Silicon Image CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.26.10 | About: Silicon Image, (SIMG)

Silicon Image Inc. (NASDAQ:SIMG)

Q3 2010 Earnings Conference Call

October 26, 2010 5 PM ET

Executives

Mike Bishop – IR

Camillo Martino – CEO

Noland Granberry – CFO

Analysts

Raji Hill – Needham & Company

Richard Shannon – Northland Capital Markets

Operator

Welcome to the Silicon Image Q3 2010 earnings call. (Operator Instructions). As a reminder this conference is being recorded Tuesday, October 26th, 2010. I would now like to turn the conference over to Mike Bishop from Silicon Image’s Investor Relations. Please go ahead, sir.

Mike Bishop

Good afternoon and welcome to Silicon Image’s Q3 2010 financial results conference call. Joining me today from Sunnyvale is Camillo Martino, the company’s Chief Executive Officer, and Noland Granberry, the company’s Chief Financial Officer. The agenda for today’s call includes a discussion of the financial results and the product and market strategy from Camillo. Noland will then provide a more in depth discussion of the financial results and will provide our financial performance estimates for the Q4 of 2010. We will then open the call for Q&A.

Before I turn the call over to Camillo, 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 financial results and performance, our current and future products and technologies, the timing of new product introduction, average selling prices, design wins, market demand for our products and operating expenses. Our actual results may differ materially from our forward-looking statements and we disclaim any obligation to update any of our forward-looking statements. Moreover, the forward-looking statements and the company’s future results are subject to risks and uncertainties which we describe 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 10K and 10Q. 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 table and a reconciliation of non-GAAP financial information to GAAP information in our Q3 2010 results press release which is available on the investor relations section of our website at siliconimage.com. And with that I’d like to turn the call over to Camillo.

Camillo Martino

Thanks, Mike. Good afternoon and thank you for participating in our conference call today. Silicon Image performed well during the Q3 and we’d like to provide you some financial details and our view of the company and industry. I will first give a brief overview of the company’s performance followed by a market update. Then Noland will go through the numbers in more detail and provide an outlook for Q4.

All our financial results were positive this quarter, showing both revenue and earnings growth sequentially and year on year. First of all, I’d like to explain one particular item. Our Q3 revenue of $60.5 million was favorably impacted by IP revenue resulting from a royalty audit. This revenue item is a catch up HDMI royalty of $7.5 million for the first half of 2010 and prior periods. From time to time HDMI Licensing, LLC, conducts audits to ensure that adopters are paying their proper royalty amounts per the terms of their HDMI adopter agreement. However, royalty catch ups occur from time to time. In Q3, this royalty amount was of such significance to the quarter that we believe it is important to break it out for two reasons: first, we don’t expect to say a royalty catch up of this magnitude in the future, and second, to help you gain a sense of the business trends during the quarter. Even without this royalty catch up, revenues for the quarter would have been $53 million, a very strong top line for us.

Our bottom line in the Q3 continued to improve as well. GAAP EPS was $0.15 while non-GAAP EPS was $0.18 with the royalty catch up, and $0.08 without. Our overall performance in the quarter was driven by strength in our CE products. Sales into the home theater segment drove much of the upside to product revenue. DTV products grew quarter over quarter as expected, and we also saw a sequential uptick of mobile products. Geographically we saw robust revenue growth into all regions in which we sell and our sales to Japan continued at a strong pace, similar to the pattern we saw last quarter. We have been successful this year at growing revenue by increasing our market share in an expanding global DTV market. Our standards for this approach are providing high value innovations together with HDMI-compliant products has enabled us to capture the mid-tier of the DTV market in addition to the high end where we have historically had a large market share.

