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Executives

Kevin D. Trosian - Vice President of Business Development and Investor Relations

Raouf Y. Halim - Chief Executive Officer and Director

Stephen N. Ananias - Chief Financial Officer and Senior Vice President

Analysts

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

Elizabeth Howell

Mindspeed Technologies (MSPD) Q2 2013 Earnings Call April 30, 2013 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Mindspeed Q2 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Kevin Trosian, Vice President, Corporate Development and Investor Relations. Please go ahead.

Kevin D. Trosian

Thank you, and good afternoon to all of you who have joined us for today's call to discuss Mindspeed's fiscal second quarter of 2013 financial results. Our press release issued this afternoon detailing these results may be accessed in the Investors section of our website at www.mindspeed.com.

Today, our CEO, Raouf Halim, will describe some key milestones for the business, our progress in the wireless small cell market and the strategic focus of the company going forward. Following Mr. Halim, Stephen Ananias, our CFO, will review fiscal second quarter 2013 financial results and provide financial guidance for our fiscal third quarter of 2013.

Before we begin, I want to remind you that our comments today will include forward-looking statements within the meaning of Federal Securities laws. Forward-looking statements include, among others, statements regarding our expectations, goals or intentions, including, but not limited to, our current assessment of the demand environment and trends in our target markets, including the anticipated environment and trends in fiscal 2013, our assessment of growth opportunities in specific product markets, such as 4G/LTE and the small cell wireless market generally, and our current expectations for fiscal third quarter net product revenue, non-GAAP gross margin, non-GAAP operating expenses, non-GAAP other income and expense and the provision for income taxes and weighted average diluted shares outstanding.

These forward-looking statements are based on management's current expectations, estimates, forecasts and projections and are subject to risks and uncertainties that could cause actual results and events to differ materially from those stated in the forward-looking statements.

Our businesses is, and any financial projections provided today, are subject to numerous risks and uncertainties, including our ability to grow and maintain our revenues from various product markets, our ability to manage operating expenses, the impact of any failure to realize anticipated revenue growth or operating expense savings, fluctuations in our operating results and the potential for future operating losses and negative cash flows, loss of or diminished demand from one or more key customers or distributors, our ability to successfully develop and introduce new products, pricing pressures and the potential for intellectual property and other litigation.

In addition, the financial statements released as part of our press release and earnings conference call are preliminary and include an estimated goodwill and asset impairment charge of approximately $33.5 million relating to our wireless infrastructure reporting unit. These estimates constitutes forward-looking statements under applicable securities laws. We have not completed testing related to these impairment charges and they are subject to change.

The final impairment charges reported in our Form 10-Q for the fiscal second quarter of 2013 could differ materially from the preliminary estimate that we announce today. Any increase in the amount of the impairment charge would have the effect of increasing our net loss for the fiscal second quarter of 2013.

Additional risks and uncertainties that could cause our actual results to differ from those set forth in any forward-looking statements are discussed in more detail under the caption Risk Factors in our annual report on Form 10-K for the fiscal year ended September 28, 2012, and our quarterly report on Form 10-Q for the fiscal first quarter of 2013. They will also be included in our soon-to-be-filed quarterly report on Form 10-Q for the fiscal second quarter of 2013 and in our future filings with the SEC.

Forward-looking statements made during this call are made only as of the date hereof and the company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.

During our call today, we will be making reference to non-GAAP financial measures, which exclude our preliminary estimates of impairment charges as well as stock-based compensation expense and related payroll costs, restructuring charges, non-recurring legal and settlement costs and amortization of acquired intangible assets, among other items.

For a reconciliation of non-GAAP to GAAP financial measures, please refer to the Investors section of our website at www.mindspeed.com and our earnings press release and our Form 8-K furnished to the SEC today. We do not provide a reconciliation of the forward-looking non-GAAP measures to GAAP measures because of our inability to project restructuring charges, employee separation costs and stock-based compensation-related expenses.

With that, I will now turn the call over to Raouf Halim, our Chief Executive Officer. Raouf?

Raouf Y. Halim

Thank you, Kevin. Good afternoon, everyone. Let me start by saying that like many of you, I was disappointed with our performance this past quarter, which was driven primarily by weakness in the 3G wireless markets. That said, our product lines for high-performance analog and communications processors performed consistently with our expectations and 4G/LTE met our goal of doubling in the quarter.

