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Pericom Semiconductor Corporation (NASDAQ:PSEM)

F2Q2011 Earnings Call Transcript

February 1, 2011 4:30 pm ET

Executives

Robert Strickland – IR

Alex Hui – President and CEO

Aaron Tachibana – CFO

Analysts

Krishna Shankar – ThinkEquity

Hans Mosesmann – Raymond James

Christopher Luongo – Fidelity & Company

Operator

Good day, ladies and gentlemen, and welcome to the Pericom Semiconductor Corporation second quarter 2011 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. Please go ahead.

Robert Strickland

Thank you. Good afternoon and welcome Pericom’s second quarter fiscal year 2011 conference call. Our speakers today are Alex Hui, President and CEO; and Aaron Tachibana, the 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, comments on the industry and on Pericom’s business and provide guidance for the third quarter of fiscal 2011. 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 factor 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 third quarter of fiscal 2011. Aaron?

Aaron Tachibana

Thank you, Bob, and good afternoon, everyone. We are very pleased to report another solid quarter of earnings and results despite the recent inventory adjustments by our customers and channel partners and the slowdown of the consumer and PC segments.

Q2 was our 23rd consecutive quarter of profitability and we are very proud of this accomplishment. During Q2, we generated almost $8 million of cash, forged ahead with the PTI integration, consolidated our first full quarter with PTI and announced nine new products for our Signal Integrity, Timing, and Connectivity product areas. Please note that we are reporting non-GAAP financial measures for net income, gross profit and operating expenses in addition to our GAAP financial results. Due to the PTI acquisition, we have a significant amount of non-cash and non-operating expense items included in the income statement which are not reflective of the performance of our normal business operations. Also, Q2 included three months of PTI results, whereas last quarter only had one month due to the close timing of the acquisition.

Now, let’s review some of the detail. Our consolidated net revenues for the second quarter were $40.7 million and represented a 5% decrease from the $42.8 million reported last quarter and a 14% over the $35.8 million for the same period last year. The PTI revenue for Q2 was $5.4 million compared with $1.8 million or one month of Q1. The sequential decrease of 5% was mostly attributed to the inventory reduction efforts by our distributors and customers and also the softness from PC and consumer sectors.

The Q2 geographic distribution was as follows. Asia, 88%; US, 8%; and Europe was 4%. Our channel sales mix was; international distribution, 63%; contract manufacturers, 22%; OEM, 10%; and US distribution was 5%.

Consolidated non-GAAP gross profit was $14.8 million for Q2 compared with $15.1 million last quarter and $12.1 million last year. Non-GAAP gross margin for the second quarter was 36.3% and was 100 basis points higher than last quarter’s 35.3% and 240 basis points higher than last year’s 33.9%. The sequential quarter gross margin increase was primarily due to the benefit of consolidating PTI results for a full quarter and 50% plus gross margin. PTI’s gross margin added roughly 200 basis points to consolidated average, but was partially offset by unfavorable absorption due to low volume in Q2 and also unfavorable currency exchange from the weaker dollar.

Non-GAAP operating expenses were $10.5 million for Q2 compared with $10.3 million last quarter and $9.4 million last year. The Q2 expenses were sequentially higher by $0.2 million due to consolidating PTI for a full quarter, compared with only one month of PTI expenses last quarter. We partially offset the PTI increase with reductions in payroll-related costs from the winter holiday shutdown, lower variable selling costs due to the volume decline, and lower order-related expenses in Q1.

The Q2 operating income on a non-GAAP basis was $4.2 million, 10% of revenue, compared with $4.8 million or 11% of revenue last quarter and $2.7 million or 8% of revenue for the same period last year. The sequential decrease of 1% was due to the $0.2 million increase in OpEx on slightly lower revenue for the quarter. Interest and other income for Q2 was $0.8 million compared with $1 million last quarter. The $0.2 million sequential decrease was due to realized gains from the sale of cash investments in Q2 compared with last quarter.

During Q1, we sold more cash investments in order to acquire PTI. Income from our unconsolidated affiliate, JCP, was $0.1 million for Q2, compared with $0.6 million last quarter. The sequential quarter decrease was due to Q1, including two months of PTI income, whereas Q2 had none, since PTI results are now fully consolidated with Pericom.

Income before tax was $5 million on a non-GAAP basis for the second quarter compared with $5.8 million last quarter and $4 million last year. On a non-GAAP basis, the effective tax rate was 21% for Q2, compared with 35% last quarter and 32% for the same period last year. The Q2 sequential tax rate decrease was due to the mix of income by jurisdiction and due to the true-ups that included the refundable R&D tax credit.

