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

Oct.31.07 | About: Exar Corporation (EXAR)

Exar Corp. (NASDAQ: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 - JMPSecurities

Operator

Ladies and gentlemen, thank you for standing by, and welcometo the Exar Fiscal Year 2008 Second Quarter Result. At this time, all lines arein a listen-only mode. Later, we will conduct a question-and-answer session andinstructions will be given at that time. (Operator Instructions). And as areminder, 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 forjoining us for our fiscal 2008 second quarter investor conference call. We willbegin the call with a discussion of the business by Ralph Schmitt, Presidentand CEO, followed by a financial overview of the quarter by Scott Kamsler,Senior Vice President and CFO. We'll then open the conference call toquestions.

Before we begin, let me state that Exar is subject to theSEC's requirements governing public company reporting obligations. The companyprovides its investors, financial analysts and the general public with businessand financial update, each quarter in its earnings news release and in itsconference call. Exar will not provide any further guidance on its performanceduring the quarter and if it does so in a news release or other matter that iscompliant 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 currentinformation and expectations as of today, October 31st, 2007. The companyundertakes no duty, to update such statements.

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

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

I also need to inform you that the information communicatedin this conference call relating to the Company statements about its growth orfuture financial performance, the anticipated results of the merger with SipexCorporation, improvements in gross margins and revenues. Uncertainty with respectto time and expense reduction or achieving synergies among others areforward-looking statements that involve, risk uncertainties and are notguarantees of future performance.

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

I will now turn the discussion over to Ralph.

Ralph Schmitt

Thanks, Tom. Good afternoon, everybody. This is my firstcall as the new CEO of Exar, and I want to express to investors my excitementat the opportunity to grow our business into something much more substantialthan we have today. Our revenue grew 4% in this past quarter if you compare thecombined 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 thecombined revenue numbers if we reported the two companies separately, and wewanted to show you this in order to allow you to better view our results.

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

Exar is now being re-organized into three distinct productgroups: communications, interface and power. The communications group is madeup 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 interfacetransceiver business. And finally the power group is made up of the Sipex powerbusiness.

It’s our intention to have a more focused R&D effort, inorder to drive the company into a leadership position in one or more productmarkets. We’ve made cuts to R&D projects to focus our dollars more. Andcurrently we've got large market share in UART’s transceivers and T1, E1product categories. However, none of these products really have explosivegrowth.

The company's technical capabilities in IP, however, arepowerful, allowing us from flexibility to use them in higher growthopportunities. So, more will be discussed along specific strategies for theseproduct groups over the coming quarters as we finalize these changes, but wewanted to sort of outline you, where we are heading with the combinedorganizations.

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

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

The UF part of the business was up as we gained market sharein the quarter. We also continued to see these products being designed intoachieve maximum performance in such applications as handsets, GPS and PMPplayers. The communications business was also up in the quarter, with theadoption of some of the framing devices in network equipment.

And our T&E products revenue was down on slower demandfrom customers. Even with the logistics of the merger we had a good quarter inregards to new product introductions. Power led the way with a variety of newLED management products and we are especially excited about the newlyintegrated flash and backlight drivers and products we've released forarchitectural lighting. These are both growth areas.

The communication group had two very significant productsreleased as well: a 16-channel highlyintegrated Line Interface Unit for T1/E1, and a very complex system on Chip24-port Ethernet aggregation products. This product is an example of the highdensity 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 overone, 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 verywell. We had a reduction in the first few weeks after the close, to quickly setup a new organization. Our facilities have been integrated and we'veaccelerated our movement of the wafer probe, manufacturing process to Malaysiain order to further reduce cost. So we are on track to meet the 10 millionannualized 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 fromorganic robust growth that, we believe, we'll be able to drive with the crossselling opportunities and synergies we have in the companies, as well asacquisition activity that we have already aggressively been pursuing.

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

Scott Kamsler

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

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

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

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

We expect further operating expense reductions in our thirdquarter and are on target to achieve at least $10 million in annual costsynergies 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 $0.10diluted earnings per share in Q1.

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

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

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

Question-and-AnswerSession

Operator

(Operator Instructions)

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

Sandy Harrison -Signal Hill

Yeah, congratulations on getting this thing put together andmoving 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 aquestions and then drop back into the queue for others, but one of the thingsthat kind of wanted to get a handle on, from an operating basis and the way youare talking about your 10 million at synergy, should we be looking at that 10million at synergies that are 19.9 number or sort of a 18.7 number or anothernumber out there that was sort of floating around before the things, so I willput together?

Ralph Schmitt

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

Sandy Harrison -Signal Hill

So that we think some time in the June quarter we shouldsomewhere around, you know, $10 million or $12 million operating number oroperating 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 fromsomewhere around $20.2 million or $20.3 million and that gets this down tosomewhere around $17.7 million to $17.8 million.

