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Executives

John East – President and CEO

Maurice Carson – EVP and CFO

Analysts

Richard Shannon – Northland Securities

Brad Evans – Heartland

Neil Gagnon – Gagnon Securities

Actel Corporation (ACTL) Q1 2010 Earnings Call Transcript April 29, 2009 4:30 PM ET

Operator

Welcome to Actel Corporation’s conference call regarding its results for the first quarter of 2010. A replay of this call will be available for one week at 1-800-642-1687, conference ID number 50403983. You can also access this call on Thomson CCBN through a link on Actel’s website at www.actel.com.

This call is being recorded. To ensure that the question-and-answer session proceeds in an orderly manner, participants will return to the queue after one question and one follow-up question.

All forward-looking statements during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected in the forward-looking statements.

Information concerning factors that could cause actual results to differ materially from those projected in the forward-looking statements are contained in Actel’s most recent Form 10-K, which is available on Actel’s website.

At this time, all parties have been placed on a listen-only mode. The floor will be opened for questions and comments following the presentation.

It is my pleasure to hand the floor over to your host, Mr. John East, President of Actel.

John East

Thanks, Jenna. Good afternoon. I am John East, the President and CEO of Actel. With me is Maurice Carson, our Executive Vice President of Finance and CFO. After Maurice reviews the results for the quarter, I will talk about our current business environments; then I will give you a brief update on products, and then we will open up the call for questions.

So now, I would like to turn the call over to Maurice.

Maurice Carson

Thank you, John. Before I talk about the financial details for the first quarter, let me tell you how we will provide financial information regarding the first and second quarters of 2010. In addition to the actual results, we will give guidance on the call today. The guidance will be our targets for sales, gross margin, operating expense, other income, and the tax provision and share count for the second quarter of 2010. Next, we expect to provide a financial update in early June. In the absence of a material change, that will be the only financial guidance the company will give during the quarter.

As is generally the case, my remarks today will include non-GAAP measures as a supplement to our GAAP results, in order to provide a more comprehensive view of our financial results. A reconciliation of non-GAAP to GAAP statement of operations is included in our earnings release and is posted in the Press Room of the company’s website. I will focus on comparisons of the first quarter with the fourth quarter.

Now to the financials. First quarter sales were $52.3 million, a bit below the mid-point of our updated guidance. At our size, one order moving from the end of one quarter to the beginning of the next can cause us to be below where we anticipate. There should be no concerns with this, given our Q2 revenue guidance. The revenue split came in as expected, Radiation Tolerant up, Non-Space No Arrow down, and Flash up. Silicon book-to-bill was substantially above one.

On to the full income statement. Non-GAAP gross margin in the first quarter was 62.2%, flat to Q4. This includes the benefits of the cost reductions we discussed last quarter. Non-GAAP operating expense for the quarter – operating expenses for the quarter were $27.7 million, compared with $26.4 million in the fourth quarter. R&D spending was $13.6 million, compared with $12.9 million, and SG&A was $14.1 million, compared to $13.5 million. We are on track to meet our spending targets in Q3, something I will discuss in detail later.

Other income was $0.6 million, compared with $0.1 million in the prior quarter. Non-GAAP net income was $3.8 million, compared with $3.3 million last quarter. Diluted share count was $26.5 million, and this all resulted in an earnings per share on a non-GAAP basis of $0.14, compared to $0.12 last quarter.

A quick comment on the share count. During the quarter, we bought back almost 250,000 shares of stock. However, only 80,000 shares are reflected in the diluted share count I just mentioned. We used the diluted weighted average share count for non-GAAP reporting. The quarter ending share count was around $26.3 million.

Cash, cash equivalents and investments were $149.3 million at the end of the quarter, a decrease of $3.4 million. We generated $7.7 million from the income statement and $2.1 million from share issuance, ESPP and auction exercises. This was offset by an increase in net working capital of $7.4 million, share buyback of $3.4 million, and CapEx of $1.8 million.

Accounts receivable was really the big story in the working capital, and it increased $14.1 million to $33.2 million. This was due to an increase in the shipments in the month of March, compared to December, as a result of the December shutdowns. December DSO increased by 23 days to 58 days. We believe that DSO will come down in Q2.

