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Exar Corp. (NYSE:EXAR)

F2Q08 (Qtr End 9/30/07) Earnings Call

October 31, 2007 4:30 pm ET

Executives

Ralph Schmitt - President and CEO

Scott Kamsler - SVP and CFO

Thomas Melendrez - EVP, Secretary and General Counsel

Analysts

Sandy Harrison - Signal Hill

Nicholas Aberle - Caris & Company

Krishna Shankar - JMP Securities

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Exar Fiscal Year 2008 Second Quarter Result. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). And as a reminder, we are recording today's call.

I would now like to turn the conference over to our host, Mr. Thomas Melendrez. Please go ahead, sir.

Thomas Melendrez

Thank you Val. To our listeners, good day, and thanks for joining us for our fiscal 2008 second quarter investor conference call. We will begin the call with a discussion of the business by Ralph Schmitt, President and CEO, followed by a financial overview of the quarter by Scott Kamsler, Senior Vice President and CFO. We'll then open the conference call to questions.

Before we begin, let me state that Exar is subject to the SEC's requirements governing public company reporting obligations. The company provides its investors, financial analysts and the general public with business and financial update, each quarter in its earnings news release and in its conference call. Exar will not provide any further guidance on its performance during the quarter and if it does so in a news release or other matter that is compliant with Reg FD and Reg G, as the case may be, and other applicable laws, rules and regulations. The company's guidance and remarks are based on current information and expectations as of today, October 31st, 2007. The company undertakes no duty, to update such statements.

The Company reports its financial results in accordance of GAAP. However, for the periods presented today, we are disclosing non-GAAP gross margin, non-GAAP R&D expenses, non-GAAP SG&A expenses, non-GAAP operating expenses, non-GAAP operating income and loss, non-GAAP net income and non-GAAP diluted earnings per share, which are adjusted to exclude from our GAAP results, items that are required to be included by GAAP, such as stock-based compensation and various merger related cost.

The Company uses these non-GAAP measures internally to evaluate the Company's operating performance, and the measures are used for planning and forecasting of its future periods. The Company believes the non-GAAP measures set forth therein are useful to investors, financial analysts and other parties interested in and following the semiconductor industry, as well as performance of financial analysis. The complete reconciliation from non-GAAP to GAAP financials for the most recent or prior period or event that may be disclosed or discussed today can be found in the Company's filed reports, Form 8-Ks and press releases filed with the SEC.

I also need to inform you that the information communicated in this conference call relating to the Company statements about its growth or future financial performance, the anticipated results of the merger with Sipex Corporation, improvements in gross margins and revenues. Uncertainty with respect to time and expense reduction or achieving synergies among others are forward-looking statements that involve, risk uncertainties and are not guarantees of future performance.

Please review the safe-harbor statement contained in today's press release as well as the other risk detailed from time-to-time in the company’s SEC reports including the annual report of Form 10-K for the year ended March 31, 2007, the quarterly report on Form 10-Q for the quarter ended June 30, 2007, as well as those risks set forth in Sipex Corporation's annual report on Form 10-K for the year ended December 31, 2007 and its quarterly report on Form 10-Q for the quarter ended June 30, 2007. Listeners are encouraged to review these documents.

I will now turn the discussion over to Ralph.

Ralph Schmitt

Thanks, Tom. Good afternoon, everybody. This is my first call as the new CEO of Exar, and I want to express to investors my excitement at the opportunity to grow our business into something much more substantial than we have today. Our revenue grew 4% in this past quarter if you compare the combined full quarter revenue for the September quarter with the June quarter, increasing from 35.5 million to 36.8 million.

Our GAAP financials do not show this, but these are the combined revenue numbers if we reported the two companies separately, and we wanted to show you this in order to allow you to better view our results.

The performance is within the guidance that was previously given. If you base our December guidance on the same methodology, we expect to continue to grow. However, we established the third revenue recognition through our distribution partners for the old Exar products, which will have an impact on a go-forward reported numbers.

Exar is now being re-organized into three distinct product groups: communications, interface and power. The communications group is made up of a networking and transmission business, as well as, the storage business. The interface group is made up of Exar's UART business and the Sipex’s interface transceiver business. And finally the power group is made up of the Sipex power business.

