Exar Corporation F3Q09 (Qtr End 12/28/08) Earnings Call Transcript

Feb. 9.09 | About: Exar Corporation (EXAR)

Exar Corporation (NYSE:EXAR)

F3Q09 Earnings Call

January 29, 2009 4:30 pm ET

Executives

Pedro Rodriguez – President and Chief Executive Officer

Scott Kamsler - Senior Vice President and Chief Financial Officer

Thomas Melendrez – Executive Vice President, Secretary and General Counsel

Analysts

Blake Harper – Signal Hill

Elliot Glazer – Du Pasquier & Company

Vernon Essi – Needham and Company

Operator

Welcome to the Exar Corporation 2009 third quarter results conference call. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the call over to your host, Mr. Thomas Melendrez.

Thomas Melendrez

Thank you for joining us for our fiscal 2009 third quarter investor conference call. Scott Kamsler, Senior Vice President and CFO, will begin the call with a financial overview of the quarter and a discussion of the fiscal 2009 Q4 outlook. Pete Rodriguez, our President and CEO, will then provide more details regarding the business. Following these presentation, the conference call will be open for questions.

Before we begin I would like to remind you that the company provides its investors, financial analysts, and the general public with a business and financial update each quarter in its results news release and conference call. Please note that our fiscal 2009 third quarter results release was disseminated today after market close and can be viewed on our website.

Exar will not provide any further updates on its performance during the quarter unless it does so in a news release or other manner that’s compliant with Reg FD and Reg G as the case may be and other applicable laws. The company’s guidance and remarks are based on current information and expectations as of today, January 29, 2009. The company undertakes no duty to update such statements.

The company reports its results in accordance with GAAP. However, for the periods presented today, we are disclosing various non-GAAP measures. The company uses these non-GAAP measures to evaluate the company's operating performance, and the measures are used for planning and forecasting of our future periods. The company believes non-GAAP measures are useful to the performance of financial analysis. The reconciliation from non-GAAP to GAAP financials for the most recent or prior period or event that maybe discussed today can be found in the company's applicable SEC filings.

I also need to inform you that during the course of this conference call we will be making forward-looking statements that involve a number of risks, uncertainties, and are not guarantees of future performance. Please review the Safe Harbor statement contained in today’s press release as well as the other risks detailed from time to time in the Company's SEC filings. Listeners are encouraged to review these documents.

I will now turn the discussion over to Scott Kamsler.

Scott Kamsler

Net sales for the December 2008 quarter were $26.3 million compared to our updated guidance for the quarter of $25.5 to $27 million and compared to $32.7 million for the September 2008 quarter. I will now summarize the revenue by market, region, channel, and customer for the December 2008 quarter compared to the September 2008 quarter.

Communication sales decreased to $6.2 million from $8.4 million and accounted for 24% of revenue versus 26% of revenue. Interface sales decreased to $14.1 million from $18 million and accounted for 53% of revenue versus 55% of revenue. Power sales decreased to $6.1 million from $6.4 million and accounted for 23% of revenue versus 19% of revenue.

By region, sales as a percentage of net revenue for the December quarter compared to the September quarter were 26% in both quarter in North America, 24% versus 20% in Europe, and 50% versus 54% in Asia. Sales through distributor revenue as a percentage of sales were 61% for the December quarter compared to 58% for the September quarter. Revenue for the same periods for Future Electronics, our largest distributor, was 35% versus 34%. Our largest customers during the December quarter were Alcatel-Lucent, Samsung, and Nokia-Siemens, although no end customer accounted for more than 10% of net sales.

Non-GAAP gross margin for the December for December quarter decreased to 45.3% from 49.3% from the September quarter primarily due to a mix shift in revenue and to an increase in excess and obsolete reserves. The mix shift in revenue resulted principally from the larger decline in sales of our higher margin communication and UR products compared to the decrease in sales of our lower margin serial transceiver and power products.

Non-GAAP operating expenses decreased to $14.8 million for the December quarter from $16.5 million in the September quarter largely due to lower compensation, benefits, payroll taxes, commissions, and legal expenses as we continue to focus on lowering expenses. Furthermore, in January, we reduced our headcount to 368 from 392 at the end of December.

On a non-GAAP basis, the net loss for the December quarter was approximately $800,000 or a net loss of $0.02 per share, compared to net income for the September quarter of $1.9 million or $0.04 diluted earnings per share. On a GAAP basis which is fully detailed in our press release, the net loss for the December quarter was $63.8 million or a net loss per share of $1.49, compared to a net loss for the September quarter of $2.2 million, or a net loss per share of $0.05. Our GAAP results for the December quarter included estimated non-cash charges of $60.9 million related to the full impairment of goodwill, partial impairment of intangible assets, and to the acceleration of depreciation due to abandonment of equipment.

