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MIPS Technologies, Inc. (NASDAQ:MIPS)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

October 29, 2008, 4:45 pm ET

Executives

Jen Bernier – Senior Public Relations Manager

John Bourgoin – President and CEO

Maury Austin – CFO

Analysts

Gary Mobley – Piper Jaffray & Co

Anthony Stoss – Craig-Hallum

Operator

Good afternoon and welcome to the MIPS Technologies first quarter fiscal 2009 financial results call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Jen Bernier, MIPS Public Relations Manager. Ma’am, you may begin.

Jen Bernier

Thank you and welcome to MIPS Technologies first quarter 2009 earnings conference call. I’m Jen Bernier, MIPS Public Relations Manager. Leading the call today are John Bourgoin, Chief Executive Officer; and Maury Austin, Chief Financial Officer. After they discuss the business highlights and detailed financial results, we’ll open the call for Q&A.

If you do not have a copy of the earnings release, it is available on our website at www.mips.com. Before we begin, I’d like to remind you that this conference call may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, including projections of certain operating results for the fourth quarter and fiscal 2008. Listeners are cautioned not to place undue reliance on this forward-looking information.

Many important factors could cause the results to differ materially from those contained in such projections or forward looking statements. We refer you to the Risk Factors section of the documents that we file from time to time with the Securities and Exchange Commission for factors that could cause the results to differ materially from our forward looking statements.

In our financial discussions today, we’ll be referring to first quarter 2009’s GAAP and non-GAAP results. MIPS management believes that non-GAAP information is useful because it can enhance the understanding of the company’s ongoing economic performance. MIPS Technologies uses non-GAAP measures when evaluating its financial results as well as for internal planning and budgeting purposes. The non-GAAP results exclude FAS 123R stock option expense, certain costs & expenses related to the Chipidea acquisition, impairment and restructuring costs incurred during this quarter.

Please refer to the earnings press release or to the Investor Relations page of our website for a reconciliation of GAAP to non-GAAP. As a reminder, the playback number for this conference call is 203-369-1154 and the access code is MIPS. The recorded call will be available for 30 days after the call. An audio replay will also be posted on the Investor Relations page of our website at www.mips.com.

With that, I will now turn the call over to John Bourgoin.

John Bourgoin

Thank you, Jen, and thank you for joining our call today. Our September quarter results at $26.2 million were 3% below the low side guidance of $27 million. The numbers were composed of nearly $20 million in processor licensing and royalties and roughly $6.4 million in analog licensing. Helping the processor results were a solid quarter in royalties. The increase in royalty revenue was driven by higher licence unit volumes with end user license units growing 10% to 112 million units. Well over 50% of this royalty growth came from the continued success in the Digital Living Room. 10% of the upside was in portable products, and the remaining success was spread across broadband, microcontrollers and networking infrastructure.

With ATI’s acquisition by Broadcom, our royalty contributors are now reduced by one. We also added two new royalty contributors this quarter; one from China and one from Taiwan. Our processor licensing numbers were in line with our expectations and we continue to see a lot of interest in our products. Although we saw an extraordinary – although the extraordinary market conditions are a major concern, we saw a normal number of deals pushing out at the end of the quarter. We haven’t witnessed any exceptional reluctance in our customer base to close new license agreements.

Unfortunately, we fell short in our revenue goals in the Analog group licensing activity. The September quarter had series of challenges which collectively affected our outcome I believe. As you probably know, Analog revenues depend to a significant extent on porting and other activities, from engineering teams in preparing their cores for shipment and specific technologies.

During the quarter, we restructured the organization and witnessed the departure of Jose Franca, who had led the team since the inception of the Chipidea organization. Added to the traditional August vacation, we lost significant amounts of productivity. Although we believe we haven’t materially cut into our ability to deliver revenues as a result of the restructuring, we need to prove this quarter that we can book and deliver from ABG at higher levels than we did this quarter.

While we’re continuing the integration effort following the acquisition of Chipidea, I want to stress that we have continued confidence in the long-term success with the analog business. Approximately 80% of the analog design work we believe is still captive inside of companies and we’re quite optimistic that this work will increasingly be outsourced as companies look to cut costs for development during these difficult times.