When we look at the overall end markets for digital televisions, we see the Americas representing approximately 1/5 of the worldwide DTV market in 2010. China’s TV consumption is growing, and is expected to overtake the US by next year. Europe is also a significant portion of the DTV market. All things considered the US is no longer the dominant DTV market. We benefit from this trend because our products are not limited to a specific geography, unlike some SoC devices. We are therefore not significantly affected by trends in any one geographic region. We believe this dynamic worked in our favor in this quarter in light of the mixed news about the state of the DTV market in some regions.

Our product strategy is to launch new products on an annual cycle, aligned with our customers’ product development schedule. Our products feature new innovations and technologies that provide a compelling value proposition to consumer electronics manufacturers every year. For continued success in DTV and home theater, part of our strategy is to simplify the connectivity between DTVs and mobile devices by layering in mobile device compatibility and other valuable innovations.

We recently announced our new family of products that feature the MHL standard, which is an HD, video, and digital audio interface for connecting mobile phones and portable devices to DTVs and other home entertainment products. High definition video is becoming an increasingly important feature on mobile devices, and we saw 7% of product revenue coming from our mobile product family in the Q3. This first push into high definition for mobile devices is exciting and we believe it is a leading indicator of the overall adoption to high definition connectivity on mobile devices.

The new industry MHL standard optimized for mobile devices is making solid progress. As you may recall, the MHL Consortium was formed in April, 2010, and the 1.0 specification was made available to adopters late in the Q2. We recently announced the availability of our first MHL-enabled products and are currently sampling them. We’ve made good progress toward their design win goals, and our customers are showing significant interest in incorporating MHL technology into their next generation CE and mobile devices.

The advantages to MHL technology include the ability to leverage existing connectors and to provide power to the mobile device, charging the battery while simultaneously transmitting high definition content. Meanwhile, the number of MHL adopters is beginning to grow and we’re currently at the beginning of a multi-year cycle of penetrating the CE market with this new standard.

Consistent with what we’ve said in the past, we expect MHL-enabled products to contribute incremental revenue starting in early 2011 and more meaningful revenue in the second half of 2011. As part of our long-term mobile strategy, we continue to make progress towards acceptance of a new mobile memory interface standard called SPMT, which is short for serial port memory technology. Memory is the last frontier for serialized bus interfaces. Storage interfaces, external connectivity, and internal bus architectures have already gone serial. We believe SPMT is the best solution on the market to address the memory bandwidth flexibility, low pin count, and low power required for future generations of mobile and consumer electronics devices. We expect that SPMT will contribute to our IP revenue in the future.

Our long-term strategy is to enhance and simplify the customer’s connected HD experience. We are focused on advancing HD connectivity and interoperability technologies that can address the various ways in which consumers are obtaining and consuming content. Digital TVs are transitioning into smart TVs, and mobile devices, such as smartphones and tablets, are adding HD video capability. Hand in hand with the evolution of these platforms, consumers expect them to seamlessly connect and interoperate. Silicon Image, with its serial connectivity heritage, is well positioned to be at the forefront of the technology innovations needed to meet the consumer-driven desires for advanced interoperability and HD connectivity, whether that is experienced via a smart TV or a smartphone.

I will now turn the call over to Noland to provide a more detailed update of our financial results and our financial goals for Q4. Noland?

Noland Granberry

Thanks, Camillo. Good afternoon. I would like to cover two topics: highlights of our financial results for Q3 2010, and our financial performance estimates for Q4 2010. Unless otherwise indicated, gross margin, expenses and earnings related items are reported on a non-GAAP basis which excludes stock-based compensation expense, amortization of intangible assets, restructuring charges and other nonrecurring expenses. Our GAAP financial results and a reconciliation of non-GAAP measures referenced in today’s call are available on the investor relations page of our website, www.siliconimage.com.

As highlighted by Camillo in his prepared statements, our results for the Q3 include the catch up royalty revenue in the amount of $7.5 million. While the company receives royalty catch up revenue from time to time, such amounts aren’t considered in our financial outlook. The catch up revenue related to ongoing audit activity in Q3 was much higher than typically received. As such, my commentary incorporates this significant catch up revenue on a with and without basis. Unless material to the quarter, it would not be highlighted.

