QuickLogic Corporation
Q3 2008 Earnings Call Transcript

Published: 24 Oct 2008

[Operator:]

Good day, everyone, and welcome to the QuickLogic Corporation third quarter 2008 earnings conference call. Today's call is being recorded and will be available for playback beginning one hour after the completion of the call. To access the replay please dial 719-457-0820 with the passcode 4545787. At this time for opening remarks and introductions I’d like to turn the conference over to Mr. E. Thomas Hart , Chairman, President, and CEO for QuickLogic.

[E. Thomas Hart:]

Thank you, Jamie. Good afternoon ladies and gentlemen and thank you for joining us today for the QuickLogic third quarter 2008 earnings conference call. Joining Carl and me today is our new VP of Finance and incoming CFO, Ralph Marimon. Carl is wrapping up on the Q3 2008 SEC reporting requirements and after the 10-Q is filed, Ralph will assume the duties of our Chief Financial Officer. Welcome aboard, Ralph. At this point let me extend our thanks and gratitude to Carl Mills, our departing CFO. Carl served admirably as our CFO for over 6 years and being the true professional he is, he’s made this transition go very smoothly, even beyond expectations. Thank you, Carl, for all of our efforts on our behalf. Our best wishes to you on your new adventures. Carl will take you through our 2008 third quarter financial results and then I’ll share my perspective on our business. Finally Carl will detail our guidance for the fourth quarter of 2008 and then we’ll take questions.

[Carl M. Mills:]

Thank you, Tom. Before we get started, I’d like to read a short Safe Harbor statement. During this call we will make statements that are forward-looking. These forward-looking statements involve risks and uncertainties including but not limited to stated expectations relating to revenue growth from our new products, statements pertaining to our design activity, and our ability to convert new design opportunities into customer activity, market acceptance of our customers’ products, the effects of our customer specific standard products or CSSPs, our expected results, and our financial expectations for revenue, gross margin, operating expenses, profitability, and cash. QuickLogic’s future results could differ materially from the results described in these forward-looking statements. We refer you to the risk factors listed in our annual report on Form 10-K, quarterly reports on Form 10-Q, and prior press releases for a description of these and other risk factors. QuickLogic assumes no obligation to update any such forward-looking statements. For your information, this conference call is open to all and is being webcast live. It can be accessed from the Investor Relations area of the QuickLogic website located at www.QuickLogic.com. We had a very solid third quarter compared with our non-GAAP guidance especially in terms of total revenue, gross margin, operating expenses, and cash flow. Our favorable operating expenses and cash position protect the value of our recent operational realignment. Our revenue of $6.2 million was near the high end of our guidance and included new product revenue of $1.4 million which was at the midpoint of guidance for the quarter. Our non-GAAP gross margin of 56.7% of revenue was at the high end of guidance for the quarter in the period with 55.7% in Q2. The sale of previously reserved inventory improved our gross margin by 0.9% of revenue in the third quarter. Our operating expenses were lower than guidance and reflect the benefits of the operational realignment that we completed in Q2. The realignment of our R&D activities for instance included a significant investment in [inaudible] while maintaining our core competencies such as the definition of chip architecture. Physical chip design will be outsourced, allowing us to save money between designs and enabling multiple designs at once should the need arise. R&D spending for Q3 was $1.3 million down $1.1 million or 48% sequentially. Our guidance was $2 million to $2.2 million. We have no IP charges or outsourced chip design spending in Q3. We do expect to see an increase in these expenses in Q4. SG&A expenses of $2.4 million declined by $900,000 sequentially and were also favorable compared with our guidance of $2.9 million to $3.1 million. The savings were due to a more rapid than expected benefit from our new operating model. Total non-GAAP operating expenses were $3.7 million and decreased by $2.1 million or 36% sequentially. Other income and expense was a net expense of $105,000 in the third quarter, primarily due to low earnings on our invested funds which were invested in Treasuries and