Friday, February 10, 2006

Genesis Microchip--Cramer Says Buy--Turn Off the TV!

On Friday, January 20, 2006, Genesis Microchip Inc. reported a profit in its fiscal third quarter ended December 31, 2006; but investors were disappointed with the Company’s weak fourth-quarter outlook and its stock price fell 9%, or $1.73, to close at $17.50 per share. The stock has changed hands between $11.96 and $27.69 in the past 52 weeks.
Genesis Microchip, Inc. (GNSS-$19.25), develops and markets integrated circuits that receive and process digital video and graphic images. The target market for the Company’s image-processing solutions are the manufacturers of advanced display products, including LCD monitors and flat-panel televisions.
On Tuesday, January 24, during the lightning round segment of his Mad Money television show, host James Cramer blithely said: “Take my word for it and buy Genesis Micro [$18.30]…. if you opened up the guts of a big flat-screen TV, you'd see a lot of Genesis product inside.”
Unfortunately, as Cramer knows too well, a 30-second sound bite does not begin to depict the true state of affairs of Genesis—or any publicly traded company.
According to Elias Antoun, CEO, on a GAAP basis, earnings were $7.4 million, or $0.20 per diluted share, down from $9.3 billion or, diluted share-net $0.25, in the prior quarter. This drop was largely due to a higher effective tax rate in the December quarter.
Sales were slightly below the midpoint of previous guidance, primarily due to lower shipments of LCD monitor units to the Company’s largest end customer (Dell?). For the fourth quarter, Genesis said it expects revenue in the range of $62 million to $67 million. Analysts had previously forecast earnings of 19 cents per share on sales of $70.1 million.
Looking at the Company’s key markets: In the TV controller market, revenue’s grew 4% sequentially to $44.4 million. TV controllers contributed 60% of the revenue for the third quarter ended December 31, 2005, up from 57% in the previous quarter. Unit shipments of flat panel TV controllers grew 5% to 4.5 million units during the quarter. This modest growth in units was in-line with corporate expectations, especially following a significant surge in unit shipments during the September quarter.
In addition, the moderate growth in unit shipments was slightly impacted by the beginning of an anticipated transition away from shipping a two chip solutions—mainly Malibu and FLI2300—into many of Genesis’ flat panel TV design wins to shipping the single chip Cortez. This product is central to the Company’s strategy of maintaining market leadership through integration of new features and functions and by providing the highest image quality at a cost-effective price.
For its monitor products, average selling prices (ASPs) decreased by approximately 20% for the three months ended December 31, 2005 from the same period in the prior year, reflecting product transitions and competition driving other companies to design lower-priced and cost-efficient next generation products. ASPs increased 4% in the TV/video market for the three months ended December 31, 2005 from the same period in the prior year, reflecting higher demand for chip shipments into displays with video capability, such as flat-panel televisions.
Gross margin’s increased for the third quarter to 48.9% from 46.5% in the prior quarter. This improvement was substantially the result of the continuing shift in the Company’s product mix. As previously mentioned, flat-panel television continued to become a larger proportion of total revenue volume. Yes- Cramer called the ball—but he was irresponsible for failing to mention, too, that ASP increases are not expected to grow exponentially as the market expands and competition increases. Still, the 10Q Detective applauds Genesis for quickly bringing to market next generation technology.
The problem that Genesis will continue to face is technological obsolescence. Ergo, ASP and product margins of products are typically highest during the initial periods following product introduction and decline over time and as volume increases.
From the 10-Q playbook: “Our industry is very competitive and growth industries like ours tend to attract new entrants. The LCD computer monitor industry is highly competitive. Our average selling prices of monitor display controllers, in spite of increased functionality have declined by more than 50% over the past two fiscal years. We expect the flat panel television industry will be as competitive over time.”
As competitive forces put pressure on ASPs, the Company’s selling cycle makes the stock more akin to a cyclical play—unending sales hiccups as customers hold of on buying legacy products as they transition to newer products—e.g. legacy two-chip solutions and newer one-chip solutions. Therefore, buying Genesis’ stock becomes like buying a semiconductor play—look to buy when supply exceeds demand—and stock prices are bouncing around “seasonal” lows.
The offset to product obsolescence, seasonality, and competitive pricing pressures rests on the Company’s ability to gain momentum in design wins and ramp new designs into volume production. Genesis’ did report such wins in the third-quarter, which should boost top-line growth in the second half of calendar year 2006.
Hisense, the largest LCD TV OEM in China, chose Genesis’ proprietary Cortez and Hudson controllers for their new 32, 37 and 43-inch LCD platforms available in China’s domestic market.
Additionally, Westinghouse—one of the Company’s largest customers—selected Genesis as its primary supplier of video processing controllers in its 27 and 32 inch LCD TV’s, as well as their 37 and 42 inch ADP video monitors.
Cramer—in his BOOYAHH Way—also forget to mention several other radioactive nuggets that were easy to spot in the Company's most recent 10-Q filing:
  • · The majority of revenue—approximately 83 percent—continued to be to customers located in Asia. China represented approximately $32 million, or 43% of net revenue for the third quarter. This leaves the Company vulnerable to any political typhoons blowing through this part of the world.
    · For the three-months ended December 31, 2005, Genesis derived 25% of net revenues from just two customers. Sales to its largest five customers accounted for 49% of its revenues. Corporate, expects that a small number of customers will continue to account for a large amount of its revenues. The decision by any large customer to decrease or cease using Genesis’ products by bringing R&D in-house to internally develop its own solutions could harm Genesis’ business going forward.
    o In the third quarter, one of the Company’s largest South Korean customer decided to stop manufacturing LCD monitors for their OEM customers and instead will focus on producing monitors only under their own brand name.
    · Interest income of $1.4m contributed 4 cents to the Company’s bottom-line. Genesis is entangled in a licensing/royalty battle with Silicon Image, Inc. An amended final judgment stated that Genesis had received a license from Silicon Image, Inc. for certain of their DVI and HDMI patents, and must pay Silicon Image royalties on all of its DVI and HDMI products. This amended final judgment, if not overturned on appeal, could hinder the Company’s ability to compete with unlicensed competitors that are not required to pay royalties on competing products. [ed. note. The Company has not made provisions—set aside reserves—to meet this possible future obligation.

Management is confident that current market and product trends are temporary, and that the product mix shift will largely be complete by the end of the current fiscal fourth quarter. Corporate believes, too, that its design wins portfolio and customer penetration will allow the Company to resume its growth in the following quarter(s). If this proves to be true, a forward 12-to-24 month EPS growth rate of 20% could prove to be conservative. If so—Cramer is right—think flat-screens—buy Genesis Microchip.

Nonetheless, the 10Q Detective believes that management has another shoe to drop. We believe that management has not come totally clean on potential inventory logjams, which would dampen top-line growth. We also need to be shown that the transition to the new design wins/contracts will lift margins and the bottom-line, too. SELL.

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