QuickLogic: A Light at the End of the Tunnel?

As investors in emerging growth companies (public and private), we always steel ourselves to the likelihood that no matter how compelling or seemingly inevitable a new technology appears, for countless reasons its market adoption invariably takes longer, and usually much longer, that we initially expect. 

QuickLogic (QUIK) has treated us to another such occasion as we have waited for the better part of three years for its new products to get design and revenue traction in the wireless handset market.  We believe the company now has a revenue-rich design activity pipeline that suggests the wait may be coming to an end. 

While all this waiting has caused an attrition of all but the most patient (and maybe stubborn) investors, as these situations often do, we believe that for an investor the decision to invest in QuickLogic at $1.53 per share is actually rather binary. 

Either you believe that there is a market for CSSPs and 2009 will be a growth year, which makes the current valuation at less than 1x trough-year sales extremely compelling, or you don’t and you view QUIK as a perpetual value trap.  We happen to fall into the camp of cautiously optimistic believers and think that at sub-1x sales there is a compelling long-side set-up for investors in QuickLogic.

QuickLogic is pioneering a new class of semiconductor for wireless devices that it calls Customer Specific Standard Products or CSSP for short.  In short, CSSPs are a type of co-processor to the primary apps processor and provides a programmable connectivity fabric. 

This architecture provides wireless handset OEMs and ODMs extreme flexibility in designing new handsets by enabling numerous handset models of various price points to be spun out of the same design platform thereby lowering costs and shortening the time to market and extending the time in the market for handset models. 

Recently, QuickLogic began offering its visual enhance engine [VEE] as an integrated feature of its Arctic Link II chip.  VEE, based on an algorithm QuickLogic exclusively licensed from Apical, improves LCD viewing in all lighting conditions including bright ambient light by optimizing the dynamic range, color, and saturation.  VEE provides a dramatic improvement in LCD viewing compared to traditional techniques that adjust the LCD backlight which can also quickly deplete the device’s battery.  The VEE application puts QuickLogic in the signals processing realm of design and could be a company maker for QuickLogic.

Despite the intuitive appeal of including CSSPs in handset designs, revenue progress from this category of products has come in fits and starts for QuickLogic.  Actually, truth be told, it’s been more fits than starts.  For the third quarter, management has guided to a sequential decline in revenue—from $8.7 million to $6.3 million—as the contribution from certain end-of-life products winds down toward $0 and the revenue from its new CSSP products declines to approximately $1.4 million.  The decline in new products is disappointing—after all it is supposed to be the growth category—but not entirely unexpected as two very early design wins—that we believe are with Garmin—have expired as expected.  At the same time production from other CSSP design wins in the pipeline are not expected to generate revenue until 4Q at the earliest.  

While 2008 will mark another year of uninspiring revenue performance for QuickLogic, the Company has nonetheless made substantial progress in transitioning from a supplier of FPGA parts to a supplier of CSSP solutions.  This transition includes a complete restructuring of its operations and a realignment of its cost structure.  The Company has hired a new head of sales (Andy Pease, from Broadcom), turned over of its entire sales force, and eliminated several internal engineering functions in favor of outsourcing.  While the results of these efforts are not yet manifested in revenue performance they can be seen in the Company’s burgeoning design win pipeline and pro forma operating costs and financial leverage.

First, on the cost side, management indicated that by 4Q the corporate restructuring and realignment would reduce pro forma operating costs by 25% from 1Q levels and would reduce break-even revenue from $12.5 million per quarter to $8.5 million.  This is very significant.  But from an investors standpoint cost savings alone, impressive as they are, will not translate into a higher stock price.  We consider QUIK shares cheap only if QUIK becomes a growth stock and it goes without saying that QUIK has not been too “growthy” lately.  This could change starting in 4Q and as we begin to move into 2009 as management has begun to provide some encouraging details around its new sales efforts.   Specifically, for the first time QuickLogic is providing some insight into its sales funnel and design win pipeline. 

The Company breaks its opportunity pipeline into five stages: Qualification, Evaluation, Verification, Design Win, and Production Win.  At the end of the second quarter management indicated that it had 56 engagements (which it refers to as “SSOs” short for Single Sales Opportunity) up from 23 at the beginning of the year.  A couple of data points that highlight the quality of this pipeline and possible near-term revenue implications: first, management indicated that two-thirds of SSOs are with tier-1 and tier-2 accounts that represent over 500k annual unit volume potential.  This implies that 37 current SSOs are with tier-1 and tier-2 accounts with aggregate annual unit volume potential of over 18 million parts.  Assuming a $3-5 ASP and we can ballpark the nominal size of these tier-1 and tier-2 engagements at an annual revenue opportunity of $54–90 million, compared to estimated new product revenue in 2008 of approximately $9 million.  That’s interesting. 

Further, management indicated that 21 of its SSOs are for VEE (Visual Enhancement Engine) applications.  This is extremely important since as noted, QuickLogic’s CSSPs have typically provided mobile handset designers with a connectivity fabric.  VEE on the other hand, which is integrated in the ArcticLink II, puts QuickLogic into the signals processing realm which elevates its importance during the design process.  That 21 of the 33 SSO engagements that QuickLogic secured during the first half of the year are for VEE applications is testament to the importance of VEE to designers and to QuickLogic’s future.

As well, management indicated that one-quarter (14) of its total engagements are in the later two stages—Design Win and Production Win—of its SSO pipeline.  While management did not have enough historical data to indicate what percentage of SSOs that began the Qualification process ultimately became Production Wins, it is encouraging that 14 have advanced to this point when there were 23 SSOs at the start of the year.  Intuitively it would seem to make sense that the 33 engagements secured over the first half of the year are in earlier stages while more mature SSOs have advanced towards Design Win and Production. 

Taken together these data points suggest: one, at a minimum that QuickLogic has some significant revenue opportunity in its sales funnel; and two, it has some SSOs moving toward the cusp of revenue contribution.  With the shares trading at an enterprise value to 2008 sales (which should be the trough year in sales) ratio of 0.85x, the market is clearly not giving QuickLogic any credit for getting back to a growth path.  This makes the insights into the opportunity pipeline even more interesting since any growth should cause a revaluation of the shares.  We expect 3Q’08 to mark the low-point in revenue and the first evidence of real progress from CSSP sales.  As we move into 2009 we expect the monetization of the opportunity pipeline to be quickly reflected in Company’s newly enhanced earnings leverage and ultimately share price.

Disclosure: Author holds a long position in QUIK shares.

Comments

[Bapcha's St...:]

Andy Chan and John Birkner who co-founded QUIK along with HT Chua [I do not know where HT is these days] moved on to a new company called SiliconBlue. QUIK is rudder-less and is destined for the junk heap. At best, they should merge with Actel, and focus on the military market.

Bapcha

2008 Aug 11 01:54 PM

[TheSnail:]

Bapcha,

A little harsh there dude. If your so pessimistic, why even pay any attention to the company?

2008 Aug 12 01:40 AM