foreign exchange losses. We had a tax benefit of $58,000 in the quarter due to the favorable resolution of an international tax audit and expected refunds associated with R&D credits that became effective this year. Our non-GAAP net loss was $196,000 or $0.01 per share compared with a net loss of $929,000 or $0.03 per share in the second quarter of 2008. This improvement reflects the benefits of our operational realignment. Our ending cash position of $18.8 million compares with $19 million at the end of the second quarter and was favorable compared with our guidance. Our expenses were significantly lower than expected. In the quarter in our accounts receivable were 33 days sales outstanding which was lower than we expected. We also decreased inventory more than was expected in the quarter. Before I make a few other comments on the quarter, most importantly, new products as we noted earlier contributed $1.4 million of revenue and were in line with our guidance. We mentioned on our last call that our largest new product customer was converting two out of 4 designs to a new processor and that we expected a sequential decline in revenue from these applications. As expected, revenue from this single customer declined by $1.1 million sequentially as did our total new product revenue. Revenue from end of life products declined by $1.4 million sequentially. Combined, this led to a $2.5 million sequential decline in revenue. The P&D market leader purchasing our new products represented 13% of total revenue in the quarter. Furthermore, a long term customer in the instrumentation and test market contributed 28% of our revenue in Q3. I just want to take a moment to discuss our GAAP results for the quarter. Our GAAP results include stock based compensation charges of $389,000 in cost of revenue, R&D, and SG&A, as well as $30,000 for the write off of fixed assets. Our third quarter GAAP net loss was $615,000 or $0.02 per share. On a GAAP basis, our third quarter gross margin was 55.4% of revenue and operating expenses totaled $4 million. Now let’s turn our attention to the balance sheet and some cash flow items for the quarter. Our net inventory declined by $500,000 during the quarter. Our capital expenditures were $180,000 for the quarter. We currently have 80 days of inventory on hand and we may have noted on our balance sheet that our Q3 results included a decline in inventory held by distributors. Let’s spend a few minutes talking about this and begin with a discussion of our revenue recognition policies. We recognize revenue on shipment of programmed product including CSSDs. The price is negotiated prior to shipment and the distributors have no stock rotation or price protection privileges on programmed products. This is referred to as a sell in revenue model. We historically have allowed stock rotation and price protection on our un-programmed products and have recognized revenues on the sell through basis for these devices. Since programmed products dominate our strategy and our volume, in Q3 we started changing our distributor agreements to reflect a sell in revenue model for all of our business including un-programmed products. As of the end of Q3, most of our distributors no longer have price protection or stock rotation privileges and this contributed to a decline in inventory at distributors, which is on our balance sheet as deferred revenues less cost of revenue. We expect to complete this transition to a 100% sell in by early Q1 2009. The movement to a selling model was not significant to our revenue results for the third quarter. I’d like to take a moment also to discuss our investment in Tower. Three months ago we wrote down the value of our Tower ordinary shares to $0.86 per share. In accordance with our internal policies, if the value of Tower shares remains below $0.86 at the end of Q4, we will incur a write down in the fourth quarter. Tower recently closed at $0.33 per share. If the December ending value is at this level we will incur a non-cash charge of $700,000 in Q4. Finally you may have noted an 8-K we filed where we mentioned that we amended our agreement with Silicon Valley Bank. We did that in August. The amended agreement is a great credit facility for us. It’s a $6 million revolving line of credit that runs through June 2010. During the quarter we repaid long term debt including debt with Silicon Valley Bank in the amount of $2.8 million and we borrowed $2 million against the revolving line of credit, so on a net basis, we repaid $800,000 of debt in the quarter. Please note that our debt-free or net cash increased b y $700,000 to $15.9 million in Q3. Now I’d like to turn the call back over to Tom.