To provide a quick overview of our performance in the quarter, Q2 product revenue was $35.4 million, down 8% sequentially versus the prior quarter's product revenue. Further, we posted a modest non-GAAP operating loss of appropriately $541,000, versus a $1.4 million non-GAAP profit the prior quarter after excluding the positive benefits of the $6 million noncore IP sale.

On the call today, I will provide an overview of the performance of our 3 product lines during the quarter, and I'll touch a bit on our announcement that we are working with Morgan Stanley.

Starting with HPA. HPA accounted for 44% of our revenues in Q2, down sequentially after a rapid pace of growth in the last 4 quarters, as we had anticipated. Overall strength was driven by a number of new products, which we demonstrated at both the National Association of Broadcasters conference, or NAB, as well as the Optical Fiber Conference, or OFC.

At NAB, we were showcasing our 3-gigabit, 6-gigabit and 12-gigabit products, which we believe are at the forefront of the industry's shift to 4K ultra high-definition TV.

At OFC, our new products received a lot of customer interest, including our low-power 28 gigabit per second CDRs, which enable high-density networking within data centers, our broad Crosspoint Switch product line, as well as our broad PMD portfolio for fiber-to-the-home deployments worldwide.

At the broadcast video segment, we continue to record share gains, where we lead the industry with state-of-the-art Crosspoint Switches and SDI Components. We expect the 4K ultra high-definition TV to drive an infrastructure upgrade cycle, which supports this new truly incredible viewing experience.

Mindspeed is leading the interface and switching upgrade with this inflection point by offering highly integrated, low-power 4K SDI and Crosspoint silica.

Another factor driving our success in HPA is our broad portfolio of PMDs targeting FTTx infrastructure worldwide. We continue to see strong on-demand, primarily from Asia and see significant traction for our next-generation devices, targeting GPON, GEPON, XG-PON and 10G-EPON.

Lastly, the HPA team is making significant strides in the 100-gig space, with traction at multiple tier-1 customers. Enterprise networking companies require density improvements for 100-gig networking relative to current form factors. Mindspeed's portfolio of CDRs and PMDs enables this improved density by offering the industry's lowest power consumption.

We believe we are very well positioned with our high-performance analog products and look forward to keeping you updated on our continued progress in growing revenue and market share within HPA.

Moving on to our communications processors. Revenue represented 49% of our Q2 revenues and reached $17 million in our fiscal second quarter, up 17% sequentially. We continue to focus on increasing market share in our core service provider provision, broadband home router, or BHR, market with a number of new initiatives, including a focus on consumer NAS, Deep Packet Inspection, as well as mobile broadband routers. We believe we can leverage our on-base processor platform into adjacent markets with low incremental R&D expense, providing earnings leverage to our model in FY 2014.

In the quarter, we closed 5 key design wins, including tier 1 wins in Japan and Europe.

And finally, let me update you on our wireless infrastructure business, which accounted for $2.6 million or 7% of Q2 revenues. We expect that the seasonal slowdown in 3G will be largely offset by some new 3G rollouts. We had originally expected these orders to turn on late in the quarter as they typically do post the lunar New Year in Asia. Late in the quarter, however, we determined these anticipated ramps were pushing out, due to operator delays in deployments. That said, the overall small cell market has appeared to push out, which I will discuss momentarily.

Turning to the 4G/LTE market, we are pleased that we met our target for 4G/LTE rollouts, which doubled versus last quarter to approximately $1 million in our fiscal Q2. We expect the 4G/LTE small cell market to be a long-term grower, though it may be lumpy as new deployments layer on. We expect rollouts in both Japan and the U.S. to follow the existing rollouts occurring in Korea at the moment, although these deployments are rolling at a slower pace than we had originally anticipated.

From numerous recent meetings with carriers, as well as third-party research, we believe operators are committed to small cells. And although there are some delays, carriers are expecting to continue with their deployment plans. Further, while we have provided forecasts in the past on specific rollouts and the expected size of these rollouts, we're not going to comment on the magnitude and specific timing at this time.

We remain focused on the small cell wireless market, which we believe has a number of growth opportunities which we are well positioned to capitalize on. Although at the same time, we forecast this revenue stream will be lumpy in the early stages of deployments.

First, as published by a number of third-party research firms, we hold the #1 position for small cell SoCs, and we will continue to focus on maintaining this market share position and our technology and design win lead against our competitors.

