QuickLogic Is In The Right Place At The Right Time, Thanks To Apple

| About: QuickLogic Corporation (QUIK)
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In my last article about QuickLogic Corporation (NASDAQ:QUIK), I described the company's business and future prospects. In my view, one of the most interesting prospects of QuickLogic's business is the new ultra-low power sensor hub. As a reminder, this sensor hub is a chip that brings the "always on context awareness" mode to life, thanks to the chip's very low power consumption. Usually when one of your apps uses data that come from the many sensors inside your smartphone, it goes through the main app processor. QuickLogic's sensor hub offers the ability to handle the data gathering from the sensors and remove a lot of the "pressure" from the main processor. Then, the sensor hub interrupts the app processor only when it's necessary, thus giving it more "sleep" time. What does that enable? Continuous monitoring of the smartphone sensor, which enables apps to do amazing things without draining your battery.

Apple Moves. Others Will Follow

For the first time in the history of the iPhone, Apple (NASDAQ:AAPL) has included in the iPhone 5S a chip called the M7. In the words of Apple:

Source: Apple Website

The M7 does exactly the same thing as does the QuickLogic sensor hub, and thus its inclusion in the iPhone 5S marks an important step in the vision of future smartphones. Usually when Apple includes a feature in one of its designs, the other vendors try to copy it. However, sometimes they just don't have the technology to do so (see the Apple-AuthenTec acquisition in reference to the Touch ID, the iPhone fingerprint sensor). The M7 offers a lot of value to users as it enables a new world of applications to be developed, which, before the inclusion of the M7, would have drained your battery very fast. A good example of this is the Argus fitness app. Before the app was designed to work with the M7, it drained about 20%-30% of battery power per day as it worked in the background and counted your steps. When the Argus app uses M7 to track your movement, it takes almost none of your battery at all. I believe that the fact of better battery life + better apps will drive other vendors to follow Apple's suit and try to include their own versions of the M7 in their designs. The thing is, Apple has one heck of a design team and they had the in-house ability to design the M7 chip themselves.

Source: Chipworks

This is not an ability every smartphone maker has; they will have to look for it in other places. QuickLogic's ArcticLink 3 S1 (the sensor hub product's name) will enable smartphone designers not only to enjoy an M7 of their own, but the QuickLogic programmable design will enable them to program the chip to act as they wish. This unique product offers every smartphone vendor the ability to quickly include an M7 of its own without going through the very costly and lengthy process of designing a chip and partnering up with a foundry (like NXP) to actually make the chip according to their specifications.

The M7 and ArcticLink 3 S1 Die size

To try and quantify QuickLogic's opportunity with this interesting product, we first need to get two things clear: costs and price. Let's start with the M7.

M7 Cost

The M7 is a 90 nm chip. The next photo is a photo of the iPhone 5S teardown that shows the A7 and the M7 on the same board. After doing some cropping and pasting, I came to the conclusion that the M7 is about 1/20 the size of the A7.

Source: iFixit iPhone 5S teardown. The highlighted chip to the left is the M7. You can easily recognize the A7.

We know that the A7 size is 102 mm^2. That gives the M7 the size of about 5 mm^2. From the iPhone 5S BOM, we know Apple paid $19 for each unit of both the A7 and the M7 (IHS estimation).

The $19 figure for the A7 + M7 doesn't tell us much without knowing the share of the A7. For that reason, we will take a look at the iPhone 5 BOM:

So, a year ago the A6 cost Apple $17.5 per chip. A year later it cost Apple $19 for the A7 + M7 combo. I suspect that Apple didn't pay more than $1 per M7 chip. Apple paid NXP the foundry margin, but not the design margin, as I expect Apple designed the M7 itself. According to NXP's (NASDAQ:NXPI) last quarterly results, they had a gross margin of 45.6%. Assuming Apple pressures NXP a bit (as it does with any supplier), we can assume that NXP makes a 40% gross margin on these chips. That means that NXP is making those M7s at a cost of about $0.60 apiece.

ArcticLink 3 S1 Cost and Price

According to QuickLogic, the ArcticLink 3 S1 comes in a package of 2 mm × 2.5 mm, giving it an area of 5 mm^2, which is exactly the size of the M7. I suspect QuickLogic, as a fabless company, pays the same $1 per chip to their foundry (possibly TSMC), and that QuickLogic enjoys gross margins of 40%-50% on those chips, as they are approaching their long-term goal of 50% gross margin. That means that QuickLogic will get approximately $1.4-$1.5 per chip.

