GSI Technology, Inc. (GSIT) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to GSI Technology's Fiscal 2013 First Quarter Conference Call. [Operator Instructions] Before we begin today's call, the company has requested that I read the following Safe Harbor statement. The matters discussed in this conference call may include forward-looking statements regarding future events and the future performance of GSI Technology that involve risks and uncertainty that could cause actual results to differ materially from those anticipated. These risks and uncertainties are described in the company's Form 10-K filed with the Securities and Exchange Commission. Additionally, I have also been asked to advise you that this conference is being recorded today, July 26, 2012, at the request of GSI Technology. Hosting the call today is Lee-Lean Shu, the company's Chairman, President and Chief Executive Officer. With him are Douglas Schirle, Chief Financial Officer; and Didier Lasserre, Vice President of Sales. I would now like to turn the conference over to Mr. Shu. Please go ahead, sir.

Good afternoon, everyone. Thank you for joining us. I am pleased to note that despite a challenging environment, today, we were able to report our 35th consecutive quarter of profitability. Net revenue of $16.8 million was slightly below the lower end of our guidance due primary to softness in orders from our 3 largest customers, each of whom, does significant business in Europe where the ongoing economy turmoil and the slowing economy has led to a reduction in capital expenditure for network equipment manufactured by our OEM customers. As in the previous quarter, our revenue were also negatively affected by uncertainty regarding our patent -- our pending patent litigation with Cypress Semiconductor Corporation. Gross margin was 40.3% compared to 44.2% a year ago and 46.2% in the prior quarter, principally as a result of a shift in our product mix and, to a lesser extent, the impact of reduced revenue on our fixed manufacturing costs. First quarter gross margin was lower than we had expected. The unusually high fourth quarter 2012 gross margin also was outside our target range, and this sharp quarter-to-quarter fluctuation points to the considerable effect of product mix on our gross margins, as well as the challenge of accurately predicting product mix and gross margin on a quarter-to-quarter basis. Last quarter, in knowing that gross margin was outside our target range, I cited a particularly favorable product mix and cautioned that such margins are not sustainable on a regular basis. In a similar event, it is to be expected, from time to time, we will see margin close to 40%. With that in mind and given that much of Europe, again, appears to be in or on the verge of another recession, we currently expect that second quarter gross margin will be approximately 41%. First quarter operating income of $880,000 or 5.2% of net revenue continued to be adversely affected by legal expenses, related primarily to a patent infringement proceeding pending before the United States International Trade Commission which was instituted in response to a complaint filed by Cypress Semiconductor in which they allege patent infringement on GSI's part. First quarter litigation-related expenses of $455,000 were in line with our forecast and filed that in the preceding quarters when total litigation-related expenses of $3.7 million led to an operating loss. Total second quarter litigation-related expenses are currently expected to be less than $500,000. We anticipate that for at least the next several quarters, litigation-related expenses will continue to have a negative effect on operating income and the bottom line. Some of these expenses will be associated with ITC proceedings. That proceeding is now in abeyance, pending the issuance of an initial determination by the administrative law judge handling the case. Citing the workload consideration, we've recently announced that the initial determination will be delayed by approximately 3 months to October, with the conclusion of the preceding not expected until February 2013. Based on evidence present at the hearing in March and the post-trial brief submitted in April, we continue to believe that both the law and the facts are on our side. In coming quarters, we will also incur litigation-related expense in pursuing our antitrust lawsuit against Cypress filed in July of last year. A recent ruling by the U.S. District Court in which it denies Cypress motion to dismiss our complaint is of major significance, since we now allow GSI to actively pursue pretrial discovery of our camp against Cypress. In this suit, we seek trivial damage, recovery of attorneys' fees and costs, and especially important, any injunction prohibiting Cypress from continue its illegal behavior, behavior that has a limiting of ability to fully benefit for intellectual property that is rightfully ours. I will now turn the call over to Doug.