Revenue for the Q3 totaled $60.5 million versus $44.6 million for Q2 2010, and $37.2 million for Q3 2009. The 35.7% sequential increase and 62.8% year over year increase was primarily the result of the royalty catch up revenue previously discussed and continued strong product demand during the quarter. Excluding the royalty catch up revenue, our Q3 revenue grew 19.1% sequentially and 42.7% year over year.

Product revenue totaled $46.1 million or 76.2% of total revenue for Q3 2010, versus $38.4 million, or 86.1% of total revenue for Q2 2010, and $30.7 million, or 82.7% of total revenue for Q3, 2009. For the Q3, we saw seasonally strong customer demand across all product lines, particularly in the home theater space. CE product revenue contributed 87.8% of total product revenue, while PC storage contributed 12.2%. Average selling price for product sales was $1.38 per unit during Q3 2010 and in line with our expectations.

Q3’s product gross margin was 51.3% as compared to 49.6% for Q2 2010, and 46.5% in Q3 2009. Product gross margin for Q3 2010 was higher than planned due to a more favorable mix of higher margin products, such as home theater products, and as well as better overall absorption. We recognize that our product margin for the quarter was unusually high. We believe we will see a sequential decline to the 46% to 48% range, and longer-term our product margins will move back into the 44% to 46% range supporting our company’s overall gross margin target of 55%.

IP revenue for Q3 2010 was $14.4 million or 23.8% of total revenue, versus $6.2 million or 13.9% of total revenue for Q2 2010, and $6.4 million, or 17.3% of total revenue in Q3 2009. For the quarter, IP revenue included royalty catch up revenue of $7.5 million as previously discussed. Including this catch up revenue, our IP revenue would have totaled $6.9 million or 13% of total revenue.

Our IP gross margin was 99.5% in Q3 2010, 99.8% in Q2 2010, and 97.6% in Q3 2009. Our IP gross margin varies depending on the mix of our IP customization projects that are in progress during any particular quarter. Our overall gross margin exceeded our expected range of 54% to 55%, hitting 62.8% for Q3. The higher gross margin is primarily due to the royalty catch up of revenue during the quarter as well as the stronger product margins noted. After the royalty catch up our overall gross margins would have been 57.5%. Gross margin was 56.5% for Q2 2010, and 55.3% for Q3 2009.

Operating expenses for Q3 2010 were $23.7 million and in line with expectations. Operating expense for Q2 2010 and Q3 2009 were $23 million and $25.7 million respectively. As noted previously, we expect to start making additional R&D investments as we look to execute on our longer-term strategy. However, we will continue to focus on our expense management as we look to make such investments.

Head count as of Q3 2010 was 420 as compared to 415 at the end of Q2 2010, and 560 at the end of Q3 2009. For Q3 2010 we achieved an operating profit of $14.3 million as compared to an operating profit of $2.2 million for Q2 2010, and an operating loss of $5.2 million for Q3 2009. The increase in our operating profit for the quarter is due to strong product revenues and margin, continued controlled spending, and the royalty catch up revenue. Excluding the royalty catch up revenue our operating profit would have been $6.9 million.

Other income totaled $0.6 million for each of Q3 and Q2, and $0.7 million for Q3 2009. Stock based compensation is excluded from our non-GAAP results and was $1.8 million for Q3 2010 as compared to $2 million for Q2 2010 and $7.6 million for Q3 2009. Our Q3 2009 stock compensation expense included a multi-year adjustment related to the method used to calculate the expense.

