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Executives

Bruce Thomas - Vice President of Investor Relations

Dan Artusi - President and Chief Executive Officer

Karen Roscher - Senior Vice President and Chief Financial Officer

Analysts

Kevin Wenck - Polynous Capital Management

Blayne Curtis - Jefferies & Company

Analyst for Tristan Gerra - Robert W. Baird & Company

Blake Harper – Signal Hill

Rob [Brody] – Tudor Investments

Eric [Rivell] - NPR Securities

Presentation

Conexant Systems, Inc. (CNXT-RETIRED) F1Q08 Earnings Call January 24, 2008 5:00 PM ET

Operator

I would like to introduce Bruce Thomas, Vice President of Investor Relations for Conexant who will chair this afternoon’s conference call. Mr. Thomas, please go ahead.

Bruce Thomas

Thank you, Marcello. Good afternoon everyone and welcome to Conexant’s first quarter fiscal 2008 earnings conference call. Joining me today are Dan Artusi, our President and Chief Executive Officer and Karen Roscher, our Senior Vice-President and Chief Financial Officer. Dan will begin today’s call. Karen will then review our first quarter financial results and Dan will return to provide a business review and our outlook for the second quarter of fiscal 2008. We will then open the call for questions.

Please note that our comments today will include statements relating to future results that are forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ substantially from those projected as a result of certain risks and uncertainties including, but not limited to those noted in our earnings release and those detailed from time-to-time in our SEC filings. The financial information we will discuss today is based in part on non-GAAP financial measures. The company believes that these financial measures, which we term core financial measures, provide an enhanced understanding of our underlying operating performance. Reconciliation of core to GAAP measures is included in our earnings release, a copy of which is available on our web site at www.conexant.com.

I will now turn the call over to Dan.

Dan Artusi

Thank you, Bruce. I am pleased to report that the Conexant team exceeded expectations for our first quarter financial performance. We also achieved our highest priority goal of delivering break even financial performance on a core-operating basis. Before we discuss our results and provide second quarter guidance, I would like to review the progress we have made from forming our company and then talk briefly about the kind of company we intend to become.

For the past two quarters, we have been focusing on the first part of our turn-around plan, which consists of reducing expenses and improving our financial performance as quickly as possible. Our first quarter results demonstrate that we have made significant progress on both fronts, but we still have more work to do in this area. We have also been working to narrow our project development focus and prioritize our investments to ensure that we have appropriate resources on the most important projects. The ability to deliver innovative new projects that excites customers is the life-blood of our industry. Our team is committed to improving our product development capability, our engineer and execution and our ability to meet customer’s schedules. Over the next several quarters, we intend to re-establish our credibility by building a track record of consistency delivering improved financial performance. At the same time, we will be focusing on the actions necessary to deliver profitable growth. Our growth strategy consists of two parts. First, we plan to increase market share in expanded segments that we currently serve. These areas include video cell, PC audio and video, and satellite and cable setup boxes. We have the talent, the technology and the customer relationship required to be even more successful in this segment. Second, we plan to address new markets with new products that allow us to leverage our core technical expertise in digital signal processing and analog mixed signal design. We will also be working hard to ensure that our product development investments and expected returns support our achievement of our target business model. We will provide more detail in our gross strategy and target business model in the coming quarters.

In our industry our speed is critical. I want to assure you that we are retooling our company as fast as we can. As we have previously indicated, the successful completion of our turn-around strategy will take time. We did not get into this situation overnight and we cannot correct it quickly. Once we have successfully completed our turn-around strategy, we intend to be a focused, disciplined company that regularly delivers compelling semiconductor solutions to customers on a schedule. We also plan to grow profitably on a consistent basis. We expect to take our place as a preferred employer for the brightest, most talented people in our industry.

I have complete confidence in the Conexant team’s ability to successfully complete our turn-around strategy and create a company that consistently delivers increasing value to customers and investors over time.

The first fiscal quarter we exceeded our expectations on revenue, gross margin and operating expenses. We also maintained our target levels for channel inventory. I will provide more details in our business and our outlook for the second fiscal quarter after Karen reviews our financial results. Karen.

Karen Roscher

Thank you, Dan. Revenues in the first fiscal quarter of 2008 were $197 million up 7.1% from the $183.9 million we delivered last quarter. We exceeded our revenue expectations for the quarter but our sequential increase came primarily as a result of the non-recurring royalty payments of $14.7 million related to an existing license agreement. Poor growth margins improved to 50.5% of sales in the first quarter compared to 44.7% last quarter. This sequential improvement of 580 basis points was largely due to the non-recurring royalty payments. Without the impact of this one time item, growth margins would have been 46.5% of sales, a sequential improvement of 180 basis points. Core operating expenses were $80.3 million, $10 million lower on a sequential basis and nearly $2 million better than the lower end of the guidance range we provided in November. Our savings resulted from the head count reductions we initiated in September and our decision to discontinue investments and stand-alone wireless networking solutions and other product areas. Throughout the quarter, the entire Conexant team outperformed our expectations on cost reduction.