Thank you, Lee-Lean. We reported net income of $920,000 or $0.03 per diluted share on net revenues of $16.8 million for our first fiscal quarter ended June 30, 2012, compared to net income of $3.3 million or $0.11 per diluted share on net revenues of $23 million from the comparable period a year ago. In the prior quarter ended March 31, 2012, we had $829,000 or $0.03 per diluted share and net revenues of $18.7 million. Total operating expenses were $5.9 million compared to $8.7 million from the prior quarter and $6 million in the first quarter of fiscal 2012. First quarter 2013 research and development expense was $2.8 million compared to $2.7 million from the prior quarter and $2.6 million a year ago. First quarter selling, general and administrative expense of $3 million included $455,000 in litigation-related expenses compared to SG&A of $6.1 million in the prior quarter, when litigation related expenses of $3.7 million comprised more than half of SG&A. A year ago, SG&A of $3.4 million included $782,000 in litigation-related expenses. As it has previously been explained at considerable length by us, this litigation-related expenses are primarily associated with the patent infringement proceeding pending before the United States International Trade Commission, which was instituted in response to a complaint filed by Cypress Semiconductor Corp. in June 2011 and the related antitrust lawsuit filed by GSI against Cypress in July of 2011. First quarter direct and indirect sales to Cisco Systems were $4.1 million or 24.2% of net revenues compared to $6 million or 32.1% of net revenues in the prior quarter and $9.6 million or 41.6% of net revenues in the same period a year ago. Sales to Huawei Technologies, our second largest customer, were $1.3 million or 74.5% of net revenues in the first quarter compared to $1.4 million or 7.2% of net revenues in the prior quarter and $1.4 million or 6% of net revenues a year ago. Military/defense sales were 11.9% of shipments compared to 11.1% of shipments in the prior quarter and 8.9% of shipments in the comparable period a year ago. SigmaQuad sales were 38% of shipments compared to 38.3% in the prior quarter and 32.5% in the first quarter of fiscal 2012. Total first quarter pretax stock-based compensation expense was $562,000 compared to $539,000 in the prior quarter and $511,000 from the comparable quarter a year ago. At June 30, 2012, we had $59.2 million in cash, cash equivalents and short-term investments, $30.4 million of long-term investments, $86.2 million in working capital, no debt and stockholders' equity of $128.6 million. Accounts payable at June 30 is $4 million, down from $5.5 million at March 31, 2012. Net inventory was $17.1 million at June 30, slightly up from $16.7 million at March 31. Inventory turns at June 30, 2012 are 2.3x compared to 2.4 at March 31, 2012. Depreciation and amortization expense was $638,000 for the quarter. Under our expanded repurchase program, we are authorized to repurchase up to a total of $20 million of our common stock from time to time from the open market or private transactions. Specific timing and amount of the repurchases will be dependent on market conditions, securities law limitations and other factors. The repurchase program may be suspended or terminated at any time without prior notice. During the quarter ended June 30, 2012, we repurchased 427,500 shares at an average cost of $4.25 per share. To date, we have repurchased a total of 3,247,560 shares at an average cost of $3.39 per share for a total cost of $12.3 million. We currently expect net revenues in the second quarter of fiscal 2013 to be in the range of $16 million to $18 million with gross margin or approximately 41%. Net revenues in the June quarter continued to be negatively affected by uncertainty regarding our pending patent litigation with Cypress. We believe that this uncertainty will continue to extract our revenues and will likely have a continued impact in the second quarter. We also expect that ongoing legal expenses, related patent litigation and antitrust litigation will continue to affect our operating income and our bottom line. These expenses are expected to be approximately $500,000 in the second quarter. Operating expenses in total are expected to be similar to the first quarter of 2013. Operator, at this time, we will open the call to Q&A.

[Operator Instructions] Our first question comes from the line of Raji Gill.

Your competitor just announced a potential acquisition to acquire a company, the embedded NOR market. Wondering if you had any thoughts there, and if you are looking outside of the SRAM market as well, or are you continuing to focus on the SRAM side?

Yes, we do look at the opportunity which can be seen into our product line. I think so far, we do look at that but at this moment, we don't have anything concrete to buy or -- but we continue looking for it.

In the -- could you describe the demand landscape a little bit more in the comm equipment space? That continues to be soft, given a lot of the results coming out of that sector. Are you getting any indication that there's going to be some sort of rebound, and if there's going to be any resurgence in demand exiting the year?

It's certainly hard to predict at this point. I mean, we certainly have some programs on the horizon which had certainly benefitted us. We've talked in the past about the edge router, the service provider router coming out of Alcatel. And certainly they're in trial right now with their customers and they're looking for orders to be placed. And certainly, we hope that it's going to help us this calendar year towards the end of the year. Also, which may not benefit us this year, but certainly early next year is -- Alcatel has also announced that they're entering the core market space and this is a market that they have not participated in the past. And this is especially [indiscernible] for us, because they in the system, have 2 very high-end parts from GSI, 2 high ASP, high-margin parts. So we're certainly looking forward to that program taking off. But certainly, in general, I still think visibility is hazy. I read somewhere yesterday, I want to say it was TI that said that a lot of folks are placing orders at the last second, because lead times are as low as they've been. And certainly, we're seeing similar dynamics as to that. Certainly, our lead times are very low right now, and so there is a lot of last-second ordering. And so in that respect, it's really hard for me to predict exactly what's going to happen at the end of the year.

