Vitesse Q406 Conference Call Notes

I was strapped into a dentist’s chair (literally) while the Vitesse Q406 call was conducted. I’ve assembled my notes and thoughts from the replay.

My feeling that the market was too pessimistic on cash burn was vindicated. Following the call in July, most believed Vitesse (VTSS.pk) would shortly become insolvent, or at best, require an additional infusion of high-cost capital. The company ended up burning $2.8M in Q4, including $4.9M paid for gumshoe accounting. Looks like next quarter will be a little worse, but nowhere near the $50M burned in the previous six months.

The bondholders seeking to take control of the company extracted their pound of flesh and have gone away, as I postulated. This should not have been a surprise.

Consumption Revenue grew from $52M to $58M. This was a pleasant surprise to me given the weakness in every other Comm Semi sector company. Revenue breakouts per product line were made available in both the Q3 and Q4 call so one can infer the following shift:

• Networking – $27.6M (53%) -> 28.4M (49%)
• Storage- $15.6M (30%) -> $19.7M (34%)
• Ethernet- $8.8M (17%) -> $11.6M (20%)

As much as $6M of this was GaAs EOL revenue, almost all of it most likely from Networking.

In short, I thought this was an extremely positive call that reinforced my Vitesse Investment Thesis. The expansion in Storage revenue while cannibalizing Fibre Channel was by far the best news as it transitions the company to higher margin, higher value products.

My major concerns at this point involve the upcoming restatements, very possibly in the next quarter, and their impact on Inventory values. The cash being expended on outside accounting services is atrocious. It sounds as though these expenditures will increase in the near term, contrary to my expectations that they would decrease. The margin for error in operating cash is low, and still could trigger more outside financing, something I would like to see avoided at all costs.

Notes from the Q3 2006 call can be found here.

Full Disclosure: I am long Vitesse Semiconductor

Detailed Notes.

Shawn Hassel – CFO

• Special Committee activities targeted for completion by end of December ’06, early data indicates that investigation is likely to result in restatements.
• Consumption – $58-60M, Q3 was $52-$54M, revised upward from $50.7M, prev Q’s probably $1M light.
• Cash Balance $25.5M, Q3 was 28.3M, revised downward since reported. Cash burn 2.8M. $4.9M spent on professionals cleaning up the accounting mess (what a waste). $48.3M burned during Q2 and Q3.
• 5-6M of cash used to build net inventory. (Not sure what this means- did inventory expand by 5-6M this Q?). Distribution inventories ‘normalized’.
• Accounts Receivable down by $5.8M. Payables up by $2.2M. Cash interest paid to T-Baum in October.
• Operating Expenses (Not including professional fees) were $33M. Q3 was $35M. Q1 Cash burn dependent on consumption, $1.6M in cash interest, additional professional fees as a result of the conclusion of investigations (MORE NOT LESS?), and monetizing sizable inventory.

Chris Gardner – CEO

• Networking – 49% of sales. Down slightly relative to previous quarter. Not expected to be long term trend. 80 new design wins (this is always data that should be ignored). All top 5 module makers using 10GE chip with EDC for LRM (ie screw you Quake/AMCC (AMCC) ). EOS designed into 8 of 10 Tier 1 vendors.
• Storage – 34% of sales. SAS replacing Fibre Channel. Deal with Promise for Raid on Chip software. SAS growing faster than Fibre Channel declining.
• Ethernet – 20% sequential growth, 20% of business (shouldn’t it be 17%?). 5 & 8 Port switches doing well.
• Exited some GaAs markets. Doing strategic planning.

Q&A worth noting

Chapman - Board using shareholder money to cover their own ass. When can board which likely engaged in illegal compensation activities be replaced? Gardner – Investigation needs to be completed. Until then everything is preliminary. Chapman – Cole is guilty. We will file 13-D with this data. Would be better if board stepped down prior to us filing a 1480.

Kevin W. – GaAs EOL’s accounted for how much? Gardner – Single digit %, should continue for several quarters.

Ben David from CA Amico – Grandstanding question about Jim Cole read from script. Clearly a ploy to make listeners aware of Gigatronics acquisition of Microsource, and the potential conflict of interest he faced.

Another caller mentioning Jim Cole being asked to resign but refusing. No comment from company.

Sale of Fab 2 – No impact on opex.

The call was notable due to the total lack of any questions from sell-side analysts.