[E. Thomas Hart:]

Thank you, Carl. We’ve talked in the past about the transformation that our customer-specific standard product, CSSP model, brings to QuickLogic and now it seems some of the financial impact this model has had on expenses for Q3. Now the fun part. We get to talk about how the offense is doing. The proof will be the posting of significant new product revenue which we believe is on the way. I will share with you how we’re measuring the progress that supports our belief. While most companies are guiding down in Q4, customers are carefully targeted markets are recognizing the inherent best that we can provide with CSSPs and embracing them as design solutions. Carl will detail Q4 guidance later in the call but I will tell you that it’s up slightly both in total and for new product revenue. Before we examine the metrics of our sales funnel, let’s address the elephant in the room that demands to be acknowledged. How is the current global economic situation impacting QuickLogic? There’s no doubt, absolutely no doubt, that lower end user demands in almost every sector have rippled through the supply chain, leaving some of our significant suppliers to forecast significant declines in revenue. There’s also no doubt that this global economic turmoil has slowed the rate at which some of our opportunities move through the funnel to revenue. But we’ve seen few opportunities canceled. We do see uncertainty in production start dates. We do believe Q3 will prove to have been, by the way, our new product revenue low point in spite of this. Last quarter I introduced you to our custom implementation of salesforce.com, a Web 2.0 system we use to track our progress and focus our resources. Leveraging this system has helped us address a broader spectrum of opportunities, manage them with greater predictability, and lower our fixed operating costs. We track future revenue opportunities with what we call single sales objectives, also known as SSOs. SSOs identify a customer’s specific project whereas CSSP can add clear value and implement a desired solution. Within our tracking system we have five distinct stages that SSOs must progress through in moving from qualification from revenue. We also track the potential annual value of the SSOs. The number of our total worldwide SSOs increased 34% in Q3. Even more impressive is the fact that the value of the SSOs increased by 56% sequentially. We view this as a clear indication of our CSSP momentum continuing to build. Now let’s talk about metrics that are most important to investors. 63% of total SSOs are in our target markets of Smart Phones, portable navigation devices, portable media players, and broadband data cards. As a result of our focused sales efforts in these target markets, these SSOs represent 79% of our total SSO potential revenue. From a geographic perspective, 60% of the total SSOs are from Asia Pacific and Japan. While European SSOs represent 22% of the total SSOs, they account for 43% of the total potential revenue. What this says is that European SSOs have significantly higher total revenue potential per design. Finally, just over 60% of the total SSOs are with Tier I and Tier II customers which are our focus accounts. They also account for 80% of the total potential annual revenue. Our visual enhancement engine or VEE as we call it design activity continues to build from our formal watch in March. In just over 7 months, 77 editors have written 316 articles featuring VEE. We now have over 40 SSOs involving VEE in various stages of the sales funnel. This is nearly double the 21 that we had at the end of Q2. VEE has also gained the attention of several of the largest cellular operators in the world. We have done many demonstrations using side by side displays, one with and the other without VEE for easy direct comparison purposes. In critical direct sunlight conditions, our customers tell us that VEE provides an image that is far superior to other competitive display and handset products. Even when using nearly 90% less backlight power then the display without VEE, our solution provides a superior image. We believe that as video becomes a bigger deal on Smart Phones, so will VEE. We now have VEE demos running on multiple mobile platforms including Smart Phones MPDAs, and they look just great. To further our VEE and CSSP marketing efforts, we will have booths and meeting rooms at the upcoming Mobile Asia conference in [Macow] in November, at the Consumer Electronics Show in Las Vegas in January, and the Mobile World Congress in Barcelona in February. Please stop by and see the VEE for yourself, or as we all know, seeing is believing. Carl, back to you.

[Carl M. Mills:]

Thank you, Tom. Let’s continue by providing our non-GAAP guidance for the fourth quarter of 2008 and some comments on our business. Total revenue was at the high end of guidance last quarter. We are pleased with the growth of our sales funnel and we continue to engage with wireless network operators. Customers and operators have seen the value of our CSSPs. We entered Q4 with a strong new product backlog position and as a result we expect new product revenue to increase 13% sequentially to $1.6 million plus or minus $200,000. The rest of our business is expected to be essentially flat sequentially and as a result we expect the total revenue will be up to $6.3 million plus or minus $300,000. Based on the mix of products we expect to ship in the fourth quarter, and planned production variances, we expect that gross margin will be 55% plus or minus 2%. We do expect an increase in our operating expenses in the fourth quarter as we continue to drive opportunities and new product development. This will include costs for IP and outsourcing physical design, expenses that were not mature yet in Q3. We expect a sequential increase in our R&D expenses of $600,000 to $800,000. We also expect fourth quarter SG&A expenses to increase by $200,000 to $400,000. Due to expected levels of interest income and interest expense associated with debt, we expect interest income and other net will be an expense of up to $60,000 in the fourth quarter. We do not think that our tax [inaudible] will be a significant item in the fourth quarter. We conclude by saying that our stock based compensation could be up to $500,000 in Q4. We may use up to $2 million of cash in the quarter based on expected increases in operating expenses, increases in accounts receivable, and expected revenue levels. Let me mention just a few other points. End of life products only contributed $200,000 of revenue in Q3 and the end of this business really has arrived. While we expect some end of life product revenue going forward, it will be lumpy and will probably contribute less than 10% of quarterly revenue. The operational realignment we undertook provides agility, lowers our cash consumption, lowers our break even, and provides profits scalability with revenue growth. We have always seen its benefits both in lower operating costs and improved new business development. As we guided last quarter, we continue to expect our motto will provide us with break even results and $8.5 million in revenue. On a personal note I’d like to welcome Ralph to the company and wish him well. Ralph has already hit the ground running. I expect he will really enjoy QuickLogic. Now I’d like to turn the call over to Tom for his closing comments.

