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Executives

Mike Hickey - CEO

Mark Cubitt - CFO

Analysts

Nick James - Numis

Robert Ernst - JPMorgan

Andrej Krneta - Jefferies

Ian Robertson - Seymour Pierce

Francois Meunier - Morgan Stanley

Tim Shaw - Citigroup

Didier - RBS

Dan Ridsdale - Edison Investment Research

Wolfson Microelectronics (OTC:WLFMF) Q3 2010 Earnings Call November 4, 2010 5:00 AM ET

Operator

Good morning ladies and gentlemen and welcome to the Wolfson Microelectronics Plc Q3 Results Conference Call. Today, I'm pleased to present our speakers Mike Hickey, Chief Executive Officer and Mark Cubitt, Chief Financial Officer.

For the first part of this call, all participants will be in listen only mode. Afterwards there will be an opportunity to ask questions. Mike over to you.

Mike Hickey

Okay, thank you. Good morning and welcome to Wolfson Microelectronics third quarter result conference call. I am Mike Hickey, CEO of Wolfson and also present here is Mark Cubitt the company’s Chief Financial Officer.

Let me quickly take you through some of the key points of the third quarter and then we will be happy to take any questions. I am pleased to report that the promised impact of our class of 2009 designing reaching volume production was delivered in the third quarter. Despite being supply constraint, Wolfson achieved revenue growth over 30% sequentially and annually and for the first time since 2008 returned to profit underlying in full IFRS basis.

So in the third quarter of 2010, the financials were, revenues were up sequentially in year-on-year to $47.1 million, an increase of 31% and 33% respectively. Revenues were supply constrained in the third quarter due to customer equivalent mix changes and supply ramp issues. These are now result and we are no longer constrained by supply.

Gross margin was 49.7%; underlying operating profit was $3.2 million or 7% up 11 percentage points sequentially from Q2 2010 which is a 4% loss. Underlying diluted earnings per share also increased to $0.021 compared to $0.4 last year. Operating profit was 0.6 million compared to a 2.3 million loss in Q3 2009. Diluted earnings per share was $0.05 compared to $0.013 loss in Q3 2009.

Now let me talk about what happened from an application market perspective. We saw strong sequential revenue growth in mobile phones, gaming and accessories, Blu-ray DVDs and eBooks. Mobile phones grew 76%. Gaming consoles and accessories grew 82%, Blu-ray DVD grew 88% and eBooks were up a 148%. Sales were mainly flat in applications such as PCs, printers and automotive and lower portable navigation, portable audio applications and after a strong first half, televisions were also lower.

I am pleased to report that the positive momentum on revenue in profit is also evident in our design-ins and product loan performance. From a design-in prospective, the design-ins won in 2009 that continue into transition to volume manufacturer is previously outlined.

Around 80% have already transitioned and we still have some high value ones that will work their way through to revenue in 2011. Our strong design-in momentum was maintained, given a year-to-date today of 297, an increase of 55% year-on-year. This means we have already exceeded last year’s total of 254.

As well as the mobile handset design-ins, our audio hub and sub-system products were selected by multiple consumer electronic manufacturers including many Tier 1s for their new tablet PCs.

LG has selected Wolfson’s audio subsystem products recently launched, Optimus 1 and Optimus Chic Android-powered smartphones. Our design-in performance is driven by strong performance in the mobile segments with over a 100 new design-ins here today. This is a result of our ODL Hub in subsystem architectures becoming more widely adopted for handsets. This also increasingly is the case for many other applications such as tablet PCs, eBooks and for example one of our audio hubs were selected by leading Tier 1 TV manufacturer bringing HD audio to its new range of 3D and HD TVs.

In addition to the encouraging design-ins progress good product development performances continued with six new products being launched. These include Wolfson’s next generation HD audio for smartphones and other portable media application such as tablet PCs and eBooks. Two power management devices including the world’s highest current monolithic power management IC which is designed specifically for portable media players applications including smartphones, eBooks readers, media players and tablet PCs. And we also launched a new stereo line driver and immense transducer in new analogue front end digitiser for multi-function printers.

