Zarlink Semiconductor Inc. F2Q09 (Qtr End 9/26/08) Earnings Call Transcript

| About: Zarlink Semicond (ZLKKF)

Zarlink Semiconductor Inc. (ZL) F2Q09 (Qtr End 9/26/08) Earnings Call Transcript October 22, 2008 5:00 PM ET

Executives

Scott Milligan – SVP and CFO

Kirk Mandy – President and CEO

Steve Swift – SVP, General Manager of Medical Communications

Analysts

Sandy Harrison – Signal Hill

Chris Wilson – Stonehill Capital

Bench Galander [ph]

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Zarlink Semiconductor second quarter fiscal 2009 results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (Operator instructions) I would like to remind everyone that this conference call is being recorded on Wednesday, October 22, 2008 at 5 O'clock Eastern Time. I will now turn the conference over to Mr. Scott Milligan, Chief Financial Officer. Please go ahead, sir.

Scott Milligan

Thank you, operator. Good afternoon and thank you for joining the Zarlink Semiconductor fiscal 2009 second quarter results conference call, on this, October 22, 2008. Our speakers this afternoon are Kirk Mandy, President and Chief Executive Officer and myself, Scott Milligan, Senior Vice President and Chief Financial Officer. Please note that our second quarter results news release was released via our wire service earlier today and will be available on our web site at www.zarlink.com.

The running order for this call is as follows. I will provide a financial review of the second quarter and look ahead to the third quarter of fiscal 2009. Kirk will then review the quarter and discuss our plans going forward. And then we will open up the call for questions.

Before we begin, I would like to remind everyone that this conference call contains forward-looking statements that are based on our current expectations, forecasts and assumptions that involve risks and certainties that could cause actual outcomes and results to differ materially. For a complete description of such risks and uncertainties, please see the MD&A section of our Form 20F and the reports we filed the Securities and Exchange Commission.

Looking at second quarter results, revenue totaled $61.8 million, up 2% compared to first quarter revenue of $60.5 million and up 25% versus the same quarter a year ago. Zarlink recorded net income of $7.2 million or $0.05 per share, compared with our guidance range of earnings per share of between $0.01 and $0.03. In the previous quarter, Zarlink recorded net income of $1.1 million or breakeven per share. Second quarter results included a gain of $2.4 million related to income tax recovery. Integration costs related to the Legerity acquisition totaled $1.2 million including $800,000 in cost of good sold, $300,000 in selling and administration, and $100,000 in research and development.

Zarlink also recorded a non-cash foreign exchange gain of $1.9 million related primarily to the convertible debenture used to fund the portion of the acquisition of Legerity.

Gross margin 50% which includes integration costs of $800,000. This compares with gross margin of 46% in the first quarter which included integration costs of $1.3 million.

Research and development expenses were $11.2 million in the second quarter or 18% of revenue and included integration costs of $100,000. This compares with research and development expenses in the previous quarter of $12 million or 20% of revenue.

Selling and administration expenses were $13.6 million in Q2 or 22% of revenue. This includes proxy contest cost of $1.2 million and severance and integration costs of $300,000. This compares with first quarter S&A expenses of $12.4 million or 20% of revenue which included severance and integration costs of $100,000.

Revenue from Zarlink’s Communications Products improved to $39.7 million for the second quarter compared with $39.1 million in the previous quarter due to increased sales from our Legerity portfolio. The acquisition of Legerity accounted for $24.6 million in revenue in the second quarter compared to $23.2 million in the first quarter.

Medical Products revenue in the second quarter was $7.8 million compared to $9.2 million in the previous quarter. While for our new wireless solutions increased over the quarter, we did see some seasonal slowdown in our legacy medical products.

Optical Products revenue increased in the second quarter of fiscal 2009 to $6.8 million compared with $6.2 million in the first quarter. Increase sales of our audio technology products accounted for the majority of this growth in the quarter.

Custom and other revenue grew from $6 million in the first quarter to $7.5 million in the second quarter due to increased sales of custom products for government and industrial customers.

Cash and short-term investments increased at the end of the quarter to $46.1 million from $40.3 million at the end of the first quarter.

Turning to the third quarter, our opening 90-day backlog at the start of the quarter was approximately $53 million compared to $56 million at the start of the second quarter. Based on our opening backlog and current limited visibility on order activity and uncertain economic conditions, we are anticipating third quarter fiscal 2009 revenue will be $53 million to $58 million. Gross margins are expected to be 49% to 51%. Operating expenses are expected to be approximately $23 million to $24 million excluding amortization of intangibles. Excluding any potential impact of foreign exchange fluctuations and the effect it would have on our debentures, we anticipate third quarter net earnings of between breakeven and $0.02 per share.

