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Conexant Systems (NASDAQ:CNXT-RETIRED)

F2Q08 Earnings Call

April 29, 2008 5:00 pm ET

Executives

Karen Roscher - Senior Vice President and Chief Financial Officer

D. Scott Mercer - Chief Executive Officer

Christian Scherp - President

Analysts

Blake Harper - Signal Hill

Eric Reubel - MTR Securities

Blayne Curtis - Jefferies & Company

Operator

Welcome to the Conexant Systems second quarter 2008 earnings conference call. (Operator Instructions) I would now like to introduce Karen Roscher, Senior Vice President and Chief Financial Officer for Conexant Systems, who will chair this afternoon’s conference call.

Karen Roscher

Welcome to Conexant’s second quarter fiscal 2008 earnings conference call. Joining me today are Scott Mercer, our Chief Executive Officer; and Christian Scherp, our President. Scott will begin today’s call, I will then review our second quarter financial results, Christian will provide a business perspective and review and Scott will return with our outlook for the third fiscal quarter. 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. A reconciliation of core to GAAP measures is included in our earnings release, a copy of which is available on our website at www.conexant.com.

I will now turn the call over to Scott.

D. Scott Mercer

Before I talk about our Broadband Media Processing announcement and our second fiscal quarter financial results, I’d just like to say how pleased I am to be serving our shareholders, customers and employees in this new position. Although I’m still on a steep learning curve, as you would expect, I’m becoming more enthusiastic about our capabilities, opportunities and long-term prospects with each passing day.

At the time of my appointment as CEO, we also announced Christian Scherp’s promotion to President. I’m responsible for our overall strategy, for improving our financial performance and position and, certainly of equal importance, establishing a stable and sustainable capital structure for Conexant.

As President, Christian is responsible for the performance of our business units, our product strategies and roadmaps and our customer relationships and he will also play a key role in communicating our ongoing company story to investors and financial analysts.

Earlier today we announced that we have signed a definitive agreement to sell our Broadband Media Processing, or BMP business, to NXP Semiconductors in a transaction valued at up to $145 million. Under the terms of the agreement, we expect to receive $110 million in cash and up to $35 million in an “earn-out” fee, which is subject to the achievement of certain milestones over the next two years. We expect to close the transaction within the next 60 days.

Over the years, our BMP team has successfully developed and delivered solutions for satellite, cable, terrestrial and IPTV set-top box applications to customers around the globe. Continued success in this business requires an ongoing level of investment that we are no longer prepared to make, which is why we decided to sell our BMP product lines to NXP. NXP has a long history in consumer electronics and they possess the scale, skill sets and resources required to expand the positions we established.

Divesting our BMP business represents a major step in our continuing efforts to restructure our company’s business model and cost structure. In the past four quarters, our BMP product lines generated operating losses of approximately $40 million on revenues of about $200 million. Divesting these product lines will result in immediate improvements in our gross margins and cash flow generation.

We also intend to improve our balance sheet by using the great majority of the net proceeds from the completed transaction to retire debt. As we get closer to completing the transaction, we will provide you with more information on the financial performance and business model we expect from our continuing company. Also expect us to review additional opportunities to further optimize our ongoing businesses and increase shareholder value.

When the transaction is completed, the continuing Conexant will consist of our Imaging and PC Media and Broadband Access product lines. In Imaging and PC Media, we will be focused on providing analog and mixed signal semiconductor solutions targeted at high-volume, high-growth applications that include PC and consumer audio and video, digital imaging and video surveillance.

In Broadband Access, we will continue to deliver DSL products for client-side and central office applications, including residential gateways, as well as solutions for VDSL and passive optical networking. The total available market addressed by our continuing company is greater than $3 billion today and expected to grow over the next several years. We occupy leading positions in multiple segments within this market and we have strategies in place to address opportunities in emerging high-growth sectors.

Like every company in our industry, we face challenges, but we are committed to delivering increased value to customers and shareholders as we move forward. Over the past three quarters, the entire Conexant team has done an outstanding job of reducing expenses. We plan to continue focusing on this area and the results of those efforts to-date are reflected in the financial performance reported today. For the second fiscal quarter, we met or exceeded our expectations on every major financial performance metric.

I’d now like to turn the call over to Karen for a review of those second quarter financial results.

Karen Roscher

Second fiscal quarter revenues of $174 million were better than the high end of the range we provided entering the quarter. Revenues of $197 million in the prior quarter included a non-recurring royalty payment of $14.7 million. Removing the effect of the royalty payment, revenues declined by 4.6% sequentially in a quarter that is typically down 10% to 15% for companies such as Conexant that address consumer electronics markets.

Core gross margins for the quarter were 45% of revenues, in line with our guidance, as well as our relative performance in the past few quarters with the exception of the 50.5% achieved in the first quarter, which included the one-time royalty payment. Core operating expenses of $72.3 million were less than we anticipated entering the quarter and significantly lower than the $80.3 million we reported in the first quarter. This outstanding performance resulted from our team’s ongoing focus on cost reduction initiatives.