I mean, one last question, sorry. What's the -- your competitor has been making some decent traction on the LLDRAM opportunity. They are talking about some revenue in the second quarter and then sampling their LLDRAM III product for production in 2013. I'm wondering kind of where you are with respect to that opportunity?

Yes, so we're currently in the qualification phase ourselves. We have a couple of high-value sockets that we're chasing that our competitor, that you mentioned cannot -- this is the 533 megahertz sockets that are 15-nanosecond latency which the part is enabled to obtain. So a couple of the sockets that you've mentioned are the lower-end sockets. The high-end, the higher-value sockets are the ones we're in the process of qualification now. Certainly, that process is taking a while and I'm not sure how much is going to help us this calendar year, but certainly we will be closing a fair amount of those qualifications this year. As far as the LL3, we're not doing an LL3, we're going in a different direction which we'll talk about later. But that RL3, as you know, is really just the Micron died, that they're repackaging. So it's certainly not their own design.

Your next question comes from the line of Tristan Gerra.

Can you give us more feedback on what products impacted gross margin in the quarter and whether there's a permanent mix change?

It's not a permanent mix change. And so as Lee-Lean mentioned earlier in the call, time-to-time, we do have mix changes. And in this particular quarter, some of the higher-end margin parts were less ordered and replaced them with lower margin parts. So the answer is there's certainly room for return. As Doug mentioned, some of the reasons for the lower margin have to do with the fixed costs that we associated with our lower revenue market. So certainly, once we get the revenues back up, the margins will grow as well even without the mix. But in general, I would say this is something that we can certainly return to the 43%, 44%.

Yes, we don't see any change in our more near-term, long-term view. We still believe the 43% to 45% range that we've been experiencing last couple of years is where we should be and will be. My calculation, it probably cost us somewhere about 1.5% or so, plus or minus, impact on our gross margins and lower revenue, and of course, the mix, that was a bigger part.

And then do you guys have a sense of inventories at the hub? I'm curious if automatic inventory pull from the OEMs at the hub is still happening?

Yes -- no, we're actually in pretty good shape there. First of all, in distribution, we're still through mile and miles to fill in, so there's certainly no issues there. As far as the hubs, you were referring to is the kind of the aging hubs, where they're forced to take product to the 90-day refresh, and we haven't seen those happening either. So in general, I'd say we're in good position as far as valid inventory, not excess inventory.

And then in terms of the second half, I mean, are you guys seeing any inflection points, positive or negative?

Well, I think -- well, just like we focus, go for it. I think we pretty much are focused at the front quarter. I think the bigger customer looks like they will be healthier, but I think the general condition is still sluggish. So I think that we probably look at the front quarter.

All right. And if you could give me an idea of what are the trends you're seeing by your end markets in the second half. Really, I mean, where do you think comm is tracking and what do you expect out of military?

So military has actually been very stable for us. It's been running really about 11%, 12% for a few quarters now, so military has been very stable. As I've mentioned in the past calls, it's never the same or I should say it's never the same. The military folks kind of being that they're lumpy, will have 5 or 6 guys in the top 20 and they're not always the 5 -- same 5 or 6 guys because of their nature. But we certainly see that market continuing. There's just a few programs that we've talked about in the past that hopefully will start kicking in in the fourth quarter of this year. And certainly, it'll be more on a limited basis and it'll be a little bit more in 2013 and '14. But in general, military has been healthy. And again, networking in telecom have been 70-plus percent of our businesses historically. So we're really tight in that market unless we discussed a bit earlier, it still unfortunately a bit hazy out there sort of the forecasting and the visibility that we're seeing from the top telecom folks.

Your next question comes from Ted Moreau.

Just a general question probably for Didier more than anybody else. But in light of the overall market, maybe even the lawsuit and the situation with Samsung. How do you think you're coming out at market share in your core market? Do you think it's stable, do you think you're improving, if everybody else has been weak or -- and is Samsung sort of winding down? Where are you in the share?