From a supply perspective, as I said earlier we were supply constrained in the third quarter of 2010. This was caused by some mixed changes in the quarter and buy some supplier ramp issues which are now resolved. The mixed changes were from products where we had supplied to products were supply was tight. And some reprioritization of supply to make the parts needed to key production lines running for some customers who experienced stronger than expected demand for their products. There are also some in the quarter’s supplier de-commits as they'd struggled to meet deep volume ramps on some products. These ramps have now been achieved.

Regardless of these issues we still managed to deliver over 30% growth in the quarter and have ramped supply by over 70% year-to-date very high industry wide supply environment. So in summary for Q3 revenues were supply constraint for the lower end of our expectations mainly because some of our supplies slip their ramps by a few days, there are now at the level we need them to be. However, the material thing is that the 2009 design-ins delivered in Q3, a significant step up in revenue over 30% sequentially and returned us to profit.

Now looking forward, the company expects revenues for Q4 2010 to be in the range of 40 to 48 million driven by demand in smartphones, gaming consoles and accessories and eBooks. Wolfson expects continued strength in these markets in 2011. The ranges is wider than normal due to some uncertainty over potential year-end inventory corrections and after a period of strong demand growth. However, the bottom of the range would represent Q4 year-on-year revenue growth of over 45%. Product mix and volume related price breaks will result in some gross margin decline in Q4 2010. However, 2010 full year gross margin is expected to be around 50%.

So Q4 is all about taking the step up in revenue and profit we achieved in the third quarter and then overlaying on this the influence of the general macro demand environment in Q4. this is some demand softening due to some customer inventory corrections coming off three quarters off a strong industry demand and tight supply coupled a normal seasonal uncertainty as we pass the peak manufacturing period for the fourth quarter holiday season.

The material thing here is that we are in the applications and I would argue with the customers which have the strongest demand such as smartphones, eBooks and gaming consoles and accessories in this environment.

Looking further ahead, we take the step up of revenue and profit achieved in the second half of 2010 and add to this some high value 2009 design-ins which are yet to transfer to revenue and their very strong 2010 design-in performance.

Again, the material thing here is that the step up in revenues in the design-ins achieved so far are mostly in the applications which have grown the fastest and expected to continue to grow in 2011 i.e. in smartphones, tablet PCs or pads, eBooks and next generation gaming. This gives us confidence that we can continue the strong growth seen in 2010 into 2011.

So putting it all together, Q3 2010 was a significant ramp quarter for Wolfson with a promised impact of our class of 2009 design-ins reaching volume production.

Despite being supply constrained, we achieved strong revenue growth sequentially and annually and return to profit. Our audio hub architectures have been adopted in most exciting and fastest growing consumer electronic products such as smart phones, tablet PCs, eBooks and next generation gaming products. This coupled with our class of 2010 designing performance gives us confidence of further strong growth in 2011.

Thank you for listening, we are now happy to take any questions now.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Nick James from Numis. Please go ahead.

Nick James - Numis

I just had a few questions. Firstly on the supply constraints you saw in Q3. Did those impact on your revenue from your new product ramps in audio hubs or was it constraints in other areas?

Mike Hickey

Basically, there was constraints across a lot of the products. We didn’t move a lot of things around in order to keep lines running for our customer end products but also the ones which were ramping fast were all obviously on our new products, audio hubs, and they were mainly limited to real big ramps on chip scale packaging et cetera which was, there is shortage on. So, basically we had supplier commits and they were ramping through with no one quite making it, we’re catching up through the end of the quarter but we didn’t. They are couple of days behind their ramps et cetera but then now there are velocity rates that we need.