Core operating income in the second quarter was $6 million, compared to $4.4 million in the prior quarter, excluding the impact of the non-recurring royalty. Core other expenses declined slightly on a sequential basis to $8.3 million and primarily reflected interest expense related to our debt, partially offset by interest income generated from our cash and investments. Net interest expense declined sequentially primarily due to lower average interest rates during the quarter.

The core net loss for the second quarter was $0.01 per diluted share based on approximately 493 million diluted shares outstanding. Core net income of $0.02 in the prior quarter included the one-time royalty payment, which provided a benefit of $0.03 per diluted share.

Core EPS excluding the effect of the royalty payment was flat sequentially despite the decline in revenue during the quarter of approximately $8 million. This demonstrates the improvements we have made to our business model as a result of the cost-saving initiatives we have implemented over the past several quarters and further supports our goal of driving bottom line profitability that is not solely contingent on revenue level.

As we have discussed in the past, we continue to conduct a thorough evaluation of our business, products and projects, intended to enable us to determine the best way to achieve our long-term goals and objectives. Through this process, we are making a number of decisions regarding our product portfolio and development projects that necessitate a review of our goodwill and intangible. As a result, we recorded an asset impairment charge of $121.7 million during the second quarter, which was primarily related to the write-down of goodwill associated with our Broadband Media Processing product lines.

Now turning to the balance sheet, at the close of the second quarter, our cash and cash equivalents totaled $164.1 million, a sequential decrease of approximately $68 million. This decline was largely due to the repurchase of $53.6 million of our 2010 floating rate senior secured notes, which was consistent with our strategy to utilize the proceeds from the sale of non-core assets to retire debt. We expect that this reduction of debt will lower our quarterly interest expense by approximately $900,000 beginning in the third quarter of fiscal 2008.

During the quarter, we also used approximately $7 million of cash to collateralize interest rate swap designed to fix the interest rates on approximately 90% of our senior secured floating rate notes. We executed these transactions at attractive long-term rates and the resulting fixed rates will make the amount of our quarterly interest expense payment more predictable moving forward.

Excluding the use of cash associated with the retirement of debt and the collateralization of the interest rate swap, cash used by operations during the second quarter was $7 million, primarily driven by our semi-annual interest payment on our convertible notes. Operating cash flow is slightly positive on a year-to-date basis.

Accounts receivable represented 38 days, up slightly from 35 days in the previous quarter. Inventories declined by $5.5 million sequentially to $55.4 million during the quarter and inventory turns improved to 6.9 compared to 6.4 in the prior quarter.

I would now like to turn the call over to Christian for his review of our businesses.

Christian Scherp

I would like to begin by saying I’m excited about my new responsibility, our company’s long-term prospects and the opportunity to become more involved in communicating our story to investors and analysts. I’d like to spend a few minutes talking about our second quarter business and product highlights, focusing primarily on Imaging and PC Media and Broadband Access, which will comprise our ongoing businesses when the Broadband Media Processing transaction closes.

Our foundation Imaging and PC Media product lines accounted for nearly 40% of our total revenues in the second quarter as we had the channel inventory levels approximately flat on a sequential basis. In our PC Modem business, we focused on increasing our overall market share and aggressively pursuing design wins at major OEMs for products that will be introduced later this year. In Digital Imaging, we secured a design win with our next-generation SoC fax solution at a leading fax OEM.

During the quarter, we continue to gain traction with our new audio offerings. The team is concentrating on capturing audio share in notebook PCs at major OEMs and in consumer products that include iPod and MP3 docking stations, speakers, multimedia LCD displays and speakerphones.

We also won audio designs at a top-tier PC OEM and a major PC OEM based in Taiwan. During the quarter, we also collaborated with a world leader in software configurable processors to deliver a reference design in our world’s first eight-channel video decoder for the rapidly growing video surveillance market.

In the second quarter, our Broadband Access product line accounted for nearly 30% of our total quarterly revenues. During the quarter, demand for our highly integrated ADSL2plus CPE Gateway solutions with integrated wireless LAN functionality increased significantly as customers that included Linksys, Siemens, Huawei, ZTE and NETGEAR began to ramp shipments into North America, China, Europe and Australia.

We are also gaining market traction with our latest ADSL central office solution. In China, following a rigorous evaluation period, we received production orders from DTE for our 16-port [Matrix] ADSL central office solution that will be used in multiple DTE line cards. Our teams drove this project to volume production in record time.

Mixed-end designs are also in field trials with other customers in Asia, the Middle East and Western Europe, where our ability to meet lower power consumption requirements is the key competitive differentiator. We expect to continue gaining share with our mixed-end solutions.

VDSL2 subscriber rates continue to accelerate with our central office and CPE SoC solutions powering networks that include AT&T’s [Uber] IPTV service offering in the US, SaskTel’s IPTV deployment in Canada and PCCW’s IPTV network in Hong Kong.