On a GAAP basis, our net income was $9.5 million or $0.12 per diluted share for Q3 2010, as compared to our Q2 2010 GAAP net income of $1.8 million or $0.02 per diluted share, and our GAAP net loss for Q3 2009 of $15.5 million, or $0.21 per share. GAAP net income was $13.7 million or $0.18 per diluted share for Q3 2010 versus a non-GAAP net income for Q2 2010 of $2 million, or $0.03 per diluted share. For Q3 2009 our non-GAAP net loss was $3.4 million or $0.04 per share. Excluding the royalty catch up revenue, our non-GAAP net income would have been $6.4 million or $0.08 per diluted share.

Diluted weighted average shares outstanding was 78.1 million for Q3 2010 and 77.5 million for Q2 2010. For Q3 2009, basic weighted average shares outstanding were 75 million.

Turning to our balance sheet – As of September 30th, 2010, our cash and investments totaled $184.6 million. As of June 30th, 2010, and September 30th, 2009, our cash balances were $168.7 million and $153.2 million respectively. The increase in cash and investments were the direct result of increased collections on higher revenues and the collection of a portion of the royalty catch up previously discussed.

For Q3 2010 our accounts receivables totaled $24.2 million, resulting in 36 days sales outstanding. For Q2 2010 and Q3 2009 our DSO was 35 days and 59 days, respectively. The lower DSO on a year over year basis was the result of timing on collections of higher revenues during the quarter. Net inventory as of September 30th, 2010, was $11.6 million, representing 7.7 turns on an annualized basis, exceeding our target of 7 turns. This compares to 7.6 turns at June 30th, 2010, and 5.2 turns at September 30th, 2009. Capital expenditures for Q3 2010 were $1 million compared to $1.2 million for Q2 2010, and $0.6 million for Q3 2009.

This completes my summary of our Q3 2010 financial results. Next, I would like to discuss our Q4 2010 financial outlook.

The following are our financial estimates for Q4 2010. Revenue, approximately $46 million to $48 million; gross margin, approximately 55% to 56%; GAAP operating expenses, approximately $26 million; non-GAAP operating expenses, approximately $24 million; interest income, approximately $0.5 million; diluted shares outstanding, approximately 78.5 million; non-GAAP tax rate, approximately 2% of revenue.

Our Q3 product revenue was greater than our normal seasonal pattern and represents the peak product revenue period. Entering Q4, we expect to return to normal seasonal patterns, and therefore we expect a seasonal decline in product revenue. We also believe this will be true heading into our fiscal 2011 year. As such we expect our Q1 revenue to be seasonally down from our Q4 guidance.

This concludes my remarks. Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Christopher Longiaru with Sidoti. Please go ahead. Christopher Longiaru, your line is now open if you have registered for a question. I’m afraid we’re unable to hear you, Mr. Longiaru; please reregister for a question if you wish to. Our next question comes from the line of Raji Gill with Needham & Company. Please go ahead.

Raji Hill – Needham & Company

Yes, thanks for taking my question. Congrats on good results in light of a very tough digital TV environment. Apologies in advance if you touched on this in your scripted remarks; I’m in between three different calls right now. But maybe if you could talk about what happened during the quarter in terms of your competitive positioning in the DTV market, obviously the TV market has been very weak. You’ve seen other suppliers into that market support bad results. Maybe walk us through a little bit about what you’re seeing in the overall TV environment. How do you see the TV demand market going into the Q4 and into the Q1? That would be helpful. Thank you.

Camillo Martino

Sure, Raji. You know, one comment we made in the prepared remarks is that the US or the Americas represents roughly 1/5 of the global TV market as we’ve discussed together in the past. So I don’t think we’re limited or directly impacted by one regional issue versus another. So yeah, and it is true that the market did experience some downside pressure as reported in the news in some certain channels. This is kind of built into our model as we’ve talked about in the past. We expected some of this to occur in Q4, which could outline or which explains the reason why we gave this guidance that we did for Q4. By the way, we gave you roughly the same guidance back in July for Q4 as well.

