Summary of LSI's October 14, 1998 Conference Call.
“What's There to Like?”
Shane: There was nothing whatsoever at the conference call that would even remotely indicate that LSI is one of the Big Boys. To the contrary this is a weak company that is going to have a very very difficult year in 1999 if the United States economy runs into trouble. And yesterday's rate decrease has done nothing to allay those fears. I am providing a detailed summary of the CC as well as my comments. At the very least, it is obvious that at best, LSI is a year away from turning things around. In short, the outlook is far bleaker than even K The Investor predicted.
Present at the Conference Call were: Diana Matley; Wilfred Corrigan; Doug Norby;
Eli Antoun; John Daane,; Bruce Entin; Rick Morris
Started with Diana Matley reading the company's written announcement.
Wilf: Q 1 and 2 gave confidence going into second half. Two major factors started to hurt in July—Asia, which affected the consumer business and telecommunications. Sony, networking, and storage were “OK”. Storage recovered in Aug and Sept. Wilf expects recovery in 4Q but sees relatively flat billings. He doesn't expect ‘99 to be as good as he thought. As a result they are restructuring. Are closing their oldest Japan fab effective 4 /99. Remaining Japan fab will focus on .35. Remaining mixed signal Symbios fab will focus on .5. (Mixed signal fab has longer life than a straight digital fab.) Gresham will be leading edge fab for .25 and .18. Assembly operation in Colorado Springs will be closed. All Colorado Production testing will be moved to off shore. Symbios design centers will be combined with LSI centers. Sales forces already integrated and redundant offices closed. Independent Symbios reps canned with certain exceptions and replaced with LSI in-house sales staff. As a result, revenue from the sales force has increased. Consolidating management systems. Consolidation of Symbios results in a workforce reduction of 17 percent. These actions are taken to get to targeted business model even with reduced sales expectations for the next Q and next year. 43 % is target model for gross margin and includes the lower margin memory system in storage. The business model is 13% R& D and 13 % SG&A. The targeted margin is thus 19%. (Comment: This seems to add up to 17%--not 19%)
Going forward, Q4 will be break even or a small loss with about 425 million in sales. This is primarily due to bringing on stream Gresham. Things will be better in 1 Q. At the end of 2 Q Gresham will be up to full operating efficiency. Second half of 99 is expected to be better. When restructuring is completed, LSI, will be at 80 % capacity. Then LSI will turn to Gresham for further capacity. For future expansion SG&A is in line and R&D is positioned “realistically” relative to sales expectations. World semi sales were expected to grow 15% in '98, but it has declined by 15%. (Comment: Two problems here. First there is no business at .25 micron until the second half of '99, and no business for .18 in '99. Thus, it is debatable as to just how needed Gresham would have been this year. Moreover, after restructuring the 80% capacity mark puts LSI just about where it was at at 1Q this year, except that the margins are lower because of Symbios Storage Systems and the added cost of Gresham.)
Questions from the Analysts
Joe Moore of Goldman Sachs: Your Standard Cell sales in July and August showed underperformance relative to other product categories.. Are you lagging the industry?
Wilf: Industry wide, standard cell sales were down 17% in first half, and LSI was clearly outperforming the industry. Thus, LSI's Standard Cell decline was a “delayed reaction.”
Maybe we got a wrong signal.
(Comment: That's a pretty bad idea to assume that your semiconductor company is immune to the vagaries of the semiconductor market. At 1Q, Wilf mentioned that a lot of analysts were getting “week kneed” with their growth estimates for '98. If anything they were bold. One has to wonder as to whether LSI would have purchased Symbios a month after it did. And while we are on Symbios, let's talk about the true price LSI paid for the company. This price includes lower margins. Now taking a look at lower margins in this newer plan, two CCs ago Wilf was talking about getting back up to 49% by the end of this year. Now with the addition of Symbios, the combined margin is supposed to be hopefully 43%. This means that since Symbios is going to add about 50 % to sales, the margin for Symbios will be 31%--or it means that old LSI is not going to hit 49% margins toward the end of the year as predicted. After you take out the “new” R&D and SG& A of 26%, that leaves a true margin of 5% for Symbios. In short, quarter to quarter, things do not add up. The other idea that appealed to adding Symbios was the need to get to 2 billion in sales, so that you could build next generation fabs or at least modular additions. But it seems that there is virtually no profit coming from Symbios in the near future, and due to the nature of their business, LSI will be keeping open a mixed (analog and digital) fab to account for Symbios' needs
John Daane: It's hard to comment on general market. Different markets go through different things. Impact of late has been telecom market. Certain market economies and price decreases due to competitions are responsible. There is no sign that the standard cell is going away. (Comment: You didn't answer the question.)