It’s our intention to have a more focused R&D effort, in order to drive the company into a leadership position in one or more product markets. We’ve made cuts to R&D projects to focus our dollars more. And currently we've got large market share in UART’s transceivers and T1, E1 product categories. However, none of these products really have explosive growth.

The company's technical capabilities in IP, however, are powerful, allowing us from flexibility to use them in higher growth opportunities. So, more will be discussed along specific strategies for these product groups over the coming quarters as we finalize these changes, but we wanted to sort of outline you, where we are heading with the combined organizations.

We go back to the quarter, just completed. In aggregate, we saw revenue up in Asia and down in both Europe and the Americas. The revenue percentage breakout is as follows: 43% in Asia, 27% in Europe, 25% in the Americas and 5% in Japan. If we look at some of the business dynamics, power was up in the quarter, driven by adoption of some of the new LED driver and DC-to-DC products.

Interface was down in the quarter, mostly driven by a slower than anticipated production ramp at Sea-Land, our fab partner in China. The backlog was available for us to grow--the transceiver business in the quarter--but we didn't have the fab out necessarily to support it because we drained inventory faster than we had anticipated. Hence, we were manufacturing limited in that quarter. We now have enough wafers in the line to recover this business in fiscal Q3 and Q4 that the current quarter and the upcoming quarter.

The UF part of the business was up as we gained market share in the quarter. We also continued to see these products being designed into achieve maximum performance in such applications as handsets, GPS and PMP players. The communications business was also up in the quarter, with the adoption of some of the framing devices in network equipment.

And our T&E products revenue was down on slower demand from customers. Even with the logistics of the merger we had a good quarter in regards to new product introductions. Power led the way with a variety of new LED management products and we are especially excited about the newly integrated flash and backlight drivers and products we've released for architectural lighting. These are both growth areas.

The communication group had two very significant products released as well: a 16-channel highly integrated Line Interface Unit for T1/E1, and a very complex system on Chip 24-port Ethernet aggregation products. This product is an example of the high density logic capability of the company with over 12 million gates in this design. It sits at the heart of various networking equipment that route many lines of Ethernet.

Our top customers in the quarter were: Alcatel, Lucent, Samsung, Nokia, Siemens, Cisco, ZTE, Marconi, RIMM, Huawei, Toshiba and Motorola. Our book-to-bill was over one, and we started this quarter that we currently are in at approximately 70% booked. And we significantly reduced our channel inventory to under 10 weeks, hence positioning ourselves very well moving forward.

The integration of the two companies is progressing very well. We had a reduction in the first few weeks after the close, to quickly set up a new organization. Our facilities have been integrated and we've accelerated our movement of the wafer probe, manufacturing process to Malaysia in order to further reduce cost. So we are on track to meet the 10 million annualized synergy targets that we had previously announced.

We continue drive to meet our three-year plan of hitting a $300 million revenue level at a 20% operating profit. This will come from organic robust growth that, we believe, we'll be able to drive with the cross selling opportunities and synergies we have in the companies, as well as acquisition activity that we have already aggressively been pursuing.

So, with that summary, let me pass this off to Scott to dig deeper into some of the numbers and metrics.

Scott Kamsler

Thank you, Ralph. Due to the complex and kind treatment of revenue in a merger, I would like to reiterate what Ralph stated earlier regarding the underlying level of business that exist at Exar. On an as if combined basis, using historical revenue recognition accounting, revenue grew by 4% in the second quarter to $36.9 million from $35.59 million.

However, on a GAAP basis, net sales for the second quarter of fiscal 2008, were $19.2 million, a 12% increase from that sale of $17.1 million for the first quarter of fiscal 2008. On a GAAP basis, we reported a net loss of $16.4 million or $0.39 diluted loss per share for the second fiscal quarter of 2008, compared to net income of $4.6 million or $0.13 diluted income per share for the first quarter of fiscal 2008.

