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Pericom Semiconductor (NASDAQ:PSEM)

F3Q10 (Qtr End 03/27/10) Earnings Call

May 03, 2010 4:30 p.m. ET

Executives

Robert Strickland - Director, IR

Aaron Tachibana - CFO

Alex Hui - President & CEO

Analysts

Suji De Silva - Kaufman Brothers

Hans Mosesmann - Raymond James

Christopher Longiaru - Sidoti & Company

Operator

Good day ladies and gentlemen and welcome to your Pericom Semiconductor Third Quarter 2010 Earnings Conference Call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Robert Strickland.

Robert Strickland

Thank you. Good afternoon and welcome to Pericom's third-quarter fiscal 2010 conference call. Our speakers today are Alex Hui, President and CEO, and Aaron Tachibana, our recently appointed CFO. Before we get started, please be aware that we will be presenting several visual slides during management's discussion of the business. To view these slides, please go to www.pericom.com and click on the Investors link.

Today the Company will discuss its financial results, comment on the industry and on Pericom's business and provide guidance for the fourth quarter of fiscal 2010. Certain matters discussed in the press release and on this conference call may contain forward-looking statements that involve risk and uncertainty.

Therefore, we encourage you to review all filings made by the Company with the Securities and Exchange Commission, particularly the risk factors sections of such filings. In accordance with regulations of fair disclosure, Pericom will continue to only provide guidance via its earnings release and its conference calls. The Company will not provide further guidance or updates during the quarter unless it does so via a press release.

Aaron will discuss the financial performance for the quarter, and Alex will give his comments on the industry and on Pericom's business. Then he will provide guidance for the fourth quarter of fiscal 2010. Aaron?

Aaron Tachibana

Thank you, Bob, and good afternoon, everyone. This is my first conference call with Pericom as I recently joined the Company about a month and a half ago. I am thrilled to be a part of this team and I look forward to working with all of you going forward.

Our fiscal year 2010 third quarter results were better than expected with net revenues growing by 2.4% sequentially and by 50% year over year. We increased gross margin by 166 basis points over last quarter. Also, GAAP net income exceeded last quarter by 23% and was nearly 1,100% higher year-over-year.

Now let's review some of the detail. Our consolidated net revenues for the third quarter were $36.7 million and represented a 2.4% increase from the $35.8 million reported last quarter and a 50.3% increase over the $24.4 million for the same period last year. End-market shipments were as follows; computer, 47%; communication, 35%; consumer, 12% and 6% from all others. Geographic distribution was as follows; U.S., 10%; Asia, 85% and Europe, 5%. Channel sales mix was as follows; domestic distribution, 7%; international distribution, 55%; contract manufacturers, 22% and OEMs were 16%.

Consolidated gross margin for the third quarter was 35.3% and was 166 basis points higher than last quarter's 33.6% and 22 basis points lower than the 35.5% for the same period last year. Gross profit was $12.9 million for the third quarter, compared with $12 million reported last quarter and $8.7 million for the same period last year.

Operating expenses were $10.5 million for the third quarter, compared with $10.4 million last quarter and $9.4 million for the same period last year. Share-based compensation expense for the third quarter was approximately $1 million.

Operating income for the third quarter was $2.5 million, compared with $1.7 million last quarter and an operating loss of $0.8 million for the same period last year. We were extremely pleased with the 49% sequential increase in our operating income for the quarter concluded. Interest and other income was $1.2 million for the third quarter, compared with $1.3 million last quarter and $1.5 million for the same period last year. Income generated from our unconsolidated affiliates, PTI and JCP, was $0.6 million.

Income before tax was $3.7 million for the third quarter, compared with $3 million last quarter and $0.7 million for the same period last year. The third quarter effective tax rate was 34% and was approximately the same as last quarter. GAAP net income for the third quarter was $3.1 million or $0.12 per share, compared with $2.5 million or $0.10 per share last quarter and $0.3 million or $0.01 per share for the same period last year.

Now let's turn to the balance sheet. Cash including both short and long-term investments and marketable securities, was $126 million at the end of Q3 and was about the same level as last quarter. Working capital was $136 million at the end of Q3. Accounts Receivable was $22.5 million and the DSO was approximately 56 days for the quarter. Net inventory was $18.6 million, equating to approximately 71 days of supply.

Our book value was $8.69 per share. During the quarter, we also repurchased approximately 338,000 shares of common stock at an average price of $9.46 per share. The total cost of repurchase was $3.2 million. Cash plus investments were $4.98 per share at the end of Q3.

At this time, I would like to turn the call over to Alex for commentary about our business, the industry and the Q4 guidance. Alex?

Alex Hui

Thank you, Aaron. We are pleased to report 2.4% sequential revenue increase, driven by strong demand from computing, telecom, and networking customers. As expected, demand from consumer customers came down in Q3. Gross margin improvement was driven by improved product mix. With higher gross margin and expense control, our operating profit increased 49% sequentially.