Nick James - Numis

So I guess this drives the question in terms of the Q4 revenue guidance, and some of the products that you're in, in the smartphone space, have sold very well in Q3, now looking very good for Q4. You would anticipate there's quite a bit of pent-up demand, given you didn't manage to supply all that people needed in Q3. So just wondering why the Q4 revenue guidance is somewhat on the weaker side?

Mike Hickey

Although we have a good backlog going into Q4, we weren’t the person that we’re holding up, the shipments of those devices, so we do think there will be some inventory correct in terms of matching sets et cetera as they tune everything back. And then it normally happens at the end of the year, they match that, they are roughly going to shift and even though we might ship less into them, they could in fact ship more and then we go with aiming Q1.

Nick James - Numis

And then I guess the second question was just on competition. I know you had kind of a lead with the audio hubs and that’s really given you quite a strong market position in some of the smartphones to the Koreans currently. Some of your competitors have made some comments that they believe that they are kind of advanced process of the design-ins as well. So just one thing if you are seeing more competitive pressures as some of your resisting customers as well as on your transit to win new customers?

Mike Hickey

We’ve got some great stuff in development. So I think the category is obviously becoming established and we are going to see more competition. So we are aware of that. And we are design-in hard, we believe we got another generation of products coming out in the middle of next year, and the job is to build the category and stay ahead of the competition, and that you can’t stand still.

Nick James - Numis

And then just a final question on FX. I noticed in the statement you said you haven't hedged FX for 2011. Do you plan to hedge, or are you now adopting a no hedging type of strategy?

Mark Cubitt

The policy we have is the minimum; we were always here at least one quarter ahead. So we have hedged Q4. So by the end of this quarter the minimum we have done is Q1 2011. We may by the end have done more.

Operator

Our next question is from Robert Ernst from JPMorgan. Please go ahead.

Robert Ernst - JPMorgan

So I suppose my question is around the 2011 outlook. I'm just wondering how comfortable you are with, say, top-line forecast. I know there's a big range out there, but is there anything; I suppose my question is, has your visibility of new products ramping in 2011, has that changed at all for the worse, for the better, in the past couple of months, couple of weeks? And then maybe just to follow up, be interested to hear about certain product categories that you saw some lumpiness within those categories in terms of demand.

Mike Hickey

In 2011, I mean basically our design-ins from 2009 and for 2010 are in categories like smartphones, eBooks, pads, Blu-ray et cetera, gaming, and all those categories we are expecting those to grow next year. Overall consumer electronics was still seeing forecast in the industry of 10% growth but smartphones something like 30, over 30% growth; mobile itself still around 10%, pads something like 300% and there’s other much bigger numbers out there; eBooks 50% and even in sort of PC, netbooks, smartbooks et cetera, 35%; Blu-ray is up. TVs, although they went down for us in the third quarter we had a very strong first half, and they are expected to grow LED TV sort of 15-20% next year.

So, what we are seeing no moderation of that growth going into 2011 in the market and if those categories do well our design-ins are in those categories. They are spread across a widening base of customers and we have had nothing that’s happened to us. That means that any of those design-ins that we have or any of the forecast for those category is going up are going to be moderated at all. So we are still very confident about the overall industry environment in 2011. And then if those both numbers don’t come through in those applications then that will affect our numbers but we don’t see that so far.

Robert Owens - JPMorgan

And then maybe just thinking about the combined tablet/smartphone market. In terms of as a percentage of sales for 2011, 2012, what would be the best way to model that?

Mark Cubitt

I mean it’s quite a hard one there because it depends what your total revenue number is. I mean at the moment just that the mobile or the handset over a third of our revenues. We think that’s going to grow.

Mike Hickey

A couple of things which are fast growing, so how fast will pads grow? Obviously that’s a very small percentage of our current revenue although mobile smartphones is bigger, but we’ve done very well. In fact we’re succeeding in most of the, in this one but a lot of the others, okay. And if that grows anywhere near the size what people are talking about then that’s obviously going to be a big impact on our numbers.