Second, we are seeing a number of opportunities for rollouts in TD-SCDMA in China, where we ship the only chip in commercial deployment at this time and have a core position with leading operators, such as China Mobile.

Following our strong product showcase at Mobile World Congress, we have strong interest from customers to further evaluate and engage with our dual-mode 3G WCDMA plus LTE Transcede-based solutions. We are also surprised with strong interest in LTE advanced features, such as carrier aggregation. We are engaged with tier-1 OEM and service providers for Transcede-based evaluation of our carrier-grade solution, consisting of our award-winning SoC and internally developed advanced physical layer software, as well as robust integration with partners' commercial stacks.

Continued advanced features and real carrier deployments of our small cell solutions are positioning us well for continued deployments in Korea and follow-on deployments in Japan and in the U.S. Continued hardening of our carrier-grade software and significant improvements to our solution are putting more space between us and our competitors and maintaining or improving our market share.

Turning to our small cell wireless outlook for the rest of 2013. We are focused on guidance for the current quarter and will not be providing a forecast for the full year for wireless nor quarterly revenue forecast for each of our product lines. However, it's fair to say that our wireless revenues will not quite reach the level of our prior forecast of roughly $25 million in this fiscal year.

That said, we still believe the small cell market offers a great growth opportunity for us, and we want to make sure the investment community understands our key differentiators and in particular, why Mindspeed remains the leader in the small cell SoC market.

First, the market has become standardized on the system-on-a-chip approach versus discrete processors and FPGAs. Additionally, Mindspeed owns the industry's broadest range of wireless radio air interface standards and can therefore market in any region across the globe.

And finally, we have carrier-proven technology for typically risk-averse service providers, enabling a smoother testing cycle and faster deployment for our OEM customers. These, amongst many other factors, have given us the market-leading position for system-on-a-chip solutions in the growing small cell markets.

Finally, you probably saw that we issued a second press release today. We announced that we are working with Morgan Stanley to explore strategic alternatives. In the context of changing industry conditions, our financial profile, as well as approaches by third parties, we believe it is prudent to evaluate our alternatives thoroughly. Obvious, we'll keep you updated if there are material developments that come out of the process. That's all we're going to say on the subject on today's call.

With that, I'd now like to turn the call over to Stephen, to provide more detail on last quarter's financials and our fiscal Q3 guidance. Stephen?

Stephen N. Ananias

Thank you, Raouf. I will now review the financial results for our fiscal second quarter of 2013 and provide the financial outlook for our fiscal third quarter.

First, let's discuss our Q2 results. Total revenue for the fiscal second quarter was $35.4 million. Product revenue from the high-performance analog business represented 44% of total revenue and recorded $15.7 million, down 18% compared to the prior quarter.

Product revenue from the communications processors business represented 49% of total revenue and recorded $17.1 million, up 17% compared to the prior quarter. Product revenue from the wireless infrastructure business represented the remaining 7% of total revenue and recorded $2.6 million, down 44% versus the prior quarter.

Product revenue for the fiscal second quarter was split by geographic region as follows: Asia Pacific at 72%, Americas at 19% and Europe at 9%. China specifically represented 33% of total fiscal second quarter product revenue. No end customer represented product revenues of 10% or greater in the fiscal second quarter.

Now turning to gross margin. Non-GAAP gross profit was $21.5 million or 60.7% of product revenue, consistent with our expectation of between 60% and 61%. This was down 80 basis points versus our prior fiscal quarter on a non-GAAP basis, after excluding the positive benefit of the $6 million noncore IP sale in the prior quarter. Margins declined compared to the prior quarter, principally due to product mix.

Total non-GAAP operating expenses were $22 million, consistent with our original guidance to reduce operating expenses to the level prior to the Picochip acquisition. Non-GAAP operating expenses were comprised of research and development expenses of $14.9 million and selling, general and administrative expenses of $7.1 million. The resulting non-GAAP operating loss for the fiscal second quarter was approximately $541,000.

Now finishing the income statement for the fiscal second quarter. Non-GAAP other income and expenses totaled a net expense of approximately $283,000, composed primarily of net interest expense, partially offset by a reimbursable foreign research and development credit. The provision for income taxes was $154,000. Non-GAAP net loss for the fiscal second quarter was approximately $978,000, resulting in a non-GAAP loss per share of $0.02.