Non-GAAP net income was $4.1 million or $0.16 per share in Q2, compared with $4.3 million or $0.17 per share last quarter and 3.2 million or $0.12 per share for the same period last year.

Now, let’s turn to the balance sheet. Cash, including both short and long-term investments in marketable securities, was $121 million at the end of Q2 and was up approximately $8 million from last quarter. The sequential quarter increase was a result of $4 million from non-GAAP net income and $4 million from the changes in working capital and long-term investments in marketable securities.

Capital additions – capital equipment additions were approximately $3 million for Q2 and were pretty much offset by depreciation and amortization of $2.7 million. Cash, plus investments per share were $4.86 at the end of Q2. Working capital was $124 million at the end of Q2. Accounts receivable was $22 million and DSO was 49 days. Net inventory was $28.5 million, equating to 100 days of supply. The sequential decrease of $2.5 million was due to the reduction of IC inventory. Our channel inventory at the end of December was around eight weeks and was within the target range of six to ten weeks.

We expect both in-house and channel inventory to be flat to down a bit by the end of the March quarter. Our book value per share was $9.65 at the end of Q2. At this time, I would like to turn the call over to Alex for commentary about our business, the industry and the Q3 guidance.

Alex Hui

Thank you, Aaron. We are pleased to deliver good operating results in the quarter. We generated strong cash flow with our operating profit, reduction in inventory and better DSOs. Our top five end customers account for 23% of our revenue and there were no 10% customer. On a consolidated basis, the revenue mix for our product family was, IC, 67%, which included 22% analog switches, 6% digital switches, 7% silicon clocks and 17% connect products; 2% interface products and 15% from PTI products.

The book-to-bill ratio was lower than 1 for the quarter just concluded, but higher than the book-to-bill ratio in fiscal Q1. The weaker bookings were mainly due to PC customers and distributing channel adjusting the inventory on hand which we believe are mostly over by now.

Segment wise, shipments to telecom networking customers were up, computing were down, and consumer customers were down also. We continue to strengthen our high-performance serial connectivity solution with the introduction of nine new products in this quarter. I will refer you to our earnings press release for additional information.

Demand creation is a key focus of our sales and marketing teams. We saw activity for our serial connectivity and timing product solutions remain strong. I would like to update you on some of our recent key design wins. We have several key design wins with our PCI Express, USB switch bridge combo chip on high-performance desktops, networking switch, security switch, and multi-function printers. This single-chip product could replace up to three ICs and save customers significant bond costs, spot space [ph] and participation budget. PCI Express product’s design wins on multi-function printers, telecom systems, embedded accessories and network switch and routers.

We also have multiple design wins with – for our SATA3 and USB 3.0 signal integrity solution on notebook computers. So we have key design wins with our USB flip and chart products on desktop and notebook PCs and also a key design win with our PCI Express Packet Switch on our next generation multi-radio wireless router. Overall, we see an increase in adoption of our first and second generation serial connectivity and timing products across computing, communication and consumer platforms.

We also see strong interest and design activities for our first generation PCI Express, SATA, SAS and USB solution from computing/storage customers who tend to be early adopters of next generation, high speed serial connectivity products. We believe these design activities position us well for healthy growth going forward as the industry completes its inventory adjustment cycle.

At this time, I would like to provide our guidance for the fiscal third quarter 2011. We entered fiscal Q3 with lower backlog compared to last quarter. However, we are seeing strong sales booking quarter to date. So overall, we expect slightly lower shipment this quarter on the sequential basis due to the seasonal lower level of shipments in the computing and consumer customers.

We currently expect that Q3 non-GAAP results to be as follows; revenues in the range of $38 to $41 million, gross margin in the range of 34.5% to 36.5%, operating expenses are expected to be in the range of $10.6 million to $11 million, other income is expected to be above $1 million, consisting of interest income and realized gains from cash investments. Our effective tax rate will be in the range of 23% to 25%. This concludes my formal comments. I will now open up the section for Q&A.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from Krishna Shankar with ThinkEquity. (Operator instructions) Our next question comes from Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Thank you. Hey, guys. Just several questions regarding the outlook, Intel earlier this week indicated that they had some issues regarding a chipset that supports the Sandy Bridge microprocessor. How important is that dynamic as it relates to your business in PCs and notebooks in terms of your outlook?

