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Mindspeed Technologies, Inc. (NASDAQ:MSPD)

F3Q08 Earnings Call

July 21, 2008 5:00 pm ET

Executives

Thomas Stites - Senior Vice President of Corporate Communications

Raouf Y. Halim - Chief Executive Officer, Director

Bret W. Johnsen - Chief Financial Officer, SVP, Principal Financial Officer, Principal Accounting Officer, Treasurer

Analysts

Sandy Harrison - Signal Hill Group LLC

Allan Mishan - Oppenheimer & Co., Inc.

N. Quinn Bolton - Needham & Company

Michael Easson - Merriman Curhan Ford & Co.

Operator

Welcome to the conference call discussing the results of Mindspeed Technologies, Inc. third quarter of fiscal 2008 which ended on June 27, 2008. (Operator Instructions) I would now like to introduce Tom Stites, Senior Vice President of Corporate Communications, who will chair this afternoon’s conference call.

Thomas Stites

On the call today is Raouf Halim, our Chief Executive Officer, and Bret Johnsen, our new Chief Financial Officer. Bret will begin with a review of our third quarter financial results. Raouf will then provide his perspectives on our third quarter and the outlook for our current quarter. And we’ll then open the call for your questions.

Before we begin, I want to remind you that our comments today will include statements relating to our anticipated future results including the financial outlook and expectations for our fiscal 2008 fourth quarter and other market, business and product trends that are forward-looking statements within the meaning of Section 21(e) of the Securities Exchange Act of 1934. These may include statements about trends and expected performance of our business units, deployments and our ability to benefit from them, product features and their benefits, market share, demand for our products, customer relationships and production ramps, the impact of technological developments in our industry, growth prospects in various markets and for various products, design wins and their impact on future performance, our expectations for fourth quarter revenues, gross margin, operating expenses, operating income and cash flow, seasonality, backlog, and order trends and other expected operating results. The company undertakes no obligation to update or revise the forward-looking statements whether as a result of new information, future events or otherwise. Actual results may differ materially from those projected in any forward-looking statement as a result of certain risks and uncertainties including but not limited to those noted in our earnings release and our Form 10Q for the quarter ended March 28, 2008 and other filings with the SEC.

During our call today we will be making reference to non-GAAP financial measures which exclude stock-based compensation expense, employer taxes on stock-based compensation, amortization of intangible assets, employee separate costs, and special charges. For a complete reconciliation of non-GAAP to GAAP financial measures please refer to our earnings press release and our Form 8K furnished to the SEC today. Copies of both documents are available in the Investor section of our website at www.mindspeed.com.

I will now turn the call over to Bret for a review of our financial results for the third fiscal quarter of 2008.

Bret W. Johnsen

Today we announced record revenues for the third fiscal quarter of $38 million, up 5% compared to the prior quarter and up 15% from a year ago. Our results were towards the high end of the revenue guidance range of up 2% to 6% we provided at the beginning of the quarter without the benefit of any patent sales. Revenues from our family of multiservice access voice over IP processors increased 16% sequentially contributing 36% of total third quarter revenues. Revenues from our high performance analog products increased 8% sequentially representing 29% of the total. WAN communications product revenues were down 6% sequentially contributing the remaining 35% of total revenues. In terms of revenue contribution by geography, the Asia Pacific region contributed 66%, the Americas 23%, and Europe contributed 11%. Huawei was our only 10% end customer this past quarter including both direct and indirect sales through third parties.

A Non-GAAP gross margin was $25.8 million or 68% of revenues consistent with our guidance. Included in this number is a 50 basis point benefit from the sale of products written off in fiscal 2001. We had no patent sales this past quarter.

Total non-GAAP operating expenses were $24.1 million comprised of research and development expenses of $13.6 million and selling, general and administrative expenses of $10.5 million. This is consistent with our guidance and resulted in non-GAAP operating income of $1.6 million. Other income and expenses and the provision for income taxes in the aggregate totaled net expenses of approximately $0.5 million. We delivered non-GAAP net income of $1.1 million resulting in earnings per share of $0.05 based on approximately 23.1 million average shares outstanding for the quarter. The number of outstanding shares reflects the 1-for-5 reverse stock split which occurred on June 30 of this year.