So it’s very consistent with the model that we had built up. So going into Q1, I think that was your other extension in the question, as Noland mentioned we expect to fall back into typical CE seasonality. We expect, I think the only comments we’re making at this moment regarding Q1 is that it’ll be seasonally down a little bit. So that’s where we are at this point on that topic.

Raji Hill – Needham & Company

Okay, very good and thanks for that clarification. Just switching gears to the MHL, and again, you might have mentioned this in the remarks, but how is the sampling process going? What is some of the feedback from some of your customers? Would we be expecting to see some design win announcements coming soon? And would that be in the form of a press release or would that be a separate call? Maybe if you could just update how you’ll communicate that to the investment community, analyst community?

Camillo Martino

Sure. Let me say something now which I think has been typically pretty consistent with what we’ve said in the past. And so since the specification was finalized and published back in June of this year, we have indicated that we’ll be sampling products roughly about now, which we are. In fact we’ve made a formal announcement for a few of our products just recently, so we’re on track with what we said we were going to do with respect to the sampling of the products. We’ve also indicated in the past that we would expect some very early design win revenue from MHL starting in 2011 in the first half of the year, potentially in Q1. But we also have indicated that we believe the material revenue or the bigger portion of the MHL revenue would be occurring in the back half of the year.

So I think we’re pretty consistent with that. We’re reiterating the same position today as we’ve said in the past and we’re comfortable with that position. Now relative to press releases and what have you, you know, this has been a question obviously that comes up continuously, and we certainly respect the question. At the same time we need to respect some of the confidentiality agreements we have with our customers. Every customer has a different policy; some may allow suppliers to make an announcement, others will not allow suppliers to make an announcement. That’s not because we don’t want to share this information; we’re just trying to respect confidentiality with our key customers.

Now obviously if there’s a teardown done as has been done this year, for example, there’s some product that’s been ripped apart and someone notices a Silicon Image chip is in there, well at that point obviously we can’t reject that. For example, earlier this year I believe the HTC-EVO platform was opened up and noticed that one of our chips was in there, and at that point we were able to confirm that. But we were not able to pre-confirm. Then I think more recently the Logitech review product was also, there was a teardown done and noticed that one of our products was in there as well. So that’s how we would be communicating to the investment community on that topic.

Raji Hill – Needham & Company

Okay, very good. And about the MHL business model, how do you see that kind of playing out? Will the OEMs supply the MHL cable when they sell an MHL-enabled phone? Or will that be kind of off market? Maybe describe how you’re thinking how that model will work once MHL comes around?

Camillo Martino

Sure. I think once it ramps, I think both models will work. I mean there will be some cases where an OEM may choose to bundle it, and there’ll be other cases where an OEM decides not to bundle it, at which point you will purchase it as an accessory product through resale channels or online, (inaudible) channels. But it’s not one model or another. I think both models will coexist.

Raji Hill – Needham & Company

One last question, Noland, on the R&D and the OPEX actually. You have the MHL product cycle that you’re preparing for, you’ve done a good job really getting the OPEX down in ‘09 and benefiting that in this year. How do you look at the OPEX levels going forward? And what type of some leverage that we could maybe generate in this model as the revenue ramps?

Noland Granberry

I think as I highlighted on my remarks that we are outlooking Q4 at about $24 million. And we think at this point that’s a reasonable level, although as I also highlighted there may be scenarios where we’re going to make some investments that actually allow us to move along our longer-term strategy. So there may be some things that we will look to to add to that number. But at this time and as I noted, I mean we are constantly watching where our OPEX is at and managing that closely. I think our real focus is making sure we can move along our strategy and yet still provide an opportunity to leverage our current OPEX model. And I think that’s where we are. So $24 million is about where we are today.

Raji Hill – Needham & Company

Okay, great. Thanks guys. Congrats on a very good quarter and good guidance.

Camillo Martino

Thank you.

Operator

(Operator Instructions). Our next question comes from the line of Richard Shannon with Northland Capital Markets. Please go ahead.