Net inventory increased by $1.1 million to $38.4 million. This included $5.6 million of legacy wafers purchased as part of the last-time buy we discussed in the past. We will continue to purchase these wafers for two more quarters. Even with this purchase, net days of inventory decreased by four days to 177 days when compared with the fourth quarter. CapEx was $1.8 million during the quarter and we recorded $3 million of depreciation and amortization.

Now, I will give the financial outlook for the second quarter of 2010. Taking into consideration all of the information currently known by us, we are projecting revenue to be up 8% to 12%.

For the rest of the P&L, please remember that these are non-GAAP numbers. Gross margin is expected to be about 60%. Over the next couple of quarters, we will see the full effect that mix can have on our margins. The 200 basis point decline in Q2 is due to a decline in the Radiation Tolerant products, combined with an uptick in the Flash revenue. Although the increased Flash sales will have reasonably good margins, they will not be at the corporate average. We expect this situation to reverse in Q3, when we will have very good shipments of Radiation Tolerant product and our margins will exceed the base line of 62%.

Non-GAAP operating expenses are anticipated to come flat to Q1. At this point, some of you may be worried that we are getting very close to the date when we promised to be at $25 million, and we still a ways to go. One item that we have not talked about is variable spending. We have some variable spending in OpEx that will take us higher than the $25 million spending target in any quarter when we exceed $54 million of revenue that the spending target was based on.

Now, let me take you through, in general terms, what will happen to OpEx between now and Q3. In broad terms, a third of the remaining $3 million of savings will come from project-related spending, and these include IT and engineering projects. A third will come from people-related spending, including the recent reduction in force, and the balance will be spread over quite a few areas. We will, we are, still anticipating that we will make the $25 million spending, given the variable costs I talked about a moment ago.

Other income will be around $0.6 million, and the non-GAAP tax rate for the quarter is expected to be 30%. Fully diluted share count is expected to be 26.4 million shares.

In April, we had a reduction in force that affected 23 people, mostly in engineering and all in the U.S. This restructuring – the restructuring cost for this was around $1 million, and the quarterly savings, starting in Q3, will be about $650,000 per quarter.

To sum up, revenue was up for the third quarter in a row, and we expect continued growth. Gross margin is expected to fluctuate, as there are significant mix shifts over the next couple of quarters. However, at any mix, the rate was better than it would have been, with all the work in reducing manufacturing costs. And we are still on track to meet our promised OpEx levels.

Thank you. And I would like to now turn the call back to John.

John East

Thanks, Maurice. First, I will talk about Q1. As we have told you, our sales were up about 5% from the prior quarter. Bookings were very strong. Our book-to-bill was way over one. A relatively low percentage of the bookings were turns bookings, most of them aged into Q2 and Q3. Bookings was strong across the board, but there was particular strength in our Radiation and Flash products. As a result of the strong bookings, our backlog going into Q2 was very high.

I told you in February that I expected the bulk of our growth to come from Flash and Satellite. We did in fact booked very well in both Flash and Satellite, and our Satellite billings were correspondingly high. We had a record billings quarter in Satellite products. Flash products billings, however, were only up about 5% from Q4. That means that the high Flash bookings led to a greatly increased Flash backlog going into Q2, and that bodes very well for Q2 Flash billings.

Now, let us switch to Q2. Our backlog shippable in Q2 going into the quarter was considerably higher than the equivalent Q1 beginning backlog. In addition, bookings for the first three weeks of this quarter have been very strong. It is important to remember that we take sales when our distributors ship to their customers; that means that our increased distributor backlog pays off when our distributors ship the product. The situation going into this quarter is that our distributor's resale forecasts are not as high as their demand on it, and that is very similar to the last quarter. If you did the original check, you would think that they were planning to build quite a bit of inventory. Whereas I wouldn't be surprised to see some inventory build on our distributors shelf, I would be surprised to see very much of it. Since we run in a neighborhood of 75% distribution, this matters a lot to our overall billings number.

As I already spelled out, our backlog for Flash products increased significantly. As the distributors ship as we think they will, our Flash shipments will take a very nice jump. The jump will include older Flash products, which have relatively normal margins. It will also include newer Flash products, which have margins considerably lower than our average. So coupling that with the likelihood that our Radiation product billings taper off from the record Q1 numbers, it is likely that our direct margins will come in lower in Q2 than they did in Q1, and this would not be a reflection on our spending or on our ASPs, it would be a question of product mix.