Mark Edelstone of Morgan Stanley. What are incremental sales for Symbios in 4 Q? What is absolute level of operating expense in 1Q once restructuring charges are implemented?
Wilf: In 4Q we are looking for reasonably flat situation with old LSI. Symbios will be modestly affected by the take over. Both storage components and systems look good. Will come back better in the new year.
Doug Norby: R&D will be below $70 Million and SG&A will be below $60 million
Carl Boucher of DLJ: Is the total effect between 3Q and 4Q (i.e the difference between this quarter's profitability and next quarter's loss or at best break even status) the start up expense of Gresham?
Wilf : The big expense that we are talking about is Gresham. We are reducing overall capacity by 30%. LSI clearly has to phase the two operations. Will be closing Japan as a current target of April '99. Will be expenses incurred. When you take 700 million dollar operation and bring it on with no revenue output it's a heavy load for 4Q and 1Q , while by 2Q, Gresham will run at a reasonable rate. And by mid-year, Gresham will be at full economic growth. (Comment: Since October of last year we were warned about Gresham, but the bite out of LSI was never estimated to be this high.)
Wilf : The bookings were slow in the quarter. Telecommunication. Lots of the telecom companies talked about the slowness. It's a derivative of Asia. They are putting in backup and a lot of growth has come out of Asia. Delayed reaction to Asia, particularly with the European companies. Consumer decrease was clearly a direct Asia effect. Sony Playstation is actually quite strong but that is a US and Europe market. As things look in October, they have come back to normal.
Terry Ragsdale of JP Morgan (one of the very brightest guys on the street)
Do you think it's fair to characterize the current climate as a week economic situation that will be around for few more quarters. What is basis for your belief that the second half of '99 will be better?
Wilf: Three years is the longest slowdown for the semi industry that he has ever seen. It's particularly unusual against the strong background of the US economy. We have worked out inventory in the system. If you look at unit volume, you see an increase of 35%. And the unit volumes tell what real end demand is. Pricing and overcapacity recession have been prevalent in the semi industry. There has been a gathering of momentum the past three to six months with plant closings. Capacity is both being killed and capacity is dying in place. The industry peaked in late 95 with one generation lasting 18 months. Process technology has moved on two generations, thus capacity is dying in place. We are at that position looking forward to more advanced technologies. In terms of the general economy, we have concerns about a global economy but unit volumes will still continue to grow. Seems to be a conservative consensus of ten to 15 percent growth next year, but it's not that common a figure, since the growth is usually less than 10 or greater than 20 percent. (Comments: Things obviously can get worse, since the US economy is very possibly entering into a recession—indeed those parts of the economy that LSI serves—are very likely in a “recessive growth” period.
Mike Lind for Drew Peck of Cowen and Company:
Why didn't gross margins not detract from the top line? What is the guidance for turnabout in Q1?
Wilf : At the beginning of the year, the order input rate was confirming that we were coming to come to end of slowdown and business was about to pick up but meltdown hurt big time. LSI believed revenues would grow. They are not seeing this work out. Need a business model that is based upon flat sales. Gresham is ready to go to so they can deal with upside surprises in capacity, but they want to be in a position for flat or modest sales. Still want margins in the high teens or low twenties.
Doug Norby. In response to impact of margins. Q2 was running a high rate of utilization, and thus margins were not that strongly impacted. This still applied to Q3, and that is why gross margins were not as impacted.
Mona Urebe of Gruntal and Company: (The lone LSI bull among analysts)
Could you go through the percentage of revenue for each end market post acquisition of Symbios?