Richard Shannon – Northland Capital Markets

Good afternoon, gentlemen, and congratulations on the nice results. I guess my first question kind of delves into one of the previous questions about the Q3. You made some commentary about home theater doing pretty well, and I think this was the second quarter in a row. Was this most if not all of the upside in your product revenues relative to what you would think of as seasonal guidance? And would you characterize TV as kind of being in line with that, or can you correct that if that’s different than what you think?

Noland Granberry

This is Noland. Richard, I think when we look at home theater you know that it consists of AVRs, set-top boxes, the (inaudible) TV space, and actually we saw good demand in our product going into those products during the quarter. I think there was some seasonality obviously being that it’s typically our strongest quarter. When you look at where we saw growth – Japan and APAC – I mean those were markets where this was really a strong push. So it was very strong, it was a seasonal push. And when you look at DTVs, it did grow quarter over quarter and it was in line with what we had expected. But home theater was the stronger portion.

Richard Shannon – Northland Capital Markets

Okay, and I think Camillo commented regarding you’re doing well in the mid-tier, which obviously you’ve talked about before. Can you give us a sense of what you think your market share either in terms of shipments or in design wins in that mid-tier? And where do you think it could go maybe next year?

Camillo Martino

Sure. I think the number that we have been communicating publicly, pretty much at many different forums, is over 60% market share of the mid-tier and high end bracket. I mean that’s the number, and I think we feel comfortable with that position.

Richard Shannon – Northland Capital Markets

Okay. Any way that you can segment it out just by the mid-tier, Camillo?

Camillo Martino

I think it’s, you know, it may be slightly higher at the high end and may be slightly lower in the mid-range, but you know, the blended average is probably in the 60 points.

Richard Shannon – Northland Capital Markets

Okay, fair enough then. Regarding your outlook into the TV and related consumer electronic markets in 2011, I’m kind of curious where you are sitting in terms of design wins. Have you won any already for 2011? Or what timeframe should we expect to see those completed?

Camillo Martino

I think new tier one companies typically announce a new model lineup at CES as an approximate timing. And each of them will have a different ramp schedule but I think most of the companies will be ramping anywhere between January and March timeframe. That’s kind of the typical ramp of the new model season. So I think next year will be no different to that.

Richard Shannon – Northland Capital Markets

So that would suggest the design wins, if they haven’t already been awarded are to come pretty soon then. Is that correct?

Camillo Martino

Absolutely. You know, if the design win has not happened at this point it’s pretty tough to make the Q1 schedule.

Richard Shannon – Northland Capital Markets

Okay. So how is your design win rate been going so far? Do you expect to maintain if not gain share next year?

Camillo Martino

I think the design win activity is on track with where we expected to be, and it’s definitely in line with the guidance we’ve given to date.

Richard Shannon – Northland Capital Markets

Okay, fair enough, and maybe just one last quick question. You mentioned mobile being about 7% of revenues. Obviously there’s many different types of devices in there, that could fit in that category. Any way that you can give us an idea how much is specifically smartphones in that category, and also is there a comp to the Q2 for that number?

Camillo Martino

I don’t think we have a comp number for the Q2, for the next quarter, although you know, it’s probably in the same vicinity or higher. We’re not guiding necessarily, but I would expect it to be a similar type number next quarter. The type of products that it’s going into – one is a smartphone category, and the second would be the tablet. The tablet is a new category that’s energizing the market out there. So I think they’re the two categories that we’re participating in.

Richard Shannon – Northland Capital Markets

Okay, great. That’s all for me. Thanks a lot, guys. Congratulations.

Operator

We are not seeing any further questions at this time. I will now turn the call to Camillo Martino for closing remarks.

Camillo Martino

Thank you. I would like to thank everyone for participating on today’s call. We are moving aggressively into Q4 and to 2011, and we look forward to updating you on our next quarterly call. Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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