Yes, I don't think that the Samsung share has been divided out yet. Certainly, I don't see that happening before the end of this year. So in that respect, I think people have been slowly designing them out and adding sources if they're not already sharing a socket with Samsung. But as far as the revenues go, I haven't seen them being dispersed yet. As far as the rest, I would say that we've lost a little bit of market share only due to the pending ITC litigation. Certainly, we've seen a little bit of a drop off with some of the respondents or codefendants in the case which was expected. And there are a few other folks that -- it's certainly have been cautious in the way they're spending. Cypress, as we've mentioned in the past, has been very aggressive and making misleading statements to the market space and to the customers. And so certainly, some of the folks have been a little bit cautious. The good news is, though, I think we're getting over that. We've had lots of discussions with companies that are involved in the case and that are not involved in the case. And I think they certainly have a much better feel of what's happening. With that said, we're certainly disappointed that the initial ruling in the ITC case was pushed out because we were certainly looking for having the truth come out and get beyond all these misleading statements that we've been incurring. So with that said, again, I would say we've lost a little bit of market share, but I think it's certainly very temporary.

Have any of the court proceedings been public at all to get a sense of your confidence in how the hearings are going and all that or...

They're not public in a sense that there's not been a lot of data or information let out. But if you go on the ITC website, if you have the action or the case number, there's a lot of documentation there that you can read. Of course, a lot of it has been redacted, you can't see confidential business information of us or Cypress, but there is a lot of information still there. And a lot of it is very favorable if you read through that to GSI.

Okay. That's what I was going to ask, is you can get a sense then by doing that of your positioning there and how the proceedings are materializing in that case...

Yes, you can.

And a lot of them were actually before the trial actually started. If you look there was a lot of motions that were filed by us and then also by Cypress. And so you could see which motions were denied and which ones were accepted and you could see that certainly we felt like it was very favorable in our camp.

Didier, one of the question on Samsung, even though there hasn't been any revenue shifts as of yet, you mentioned conceivably getting designed in. Are you seeing more -- do you have the opportunity in terms of bidding activity and demonstrations and all that at the expense of Samsung to move ahead from that standpoint even though their revenue hasn't developed at this point?

Besides the bidding stage at this point, right now it's at an AVL stage. So what's happening is the customers are just making sure that they have qualified suppliers where Samsung was or is. And so it's more making sure that they have designed or qualified suppliers. We haven't gotten to the bidding stage yet. And in most cases, we're in very good shape. Certainly, as I mentioned earlier, some of the respondents right now are in a bit of a holding pattern. The good news is that folks like Cisco, which is, of course, one of the respondents, were already qualified in a very high percentage of the Samsung sockets. At that point, once we go out from the end of the year, we'll see just a simple shift in market awards by Cisco. It doesn't require any calls at this point.

Yes. And one final question on this and then I'll turn it back. What -- sure, it's readily available, but does your commentary on what the opportunity might be with the Samsung exit over the next couple of years?

The numbers are anywhere between 15% and 20% of the market. I think they certainly were not too long ago in the low- to mid-20s, but I think they may have started to fade away. But certainly, I would say, no less than 15% and at least 20%.

Yes. And so what would that be in dollars?

Well, that's percent. So you said market, yes. So I think -- so if you were to translate that, it's somewhere round numbers, $150 million or so.

So it's pretty sizable opportunity even if you just get part of that?

Absolutely. Yes, it's certainly exciting for us.

Your next question comes from Chris Sigala.

Didier, just wanted to go back. You mentioned the core router opportunity. Maybe you can kind of provide a little bit more color and give us a sense for when that opportunity might start to show up in revenue?

Well, that's a great question. Certainly, it's hard for me to predict when it's going to happen. I talked about the edge router, which was the first product Alcatel had. And certainly, because of some of the economic challenges are out there right now, that program hasn't taken off for Alcatel as quickly as they had expected. So they've talked about the core router being very end of this year, beginning in next year. And so I'm going to go with their information, but it could certainly be delayed a bit. Again, what's exciting about it is that it's complete upside for us, because it doesn't replace any of their existing boxes. It's a new entry in to the market space. And I don't have the numbers in front of me, but I want to say that their performance target, they fare 5x faster than any other competitors. So it's certainly a very bullish statement by them getting into this market. And as I mentioned, we have a fairly high dollar content in the box, so we're cautiously optimistic. Now, when this thing does take off, it's going to be a nice runner for us.