[E. Thomas Hart:]

We’ve undergone some extraordinary changes here at QuickLogic during the last year. Through the dedication of the QuickLogic team, we’ve become a better company for it. During the last quarter we’ve accomplished more with less. This is a testimony to good people even more than it is to good systems and opportunities. Today we’re a startup company that has the benefit of a 20 year foundation, an extraordinary core of talented and dedicated team members. Thank you one and all. Ralph Mariman will be joining me at the American Electronics Association Classic Financial Conference in San Diego on November 4 and 5. We will do a live webcast from the conference, the details of which can be found on our website. Please join us. We’ll also be presenting at the Needham Growth Conference in New York City on January 6 and 7 at the New York Palace Hotel, and then later that same week we’ll have a booth and a meeting room at CES in Las Vegas. Please do come by and see our VEE demos. Our fourth quarter and fiscal year earnings conference call is scheduled for February 3, 2009 at 2

[Operator:]

(Operator Instructions) Your first question comes from Edwin Mok with Needham and Company.

[Edwin Mok:]

First let me ask you just some housekeeping questions. We got in the financials $700,000 charged relate to the Towers and investment. I was just wondering, Carl, are you going to report that as a non-GAAP or is that going to be part of the ---

[Carl M. Mills:]

That happens in Q4, that will be part of our GAAP results.

[Edwin Mok:]

So it will be part of GAAP and it will count as a one time --

[Carl M. Mills:]

Exactly and it’s a non-cash charge.

[Edwin Mok:]

On the OpEx line, comp base on your commentary sounds like third quarter was unusually slow because you have very little outsourcing expense there. I was wondering how do you look at that if you just average out over a longer term, how much R&D outsource expense do you guys expect per quarter?

[Carl M. Mills:]

We haven’t provided guidance on that going forward. I guess the thing I would say is that as we outsourced our R&D, one thing we expect is much lower cost per design. Whereas we had a fixed cost in Canada for R&D through the second quarter, really that fixed cost has largely gone down and the variable cost per design was much slower than the fixed cost was per design. The net effect should be, even after variable costs, lower R&D costs for the same amount of product or if we elect to do more designs, of course R&D would be more expensive. But it is a variable model as opposed to a fixed model.

[Edwin Mok:]

Maybe I should ask you differently. Is it fair to say that the third quarter numbers is basically your fixed R&D costs where you would expect some other outsourcing costs along the way for example in the fourth quarter where your guidance is for higher R&D expenses, is that correct?

[Carl M. Mills:]

That’s reasonable and it’s not only just the outsource cost but we may purchase [inaudible] expense in the quarter too, so it’s really a combination of those two things and plus then prototypes will hit the project expense kind of category.

[Edwin Mok:]

So it is a function of when you are going to do that is the end net result.

[Carl M. Mills:]

Yes but your interpretation of last quarter being close to the baseline is good.

[Edwin Mok:]

So in your last quarter if I kind of look at your OpEx, your OpEx is around $3.7 million non-GAAP and if I kind of look back at your guidance of break even of $8.5 million [inaudible] non-GAAP OpEx is closer to high for maybe how you’re guiding for the full quarter, is that how I should visualize that in the longer term type of model?

[Carl M. Mills:]

Those longer term models I really have to leave up to you. We just provide guidance one quarter out, sorry about that. I think given the $8.5 million break even, given our margin objectives from our model, I think you’ll be able to get where you need to be.

[Edwin Mok:]

Maybe you can help remind me what is your margin assumption for the break even model?

[Carl M. Mills:]

Margin assumption is 50 points plus or minus 2 points. Long term model.

[Edwin Mok:]

Long term model, did you say 50?

[Carl M. Mills:]

Yes, 50 plus or minus 3.

[Edwin Mok:]

Now moving onto the product side, last quarter you guys talked about the VEE and you have, I think you mentioned that you had 10 of the 21 designs engagement actually with Q1 handsets, OEM, I was wondering if you could put some color on the progress there and also since you have given the over 40 SSOs this quarter, I was wondering how much of that is Tier I customer.

[Carl M. Mills:]

First of all the progress as you know Tier I guys are big guys move, they measure the speed of light in weeks, and so they move at their own pace. I can’t give you the names but I can tell you that typically if anybody’s ever done any business with these guys, they know that just being certified as a vendor can wind up taking you a year, so our first revenue will not come from Tier I guys. What we’re trying to show is that VEE is being embrace by Tier I guys even though it won’t impact revenue, so whatever it points to is the value that they perceive and by the way the value is really along two axes, of course the critical one for some of them is sunlight, if you’ve ever looked at any of these LCDs in the sunlight, it’s virtually impossible to be able to see what it is. The second is really about power, how long the operating life between recharges, and VEE addresses both of those very aggressively. So the additional 40, I don’t know that we’ve picked up any new in Tier I customers during Q3 to be honest. I think it was Tier II guys for the additional SSOs but I don’t have that number off the top of my head, but that’s my sense.