Alex Hui

At this time, we are still trying to (inaudible) we have a lit bit of difficulty because we are right at the – around the corner, we have Chinese deal here in Asia. But initial assessment is that the impact probably is not going to be very significant. We see – however, expect some push-out in some of the new program, but we also maybe expect stronger demand on some of the older programs. So all in all, we do not expect it is going to be a big impact one way or the other.

Hans Mosesmann – Raymond James

Okay.

Alex Hui

You can find more, we are going to update, but this is our initial assessment.

Hans Mosesmann – Raymond James

Okay. And then in terms of the outlook, you are seeing overall kind of seasonality in the PC and consumer areas, what about networking and telecom, is there stability there? Is there a recovery? Any thoughts there would be helpful.

Alex Hui

Yes. I think we expect it to be pretty much similar to last quarter, which actually we PTI, LP and LK [ph] telecom customers. We are also waiting for some of our key customers (inaudible) in the March timeframe, but all in all, we feel it is going to be pretty healthy.

Hans Mosesmann – Raymond James

Let me say, help you like, flat – flattish or even some growth?

Alex Hui

Well, we expect it is probably going to be slightly up.

Hans Mosesmann – Raymond James

Okay. And then any thoughts on the competitive environment over the past quarter, is there a change in the dynamic or –?

Alex Hui

Not really. I think we continue to see a similar sell-up of competitors that we are competing with which are mainly US based industry and peer companies. And so I would not say there is any significant change in terms of the competitive landscape.

Hans Mosesmann – Raymond James

Okay. And then, one last one, I’ll let others ask some questions. USB 3.0, where are we in that cycle as it’s becoming a mainstream type solution in PCs and how do you participate there?

Alex Hui

We feel that it’s still at the early stage where, as you know, Intel has not included or integrated our USB 3.0 function into the main chipset platform in this generation. And they are looking at doing it in the next generation. So we feel that while the attach rate for USB 3.0 funnel is increasing, you could see there certainly is some high-end notebooks and also (inaudible). I think the big war – ramp-up, (inaudible), but we have seen a lot of interest from our high-end notebook customers and others on the storage customers. And we are seeing a lot of design activities with our USB 3.0 signal integrity solution.

Hans Mosesmann – Raymond James

Okay. And then, all right, one more question, I forgot about the FCP area, how are your cost reduction efforts coming along in that space? How are the utilization rates of your fabrication facilities in Asia? Thank you.

Alex Hui

Yes, actually I think our China facility has done extremely well. We actually – last year, 2010, was the first year of full year of operations. We target the factory with 1 million output in January and we finished the year at 8 million units and we are on our way to break the 10 million unit mark in early part of this year. So we fully expect China factory will begin to contribute to positive gross margin sometime this year, probably in the last spring, in early summer timeframe, and there will be positive contribution for the rest of the year. So, all in all, I think that is doing quite well. In fact, the overall utilization, we didn’t do too well overall. As we know, last quarter, the December quarter was the soft quarter. So, as Aaron mentioned, we do have some absorption in the frequency control factory. But here today we are seeing a pretty good improvement in that. So I feel that should be over pretty much this quarter.

Hans Mosesmann – Raymond James

Great. Thank you, guys.

Alex Hui

Thank you.

Operator

Thank you. Our next question comes from Krishna Shankar with ThinkEquity.

Krishna Shankar – ThinkEquity

Yes, Alex and Aaron, can you talk a little bit about, I know it’s still early to talk about the June quarter, but would you expect the PC and consumer electronics market for you to pick up in the June quarter after this sort of seasonally slow Q1? And in telecom and networking, do you expect that to sort of stay at steady-state levels now, or to further improve in the June quarter?

Aaron Tachibana

Yes, hi, Krishna. This is Aaron. How are you?

Krishna Shankar – ThinkEquity

Good.

Aaron Tachibana

Good. With regards to your question the June quarter, so let’s start with the March quarter. So March quarter is typically, seasonally down a little bit for Pericom and we’ve seen slowness in the consumer and the PC sector. In terms of looking out into the June quarter, we expect to see it be up a little bit from the March quarter, not extraordinarily high, but we do see some strength from the enterprise sector, networking, server storage markets. And so, we do anticipate some slight growth there into the June quarter. And as Alex had mentioned in his description of what happened in the December quarter, if you look at the last four quarters, the book-to-bill ratio had been normalized above 1over the last four quarters. And so we see that getting through the March quarter, we should be hopefully in balance and that should lead us into a decent June quarter from a demand standpoint.