AT&T recently reported that it is on-track to reach its target of more than 1 million [Uber] subscribers by the end of 2008 and SaskTel has now more than 100,000 subscribers. In addition, our client-side VDSL2 SoC solutions are now being deployed in Motorola’s new Netopia 7000 series residential gateways, which are designed to deliver high-speed data and IPTV services over broadband networks.

Our Broadband Media Processing business, which we are selling to NXP, accounted for 32% of our total revenues in the second quarter. This growth was primarily driven by increased demand for our cable set-top box solutions in North America and Korea.

I would now like to turn the call back over to Scott for our third fiscal quarter business outlook.

D. Scott Mercer

Conexant addresses a variety of consumer electronics markets and economic conditions and consumer spending trends have been well documented in headlines around the world. As a result, for the third fiscal quarter, we expect revenues in a range between a $167 million and $171 million. We anticipate that third quarter gross margins will be between 44.5% and 45.5% of revenues.

As a result of one-time executive separation costs, we expect core operating expenses to be in a range between $72 and $74 million. Combining these estimates, we anticipate our third quarter core operating results will be in a range between breakeven and income of $5 million, resulting in a core net loss of $0.01 or $0.02 per share.

Karen Roscher

That concludes our prepared comments today. We’re now ready to open the lines for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Blake Harper - Signal Hill.

Blake Harper - Signal Hill

I just wanted to ask you after some of the moves that you made and I’m looking at the markets that you have going forward, I know you addressed some in your comments, but could you just talk maybe about how you feel about the landscape of what you have going forward and how comfortable you are and when we can expect to see any other changes that could be on the horizon?

Christian Scherp

As we talked about, we are driving our Broadband Access business and our IPM business product lines forward and we are very excited about the opportunities that we see in our audio, video and imaging product lines and of course as well in our modem product lines where we are a market leader, as you all know.

Additionally, we are a market leader or one of the market leaders depending a little bit on the segment in the Broadband Access space and we see exciting growth opportunities here also in several of the segments and these are the segments we’re going to focus on initially.

Operator

Your next question comes from Eric Reubel - MTR Securities.

Eric Reubel - MTR Securities

Karen, could I ask you to frame our expectations around where gross margin could go for the restructured company and what we could expect for a range for core operating expenses?

Karen Roscher

Eric, we will be, as we mentioned in the prepared comments, coming out with those target models here in the very near future. We’re not prepared to discuss those today, but stay tuned because we will be coming out with those well before, by the way, our next earnings call.

Eric Reubel - MTR Securities

Karen, you also mentioned that all of the proceeds from the expected transaction will go towards debt reduction or a majority of those, I think is how you characterized it. As you look out as you consolidate around the Access business, are there acquisitions that you feel you may need to do or if you could talk a little bit about how you feel about the Access product segment?

D. Scott Mercer

I think that clearly look for us to be adding to our product portfolio with some judicious investments and probably around not major companies, but looking at teams and product sets perhaps from other companies that augment our existing product lines, so certainly.

Eric Reubel - MTR Securities

Can you update us on any asset sales that may be in the works away from the set-top box business that was announced today?

Karen Roscher

Eric, from that standpoint, at this point, I wouldn’t say that there’s anything in the same county as the announcement today but we have recently completed the sale of a building in India, for example, that gave us the total between cash received at signing and the actual close that just occurred and $8.5 million that came in as a result of that. So we are continuing to look everywhere again at the non-core assets for opportunity to turn those into cash to use going forward.

Operator

Your last question comes from Blayne Curtis - Jefferies & Company.

Blayne Curtis - Jefferies & Company

In terms of your Broadband Access products, that product line has been flat for essentially five quarters, do you expect to be able to bring this back to growth as well as profitability?

Christian Scherp

As we talked about, we see continued opportunities for us in the video dell space, but particularly also in the gateway space. And these are market segments that are growing relatively significantly at the moment and I think we are very well positioned in these market segments, so those market segments will enable us to grow business in these related businesses.

D. Scott Mercer

I think that I agree with everything that Christian just said, but I think it’s safe to say that this management team now will have maybe a somewhat shorter-term vision and critical eye toward cash flow generation from certain product lines and businesses and we will be looking very hard at all of our product lines for contributions going forward.

Blayne Curtis - Jefferies & Company

And then just quickly back on the real estate, what’s the status of that?

Karen Roscher

Are you speaking specifically about the Newport Beach land? We’re continuing to push the entitlements process. Again, I think we mentioned last quarter that we were hoping to get through that portion of it. Probably the earliest would be September realistically if we’re talking about some time in calendar Q4, which then will give us the full allocation and what we think is the maximum potential value coming out of the land when we are ultimately able to sell it.

Blayne Curtis - Jefferies & Company

Given that the set-top box deal was supposed to close in 60 days, is it safe to assume that you included the whole quarter of worth of contribution?

Karen Roscher

Yes, that’s correct.

Operator

There are no further questions at this time.

D. Scott Mercer

Well, thank you, everyone, for joining us and we look forward to talking to you in future quarters.

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Source: Conexant Systems, Inc. F2Q08 (Qtr End 3/28/08) Earnings Call Transcript
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