Synaptics Incorporated (SYNA) Q4 2006 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and welcome to the Synaptics Fourth Quarter 2006 Conference call. [Operator Instructions] As a reminder this call is being recorded, Thursday, July 27, 2006. I'd now like to turn the conference over to Molly Pyler. Please go ahead.

Thank you for joining us today on Synaptics Fourth Quarter in fiscal 2006 Conference Call. This call is also being broadcast over the Web and can be accessed from the Investor Relations Section of the Company's Website www.synaptics.com. With me on today's call are Frances Lee the President and Chief Executive Office of Synaptics and Russ Kittel, Chief Financial Officer. We would like to remind you that during the course of this conference call Synaptics will make forward-looking statements including predictions and estimates that involve a number of risks and uncertainties. Actual results may differ materially from any future performance suggested in the Company's forward-looking statement. We refer you to the Company's SEC filings including Form 10-K for the fiscal year ended June 30, 2005 for important risk factors that could cause actual results to differ materially from those contained in any forward-looking statement. We expressly disclaim any obligations to update this forward-looking information. And now I'd like to turn the call over to Francis Lee. Francis.

Thanks Molly and thanks everyone for joining us on the call today. I'm pleased to report that we have posted another year of solid operating performance at Synaptics. As you know, in contrast of the last year's record-breaking results we've faced some challenges in customer specific dynamics during fiscal '06. In light of this a few weeks secured it very well achieving revenue for fiscal '06 of $184.6 million essentially in line with outlook we provided at the start of the year. During fiscal '06 revenue from pc applications grew more than 28% and represented approximately 85% of revenue as we further increased our leading market share within a local segment and continue to capitalize to the shift to the digital lifestyle trend. Turning to the fourth quarter, our revenue of $43.9 million was at the high end of our expectations representing an increase of 9% over the March quarter. As anticipated, we're the heavily back-ended loaded quarter corresponding with the pc industry data showing an upward inflection if the month of June. Excluding the impact of non-cash stock-based compensation, non-GAAP operating margins was 11.6% and non-GAAP net income was $4.2 million or $0.15 per share. Again, at the high end of our guidance for the June quarter. Revenue from PC applications increased approximately 9% sequentially and non-PC applications grew approximately 4%. Backlog entering the September quarter was approximately $28.7 million up significantly from $15.2 million last quarter. We believe the increased backlog reflects our customer's expectations for season of growth that normally occurs in the second half of the calendar year. Now I'd like to make a few comments about a progress we have made in our market over the past three months. We are sending increasing design momentum for our Light Touch Solutions, which provide controls for multi media features on [unintelligible at 4:19] computers and separate controls in addition to the touch pad this solution's increased our revenue content for in the book. During the quarter Alien Ware announced a 9700 Series, which uses a Light Touch Solution to provide a sleek control center for playing music and viewing movies on TV. Additionally, HP has launched a number of new and DV models, including HP DV2000 and Compaq 3000 Series. They integrate our Light Touch controls with HPs quick play technology allowing users to play a DVD or music without putting up the PC. Our solutions provide multi media controls in different configurations depending on the local platform. As we look to increase our content in notebooks capacity based buttons and multimedia controls enable our customers to develop products that feature sleek and unique industrial designs. We continue to see interest from our local customers in [unintelligible at 5:23] in ways other than a typical touch pad. As I mentioned last quarter we are pleased to see our Touch Tech Pointing Solution incorporated into a number of ultra mobile PC designs. During the quarter we announced that Asus, Founder, and AMTek are all shipping ultra mobile PC products utilizing Synaptics solution and we are excited to be participating in so many new PC categories. Another area where we are seeing increasing interest is in the PC peripheral space including keyboards and monitor controls. Specifically during the quarter Synaptics developed touch pad and scrolling solutions for new Novel and Asus keyboards, which are now shipping as part of home media centers. Microsoft also recently announced their first wireless rechargeable backlit desktop and we are pleased to announce that we are participating in the keyboard design. The design calls for some unique implementations of our technology and illustrates how Synaptics continues to evolve our capabilities to address new market opportunities. We look forward to updating you more on the specifics of this program when Microsoft makes an official product announcement. On the cell phone front we recently reported that Pantech & Curitel incorporate our mobile touch