Techwell, Inc. Q4 2007 Earnings Call Transcript

Techwell, Inc. (TWLL)

Q4 2007 Earnings Call

February 7, 2008 5:15 p.m. ET

Executives

Hiro Kozato - President and Chief Executive Officer

Mark Voll - Chief Financial Officer

Beverly Twing – Investor Relations of Shelton Group

Analysts

Gary Mobley – Piper Jaffray & Co.

Jay Srivatsa - Roth Capital Partners

Quinn Bolton - Needham

Chris Chaney – Stanford Group

C.J. Muse - Lehman Brothers

Presentation

Operator

Good afternoon ladies and gentleman and welcome to Techwell's Fourth Quarter and Full Year 2007 Financial Results Conference Call for the period ended December 31, 2007.

(Operator Instructions).

I would now like to turn the call over to Beverly Twing of Shelton Group Investor Relations. Beverly, please go ahead.

Beverly Twing – Investor Relations of Shelton Group

Thank you and good afternoon. Welcome to Techwell's Fourth Quarter and Full Year 2007 Financial Results Conference Call. The press release and financial tables associated with today's Conference Call were distributed as of the close of the market today. If you do not have a copy, you may find them on the company's website at www.techwellinc.com. This call is being broadcast live over the internet and may be accessed in the Investor Relations section of Techwell's website.

Before management begins the discussion of the fourth quarter's results, I would like to remind you that this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which include without limitation, statements that relate to future events and include but are not limited to, the company's belief that demand for its products will continue to grow. The company's ability to better address customer requirements, leverage technology capabilities and to integrate additional functionality and achieve greater market share, statements relating to future opportunities, its anticipated revenue, gross margin and operating expenses for the first quarter of 2008, anticipated revenue and effective tax rates for the full year 2008, future product introductions, future objectives and anticipated trends and growth in the company's business and end markets in which it operates.

Any forward-looking statements made during this call are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information concerning factors that could cause actual results to differ materially from any forward-looking statements made during this call are contained in the company's written earnings release and in the company's quarterly report on Form 10-Q filed with the Securities and Exchange Commission on November 9, 2007. Techwell undertakes no obligation to publicly update any forward-looking statement for any reason, except as required by law, even as new information becomes available or other events occur in the future.

Thank you for your time and attention. I will now turn the call over to Mark Voll, Techwell's Chief Financial Officer. Mark, please go ahead.

Mark Voll - Chief Financial Officer

Thanks Beverly. Good afternoon everyone and welcome to our Fourth Quarter and Full Year 2007 Financial Results Conference Call. With me today is our Chief Executive Officer, Hiro Kozato. I will begin today's call with the review of our quarterly financial results as well as provide a summary of our full year. We will then provide our business outlook for the first quarter and revenue outlook for 2008. Following my remarks, Hiro will provide an update on our business. We will then open the call for a question-and-answer session. Please keep in mind that all reported financial results, unless otherwise noted, are presented on a GAAP basis.

For the fourth quarter ended December 31, 2007, we reported record total net revenue of $16.5 million which was at the upper end of our previously provided guidance range of $16 to $16.5 million. Total net revenue for the fourth quarter compares to $16 million in the same period a year ago representing a year-over-year increase of 3% and $15.1 million in the third quarter of 2007 representing a sequential increase of 9%. Total net revenue in the fourth quarter of each of our product lines consisted of security surveillance revenue of $12.3 million, representing 75% of total net revenue, LCD display revenue of $1.6 million, or 10% of total net revenue, video decoder revenue of $2.5 million or 15% of total net revenue, and other revenue of approximately $94,000. Security surveillance revenue grew 27% year-over-year and 21% sequentially. LCD display revenue declined 40% year-over-year, however, increased 23% when compared to the third quarter. Video decoder revenue declined 27% when compared to the same period last year and 25% sequentially. During the fourth quarter, 41% of our total revenue came from products fabricated 0.18 micron up from 40% the prior quarter. We expect the percentage of our revenues fabricated in 0.18 micron continue to increase throughout 2008. In the fourth quarter, we had one customer that represented more than 10% of total net revenue. CSR our distributor in China represented 32% of revenue in the quarter which included shipments to multiple-end customers with no single end customer representing 10% or more of total net revenue. In the fourth quarter, 35% of total net revenue came from products we shipped into China. Combined, our 10 largest customers represent 85% of total net revenue in the fourth quarter, of which 7 of these customers are distributors.