By the way, even though we expect our Satellite sales to be down a bit in Q2, we believe that to be just a minor blip in what we believe to be a continuation of the Satellite product growth pattern that we have been experiencing for a long time now. We believe that our Satellite business is going to grow to new highs in the back half of the year, and that means that we expect our margins in Q3 and Q4 to be considerably higher than what we expect to see in Q2, or even what we saw in Q1.

So, on balance, we are going to call Q2 revenue somewhere between 8% and 12% up compared with last quarter. To make the mid-point of that range, we will need fewer turns than we needed last quarter. Maurice has already discussed our expense reduction activities. I won't belabor the point, except just to say that we still expect to deliver the expense reductions that we promised you over a year ago.

Now, I will talk about products. In March, we announced SmartFusion. SmartFusion of course is our natural evolution of the original Fusion family that we announced about three years ago. One of our observations of the microcontroller market has been that many 32-bit microcontrollers have programmable logic devices on the same board. I/O expansion is one of many applications assigned to those PLDs. Another of our observations is that ARM is the clear winner in this market. SmartFusion addresses these observations. SmartFusion is essentially an ARM Cortex-M3 processor on a same chip as a low-power FPGA and a powerful analog block. It is aimed at our traditional Industrial, Military and medical customers in applications such as system management and motor control.

Over my 42 years in this business, I have heard many theories of when to announce our products. In the FPGA space, for example, one theory is to announce our products when the software is ready, even if the silicon isn't, and that is not a bad theory for our FPGAs. In the case of SmartFusion though, the theory we employed was different. SmartFusion is a very complex product, much more so than a typical FPGA. We worry that to announce the product if all aspects of it were not quite right, it might lead to bad customer experiences, and bad customer experiences often come back to haunt you.

The theory we employed was that everything must be ready at product launch. So in March, when we announced it, we had production-qualified silicon on the distributor shelf, along with production-worthy software and applications support. Most importantly though, we had engaged in a lead customer program, which allowed us to line up dozens of interested customers prior to launch. As a result, the overall customer response to our SmartFusion launch has been excellent.

Finally, I will make a comment on our CEO search. The search is ongoing. We are comfortable with the way it is going. We are focusing on getting an extremely high quality person, because we think that is much more important than the amount of time it takes us to get the job done.

That concludes my formal remarks. Jenna, would you please open the line for questions?

Question-and-Answer Session

Operator

(Operator Instructions) And you have a question from the line of Richard Shannon.

Richard Shannon – Northland Securities

I got on the call just a second late. I think I caught on, Maurice, on your comments regarding bookings trends for radiation and Satellite and Flash. I was wondering if you could repeat those for me, please?

Maurice Carson

Actually, I just covered the forecast, but I will repeat that. The Q2 is going to be up in Flash significantly, down in radiation tolerant, and back into Q3 will be a significant uptick in Radiation Tolerant products. So it is the same angle that John came out with.

Richard Shannon – Northland Securities

Okay, great. In terms of the Flash bookings, you are talking about some very nice growth here in the June quarter. I wonder if you could talk about some of the applications you think are ramping up here. You also mentioned some mixture – a mixture of older and newer products. If you can distinguish between where those products are going, that would be great.

Maurice Carson

Sure. East here. Richard, you have been with us a long time. You have heard of what I call the annuity curve and various times I have called the things like the neutron star, but the bottom line is, when we first announced product, we get lots of different types of customers included, and those lots of different types in the early days would be a lot of consumer customers. The consumer customers invariably come on sooner and invariably have a lower pricing and then we get lower margins. So if you look at the family and in the early stages, it would last up to three or four, maybe five years even, you tend to see lower ASPs and lower margins, and if you look at the total list of customers, you would see quite a few consumer guys in there. As the products mature, so as we get well down the curve, well enough down that we have announced the next family, the consumer customers generally hop along to the next newest family, but the Industrial, medical, Military, and in some cases, Satellite customers don't go away. They stay there forever.

