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Executives

Scott Milligan – SVP and CFO

Kirk Mandy – President and CEO

Analysts

Sandy Harrison – Signal Hill

Brian Piccioni – BMO Capital Markets

 

Zarlink Semiconductor Inc. (ZL) Q1 2009 Earnings Call Transcript July 23, 2008 8:30 AM ET

 

Operator

 

Good morning, ladies and gentlemen, welcome to the Zarlink Semiconductor first quarter fiscal 2009 results conference call. I would like to remind everyone that this conference call is being recorded today, Wednesday, July 23, 2008 at 8:30 AM Eastern Time. I would now like to pass the call over to Mr. Scott Milligan, Chief Financial Officer. Mr. Milligan, please go ahead.

Scott Milligan

 

Thank you, operator. Good morning and thank you for joining the Zarlink Semiconductor fiscal 2009 first quarter results conference call, on this, the July 23, 2008. Our speakers this morning are me, Scott Milligan, Senior Vice President and Chief Financial Officer and Kirk Mandy, President and Chief Executive Officer. Please note that our first quarter results news release was released via our wire service earlier today and is available on our website at www.zarlink.com.

The running order for this call is as follows. I will provide a financial review of the first quarter results and look ahead to the second quarter of fiscal 2009. Kirk will then review the quarter and discuss our plans going forward. We will then open up the call for questions.

I would like to remind everyone that this conference call contains forward-looking statements that are based on our current expectations, forecasts and assumptions that involve risks and certainties that could cause actual outcomes and results to differ materially. For a complete description of such risks and uncertainties, please see the MD&A section of our Form 20F and the reports we filed at the Securities and Exchange Commission.

Before we start, I would like to note that this call is not being hosted by Mike McGinn. Unfortunately, Mike is unable to be here due to illness. We’re hoping for a speedy recovery for Mike and looking forward to seeing him back in the office.

First quarter revenue totaled $60.5 million, an increase of 10% compared with the fourth quarter of 2008 revenue of $54.8 million. We recorded net income of $1.1 million or just less than $0.01 per share, compared with fiscal 2008 fourth quarter loss of $19.1 million or $0.16 per share. First quarter results included a gain of $900,000 related to the sale of land in the United Kingdom and severance and other integration costs related to the Legerity acquisition of $1.4 million. The company also recorded a non-cash foreign exchange loss of $300,000 related primarily to the convertible debenture used to fund the portion of the acquisition of Legerity.

Gross margin in the quarter was 46% which included integration costs of $1.3 million. This compares with gross margins of 45% in the fourth quarter which included integration costs of $1.4 million.

Research and development expenses were $12 million in the first quarter or 20% of revenue. This compares with R&D expenses in the previous quarter of $13.8 million or 25% of revenue which included $500,000 in integration costs.

Selling and administration expenses were $12.4 million in Q1 or 20% of revenue. This includes $100,000 in severance and integration costs, and compares with fourth quarter SG&A expenses of $15.5 million or 28% of revenue which included severance and integration costs of $1.1 million.

To more accurately represent our lines of business, we have recently renamed our major product groups. Revenue from Zarlink’s Communication Products, formerly Wired Communications, was $39.1 million for the first quarter compared with $35.7 million in the previous quarter. The acquisition of Legerity accounted for $23.2 million in revenue in the first quarter compared to $19.9 million in the fourth quarter. Medical Products revenue in the first quarter of fiscal 2009 was $9.2 million compared to $7.5 million in the previous quarter. Optical Products revenue in the first quarter of fiscal 2009 was $6.2 million compared with $4.9 million in the fourth quarter. Custom and other revenue in the first quarter of fiscal 2009 was $6 million. In the fourth quarter of 2008, custom and other revenue was $6.6 million which included nine weeks of revenue from the Swindon Foundry.

Cash and short-term investments at the end of the first quarter were $40.3 million, and restricted cash was $17.3 million. This compares to cash and short-term investments of $42.6 million and restricted cash of $17.3 million at the end of fiscal 2008.

Our opening 90-day backlog at the start of the second quarter for fiscal 2009 was $56 million compared to $53 million at the start of the first quarter. Based on this opening backlog and current visibility on order activity, we are anticipating second quarter fiscal 2009 revenue will be $61 million to $63 million.

Severance and other integration costs are expected to be about $0.5 million. Excluding these integration costs, gross margins are expected to be 47% to 49%. Operating expenses are expected to be approximately $24 million to $25 million excluding amortization of intangibles. Excluding any proxy-related defense cost at any potential impact of foreign exchange fluctuations and the effect it would have on our debentures, we expect second quarter net earnings to be between $0.01 and $0.03 per share.

Yesterday, we announced that Zarlink will be delisted from the New York Stock Exchange as the Exchange had informed us we had run out of time to get the stock price above a dollar. This was not unexpected. We reviewed the situation with a number of our large and small shareholders in Canada and the U.S. this spring. The feedback that we got was that although shareholders would prefer that we stay listed in New York, we should not do a reverse split to maintain the listing. We hope that better financial performance and the stock buyback would move the stock price over a dollar, but we did not do a reverse split based on this investor feedback.