For the full year, total net revenue increased 11.5% to $59.9 million compared to $53.7 million in 2006. Our revenue growth was driven by the strength in our security surveillance business which grew 47%. Gross margin increased to 61% for the fourth quarter which continues to exceed our long term target of 55%. This compares to gross margin of 57% in the fourth quarter of 2006 and 60% in the prior quarter. Total operating expenses for approximately $7.2 million for the fourth quarter of 2007 representing 43% of total net revenue. This compares to operating expenses of $6.6 million or 44% of revenue in the third quarter of 2007 and $4.8 million or 30% of revenue in the fourth quarter of 2006. Of the $7.2 million of operating expenses in the quarter, $3.7 million consisted of research and development expenses and included more than $500,000 in tape-out expenses for new product development. Operating expenses also include approximately $1.3 million of pre-tax stock-based compensation expenses under SFAS 123R. Net income for the fourth quarter totaled $4.3 million or $0.20 earnings per share which included $438,000 tax benefits for the quarter. The tax benefit was primarily the continued result of the release of the valuation allowance on the company's deferred tax assets taken in the third quarter. Net income for the quarter also included pre-tax stock-based compensation expenses equating $0.06 per diluted share. Fully diluted earnings per share for the quarter were calculated using 21,834,000 shares.

Now, turning to the balance sheet, accounts receivable were $2.1 million at the end of the fourth quarter compared to $1.9 million at the end of the third quarter. Historically, we have sold on credit terms only to OEM customers and as a result, our accounts receivable balances have been low in comparison to overall revenue. In the fourth quarter, revenue from direct sales to OEMs represented 24% of our revenue, while sales to distributors represented 76% of revenue.

Inventory as of December 31, 2007 was $4.8 million, increasing slightly from $4.5 million in the third quarter of 2007. Our cash, cash equivalent in both short and long-term investment balance as of December 31, 2007 was approximately $68.4 million, compared to approximately $54.5 million as of December 31, 2006 and $65.4 million as of September 30, 2007. The sequential increase in cash, cash equivalents in both short and long term investments is a result of approximately $3 million in cash provided from operations in the fourth quarter. Again in the fourth quarter, we had 143 employees, 61 of which are in research and development.

In terms of guidance for the first quarter of 2008, we expect total revenue to range between $15 million to $16 million. The midpoint of our guidance range would represent a 15% increase year-over-year and a decrease of 6% from revenue at the prior quarter.

First quarter guidance reflects typical seasonality and we expect the return to revenue growth in the second quarter. For the full year of 2008, we expect total revenue to range between $70 million and $75 million which at the midpoint of our range represents more than 20% increase over 2007. Gross margin for the first quarter is expected to continue to run above our long-term target of 55%. Total operating expenses for the first quarter are expected to range between $5.5 million and $6 million excluding stock-based compensation expenses. We estimated our effective tax rates throughout the full year of 2008 will be at 35%.

This concludes my prepared remarks. I will now hand the call to Hiro for additional comments.

Hiro Kozato - President and Chief Executive Officer

Thanks Mark. Good afternoon, everyone. Thank you for joining us today. Today, I would like to provide you with an update on our three main businesses: Security surveillance, LCD display, and video decoders. Our security surveillance business remained very strong in 2007 recording year-over-year revenue growth of 47%. As we have discussed on previous calls, we believe the growth in this market segment continues to be driven by increased awareness for security, improved system functionality related to video networking, and straight-hand analysis and continued reduction in overall system costs.

I&S Research, a leading market research provider to the global electronics industry, recently forecast that the market for CCTV and video surveillance equipment including digital video recorders and video service will grow from 1.8 million units in 2007 to 6.5 million units 2012, representing a 29% compound annual gross rate. As the market leader in front-end analog video decoding, video multiplexing, and video display processing we believe we will continue to benefit from these strong market dynamics. As a result we expect that revenues from our security business will increase by more than 25% over 2007. This overall unit gross above 35% expected to be offset by marginal ASP declines.