Turning now to the balance sheet, our cash and cash equivalents totaled $29.9 million at the end of June. As anticipated we delivered our third consecutive quarter of positive cash flow generating $1.2 million in cash driven by positive cash flow from operations of $3.4 million. Accounts receivables were $17.2 million resulting in net day sales outstanding of 41 days compared to 44 days in the prior quarter. Inventory increased $900,000 to $10.6 million resulting in inventory turns of 4.7, down slightly from 4.8 in the prior quarter.

Lastly, this morning we announced the sale of several non-core patents earlier in the current fourth fiscal quarter for a total of $10 million.

I would now like to turn the call over to Raouf for his comments on our third quarter results.

Raouf Y. Halim

Mindspeed delivered excellent financial performance this past quarter with strong growth from both our multiservice access processor and high performance analog product portfolios. Among the highlights of our third fiscal quarter we achieved record revenues towards the high end of our guidance range. We reported non-GAAP net income of more than $1 million and our third consecutive quarter of positive cash flow ending the quarter with almost $30 million of cash.

Our voice over IP business delivered record revenues again and a third consecutive quarter of double-digit sequential growth. For the first time in our history this past quarter our voice over IP business was the largest revenue contributor of our three product segments. We are especially proud of our results given the supply constraints we struggled with throughout the quarter to meet strong demand for our voice over IP processors and other products. Our supply challenges were primarily associated with tight back-end assembly and test capacity. We were able to mitigate the vast majority of our supply shortages towards the end of the quarter.

I will now cover a few specific business highlights from our third fiscal quarter. Starting with our multiservice access processor portfolio revenues increased 16% sequentially. This business has grown 55% over the past three quarters and is now the largest of our three product segments. Revenues from both our carrier and enterprise voice over IP products grew by double digits this past quarter with enterprise setting another record high. Key voice over IP customers included Huawei, ZTE, Alcatel-Lucent, Nortel, Ericsson, Samsung and Acme Packet amongst others for a variety of converged network applications.

We are encouraged by the significant growth in shipments of our Comcerto processors into GPON based optical access networks in China this past quarter enabling service providers to recognize the cost benefits of fiber based access in high density residential installations in office complexes. China Telecom is currently ramping GPON fiber based networks and we expect they will soon be joined by China Netcom and eventually China Mobile. We believe that we are at the beginning of a multi-year rollout of GPON access networks of a significant scale across China. According to a recent market forecast provided by the research firm IDT, last year China surpassed the US with the largest number of Internet users and it estimates that China’s online population will grow from 275 million users this year to 375 million in 2012.

We believe that optical fiber will become the access technology of choice in other developing Asia Pacific and [BRIC] economies over the next several years and eventually extend worldwide. Our Comcerto processor family is the result of our strategic investment over many years in developing the industry’s leading system on a chip solution specifically targeting the convergence of voice, data and video over IP based access networks. Our Comcerto voice over IP processors are being broadly shipped by the majority of tier 1 OEMs worldwide in a variety of carrier edge and access equipment types. We expect Mindspeed will continue to benefit significantly from these deployments going forward.

During the quarter we announced the addition of Wind River systems to our open mind third party developer program. Wind River will be porting its industry leading VxWorks real-time operating system and Linux solutions to our Comcerto 100 broadband gateway processor family. The combination will offer our customers a complete software rich solution for designing a broad range of systems including residential gateways, enterprise routers and media gateway equipment.

Design win activity was particularly strong this past quarter for our Comcerto voice over IP processors across both enterprise and carrier applications including design wins at Nokia Siemens networks, at Huawei, Ericsson, Panasonic Panacom, UT Starcom, Toshiba and Fiber Home amongst others.

In our high performance analog product portfolio revenues grew 8% sequentially with another record quarter for shipments of our broadcast video products. Key customers for our switching signal conditioning and video products included Alcatel-Lucent, Huawei, Infera, [Everest] and Harris amongst others.

During the quarter we continued to benefit from strength in PON deployments worldwide for both GPON and GPON technologies. We experienced significant strength in shipments of our PMDs to key optical module customers including Sumitomo, Mitsubishi, NEC, Hitachi, Neophotonics, [True Light] and [WTD]. We believe we are continuing to expand our global footprint with PON service providers worldwide.

We also broadened our family of 3 gigabit per second broadcast video products this past quarter with an enhanced single port multi-rate video reclocker and a 4x4 cross-point switch integrating quad channel clock and data recovery. Our 3 gig video products support the double high definition data rates required for next generation broadcast video routing and production switcher applications.

