Actions Semiconductor CEO Discusses Q3 2010 Results – Earnings Call Transcript

Nov. 2.10 | About: Actions Semiconductor (ACTS)

Actions Semiconductor Co., Ltd. (NASDAQ:ACTS)

Q3 2010 Earnings Call Transcript

November 2, 2010 5:30 pm ET

Executives

Grace Reyes – IR, The Blueshirt Group

Patricia Chou – CFO

Niccolo Chen – CEO

Analysts

Rick Fearon – Accretive Capital Partners

Douglas Whitman – Whitman Capital

Operator

Good day, ladies and gentlemen, thank you for standing by. Welcome to the Actions Semiconductor third quarter 2010 earnings conference call. During today’s presentation, all parties will be placed in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) This conference is being recorded today, Tuesday, November 2nd, 2010.

I would now like to turn the conference over to Grace Reyes. Please go ahead, ma'am.

Grace Reyes

Good afternoon and thank you for joining us on today’s conference call to discuss Actions Semiconductor's third quarter 2010 financial results. This call is being broadcast live over the web and can be accessed on the Investor Relations section of Actions’ website, www.actions-semi.com for 90 days. On today’s call are Niccolo Chen, Chief Executive Officer; and Patricia Chou, Chief Financial Officer.

After the market closed in the U.S. today, Actions issued a press release discussing the results for its third quarter ended September 30th, 2010. The press release was also filed on Form 6-K with the U.S. Securities and Exchange Commission. The press release is accessible online at the company’s website, as well as the SEC’s website or you can call The Blueshirt Group at 415-217-7722 and we will fax or e-mail you a copy.

We would like to remind you that during the course of this conference call, Actions' management team may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are simply estimates and actual events or results may differ materially.

We refer you to the documents that Actions files from time to time with the SEC, specifically the company’s most recently filed Form F-1, 20-F and 6-Ks. These documents identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

And now, I would like to turn the call over to Patricia Chou.

Patricia Chou

Thank you for participating in Actions’ third quarter earnings conference call. We appreciate your continued interest and support for Actions. I will provide a business update and discuss financial results for the third quarter, as well as expectations for future performance. And Niccolo will be available during the Q&A portion of the call where I will translate from Mandarin to English on his behalf. As a reminder, our financials are reported on a U.S. GAAP basis.

Our results for the third quarter were largely in line with our expectation. Our gross margins were slightly better than expected, continuing a positive trend since the beginning of 2010. We experienced increased revenue contribution from our high-end products, which leaded to higher average selling prices during the quarter. With reduced sales of our low-end products, such as automotive and boom box products, we saw a decline in shipment volume sequentially.

During the quarter, we recognized several one-time items that significantly contributed to our bottom line results, such as the foreign exchange gain, a reversal of overestimated employee stock-based compensation expenses, and a gain resulting from the acquisition of additional equity interest of Mavrix.

For the third quarter ended September 30th, 2010, we recorded revenue of $9.3 million compared to $9.7 million in the second quarter. Our gross margin for the third quarter was 40.1% compared to 39.6% for the second quarter. As noted, we were pleased our gross margins benefited from a product mix shift to advanced products, higher ASPs, and favorable unit cost as a result of enhanced processing technology, as well as improved product design.

For the third quarter, total stock-based compensation expense amounted to a credit of $0.2 million, after a true-up of underestimated forfeiture rate compared to an expense of $0.9 million in the second quarter.

R&D expense was $3.9 million or 42% of revenue for the third quarter, which was slightly lower than the second quarter of $4.4 million, due to the reversal of overestimated stock-based compensation expense. With the addition of approximately 40 engineers from Mavrix, which we acquired this quarter, we anticipate our R&D expense to continue to represent a high percentage of revenue as we focus on our product development initiatives.

G&A expense was $1.8 million in the third quarter or 19.7% of revenue, which was slightly lower than the second quarter of $2.4 million, also due to the true-up of employee forfeiture rate on our stock-based compensation expense.

Sales and marketing expense was $0.2 million in the third quarter or 2.5% of revenue compared to $0.3 million in the second quarter. We continue to tightly manage expense levels in this category, as a demonstrated by our hiring freeze across non-engineering functions and the salary cuts at the management level.

Operating loss was $1.8 million for the third quarter compared to operating loss of $2.9 million for the second quarter. We continue to focus on the sequential improvement in profitability and our persistent cost management in the third quarter.

Net other income was $1.1 million as a net result of a foreign exchange gain due to the appreciation of renminbi versus U.S. dollars. Other income of $0.5 million for the second quarter was also related to a net foreign exchange gain.