Our first quarter core operating profit of $19.1 million represented a $27 million sequential improvement over our fourth quarter operating loss of $8 million. This performance was substantially better than our expectation entering the quarter due to the higher revenue, higher margins and lower expenses.

As Dan mentioned we also achieved our highest priority goal of breaking even on a core operating basis by generating $4.4 million in core operating income, excluding the impact of the non-recurring royalty. Core other expenses were $8.5 million primarily reflecting interest expense related to our debt, partially offset by interest income generated from our cash and investments. For the first quarter, our core net income was $0.02 per diluted share based on approximately 492 million diluted shares outstanding.

Now to the balance sheet. The company’s cash and cash equivalents was $232.1 million at the end of the first quarter, a decrease of $3.5 million from the previous quarter. We generated positive operating cash flow for the first time since the first quarter of fiscal 2007. Even without the impact of the one-time royalty payments, we generated approximately $8 million of cash flow from operating activities during the quarter. Uses of cash included working capital changes and a debt reduction of $9 million as we reduced our borrowing against the receivables line of credit. Accounts receivable declined sequentially by $9.2 million. Days sales outstanding, after adjusting for the non-recurring royalty, improved to 35 days down from 40 days last quarter due to continued improved sales linearity across the quarter. Inventories declined by $2 million sequentially to $61 million and inventory returns remained at $6.4 million.

As we mentioned last quarter, we expect to make an offer in February to repurchase approximately $55 million of our senior secured note. This is consistent with our strategy of using the proceeds of the sale of non-core assets to retire our debt.

I would now like to turn the call back over to Dan.

Dan Artusi

Thank you Karen. I would like to spend a few minutes talking about our first quarter business and product highlights for imaging and PC media, broadband access and broadband media processing. Our foundation imaging and PC media product lines accounted for nearly 40% of our total revenues in the first quarter, even as we further reduce channel inventories on a sequential basis. Channel inventories are now at the target level required to sustain this business. During the first quarter, our team concentrated on meeting demand for the traditionally strong December quarter. We also continued to support customers and execute on the designs we won previously and we are now competing for business that will result for new product cycles.

In general terms, our imaging and PC media product lines are characterized by meeting market share position. Developed over many years, attractive margins and new avenues for profitable growth. Our team is working to leverage our foundation intellectual property positions to expand into market segments we have not previously addressed. These areas include PC audio, particular for notebooks which represent the fastest growing segment of the PC market. Customer interest in our audio solutions is high. We are preparing new audio product for introduction now and we expect to be sharing this expanded market.

Our PC video solutions allow personal computer users to edit and preserve digital video and watch and record television on their desktop and notebook PCs. We are engaged with the world’s leading PC manufacturers and we expect to increase our market share with new PC video products in the coming quarters.

We are also leading providers of solutions for document imaging, which includes products for fax machine and printers that feature copy, scan and fax capabilities. We have partnered with the world’s largest fax and printer manufacturers and we will continue to focus on these areas. We will remain the world’s number one supplier of analog modern solutions offering products that go into a variety of handheld appliances, setup boxes and personal computers.

In the first fiscal quarter, PC modern solutions accounted for just over 10% of our total company revenues. In the first quarter, our broadband access product lines accounted for approximately 35% of our total revenues. During the quarter, our team sharpened its focus on driving the acceptance of our highly integrated DSL gateway solutions that incorporated wireless networking and voice override capability.

Last quarter we reported that we had won an ADSL 2+ gateway design. We are one of China’s largest service providers. We have commenced volume shipments to their OEM suppliers and expect deployment of equipment incorporated in our solutions to begin next quarter. In addition, we expect a multiple ADSL 2-ply gateway at this time, we have secured in Europe and Australia, to begin ramp into volume production this quarter.

In the first quarter, we also saw a continued acceleration in AT&T’s U-verse high IPTV deployment, which incorporates our next generation central office and VDSL CP solutions. AT&T recently reaffirmed its commitment to U-verse and said they expect to significantly expand the scope of their network by installing the equipment necessary to provision 30 million homes by the end of 2010.

Our broadband media processing business accounted for more than 25% of our total revenues in the first quarter and delivered double digit sequential growth. Revenues were higher than we expected entering into the quarter due to a stronger than anticipated demand for our satellite and cable setup box solutions.