solution into their recently announced PT-K2300 mobile phone shipping in the domestic Korea market. The custom interface solution provides both display navigation, as well as quick launch buttons that provide easy access to applications such as music and messaging. As Russ will detail in a few minutes, we expect a strong start to fiscal '07 with backlog and other indicators pointing to a strong first half. As I mentioned earlier we are benefiting for the extension of our solutions into a variety of multi media applications supporting the growing digital lifestyle trend in consumer electronics. The continued extension of digital media, convergence of applications on hang out devices, and the trends to the home entertainment systems plays directly in Synaptics strengths. Not only does it provide a solid pipeline for continual growth in the local market but also for solutions that enhance the digital media experience in products from portable entertainment devices and cell phones to monitors, keyboards, desktops and remotes. As we enter the new fiscal year we believe we are only at the beginning of this very large and growing opportunities. While we continue to expand our markets that have OEM customers pioneered in mix ways of interface solutions we also prepare to strengthen our position as a total solutions provider. During the course of the year we plan to enhance our core competencies and customer care structure through the establishment of two device centers and offices in Korea and Taiwan. By moving our resources closer to our customers and localizing product development we will be able to elevate our service levels by offering real time design, engineering, and product support. We continue to take pride in our ability to provide innovation, excellent service and support our customers and from our on-going track record of solid institution and operating performance having shipped over 200 million units today. Our ability to provide end-to-end solutions for our customers continues to set Synaptics apart as a premier provider of innovative solutions. And focusing on the entire process from concept to design to delivery we are able to help customers solve problems into ideas and create new features or products that help differentiate their products in the market place. Going forward we plan to further expand the flexibility we provide our customers while also enhancing our abilities to compete more effectively within the evolving and increasingly complex competitive environment. We are very excited about the prospects ahead of us and are well positioned to deliver strong results in fiscal '07. There is no shortage of opportunities to pursue and we continue to invest our results prudently in those areas we believe we have the most potential. We remain focused on maintaining our leadership in PC market through expanded applications for notebook, PCs, PC peripherals, and a trend towards new multi media interfaces. Additionally, we continue to work the further diversify our revenue in non-PC verticals including portable digital entertainment devices and cell phones. Design activities remains very robust across all this market and we expect to continue hiring staff to support our growth efforts. While [unintelligible at 10:23] the challenges we face are dynamics fast in the markets we serve we are proactively taking the steps we think are necessary to insure our continued success. We are more confident than ever in our long term pro strategy and expect fiscal '07 to be another positive year with strong year over year revenue growth and possibility. I will now turn the call over to Russ who will review our detailed financial results for the fourth quarter and provide guidance on our near term outlook. Russ Kittell – Synaptics, Inc.: Thanks Frances. In addition to our GAAP results I'll also provide supplementary results on a non-GAAP basis, which exclude the compensation expense and tax affects associated with expensing the stock based compensation in accordance with PHAS 123-R. Revenue for our fourth fiscal quarter was toward the high-end of our guidance at $43.9 million up approximately 9% from the March quarter as we benefited from strong demand within our core PC market, which included new product launches incorporating our Light Touch multimedia controls. Within the notebook market we saw more than a 255 sequential increase in revenue from Dual Pointing applications heeded by new designs, which ramped at the end of the quarter. As a result, Dual Pointing revenue was approximately 17% of total revenue, up from 15% in the March quarter. Gross margin for the quarter, including the impact of PHAS 123-R was 43% compared to 44.9% in the March quarter. Non-GAAP gross margins were 43.4% compared to 45.2% in the March quarter. This was in line with our guidance. It was also within our target range of 40-45% blended gross margins. Total operating expenses for the quarter were $17 million compared to $16.1 million in the preceding quarter including non-cash share based compensation charges up $3.1 million in both quarters. Excluding the impact of PHAS 123-R in the June quarter non-GAAP operating expenses were $14 million, up approximately 8% from the preceding quarter primarily reflecting the combination of higher product development related project costs, higher legal costs related to our [unintelligible at 12:47] and plant increases in [unintelligible at 12:51]. Total