The other thing is things like eBooks, we have done very well, and they are still needed to grow. So, I think if you took smartphones, tablet PCs et cetera and eBooks, then you are talking roughly about half of our overall revenue I would guess. It could be as high as that. They are 40% dependent on how fast they grow.

Mark Cubitt

Currently over a third, just over a third of our revenue, at the movement it’s currently in handsets and mainly in smartphones. We as we’ve all previously announced, we've got that new Tier 1 design win that's going to kick into, we think fairly significant revenues from Q2 onwards next year. That’s incremental to what we’ve already got.

And on top of that we’ve got all these eBooks and the pads where we've done really well with our designs-ins. And to be perfectly honest there is very little in the numbers at the moment on those. And again, they should continue to ramp as we go through next year. So if you’re adding there into the smartphone category then yes it’s going to be in the mid-40s, that’s 50% of the business.

Mike Hickey

I think we announced in 2009 we had over a 100 mobile design-ins. We have got 100 year-to-date already. So it’s obviously going to be a big part of our growth engines. And then pads are in there as a new, or tablet PCs are in there as a new category. So we’d be very pleased with eBooks as well so we’re hoping eBooks are widely adopted as well.

Operator

Our next question is from Andrej Krneta from Jefferies. Please go ahead.

Andrej Krneta - Jefferies

Just an inventory question here, just wanted to see if you guys are seeing any build up in inventory from your customers, and if there is any impact of this for your next year 1Q and 2Q sales. And just a bit more color on the volume-based discounts that you talk about for 4Q. Is this coming from a specific customer, your largest customer or your new customer, that you've got this year? Can you just give us a bit more color there? Thanks.

Mike Hickey

I think in terms of the demand of, we're really seeing is piece-part inventory corrections rather than in June inventory corrections. So I don’t think we have any evidence of that maybe happening but I'm unaware of it. In terms of perhaps maybe we’re working out some inventory in the second-half on TVs et cetera that might be the case because some of the things were strong in the first-half but of course our biggest growing segment I think is much more matching sets of piece-parts rather than end units.

Some of our customers we have volume price breaks, and they’ve ordered lots of stuff and that’s coming sooner than we had with what we see time cost reductions to compensate for that et cetera but they’re due related in the first-half of next year and some of our parts have got very high margin others have got lower margins and we do get quarter mix variations on those and that’s just gone in that first part of [fashion] in Q4. In terms of the overall 2011 business model we don’t think we need any change there.

Mark Cubitt

No. We don’t want to lose any change to our model but the fact is there is some place in Q4.

Operator

Our next question is from Ian Robertson from Seymour Pierce. Please go ahead.

Ian Robertson - Seymour Pierce

Hello, guys. Two things. First of all, I've looked through the statement a few times and just going through what's been said so far, I'm just trying to actually find out what was the extent of the revenue constraint in Q3? And, therefore, how much of that should be flowing through into Q4 to find out an underlying revenue level for Q4? And also, could we have any kind of visibility on what level of revenues is coming out of the noise cancellation and microphones specifically?

Mike Hickey

We said that the interims we felt we had capacity in orders after the high end of our guidance which actually what was true. We weren’t able to secure supply ramps to execute in all of that capacity. And the orders that we have were some differences from what was expected going in to Q2 but on aggregate level we did have demand up to that level so we have got a good backlog going into the fourth quarter. The concern obviously is how much of that backlog sort of stays in the fourth quarter if there is any inventory correction or has it moved out in Q1 et cetera. So that’s hence the range some uncertainties there that’s why we have given them the guidance range we have.

In terms of the noise canceling and microphones that they are still a very small percentage so they are much more in the design-in stages rather than in the revenue realization stages.

Mark Cubitt

The combined revenues from microphone and noise cancellation was about half a million so its still in early stages but what was also encouraging was the power management revenues we begin to see them and they were 7.5% of revenue in the quarter. And we are quite positive about how the power management chips are now getting designed in.