Turning now to the balance sheet for the fiscal second quarter. Cash and cash equivalent were $46.6 million at the end of the fiscal second quarter of 2013, down $4.6 million versus the prior quarter. Accounts receivable at the end of the quarter were $19.3 million, resulting in net days sales outstanding of 48 days, up from 38 days in the prior quarter. Inventories at the end of the quarter were $11 million, resulting in non-GAAP inventory turns of 5.1 versus 6.4 turns in the prior quarter.

As we first discussed during our fiscal Q3 2012 earnings call, we committed to return our non-GAAP operating expenses back to the pre-Picochip acquisition level of $22 million per quarter. We have achieved this goal and expect to modestly lower operating expenses in the fiscal third quarter of 2013. Further, we expect to narrow our cash burn in this current fiscal quarter.

As you likely saw in our press release and as we mentioned at the beginning of the call, the GAAP financial results we presented today are preliminary, based on an estimated goodwill and asset impairment charge. We will be writing down the value of goodwill, definite-lived intangibles and indefinite-lived intangibles in the fiscal second quarter associated with the wireless infrastructure reporting unit.

This lower-than-expected deployment of 3G small cell base stations triggered an impairment evaluation. We are currently estimating the goodwill and asset impairment charge to be approximately $33.5 million. We will be finalizing our work on the goodwill and asset impairment analysis between now and the filing of our Form 10-Q. The final goodwill and asset impairment charge could vary materially from our current estimates. Changes in the goodwill and asset impairment charges will result in corresponding changes in the GAAP net loss for the fiscal second quarter.

Revenue, non-GAAP metrics, including the non-GAAP results we disclosed in our earnings release and financial tables, and our cash and cash equivalent balance will not change as the result of any change in the company's current estimate of goodwill and asset impairment charges.

Further, I have an update on the earnout and net asset adjustment related to the Picochip acquisition. On April 26, 2013, we entered into a settlement agreement with the representative of the Picochip shareholders, closing out all outstanding obligations under the acquisition agreement. This included escrow claims, earnout payments and the net asset adjustment on the purchase price.

As part of this settlement, Mindspeed will receive net payment of approximately $1 million in cash and was released of approximately $5.4 million in amounts payable to the Picochip shareholders. We will record this $6.4 million settlement to GAAP other income in the fiscal third quarter.

Had this settlement occurred within 12 months from the date of the Picochip acquisition, the $6.4 million would have resulted in a reduction of goodwill and reduced the estimated impairment charge in the fiscal second quarter.

Now I would like to provide our outlook for the fiscal third quarter of 2013. Given the recent market volatility, we anticipate Q3 product revenue will be approximately flat compared to fiscal Q2. We expect non-GAAP gross margin to be approximately 60% and non-GAAP operating expenses to be approximately $21.5 million.

Finally, we expect non-GAAP other income and expense and the provision for income taxes to be approximately $1.1 million and weighted average shares outstanding to range between 40.4 million and 40.9 million shares.

Operator, we are now ready to open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Kevin Cassidy with Stifel Nicholas.

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

This is Dean Grumlose calling in for Kevin. I was wondering if you could characterize the pushouts of the small cell deployments a little bit more. Are these related to CapEx decisions by carriers? Or is it related to the status of field trials? Or what can we learn about when this ramp may continue?

Raouf Y. Halim

Yes. Dean, this is Raouf. I would say that the pushouts of small cell deployments are primarily associated with the technical implications and some of the interactions between small cells and macro cells. As you know, there are a lot of standards that are developing in this areas, such as heterogeneous networks or HetNet, a lot of interference mitigation implementations and standards are developing. And I think there's a tremendous amount of real-world learning that carriers are going through right now as they finalize their exact deployments of small cells and as they figure out how to make them coexistent and success from the presence of existing macro cell-based networks. So it doesn't really have much to do with CapEx. It has a lot to do with learnings from field trials and how those are getting incorporated into the base technology. We're very pleased in fact to be in the forefront of these deployments. As you may know, we're deploying 4G/LTE small cells in Korea and we are learning alongside our customers and carriers, such as SK Telecom and Korea Telecom. These are very valuable learnings. And as I commented in my prepared script earlier, we are certainly benefiting from that learning experience and hardening our software implementation and achieving interop with a variety of user equipment, or UEs, and also bringing out these coexistence issues that I mentioned. So again, it doesn't have anything to do with CapEx. It has a lot more to do with the learning cycles from field trials.