employee head count at the end of June was 254 up from 235 in the March quarter. We expect our headcount to continue to grow based on planned staffing initiatives to fill positions required by our increased operating levels and to add skill sets necessary to meet our business objectives. Net interest income was $1.9 million compared with $1.7 million in the prior quarter reflecting the impact of both higher average invested balances and higher interest rates. Our GAAP and non-GAAP tax rates for the quarter were 52.7% and 39.1% respectively. As we've pointed out in our prior conference calls and in our SEC filings we expect to continue to see substantial volatility in our GAAP effective tax rates primarily due to the accounting treatment associated with our extended stock options. Net income for the quarter was $1.8 million or $0.07 per diluted share. Non-GAAP income, which excludes $3.2 million of non-cash share based compensation charges and the associated tax benefit of $750,000 was $4.2 million or $0.15 per diluted share essentially flat with the preceding quarter and at the high end of our guidance. Now a few comments on our balance sheet; we ended the fiscal year with total cash and short-term investments of $245.2 million up from $237.5 million at the end of the March quarter and $228.9 million at the end of fiscal 2005. Cash flow from operations was approximately $5.3 million for the quarter and $24.8 million for the year. Stock option exercises contributed approximately $1.9 million for the quarter and approximately $8.5 million for the year. During the year we used $18.8 million to repurchase approximately 1.2 million shares of our common stock. Capital expenditures were $693,000 for the quarter and approximately $3.1 million for the year, including approximately $1.6 million associated with the build out of our headquarters in Santa Clara. Capital depreciation was $441,000 for the quarter and approximately $1.6 million for the year. Receivables at the end of June were $34 million compared to $29.7 million at the end of March, resulting in DSO’s at the end of the quarter at 70 days compared with 66 days at the end of the prior quarter. The increase in DSO’s is primarily a reflection of the back-end loaded revenue we experienced in the June quarter. Inventories at the end of June were $10 million compared with $10.6 million at the end of March. Inventory turns for the quarter were 10 times compared to 8 times in the March quarter. I would like to make a few comments regarding our near-term business outlook. As Frances mentioned earlier, our backlog increased by $13.5 million during the quarter to $28.7 million, as our customers enter into what is typically the seasonally strongest quarters of the calendar year. Considering our backlog level and the other indicators we have today, our current outlook for the September quarter calls for sequential revenue growth of 20% to 25%. This outlook is based on the combination of expected seasonality in our target markets and in particular strong demand within our core PC market, reflecting the ramp of new designs and increased integration of our multimedia oriented products. We expect these trends to continue into the year-end holiday season, and anticipate the December quarter revenue will be up 8% to 10% above our September quarter guidance levels. Any increase in demand from the portable digital entertainment market where our visibility and predictability are more limited would represent upside to our current outlook. Looking beyond the December quarter, taking into consideration our current design activities and identified opportunities, our preliminary view suggests that revenue for fiscal 2007 may exceed fiscal 2006 by approximately 20%. We expect gross margins for the first quarter to decline, reflecting anticipated product mix changes and are forecasting non-GAAP gross margins to be in the range of 41% to 42%. This range is within our target model and reflects the combination of our backlog and the expected turns business during the quarter. We expect non-GAAP operating expenses in the September quarter to be up sequentially as we anticipate increased headcount from our ongoing staffing initiatives. Our headcount increased approximately 16% in fiscal 2006 and we anticipate adding approximately 20% in fiscal 2007. For the September quarter, we expect the impact of FAS 123R on our operating margins to be approximately $3.5 million compared to $3.2 million in the June quarter. Non-GAAP net income per diluted share for the September quarter is expected to be in the range of $0.18 to $0.21. In closing, we executed extremely well during our year, in a year characterized by low visibility and uncertainty in some of our markets. We are very optimistic as we head into fiscal 2007, supported by our strong outlook for the first half of the year, increase in pipeline of design opportunities, and the adoption rate of our new light touch multimedia solutions. We continue to be focused on maintaining our competitive edge in the PC market and ensuring our ability to compete effectively in our expanding addressable markets. Our growth and diversification strategies are backed by an increasingly strong balance sheet providing a very solid foundation for our continued long-term success. That concludes our formal remarks and we will now turn the call over to the operator to start the question-and-answer session.

