Microsemi Management Discusses Q2 2013 Results - Earnings Call Transcript

Apr.25.13 | About: Microsemi Corporation (MSCC)

Microsemi (NASDAQ:MSCC)

Q2 2013 Earnings Call

April 25, 2013 4:45 pm ET

Executives

Terri Donnelly

John W. Hohener - Chief Financial Officer, Chief Accounting Officer, Executive Vice President, Treasurer and Secretary

James J. Peterson - Chief Executive Officer, President, Director and Chairman of Executive Committee

Steven G. Litchfield - Chief Strategy Officer and Executive Vice President

Analysts

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Michael C. Lucarelli - Evercore Partners Inc., Research Division

Richard Sewell - Stephens Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Microsemi Second Quarter Earnings Call. [Operator Instructions] I would now like to turn today's call over to Terri Donnelly, call coordinator. Please go ahead.

Terri Donnelly

Good afternoon, and welcome to Microsemi's earnings conference call for Microsemi's second quarter of fiscal 2013. I am Terri Donnelly, coordinator of this call. In a few moments, you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer; of John Hohener, our Executive Vice President and Chief Financial Officer; of Steve Litchfield, our Executive Vice President and Chief Strategy Officer; and of Paul Pickle, our Executive Vice President, Integrated Circuits Group.

A recording of this conference call will be available on the Microsemi website under the Investors section. Our website is located at www.microsemi.com.

Microsemi issues guidance in the form of a limited business outlook on our expectations for the next quarter. This business outlook reflects our expectations as of April 25, 2013, and is continually subject to reassessment due to changing market conditions and other factors, therefore, must be considered only as management's present opinion.

Actual results may be materially different. However, management undertakes no obligation to update these or any forward-looking statements, whether as a result of new information, future events or otherwise. If an update to our business outlook is provided, the information will be in the form of a news release. We wish to caution you that all of our statements, except the company's past financial results, are just our current opinions, predictions and expectations. Actual future events or results may differ materially.

For a review of Risk Factors, please refer to Microsemi's report on Form 10-K for the fiscal year ended September 30, 2012, which was filed with the SEC on November 21, 2012, and our latest Form 10-Q, which was filed with the SEC on January 29, 2013.

With that said, I'm going to turn the call over to John to discuss our financial results. And then Jim will address our end markets and overall business strategy. Here's John Hohener.

John W. Hohener

Thank you, Terri.

Net sales for the quarter ended March 31, 2013 were $235.3 million, booking strength in our last quarter, resulting in a book-to-bill ratio greater than 1:1. And as such, Microsemi expects that net sales in the third quarter of fiscal 2013 will increase 2% to 4% sequentially. As discussed last quarter, we took a number of cost reduction actions. We initiated restructuring programs at several facilities, resulting in reduced headcount and related expenses.

Our GAAP and non-GAAP gross margin was 56.7%. Gross margin sequentially decreased 90 basis points due to absorption and unfavorable mix. However, gross margin increased 170 basis points over the prior year even when measured against lower revenue. This demonstrates execution on our cost reduction efforts. We expect gross margin to be between 56.7% and 57.3% next quarter, driven by continued cost reductions and consolidations implemented in the quarter and expected increase in revenue.

This quarter, non-GAAP selling, general and administrative expenses were $41.6 million, a sequential decrease of $1.1 million. For the third quarter, we forecast that SG&A expense will decrease as a percentage of revenue by 100 to 130 basis points due to continued cost controls.

Research and development costs were $42 million compared to $43.2 million in the prior quarter, a decrease of $1.2 million. We remain committed to new product development and will invest R&D dollars in our core strategic initiatives. That said, for the third quarter, we forecast R&D expense to decrease as a percentage of revenue by 10 to 20 basis points.