Our LCD display business which is focused principally under automotive infotainment display market declined by 13% year-over-year. As the increase in popularity for real CD entertainment displays was overshadowed by the slow down in sales of SUV and mini-vans of our North American customers. Also, the current macro environment may present challenges for automotive manufacturers. We believe the market for In-Car displays remains very attractive driven by demand for navigation, back-up cameras, DVD entertainment, and CD in the car. Telematics Research Group, a global provider of business intelligence services with the automotive and mobile electronics industries recently forecast that market for multi-purpose head unit display will grow from 12 million units in 2007 to 27 million units in 2011, representing a compound annual gross rate of 30%. At CES 2008, we introduced several new products for the automotive infotainment display market. We believe that this product line now represents the most comprehensive group of IC display solutions for In-Car displays today. We believe our strong product portfolio and significant design win momentum will allow us to become the leading supplier in the emerging In-Car display market. As a result, we believe our revenues in 2008 for LCD display products will increase by over 80% over 2007.

Finally, our latest analog video decoder business declined by 32% year over year, driven by the continued integration of analog video decoders into more applications that seek IC solutions, both by Techwell in security surveillance and In-Car LCD display and by other IC suppliers across multiple video-related markets. We believe the integration of analog video decoding has largely been completed throughout the industry as we are seeing in the number of sockets for standalone decoders in the consumer and PC segment stabilize with the lead in portfolio of analog video decoder products. We believe Techwell continues to win a significant portion of the remaining available market. As a result, we believe that video decoder business in 2008 would be roughly in line with Q4 2007 revenue run rate levels.

Before my concluding remarks, I also want to spend some time discussing our R&D activities for long-term benefit to our business. In 2008, we expect to deliver 11 new products for the security surveillance and LCD display markets. Our strategy for these two key businesses is to maintain our leadership position by refreshing our existing products while also integrating additional CD-com contents to grow our address for market. In addition, we are spending significant resources to develop proprietary DTV demodulator course for the USA and the European markets. Our strategy is to introduce standalone demodulators in 2008 to complement our analog video decoder business and our newer audio/video decoder solution.

In the future, we also plan to integrate PCI and PCI express functionality with our standalone analog and Vista TV course to address high growth PC-TV market. As a result of this significant investment in R&D, we are confident that we will continue to expand our security surveillance and LCD display business beyond 2008. We shall focus in 2009 on growing our standalone video decoder business and enter in the PC TV business.

In summary, we believe that our future growth prospect at Techwell continues to be strong driven by increase in demand for video solution across the security surveillance, automotive, consumer, electronic and PC markets. We look forward to reporting continued success in 2008. That concludes my prepared remarks.

Operator, we will now open the call for questions.

Question and Answer Session

Operator

Thank you.

(Operator instructions).

And our first question comes from the line Gary Mobley with Piper Jaffray. Go ahead.

Gary Mobley

Hey guys. I got a couple of questions regarding OpEx and forgive me if I ask the question wrong on the general topic right now, but OpEx was a bit higher than what you have guided for in the fourth quarter and that was primarily to write increased tape-out expenses and if so, could you give some color on what exactly you are taping out there?

Mark Voll, Chief Finance Officer

Correct. In the third quarter call we said that we believe that tape-out cost would be reduced in Q4 because they were quite high in Q3 although some of our projects were moving right along and we incurred those expenses in Q4 and so we had anticipated tape-out cost would be about $250,000 and it actually came in a little bit more than $500,000.

Gary Mobley

Okay. And then I hear that you mentioned that you expect the security surveillance business to be up 25% in '08?

Mark Voll

By more than 25%.

Gary Mobley

By more than 25%, so therefore, the mix of security surveillance will be increasing, does that mean that you will be running well above that, your target gross margin throughout '08 of 55%?

Mark Voll

Yes, that is correct.

Gary Mobley

Okay. That is all I have for right now. Thanks.

Mark Voll

Thank you.

Operator

Our next question comes from the line of Jay Srivatsa with Roth Capital Partners. Go ahead.

Jay Srivatsa

Thank you, and a nice quarter congratulations. Couple of questions if I may on China, what percentage of your business was from China in terms of revenues?

Mark Voll

35% of our revenues were products we shipped in to China.

Jay Srivatsa

Okay. Maybe you can elaborate a little bit on China and going forward on CSR, China Security and Surveillance has been getting a lot of the contracts. What is the situation there? Do you expect further momentum there or is it a one-time contract? Can you speak to that please?