Operator

[Operator Instructions] Our next question comes from Bill Dumas [ph] with GeoCapital.

Unknown Analyst

This question is for Steve. So just a couple of quick questions on cash flow. So CapEx for the year, without payments under license agreements, you're still looking at $4 million or so?

Stephen N. Ananias

Third quarter? Yes. It's likely to come down a bit from there but that certainly where it's been in the past.

Unknown Analyst

I'm sorry, for 2013, fiscal 2013. So it's $1 million a quarter and $4 million for the year, correct?

Stephen N. Ananias

You're talking about just CapEx specifically?

Unknown Analyst

Specifically without payments under license agreement.

Stephen N. Ananias

Yes, that's correct.

Unknown Analyst

Okay. And in terms of the license agreement payments, with lower revenues, does that number get reduced? Or do you still expect it around the $12 million to $13 million?

Stephen N. Ananias

At this point, I think, assuming the $12 million to $13 million is still appropriate. However, obviously, this is one of the things that we are evaluating and hoping to prioritize the investment and bring our cash expenses down.

Unknown Analyst

Okay. Because it's -- I mean, through the first 6 months, it looks to be $2.7 million. So it's mostly back-end loaded. Is that fair?

Stephen N. Ananias

Yes, that's correct.

Unknown Analyst

Okay. So then of course you have the convert, which is $15 million, which is the bulk of your cash burn for the year. Does part of -- I don't know if you can comment on this, but part of your strategic priorities here has to be -- if you raise another $15 million, you're somewhat, not fully in the clear but somewhat in the clear here, and obviously that leaves a lot of value on the table for everyone potentially. So is that one of the -- $15 million, $20 million of capital raised, is that one of the alternatives you're considering here?

Stephen N. Ananias

Well, we're evaluating all strategic alternatives but I'll say that we are very mindful of shareholder dilution in that process.

Operator

[Operator Instructions] Our next question comes from Elizabeth Howell with Raymond James.

Elizabeth Howell

So could you give us a sense for how we should think about CCP and HPA for the remainder of the year? And maybe if you could comment a little bit on what you're seeing in China in the contract awards. How they materialized in the quarter?

Raouf Y. Halim

Yes, definitely. Yes, Elizabeth, this is Raouf. So starting with your first question first. The communications convergence business, or CP for short, as well HPA performed very consistently with our expectations in the first half of the year. And as we look to the second half, of course we're not going to guide beyond the current quarter, but I would say that they're very much on track with our expectations, and we're very pleased with how those 2 platforms are playing out for us. And also very pleased, frankly, with the design wins we have that are broadening the platforms in both comm processing and HPA. So we're not going to guide beyond the current quarter, but I would simply say that they're performing right on track with our expectations at the beginning of this fiscal year. Then you're second question was about China. And we certainly experienced a good comeback after the Chinese New Year ended February of last quarter, and we saw order patterns start to pick up in the month of March. They're a little later to pick up than we had expected, but they certainly started coming back. And we're looking forward to a pretty decent year in China this year. Expectations are for significant growth in the fiber-to-the-home market. The numbers out there are anywhere from 30% to much higher numbers for annual subscriber growth, fiber-to-the-home in China specifically. And as you know, we have a very strong position there with our HPA business. So we're generally, I would say, positive on trends in China.

Elizabeth Howell

Great. And then just one quick one. Did I hear you right, did you say that you do have an engagement now for your dual-mode small cell solution?

Raouf Y. Halim

Yes, we do. We're making very good progress with our dual-mode 3G, 4G small cells. And yes, we do and expect to have a good play in dual-mode small cell deployments eventually. Those are pushing out, dual-mode, you will see that in North America. Primary carriers are going to be people like AT&T, certainly. But outside of North America as well, carriers like Vodafone. And then in China, you're going to see dual-mode of a different kind, TD-LTE and TD-SCDMA in China specifically. And so dual-mode takes on different flavors in different parts of the world, and we think we're very well positioned across the board.

Operator

I am not showing any other questions in the queue. I'd like to turn it back over to Raouf for closing comments.

Raouf Y. Halim

Okay. Well, thank you, all, very much for joining our fiscal second quarter call. We look forward to talking to you in roughly 3 months. Thank you, and have good day.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect.

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