As announced in the fourth quarter of fiscal 2008, Zarlink is repurchasing common shares on the TSX. To date, we have repurchased and cancelled approximately 1.9 million shares. This stock repurchase program remains open until May 25, 2009. We will continue to evaluate our cash position and current economic conditions and repurchase common stock when appropriate. I will now turn the call over to Kirk.

Kirk Mandy

Thank you, Scott. So as I said in our second quarter results press release, I am pleased with the progress made this quarter. Revenue increased, costs are firmly under control and as a result, we were able to deliver an earnings per share (inaudible) guidance for the quarter. We said that fiscal 2009 will see a return to profitable growth for Zarlink and results in this quarter are another good indication that we are on the right path. While we are pleased with second quarter results, our attention is quickly turning to the unusual challenges that Zarlink and our peers and our customers will face in the third quarter and beyond.

As reflected in our guidance, we do anticipate the third quarter seasonal softness would affect our voice products and our communications business. In previous years, this business has traditionally returned in the fourth quarter and we will be monitoring our customer activities very closely over the coming weeks.

Our greater concern, as we look to the third quarter and beyond, is the impact of the current economic slowdown. We anticipate many equipment manufacturers and service providers will be more conservative in their spending as they assess the impact of the global economy and the potential for a slowdown in business and consumer spending. For a number of reasons, I do believe Zarlink is positioned in the right path to weather this unique economic situation. One important thing to remember is that economic challenge is really nothing new for many companies that survived the tech bust earlier this decade. From that downturn, we learned just how important customer relationships are and the need to move proactively and quickly as situations change.

Continuing to build strong relationships with our customers throughout this period is critical. Just as important, we need to pay very close attention to what customers' customers are saying with regards to where they are cutting budgets and where they are continuing to spend. For the most part, service providers remain optimistic. Speaking recently at a conference hosted by Dow Jones, Verizon's CEO and Chairman said that while there may be a slowdown in spending on some data services, we anticipate the American consumers will continue to spend money on wireless and broadband. In Canada, (inaudible) upgrade their wireless networks to better support mobile broadband applications and compete with cable providers.

Despite the economic uncertainty, service provider spending will continue though potentially in more selective areas. I believe we are focused on markets where spending will continue. Our Legerity portfolio of products targets the continuing battle between cable and telephone operators, as they attempt to grow their customer base by delivering a full range of television, Internet and voice services. Some speculate that a recession may heighten this battle and home owners consider trimming spending and starting to look more closely at voice-over-broadband and wireless services. At the same time, as consumers cut cost and spend more time at home, that could potentially translate into a demand for more television and Internet services.

To address this growing market, this quarter we expanded our Next-Generation Carrier Chipset or NGCC portfolio. Designed for DSL or digital subscriber line cable and fiber-based residential gateways, this highly integrated chipset performs all the functions necessary to create a two-wire, twisted pair telephone interface from any broadband digital source. In addition, integrated lines have allowed service providers to quickly and more cost effectively diagnose and solve performance issues.

One of the main drivers for our timing portfolio, is the wireless market. Equipment manufacturers are evaluating our synchronous to Ethernet, timing over pocket and circuit emulation solutions as key technologies that will help wireless operators more cost effectively and efficiently carry voice, data and video services over wireless networks. Announcements of expanding wireless networks and new devices from the likes of (inaudible) to deliver mobile broadband applications are all encouraging signs that they will be continuing spending in the wireless market.

In the optical market, we continue to win new business with our integrated optical cable solutions. In early November, we will be demonstrating both CX4 and QSFP terminated ZLynx cables at the Super Computing Show in Austin, Texas.

Our medical business remains consistent as we enjoy long-term partnerships and joint R&D projects with customers like (inaudible), Medtronic and St. Jude. Over the past four years, we have been very proactive in reducing cost and building a far more efficient organization. Our R&D spending is focused on very targeted opportunities in the voice, timing, optical and medical markets.

Through the Legerity acquisition, we now have the scale to secure better pricing on our suppliers and the ability to fully outsource non-core activities such as test and assembly. Over the past 12 months, we have created a very nimble organization and as the economic situation unfolds, we will be able to trim spendings and find further cost reductions as required.

All this said, we are approaching the third quarter and beyond with a great deal of caution. We were anticipating softness in the third quarter, but had not expected the across the broad mass market volatility we are now experiencing. I remain confident about our prospects in the third quarter but obviously (inaudible) wide-reaching economic slowdown will have an effect on Zarlink and our customers.

Before closing, I would like to address the concerns from our shareholders regarding stock price. Obviously, no one is happy to see Zarlink trading in its current levels. The management team is intensely focused on building the company to deliver shareholder value over the long-term. I remain confident that when rationality returns to the market, our stock should reflect the positive progress we have made as a company.