Our non-GAAP operating income was $50 million or 21.2% of sales, compared to $56.7 million or 22% -- 22.9% of sales in the first quarter of 2013. We recorded $8.2 million in non-GAAP interest and other expense compared to $8.3 million last quarter. During the second quarter, we amended our credit facility, lowering the interest rate on our term loan to 3.75% and extending the term loan maturity date to February 2020. Subsequent to the end of the quarter, we initiated an optional term loan principal payment of $27 million that brought the principal balance outstanding on the credit facility to $699 million, down from a high of $850 million.

As a result of the principal payments and the reduction in interest rate, we expect interest and other expense to decline approximately $700,000 next quarter.

Non-GAAP net income was $38.9 million or $0.43 per diluted share. The company expects third quarter non-GAAP earnings per diluted share to be between $0.47 and $0.50. Our non-GAAP effective tax rate for the quarter was 7%. Next quarter, we expect the same.

For the second quarter, we recorded GAAP operating income of $11.8 million compared to $25.5 million last quarter and $11.1 million recorded a year ago. We recorded GAAP net loss of $2.9 million compared to GAAP net income of $14.2 million last quarter, and a net loss of $4.8 million reported a year ago.

For the second quarter, our GAAP results included non-cash expenses of $21.1 million in amortization, $10.2 million in stock-based compensation; $3.3 million in debt extinguishment cost and $6.8 million in restructuring, including headcount reductions and related severance charges and other expenses.

The noncash debt extinguishment charge will result in lowering of amortization charges from approximately $345,000 a quarter to approximately $160,000 a quarter in the future. We estimate that third quarter stock-based compensation expense will be between $10 million and $11 million.

Capital spending was $9 million, compared to $8.5 million in the prior quarter. Next quarter, we expect capital spending to be between $10 million to $12 million. Depreciation and amortization expense was $28.3 million compared to $29 million in the prior quarter. Accounts receivable was $158.4 million compared to $159.4 million at the end of the first quarter. Inventories were $162.7 million compared to $158.9 million at the end of the first quarter.

DSO increased to 62 days from 58 days due to end-of-quarter customer expedites. Days of inventory increased to 144 days as a function of lower revenue and increased build activity to support second half demand requirements. Our goal continues to be 125 days.

We ended the quarter with a cash balance of $206.9 million, and our operating cash flow was $31.9 million. As I mentioned earlier, subsequent to the end of the quarter, we prepaid $27 million in principal on our term loan. Our best estimate of the end market percentage breakout of net sales for the second quarter was approximately: communications, 27%: defense and security, 34%; aerospace, 19%; and industrial, 20%.

With that, I will turn the call over to Jim Peterson.

James J. Peterson

Okay. Thank you, John. With that, let's get our end markets.

Let's start off with communications, where our revenues were down about $12 million sequentially and accounted for 27% of the total business in the March quarter.

Looking at the results, we saw seasonal declines compounded by slower macro environment. PoE, power management, RF and voice circuit product lines were down in the quarter, while timing and sync remained steady. As John related earlier, bookings rebounded in the quarter and strengthened throughout the end of March. As we look into the June and second half of the calendar year, we expect to return to growth.

In our timing and sync products, we see indications of a stronger second half, as our customer visibility has improved. In PoE, we expect to grow, driven by seasonality, market share gains and expansion into small cell markets. In RF, we put capacity in place and are beginning to deliver early-stage shipments to our customers.

Defense and security end markets. Revenues here grew 5% sequentially to $79.4 million, accounting for about 34% of total revenue. Billings in the March quarter benefited from 2 major missile defense programs that are now in the procurement phase, driving upside to the results. And the success of this end market is a function of the fact that Microsemi is more valuable than ever to our end customers. As we execute on our total solution approach to the market, we are winning higher-value engagements and executing in a difficult market. To be short, this is a strong, growing, cash-generating business.

Aerospace accounted for 19% of revenue and declined $4 million sequentially to $44.2 million. Within the end market, longer lead times base-level revenues remained softer, yet bookings continued to grow nicely in March. Based on bookings strength for the last 3 quarters, we expect strengthening in our Aerospace end markets and return to growth in the June quarter.

