Microsemi Management Discusses Q4 2013 Results - Earnings Call Transcript

Nov. 7.13 | About: Microsemi Corporation (MSCC)

Microsemi (NASDAQ:MSCC)

Q4 2013 Earnings Call

November 07, 2013 4:45 pm ET

Executives

Terri Donnelly

John W. Hohener - Chief Financial Officer, Executive Vice President 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

Paul Pickle - Executive Vice President of Integrated Circuits Group

Analysts

Harsh N. Kumar - Stephens Inc., Research Division

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

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

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

N. Quinn Bolton - Needham & Company, LLC, Research Division

Christopher J. Longiaru - Sidoti & Company, LLC

Mark Delaney - Goldman Sachs Group Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Microsemi's Fourth Quarter and Fiscal 2013 Earnings Call. [Operator Instructions] I would now like to turn today's conference over to Terri Donnelly, conference call coordinator. Please go ahead.

Terri Donnelly

Good afternoon, and welcome to Microsemi's Earnings Conference Call for Microsemi's fourth 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 November 7, 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 July 30, 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 September 29, 2013, were $250.4 million. Book-to-bill was greater than 1, driven by orders for longer lead time products. As a result of some timing uncertainties surrounding the recent government shutdown and ongoing customer cautiousness, Microsemi currently expects net sales in the first quarter of fiscal year 2014 to decrease 3% to 5% sequentially. To be clear, we are not including the acquisition of Symmetricom in our guidance today, and we will not be answering any questions related to this acquisition.

Our GAAP and non-GAAP gross margin remains strong at 57% compared to the last quarter. We expect gross margins to be between 55.8% and 56.6% next quarter, reflecting the expected decrease in sales and overall mix and expected product shipments.

As we have previously discussed, we took a number of cost reduction actions, which have resulted in our improved operating metrics. We executed targeted restructuring programs at several facilities, resulting in reduced headcount and related expenses.

This quarter non-GAAP selling, general and administrative expenses were $40.4 million or 16.1% of sales, compared to 17% in the prior quarter. Research and development costs were $42.2 million or 17.3% of sales, compared to 17.4% in the prior quarter. Operating expenses were 33.4% of net sales, a sequential improvement of 100 basis points, reflecting targeted cost reductions.

For the first quarter of fiscal year 2014, we forecast that operating expenses will remain roughly the same in absolute dollars.

Our non-GAAP operating income was $59.2 million or 23.6% of sales, compared to $54.8 million or 22.6% of sales in the third quarter of 2013. We recorded $7 million in non-GAAP interest and other expense, compared to $7.2 million last quarter, reflecting the impact of terms loan principal payments. We expect next quarter to be approximately the same.

Our term loan brought balance at the end of the quarter is $676 million, down from a high of $849.6 million. We also met our commitment of paying down $100 million of our term loan during fiscal year 2013. It is still our intent to pay down an additional $100 million during our fiscal year 2014.

Non-GAAP net income was $49.1 million or $0.53 per diluted share. The company expects non-GAAP earnings per diluted share of between $0.42 and $0.46 for the first quarter of 2014. Our non-GAAP effective tax rate for the quarter was 6%, which we expect will remain the same next quarter.

For the fourth quarter, we recorded GAAP operating income of $26.9 million, compared to $25.2 million last quarter, and $26.6 million reported a year ago. We recorded GAAP net income of $14.4 million, compared to $18.3 million last quarter and $11.6 million reported a year ago.

For the fourth quarter, our GAAP results include noncash expense of $21 million in amortization, $9.2 million in stock-based compensation and $200,000 in income related to change in the fair value of our interest rate swaps, offset by amortization of refinancing costs. We recorded $2 million in restructuring charges and other expenses, primarily related to severance and facility shutdown cost.

We estimate that first quarter 2014 stock-based compensation expense will be approximately $9 million. Capital spending was $6.2 million, compared to $13.6 million in the prior quarter, with a decrease reflecting the timing of payments on capital projects. Next quarter, we expect capital spending to be approximately $9 million.