In the satellite setup box segment, our shipments have extended the definition solutions and remained strong and the transition to high definition solutions with DVR capability continued to accelerate as more HD programming becomes available to subscribers. In Europe, the connection HD DVR solution for a major satellite broadcaster is going to the final approval phase. We also saw increased demand for solutions targeted at the worldwide free to air segment with one of our major customers gave us our market share in Asia. In addition deployments of advanced feature setup boxes in our solutions accelerated in China as the country prepares itself for the Beijing Olympics this summer. In cable setup box we saw a strong demand for our solutions, particularly in Asia. In Korea, new legislation went into affect allowing Korean telecommunications companies to offer broadcast television over the Internet. Korean cable companies have responded by building out the networks, which has increased the demand for our cable setup box solutions. We are also seeing continued demand for our stand out definition products resulting from China’s conversion for an analog to digital cable networks.

Before I provide our business outlook for the second fiscal quarter, I would like to summarize my thinking about our company. We have the talent, product positions and customer relationships required to be successful. We have now delivered two quotas of significant progress across multiple fronts but our turn-around strategy will take more time to complete. Most importantly, we have the cash we need to operate our business, complete our turn-around strategy, and make the investment necessary to deliver profitable growth.

I would now like to provide our business outlook. A semiconductor company such as Conexant that addresses consumer electronic markets, the March quota is traditionally weaker on a sequential basis. We are seeing evidence of this trend in the current quarter. As a result, for the second fiscal quarter, we expect revenues in the range between $165 million and $170 million. We anticipate the second quarter gross margin would be between 44% and 45% of revenue. We expect to reduce core-operating expenses again on a sequential basis to a range between $76 million and $79 million. Combining this estimate, we anticipate that our second quarter core operating results will be in a range between break-even and a loss of $7 million resulting in a core net loss of $0.02 to $0.03 per share. Bruce.

Bruce Thomas

Thank you Dan. That wraps up our prepared comments today. Marcello we are now ready to open the lines to questions and answers session.

Question-and-Answer Session

Operator

At this time we will open the floor for questions. (Operator Instructions) Our first question comes from the line of Kevin Wenck - Polynous Capital Management.

Kevin Wenck - Polynous Capital Management

Good afternoon Dan, thanks for the overview. Now that you have had some time as CEO and thought about longer-term financial models, given potential feature growth rates. What is a reasonable R&D level for the company for the percentage of sales at some point in the future?

Dan Artusi

Well, I can tell you that the current one is not acceptable and for this type of industry we are looking at a model that should be between 20% and 25% of our revenue for R&D.

Kevin Wenck - Polynous Capital Management

Okay. Does that imply any gross margin improvement along the way or you can have higher level of R&D? Or does that imply current levels of gross margins?

Dan Artusi

That implies that we are going to be focusing on the efficiency of our R&D builders. Most likely our gross margin will remain at the level they are today and the model is down point. Our focus is improving the efficiency of our R&D builders overall.

Kevin Wenck - Polynous Capital Management

Okay. We all know the seasonality in your business, but still sequentially we are talking about close to a 10% decline in revenues from December through March. Could you give us more color as to which areas of the business are affected the most and which areas of the business are affected less?

Dan Artusi

For this quarter, as I mentioned in my earlier remarks, the December quarter was particularly strong in the PC space and as you can see on the publications in recent dates that market is forecasted to go down. We expect that part of our business to be the one that is down compared to other parts of the business.

Kevin Wenck - Polynous Capital Management

Okay. Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Blayne Curtis with Jefferies and Company. Please go ahead.

Blayne Curtis - Jefferies & Company

Thank you. I just want to go back to the OpEx level that you will be able to bring down more than your guidance and you guided down again. I know people tried this last quarter; it kind of gets them target operating margin levels. I’m wondering if I can

just try again.

Dan Artusi

Blayne, I think what we need to stick to here is that we clearly made a lot of progress from a peak operating expense level of about $93 million not too long ago. We delivered $80 million this quarter, and we guided for additional improvement for the quarter that we are in. We are going to continue to guide one quarter at a time. We would love to answer the question with a lot of detail, but because we have work-in-progress, it is just not the right time for us to go into more elaborate detail.

Blayne Curtis - Jefferies & Company

Maybe I should try; just as you look at the ways you can reduce out backs there are obviously some shorter-term things and some longer-term things, which is facilities and such. Just looking out to the rest of the year. What types of things can we look at as a way of reducing your out backs?