With Analog lagging [ph] processor licensing and customers design decisions, one of our key challenges is engaging customers for Analog earlier in the process. Our strategy is to sell Analog that fits the IP licensing model, so we can sell the same IP multiple times to multiple customers. We believe this is a sound strategy as customers increasingly understand that access to Analog IP cores can reduce their risk and integration effort.

As I referenced earlier, we recently underwent a broad restructuring of our business, aimed at taking $5 million of spending out. The restructuring included reductions in headcount in Analog and across other parts of the company as well. At this point, we have executed about 80% of our total spending reductions and we are on track with the plan.

Looking forward, our processor and analog products continue to be well positioned for success. This quarter, we introduced our new HDMI cores in 90, 65 and 45 nanometer technology. Our HDMI core IP was also named as a finalist for the Embedded System Product of the Year in the annual Elektra European Electronics Industry Awards. Market analysts estimate that HDMI enabled equipment will grow at a compound annual growth rate of 32% from 2007 to 2012, so there’s a clear opportunity here for HDMI.

We’re in a great position to capitalize on this opportunity as the only company offering the combined controller and PHY in 45 and 65 nanometer, and we’re seeing interest and traction in the HDMI IP. We also introduced Silicon-Proven GPS RF Tuner IP and announced breakthroughs with USB PHY, including the industry’s first 40 nanometer USB PHY IP core. With so many functions using USB connectivity, our advanced technology USB core speeds the development of the newest designs in consumer application. A leading cellular communication chipset provider will be the first to go into production with an SoC that integrates our silicon-proven 1.8 volt 45 nanometer PHY.

On the processor side, our momentum continues for our low powered M4K and 4KE cores as well as the popular 24K cores and multiple new and renewal licenses this quarter including several multicore deals. Customers are also showing increasingly strong interest in our high performance cores. The 1004K, our new multicore product, continued to gain traction with two new licenses this quarter, and we had four new licenses for the 74K. With these high performance cores, licensee applications are primarily in the digital living room and in broadband.

In our tools products, last month, we introduced the new Navigator Integrated Component Suite to help MIPS developers get products to market faster and with higher success rates than ever before. The product is already getting good reception and we’re confident that the development tools and associated plug-ins will produce significant results for our customers, the majority of whom are developing on Linux.

As a closing note, it’s impossible not to have some concerns about the business climate. While our business has not been impacted in a major way at this point, the macroeconomic conditions create the potential for a serious problem. We believe we’ve taken the right steps to protect ourself and we continuously re-evaluate market condition. We have a strong royalty revenue stream and a leading position in many key markets. We have a comprehensive processor product line offering solutions for everything from low-power microcontrollers, to feature rich set top boxes and HDTV.

We have the industry’s broadest portfolio of analog IP and a wide range of processes and foundries, and we’re the only company offering a combination of analog IP, processor IP and development tools for the embedded market. We believe this offers a clear and unique value proposition to our customers, and we have a line of credit that’s available to us through Silicon Valley Bank, who by the way we think is doing fine, and our cost reduction efforts are beginning to have a positive impact on our cost structure.

So now, I’ll hand the call over to Maury who will discuss the financial results in depth.

Maury Austin

Thanks John. Like the equity markets, we had a mixture of positive and negative impacts on our business this past quarter. On the plus side, we've returned to a positive growth in our licensee royalty units and revenue, we generated over $2 million dollars in cash during the quarter, and our cost reduction efforts are taking effect nicely. We did however see – continue to see softness in the analog licensing business.

To recap our financial results, MIPS had total revenues of $26.2 million in the first quarter of fiscal 2009, a decrease of 9% from the $28.9 million in the prior quarter, but an increase of 18% from the $22.2 million reported from the same quarter a year ago. Overall revenue came in approximately $800,000 or 3% below the low-end of our expectations due to lower than anticipated analog business license revenue. The total first quarter revenue from the processor business was $19.6 million, and revenue from the analog business group was $6.6 million.