Depreciation and amortization expense was $28.2 million compared to $28 million in the prior quarter. Accounts receivable were $162.1 million, compared to $151.2 million at the end of the prior quarter, reflecting increased sales. However, DSO decreased from 58 days to 57 days. Inventories were $162 million, compared to $166.6 million at the end of the prior quarter. Our days of inventory decreased from 144 days to 139 days.

We ended the quarter with the cash balance of $256.4 million, and our operating cash flow was $52.4 million. Free cash flow was $46.2 million in the fourth quarter, an improvement of $7.2 million over the third quarter. Our best estimate at the end market percentage breakout of net sales for fourth quarter was approximately: aerospace, 20%; communications, 28%; defense and security, 30%; and industrial, 22%.

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

James J. Peterson

Okay. Thanks, John. With that, let's get to the end markets.

Our communications end market continued on a growth path in September quarter, with revenues up 2%, accounting for 28% of total revenues. This is a solid performance as some of our voice circuit products tend to be more seasonal in the second half of the calendar year. Overall growth were driven by steady contribution from PoE and stronger trends from our timing and synchronization in wireless products. We're especially pleased with the results in timing and sync. September marked the third consecutive quarter of a book-to-bill above 1, and we expect strong sequential growth in the current quarter.

Microsemi's benefiting from strengthening telecom spending worldwide, including emerging markets such as China, and India, as a function of our rocksolid positioning with all the Tier 1 communications equipment manufacturers.

In wireless, revenues benefit from second half seasonality and some long awaited activity for 802.11ac product portfolio. In fact, we continue to see strong interest in our industry's first single-chip monolithic solution for Wireless LAN connectivity applications, and have recently seen some relatively high-volume design wins that should be a healthy contributor to the second half of our fiscal year.

Our defense and security shipments declined 1.8% to approximately $75 million and accounted for 30% of the total revenue. While we did grow backlog in defense and security through the September quarter, we're looking for softer results in the December, as a result of some pushouts due to customer hesitation surrounding the recent government shutdown and the lack of agreed-upon budget. We've not lost any business and the pushouts we were seeing are for funded programs but the uncertainty created by the shutdown slowed some near-term appetites for our customers awaiting resolutions.

The aerospace growth tried to accelerate in September quarter, where revenues grew almost 10% and accounted for 20% of total revenues. Satellite revenues continue to benefit from the strong satellite booking levels of the prior 3 quarters, and we look forward to continued booking strength.

In commercial air, we're benefiting from the pipeline so that the major OEMs and subcontractors as they replenish supplies while ramping production. We're benefiting from the significant content growth on newer planes at both Boeing and Airbus.

Our industrial end markets continued their strong contribution in September, growing 6% and accounting for 22% of the total company revenues. Medical shipments benefited from the ongoing ramp of the ultra-low power radios, which are now at record revenue levels. Also noteworthy, our solar and semi-camp.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Harsh Kumar with Stephens.

Harsh N. Kumar - Stephens Inc., Research Division

Jim, if I was to ask you to rank your end markets in the December quarter by growth, what would that ranking be?

James J. Peterson

Check it out. Right about -- for the last 2 quarters, we've been really hesitant in giving guidance by end markets. I mean the big focus here is the company, we're guiding down 3% to 5% as a company. And so that's what we'd being measured on, as the company, not necessarily the independent end markets.

Harsh N. Kumar - Stephens Inc., Research Division

Okay, fair enough let me try to get it in some other way then. Then I'll jump back in the queue. Can we -- I think you said comp, based on your commentary, I think will be up sequentially in the December quarter? First of all, is that correct? And then secondly, where are you seeing strength in the comp side? Are you seeing strength in Wireless and the Chinese infrastructure upgrade and part of what's going on? Or is there something else that's happening there as well?

James J. Peterson

Yes. Thing about comp, it's 20% of our business now, right? And so more and more, we're becoming a communications flight. The revenue was up 2.2% sequentially last quarter. The timing of the [indiscernible] business we essentially hit the ball out of the park. We've 3 consecutive quarters of positive book-to-bill, record in timing and sync. And the December quarter, Q1 signaled a record, we're essentially communications play .