I will now provide some balance sheet comments. We ended the December quarter with $257.5 million or $6 per share in cash and marketable securities, and our tangible net book value was $6.71 per share. During the December quarter, we used $3.3 million of cash in our operations primarily due to the cycle time required to adjust inventory levels to the drop off in sales. We used $500,000 to buy back 88,000 shares of our stock and received $500,000 in proceeds from option exercises to purchase 83,000 shares.

The December quarter end days sales outstanding decreased to 26 days from 35 days at the end of September, due to the sharp drop off in shipments during the month of December. Days of inventory days at the end of December increased to 132 from 84 as the inventory grew due to lower shipments and to the pre-build of inventory in preparation for a supplier’s 45-day plant shutdown during the March quarter.

CapEx for the December quarter was $3.2 million and included $2.6 million for EDA tools which were licensed during the quarter. This compares to CapEx of $400,000 in the September quarter. Depreciation increased to $3 million in the December quarter from $1.8 million in the September quarter primarily due to a $1.2 million acceleration in depreciation on abandonment of equipment. We ended December with 42.9 million shares outstanding and $11.8 million remaining under our authorized buyback program.

I will now provide our March 2009 quarter guidance. We expect net sales to be between $21 million and $23 million due to continued weakness in the global economy. Our gross margin on a non-GAAP basis is expected to decrease to between 43% and 45% due in large part to lower production levels. Non-GAAP operating expenses are expected to be between $14.6 million and $15.1 million as higher first quarter employer taxes should be largely offset by the impact of our January headcount reduction.

Lastly, as we said on our conference call last quarter, while there is considerable uncertainty in both the overall economy and the semiconductor industry, Exar is well positioned from a financial standpoint not only to weather the current downturn but also to support future growth with $257.5 in cash and marketable securities and over $200 million in federal NOLs available to lower taxes and improve net income.

I will now turn the call over to Pete.

Pedro Rodriguez

We just completed a very difficult quarter as macroeconomic conditions deteriorated significantly. Our distributors sold from their inventors, and end-customer orders declined. Operationally, however, we continue to make strong progress across all areas of the company with a special focus on expense reduction and improvement in our ability to introduce new products that will fuel future growth. I am especially pleased with our first digital power design win that suggests the beginning of what we believe will be a very exciting product line. Let me briefly elaborate on these efforts, and then I will discuss our quarterly results followed by our views on the current period.

This quarter, we continued reducing our expenses dropping approximately 10% sequentially on a non-GAAP basis. Through our ongoing focus on operating efficiency, we have reduced non-GAAP OpEx by approximately $21 million on an annualized basis in the past 21 months. Moreover, if the macroeconomic situation warrants, we will have to cut further. Other operational efforts this past quarter included an improvement in our on-time deliveries to 98% from 97% in the previous quarter and a continued strengthening of our leadership team as we added an industry veteran to run our communications and storage marketing group.

We also signed Mouser Electronics, a leading global online and catalog distributor of electronics, completing our already strong sales channel. We expect Mouser’s focus on the design engineering community to accelerate the evaluation and adoption of Exar’s products. I’m excited to announce that we won our initial design win with the soon to be introduced first member of our digital power product family. This product provides a cost-effective integrated solution for power management in systems like set-top boxes, media servers, storage systems, and other consumer and industrial applications. Initial customer engagements are encouraging, and we expect to see additional early adopters later this year.

In other product news, we expanded our storage product line with the introduction of the XRS 10L620 which is a PCI to SATA host controller. This product is targeted at a wide variety of data storage environments including data management systems for consumer, industrial, and small to medium business enterprise applications. These markets represent a rapidly growing market for consumer storage expansion that makes up roughly $150 million worth of semiconductor sales in 2008. Initial customer trials are underway, and we are expecting to see production orders before June of this calendar year.

The digital power win and the PCI to SATA host controller release are just two examples of our enhanced focus on new product design. Despite significant cost reduction efforts, we remain on track to release 30 new products this calendar year, which is twice as many as Exar has ever released in a single year.

Now, let’s go to the financial results for the quarter just completed. Quarter on quarter revenue was down 20% which is right in the middle of the range provided in our updated guidance in December. While I’m not pleased at all with the financial results, our performance reflects the reality that the semiconductor industry is not immune to the effect of the economic downturn, and our results are similar in magnitude to other semiconductor companies for the same period.

Our gross margins excluding the 2% E&O charge were right in the middle of the initial guidance provided at the last analysts’ call despite the margin pressure experienced during this economic downturn. As we look to this quarter and the next several quarters, one this is certain. The global economic slowdown in continuing; however, we have been preparing for this downturn for some time with extreme operational focus. We have the execution engine coupled with a strong balance sheet to increase our competitive distance as the economy recovers. We fully expect to emerge stronger from this downturn. Ultimately our distributors’ inventories will draw down and orders will resume. Determining demand levels still remains extremely challenging. We will, therefore, continue to take a conservative view until the market conditions suggest otherwise, and this is reflected in our go-forward guidance.