Royalty revenue in the first quarter was $11.8 million, an increase of 10% from the $10.8 million reported in the prior quarter and an increase of 12% from the $10.5 million reported into the same quarter a year ago. Our processor licensees reported shipments of 112 million units, approximately 14% higher than the 99 million units shipped in the prior quarter, and an increase of 22% over the 92 million units shipped in Q1 fiscal year '08.

During the quarter, the sequential shipment growth across our 44 reporting licensees was fairly evenly distributed. Q1 '09 contract and license revenue was $14.4 million, a decrease of 20% from the $18.1 million reported in the prior quarter, but an increase of 24% from the $11.6 million reported in the same quarter a year ago.

License revenue from the processor business was $8 million with eight new license agreements signed during the quarter, and contracts and license revenue from the analog business was $6.4 million, generated from existing contracts along with a portion of the 16 new license agreements signed during the quarter.

As John mentioned, we believe the analog revenues were negatively impacted during the quarter by the changing global business conditions along with the internal impact of our restructuring efforts announced during the quarter. Our first quarter gross margin of $18.6 million decreased $200,000 or 1% compared to the fourth quarter results of $18.8 million, as a result of the lower analog license revenues achieved during the quarter.

Our blended gross margin of the two business units combined was 71% for the quarter, up from 65% in Q4 '08. Included in the Q1 cost of sales was $1.4 million in intangible asset amortization related to the Chipidea acquisition.

Turning now to operating expenses, our Q1 '09 operating expense was $24.3 million, including a restructuring charge of $4.9 million. Excluding the restructuring and impairment charges, our Q1 '09 GAAP operating expense of $19.4 million compares favourably with the $22.7 million we incurred in Q4 '08 reflecting a portion of the positive impact of our cost reduction programs implemented during the quarter. First quarter operating expenses included approximately $1.2 million in FAS 123R stock option expense and $1.2 million in amortization charges related to the Chipidea acquisition.

We recorded a $0.2 million credit to our income tax provision during Q1, which was a combination of foreign withholding taxes, offset by other tax credits. Our GAAP net loss for the first quarter of fiscal ’09 was $7 million or $0.16 a share compared with a net loss of $108.5 million or $2.45 per share in the prior quarter, and a net loss of $7 million or $0.16 a share in the same quarter a year ago.

On a pro forma basis, excluding the effect of equity based compensation expense, certain costs related to the acquisition in Chipidea, and the restructuring and write-downs discussed earlier, non-GAAP net income in the first quarter of fiscal 2009 was $1.5 million or $0.03 per diluted share, a slight improvement over the non-GAAP net income of $1.3 million or $0.03 per share in the prior quarter, and non-GAAP net income of $3.9 million or $0.08 per diluted share in the first quarter a year ago.

Now, turning to the balance sheet, our cash and short-term investments were approximately $16.2 million at the end of Q1, up approximately $2.2 million from the prior quarter in spite of spending approximately $1.3 million to fund restructuring efforts during the quarter. As previously discussed during July, we financed our Jefferies debt facility and repaid the principal balance of approximately $16 million.

In turn, we do now have [ph] approximately $16.2 million from our Silicon Valley Bank term and revolving debt facility. Ending debt was approximately $18.1 million including $2.5 million in debt associated with our analog business unit.

As previously discussed, we have restructured the company to achieve improved cash flow and a 25% target long-term pro forma operating margin. This restructuring is intended to lower our total quarterly spending by approximately $5 million from our Q4 '08 level. We stated that the positive financial impact of those changes would be realized over the first and second fiscal quarters. We had estimated in our 10K that MIPS will take a restructuring charge in a range of $6.5 million to $7.5 million over the course of the first and second quarters as a result of this reduction in force.

As John mentioned, we’re on track with the previous cost savings projection, but now have a slightly lower expectation of total restructuring charges, now estimated in the range of $6 million to $6.5 million. Our employee count was reduced by approximately 56 people during the quarter, and our cost of sales and operating costs were down approximately $3.9 million from the previous quarter on an apples-to-apples basis.