Ian Robertson - Seymour Pierce

Can I just ask one other quick question which is, looking at the exposure you have to one particular customer, 23%, how many products are you actually shipping through to that customer? Is it focused on just a handful of devices, or is it pretty much across your whole product range?

Mike Hickey

We ship to them across our full product ranges actively

Mark Cubitt

And they’ve also got designs in mobile handsets.

Mike Hickey

Multiple, it is platform design in across multiple handsets.

Ian Robertson - Seymour Pierce Ltd

Right, and how much of those sales would be hub products?

Mark Cubitt

A big chunk of it.

Operator

Thank you, our next question is from Francois Meunier from Morgan Stanley.

Francois Meunier - Morgan Stanley

Just a quick question about your tablet PCs exposure. Obviously, probably the market will be dominated by one company next year. But I was wondering with which application processor you will be shipping along next year? So that's the first question. The second question is about the smartphones. The smartphone customer for 2011, you were talking about the new customer. What's the status on this one, and when do you think it's going to ramp, is it Q2, or maybe a bit later, maybe you have more visibility? And the third question is about your supply constraints this year. I understand it's around the packaging, CSP packaging. Which supplier are you using for this one? Is it ASC, or [Spiel]? And do they have enough capacity to supply a potential big ramp in revenues in smartphones and tablets next year?

Mike Hickey

Okay. Thanks, all of those questions Francois. Obviously the first question is multiple application processors, so we are in basically most of the others who are the famous one, okay? So I told you which apps processor, then you'd be able to decide which customer it was so we can’t say that. It is an emerging category and that could be a big winner there et cetera so I feel on that is well if we actually go across the few than hopefully is that whole category wise as we’ll get some benefit from that.

On the second question about the pre-announced design win, we think that will be we’ll start in Q2 next year and then ramp through the second half of next year and that’s still go into plan and then in terms of the supply constraints on CSP, we have a supplier. We have now to source that supplier, the single supplier is at there ramp, at their velocities that we need and now we are adding on the second supplier and we very much hope as we take this thing to another gear roughly Q2, Q3 next year that will be able to go through the ramp and ramp again and through which you will supply those. And as well as that I think the industry is having quite a lot of [from chip scale] packaging capacity.

Francois Meunier - Morgan Stanley

Okay, thank you. Now just to come back to the tablet market, because I just suddenly realized it could be a very big opportunity for you, in H2 2011 and 2012, and beyond, potentially. What type of chip is it? Is it a audio hub, or is it even more than that?

Mike Hickey

Mike Hickey

Its mostly audio hubs

Francois Meunier - Morgan Stanley

So the ASP should be quite good, okay?

Mike Hickey

Yes and it’s really an extension of the work that we’ve been doing on our smartphone architectures.

Francois Meunier - Morgan Stanley

Yes. Does it include also some architecture design around the speakers, as we can see on the Samsung tablet for instance?

Mike Hickey

On the Samsung tablet?

Francois Meunier - Morgan Stanley

Yes, I don't know if you saw, they've got something which is quite similar to what you show in terms of speakers, at the analyst day last year. Okay, we can take this offline.

Mike Hickey

You could say that. We can’t comment.

Operator

Our next question is from Tim Shaw from Citigroup. Please go ahead.

Tim Shaw - Citigroup

Tablet PC stuff's probably been answered now. Two things. On the inventory corrections, has that translated into any notable order cancellations, in the fourth quarter?

Mike Hickey

From our perspective we haven’t seen cancellations. We’ve just seen some forecast moves over the end of Q4, so it’s moving our forecast.

Tim Shaw - Citigroup

Okay, fine. Housekeeping question. You previously talked about a cash position of around $100 million net cash by the end of the year. Is that guidance still there, or given the working capital movements this quarter, is it likely to be less than that, at the end of the year?