The loss is primarily attributable to $1.4 million of stock-based compensation and to the following acquisition driven items, $8.8 million of in-process R&D, $1.7 million of amortization of intangible assets, $1 million of merger related expenses, such as severance cost, $8.3 million for establishment of a reserve for Exar differed tax assets and $3.2 million of associated tax effects.

Our non-GAAP gross margin for the second quarter decreased to 63.1% from 68% in the first quarter primarily due to the inclusion of lower margin revenue from Sipex. Non-GAAP operating expenses increased to $13.5 million in the second quarter from $10.9 million in the first quarter, primarily due to the addition of operating expenses from Sipex for the last five weeks of the second quarter. However, on a full quarter combined basis, non-GAAP operating expenses for the second quarter would have been approximately $18.7 million compared to $19.9 million in the first quarter.

We expect further operating expense reductions in our third quarter and are on target to achieve at least $10 million in annual cost synergies by the June 2008 quarter. Net income on a non-GAAP basis decreased to $2 million or $0.05 per diluted share, for Q2 compared to $3.5 million or $0.10 diluted earnings per share in Q1.

I will now provide some comments on our September balance sheet. The balance sheet now reflects acquisition of Sipex for approximately $251 million, primarily allocated to intangible assets of $60 million, in process R&D of $8.8 million, tangible net asserts of $5 million, and goodwill of a $171 million.

Cash from marketable securities decreased by $29.2 million during Q2 to $324 million. The company repurchased approximately 2.1 million shares of this common stock for $20.4 million at an average price of 13.35 per share. Consolidated days sales outstanding increased to 32 days from 29 days.

Now looking at inventory, days in Q2 versus Q1, Exar inventory days were 79 versus 75. Sipex Inventory days dropped to a 119 from a 147 and from 211 days at the end of March. This concludes our presentation, and we will now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Sandy Harrison with Signal Hill. Please go ahead.

Sandy Harrison - Signal Hill

Yeah, congratulations on getting this thing put together and moving forward guys?

Ralph Schmitt

Thanks Sandy.

Scott Kamsler

Thank you.

Sandy Harrison - Signal Hill

You know, lot to go through yours, so I’ll pick up a questions and then drop back into the queue for others, but one of the things that kind of wanted to get a handle on, from an operating basis and the way you are talking about your 10 million at synergy, should we be looking at that 10 million at synergies that are 19.9 number or sort of a 18.7 number or another number out there that was sort of floating around before the things, so I will put together?

Ralph Schmitt

The measuring plan we are using are the non-GAAP operating expenses on a combined basis for the March quarter, so it’s a little over $20 million.

Sandy Harrison - Signal Hill

So that we think some time in the June quarter we should somewhere around, you know, $10 million or $12 million operating number or operating income expense number?

Scott Kamsler

No. The $10 million is on annualized basis.

Sandy Harrison - Signal Hill

Annualized, okay.

Scott Kamsler

We'd be saving about $2.5 million, so we take that from somewhere around $20.2 million or $20.3 million and that gets this down to somewhere around $17.7 million to $17.8 million.

Sandy Harrison - Signal Hill

Got you, and spending a quick second on the three areas that you've now broken the company as far as comm, interface and power. Ralph, if you could spend a little bit, sort of highlighting may be one or two of the key products for those of us that remain oblivious, for many it was Sipex in each of those groups and then other products sort of what you expect the growth drivers to be within those?

Ralph Schmitt

Sure, in the comm area, which last quarter was about 21% of the total. The big area that we're seeing significant growth in is, for us, in the SONET transceiver area. Its probably right now the most robust growth, also in the framing and mapping area, we've got a couple of products now that are gaining traction and its primarily in the major telecom and networking customers that you would expect them to move forward in.

The interface area, we continue to come out with some low power and interesting UART products and we are seeing continued interest and then actually into some new applications, I've mentioned in the dialogue I had earlier, which is really more in the portable market space. Hence that should give us some excellent growth out of that market. As well as, in the transceiver end of the business, we have come out with a series of [high area] ESD and higher speed products in the RS-485 states and gaining some market acceptance in those areas.