The New York Stock Exchange delisting is expected to have a minimal impact on the stock price. Our U.S. holders indicated that they mainly buy and sell volume of shares in Toronto since there is more liquidity on the TSX than the NYSE for Zarlink stock. In addition, getting off the New York Stock Exchange will reduce our listing cost. With that, I will turn the call over to Kirk.

Kirk Mandy

 

Thank you, Scott. Well, needless to say, it has been an interesting past few weeks but, as the management team and a board of directors, we are confident that we have acted in the best interest of the majority of our shareholders. Well, we don't know the outcome of this proxy vote at our annual general meeting later this morning, before I review the business I'd like to say a few words to our shareholders.

First, thank you. The majority of people we have spoken with over the past three weeks have been supportive of management and the board of directors. Most shareholders do understand that rebuilding Zarlink has not been a trivial task. There had been many difficult decisions and significant changes over the past three years but we have remained focused on building a company that will deliver shareholder value over the longer term. Second, we also recognize that the patience displayed by our shareholders is running short and Zarlink must now deliver. I do strongly believe we are focused on the right markets and have the right people and products in place.

As Scott outlined, revenue and cost are both heading in the right direction while customer demand for new products is growing. Now, it's a matter of execution. Finally, we are always open to input from our shareholders and management and the board of directors will always consider alternative ideas to maximize shareholder value. Today, we believe we have the management team and board in place to succeed as a standalone company. As the competitive landscape changes, that view may change and we will reevaluate our position and consider best options for our shareholders. That said, I remain confident that we have a strategic plan that targets the right markets and is beginning to bear fruit.

As we said in the last conference call, our view is that fiscal 2009 will see a return to profitable growth. First quarter results and our outlook for the second quarter are good indicators that we are on the right track. We are continuing to see growing revenue from new product introductions, in particular from the Legerity voice products and our timing portfolio. Voice will be a growth driver for Zarlink for years to come. While cable and telephone operators go head to head for the consumer dollar, voice remains the most important service in the integrated triple-play telephone, internet and television offering. If you can't deliver high-quality voice, consumers simply will not be interested.

With the acquisition of Legerity, we acquired a market-leading position in voice circuit products required for voice-over-cable and voice-over-broadband applications. Over the past months, we've introduced new solutions as we continue to expand our Legerity portfolio. This includes integrated chipsets that perform all the functions necessary to create a telephone interface from any broadband digital source and diagnostic software that allows service providers to remotely and more economically monitor, test and fix infrastructure issues to ensure quality of service.

This quarter, we also introduced a new family of voice interface solutions for the DSL market. This is a marketplace for growth, particularly in Europe where BT, France Telecom and Deutsche Telecom are rolling out DSL service. The VE890 voice interface chipset allows operators to easily support both voice-over-IP and traditional telephone services. As well, the chipset offers the industry's lowest power consumption. This is becoming increasingly important in Europe where legislation is being considered to reduce power use in telecom equipment. We already have a number of design-institutions for this product with broadband access equipment manufacturers.

We have continued to strengthen our timing portfolio with a particular emphasis on the synchronous Ethernet solutions. Service providers are now starting to include synchronous Ethernet performance in request for proposals. Not only are we leading the development of these solutions, we are also heavily involved in the standards bodies focused on this technology.

In the optical market, we continue to ship ZLynx cables for data center and computer cluster interconnect in volume. We have also taken that expertise and looked at adjacent opportunities, including video surveillance for security and industrial automation applications.

Our Video IP Surveillance or VIPS modules are extremely compact, plug-and-play devices that enable an extended more secure and higher bandwidth connection between remote cameras and control room equipment. Over the past quarter, we showcased this technology with Axis, one of the world's leading video surveillance equipment manufacturers. This is still early-stage technology but with a very minimal R&D investment, we have been able to enter the market.

In the Medical Products Group, we were honored to receive an Electronics Engineering Times Product of the Year Award for our ZL70101 radio chip. This was a true recognition of the innovative leading technology developed by our Medical Products Group, with EE Times calling the product creative technology that sells key performance challenges in a growing market. This chip is used in both inbody devices and associated programming and monitoring equipment, and is shipping in volume to a number of customers. Last week, we announced a shipment of over 30,000 of these MICS modules integrating our ZL70101 MICS chip to St. Jude Medical. St. Jude is using this module in its wirelessly-enabled cardiac defibrillators. If you want a sense of where the medical wireless market is heading, St. Jude Medical have made a number of announcement in recent months about future applications including FDA approval of its home monitoring system and devices that will be implanted in the brain to treat depression.