So if you look at a product that has been out seven or eight years, if you look at the customer list, it has few, if any, consumer people. It has lots of Industrial and medical and Military and some Satellite people. Those ASPs are always higher. By then, we have always done a lot of cost reductions, so you have seen much higher margins. So, that is where we sit on existing Flash families, what we call APA, Advanced ProASIC families that have been out seven plus years now. The consumer guys have pretty well burned off. We have done quite a bit of cost reductions, and so the margins on that have come up in the neighborhood of the average for the company. And in my view, they will just keep coming up, and the family will last, in my view, as all families last for us, which is 20 years is normal, we are making very nice margins at the end.

If you look at our 130 nanometer stuff, and there are actually three subfamilies there, that was what we call ProASIC3 and then what we call IGLOO and then what we called IGLOO-Nano. Those are all pretty new. We still have a lot of consumer customers. We haven't had the time to do all the work on yields and costs that we will do by the time the (inaudible). So with those families, if you look at the customer relationship, there would be quite a lot of consumer people, there would be quarterly lower margins. But to me, it is not a concern. I think that the consumer guys will eventually burn off, as they always have for us. And I think that the margins on the Military and medical and Industrial stuff will rise, as they always have done. And by the time those products have been out a decade, the margins will be sweet. You have to be patient to be involved with Actel, because I am not giving you any time scales that are weeks or months, barely even years, but after 21 years of Actel, watching what I just described happen over and over and over and over and over again, I am totally convinced it happens.

So, why did we make the point? To help you guys build your models. So, a long answer to your short question, Richard. I always do that to you, but I think you have had your follow-on, so let us, Jenna, can you take the next question, please?

Operator

Yes. The next question comes from the line of Brad Evans.

Brad Evans – Heartland

Brad Evans of Heartland. Good afternoon, gentlemen. Just a point of clarification. So, we are still committed to lowering the operating expenses about $6.5 million from the level of the third quarter of 2008 and as you indicated, John, or maybe it was Maurice, so we came in this quarter total operating expenses on a cash basis of roughly $28.6 million a year. You are sticking to a goal of getting down to that $25 million per quarter, with the exception now being that the variable expenses will start to come in when you get above $54 million per quarter revenue. Did I hear that – is that a correct understanding of the situation?

Maurice Carson

Brad, I think everything was correct, except I show our non-GAAP OpEx at $27.7 million, but that is correct and just to clarify, I think we always have guided that $25 million as $6.5 million savings was predicated on a $54 million quarter. I don't think we were explicit about the variable cost part, but everything else we agree.

John East

Variable cost, not that much, we are talking about sales commission and a little extra management bonus that comes in. We are not talking about huge margins.

Brad Evans – Heartland

Well, thank you for that, John, I appreciate that. Can you give us a rough guesstimate of if you were to bridge from $54 million up to $60 million in sales per quarter, what would the variable component be roughly, within a wide range?

John East

I don't think we were really prepared to do that, but I will try and get a quick thought on it. Less than half a million dollars range, even less than hundreds.

Brad Evans – Heartland

Okay. I appreciate that. So, I know you are not giving guidance for the third quarter, for the back half of the year, but I was just playing with the numbers here while you were giving us the kind of the OpEx of what the second half will look like and is it conceivable that the company could approach a high-teens to the near 20% EBITDA margin in the back half of the year?

John East

Well, I am wrestling, partly based on the leer from my corporate attorney. So, how am I going to parse this? We have a policy of giving one quarter guidance only. In power for the last almost two years, we have been talking explicitly about Q3 of 2010, because we gave you financial targets for Q3 2010. We felt like we needed to keep you up to date. So I have a little more leeway than normal, and normal I would only talk about this quarter. But, you know, we have already told you that we think the margin will be better in Q3 than it was in either Q1 or it will be Q2. We haven't talked about sales for Q3, but I did tell you that backlogs are high and bookings so far continue to be strong. So I think you could rationally make your own judgment that we are feeling pretty good about sales in Q3 so long as sales don't tank and we have told you that we see no signs of that yet. So if you couple better margins with sales in the neighborhood of what we have given, you have got to come up with a number.

Brad Evans – Heartland

Okay, so John, I appreciate the color. So I have built them over there, it seems like I have not made any assumptions that are not beyond the realm of possibility.