And then the, in the power arena we basically have broken power into two fundamental areas and that's the DC-to-DC converters where we've got a family of products called the power box products that can support up to 12 amps and is used in I'll say comm-related and industrial-related equipment and in the LED backlighting, we've prior released the most products there and we are winning designs in some of the higher end handsets, GPS areas that use camera flash and LED backlighting for the LCD display. We are also migrating that product into some of the smaller size displays in the consumer market and into even small size TVs.

So in there, in each area, has some interesting products and, as I mentioned earlier, what you will see us do is really consolidate our R&D efforts down a bit more in each of these space, so that we can we can start putting ourselves into a leadership position.

Sandy Harrison - Signal Hill

All right great thanks Scott.

Operator

And our next question comes from the line of Nicholas Aberle with Caris & Company, please go ahead.

Nicholas Aberle - Caris & Company

Thanks for taking my question guys. First of did you guys say what Exar revenues would have been broken out standalone?

Scott Kamsler

The revenues would have been $18.4 million and changing to the sell-through metric from the sell-in that decreased revenue approximately $2.1 million.

Nicholas Aberle - Caris & Company

Got you and did you guys give kind of all end combine number for gross margin as well for the quarter?

Scott Kamsler

If you look at it, it probably would have been approximately 46% and Exar's portion would have been close to 70%, and the Sipex fees for the quarter would have been somewhere around 21%.

Nicholas Aberle - Caris & Company

Perfect. And then I might have missed this, but was there any specific guidance going into the December quarter for revenues and some of the other income statement metrics?

Ralph Schmitt

So I’ll take that the -- the guidance we gave or I gave, I should say early on, was that we were seeing growth off of the number of the numbers as reported on a standalone basis. And we didn’t give specific range. And then one other reason is that our accounting has become quite complex, and as we are going to this sell-through methodology on some of the revenue that in the past was in a sell-in basis, it makes it really difficult for us to give you exact guidance. It's our intention moving forward as this stuff clears out that will be clearer to you, but if you looked at it on a kind of a standalone basis, we expect both companies to grow in the low single-digits.

Nicholas Aberle - Caris & Company

Would you expect the revenue recognition stuff to come out to be fully completed going into the March quarter will be a clean number than or will it take longer time?

Scott Kamsler

Correct, most -- there is somewhere in excess of $12 million, both at the Sipex and Exar side that won’t be recognize as revenues. It's been recognize as revenue or in the case of Sipex will be never be recognized revenue because it's pretty clear from accounting purposes. So as we work that off, we believe a substantial piece of that will work itself out in the December quarter, but we don’t know precisely when and some of that may flow into the March quarter, but yes most of it will be gone in the December quarter.

Nicholas Aberle - Caris & Company

Got you. And then you provided some guidance for the OpEx and how much, I guess, when they come out of the business by June of next year, has there been any kind of longer term or medium term guidance, what gross margin looked like by that time?

Ralph Schmitt

Well we think that if you take a look at the historical trends, Exar has been 65% to 70% over the last several years, and we think it will remain in that range, a substantial amount of work is being done on the Sipex side with the transition from Milpitas, California fab offshore, most of that inventory is being flushed through the system. There has been some issues that have occurred in past several quarters that additional charges have been incurred which you cull down the margins but it appears that we are making very good progress on resolving those issues and our revenue is beginning to ramp.

Our production is beginning to ramp and some of our offshore facilities are China Fab and [Hangzhou], and we believe that we’ll start seeing the cost reductions there. We are doing a lot of work on shifting some of the back-end work offshore, additional work offshore and premier test times. So there is a lot going on, reducing our package cost. So, as we move through this calendar year in to the next, we believe we will start to see substantial improvements on the cost side.

Scott Kamsler

To answer your answer more directly, is that, just simply put, if you keep the revenue about half and half at this point, we are expecting the Sipex margin to be up from the low 20s into an approaching 40% during that timeframe, and the Exar margin to stay relatively the same. And so it's up to you, you averaged those two out, that's about what it'll be.

Nicholas Aberle - Caris & Company

Perfect. That's helpful. And then lastly just in terms, just strategy with the cash balance, will there be additional share buyback here in the near-term and then you talked about that you are aggressively looking at acquisitions. May be a little color on may be what type of complimentary business that you guys might be looking at? Thank you.