This was another strong quarter for design wins across our high performance analog portfolio with key customers such as Huawei, Nortel, Mitsubishi, Motorola, WTD, Sumitomo and Ikegami.

In our WAN communications portfolio revenues declined 6% primarily as a result of higher-than-expected declines in our legacy ATM products as customers transitioned to IP based solutions. We are encouraged however by the double-digit revenue growth from our Ethernet MAC aggregation products this past quarter which contributed more than 10% of our total WAN revenues. We had strong Ethernet product shipments to customers including Nortel, [Foresten], Sienna and Nokia Siemens Networks amongst others.

Third quarter design wins for our WAN communications portfolio included key customers such as Alcatel-Lucent, Fujitsu, [Kalix], Ericsson and Juniper networks.

In conclusion, I’m proud of our excellent business performance this past quarter.

And now turning to the outlook for our fourth quarter of fiscal 2008. Our backlog is currently stronger than it was at this point during the prior quarter and we are encouraged by the continued strength of our voice over IP business which we expect to more than offset traditional fourth quarter summer seasonality and anticipated ordering trends. As a result we expect fourth fiscal quarter revenues to be up 2% to 5% sequentially. We expect non-GAAP gross margin to be approximately 67% and non-GAAP operating expenses to remain approximately flat sequentially. We anticipate delivering continued positive non-GAAP operating income and positive non-GAAP cash flow. Our fourth quarter guidance is net the benefits of the $10 million patent sale we announced today.

That concludes our formal comments today.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Sandy Harrison - Signal Hill Group LLC.

Sandy Harrison - Signal Hill Group LLC

Just a couple questions on some of the results you had here. I guess the one question is, it sounds like Comcerto is really starting to come into its own and the fact that in your prepared remarks that the design wins are picking up and gathering momentum. What are some of the thoughts behind that? Is there a particular event? Is the converge platform starting to really pick up momentum and is that an industry event? Just would appreciate anything else you could offer us on this.

Raouf Y. Halim

Certainly Sandy. I think what we are witnessing is the increasing adoption of IP based technologies at all levels of the network, not just in the core of the network or traditional so-called Class 4 applications but increasingly in fixed mobile convergence where we are seeing a significant uptick in demand and have reported that previously and more recently in the pickup of next generation networking or NGN for short. That is the phenomenal packet positional services all the way to the subscriber. We’re quite happy with the uptick of our Comcerto processors that are specifically optimized for these next gen applications worldwide and in particular the one event I would point to over the past quarter, maybe couple quarters, is the advent of GPON and the uptick of GPON particularly in China at a very rapid clip. We are very well positioned to benefit from that trend of packetization over fiber optic networks and we expect in fact that the deployment model will pick up dramatically outside of China as well into other parts of Asia, BRIC countries and eventually to Western Europe.

I would only add to that that the benefits we are seeing in terms of production revenue ramp today is with products and design wins we have scored several years ago. They are just now going to production. We have continued to win significant designs with the top tier equipment manufacturers over the course of the last two years and we are in fact experiencing yet another acceleration of design wins at this time as I reported on the call which bodes well for the future of this business.

Sandy Harrison - Signal Hill Group LLC

I guess asking the question sort of a different way, if you look at it, we’ve all been expecting this transition to IP and talking about it, not only you but the industry in general and it just seems like people are being caught by surprise as we’ve started that transition. I’m just trying to figure out what may be causing the re-acceleration out there across the board?

Raouf Y. Halim

I think in our mind it’s really the advent of next generation broadband technologies particularly PON that is precipitating or canalizing this growth in packetization. I think if you go back in time and look at prior broadband technologies, be it DSL, be it cable, be it wireless, they were really first generation broadband technologies. The next gen which is all optical is really optimized from the ground up for convergence and the cost points have just now finally gotten to the point where you’re seeing GPON fiber optic access become deployed quite broadly not only in Japan but also in China and increasing in other parts of the world. So I think it’s really the combination of the next gen broadband access technology and the cost economics associated with it.

Sandy Harrison - Signal Hill Group LLC

My last question is sort of the tale of two cities, that’s the new and you had made comments that ATM fell off. Is this something that just as the ramping of the next generation networks comes up this is the last gas for ATM or is this just one specific customer or two specific customers or is this just more of the general trend on the older technologies?