Our industrial end markets grew 1% sequentially to $47.3 million in the March quarter, up about 1% sequentially and benefited from some customer-expedited requests to drive the positive sequential results. With the exception of the solar markets, bookings were also strong throughout the quarter, benefiting from the steady medical contribution and improving bookings in semicap, industrial lasers, MRI and other broad-line industrial applications.

With that, let me sum up in saying that the March quarter has certainly given us increased confidence as our book-to-bill ratio moved above 1:1, reflecting our customers' increased visibility. Profitability benefited from the cost control measures we implemented throughout Microsemi, and we saw an accelerating trend in bookings for Microsemi total solution market approach. We look forward to growth in June and the second half of 2013, as we continue to execute on our strategies.

With that, I thank you for your interest and support, and we'll now take questions from our analysts.

In the interest of time, please limit yourself to 1 well-thought-out question, and if necessary, a brief follow-up. Susan?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Steve Smigie with Raymond James.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

I just wanted to talk about the defense and security business, obviously very strong. Can you talk about your success relative to sequestration? We've heard a number of other folks out there are getting hit on, say, the federal side, but you guys are doing well. Is this you guys getting share? Do you think it's just you're getting onto new programs that didn't exist before? You've been saying all along that this is going to turn out well, but can you help give color on why you're so successful?

James J. Peterson

Yes. We've been talking for almost a year now about the great uncertainties with sequestration. And I think the important part is that a lot of this uncertainty is starting to subside. We have been very successful early on in identifying programs and teaming up with our customers. Essentially, we had strong shipments in the March quarter, right? Missiles, defense system and Raytheon's PAC missiles and THAAD missiles and the like were very strong. As far as military sales, as we said would, are continuing to strengthen. At Microsemi, we have tremendous new solutions, right? And we have more dollar content per platform. And probably the biggest thing we've been talking about is the electronic content is growing 4% in the U.S. and 7% worldwide. So for us, sequestration has actually turned out to be a benefit.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Okay, great. And just as a follow-on, you talked about building some inventory for the back half strength. Is that related to solutions for handsets or is that something else?

James J. Peterson

Yes, across the board. We're seeing strong customer demand. I read what's going on and hear what's going on in the market, but we are seeing our customers have strong demand, and we're building to their demand.

Operator

Your next question comes from the line of Rick Schafer of Oppenheimer.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

I know it's kind of tiresome to you, but you guys get the question a lot on sequestration. I know Steve just asked one. I'm just-- is there any way to quantify, I guess, some -- put some dollars to some of these programs you're on or talk about the potential? Because clearly, you guys don't seem to be seeing what everybody else is seeing out there, what a lot of your peers or customers are seeing out there.

James J. Peterson

Yes. There's markets that we historically have not been able to play in that we're playing in today, newer platforms, stronger platforms, across-the-board in defense market space. And the security market space. We were the first to move on anti-tamper. We were the first to move in hardware and software for anti-tamper. And those investments and those technologies, including some of the Millimeterwave investments that we've done, across-the-board in the last 3 years, Microsemi's manager team, we shifted. We saw this coming. I'm sure if you're an air traffic controller, you had no idea what sequestration was 3 months ago. We had the benefit of seeing it coming. And quite frankly, applause to my management team, we modified our business plan to excel in the sequestration.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

And you're not seeing some of the -- you know how this channel can get kind of squirrely when everybody is kind of scared right about the unknown or how uncertain -- what the effects might be of sequestration, so order patterns can get kind of funny or guys pay late or whatever. I mean, you're not seeing that sort of...