Operator

Your next question comes from the line of Steve Smigie with Raymond James.

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

Great. As we look at the EPS drop in Q4, or accounted Q4, John gave some color on the margins there, but what's in the mix of business? What's changing that's maybe making the margins a little bit lower? Harsh was kind of trying to get at that. But just what would be more impactful to the next year? And as we look, say past this period, I know you only guide for 1 quarter, but is it reasonable to think that you might have some pickup again in subsequent quarters with a high book-to-bill?

James J. Peterson

There's going to be pickups such a quarter nothing bothers me more than a CEO that says "Hey guys, look at this quarter and it's going to be a stronger second half". That hasn't been said, I'm telling you, look at this quarter, it's going to be a stronger second half. This whole thing with the EPS is based on the revenue downtick. And it's a macro headwind, we're all seeing it. And so, the answer there is revenue. Hope go with product mix, new design wins, we'll do just fine.

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

And you said you had a book-to-bill above 1, is that just slightly above 1? Or is it more meaningful?

James J. Peterson

No, it's slightly above 1, right? But above 1 in this environment is d*** meaningful.

And just what it does, it should give you the color that the longer lead time products, we know where they fall, right? There's still developing momentum.

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

Great. if I could just sneak one more in. If I just to get some update on the cybersecurity. I know it's become a big area for you guys and security overall, just talk about any upcoming opportunities there that could potentially drive growth over the next 12 months or so?

James J. Peterson

That's -- no problem, in fact, Litch is kind of running the security part of the company, so Litch?

Steven G. Litchfield

I mean, I think we're just as motivated as ever and seeing good traction on the security side of our business. That said on the kind of the defense environment, we definitely see we can push out here and there on major programs. But I'd say within that, I mean you continue to see a commitment to technology, I mean even heard the DoD coming out this week, in fact, talking about the focus on technology. And this is something that I know we've been saying for 12, 18 months, talking about as the budget changes, they're going to commit more to technology. We're really seeing that, and we're excited about it.

James J. Peterson

Litch is right. Let's feed in the straight closing more basis, but a lot of funding in precise munitions. We'll be okay.

Operator

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

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

First question, it sounds like your defense business is going to be down sequentially in the December quarter, you did some pushouts, just wondering what type of read you have into those programs? And when could those potentially start materializing? Would it be as early as the March quarter?

James J. Peterson

With the government shutdown, right? At this point it looks like March quarter at best. But once again, we're not losing funding programs, Tore, it's just government shutdown is kind of push things to the right and left a little bit and we're reassessing as we speak. But if you look at overall, defense and security, year-over-year, FY '12 over '13, we're up 7%. So I'm a big believer, we know the risks in this particular market, and we certainly know the rewards.

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

Very good. My follow-up is on the balance sheet. So your inventory there has come in at 139, I was hoping you could just remind us what Raytheon should intend to operate in? And for the December quarter, is your attention to keep inventories fairly flat? Roll them or see a decline?

John W. Hohener

Yes, certainly as you may recall, our inventory days are impacted a little bit by some of our higher or longer cycle time products. However, we have decreased those number of days nicely over the last several quarters. Certainly, our goal -- our long-term goal is to get it below what we see today, but I think we're going to be relatively flat in the December quarter with the decrease in revenue.

Operator

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

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

Just a quick clarification I guess, it sounds like it's pretty clear that the majority of the softness for the December quarter seems like it's blamed on just defensive and security. Can you just say, the rest of your major business segments, did they have a positive book-to-bill?

James J. Peterson

As you go across communications, have a positive book-to-bill. The aerospace is up sequentially from a shipment point of view, call it about flattish. And the industrial market was up 6% sequentially, and I'm not breaking out but if you put on flattish, it wouldn't be too far off.

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

Okay, okay, that helps a lot. And then just drilling in on defense and security for a second. I mean, as that channel starts normalizing, and I know it sounds like you guys don't know when that's going to be at, maybe I guess you said best case scenario, March quarter. But -- because you're talking about pushouts and not cancellations, right? Or lost sockets or anything, to me, that sounds like there's probably some pent-up demand. So how does that play out next year? When this thicket sort of gets turned back on? Or when people starts feeling more comfortable? Is there going to be a step function kind of catch up in the calendar first quarter, calendar second quarter? Or is it going to be more of a gradual kind of a catch-up in demand? But am I wrongly think of it or categorize it as pent-up demand?