All of the domestic reductions were achieved and the international reductions are in progress with the vast majority of the notifications already given. Recall that the target 25% operating margin was based on a revenue level of approximately $28 million. So, even in these currently uncertain economic times, we do plan to be profitable and to generate cash.

I’m sure you can imagine how difficult predicting the future is in this business environment. While we did not see a lot of large deals fall out of Q1, we are clearly concerned over the business environment in general. And we have said many times, the licensing business is a fairly lumpy business.

On a positive note, we do have a large number of deals currently in play this quarter, especially on the processor licensing side of the business. Depending on how many of those deals are closed during the quarter, our results could vary significantly. Our baseline guidance relative to revenue will be conservative though, given these uncertain business conditions.

We project our Q2 '09 revenues to be in the same range as this quarter, plus or minus 5%, so approximately $25 million to $27.5 million. I’m more confident on the upside than on the downside though, as we have a number of deals in play that could enable us to exceed the top end of that guidance.

With that, I’d like to open up the call for any questions the listeners may have. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from Gary Mobley, sir you’re line is open.

Gary Mobley – Piper Jaffray & Co

Hi guys

John Bourgoin

Hi Gary.

Maury Austin

Hi Gary.

Gary Mobley – Piper Jaffray & Co

I’m assuming with revenue guidance of roughly $26.2 million for the December quarter, you’re going to – and also considering the restructuring plan at play that you may be close to achieving the 25% non-GAAP operating margin target. Maybe you can provide some additional guidance besides revenue and what your non-GAAP operating margin target might be for that quarter?

Maury Austin

I think we ended at – pro forma basis we did 13% this quarter with our target at 25. I would think the pro forma operating margin should be approximately 20%, plus or minus 1% or so.

Gary Mobley

Okay. And John, could you give us a more detailed update on what exactly is going on in the analog business group in terms of top level management in the poised direction of the business or just some additional color to give us some comfort that there might be some turnaround in this business?

John Bourgoin

Yes, sure. You might recall, Gary, that in July, we appointed John Derrick as COO in the company and John is responsible for the analog business as well as the processor business here. And in fact, he runs most of the things in the factory except the sales force. So, John’s been focused pretty heavily on the analog side of the world since roughly mid July, and has taken a lot of actions over there, has spent a lot of time with the team and we’ve collectively spent a lot of time with the sales force tuning up actually how we deal with and respond to that market trying to work through the way we do business in the organization to streamline it.

There’s some inefficiencies in how that business has been conducted interactively between our own sales guys and the people running the BUs, and we’re making quite a bit of progress towards streamlining that. I think I said in the call that we still feel very good about the fact that over the long run, we expect a lot of people to want to outsource analog as it can be expensive to do internally and we think most companies are still doing an awful lot of it internally, and we think our guys are pretty good at it.

So, we believe that over time, as we get our activities streamlined and the market settles in a little bit, and we settle into ourselves – settle into our own procedures a little better than we have that there should be some reasonable upside in that business. But that’s how we’re managing it right now.

The business unit managers are the same guys who were in place at the time of the merger, they’re all here. They’re all working hard and their teams are substantially intact as well. We have taken some people out of the organization. We took people out of parts of the organization frankly where the business wasn’t very strong. Yes, go ahead?

Gary Mobley

I’m sorry, if I can follow up with a question on that topic?

John Bourgoin

Sure.

Gary Mobley

Given the people, that you’ll be taking out of that analog business group and perhaps some of the business you might be turning away because of the profitability profile, what do you think towards the quarterly maximum revenue run rate would be for the ABG?

John Bourgoin

The quarterly maximum revenue – you mean based on the number of people we have today?

Gary Mobley

And the type of business you may be going after, what will be a normalized environment?

John Bourgoin

Well, I don’t know that it’s possible to predict that. It depends to a substantial extent on how much market share we can take from certain competitors. There are certain devices like USB for example where we have a lot of products that don’t require effectively very much of any work from the teams and HDMI. And if we book a lot of those deals and certainly there’s market share out there to go get, we have the potential for a lot of upside. Obviously, we have to be able to get in there and do that. There is a capacity limit in terms of products that require some degree of customization. And depending on which products you sell and how much customization is required, you can run into capacity limits that way. And in fact, I think we did have a little bit of that impact this last quarter. But, a lot of our upside really relates to how effective we are at selling things in the markets where we know there is a market and where we know the products are substantially the same as what we already have. So, I don’t think it’s easy to put a crystal clear upside on it.