Interest income was $2.4 million for the third quarter, up from $2.2 million in the second quarter. Income before taxes was $1.7 million for the third quarter as compared to a loss of $0.2 million in the second quarter.

Net income tax expense was $370,000 for the third quarter compared to income tax credit of $64,000 in the second quarter. The income tax credit in the second quarter resulted from China’s preferential R&D expense pretax deduction available for certified high-tech companies after the annual income tax return is filed in May every year.

Net gain on fair value change in an equity method investee of $0.5 million for the third quarter was because of the acquisition of Mavrix. Immediately prior to the acquisition, the company held an equity interest in Mavrix. Due to the acquisition, the company remeasured its pre-existing equity interest in Mavrix to its fair value, resulting in a gain. The purchase price allocation is expected to be completed by the year-end.

Net income attributable to Actions Semiconductor on a U.S. GAAP basis for the third quarter was $1.9 million or $0.03 per diluted ADS compared to net loss of $0.4 million or $0.01 per diluted ADS for the second quarter.

As previously noted, starting from the acquisition at the end of August, Mavrix's operations and net loss were included in our results for the third quarter; and additionally, its assets, liabilities and shareholders' equities were consolidated in our balance sheet as of September 30th, 2010.

Moving to the balance sheet, cash and cash equivalents together with time deposits, trading securities and both current and non-current marketable securities totaled $237.4 million as of September 30th, 2010 compared to $245.5 million at the end of second quarter. The sequential decrease in our cash balance as of September 30th was due to $2.1 million used for the share buyback program, $0.9 million net cash paid to acquire Mavrix, $4.4 million investment in land capital, and $2 million invested in the construction of our headquarters building in Zhuhai.

Actions invested 40% of land capital to indirectly hold a parcel of land where we plan to build our Shanghai facilities and share with other investors of land capital. This reflects our decision to scale back our plans to own only 40% of the land for our future Shanghai facilities and eventually to reduce operational costs.

Of the $237.4 million total, $54 million was in cash, time deposits and short-term interest-bearing investments that were generally issued by large domestic banks in China for terms no more than three months and can be redeemed at any time. $183.4 million was in trading securities and marketable securities, both current and non-current, which were principal guarantees or pledged investments with higher interest rates and minimum terms of three months. These marketable securities were mainly issued, managed or guaranteed by top ranking state-owned financial institutions in China.

Accounts receivable, notes receivable, amounts due from related party in an equity method investee totaled $3.2 million at the end of the third quarter, up from $2.7 million at the end of second quarter.

Inventories were $6.1 million at the end of the third quarter, up from $3.4 million at the end of the prior quarter. Compared with prior quarter, our relatively high inventory balance in the third quarter was directly correlated with lower shipments in automotive, boom box, and mono-display, MP3 products. These low-end products did not enjoy a sales peak [ph] in the third quarter because of the flash memory price increase and (inaudible) shortage, which impacted the demand of our automotive, stereo and boom box controlled ICs.

Our inventory levels may fluctuate as we ramp up our advanced, higher-cost products and when we migrate into newer versions of products. Additionally, we started to consolidate Mavrix's inventories of RMVB and multimedia coprocessor ICs and CMB mobile digital TV demodulator ICs after the acquisition closed in August.

We continue to buy back shares, spending approximately $2.1 million in the share repurchase program during the third quarter compared with $2.4 million in the second quarter. Our repurchase activity remains constrained by trading volume and blackout periods for our 10B-18 program, as well as limited activity in block trading.

Although the current buyback under 10B-18 program looks passive, it has proven cost savings and provides lower risk [ph] to long-term shareholders and the company than alternative options, particularly at the current stock trading price. At the end of September 30th, 2010, the company had invested approximately a total of $33.2 million in the program, representing approximately 14 million ADS shares.

I would now like to discuss our progress in each of our product categories during the quarter. As expected, sales of the automotive and boom box products targeting low-end market segments decreased sequentially, primarily because of the NAND flash memory price fluctuation and critical component shortage. These products represented around 20% to 25% of our total shipments during the third quarter.

In the third quarter, sales to the mainstream segment of the PMP market serving the no-display, mono-display, and the small color display media products decreased in volume and as a percentage of our total revenue. Even though the mainstream market size has been cannibalized by the high-end and low-end products, we still maintain the leading position in market share of this category.

Our historical strength in the mainstream has allowed us to establish ourselves as the largest non-Apple PMP controller IC provider in the world, providing us a solid platform and a customer base to build out our diversification efforts.