Hiro Kozato

I think the trend will continue. As we mentioned before, Olympics this summer and in 2010, they will have World Expo in Shanghai (inaudible). So, we believe that the trend will continue and worldwide, I think people pay more attention to security. China is building factories to produce the security camera and DVRs. They also have a plan to export more DVRs to the U.S., Europe, outside of China. Again, we think it will continue.

Jay Srivatsa

Okay. China security recently announced that they are tapping LG as a provider for some of their camera needs. What is your relationship with LG? Can you speak to whether that plays in to your strength or not?

Hiro Kozato

I was not prepared for this. I do not think, I am not sure if I can talk about it, our customer. Mark…

Mark Voll

Can you repeat the question again?

Hiro Kozato

The relationship with LG?

Jay Srivatsa

Yeah I mean the question was China's Surveillance and Security recently announced that they are going to be working with LG for a lot of their security needs and I wanted to understand whether, how do you play in that? Is LG…?

Hiro Kozato

LG is also using our chips in the TV.

Jay Srivatsa

Okay, that was what I was looking for. Okay very nice. In terms of the automotive segments, I know there was (inaudible) introduced and you alluded to some weakness in the SDV market. When do you see that revenue starting to grow from that segment?

Hiro Kozato

Actually, seeing the orders now in Q1.

Jay Srivatsa

Okay. So does that, are we to infer that the automotive inventory has been burned through? Or is it just demand pick up?

Hiro Kozato -

Well, I guess so. We think so. At least, I think, that they have less inventory.

Jay Srivatsa

Okay, and then last question on the panels. There have been some panel shortages and stuff, earlier part of last year. What is the situation there?

Hiro Kozato

We are still seeing shortage.

Jay Srivatsa

You still see a shortage?

Hiro Kozato

Yes, especially for customers in China.

Jay Srivatsa

Okay. And the last question, I will lift up off the queue here. In terms of the guidance, is it sequentially lower because of the Chinese New Year, or is there seasonality, and if it there is seasonality, which segment are you seeing in them?

Mark Voll

No, I would think it is going to be because of the typical, the Chinese New Year that we would see many of our customers as well as our own employees out for week if not two weeks in the quarter.

Jay Srivatsa

Okay, thank you very much.

Mark Voll

Welcome.

Operator

Our next question comes from the line of Quinn Bolton with Needham Company. Go ahead.

Quinn Bolton

Thank you. I just wanted to first ask a question on the tape-out expenses. It sounds like you had higher expenses in Q3 as you had pulled in some tape-out cost from Q4.

It sounds like that happened again more from your actual explanation of the higher than expected tape-out costs. Do you see Q1 R&D down then? Are we going to accelerate some of these tape-outs and we are going down to a lower level in Q1 or do you think that we just have a higher pace of tape-out activity now, Hiro mentioned the 11 products scheduled for introduction in ’08, just trying to get a sense of how to think about tape-out going forward?

Mark Voll

Right. I would think that our tape-out schedule for 2008 is quite robust. I would expect the R&D expenses running at this rate and higher into ’08.

Quinn Bolton

So, right about $3.3 million excluding stock comp, that is kind of a good base?

Mark Voll

That is correct.

Quinn Bolton

Okay, the second question just on the LCD display. It sounds like you have won a fair number of designs, just wondering if you might be able to sort of talk about some of the new customers that begin to ramp in the second half of 2008?

Hiro Kozato

Yes. We have shifts of the design team in the system manufacturers such as the usual audio makers, DVD, audio, radio makers for the car entertainment unit and we have more than 60% of the new design release in most of the audio makers.

Quinn Bolton

It sounds like a lot of that, the folks you have in volume production today that were impacted by the inventory situation, that is a pretty small percentage of your total design wins? Is that the right way to be thinking about it?

Hiro Kozato

Aha. Very small.

Quinn Bolton

Do you have any tier 1 sort of auto OEMs? Is the end customer that starts to ramp second half of 2008? Any new tier ones?

Hiro Kozato

This comes off the audio system makers; car navigation makers will be shifting to the auto makers. We were told that there will shifting to more than 10 auto makers starting from second half of this year.

Quinn Bolton

If I could take that 10 and put it in perspective, how many would you be shifting to today? Is it 5 going to 10? Is it 7 going to 10, just trying to get a sense of the incremental ramp.