Raouf Y. Halim

If I remember correctly last quarter I think it was associated with one or two specific customers. We continue to believe that the WAN business over the long term will be sort of flattish for us and what will bring that about is clearly growth in Ethernet based carrier technologies. As of course you remember we acquired the assets of Ample Communications late last year. We were supply limited in the Ethernet product line and were unable to satisfy all our customers demand for WAN Ethernet products last quarter and hence were not able to offset that incremental ATM decline. I wouldn’t call it a very significant event but simply say that ATM is sort of on a long-term secular decline and Ethernet is clearly on a long-term secular growth within carrier and enterprise networks. We’re positioned to benefit from that very nicely going forward.

Operator

Our next question comes from Allan Mishan - Oppenheimer & Co., Inc.

Allan Mishan - Oppenheimer & Co., Inc.

Quick housekeeping item. Would you expect to include the $10 million in your pro forma results next quarter or would they be excluded?

Bret W. Johnsen

We will include them in our pro forma results but we will call them out specifically so that you’ll easily be able to separate them from the ongoing business.

Allan Mishan - Oppenheimer & Co., Inc.

Raouf, you talked a lot about the China Telecom E-PON business. How is voice over IP tied to that? Are there voice over IP products directly in that PON equipment or is it simply a case where when they put the PON equipment, they have to put voice over IP equipment in together at the same time?

Raouf Y. Halim

To answer your question specifically, the GPON styled deployments today in China as well as in many other parts of the world are not necessarily fiber to the home meaning a GPON device, sometimes known as an ONT or an ONU at the customer prem, but it’s really GPON optical access to the basement or to the floor of a very high density multi-tenant or multi-dwelling unit or for short MTU or MDU. So basically fiber is strung straight to that installation and then distribution from the end point, which once again could be in the basement or let’s say in the closet on a particular floor in a high density apartment building, the interconnect from there to the actual subscriber prem is done either over DSL connection or very simply Ethernet 10/100s or in a few cases gigabit Ethernet straight to the prem. So packetization of all the data and the voice traffic is done in the box. It’s a single box that contains Mindspeed silicon as well as possibly another vendor’s GPON type of technology. The types of equipment that I would call your attention to would be things known as IP [D-slams], IP [pizza] boxes, or Ethernet [pizza] boxes, integrated access devices and the like. It’s a broad range of types of equipment that basically terminate an optical fiber and packetize all the services within that one box.

Allan Mishan - Oppenheimer & Co., Inc.

So your silicon then would be found next to a PON MAC or something of that nature in the ONU within the building or on the floor?

Raouf Y. Halim

Yes, in many cases it would be. In other cases it might be imbedded in IP D-slam where there is only one PON MAC in that line card and distribution is done over DSL to the customer prem.

Allan Mishan - Oppenheimer & Co., Inc.

But the short answer to my question is that you would be included directly when that deploys? It’s not some sort of secondary benefit that you’re receiving?

Raouf Y. Halim

No, it’s a one for one.

Operator

Our next question comes from N. Quinn Bolton - Needham & Company.

N. Quinn Bolton - Needham & Company

Raouf, just wanted to sort of follow up on Sandy’s question about the legacy WAN communications. It sounds like the aggregate Ethernet aggregation or the Ample business is ramping pretty nicely. But if I recall, most of that business is legacy ATM or SONET. If we look forward a few quarters or years, is it best to just kind of model that flat as the Ethernet business grows and that should be strong enough over that time period to offset the decline in the legacy business?

Raouf Y. Halim

Yes. The percentage of our WAN business that’s really ATM is far less than half. I don’t have the number in front of me but I think it’s definitely less than 30% of that business at this point and it continues to gradually ramp down. The Ethernet business had a record quarter last quarter. In fact it was over 10% of total WAN revenues. So you’ve got a cross-over effect where Ethernet continues to grow and ATM continues to decline, and I think it’s probably quite a fair assumption looking out year-on-year to model the WAN business as flattish. It may have some fluctuations quarter-to-quarter either up or down but on an average let’s say year-over-year, it should be flattish.

N. Quinn Bolton - Needham & Company

And then it’s the rest of the WAN comm just sort of more traditional SONET T/E carrier type devices and if so, what will your outlook for that other 60% roughly be?

Raouf Y. Halim

The balance of the WAN portfolio has a mix of T/E carrier, T1/E1 products but also T3/E3 where there is real market growth driving it and we have a very strong position to T3/E3. Also HDLC controllers that are found at the core of the network primarily packetizing wireless data traffic. As I’m sure you know that’s an explosive market place where the degree of data traffic increases over mobile networks. And also of course next gen network processor and other type products that we are rolling out as we speak. So we have growth within the product lines within WAN and we also have product lines that are declining. Most markedly I would say the Ethernet products are growing very rapidly and we’re quite excited about the growth prospects for that market place.