James J. Peterson

There's a lot of that going on. There's a lot of lumpiness, there's a lot of questions. But probably the biggest bullish thing to tell you what's going on in the market space is this budgeting sequence in cycle, which everybody's seeing. We read it in the paper. We see what's going on. And then there's -- quite honestly, there's a spend, and the spend is always spent upon the threat, not necessarily the budgeting. So that offsets a lot of the uncertainty here.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Got it, got it. And do you think -- I mean you guys did a great job last year. I think you grew defense almost 10%. I mean does that -- can you repeat that this year or come close, do you think?

James J. Peterson

Well, my guys will cringe. I think I could beat it.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

I didn't figure. What was it that you said, Jim?

James J. Peterson

I said my team here will cringe, but I personally think we're all set my goal to beat it.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Okay. And then can I ask just a quick follow-up. It sounds like you sell somewhere to pull-ins in industrial. Was that specific to the industrial segment or did you see pull-ins in any of your other businesses?

James J. Peterson

Well, we kind of modified the word "pull-in" to customer expedite, so you don't think I'm just pulling in to make a number. And strangely enough with semicaps.

Operator

Your next question comes from the line of Tore Svanberg with Stifel.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

This is Erik calling in for Tore. Maybe just circling back with what you said in your prepared remarks. Obviously defense and security continues to amaze people. You're up 5%. You talked about 2 major defense programs that are now in procurement phase. Can you just give us an idea of the order of magnitude that those are just so we have a sense of that?

James J. Peterson

Well, they certainly tipped the scale to the 5% upside sequentially, and these are long-in-the-tooth kind of projects. These are not programs that come and go in a quarter. These are not consumer kind of projects that come and then leave you disappointed. These are long, sticky, long-in-the-tooth kind of programs. I expect strengthening in those programs and then additional new programs over the next 3 to 7 quarters.

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And then maybe, just talk about your model again. You in the past mentioned a 60-30 model, and I think you lowered the revenue range last quarter to $280 million. Are you still on track to achieve this? I think you previously talked about 4 quarters or so to get there during your last earnings call. Can you just maybe update us on that?

James J. Peterson

Just to be clear, we said 60-30, and we said on or about $280 million. John, I don't think we have modified that at all, have we?

John W. Hohener

No, no, I think that is the right answer. So whenever you get to $280 million, that's when we should be seeing that. We continue to strive to hit that, to get to that point in terms of some of the cost-cutting we've done, some of the efficiencies we put into the manufacturing operations. There's still some consolidation to come that's going to help us in that number. That's why we essentially guided up gross margins this next quarter as well, midpoint being 30 basis points. So we feel quite comfortable. The other thing to remember is that we are increasing gross margin on lesser revenue now due to the cost cutting that we've done and also the programs that we're on, higher-margin programs.

Operator

[Operator Instructions] Your next question comes from the line of Patrick Wang with Evercore.

Michael C. Lucarelli - Evercore Partners Inc., Research Division

It's actually Mike. Could you guys talk a little bit more about those second half demand requirements that you talked about in your prepared remarks?

James J. Peterson

As far as the expedited component from industrial or...

Michael C. Lucarelli - Evercore Partners Inc., Research Division

I think about the inventory. John talked about some higher inventory for your second half demand requirements?

James J. Peterson

Yes. Well, let me turn to Litch. He's sitting here and he has a big smile on his face.

Steven G. Litchfield

Well, I mean, I think there are -- we talked a little bit about visibility and some of this uncertainty going away. I mean, a lot of that is driven by very specific programs that we know are ramping, that really are uncertain at this point. And Jim has talked a lot about the size of these. I mean, the size of them are increasing. And these are very complex products that we haven't addressed in the history of the company, and so that's exciting. And what's really great in this market environment is just to be able to be sure about a lot of the revenue growth that we're going to see in the second half due to specific programs that are ramping, we don't have a lot of this. Well it depends on what the order rates are around this particular thing or that. These are much bigger customers, longer-term programs that we've been working on for a couple of years now.

Michael C. Lucarelli - Evercore Partners Inc., Research Division

All right. So it sounded like a more incremental business than business that was down the first half.