The MP4 market continues to help drive growth opportunities for Actions. Shipments of our products serving the QVGA MP4, D1 PMP, and high-definition PMP segments increased to 20% to 25% of our total shipments and represented around 40% of our total sales amount in the third quarter.

Our shipments in the MP4 segment have not grown as fast as anticipated during this quarter, due mainly to financial weakness in the U.S. and Europe, which are our major end consumer markets. Within our MP4 market segment, sales of QVGA MP4 with CMOS image sensor continued to represent the largest portion of MP4 sales in the quarter.

In the D1 segment, our Series 25 high-quality product design and comprehensive customer support are continuing to help us gain share. Our Series 27 chips for high-definition 720p products (inaudible) in the third quarter as planned and have received a very positive customer response. While this is behind our original plan and has caused a significant sales fluctuation in 2010, we expect to begin to see a meaningful revenue contribution from this new product line in first half of 2011.

Increased sales in this category should enable us to favorably shift our product mix to the higher margin and a faster growing segment of the market, thereby partially offsetting ever-present ASP erosion in the overall PMP market.

During the third quarter, 0.15 micron process technology was used for the majority of our shipment volume and current inventory. Approximately 90% of our current purchases are in 0.15 micron process now. On the top of our success for shrinkage from 0.16 micron to 0.15 micron technology, we have kicked off our 0.11 micron pilot run in the third quarter and plan to migrate our process – mass production technology to 0.11 micron in 2011.

We have been pleased to see stabilized wafer prices and relaxed [ph] the foundry capacity by using 0.15 and 0.16 micron process technology, which has benefited the company’s gross margin this year.

We remain committed to diversifying our business through expanding our product offering. We continue to believe the high-end market segments offer significant growth opportunities for Actions. To build on our initial success in the advanced MP4 product segment to – that support QVGA, D1 and high-definition, we continue to evaluate opportunities to further penetrate new high-end applications in the market segment, such as high-definition 1080p with flash game, flash UI, touch-panel display, digital video recorder, and TV box functionality.

As mentioned earlier, we completed the purchase of Mavrix, migrating additional 40 engineers into our team. These engineers are seasoned and have been working together as a cohesive team focused on developing products using the Android platform for MID. We expect to introduce new products developed by this team in the first half of 2011.

We believe that continued investment and innovation in R&D will help us best address the fastest growing segments within the portable multimedia player market and improve our ability to protect and expand our market position.

During 2010, we have demonstrated progress in improving our business. However, the delay in introducing our Series 27 products and the economic weakness in the U.S. and Europe have impacted our growth plans for the year. We believe we have taken a number of steps during 2010 that strengthened our market competitiveness. We gained momentum in the high-end market segments and have augmented our R&D capabilities. We believe this initiative will better position the company for growth over time.

Our guidance for the fourth quarter 2010 revenue will be in the range of $8.5 million to $9.5 million; gross margin, approximately flat with third quarter; and operating expenses pointing [ph] slightly higher on a sequential basis. The fourth quarter 2010 estimate included a share-based compensation expense of approximately $0.7 million.

And now, we would like to open the line for questions. Operator?

Question-and-Answer Session

Operator

Yes. Thank you, ma'am. (Operator instructions) One moment. And our first question is from the line of Rick Fearon with Accretive Capital Partners.

Rick Fearon – Accretive Capital Partners

Hi, good morning, Patricia and Niccolo.

Patricia Chou

Hi, good morning.

Niccolo Chen

Good morning.

Rick Fearon – Accretive Capital Partners

Quick question on the Mavrix acquisition. How much additional R&D expense do you expect annually from the 40 engineers that came along with that acquisition?

Patricia Chou

We don't expect it will be large. In fact, these 40 engineers have been part of our R&D expenses since mid-August. And during the third quarter, our R&D expenses were slightly lower than prior quarters. So I believe it will not be a big surprise or a jump in the fourth quarter.

Rick Fearon – Accretive Capital Partners

The third quarter R&D expense of $3.9 million was impacted by the adjustment on stock-based compensation and what would it be pre-adjustment, if you kind of gross it back up?

Patricia Chou

I would say you can add back around $0.5 million.

Rick Fearon – Accretive Capital Partners

Okay. And is that – so that – would you expect that to be the run rate now on a go-forward basis for the R&D expense, roughly – (Multiple Speakers) call it, $4.5 million quarterly?