Thank you. (Operator Instructions) Our first question comes from the line of Andrew Neff. Please state your company name, followed by your question, sir. One moment. Mr. Neff, are you there? Ted Chung - Bear, Stearns & Co.: Yes.

Please go ahead, sir. Ted Chung - Bear, Stearns & Co.:

It includes all of the markets that we serve today, but yes, today it is weighted towards PC. Ted Chung - Bear, Stearns & Co.: Can you break out, in terms of the current quarter activities in terms of the non-PC business? You briefly touched upon it. Do you still expect seasonal increases for September as well as the December quarter?

In the non-PC markets, yes we do. Ted Chung - Bear, Stearns & Co.: In terms of looking out to your full fiscal ’07, that view is based upon the current existing design activities, or does that include any potential design wins?

It includes both the design activities we are actually engaged in today plus the additional opportunities we believe we have during the year to engage in additional designs. Ted Chung - Bear, Stearns & Co.: Lastly, what type of seasonality do you expect for the non-PC business for the December quarter?

I think it is hard to put a range on that, Ted. As you know, we are serving a number of markets in that segment. Just generally, I can tell you we are expecting our non-PC applications to be up, and again primarily based on expected consumer seasonality as you enter into the second half of the year where you have grabs and dabs and Thanksgiving and the Christmas shopping seasons. Ted Chung - Bear, Stearns & Co.: For clarification, can you break down the revenue from PC business versus non-PC for the current quarter, or from the just-reported June quarter?

Yes, for the quarter our PC revenues were about 91% of total revenues. Ted Chung - Bear, Stearns & Co.: Thank you.

Our next question comes from the line of Jason Pflaum. Please state your company and your question, sir.

Yes, good afternoon. Maybe just to circle back again on the guidance on a couple of different angles. First, just to clarify again the guidance into September and December does not include any meaningful incremental bump from the non-PC segment. Is that the best way to think about that?

That is correct. We are expecting seasonal growth in that segment, but any significant up-tick in demand would represent upside to the guidance that we have given.

So a lot of the MP3 player other chip component vendors, for example, are expecting somewhere in the ballpark of 10%, maybe low-teens growth in the September quarter. Is that a reasonable ballpark for you guys?

Again, we have not pegged a specific growth rate for that segment.

Of the 20% to 25% sequential growth, can you give us a sense of the major drivers there? I know mostly coming from the PC segment, but is a good portion of that coming from some of this new dual-mode rollouts, or perhaps some of the PC peripherals?

The overall projected increase sequentially is really a combination of just expected industry growth in the markets we serve, and again particularly strong growth and demand from the PC segment, and the increase in average revenue content in per-unit and sell-through boxes because of the addition of multimedia applications to our touchpad.

Maybe another approach on that. If you think about your penetration of the dual-mode technology, can you give us a rough sense of the attached rate in your notebook business?

It is something that is just starting to ramp now. We are seeing good traction there. Again, in terms of a tax rate, we have not pegged that number yet, but we are seeing increasingly number of designs that are shipping that will include both the touchpad and multimedia controls, whether it is in dual mode form or whether it is the touchpad in conjunction with separate multimedia controls.

Okay, but that application is still a very small portion of the overall mix, below 10% or so?

Yes.

As far as the gross margin guidance, I guess it is a little bit lower than I would have expected. Can you provide a little more color on the drivers there, and kind of the major levers, thinking about that going forward?

Again for us, the gross margins really reflect the rollup of all the different designs that we are shipping at any point in time. Margins generally are a reflection of our ability to differentiate ourselves competitively and also reflect the amount of third-party content we have in any particular design or particular segment. An example there would be multimedia controls where we add additional LEDs to that solution that we would not typically have in a touchpad solution, so all of those things kind of roll up, and what you see is the aggregate effect of each design.

Generally speaking then, the dual-mode technologies generally have lower margins than [corporate]. Is that a safe assumption then?

Again, those kinds of applications where the third-party content is higher generally would have the impact of resulting in lower margins because of that higher non-proprietary content.