Mark Cubitt

There is no doubt as probably a mid 19 number now.

Operator

(Operator Instructions) Okay couple more questions. Our next question is from Didier from RBS. Please go ahead.

Didier - RBS

My question is, going back to tablet PCs. I think you've been pretty eloquent as to your strength in this area. What I was wondering is, if you could give us a sense of the number of OSCs you will support next year? And secondly, in particular, with the one starting with A, if you have a feel for the market share you may secure in the calendar year 2011?

Mike Hickey

The market share in tablet PC.

Didier - RBS

Yes, if you see what I mean, because you said you are not in the big one, so just the…

Mike Hickey

We will support multiple OS but I would guess mainly Android but multiple, the after market share is anyones guess we hope our customers, all our parts do really very well. But I think the market is so new it’s difficult to tell and obviously there is it’s a category that’s been created. So I think we have enough of them that we can participate but few wins is to be determined by the end consumers I think.

Didier - RBS

Understood. But historically I think its part of Francois' question. Historically, you've had a lot of success outside of the Qualcomm based platform, so I'm talking smartphones here. I'm just wondering if you think there could be any difference in the tablet market.

Mike Hickey

When we do think as the tablet market emerges some of the things like making sound more 3D, being steering for when that turn in voice and all of these other things. So we do think our technology can improve the experience of tablets quite a lot. I think we are in the same sort of game that we are in smart phones around how we work with different apps processors it’s the same sort of architecture et cetera.

Didier - RBS

Okay, great. And just a final one, I think Mark mentioned that power management accounts for now 7.5% of your revenues. Do you think that power management is a major growth driver for Wolfson in 2011? And if so, is it the usual suspects in terms of end applications that we should be looking for?

Mike Hickey

I think our growth driver is our audio hub architectures and then how we move them forward and adding the sound et cetera which we talked about a lot this year. We do think that the power management and MEMS mark is an incremental opportunity towards above that.

Mark Cubitt

It will grow but it’s not the main growth driver of the company.

Mike Hickey

And they are targeted on the same applications so as the same customers sometimes its same design teams and the same people in their design teams that we are selling these products too.

Operator

Thank you. Our next question is from Dan Ridsdale from Edison Investment Research. Please go ahead.

Dan Ridsdale - Edison Investment Research

Hi. Most of my questions have been answered actually, already. But just in terms of a couple of things. Firstly, you mentioned that the power management, sorry, the mics and the noise cancellation are still small. Are you still confident you're getting the design wins with those products, or has that been somewhat slower than you expected? It seems as if the growth is all round hubs now.

Mike Hickey

I mean we have been through on the microphones and stuff. We have been basically building up the full portfolio. We are in the design-in stage with those, okay. On AMC again we are on the design-in we are shipping a lot of the soundware software with parts out as you know plus one features running on our audio hubs et cetera and we have got clients where they become a more integrated part of our upfront moving forward in to 2011.

Dan Ridsdale - Edison Investment Research

Mike. So you're building the mics portfolio, what's your sense in terms of getting designed-in with those…?

Mike Hickey

With our digital mics, we are getting very good feedback from customers about the performance of those. And there were Tier 1 customers who were heavily evaluating them and so we think we are in a very good position there.

Dan Ridsdale - Edison Investment Research

Okay. And then the other question, which has been answered a bit. But in terms of getting multiple chips in devices, are you able to give any quantifiable information in terms of how many of the wins you're getting in devices are for more than one of your chips?

Mike Hickey

I mean all I can say is we are in an increasing value with some of them are multiple, some of them are more functioned. Again that’s moving more into the 2011 combined them in the 2010, Dan.

Operator

This was our final question, back over to you for any closing comments.

Mike Hickey

Okay, well thanks very much for listening. If you have any follow-up questions then please call us. Thank you

Operator

This now concludes our conference call, thank you all very much for attending.

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