We have made significant progress in rebuilding Zarlink. I recognize that at times, it has been painful, in particular over the final quarters of fiscal 2008. Following the Legerity acquisition, our goal was to move quickly to provide shareholders with a clearer view of Zarlink moving forward. We are well positioned, our finances are in order, and we intend to be profitable this fiscal year.

Once again, thank you to all of our shareholders for your patience and I look forward to our shared success. Operator, this ends our prepared remarks. Would you please give your instructions to our listeners, so that we may begin the question-and-answer portion of the call?

Question-and-Answer Session

Operator

 

Certainly. Ladies and gentlemen, we will now conduct the question-and-answer session. (Operator instructions) Your first question comes from Sandy Harrison of Signal Hill, please proceed.

 

Sandy Harrison – Signal Hill

 

Good morning, gentlemen.

 

Kirk Mandy

 

Good morning, Sandy.

Sandy Harrison – Signal Hill

 

So, it looks like Legerity grew 16% sequentially in the first quarter, or excuse me, in the most recent quarter and if, Kirk, you could spend a second, I mean – I think there has been some real questions here. When you guys bought it, there was some concern of what you were getting and then, of course, they slowed down after having a couple of customers. But the growth you have shown on the last two quarters is pretty impressive. Where do you think ultimately this business could grow, so asking the question a little differently, with the rate you are running now, is this what we should be launching from or do you think we can still see growth similar to this going forward?

Kirk Mandy

 

Sandy, I think when we made the acquisition, unfortunately, the quarter that we began the integration process, there was a substantial inventory glut that we were not aware of, particularly in the cable voice market. That seems to have worked its way through the system. I think the growth that we have seen in the last two quarters has got us back to a more sort of a quiescent run rate, if you will. We do expect to grow additionally from this base, but I think the growth maybe a little bit more moderate.

Sandy Harrison – Signal Hill

 

Okay, and then just a quick question on sort of listing, I mean the New York – you guys have been on there for a while but there has always been sort of argument that tech companies tend go on NASDAQ, if for no other reason than the interest it gets from different investors. Any thoughts that, as you guys look at your situation of dual listing in the U.S. and in Canada, that you might look at, once you again reach qualification rules, that you might look to the NASDAQ versus the New York or what are your thoughts on that?

Scott Milligan

 

Sandy, it's Scott. It is a little too early to make a call on that. I think we are open to various possibilities on U.S. listing going forward.

 

Sandy Harrison – Signal Hill

 

Got you. All right, I'll pop back into the queue.

Operator

 

(Operator instructions) Your next question comes from Brian Piccioni of BMO Capital Markets. Please proceed

 

Brian Piccioni – BMO Capital Markets

 

Following on to the questions of Legerity but taking a somewhat different angle, if we look at the filings that Legerity had made in preparations for its IPO that never happened, it would appear that Legerity’s revenues remain on a quarterly basis well below what they were roughly around the time when you acquired it. Was there a loss of a large customer or something? I mean, it looks like about 25% of revenues that just sort of disappeared since you bought the company.

Kirk Mandy

 

Brian, I don’t have access to the information you are referencing, but what I can say is when we made the acquisition of Legerity we were looking at roughly $100 million a year run rate with an expectation of 5% to 10% annualized growth. Now, this particular piece of our business behaves a little differently than some of the other businesses we have, in the sense that it does have a proportion of consumer attached to it. As you know, line circuits that are going into cable modems, that are sold in true to consumers through cable television companies like Comcast and so forth, I think the business is solid. It just has different characteristics in terms of run rates, so you get a little more peaks and valleys than some of our other business. But I’m not aware of the information you’re referring to with respect to Legerity’s IPO, so I really can't comment there.

 

Brian Piccioni – BMO Capital Markets

Okay. On the segmentation, you had given us segmentation fairly recently which had the column, custom and foundry. Silly me, I thought that that was mostly foundry and custom related to the foundry, but it seems that there is quite a business there despite the sale of the foundry. Can you tell us what’s involved in that segment please?

 

Scott Milligan

Yes, Brian, it's Scott. Most of the business was custom and a smaller portion was foundry although it varied a little quarter to quarter. It’s predominantly high-reliability ASICs, military and industrial.

 

Brian Piccioni – BMO Capital Markets

So, in effect you're doing custom work on a fabless model now?

 

Scott Milligan

Yes, exactly. Brian, if I could add a little color to that, these ASICs, these are very high-performance ASICs, designed specifically for military applications that have their roots in the old flexi [ph] semiconductor. Obviously, if you’re selling stuff that goes into – let’s call it military systems in the U.K. and other customers in Europe, this product line tends to have fairly long life, but it is not a product line we’re investing in.

 

Brian Piccioni – BMO Capital Markets

All right, thanks for clearing that up.

 

Operator

Mr. Milligan, there are no further questions at this time. Please continue.

 

Scott Milligan

Thank you, operator. Thank you everyone for participating and our next call will be on October 22, 2008, after the close.

 

Operator

 

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating, you may now disconnect your lines.

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