Yes, great. Is that a product that was specifically designed for Alcatel or could it potentially be sold to other existing customers?

So these products that we have and these boxes can be sold to anybody. And one of them is our SQ3, which is the part that's very unique to GSI that also happens to be in their -- a driver platform as well.

Okay, great. And then finally, you mentioned Europe headwinds. Just kind of curious what your revenue contribution from Europe is today. And I guess if you can see anything in the future, what we should expect going forward?

So right now, Europe is a little less than 10% for us as far as our revenue. And what Doug was talking to or alluding to earlier, he was talking to those markets who are our end customers. As far as our -- if you talk about our revenues in Europe, it's just under 10%.

Okay. And you guys don't talk at all about book-to-bill sort of trends during the quarter?

No, it's too difficult. And the reason I say that is 2 of our larger customers, they are in consignment basis. And so, by definition, their orders are at $0. We can't really give you -- it's not a simple way for us...

Yes, it's not a booking until it gets pulled. So there's also never anything in backlog.

Right. It essentially goes -- it becomes a booking in a billing of the same day. So it's too difficult for us to try and track the book-to-bill because again, the high ratio of consigned backlog in our model.

Okay. I guess what sort of gives you confidence in your forward projections if you really don't have a whole lot in backlog?

Awards. So we know what the awards are and that certainly -- it will be a percentage on a certain part number. And so, certainly, if there's a certain quantity involved with that, then we kind of know whether awards are going up or they're coming down. So in general, Doug, or I can't remember if Doug mentioned earlier in the call, a couple of our major customers we see coming back. Certainly, Cisco has been down, let's say it's 2 quarters in a row at least. We certainly see them rebounding this quarter and being up a bit. So it's still -- our comments are based off of awards that are given going into a quarter.

[Operator Instructions] Your next question comes from George Gaspar.

I apologize if you've answered part of this. Could you breakdown your R&D expenditure into product area or specific situations that you're working on? And can you target what your objectives are, looking out 3 to 6 months when you could possibly enter the market, whether it's something that could add to your revenue stream?

Actually I think -- a reasonable way to look at R&D spending, over the last several years, we added a couple of groups, one's the LLDRAM group and that runs about $1 million a year. And then in the Sony acquisition, we brought over about 10 people. That ends around $1 million a year. So that's a high-end SQ3 in the next-generation net product and other devices that we're working on. So that runs to about $2 million a year and we're running right about $2.7 million, $2.8 million per quarter. So the other dollars would be essentially redesigns of existing products, activities like that. Most of our businesses is synchronous. About 40% is -- and getting close to 40% is our QDR. There's very little asynchronous business, so a lot of our activities are spent on synchronous product. In terms of new products, you have any, Didier?

Yes, that's pretty much it. I think we always have a new product in the SMA and also given the -- Right now, we pretty much focus on the 40-nanometer in the higher density SigmaQuad product and also on the next-generation area or DRAM type of product.

Okay. Would you be able to quantify -- if you were to look through the rest of this year and you look at the end you're entering 2013 and look at what you might be able to capture a new product introduction sales volume relative to what you're doing now, can you quantify that in a percentage opportunity for 2013?

We have new product design shrinks -- it's a fairly lengthy cycle from the time we start a design and getting it qualified in, in volume production. I think the biggest thing right now is the LLDRAM and if we can get some of those major calls that Didier was talking about, that could lead to some fairly extensive growth a year from now. The other stuff is the shrinks and redesigns and a lot of that businesses is helping to improve our gross margin by reducing product costs, by getting a smaller die, maybe a faster die. If some features that can maintain EPS -- I'm sorry, ASP or at least our gross margin. There's a lot that goes into the R&D. It's not always just new business.

Okay. Well, you're doing very well. I mean, look at the shareholder equity and how it's balanced June to March. But considering what's been buying back and the stock over, what, $7 million to $12 million you mentioned, you're holding your equity pretty much across the board with what you had. And for Didier, I mean, you're doing well on the equity and your cash position looks pretty good.

Yes, we repurchased almost $6.4 million worth of stocks since the end of September when the program kicked off again. And we're continuing to buy in today's market. It's all 10b5-1 plan with Needham and when our parameters are met where we continue to buy shares, all at Needham's discretion based on the plan.

There are no further questions at this time.

All right. Thank you all, for joining us. We look forward to speaking with you in October when we report our second quarter results.

This concludes today's presentation. You may now disconnect.