese New Year season?

Sterling Du

Yes, yeah.

Vernon Essi - Needham & Company

Okay. Right, thank you.

Operator

(Operator Instructions). And there are no further questions at this time I would like to turn the call back over to Mr. Scott Anderson for any additional or closing remarks.

Scott Anderson

Well guys thank you all for your attention this morning. Please feel free to contact me at area code 408-987-5920 extension 8888 with any follow-up questions. So have a good day and thank you again for your attention, good bye.

Operator

This does conclude today’s conference. We appreciate your participation, a replay is available until 9 AM Pacific time on November 6, 2013 by calling 1888-203-112 or 1719 or 570820 using pas code 1689610. Thank you.

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