Wilf: I can't answer it because things are still in a state of flux . We have now reorganized company into six vertical markets Communications is now into Networking (fastest growing area of company) and Communications. The Computer division is now separate. Storage is divided into two components The chip section is in Colorado. The Storage Systems division is in Wichita Kansas. The sixth division is of course, Consumer. Each division is more than 10 percent of sales but less than 20 percent.
John Daane: The strength of communications in networking and wireless brought this change. LSI expects telecomm to grow more. Storage component for Symbios and LSI is being done on product and customer side. Symbios ASIC in wireless and decoder are being moved to vertical markets. Very good split LSI is in high growth markets. This and intellectual property provide a balanced portfolio. (Comment: This is clearly the man who will be Wilf's successor)
Monica asked a follow up question regarding the Consumers division.
Answer: The Playstation is solid going into Q4. DVD and digital cameras are “OK” but we don't see massive demand that we would like to see. With set top boxes there is some weakness. It's not a market issue, but a loss of a couple of customers. In general Q3 was weak and Q4 will get better. (Hardly the blast off that everyone was expecting including Wilf. OK is Wilf talk for just that--OK.)
Shikahr Whitakahr with Raymond James. Will you be reporting future revenues separately for Symbios?
Answer: No Rather, it will be one consolidated number since we are completely integrating Symbios into LSI.
Wilf also promises that with these six new vertical markets there will be a lot more “visibility into these six markets''
Did Symbios represent about 2/3 of run rate?
Answer: No a little bit more.
Clark Westmont of Nations Bank
Any one client with over 10 percent of the business in old LSI? Also referring to the telecom part of business. Are you seeing other color on telecom side?
No customer over 10 percent including Symbios. But we would have Sony at 10% in old LSI.
Telecom slowdown has to do with preannouncements and a definite slowdown in infrastructure buildouts in Asia South America and Russia. Pretty much across the board in equipment types. Includes wireless equipment structure. There will still be a buildout with Internet. Saw holding back with significant orders in 3Q
Wilf says what might be happening in telecom infrastructure case, the Alcatel, Nortel Ericsons, these companies do not operate on the Dell model. Maybe the telecom people are coming late to the inventory party.
Wilf: you are getting a coming together of companies trying to compete with Cisco, you will see a review of their structure.
Terry Ragsdale again
Help us with next year. You say you can get there 2nd half (To your business model) Do we exit next year(at the business model) or hit it (the business model target) at mid year?
Wilf: A lot of action that we are taking will be in Q4. Office shutdown of plant is happening steadily until April. Gresham has to get up to capacity of first stage and this will essentially see product in late Q1 and late Q2. Target is going into 2nd half to meet business plan. Gun shy about 3Q but hopefully 4Q. Comment; this says that the first quarter in which LSI can reasonably hit its new number is 4Q '99. This says that the best case scenario are very small profits IF the US economy holds up.)
Terry Ragsdale On storage systems side. Does it (storage systems) fit into long term strategy as opposed to silicon side of Symbios?
Wilf: The more we got involved with the business, the more we liked it. It's an OEM business, but we think margins can be improved The strength of the business is that it is architectural based and software base and the architecture flows from the base components all the way from the base component all the way to the end and the software. It's like having a MSFT and INTC integrated in one vertical market
John Daane When you get into SOC what you have to do is get a system that competes. You have to understand the system and how it works. You have to understand the expertise, the end system and how it works, and the design, the intellectual property. The storage system in Wichita provides a lot of visibility. This is a wonderful source of systems knowledge that Symbios semi conductor takes advantage of.(My Comment: Hold on here. You are cutting R&D to 13%, but at the same time you are using the storage system operation in Witchita as sort of a large R&D.
Wilf : We feel they can now implement “armlock on business and implement quickly in next generation technology. Storage is good on both sides of equation'
Question: Terry Ragsdale of Morgan Stanley
Westmont on Alcatel and Nortel. He says broadband is still strong What gives. Is it all an inventory effect.
Daane LSI is leading supplier to transmission part of business As well as infrastructure in other areas. It's an inventory as well as a downturn. Not because of lost designs or loss of business not a throttling back in orders. In the long term, importance of infrastructure and increased bandwidth it will be a good area of growth,
Dan Scovile of Fahnstock. In conjunction with the combined business model what is the geographic split?