Krishna Shankar – ThinkEquity

And turning to PTI, that had a positive contribution to gross margin, can you update us on new products there, synergies with integration of Pericom Semi and any impact there in terms of either new products being sold in China or outside?

Alex Hui

Yes, actually, last quarter, around the November timeframe, was the first time that we begin to stock the PTI product into our international channel. Initially, we are starting with some of the real-time clock and also, supervisory and timing products. And so, as time progress, I think we are going to continue to expand the presence over here. And I think we see some initial results with some of our existing, present customers picking on their solution and designing those products. So we feel this is one of the key elements [ph] driving is the cross synergy [ph] PTI using the broader sales force they have in China, and also leveraging the Pericom global sales force to sell their products. In terms of real contribution to revenue and bottom line, we expect the process will probably take six to nine months for us to really begin to see initial result, but so far from the indication, I think we are quite encouraged what we see on both sides of the channels.

Krishna Shankar – ThinkEquity

Okay. Thank you.

Operator

(Operator instructions) Our next question comes from Christopher Luongo with Fidelity & Company.

Christopher Luongo – Fidelity & Company

Hey, guys. How are you?

Alex Hui

Good. Hi, Chris,

Christopher Luongo – Fidelity & Company

A couple of questions. First, I just didn’t hear, did you buy back shares in the quarter?

Aaron Tachibana

No, we didn’t shares back during the quarter.

Christopher Luongo – Fidelity & Company

No shares. Okay. And the other question that I had, as we progress, I mean, you are looking at your 50% margins in PTI, a higher percentage of your business is going to analog, where does this gross margin kind of level out? I mean, looking at a year or two down the road, does that make up a bigger and bigger percentage of your overall sales?

Alex Hui

I think on the income goal, as we mentioned, is to get a margin in the 40% which we hope we could do in the next, for the six quarters. Beyond that, I really do not see a recap on our margin. I think we are going to improve the margin on the Pericom side and then on the PTI side. So I think our first goal is break the 40% mark and then continue to move, progress from there.

Christopher Luongo – Fidelity & Company

Okay. And the other question I had was just kind of short term versus long term, just kind of an inventory situation in both server market and also in the TV market, and I expect on the server side, it probably ends up kind of a clear (inaudible) with the introduction of (inaudible) and then within the TVs around the same timeframe, are you seeing that and what’s your expectation for your business after that kind of comes through and how is it affecting you now?

Alex Hui

Well, actually, I think as Aaron mentioned, in terms of the channel inventory, we run about eight weeks which is right at the middle of our six to ten week in the range. And again, this is with the POS shipment last quarter, which obviously is on the – slightly on the soft side. So we expect as the end shipment, end demand goes up,

Then that will naturally drop even the same inventory. So we believe the inventory correction is mostly over and we’re also looking at certainly the (inaudible) and then the transition on the server side. Overall, I think we actually – a few people above the segment. We feel from the design activities that we see with our PCI Express Gen2 Solution and now begin to walk on Gen3. We actually see a pretty broad range of activities. So, as time progress, I think as we mentioned earlier, we expect our revenue contribution from the server space will continue to increase as a percentage.

Christopher Luongo – Fidelity & Company

Would you expect that demand would bottom probably around the March quarter and kind of progress from there?

Alex Hui

Yes, I think that’s probably a reasonable view of what is going to happen, yes.

Christopher Luongo – Fidelity & Company

Okay. Great. Thank you, guys. I appreciate it.

Alex Hui

Thank you.

Aaron Tachibana

Thanks, Chris.

Operator

We have a question –

Alex Hui

Go ahead.

Operator

I’m sorry. We do have a question from Krishna Shankar with ThinkEquity.

Aaron Tachibana

Okay. So, happy to take that.

Krishna Shankar – ThinkEquity

Yes. Can you just give us a percent of your revenues by end markets? I know you’ve done that periodically PCs, server storage, consumer electronics, networking, that kind of end markets?

Aaron Tachibana

Yes, sure. No problem, Krishna. So, in terms of PC, notebook, it’s approximately 20% to 22%; server storage about the same 20% to 22%; networking, communications and telecom, it’s in the low 30s, so 32% to 35%; consumer, GPS, smartphones, digital TV, approximately 15% and the balance is all other embedded.

Krishna Shankar – ThinkEquity

Okay. Thank you.

Aaron Tachibana

You are welcome.

Operator

Thank you. I’m showing no further questions at this time.

Alex Hui

I wish [ph] to thank all of you for taking the time to participate on our conference call and we wish all of you a nice afternoon. Thank you.

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