Okay, so if we were to assume that dual-mode, for example, increases as a percentage of mix, then margins probably would trend flat to perhaps down from current levels?

Based on the designs that we are shipping today, that is true.

Thank you.

Our next question comes from the line of Rob Stone. Please state your company name followed by your question. Rob Stone - SG Cowen & Co.: I wonder if you could comment, Frances, on the up-tick in dual-mode. Is that being driven by more dual-pointing over all or is it just because you are in the right part of the designing cycle?

A lot of the consumers have been buying a lot of laptop notebooks, number one, so it is really a consumer segment, in my mind. The other part about it is this trend towards a digital lifestyles, a lot of people now are using laptops to really look at movies and stuff like that. The latest announcement of a number of those PCs that come out that you can even look at DVD movies and listen to music without putting on the computer is an indication of the growing trend of that kind of lifestyle and convergence of entertainment into mobile computing. I think the dual-mode, which allows people to control in one mode those multimedia applications and in another mode allows to navigate, really fits into that quite well. I believe that is probably what drives it. Rob Stone - SG Cowen & Co.: Frances, let me make sure that we are being clear about the terminology, because if I understood it right, what we refer to as dual-pointing in the past was a corporate oriented notebook that had both a pad and a stick.

Correct. Rob Stone - SG Cowen & Co.: Dual-mode, you are referring to the combination of navigation plus multimedia…

On the touchpad itself. Rob Stone - SG Cowen & Co.: Yes, so in the commentary about an increase to 17% of dual-pointing, that is the classic pad plus stick?

That is correct. That was in Russ’ commentary. That is actually true. Rob Stone - SG Cowen & Co.: That was my question, really was given the fact that most of the notebook buying, or more of the notebook buying lately would seem to be coming from consumers. Are you getting more mix of dual-pointing as a result of some up-tick in corporate buys or just more design wins for Synaptics?

You are actually right, Rob, but when I answered your question, you asked a question, I believe up-tick in dual mode, so I answered it in a dual-mode sense. Russ also commented on his part of the discussion that the dual-pointing did go up and we have always used that as a proxy for increased corporate buying activities.

I think in the near-term, Rob, I think it does represent actually a market share shift towards Synaptics in that particular segment of the notebook market, because these are new designs that we started shipping in the June month, and they were designs into boxes that we were not shipping into in the predecessor box. Rob Stone - SG Cowen & Co.: Okay, so looking at how big a boost to your revenue growth versus industry unit growth, the dual-pointing trend was in some prior years. Can you give us a sense of how dual-mode or pad plus separate multimedia controls, so that the new consumer oriented multimedia notebooks, how much does that influence your average revenue per box compared to just a regular pad solution?

Well, our single pointing solutions generally are in that $3 to $6 range. When we are adding the additional functionality in either dual-mode or adding multimedia controls into the same notebook, I would say generally we would be at the higher end of the single pointing range to slightly above that, depending on the number of controls or buttons that are in the multimedia application. The dual pointing segment, that is something we are just going to have to watch to see how that develops going forward. Again, I do not think this part -- I do not think this signals that there has been a swing in market demand between consumers and corporate. I think it is more a reflection, as I said earlier, of us taking some market share in this particular segment in that new designs that we won, vis-à-vis competitive bakeoff that are now starting to ship in the marketplace. In general, I think as we move forward here, that our revenue content you can expect will increase to some extent across our total product mix, with the addition of the dual-pointing design wins and the increased functionality when we are providing our light touch solutions in combinations with our touchpad. Rob Stone - SG Cowen & Co.: So the multimedia dual solution is not as big an increase in revenue per box as the pad plus sticks solution, but it sounds like where we are in the adoption curve, penetration on that could go meaningfully higher.

That is correct, Rob, in terms of both of your observations. Rob Stone - SG Cowen & Co.: Thank you.

(Operator Instructions) We do have a follow-up question from Andrew Neff. Please go ahead with your follow-up question, sir. Andrew Neff - Bear, Stearns & Co.: In terms of the backlog figure you gave, does that include -- you also made the comment about this does not include any MP3 -- sorry, digital entertainment downside. Does the backlog figures include digital entertainment in there at this point, or would that be upside in terms of your backlog?