Patricia Chou

I would expect the R&D expense slightly increasing in the fourth quarter since our headcount continues to increase, but it wouldn't be, say, a huge number, say, $1 million or $2 million increase for the quarter, since our total operating expense for the third quarter was only less than around $6.5 million even adding back the stock-based compensation expense adjustment.

Rick Fearon – Accretive Capital Partners

Okay.

Patricia Chou

And then our current headcount at the end of the third quarter was around 650 to 700 people, including those additional 40 people. So, it wouldn't be a huge jump.

Rick Fearon – Accretive Capital Partners

The 650 to 700 represents total headcount or just the R&D group?

Patricia Chou

Total headcount.

Rick Fearon – Accretive Capital Partners

Okay. And so R&D is closer to 600?

Patricia Chou

It's about 75% to 80% of our total headcount.

Rick Fearon – Accretive Capital Partners

Okay. And how much revenue are you expecting from the Mavrix R&D staff to be generated for 2011 and call it, 2012? You mentioned that there should be some meaningful contribution in the first half of 2011 from the Android product.

Patricia Chou

I meant their product would be ready for the market in the first half of 2011. But in terms of how much revenue contribution would be in the first half, I wouldn't think it's meaningful right away. But the Android-based MID products will be one of our key initiatives for next year and going on.

Rick Fearon – Accretive Capital Partners

And do you have any sort of rough estimates for 2011 and 2012 from that new product category?

Patricia Chou

We are in the budgeting process for 2011 and '12. So, we would be able to provide you more detailed information later on, but not now. And also, the MID – the Android-based MID product line is still – since we just acquired this team in August and they are in the migration process to our overall group, we do not expect that they can contribute meaningful revenue right away, but the product will be ready for the market in – within two to three quarters.

Rick Fearon – Accretive Capital Partners

Two to three quarters? Okay. And at what point do you – does the company begin to reduce its R&D staff? I mean, I understand the efforts to create some new products. This was a company at one point that ran with a staff of fewer than 100 engineers and was four times the size. Are we kind of on this path to continue with 600 engineers indefinitely?

Patricia Chou

I think our current headcount in engineering is less than 600. But since we are expanding our R&D scope, for example adding in the Android-based product lines, we believe we will need more R&D resources. So the increase of the R&D people is the current trend for us.

Rick Fearon – Accretive Capital Partners

Okay. Okay, and then on to the Series 27 product. You had also talked about some meaningful first half contribution there. And have you kind of – I know you are putting together your budget now, but do you have an estimate for the Series 27 in 2011 for what meaningful revenue contribution means for the first half?

Patricia Chou

Let's put it this way, because of the delay of the Series 27 product line, we are missing around $5 million to $6 million revenue in the second half this year. And we expect to at least cover this volume in the second half next year. But whether the ASP will be the same between these two periods, that's still a question mark. And again, since we haven’t come out our next year's budget, it's – we – I'm afraid we will not be ready to answer this question at this moment.

Rick Fearon – Accretive Capital Partners

Okay. But your estimate for the second half of 2010 was that you could have realized $5 million to $6 million of additional revenue had the Series 27 been ready?

Patricia Chou

Exactly.

Rick Fearon – Accretive Capital Partners

Okay. Okay, just a last point that I've made for sometime now and it just relates to the stock repurchase. Now that we are up to 14 million of the 86 million ADS shares outstanding, it's still only 16% of the outstanding shares and yet we continue as a company to sit on $237 million of cash and marketable securities.

So, we have about $3.30 per share of cash and no debt and buying at today's price represents an immediate 53% cash-on-cash gain on investment for shareholders and we can spend $2.15 to own $3.30 in cash. That's a – that means we get $1.15 free or a 53% gain. And so, it's – we've talked about the concept of a Dutch tender offer for about two years now and yet, this has not been done. Can you just help explain why the Dutch tender offer at the current market price is not the best possible use of our cash?

Patricia Chou

Rick, we have been discussing this issue for several years, as you mentioned. In fact, we have – we just had some very serious internal discussion, even up to the Board, for the tender offer idea. With our current business challenge, fluctuating price, and our potential expansion in R&D which may need a lot of money in a longer period of time, we do not believe that it's a good timing for us to make any huge investment in our own stock at the expense of our potential resources for, say, the business or R&D expansion need.

As you mentioned – as you can see in our third quarter, we spent quite a lot of cash for different business initiatives and it's really hard for us to say we may not need that kind of a cash in any point of time for the upcoming, say, two, three years. So for the best interest of the company and the long-term shareholders, we still believe that our current 10B-18 program would work for us the best at this – the current stage.