That is the end of our prepared remarks. We will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Elliot Glazer of Du Pasquier.

Elliot Glazer – Du Pasquier & Company

Pete and the rest of the management team, I want to compliment on running a professional outfit in these very difficult times. It’s not easy to maintain your equilibrium when things are just happening around you. This new power management for set-top boxes and servers, if your expectations were met, what kind of annual contribution could this be running 2 years from now? Could it be $10 million in sales? Could it be $20 million in sales? What’s your best estimate?

Pedro Rodriguez

First of all, thank you for the kind words. We have taken running an efficient operation very seriously from day one, and we just accelerated some of the plans that we had in place in light of this significant downturn. At the Needham Conference earlier in the month, 70-80% of the people that visited us said you guys are doing great. No, it’s not. We’re sucking wind. I take no pleasure in that we are doing better than some of the other guys out there. It’s still really tough. Now, to answer your question, this digital product family, as I’ve been presenting it at all the conferences and in chats with investors, is our venture capital bet. We’re investing significant R&D, and our hope is that 4 to 5 years down the road, this is $100 million business. I have been semi-joking with investors and analysts that it would either be $100 million or zero. Well, we now know it’s not going to be zero. This is a significant first win. It’s not a major player, and it will be real revenue, and it’s fully a year ahead of when we expected revenue for this product family. I don’t want to overstate it, and I don’t want to give you specific numbers, but I would say that a couple of years out, we would not be really happy it was less than $20 million in revenue.

Elliot Glazer – Du Pasquier & Company

Let’s says it’s five years from now. The entire family of new digital products, would that be $100 for the entire family?

Pedro Rodriguez

Yes.

Elliot Glazer – Du Pasquier & Company

You’re running like $26 million a quarter in sales, call it $100 million a year. What kind of annual revenues do you need on a GAAP basis excluding the kind of asset impairments that you were just forced to take? What kind of revenues do you need on a GAAP basis annually to break even? Instead of 100, would it be 125? Would it be 150? What do you require to have no operating pre-tax loss?

Scott Kamsler

One thing is while we do report GAAP results because we have to for SEC purposes, our focus is really on non-GAAP, and the guidance we gave is $14.6 to $15.1 million, and we mentioned we had an expense headcount reduction that took place in January, so when that gets fully implanted, we should be on the low end of that range, which is about $14.5, but our volume is currently substantially below what it has been, but if you project out and assuming we get through the downturn in the economy and the revenue gets up significantly towards the $30 million range, at 50% margin on $14.5 million in expenses, that puts us at break even of around $29 million. If the margin is a little bit less than that, that gets us to $30 or a little bit more. That kind of gives you the range on a non-GAAP basis.

Pedro Rodriguez

Let me answer the question a little more specifically. I would say that $120 million without any crazy one-off stock-based compensation gets us very close. We were running the previous two quarters at an average of about $33 a quarter. The previous quarter to that, we would have hit $33 if we hadn’t had supply chain issues, which are now over, so for three quarters, our business could have shipped around $33 million a quarter. This downturn hit us 20% last quarter. It’s going to hit us some more this quarter. We expect as the economy comes out of this, sometime hopefully in the near future, to recover to those levels of business.

Scott Kamsler

That’s a professional answer. Unfortunately, I’ve been an analyst for 41 years, and I do not expect as everyone says on television that the economy will recover during the second half of the year. I think we are looking two years down the road for this banking and financial crisis to end. I hope I’m wrong. You’re running about $8 million a quarter in R&D. Now you have the luxury of all that cash, and frankly that gives you a competitive advantage, but if I’m right on the economy, you’re see competitors fall by wayside in the next two years. So my question is do you have any plans to change the $8 million a quarter in R&D either higher or lower?

Pedro Rodriguez

We’ve trimmed back some R&D costs without impacting our ability to deliver winning products. If the economy deteriorated further and we got to the point where we were burning cash on a quarterly basis, which we haven’t got to that point and we keep fortunately lowering the bar with our prudent cost measures, then we would have to have very serious discussion. My personal opinion and this is not a board-approved opinion is that if it was one quarter where we burned a little bit of cash, I would prefer not to start cutting into bone and flesh in our R&D. If it was going to be an extended period, then we would have to do it, and probably the way we would do it is by looking at a product line versus ready peanut butter.