Operator, this ends our prepared remarks. Would you please give your instructions to our listeners, so that we may begin the question-and-answer portion of the call?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from Sandy Harrison from Signal Hill. Please go ahead.

Sandy Harrison – Signal Hill

Thanks. Good afternoon, guys. Couple of questions, Kirk, I did the macro economic thing we've heard from pretty much everyone out there but I think if you look at some of the products you guys have introduced during some of these markets that are emerging and so, if you could help us kind of understand some of the challenges that you had in each of those. So specifically in optical, one of the things we continue to hear about the slowing demand for data centers and how those guys are building, however, there is an argument about whether or not they can fund their growth. I'd be interested on your thoughts on that.

And then the follow-on would be, in the medical device area, I don't think people are getting healthier, how is the engine strategy going there? Of these two engines, which ones do you think are going to continue to really spurn [ph] growth radars?

Kirk Mandy

Okay, Sandy, thank you for that. I am going to take the second part first and talk a little bit about medical and we happen to add (inaudible). Basically, our view is that the medical telemetry business that we are building, which now represents more than 50% to 60% of our revenue in that unit and continues to grow, is that it has a very different set of dynamics. We tend to get orders long in advance, business is not choppy, it is much more predictable but it is early days. It is growing very, very quickly. We do not any evidence of any slowdown of any substance on the part of our medical customers which include primarily at this point people like St. Jude and Medtronic and so on. Steve, would you like to answer that?

Steve Swift

I can just admit the same thing, so we seem to be fairly insulated from macro economic concerns. The medical market (inaudible) continue to rise and the (inaudible) for medical devices and medical services continues to grow (inaudible). So we seem to be fairly insulated from that and we continue to see very strong growth and very strong demand for the products that we have created.

Kirk Mandy

On the second part, Sandy, on the optical space as you know, our business is (inaudible) into a few areas. Data Center Interconnect is one, high-speed computing and then of course, large optical cross-connects and routers and so on. In the telecom component, we are definitely seeing some slowdown with customers like Fujitsu and so forth. The business is still tracking along. We are expecting it to be roughly I think flat quarter-on-quarter but we are seeing some slowdown there. As far as the Data Center Interconnect markets go, there is no evidence at this time of any substantial slowdown although we are being very, very cautious.

Sandy Harrison – Signal Hill

Got you. Thanks for that. And then in your last comment, obviously you can't control the market and you can't control the stock price to an extent, but I think you've been asked this in the past and we are in interesting times here but is there any thoughts to reverse things like that to get better liquidity in other markets simply outside of over-the-counter TSX?

Scott Milligan

The track record on the gross splits has not been very good and that's part of the reason that we chose not to do one. We continue to monitor that situation and we will look at it, but it is not on the front [ph] right now.

Sandy Harrison – Signal Hill

Thanks guys.

Operator

Your next question comes from Chris Wilson from Stonehill Capital. Please go ahead.

Chris Wilson – Stonehill Capital

Thanks. Really my questions are the same one that Sandy had, so let me just congratulate you on the great quarter. Thanks.

Kirk Mandy

Thanks, Chris.

Operator

(Operator instructions) Your next question comes from Bench Galander [ph] from (inaudible). Please go ahead.

Bench Galander

Hi, I also just wanted to commend you on what look likes a pretty good quarter. But I want to commend you more on not doing the reverse split. As you just said, in almost every case, it really kills the stock price overall and if you've got it on the backburner, I just wanted to stress you put it even further on the backburner. I did research before that showed that over 90% of the capitals who do that, the shareholders are worse positioned a year later. So, keep it way back on the backburner (inaudible).

Kirk Mandy

Thanks. (inaudible) announcing that we have instituted a normal course issuer bid on the common stock, we did call a large number of our shareholders and got very, very strong feedback that a reverse split is just not something anybody wanted to see. We did listen and our research confirms exactly what you said and in fact for those of you who (inaudible) equivalent of a $200 base not that long ago and (inaudible). The track record is not good and I can assure you we will not be doing any reverse split. I will tell you however though, our debenture (inaudible) $1.40 from $1.50 [ph] something like that, are becoming very interesting to us.

Bench Galander

Interesting in terms of buying back?

Kirk Mandy

I will leave it at that.

Bench Galander

Okay. Sounds good. Well, hopefully, good sailing ahead through these choppy waters.

Kirk Mandy

Thanks very much.

Operator

There are no other questions at this time. Please continue.

Scott Milligan

Thank you, operator. This ends our call for today and our next call will be on January 29, 2009, after the close.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating, please disconnect your lines.

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