Scott Kamsler

We did a pretty aggressive buyback after the announcement that we made. We had fundamentally an old tranche of buyback, as well as the new $30 million tranche and we completed both of those. And now we are in a situation where we are going to evaluate as to how quickly and how aggressively we move forward. But we are basically in that period of time where we are going to get together with the Board itself and make that determination.

At the same time what we are looking at is we are looking at a number of other acquisitions and have been heavily engaged there and that will also have an effect on that decision. And as we previously stated we are expecting to do something fairly rapidly, because as you can tell from this quarter there is quite a bit of confusion and we want to get through that confusion rapidly, get the Company on the right path and then make it easier for investors to truly understand how we are going to get to the numbers and the performance we expect.

Nicholas Aberle - Caris & Company

Perfect, thank you.

Operator

And next question comes from the line of Krishna Shankar, JMP Securities please go ahead.

Krishna Shankar - JMP Securities

Yes. So as we look at the December quarter what I thought of suggesting is taking about half of the revenue lead from the Exar and the Sipex side of the business and ascribing 65% to 70% growth margin for Exar and probably sort of mid-20s for the Sipex part of the business. What should that be if you really think about it?

Ralph Schmitt

Yeah, I think that’s fairly accurate, that's the best we can tell right now and but as we said the accounting will probably make some changes to those numbers, but if you are looking at it on a standalone basis for two companies that's not that far off from where it'll be.

Krishna Shankar - JMP Securities

And on the standalone basis, do you think that they would see normal seasonality in the December quarter for both the businesses?

Ralph Schmitt

Well there is -- clearly we are affected by seasonality, but the two businesses address slightly different markets. If you look at it by end-market, our biggest end-market right now is industrial, which is not typically very seasonal in the fourth quarter.

Our second largest is in the comm area and you know based on other inputs, you probably heard from other people that its little bit soft in that market today.

And then our third area, which is the higher growth area is consumer and that typically does have seasonality in it. I however believe we are in the situation where we are gaining or we should be gaining significant share and so it won't as big an effect on us as you may have seen in some other companies.

Krishna Shankar - JMP Securities

I see, I am just trying to sort of get a ballpark handle on, should we be modeling sort of low to mid single-digit growth for the combined company or I mean what kind of revenue growth should we be looking at for the December quarter. That'd be helpful if you can give us some guidance?

Ralph Schmitt

As we've talked about previously it would be a low single-digit kind of number we believe right now.

Krishna Shankar - JMP Securities

First again the long-term operating models say12- months out and 24-months out for the combined company, what kind of longer term revenue growth do you expect for the combined company and longer term gross margin and operating margins?

Ralph Schmitt

So we’ve been talking about a 15% annual growth rate based on the existing products and product portfolio. And then as far as longer term models go, if you want to look out two years, prior question, we've been talking about a 55% to 60% gross margin, and dropping 20% to 25% operating margin through the bottom line and we're sizing the company both in the R & D and the SG&A space to be able to support that model.

Krishna Shankar - JMP Securities

Great and finally, can you give in for what share counts should be used in terms of modeling for the December quarter, shall we relate to what share counts should we be using?

Scott Kamsler

Okay, if you take a look at the outstanding shares at the end of September, it's about 50.4 million. As Ralph indicated, we concluded our share buyback with another 1.2 million shares in October. So that brings the share count down, and of course we have our [team] share option exercises, but it shouldn't be that nice. So that gives you a pretty good idea of the slide when the 50 million plus the dilutive impact of options on that.

Krishna Shankar - JMP Securities

Great. Thank you

Operator

And speakers, there are no further questions. Please go ahead with any closing remarks.

Thomas Melendrez

Thank you. A replay of this call will be available today after 5 pm, Pacific day light time until 11.59, and Pacific Standard Time on November 7th, 2007. Please refer to our website www.exar.com for details. Thank you for joining us today. We look forward to communicating with you again in January to review our '08 third quarter results. Have a good day, thank you.

Operator

Ladies and gentlemen, that concludes your conference for today. Thank you for your participation and thank you for using AT&T Executive Playback Service. You may now disconnect.

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