John East

Yes, it doesn't seem to me like you are off-track, but you have got up with your own model.

Brad Evans – Heartland

Understood. Thank you so much.

John East

David Van De Hey is staring at me right now.

Brad Evans – Heartland

I don't want to get you in trouble, John, thanks.

John East

Okay. Do you have a follow-on? Jenna, I think he hung up, so can you take the next question, please?

Operator

Yes. Your next question comes from the line of Neil Gagnon.

Neil Gagnon – Gagnon Securities

John Maurice, good afternoon. First on R&D, I would like know, have some discussion about how the 65-nanometer program is going and will we be seeing any bumps and tape outs?

John East

Well, it is theory, without letting the cat out of the bag, it is too late to see bumps and tape outs. We need to get some wafers out of fab and we need to figure out if they work or not. And that is an interesting time for us. It is a new architecture, new design, new process, new physics, new this and that, new the other, so it is tough to make it work the first time out but we are hopeful. But the first wafers are in fab. Now, if you are asking will you see bumps for costs in future tape-outs, we will see them, we don't particularly want you to see them, we want to work that into the number that we have been committing to you all along. It is conceivable that we are not able to work it in, but the goal now is to get to that $25 million.

In fact, let me just back up. Let me assume you asked a different question. John, are you serious about that $25 million and are you going to keep it there? I know you want to ask that, because when I see you personally, you asked me that, do it again. So my answer to that is, I put that number together. I started out with John Anderson, before he passed away, and that was – we started working on it in November of 2008. Since then, three CFOs have participated. We took on three new Board members, and then they swapped out one of those for a fourth Board member. So, how many new people does that mean who have come in and looked at that number and gotten their looks into it, and we have not changed one nickel since we first put it together in November. That means, we are sticking to it. We don't intend to change. That is the level at which we want to run. Saying is one thing, doing is another, you are right, we might have some expensive mass sticks that we didn't figure on, but we plan to get to that level and keep it at that level, until everybody believes it is a base level.

Now, if our sales are growing like crazy, we will then probably increase spending somewhat, but the proportion of that spending would be that we would drop a very significant amount of any increased spending to the bottom line, more so than even in our old days we used to talk about. But I do not want to talk about that too much now, what I want to talk about now is again our intent to get it down to the $25 million, it has been almost two years now since I have been talking about it, and make you guys believe that it is the base. And if something changes then, we will give you a lot of prior knowledge, but it could only be good if it changes. So, how is that for extensive wording? Neil, you got a follow-on?

Neil Gagnon – Gagnon Securities

Yes, sure. You have got your sales jumping nicely or moving up nicely in Q2 and hopefully thereafter. What are your thoughts about headcount in the second half of the year?

John East

Well, my view is that headcount in California is about where we want it and I wouldn't see a day when we would take it up. We will probably add some heads in Asia, they are a lot less expensive, but we would only do so to the degree that we thought they could allow us to make that $25 million number.

Neil Gagnon – Gagnon Securities

Great, thank you.

John East

You bet, Neil. Jenna, do you have more questions?

Operator

There is a question from the line of Richard Shannon.

Richard Shannon – Northland Securities

John, probably one quick follow-on from me. In terms of – in regards to your previous response on the consumer type of customers, you saw a lot of bookings come from consumer customers back, I think, in the 2008 timeframe. Kind of curious to the extent which the bookings and revenues behind these bookings or design wins, what is the relative size in this kind of movement upwards and what does the customer profile look like? I think last time you saw it as more of a, you know, lower end type of customer. Are you getting more Tier-1, steady state kind of customers, so to speak?

John East

Yes, good question. So let me start off by saying that our total percentage of consumer has not increased. I wouldn't mind if it would increase, I think I have told some of you that I would like to get it to 20% or 25%, but liking to is one thing and doing it is another. So in the quarter we just finished, we were only 16% consumer, and that is maybe a little on the low side. And I don't particularly see that taking a jump up in Q2. So, if your concern is too many consumer customers, we are going to do a repeat of 2008. Hey, that kind of thing is always possible. But I don't particularly see that myself.