Pedro Rodriguez

Once again, that’s a professional answer. That completes my questions, but I would like to make a comment. Again, I’ve been an analyst for 41 years, and this is the worst environment I’ve ever seen, I’ve ever read about, I’ve ever studied. My suggestion is that you stop listening to those hedge funds and analysts putting pressure on you to buy back the stock and you simply prepare for survival. If it’s going to take 5 years to get the new product line up to $100 million, then take the 5 years, but the point is if you throw away the money buying back the stock, it’s going to lower the competitive advantage you have, and that’s my advice going forward. Don’t buy back the stock, develop the new products, develop the marketing, and try to revive the business three to five years down the road. Thank you very much for listening.

Operator

Your next question comes from the line from Blake Harper from Signal Hill.

Blake Harper – Signal Hill

I was wondering if you could talk about how your booking trended through the quarter. I was seeing some different things. For some people, September and October were fine, and then most of the problem came in November and December, and different either up or down in January or stabilized at least a little bit, but if you could maybe talk about how they trended throughout the quarter, that would be helpful.

Pedro Rodriguez

For us it’s a little bit tougher because so much of our business is done through sell-through distribution. It’s not like we’re selling a high-end microprocessor to 20 customers or something like that where your bookings and your book to bill is an accurate number that you want to track carefully. Having said that, clearly bookings were softer in the latter half of the quarter, and bookings are softer than we would like, but we’ve gone through the same process that up until last quarter had given us successful forecasting, and we’ve taken the lessons from last quarter and incorporated that, and we’ll see where we end up this quarter, but what we guided we believe is conservative, and we believe it’s our best view as of today.

Blake Harper – Signal Hill

As far as your lead times or any issues with your customers, has anything like that changed in this environment as far as what your customers are asking from you or how you’re approaching your relationships with them?

Pedro Rodriguez

No, not really. I mean what has happened is in certain situations we’ve tightened credit to assembly houses and other places and smaller regional reps. We’ve tightened credit we don’t know if they’re really able to pay. In some cases, we’ve taken reserves where we haven’t taken the revenue until we feel comfortable that they’re going to be able to ship it and then pay us, but those are small numbers. They haven’t been huge numbers relative to our revenue.

Operator

Your next question comes from the line from Vernon Essi from Needham and Company.

Vernon Essi – Needham and Company

I missed some of the prepared comments, but I was wondering regarding guidance, and I don’t want to read too much into this because you’re a relatively smaller company than some of the other larger analog guys that have put up their numbers, but the guidance on a sequential basis is a lot better than some, like Maxim just put out a down 25% for instance. Not that I want you to comment on that, but what do you see different in the environment that gives you more confidence in the sort of higher teens number than something a little more drastic.

Pedro Rodriguez

You know that we’re not a purely analog shop, right? Quite a bit of our business is com, and with the exception of one order, the push from last quarter to this quarter, our com number had held up pretty strongly last quarter, and so we think that helps keep the boat up a little bit. We also have a real broad base of business, and when I first got here, that was like, man, we have too many products. In this market, that’s helping us a bit, and a lot of those are industrial customers. We don’t have automotive business. We don’t have that much consumer business, so I think all of those are helping out, and again we could be dead wrong. It’s just that we’ve gone through a careful process as we have every quarter with some of the lessons learned from last quarter. We’ve talked with all our distributors, and this is the guidance we’ve come up with.

Vernon Essi – Needham and Company

I don’t know if you discussed turns specifically, but do you feel you need a reasonable degree of turns or is it at the level you have to meet the March number there that you’ve given.

Pedro Rodriguez

Clearly we need some turns to hit that number. I don’t think it’s more than any other quarter percentage-wise of the number we’re trying to hit. It might even be a little less.

Vernon Essi – Needham and Company

Your longer term gross margin target, I believe, is 60%. I was just wondering if you could outline anything that’s developed in this quarter that might change that. Obviously, this new product is going to help, but are we to assume that’s going to occur over more of the layering of newer products or a function of structural changes behind the scenes or maybe a combination of both. Can you go into that a little bit?

Pedro Rodriguez

I would say a combination of both. If you look at it, most of our new products are designed in the 50-60% gross margin target ranges. We’re also defocusing a lot of the products that are lower margin. We’ll keep selling them, but we’re not reinvesting in those. For example, serial is one of our lower margin areas. We’re investing on the high analog content serial which is a much higher margin product, and not continuing to invest on the low analog content, which is more of a commodity. Power is similar to that, and we’re also getting better at how to do operations for these lower cost products.

Operator

That does end the Q&A session. We’ll turn the call back over for closing remarks.

Thomas Melendrez

A replay of this call will be available today after 5 PM Pacific Daylight Time until 11:59 PM Pacific Daylight Time on February 5, 2009. Thank you for joining us today. Your continuing interest and support is very much appreciated. We look forward to communicating with your again in April 2009 to review our FY’09 fourth quarter and year end results. The company plans on attending the March ’09 B. Riley and the May ’09 Cowen Conferences and look forward to meeting with you at that time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!