Andy, the backlog that we have provided to you has been consistently the same way how we have presented the backlogs. They are basically shippable backlogs within this fiscal quarters. A mix of the backlog obviously is depending on how the orders come in. We project a quarter range based on our estimation of the backlog in the terms business. Since this quarter, the way we forecast it is driven mostly by PC-centric applications, that is why Russ’ comment reflected the way he commented. We really have not changed the way of how we report backlog all through these quarters. Andrew Neff - Bear, Stearns & Co.: I guess one of the reasons we are asking these questions is 20%, 25% is a pretty big jump for the notebook market. It seems like a very -- I am trying to see if there is anything else in that that is driving that.

There are really three things there, Andy. Certainly we are trying to increase our revenue per box, and we are trying to increase our penetration of our revenues or shares from the other competitors. Thirdly, we [inaudible] seasonalities, right? So it is really the combination of those three things. Andrew Neff - Bear, Stearns & Co.: The comment you had in the press release which said along the lines of anything in the digital entertainment could provide upside, when will we have a sense of that, and is there any way to bracket at this point, or let us know when you will know?

The visibility and predictability, as we said in that segment, Andy, is not as good, we don’t feel, as the PC market. As you know, there are some unique dynamics in that particular segment of the market because of the competitive mix within the OEM’s there and specific customer relationships. It is really hard for us to try to bracket that, and that is why we provided guidance in the way we did, which is we have given you the best visibility we can today and said that there is the opportunity here to see some upside, but it is just not something today that has a high level of predictability to it. Andrew Neff - Bear, Stearns & Co.: Thank you for that.

We do have a follow-up question from Rob Stone. Please go ahead with your question, sir. Rob Stone - SG Cowen & Co.: Two things, if I may, Russ. One on the expense trend in Q1, can you give us a sense, a rough percentage increase in the expenses quarter on quarter? Was most of the headcount increase then coming in R&D? The second question is as you set up those two new design centers, do you anticipate, or can you comment on cap-ex requirements, or any unusual expenses that might be associated with that expansion?

I will relate it to our op-ex increased sequentially. We do expect it to be up. I guess I would refer you to what our prior increases have been as we move from the June to September quarter. It is a period where we do go through our annual performance review cycle, at this point in time, so you do see an increase in expenses from that. As you can see, last quarter we did have some real success in adding to our staff in some needed areas. We have our recruiting machine I think ramped up to a point now where we actually have some momentum there, so you are going to see some increased staffing in this particular quarter. As it relates to cap-ex for the design centers that we talked about, I do not anticipate any extraordinary capital expenditures required for that itself. We are though looking at putting in additional infrastructure this year in the form of a more corporate integrate ERP system, and we have made the decision to do that. In fact, we are in the early selection phase of that now in terms of vendors. I would guess that this year, we will probably spend somewhere around $1.5 million on just that initiative alone, but the design centers themselves will not be capital intensive. It will be a question of adding to our staffing resources to provide the necessary functionality in the multitude of engineering disciplines it takes to support our products for our customers. Rob Stone - SG Cowen & Co.: But is it fair to say that at some level, you are going to be shifting staff growth to those locations, not necessarily reducing heads in California but building up a presence over there? Just thinking about substitute versus duplicative expenses as a concept.

No, in fact, that is right. A lot of the headcount growth, even from last quarter, those hires were occurring in the greater China region. Rob Stone - SG Cowen & Co.: Thank you.

Gentlemen, there are no further questions. Please continue.

I would like to take this opportunity to thank our employees, partners, customers, board members and you, our investors, for your support over the past year and in the future. I look forward to updating you on progress during the coming year. Thank you for being on the call with us today.

Ladies and gentlemen, that does conclude today’s Synaptics fourth quarter 2006 conference call. If you would like to listen to a replay to today’s conference, please dial 1-800-405-2236, or 303-590-3000, access code 11065235. Those number again are 1-800-405-2236 or 303-590-3000, access code 11065235. You may now disconnect. Thank you for using AT&T teleconferencing. Have a great day.