Now, the second part of your question dealt with the quality of the consumer customers. And there is no question in my mind –

Richard Shannon – Northland Securities

All customers I think.

John East

Okay, well, I will hit consumer first, and then I will hit the rest. The quality of consumer customers. Back in 2008, the guys we were selling two, by and large, were ones that you would have heard of. Now, the biggest consumer customers we have are ones that you will know very, very, very well. So there is some consolation in that, but still the consumer business tends to go out at pretty darn low margins. But you will have heard of the customers and the whole lot have to go away.

Now, once you move outside consumer, well let us go to the opposite extreme. When you go to the space customers, first thing you have to understand about space, and I will try to put it into perspective, deals with the boom that we are seeing right now. When this boom first came on, all of my competitors were growing like crazy and we didn't grow very much, we were looking pretty bad. And I told you at that time, and I will still tell you that I think in the early days of what we are all now calling a boom, it is driven heavily by telecommunications customers, particularly in China, well, China and India, Asia's telecommunications customers. And we really don't have any of that market. So, it didn't help us at all. And our competitors were rocking and rolling, and we were not.

Now, we just told you we expect a big jump in our Satellite business. I will go on to say we are feeling good about Industrial and Military as well, but we are experiencing a big jump in our Satellite business, that has nothing to do with any local economy kinds of things. The Satellites that we ship into generally get planned five years in advance, five years before they place the orders, something like that. And it is occasionally true that they will get cancelled. You will read in the paper that the government cancelled this or that or the other, but by and large, my experience is they are pretty darn stable once they get planned, they happen. And so, orders that we get now that are coming from Satellites that got planned five years ago have nothing to do with the economy. It is not going to go up further if the economy goes up more, and it is not going to go down if the economy goes down, in my view. So to me, that is a very high quality customer, and it is not dependant on the economy.

So should the economy tank in the summer or in Q4, and I am not seeing signs of that, but everybody is worried about it, everybody is thinking about it, so I am assuming you are. Should that happen, I don't know why it would happen to our Satellite as well. We don't see it happening to Satellite as well. And then in between the Satellite customers would be the Industrial and Military guys. Those also tend to be less susceptible to the economy, which is why generally when the economy tanks, we don't go down as far, nor even start going down as fast as our competitors. It is also the reason why when the economy booms, we don't go up as much or start as soon as our competitors. So I think, kind of, I would say everything, in my mind, everything I just went through is positive. What it does do is it puts kind of a low-pass filter on short term part of basins in the market in my mind.

Maurice Carson

Can I throw in something on that as well? You know, specifically, I think there are some differences, Richard, in the, as you talked about, 2008 and now in the Flash bookings, and it is a much broader customer base, with a lower proportion of consumer, and as John mentioned, the consumer that is in there are names that you would know, but a much higher proportion of Industrial, well known Military customers. So the Flash, and I actually anticipated somebody would ask this question. We feel better about the Flash backlog in terms of its ability to stick and it is the duration of it. So, they are all, for the most part, very good quality customers.

Richard Shannon – Northland Securities

Okay great. Maybe just one quick one, John, I just wanted to confirm or get your broader thoughts on your supply chain. We have heard from a lot of other companies in the chip space where there is some constraints in certain places. I know your food chain is a little bit off the beaten path; just wanted to make sure that you are comfortable with your supply chain?

John East

Well, I want to grab those guys and hug them. What we have needed, they have taken care of it. Now we are a little easier than some of the other bigger guys, but we needed a billion wafers that targets a special favor and give them. But in our case, when we have gone to UMC or Trinian or Chartered, said we need some help, they have given us the help. So if any of those guys are on the phone, thank you very much. Never means you are not going to have a problem no more, but they have been good to us so far.

Richard Shannon – Northland Securities

Okay, great. Thank you.

John East

You bet. Jenna, more questions?

Operator

(Operator Instructions)

John East

It seems like every quarter we have fewer questions, that used to trouble me, but I will just let it go this time. My bet is I am still here a quarter from now. I have mentioned the search is progressing fine, but these things take a while. So I am going to be optimistic and I am going to say that I look forward to seeing you one quarter from now same time, same place. Thanks for joining us.

Maurice Carson

Thank you everybody.

Operator

Thank you for your participation in today's conference. You may now disconnect.

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