Rick Fearon – Accretive Capital Partners

Okay. Thank you.

Patricia Chou

Thank you.

Operator

The next question is from the line of Douglas Whitman with Whitman Capital. Please go ahead. Mr. Whitman, your line is open. Mr. Whitman, if you are on speakerphone, please lift the handset.

Douglas Whitman – Whitman Capital

Hello? Hello?

Patricia Chou

Hello.

Douglas Whitman – Whitman Capital

Hi. Yes, a quick question on – if you could comment on the real estate and property value that the company currently has?

Patricia Chou

We are building our company headquarters in Zhuhai, China where we have been based for so many years and the construction is almost ready by early next year. And the – we have invested cumulatively to $20 million for our Zhuhai headquarters so far.

Douglas Whitman – Whitman Capital

And how more in addition will you be investing to finish?

Patricia Chou

It's – we expect another, say, around $10 million to $12 million to wrap up this whole project within a year.

Douglas Whitman – Whitman Capital

And does the $20 million cover the cost of the land or is the cost of the land in addition?

Patricia Chou

Yes, the cost of the land is addition. But the land use right in China is relatively lower since we got the land so many years ago, which – already in our balance sheet of $1.5 million.

Douglas Whitman – Whitman Capital

Okay. So that would be dramatically understated in current terms?

Patricia Chou

You mean the cash flow out or what?

Douglas Whitman – Whitman Capital

The value of the land currently would be approximately what? You said you bought it many years ago.

Patricia Chou

Oh, $1.5 million.

Douglas Whitman – Whitman Capital

Was the original cost.

Patricia Chou

That's the original cost.

Douglas Whitman – Whitman Capital

So, would be worth approximately what today?

Patricia Chou

We don't know, since that's for our own use and it's not for sale. So we didn't bother to do any valuation on that land.

Douglas Whitman – Whitman Capital

Well, just to go back to the gentleman's point before, I'm kind of perplexed as well. You've got – we could add probably at least another $0.50 to the valuation – I mean, another $0.20 at least to the valuation that he gave of the cash per share and the stock is well under $1. I mean, so if you actually add in above what the gentleman just pointed out before, we are greater than a 50% premium if we bought back our own – given the – our own stock.

And I'm kind of perplexed how as the long-term shareholders that this is not in the best interest of a company and its investors. I would strongly urge the board to reconsider. And if not – I mean, I've never found that a good experience for a company that's doing under $10 million in revenues to be sitting on basically at this close to $300 million. I mean, it's perplexing to me why anyone would think that they would need that sort of capital and why at the very minimum, I think the idea is correct and great, but why you wouldn't be accelerating your buyback if you are not doing what you are suggesting and why you are not declaring a cash dividend.

So, could you discuss a little bit why you don't return some of the cash to shareholders, since you don't seem to want to buy your own company stock, which is –? I'm just very perplexed. In 20-plus years in the investment business, I've never seen a company not buy back their own stock when they have such an incredible cash discount and such incredible cash forward.

Patricia Chou

First of all, I'd like to remind you that we have been in the buyback program for three years.

Douglas Whitman – Whitman Capital

Buying almost nothing though.

Patricia Chou

I'm sorry?

Douglas Whitman – Whitman Capital

Buying very minimal amounts – for a very minimal amount per – I mean, you bought $2 million worth of stock last quarter. I mean, so, his whole point of buying back stock seems to be financially just so clear and concise. I'm perplexed why you – why don't – if you can't buy back your own stock and you are not willing to do – if that's your option, then why don't you do a cash dividend to shareholders?

Patricia Chou

We will definitely consider these factors and comments from you and other investors. However, because we are still in a very challenging period of time in business and also under the worldwide financial crisis, at this moment we do not think that it's a good idea for the company to distribute the cash dividend or buy back our shares in a fast way and collect a lot of shares right away.

If we turn around, we are definitely open to those ideas. And at this moment, the high level of cash on hand is in fact a very key factor to all of the employees and the customers who believe that we will survive and navigate through this financial crisis. So, those are good ideas, we all believe that, but maybe it's not a good timing right now to work on these ideas.

Operator

Thank you. And that does conclude our question-and-answer session on today's conference. I will now turn it back over to management for any closing remarks.

Ladies and gentlemen, this concludes the Actions Semiconductor third quarter 2010 earnings conference call. If you would like to take a listen on today's – would you – if you would like to listen to a replay of today’s conference, please dial 1-800-406-7325 or 303-590-3030 and entering the access code of 4375446. Thank you for your participation. You may now disconnect.

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