N. Quinn Bolton - Needham & Company

If I look in aggregate, it sounds like the ATM is probably the business within WAN communications that may be under the most pressure from a secular perspective. T1/E1 may be under pressure but you’re seeing growth in T3/E3 and HDLC and then obviously the best growth in the Ethernet aggregation business?

Raouf Y. Halim

Yes. That’s a very good characterization of it.

N. Quinn Bolton - Needham & Company

And a similar question for the HPA business. Obviously the broadcast video has been at record levels now for a few quarters. It looks like the PMD business is doing well. Any sense for the more legacy cross-point switch business? Is that still something you think is a growth business or HPA growth really going to be from the PMD and the broadcast video?

Raouf Y. Halim

Actually our cross-point product line has been refreshed recently with 6.5 gig products and also 4x fiber channel for 4.4 gig products. They’re doing extraordinarily well for us at this point in the game. So we do not perceive the cross-point switch product line as legacy by any stretch of the imagination. It’s doing very well for us. The end markets that our cross-point switches address certainly include telecom but also enterprise switching, storage, blade servers, and even digital video systems. So there’s a broad range of end markets for our cross-point switches that we have addressed very efficiently with those products. We experienced growth last quarter with our cross-point switches. We expect that to continue to be the case going forward. Bottom line is that there’s really very little legacy total in our high performance analog or HPA portfolio.

N. Quinn Bolton - Needham & Company

And then just a last clarification. Non-GAAP gross margin of 67% is net of or excludes any impact for the $10 million sale of the non-core IP patents?

Bret W. Johnsen

That excludes any benefit from the patents.

Operator

Our next question comes from Michael Easson - Merriman Curhan Ford & Co.

Michael Easson - Merriman Curhan Ford & Co.

One quick question on the Comcerto 100 opportunities. You alluded to a partnership with Wind River Systems. Can you comment on some of the design win activity there in the residential gateway markets and do you think we can see material revenue from that product line in the second half of 08?

Raouf Y. Halim

The Comcerto 100 processor is a platform that is very exciting for us. We have actually quite a large number of design wins with that product with customers serving the broadband home gateway market. Those design wins are both within Japan addressing NTTs network but also outside of Japan. Based on the visibility we have right now from our customers for those design wins we expect production to ramp with the Comcerto 100 either late this year or early 2009. The end applications would be once again a broadband home gateways but also WiMAX access nodes, enterprise routers, DECT which is Digital European Cordless Telephone applications, and a whole host of other platforms of that yoke.

Michael Easson - Merriman Curhan Ford & Co.

Could you discuss the margin profile for that product? Will it be a drag on overall gross margins?

Raouf Y. Halim

I don’t think we’ve broken out that product specific in terms of its gross margin. I think what we have said historically is that the gross margin for the Comcerto 100 is of course a little less than the blended gross margin of the company which as you know is an underlying 65% at this time; a little bit better than that last quarter. But we also expect that we have other product families ramping at the same time as the Comcerto 100 ramps that enjoy much higher gross margin profiles. So at a company level we’re not too concerned about that.

Michael Easson - Merriman Curhan Ford & Co.

If I could jump over to China for a second, there’s been some commentary and speculation that order patterns in the coming months may be a little lumpy going through the Olympics. Is there any evidence of that in what you’re seeing?

Raouf Y. Halim

Clearly the Olympics are very much factored into our guidance for this current quarter. We have thought about it quite a bit. We’re very plugged in to expectations for the China Olympics in our current fourth quarter. Basically what we believe is happening right now Mike is that there is a temporary pause in deployments or let’s call it installations during the Olympics. However the temporary pause is limited to the eight Olympic cities and that the overall impact that will result is going to be very, very small. We expect continued strong deployments of the GPON based fiber access technology as well as the broad range of our portfolio in China in this quarter as well as of course elsewhere. We have a very strong backlog at this point in China and we expect good business in China this quarter despite the Olympics. We do expect there to be quite a bit of pent-up demand once we get past August.

Operator

We have no further questions at this time.

Thomas Stites

That concludes our conference call today. On behalf of all of us at Mindspeed, thank you for participating this afternoon.

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