Hiro Kozato

Well, our current is (inaudible) to 4 of them but 2 of them are in very, very small volume and we think in the second half we will be shifting to at least 6 of them but the first 4 will start picking up in the volume, (inaudible).

Quinn Bolton

Okay. That is what is behind the 80% year-over-year that you foresee in the auto business?

Hiro Kozato

That is correct. Yes.

Quinn Bolton

Okay. Great. And then lastly just to make sure I heard the numbers right. If I kind of take your fourth quarter security business and annualize it, it looks like that already gets you to something pretty close to 25% annual growth. It seems to me the 25% growth in security, given that metric seems conservative. Are you just trying to be conservative? Do you think that there are some things; is it a slower first half? Again, just trying to get some more color on the security side of the business?

Hiro Kozato

It is not very conservative. I would say it is reasonable. Actually the unit of the parts is increasing by more than 35%.

Quinn Bolton

Okay. So we see some ASP pressures that offset some of that stronger unit cost.

Hiro Kozato

Yes.

Quinn Bolton

Okay. Great. Thank you.

Hiro Kozato

You are welcome.

Operator

The next question comes from the line of Chris Chaney of Stanford Group. Go ahead.

Chris Chaney

Mark, could you repeat your guidance for Q1 gross margin? I think that I missed that or I miswrote it.

Mark Voll

We just said that it would continue above our long-term gross margin target of 55%.

Chris Chaney

Okay, very well. And then in terms of the trend as we go next year a lot of these new designs are going to be shifting into the automotive sector? Are these on a new design shrink and therefore shouldn’t they be better gross margin than they currently are?

Hiro Kozato

Yes.

Chris Chaney

I guess it is hard to say that it looks like gross margins could remain fairly constant through the next few quarters.

Hiro Kozato

We do think so.

Chris Chaney

Okay. That is all. Thanks.

Operator

The next question comes from the line of C.J. Muse with Lehman Brothers.

Olga for CJ Muse

Hi guys. This is Olga calling in for C.J.

Mark Voll

Ah, yes. Ah-hum.

Olga

Given the previous question about gross margins, would that imply that you would actually have, if we assume the current revenue level and the intended gross margins in the first half, would the second half, will we see more of a spike as you shift to lower online new products.

Mark Voll

No. Yeah. We do not expect that gross margins would materially be different from where we would have been in 2007.

Olga

Okay. And what kind of EPS ratio are you expecting on your auto side?

Hiro Kozato

Single digit.

Olga

Okay. Just from your conversations with your auto customers are some of the orders sort of uncertain given the macro environment? Are they confident or given the newness of this technology are they sort of going ahead with their plans?

Mark Voll

I am sorry your question is with the guidance from our auto customers regarding their business for 2008?

Olga

Ah-hum.

Mark Voll

We have not gotten that kind of clarity yet as far as their guidance for the year.

Olga

Okay. I was just wondering given your forecast for 80% plus revenue growth, how much push and pull will we see, driven by the macro environment rather than the …

Mark Voll

Well, we think that our guidance for the growth and that is well-balanced worldwide and we think that is a pretty reasonable explanation on our part.

Olga

Okay guys. Thanks so much.

Mark Voll

Ah-hum.

Operator

Our next question is a follow up from the line of Jay Srivatsa. Go ahead.

Jay Srivasta

Thanks for doing my follow up. In terms of just the macro environment it looks like there is a lot of uncertainty going into ’08 from several companies. How do you see your revenue profile change depending on how the overall economy shakes out?

Mark Voll

I think (inaudible) though. Profiling is not going change that much differently from 2007. We expect security surveillance to continue to be strong and the dominant percentage of our overall revenues. We would expect to see growth in automotive as (inaudible) some of our overall revenues.

Jay Srivatsa

Okay. Thank you.

Operator

Ladies and gentlemen this does conclude the time that we have for questions today. I would like to turn the call back over to Mark for closing remarks. Please proceed.

Mark Voll

We encourage you to visit our website at www.techwellinc.com to view our latest announcements as well as our calendar of events. Later this month, we will be presenting at the Roth Capital Partners conference on the 19^th. Additionally, if you have questions or would like more information please contact Shelton Group or me directly. Thank you for joining us today.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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