Wilf : Geographically we see US as strongest. This continues. Japan has gotten weaker. Wilf is involved with several EDA companies. Vertically integrated Japanese companies are taking business back internally. Background is that quasi company business is sucked back into main semi business. Whereas with proprietary technology it's LSI. Europe has been good this year, next year will be OK despite telecom constituent of business. Telecom has been a steady but growth only in single digits no matter what happens over the years. That's the surprise and that is what Wilf thinks it's inventory He thinks US will be 50% Europe low 20% Japan mid 20s The rest of Asia with strength in consumer was starting to emerge. Now it's lower and belated expectations are for late '99 and ‘00 for consumer products. (Comments: Wilf is probably right about the correction in telcom due to inventory. What is scary is if the US economy keeps heading in the direction in which it is heading, then LSI's problems worsen. Wilf also highlights the problem with his ASIC business in a down market. And that is that a company will keep its prices down by going in house if they need to.)
Asic v non Asic. Starting to meld together Very little of new design is complete ASIC design without LSI adding intellectual property Have a continuum of some of these products evolving into standard products. Standard products are pushing 25 % but a number of those use ASIC technology, but even these are tweaked. Symbios changes this mix slightly with standard products. With Symbios about half of their business are standard products. A lot of the ASIC derivatives had some part of their intellectual property in it as well. The design activity was quite robust in the past quarter fairly low across board with vertical market. With respect to bookings in six new market areas, they are not yet ready to break out the bookings Some of these design evolve into standard product. (Comment: The design wins continue, but design wins are just that—they do not guarantee revenue in a declining semi market. At this price, this company is a tremendous buy. They really are well positioned for the future, but with the US economy about to tank, LSI could actually head to the single digits.)
Mona Urebe
Can you go through capacity by process technology? How does capacity look from point of view of after the business model is met?
Wilf: In terms of overall center of gravity, the predominant volume is .35 which is growing rapidly. With respect to .25 there is some lag with ASIC There is a one year design lag and .25 comes on next year. The mixed signal design is longer for about two more years. We are seeing the one micron to half micron products starting to move down. The plant that is being shut down still produces products from ten years ago The .5 and.6 can be run at the eight inch fab in Colorado. .35 is still dominant in 99 .25 in late 99. (So there is no .18 until '00 at the earliest)(Very interesting remark by Wilf was that companies lag microprocessors by about a year because it takes awhile for companies to put together their designs for LSI to use.)
Chikahr WhitikahrWhere will gross margins settle down to?
Doug Norby Eventually it will be 45%. But we expect to be below 40% next quarter
Additional Comments. The most compelling reason to buy LSI now is the fact that the semi market has been down so long, that there is the probability that the upturn will come sometime soon. But that decline could be even greater and longer, given the fact that this downturn has occurred during a powerful period in the US economy.
The company has almost 180 million dollars in less cash this quarter than next quarter.
LSI will be breaking even the next two quarters IF everything goes according to plan
If the industry grows dramatically, this means that substantially additional expenses will be needed to expand Gresham. That is significantly different than just adding capacity to an existing plant and will mean lower margins
I know that this is a tough business to work with, since it requires significant macroeconomic expertise in light of the fact that the semi business is exacerbated by changes in the global economy, but Wilf and company need to keep that in mind when providing forward looks
This is a company that is reducing its real expenses in R&D not just its percentage expense. Thus, the very model that made so attractive to me—we will spend money to continue our R&D makes it less attractive to me.
LSI has never really gotten to test its SOC as a reality in a strong market
Pick and choose
The reason for owning LSI is that it boils down to the market in semis will turn. That is it. Surely R&D, has produced very little in sales gains to date. It's a company that would have dropped 10 percent in sales. It's also a company that is being investigated by the SEC for the decline in its stock price just prior to the August 18 announcement. Its future is dependent on the development of further design tools, yet the development of those tools is precisely what will increase its competition. The strength of the stock is that it's such a poor cyclical business, that fewer companies will expand capacity in the business. |