Karen Roscher

Blayne, we are looking at anywhere and everywhere. We are really being ever vigilant and proactively looking across the business in terms of areas which we can reduce costs. As mentioned a key focus area is on the R&D efficiency. Making sure that we are making the investments in the product lines and projects that will deliver the growth and the profitability that we need to be successful going forward. From my perspective, nothing is sacred and we are lifting up every carpet around the place to find opportunities to bring in additional savings. We are by no means done.

Blayne Curtis - Jefferies & Company

Okay. The other part is obviously revenue growth. You talked about some of the areas you are going to focus on. Where is IPTV in that whole spectrum?

Dan Artusi

That is definitely one of the areas that we have put investment in the past. Obviously it is very early in the cycle for that business, but it is something that is projected to grow over the next several years. A compound growth rate of probably 70%. So, IPTV is gaining momentum outside the United States. We are well positioned with future customers, so we are exploring all kinds of opportunities. There is an opportunity for growth. Then again, it is really early.

Blayne Curtis - Jefferies & Company

Okay. I just want to make sure I have the math for the business. I am assuming wireless is fairly small? There was revenue in the quarterly report though?

Karen Roscher

Yes, that is correct.

Blayne Curtis - Jefferies & Company

Is it $5 million or any sort of metric you can give me?

Dan Artusi

Well, I think the best way to discuss that is that we have now taken the wireless revenue that we had prior and it has been rolled into our broadband access business. So, for our ongoing business we do expect there to be a tail here on our prior wireless brand products. As we go forward, it should get smaller and smaller. Now we have the entire broadband access business representing about 35% of our revenues.

Blayne Curtis - Jefferies & Company

Okay, great. Lastly, it looks like you saw a lot of strength in your broadband access product. One of your competitors saw some inventory in ADSL. I am wondering if you are seeing the same thing?

Dan Artusi

No, we are launching new products ADSL at the beginning of a new cycle. We are not seeing the inventory issue.

Blayne Curtis - Jefferies & Company

Beginning the cycle in ADSL?

Dan Artusi

Yes, for a new product. As I had mentioned in my comments and we talked the last quarter. We have new ADSL gateway products and those are just starting to ship.

Blayne Curtis - Jefferies & Company

Okay. So, you are not thinking inventory.

Dan Artusi

No.

Blayne Curtis - Jefferies & Company

Okay. Thank you for your time.

Dan Artusi

Thank you Blayne.

Operator

Our next question comes from the line of Tristan Gerra with Robert W. Baird. Please go ahead.

Analyst for Tristan Gerra - Robert W. Baird & Company

Hi this is Scott Herlin calling in for Tristan. I was wondering if you could talk a little bit about the order linearity that you saw in the December quarter, if there was anything kind of odd in any of the markets. There has been some talk about late December there were some push-outs either from the [disties] or from some PC customers. Did you guys see anything around that?

Dan Artusi

We had a very lenient quarter and you can see that from the DSL. We had a very satisfactorily seasonality in our business.

Analyst for Tristan Gerra - Robert W. Baird & Company

Have you seen anything that deviated from normal seasonality so far in Q1?

Karen Roscher

No, we have not seen anything different there.

Analyst for Tristan Gerra - Robert W. Baird & Company

Could you guys give kind of a book-to-bill for the last quarter at least in color, above 1 or below 1? What are your returns requirements for fiscal Q2?

Dan Artusi

Unfortunately, we don’t provide book-to-bill information. What we do is we take a good look at what is booked and what is expected and we factor all of those dynamics into our guidance, when we provide our guidance.

Analyst for Tristan Gerra - Robert W. Baird & Company

Okay, great. Thanks for answering my question.

Dan Artusi

You bet, thank you.

Operator

Our next question comes from the line of Blake Harper with Signal Hill.

Blake Harper – Signal Hill

Thank you. Yes, you have made some comments about the satellite, setup box, and some of the HD and DVR offerings. I have heard a lot of comments from cable operators and other people about their accelerating offerings of HD and DVR products. Could you talk about maybe some of what you see as some of your opportunities there?

Dan Artusi

Well, like I mentioned in my remarks we had in Europe, opportunities in Europe. So, we are going through qualification cycles right now. We are not commenting on anything specific. Yes, we are seeing strong interest in the transition to HD. It has created more momentum for this market.

Blake Harper – Signal Hill

Okay, thank you.

Operator

We do have a follow-up question from the line of Kevin Wenck - Polynous Capital Management.

Kevin Wenck - Polynous Capital Management

What is the status of potentially surplus real estate at this point? I admire what you are doing with operating expenses but how much surplus real estate is there at this point? What are plans in terms of doing something with it?