James J. Peterson

I wouldn't go as far as pent-up demand. But like I said, what these programs are being pushed out a bit. But I'm going to call that defense and security is going to be up year-over-year next year. My guys going to look at me and I think nod either way. But the way I'm looking at is, that's the intention, that's the goal. We have a lot of new products, and we're growing dollar content per platform. And I think we're better positioned than our peers, and we're taking market share from our competitors.

Operator

Your next question comes from the line of Quinn Bolton with Needham & Company.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Just for John, I'm sorry, you went through that gross margin guidance in the tick down in the December quarter pretty quick, but can you just say what that guidance again for the December quarter was on gross margin?

John W. Hohener

Sure. We just finished at 57%, we're guiding 55.8% to 56.6%. As I said in my prepared remarks, primarily due to a decrease in sales and overall mix. There is some pushout in some of our higher-margin pieces of our defense business, which Jim has been talking about, and satellite's going to be a little bit down in the quarter, which is one of our higher-margin businesses. That's primarily the mix, give some color on the mix there. As a reminder, our GAAP and our non-GAAP gross margin was the same this quarter. And so from that standpoint, we're very positive in some of the trends in the company.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Okay. And then for Jim, obviously, the government shutdown sounds like it's hitting the defense and probably the satellite part of the business. But for commercial air and perhaps, some of the industrial markets, are you seeing sort of just a typical year end inventory correction that brings those segments down? Or is the down 3% of 5% really a function mostly of the government-related parts of the business?

James J. Peterson

No, I'm going to say, the lion's share of it, defense and security, but strange enough aerospace always had a trailing effect to the defense and the security. So you might see a little tap there as well.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Okay. And then just lastly, guys, I know many of us probably rolling out the fiscal '15 models, should we be still thinking about organic growth rates in the mid- to high-single digit range, kind of on a long-term basis? That's still the right target you guys are shooting for?

James J. Peterson

Absolutely, my friend.

Operator

Your next question comes from the line of Christopher Longiaru with Sidoti & Company.

Christopher J. Longiaru - Sidoti & Company, LLC

You talked a little bit about some of the design wins that you've seen in aerospace, and I guess you said the book-to-bill was flat there. Can you give us a little more guidance on some of the timing as that ramps up? And also, kind of just talk about the content increases that you have been seeing content increases, are the content increases continuing into these design wins?

James J. Peterson

Yes, I think you're going to find out the second-half story in that market space. And that's pretty much across-the-board, in the marketplace. We've been focused on our total solution traction and dollar content, electrication [ph] of next-generation aircraft. I think across-the-board, we're going to see increased dollar content per aircraft and per platform.

Christopher J. Longiaru - Sidoti & Company, LLC

And what's the visibility in that market? What's your lead time, I know it's pretty long but just remind me?

James J. Peterson

That kind of stuff for commercial air, aerospace and defense, not uncommon, be 18 to 30 weeks.

Operator

[Operator Instructions] Your next question comes from the line of Tom Delaney (sic) [Mark Delaney] from Goldman Sachs.

Mark Delaney - Goldman Sachs Group Inc., Research Division

It's Mark Delaney. I was hoping to drill down a little bit more into the comps bucket. I know, Jim, you talked about getting some good traction on the timing products and Power over Ethernet. I know those were some of the share gain opportunities. When I look at the overall segment, it's still tracking down on a revenue basis, more than 10% year-over-year. And so I'm just trying to understand, are there legacy products coming out that are maybe offsetting some of the share gains? Is it just end market weakness? You can maybe just help me understand the pushes and pulls on the enterprise and comps segment?

James J. Peterson

Yes. That's a question we have Paul Pickle here so get him involved in the party, Paul?