Our top five end customers in fiscal Q3 accounted for 30% of total revenue and one customer came in at slightly over 10% of total revenue in Q3. On a consolidated basis, the revenue mix for our product family was IC, 63%, which included analog switches, 30%; digital switches, 7%; silicon clocks, 9%; connect, 15% and interface, 2%. Frequency control products account for 37% of our total revenue.

Our new frequency control product factory in Jinan, China went into production in December 2009. So far, we are pleased with the progress of the factory and the excellent quality of the products coming out of the line. We will ramp up our factory output over time, expecting to reach 50% of our Taiwan factory output in summer of 2010 and 100% by first half of 2011.

We continue to monitor the overall inventory situations closely. In house inventory came down slightly from 73 days last quarter to 71 days in Q3. Distribution channel inventory went up somewhat in the quarter as distributors worked to replenish their inventory. Q3-ending distribution inventory of six weeks was at the low end of a healthy range of 6 to 10 weeks.

Our book-to-bill ratio was significantly higher than 1 in Q3 and the strong booking trend has continued during the first month of Q4. Extended lead times have led our customers to place orders further out, giving us more visibility on demand going forward. We ended Q4 with a significantly higher backlog than last quarter.

With regard to new products, in the March quarter we introduced 14 new products -- [digital] wire switching, signal integrity and timing solutions that enables the deployment of high-speed serial protocols in computing, communication and consumer applications. I refer you to our earnings press release and recent product releases for details.

We are devoting the majority of our R&D resources to develop solutions for first-generation serial protocols, including PCI Express Gen III, USB 3.0, and SATA 3.0 protocols. We have released a stream of new products addressing these protocols and we have generated strong interest from key OEM customers. We are working with these customers on the verification and design of our solutions in next-generation platforms.

Design wins remain a key focus of our marketing and sales team. Some of the million dollar programs that we expect to go into production in the next 12 months will include a home media gateway with [surround] sound capability that use multiple Powercom PCI Express switch and timing products, a 10 gig Ethernet switch that uses seven Pericom timing and switch products with total dollar content of $10 per box; PCI Express Gen II great service from several top server OEMs that deploy multiple Pericom (inaudible) integrity and timing products per box.

Overall, with improved end market demand and a robust pipeline of new design wins going into production during the next few quarters, we believe Pericom is well positioned to continue delivering both revenue growth and better operating results.

At this time, I would like to provide our guidance for our fiscal fourth quarter. Please also note that Q4 will have 14 weeks this year and will conclude on July 3rd, 2010. We currently expect the Q4 results to be as follows; revenues in the range of $40 million to $42 million. The midpoint of our revenue guidance represent a sequential growth of 4% on a 13 week equivalent basis, gross margin in the range of 35% to 36%, operating expenses I expect to be in the range of $11.2 million to $11.7 million, which includes stock-based compensation expenses of approximately $1.1 million.

Again, on a 13 weeks equivalent basis, expenses will be in the range of $10.8 million to $11.1 million. The high expenses in Q4 are due to the preparation of year end SOX review, as well as higher payroll expenses for merit increase in Q4 and the end of a mandatory time-off policy that was in effect for the last five quarters.

Other income is expected to be approximately $1.1 million, consists of primarily interest income and realized gains from cash investments. Net income for unconsolidated affiliates PGI and JCP is expected to be approximately $0.6 million. The effective tax rate will be about 34%.

This concludes my formal comments, and we can now open up the section for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Suji De Silva with Kaufman Brothers.

Suji De Silva - Kaufman Brothers

Nice job on the quarter guys. The guidance, it sounds like you're getting better bookings, better backlog. What's the turn's expectation in the guidance and how does that compare to last quarter when you guided?

Alex Hui

We are looking at low to mid-30% in terms of turns for this quarter.

Suji De Silva - Kaufman Brothers

And what was that last quarter, Alex, just as a comparison?

Alex Hui

It was closer to 40%.

Suji De Silva - Kaufman Brothers

And then on the OpEx, that seems to be going up. Can you talk about how that breaks out in terms of R&D versus SG&A in the increase?

Aaron Tachibana

In terms of the increase, Suji most of the increase would be toward the SG&A. Primarily again as Alex had alluded to, preparation for SOX review. And then we've also had, in terms of some of the payroll expenses, we've got merit increases that are going to occur here in Q4 and we've also concluded the mandatory time off program that was in effect for the last five quarters. So again two-thirds of the expense increase is probably tied to SG&A.

Suji De Silva - Kaufman Brothers

And Aaron, any thoughts on how OpEx trends the rest of the year or into next fiscal year, I'd say.

Aaron Tachibana

In terms of the OpEx right now, we see this as an anomaly here in the fourth quarter, obviously because we have an extra week. In terms of SOX compliance, we're getting through this here over the next couple of quarters and then we should see that piece of the expenditure trail downward.

Suji De Silva - Kaufman Brothers

And maybe last question, Alex on the supply chain, or Aaron, what are happening with the lead times? Are they coming in or staying stable and are you seeing anything in the lines of cancellations or any inventory in the supply chain other than what you talked about with the levels you saw?