Karen Roscher

Good question, one I keep pushing on myself. I know one of the big areas that are always in question is the land here in Newport Beach and we are continuing to pursue the entitlement there. That is still a longer process and with the current state of the economy, we expect that to take a bit of time. We are aggressively pursuing sublease of space that we are no longer in and we have some nice offers coming across. As well as, we just are in the process of selling a building in India as well. So, we continue to push that aggressively to reduce the footprint of Conexant globally.

Kevin Wenck - Polynous Capital Management

Okay. Depending on what the outcome could be with the entitlement on the real estate that you have there locally. What, at this point, is the potential market value?

Karen Roscher

I think that is anybody’s guess at this point. We really don’t have a good feel for that at this point in time. We will just continue to try to augment the value through the entitlement process and ultimately realize the most that we can for that land.

Kevin Wenck - Polynous Capital Management

Okay. What is a reasonable schedule for the progress you have made so far? Are we talking another year before you will be able to work through all the issues you will need to work through or is it possibly two to three years working with the local governments?

Karen Roscher

Closer to one year.

Kevin Wenck - Polynous Capital Management

Okay, thanks for your help.

Operator

Our next question comes from the line of Rob [Brody] with Tudor Investments.

Rob [Brody] – Tudor Investments

Hey guys.

Dan Artusi

Hi.

Rob [Brody] – Tudor Investments

Couple questions. First on the debt, $55 million, I assume that is fanned down to 9.25% paper?

Karen Roscher

That is correct, the senior floaters.

Rob [Brody] – Tudor Investments

That will save you about $1 million a quarter once that is done?

Karen Roscher

That is correct. Again, assuming that we are taken up on the offer, because we make the offer and we do not know who will accept.

Rob [Brody] – Tudor Investments

Okay. Fair enough. What was the CapEx for the quarter and what do you expect CapEx to be for the full year?

Karen Roscher

CapEx for the quarter was $1.6 million and I wouldn’t expect it to be that low for our oncoming quarters. We should be lower than last year, total year.

Rob [Brody] – Tudor Investments

Okay. Then, it terms of seasonality, I am just understanding that the first calendar quarter is a weak seasonal quarter for a lot of seasonal companies. Typically, and I understand things are not terribly typical as you guys try and fix things there. What type of seasonality is typical there for the June quarter?

Dan Artusi

While I think from a traditional standpoint, Rob, the June quarter tends to be a bit of a recovery quarter for the PC market as the inventories begin to normalize a little bit. We would probably say there would be a little bit, from a purely seasonal perspective. There might be a little bit of improvement traditionally from the March quarter to the June quarter, then again that is kind of taking the PC market as a capsule and as inventories shake themselves out it is usually not a big growth quarter, lets put it that way.

Rob [Brody] – Tudor Investments

Circling back to the satellite top-box and even cable box comment. Am I just hearing what I want to hear or is the tone there a little bit more positive? The last couple of quarters during the conference calls it has been sort of very uncertain about designs, very uncertain about what stuff was going to ramp and not terribly positive on the outlook. Is something changing there?

Dan Artusi

Well, obviously this business is subject to the variances on the operators and the different suppliers were slightly more optimistic, but we are cautiously optimistic on that. Again, that is a business that consumes a lot of the R&D, so we are modulating the growth and the investment on that basis.

Rob [Brody] – Tudor Investments

Okay. Dan, do you have a window in your office or are you in a cubicle right now?

Dan Artusi

I have a window, but I moved to the second floor so I have the view of the parking lot.

Rob [Brody] – Tudor Investments

Good, good. Thanks very much. Good job on really focusing on cost, we appreciate it.

Operator

Our last question comes from the line of Eric [Rivell] with NPR Securities.

Eric [Rivell] - NPR Securities

Hi, thanks for taking my question. Quickly, depreciation in the quarter?

Dan Artusi

Depreciation in the quarter was $5.7 million.

Eric [Rivell] - NPR Securities

$5.7 million, if I can just sort of follow-up on some of the questions on asset sales on the real estate, not on the real estate side but with respect to the wireless land that was closed last quarter. Is there any progress that you can update us on and whether or not you can realize any sale from any property there from the wireless land?

Dan Artusi

Eric, we are in discussion with several parties on this issue. We can’t comment at this time, but that door is open and we are maintaining discussion with several potential buyers.

Eric [Rivell] - NPR Securities

Okay, thank you very much.

Bruce Thomas

Okay, well thank you very much everybody. We appreciate your participation in today’s call and we look forward to reporting our next quarter results three months from now.

Thank you very much.

Operator

We’d like to thank you for participating in today’s conference. A replay will be available by 7 pm on the east coast. You may disconnect at this time.

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