Paul Pickle

We definitely have some legacy products that are changing out and in exchange, we're ramping up the new products quite quickly that spent some of the growth that we've been very pleased with over the past 2 quarters and looking forward to this quarter as well, in timing and sync specifically. We're rolling out new products in POE, we just captured some new design wins, some new sockets with a Tier 1 North American supplier for power devices as well, those are new products. And interestingly enough, we're seeing some nice traction in RF. Our 802.11ac product, a single monolithic -- single-chip monolithic silicon. We just shipped against our first volume order, and we're looking for more. That's been primarily an enterprise at axis point. But great traction there, great validation of the strategy.

James J. Peterson

And Mark, while Paul answered that, I think if you look going forward, I think you can look at the RF Wireless and some of our next generation products, that's -- we're actually staying the table for a tremendously strong second half.

Mark Delaney - Goldman Sachs Group Inc., Research Division

Okay. I wanted, for a follow-up question, talk a little bit more on aerospace since I know you guys have some good orders there and longer visibility. When I look back in fiscal '11 and fiscal '12, there were quarters in the aerospace segment where revenue is in the high $50 million range per quarter. when you look at all the opportunities, do you think you can get back to that sort of a level later in fiscal '14?

James J. Peterson

It's not the beauty in that, it's a different world today, right? This is all Airbus and Boeing and all that next-generation electronic aircraft. That just plays right to our strong suit. So I think going forward, we all know the platforms, and our dollar content keeps accelerating in those areas, so I think it's going to turn out just fine there.

Operator

Your next question comes from the line of Harsh Kumar with Stephens.

Harsh N. Kumar - Stephens Inc., Research Division

Hey, thanks for reiterating the $100 million payout from the debt for next year. You've got very nice cash flow numbers now. I'm wondering is there a possibility that pay off gets accelerated from the $100 million that it's at today?

James J. Peterson

Here's the deal, alright? We set a platform for $100 million, we paid $100 million what we're doing right now when lot of things going on but where the fact that we understand $100 million and we're living up to our word of paying out $100 million at this point. I think that's good news.

Harsh N. Kumar - Stephens Inc., Research Division

That's fair. And then Jim, I was wondering if you could try to -- I'm trying to triangulate on the gross margin. I understand that satellite looks like, it's going to be flat to down, defense looks like is going to be down. Can you help us understand where your margins are in your comp business, are they below your corporate average? Or they're at your corporate average or above?

James J. Peterson

You know, I'll bet you on above par with the corporate average. I mean the thing to understand with gross margin, we are not off our 60 30 model, guys. But to talk organically, still we're going to do about $280 million, and right now looks like $280 million or slightly less. And so we're not off the 60 30 platform. With guidance down 3% to 5% in revenue, and the guide we gave in gross margins, I think we're proving to the industry that we're doing the right things internally.

Operator

Your next question comes from the line of Steve Smigie with Raymond James.

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

Great. Just within aerospace, could you sort of give a rough color on break up between commercial air versus satellite, at this point?

John W. Hohener

Commercial versus satellite. About 50-50.

James J. Peterson

50-50, yes, so same as last quarter, about 50-50.

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

Okay. And if I get the same thing for industrial, maybe between medical versus everything else?

James J. Peterson

Well, I think the interesting thing about medical is that we had the strongest quarter ever in our ULP all time products. Litch, you want to give it -- no, we don't break it out.

Steven G. Litchfield

Yes, we don't break it out. I mean, it's maybe probably 15% of that part. It's a relatively slow number in the overall corporate number.

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

Okay. Just looking at growth in defense and security. Can you talk about nondefense pieces, I mean security? Are you see any strength here at all and it's like airport scanners? Any other stuff you originally thought maybe might be is for scanning product as they came out of warehouses with the Millimeterwave technology?

James J. Peterson

Yes. All I'll tell you is the world is a lot less safer than it was 2 quarters ago. So there's a lot of programs, a lot of we can't speak to as ever-increasing for a very good reason.

Operator

And there are no further questions at this time. I would now like to turn the conference back over to management for any closing remarks.

James J. Peterson

No closing remarks. Thanks for joining. Have a great day.

Operator

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

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