Market Opportunity

This is the smartphone market according to IDC in 2013:

Needless to say, Apple is out of reach for QuickLogic. I believe that Apple will continue to improve its M7 chip further and further, relying on its own in-house design ability. Let's examine each possible DW and what can it do to QuickLogic's results. I expect that the ArcticLink 3 S1 has a much better chance to win a slot in a high-end model than a low-end one, for obvious reasons. A recent research study goes on to claim that about 66% of the Android market consists of very low end "junk phones." Going forward, I will estimate about 33% of each vendor's shipments as being the total addressable market for the QuickLogic sensor hub. I also assume that each major vendor will grow its shipments by 20% in 2014.

Samsung

Samsung plans to sell about 360M smartphones in 2014. But only 126M will be high-end smartphones. Samsung's forecast for high-end smartphone shipments in 2014 is 126M. If Samsung will choose to embed the ArcticLink 3 S1 in all of its premium models, that will generate about $182.7M in revenues for QuickLogic, and a whopping $73M in gross profits. That's in comparison to a gross profit of just $3M in Q3-2013.

Xiaomi

Xiaomi is a new entrant to the high-end smartphone market with great success in China. The company plans to double its smartphone shipments in 2014 to 40M units, which will place the company in the top 10 list of global smartphone vendors. If QuickLogic will win all of the Xiaomi models, it will generate $58M in revenue and $26.1M in gross profits.

Lenovo, LG, and Huawei

Assuming 33% of Lenovo, LG and Huawei sales in 2014 will be premium models, that will leave us with a TAM of about $20M in revenues and $8M in gross profits each from LG and Lenovo.

Rest of the Market

Assuming 33% of the rest of the market are premium models, we get to about 158M premium smartphones in 2014. That equals to $229M in revenues and $91.6M in gross profits for QuickLogic.

Summary

According to QuickLogic, operating income for the long-term model should come to 10% of revenues. Taxes and financial expenses are negligible for the company and fall within the range of $150K-$200K per year.

Source: QuickLogic Investors Presentation.

So, taking the five top opportunities I've identified for QuickLogic and examining the different market shares, we get to the following addition to QuickLogic's current result:

Design Win Samsung Xiaomi LG Lenovo Huawei Rest Total
Revenues $182.7M $58M $20M $20M $20M $229M $529.7M
Gross Profits $73M $26.1M $8M $8M $8M $91.6M $214.7M
Operating Income $18.3M $5.8M $2M $2M $2M $22.9M $53M
Net Income $18.1M $5.7M $1.8M $1.8M $1.8M $22.7M

$51.9

EPS $0.40 $0.13 $0.04 $0.04 $0.04 $0.51 $1.16
Dilutes Shares 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M

The following tables shows QuickLogic ArcticLink 3 S1 financial results in different market share analysis:

Market Share 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Revenues $53M $105.9M $158.9 $211.8M $264.8M $317.8M $370.8M $423.76M $476.7M $529.7M
Gross Profits $21.4M $42.9M $64.4 $85.9M $107.3M $128.8M $150.3M $171.75M $193.2M $214.7M
Operating Income $5.3M $10.6M $15.9M $21.2M $26.5M $31.8M $37.1M $42.4M $47.7M $53M
Net Income $5.2M $10.4M $15.6M $20.7M $25.9M

$31.14M

$36.3M $41.5M $46.7M $51.9
EPS $0.11 $0.23 $0.35 $0.46 $0.58 $0.70 $0.81 $0.93 $1.04 $1.16
Diluted Shares 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M 44.7M

Conclusion

I think that the numbers speak for themselves. QuickLogic can truly have the advantage of being the first mover here and make a move to quickly earn a substantial market share. Given Apple's recent move with the M7, I believe smartphone vendors will look to offer the same features in their premium models. Currently, the only firm that can enable those vendors to do so is QuickLogic. For this endeavor, the relationship of Samsung-QuickLogic positions the company very well. Given this business (smartphone shipments) is expected to grow ~20% a year on average in the next few years , I think giving the ArcticLink 3 S1 business a P/E of 20 is very reasonable (which will give it a PEG of 1). This means that if QuickLogic wins 50% of the market, it can add $518M to the market cap or $11.5 to share price, in comparison to a market cap of $225M and a share price of $4.3 as of the 27th of January-from this business alone.

I hope you find my research helpful. Looking forward to your feedback.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in QUIK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.