Alex Hui

Lead times, it really depends on the product line. We'll range from 6 weeks to 14 weeks which is similar to the last quarter; some areas a little longer, some areas a little bit shorter. We do not see any significant cancellation. Actually as we mentioned, we have very strong booking and we continue to see the trend in the last four or five weeks.

Operator

Thank you. Our next question comes from Hans Mosesmann with Raymond James.

Hans Mosesmann - Raymond James

Congratulations, guys. If you can Alex or Aaron, can you give us a sense on the longer term model in terms of gross margins and OpEx and the visibility that you have, how should we start to view over the next several quarters your attaining that level over the next several quarters?

Alex Hui

I think our long-term goal is still to drive our margin expansion maybe about 2% to 3% a year. And so as you see, we have very good improvement in the last quarter but our midterm goal is to continue to drive further improvement. Operating expenses, barring the year end kind of related expenses, it's probably going to stay in a similar level. We don't expect to add a lot of headcounts. But certainly, if the revenue ramped up, we expect there will be some scale up in terms of the commission payment. But we do not expect that we need to pick up significant headcount to support the growth.

Hans Mosesmann - Raymond James

And a follow-up on the product side. What can you tell us on notebooks? How is that market trending for you guys, what platforms are driving it, and how we can expect the rest of the year to happen with that particular application?

Alex Hui

Notebooks actually have been doing quite strong. As you well know from our industry peers, we actually see an extension of the Montevina refresh cycle because of the tight supply of CPUs and chipsets out there. But at the same time, we also are beginning to see Capella beginning to ramp up.

So pretty much, as we earlier guided the next quarter or two will be a transition from Montevina to Capella and probably towards the end of this year, beginning of next year, will probably be the switchover point in terms of the two platforms. But overall, we're certainly seeing very strong demand in the notebook in particular I think the benefit to Pericom is we are beginning to see stronger signs of recovery on the enterprise side.

Hans Mosesmann - Raymond James

And then if you can reiterate or just kind of say it again, I didn't quite catch it, if there is an extension of Montevina because there was a shortage or constraint of what exactly?

Alex Hui

Chipsets and CPUs.

Hans Mosesmann - Raymond James

And then, the last question that I have, and I'll open it up for the others is on the tablet side of things. Are you guys participating? That market seems to be an interesting one that has emerged here of late and there's lots of new designs that are coming out. Are you guys participating in that tablet space?

Alex Hui

Today, no. We do not see us as a significant player in the tablet market. We certainly continue to monitor the activities in there with OEMs and looking at areas. But I'd say as of today, tablet PC is not a significant contributor of our revenue.

Alex Hui

We'll certainly continue to monitor the trend very closely and look for opportunities.

Operator

(Operator Instructions). Our next question comes from Christopher Longiaru with Sidoti & Company.

Christopher Longiaru - Sidoti & Company

Congratulations, guys. Great quarter. So I have two questions, really. So your book-to-bill and your backlog is up substantially. Any specific areas you can kind of point to where that is relatively stronger than the rest?

Alex Hui

Actually, I think we see certainly more strength on the computing and network and telecom side and slower on the consumer side, which is as expected in terms of the normal season. We expect the consumer part to begin to pick up probably towards the early summer timeframe. But as of today, for the majority of the booking, the increase was driven by the computing and network and telecom segments.

Christopher Longiaru - Sidoti & Company

And does that product mix have something to do with the gross margin guidance being what it is, it's higher margin products?

Alex Hui

Again, because of the higher mix in terms of networking and telecom versus is consumer, that certainly helps.

Christopher Longiaru - Sidoti & Company

And just going forward on the gross margin line, you'd mentioned trying to drive towards about 2 percentage points of improvement. Where do you think that comes from over the next 12 months?

Alex Hui

Again, I think as our product mix got increased more in the server and networking and telecom area, that's where we see the current and next link of serial connectivity deployment. That should be favorable in terms of the margin mix. And also, on the frequency control product side, today if you look, we are running a negative absorption with our Jinan factory. We expect to get to breakeven in the later part of this calendar year and then next year we fully expect the China factory would contribute to margin expansion. So these are the several factors that I think is going to drive the margin going forward.

Operator

The next question comes from Hans Mosesmann with Raymond James.

Hans Mosesmann - Raymond James

I have a follow-up. Alex, the last quarter, you were constrained on the packaging side of the frequency control products and you may have left some sales on the table. What is the update there? And if you were constrained, what kind of constraints impacted the quarter and your outlook?

Alex Hui

Yeah, I think we're happy to say that by now that constraint is pretty much gone. The overall industry supply is tight still in the back case but we are well supported by our suppliers. So I think that's pretty much behind us right now. So we believe that it will help us to grow our frequency contributors going forward.

Operator

Thank you. I am showing no further questions at this time.

Alex Hui

I would like to thank all of you for the participation and support and wish all of you a wonderful afternoon and hope to talk to you soon and see you as we go out in the field to visit some of you. Thank you. Bye-bye.

Operator

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

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