Steven G. Litchfield

Yes.

Michael C. Lucarelli - Evercore Partners Inc., Research Division

Okay. Could you talk about the growth expectations by segment, maybe rank order them for us?

James J. Peterson

You know what, every time I do that rank ordering as what's going to be strongest, I have a better chance picking the superfecta of the Kentucky Derby. So it looks a little different. Let me just give you a little color. First, in the 4 areas: communications, defense and security, aerospace and industrial, next quarter, we expect them all to be up, okay. Which one comes in first, second, third, fourth, I don't know. We'll find out at the end of the quarter. But let me just give you a little color instead, right? Communications, bookings are up and strengthening pretty much across-the-board. Defense and security, I think we maybe beat that horse to death. That's a very strong market for us, and the tide has turned to our favor and our shareholders' favor. Aerospace, space products have been up. We expect that market to be up. We have solid bookings and strengthening bookings. And then across-the-board industrial, broadly across the board, strengthening there as well.

Michael C. Lucarelli - Evercore Partners Inc., Research Division

Fair enough. And then I guess, one last question. On your free cash flow, it's still short of the goal. When do you think you'll hit the target level for free cash flow?

James J. Peterson

That's a good question. John?

John W. Hohener

Well, certainly, with the revenue going down, we did have a little use of cash in terms of building inventory. We also went through a restructuring, so we had to pay out some severance and things like that. We're certainly guiding operating cash flow between $45 million and $50 million next quarter. It gets us back on our track and what we have said about $200 million for the year kind of an operating cash flow number. Free cash flow, of course, is a factor of our CapEx. And we're currently in a range of between $9 million and $10 million a quarter on that.

Michael C. Lucarelli - Evercore Partners Inc., Research Division

And if I can sneak one more in. Gross margin in the back half of the year, should we expect more expansion?

John W. Hohener

Certainly with the revenue growth that we're expecting, we should see more expansion.

Operator

Your next question comes from the line of Richard Sewell with Stevens.

Richard Sewell - Stephens Inc., Research Division

I guess I'll jump in on the timing products. You saw fairly stable in the March quarter and then you expect it to increase in the June quarter, and it seems like beyond as you're seeing visibility there. Can you talk a little bit about that and what's driving the growth in that segment?

James J. Peterson

I feel like last quarter. I think we're gaining share. We're gaining share and, to be sure, the carriers are spending larger dollars. I think we've got a lot of new products. We have probably the strongest product offering out there. And it's a market share gain, and we're winning.

Richard Sewell - Stephens Inc., Research Division

Great, guys. And then looking at the cash position going forward, are you going to use the cash flow from ops to pay down debt? Or would that be -- would you use that possibly and maybe write some debt to fund M&A? How should we look at that?

James J. Peterson

I don't think I need debt to fund M&A at this point. We're looking at -- if we're in the M&A area, we're looking for not necessarily small but strategic, technical M&A activity, so nothing as large as we've done within the last several years. But right now, we're focused on just what we're doing, which is deleveraging, which we told our shareholders we will do.

John W. Hohener

Yes, and just to remind everybody that we did commit $100 million to pay down our line in this fiscal year. With the last $27 million that we did this quarter, we are now at $23 million in order to hit that target.

James J. Peterson

So we're on schedule.

Richard Sewell - Stephens Inc., Research Division

And do you expect that in the June quarter?

John W. Hohener

We'll pay down the $27 million in the June quarter.

Operator

We have reached our allotted time for questions. At this time, I would now like to turn the call back over to Jim Peterson for any closing remarks.

James J. Peterson

Well, just to be short, thanks for joining, and have a great day.

Operator

Thank you for participating in today's conference. You may now disconnect.

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Microsemi (MSCC): Q1 EPS of $0.43 beats by $0.03. Revenue of $235.3M beats by $2.34M. (PR)