Sandy Harrison -Signal Hill

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

Ralph Schmitt

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

The interface area, we continue to come out with some lowpower and interesting UART products and we are seeing continued interest andthen actually into some new applications, I've mentioned in the dialogue I hadearlier, which is really more in the portable market space. Hence that shouldgive us some excellent growth out of that market. As well as, in thetransceiver 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 marketacceptance in those areas.

And then the, in the power arena we basically have brokenpower into two fundamental areas and that's the DC-to-DC converters where we'vegot a family of products called the power box products that can support up to12 amps and is used in I'll say comm-related and industrial-related equipmentand in the LED backlighting, we've prior released the most products there andwe are winning designs in some of the higher end handsets, GPS areas that usecamera flash and LED backlighting for the LCD display. We are also migratingthat product into some of the smaller size displays in the consumer market andinto even small size TVs.

So in there, in each area, has some interesting productsand, as I mentioned earlier, what you will see us do is really consolidate ourR&D efforts down a bit more in each of these space, so that we can we canstart 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 Aberlewith Caris & Company, please go ahead.

Nicholas Aberle -Caris & Company

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

Scott Kamsler

The revenues would have been $18.4 million and changing tothe 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 numberfor gross margin as well for the quarter?

Scott Kamsler

If you look at it, it probably would have been approximately46% and Exar's portion would have been close to 70%, and the Sipex fees for thequarter would have been somewhere around 21%.

Nicholas Aberle -Caris & Company

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

Ralph Schmitt

So I’ll take that the -- the guidance we gave or I gave, Ishould say early on, was that we were seeing growth off of the number of thenumbers 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, andas we are going to this sell-through methodology on some of the revenue that inthe past was in a sell-in basis, it makes it really difficult for us to giveyou exact guidance. It's our intention moving forward as this stuff clears outthat will be clearer to you, but if you looked at it on a kind of a standalonebasis, we expect both companies to grow in the low single-digits.

Nicholas Aberle -Caris & Company

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

Scott Kamsler

Correct, most -- there is somewhere in excess of $12million, 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 berecognized revenue because it's pretty clear from accounting purposes. So as wework that off, we believe a substantial piece of that will work itself out inthe December quarter, but we don’t know precisely when and some of that mayflow into the March quarter, but yes most of it will be gone in the Decemberquarter.

Nicholas Aberle -Caris & Company

Got you. And then you provided some guidance for the OpExand 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 grossmargin looked like by that time?

Ralph Schmitt

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

Our production is beginning to ramp and some of our offshorefacilities are China Fab and [Hangzhou],and we believe that we’ll start seeing the cost reductions there. We are doinga lot of work on shifting some of the back-end work offshore, additional workoffshore and premier test times. So there is a lot going on, reducing ourpackage cost. So, as we move through this calendar year in to the next, webelieve 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 therevenue about half and half at this point, we are expecting the Sipex margin tobe up from the low 20s into an approaching 40% during that timeframe, and theExar margin to stay relatively the same. And so it's up to you, you averagedthose two out, that's about what it'll be.

Nicholas Aberle -Caris & Company

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

Scott Kamsler

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

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

Nicholas Aberle -Caris & Company

Perfect, thank you.

Operator

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

Krishna Shankar - JMP Securities

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

Ralph Schmitt

Yeah, I think that’s fairly accurate, that's the best we cantell right now and but as we said the accounting will probably make somechanges to those numbers, but if you are looking at it on a standalone basisfor 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 wouldsee normal seasonality in the December quarter for both the businesses?

Ralph Schmitt

Well there is -- clearly we are affected by seasonality, butthe two businesses address slightly different markets. If you look at it byend-market, our biggest end-market right now is industrial, which is nottypically very seasonal in the fourth quarter.

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

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

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 combinedcompany or I mean what kind of revenue growth should we be looking at for theDecember quarter. That'd be helpful if you can give us some guidance?

Ralph Schmitt

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

Krishna Shankar - JMP Securities

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

Ralph Schmitt

So we’ve been talking about a 15% annual growth rate basedon the existing products and product portfolio. And then as far as longer termmodels go, if you want to look out two years, prior question, we've beentalking about a 55% to 60% gross margin, and dropping 20% to 25% operatingmargin 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 countsshould be used in terms of modeling for the December quarter, shall we relateto what share counts should we be using?

Scott Kamsler

Okay, if you take a look at the outstanding shares at theend of September, it's about 50.4 million. As Ralph indicated, we concluded ourshare buyback with another 1.2 million shares in October. So that brings theshare count down, and of course we have our [team] share option exercises, butit shouldn't be that nice. So that gives you a pretty good idea of the slidewhen 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 goahead with any closing remarks.

Thomas Melendrez

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

Operator

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

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