Gary Mobley

Okay, thanks guys.

Operator

(Operator instructions) And the next question comes from Anthony Stoss, your line is open.

Anthony Stoss – Craig-Hallum

Hi guys, a couple of quick questions for you. I don’t know if I missed this, Maury, but can you give us a sense of where you expect operating expenses to shake up for this December quarter?

Maury Austin

No, you didn’t miss it, I didn’t give it. I think the best way to catch that is that we expect the pro forma operating margins to be about 20%. I’d expect operating expenses to be down maybe $0.5 million next quarter. I think that's more of a benefit of the reduction we took this quarter.

Anthony Stoss

Okay. Also, I guess along the same vein, can you give us a sense of CapEx, what it was in the quarter, what your plans might be for the foreseeable future in that regard?

Maury Austin

Approximately $500,000 during Q1, and I expect that to be about the same level throughout the year.

Anthony Stoss

Okay. Can you also just kind of give us a brief overview on the total number of licensees and how active the pipeline might be? Also give us an update on Microchip, Media Tek and your top customers et cetera, et cetera?

John Bourgoin

Yes, sure Tony. We had eight processor deals last quarter. I think we had in the neighborhood of 16 analog deals. Microchip is rolling forward. They seem to be reasonably confident and happy with the activity around the 32 bit stuff. So, I guess we’re optimistic that that’s going to turn into a sizeable business over time. So, Broadcom of course is our largest customer; they’re doing quite well. They had a good quarter and of course they just bought ATI, or a portion of the ATI business from AMD. So I think they’re going to be strong moving forward. So, we feel pretty good about them. So do you have any questions, any more specific questions on these licensees?

Anthony Stoss

No, I guess that pretty well covers it. If you wouldn’t mind commenting, what do you think the biggest challenge is to getting Chipidea back on track, is it personnel, is it the market, is it the strategy?

John Bourgoin

Well, I think if you look at the calendar year of ’08 and compare it with calendar year of ’07, we’re actually pretty close to the same. We’ve done well. Now, we didn’t have a good quarter this last quarter, but it’s right smack in the middle of a very difficult period, both for the team and of course Europe is quieter in general in the August quarter anyway, the August-September quarter. But yes, one of the keys to us from an operational perspective is smoothing out a lot of the sales and business units relationships.

But when you’re doing analog, there’s pavements [ph] of work that can get fairly lengthy and our ability to establish roles both on our sales side and on the business unit side, make sure everybody what their role is and establish practices and procedures where that everybody understands and knows really well, so you reduce the amount of internal negotiation and debate will really help streamline things and that will help give us a lot more time to do what we want to do which is sell and create products.

But we’re moving down that path and we’ve made some changes in the way we do the operation including a little more focus with what we call inside sales to help us with some of the smaller deals that we re more effective at dealing with those and it is helping us follow up on a broader range of leads, and I think all those things will help. None of that stuff is instantaneous, but over a period of a couple of quarters, it makes a lot of difference.

Anthony Stoss

Lastly, I think you guys have mentioned that part of the Chipidea business is going well and maybe more than half is not. Can you give us a sense of what products might be doing well and which areas are not doing well and you may need focus?

John Bourgoin

Well, we haven’t talked specifically about which areas are doing more well or less well, and I don’t want to get into that here, but it’s a pretty broad product line and there’s some important standards. I think you can assume that USB and HDMI are doing quite well and we’re looking forward to very good growth over time there, and we have some other businesses that are doing well also.

Anthony Stoss

Okay, great thanks.

John Bourgoin

Okay.

Operator

(Operator instructions) And I show no further questions at this time.

John Bourgoin

Okay. Well, thanks everybody for listening to the call and if you do have questions later on, feel free to call Maury and me, and we’ll try to answer to the best of our abilities. So, thanks very much.

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