[E. Thomas Hart:]

And you know Edwin of course we, our [inaudible] design cycle

[Carl M. Mills:]

The design cycle is all over the map but as you know with Smart Phone guys, they’ve got FCC approval and that’s relatively straight forward. The longer term and all these things are serial, the longer term approval cycles come from the people that supply those phones to the operators and each of the operators, if they’re supplying the same phone to multiple operators, each of them have a little different wrinkle on what they want and so you come back in for kind of a minor redesign before you go to production and that alone can wind up being a 6 to 9 month kind of deal. So you’re looking at for Tier I OEMs, if you’ve never done business with them before you’re probably two years away from revenue on these Tier I guys, so obviously that’s one of the reasons that we’re driving so hard on Tier II as well, because there the turnaround time is much shorter. The time to revenue is shorter. The other reason of course is they are more aggressive about embracing new technology that might give them competitive advantage in the market. With the big guys you’ve got to convince them that what they’ve already done internally, this home brewed solution that they may have done internally, isn’t as good as VEE, and that’s what NIH is like and [inaudible] syndrome and companies, it’s some of the [inaudible] is such that it really kind of stifles the innovation and so you have to sell through that, and it just takes a long time.

[Edwin Mok:]

So it’s fair to say that your fourth quarter guidance is based on the existing design of your products, right, and then in terms of [inaudible] opportunity?

[Carl M. Mills:]

Correct.

[Edwin Mok:]

[inaudible] schematics, on the fourth quarter I imagine you have seasonality especially on a product that sells on the consumer side. I was wondering how much of that new product revenue do you expect in the fourth quarter, $1.6 million, I was wondering how much do you think is more subject to seasonality versus [inaudible]?

[Carl M. Mills:]

I’m sorry, how much is subject to what?

[Edwin Mok:]

Seasonality, any way you can quantify would be very helpful.

[E. Thomas Hart:]

I don’t think much of that $1.6 million is really driven by seasonality quite frankly. As Carl mentioned, we were coming into this quarter with a fair amount of that on the books already, and that’s why we feel pretty confident as opposed to a lot of the other [inaudible] guys which were kind of throwing up their arms about what’s going to happen in Q4. We’ve got on the books and we feel that that it’s in applications that probably are not as seasonal. I don’t think we’re going to be faced this year with Q4 seasonality. It’s like we will be maybe two years from now when we have a larger portion of our business coming from cell phone guys for example.

[Edwin Mok:]

Regarding your [inaudible] recognition, it’s some sort of sell in model, it’s fair to say you guys are doing selling but you have very little of your business come from [inaudible], is that a fair way to look at it?

[E. Thomas Hart:]

No, actually, we use distributors for logistics so we’re not relying on them to hold inventory anymore. They’ve got less than a day of inventory. We’re not relying on them for design wins. We use them primarily for the logistics and to carry the paper quite frankly. Dealing in China, as an example, we want somebody else to worry about the receivables there. We’ll pay a distributor some reasonable sum to manage that whole process. In Q3, do you remember what percentage of our revenue went through distribution? I think it was over half.

[Carl M. Mills:]

I’d have to check. I think it was probably close to half.

[E. Thomas Hart:]

[inaudible] distribution, a significant portion, probably 60% or 65% is programmed by us, and so you’re looking at 35% or 40% blank, that’s half of our business, so it’s less than 20% of our total business that is [inaudible].

[Edwin Mok:]

One last question. For the third quarter, really your mature product [inaudible] more than the other ones, do you guys recognize [inaudible]?

[E. Thomas Hart:]

We didn’t recognize any unusual relative revenue in the quarter, just kind of steady as she goes there, and we’ve been really pleased with the strength of our [inaudible] business, it’s been good.

[Carl M. Mills:]

Which is what we expected, by the way, and which is what we forecasted right along.

[Operator:]

There appear to be no further questions at this time and I’d like to turn the conference back to you, Mr. Hart, for any additional and closing remarks.

[E. Thomas Hart:]

Thank you kindly for your interest in QuickLogic. I hope you have an opportunity here in the short term to take a look at our VEE demos because they really are exciting. I can’t believe the major operators, the cellular operators, the excitement you see when you show them VEE operating on phones in bright sunlight. Seeing is believing. So we’ll look forward to hopefully seeing you at one of the conference or exhibitions and if not, we’ll be back February 3td for our year end conference call. Thank you kindly.

[Operator:]

That does conclude today's conference. Thank you for your participation. You may disconnect at this time.