Hittite Microwave's CEO discusses Q1 2014 Results - Earnings Call Transcript

Apr.24.14 | About: Hittite Microwave (HITT)

Hittite Microwave Corporation (NASDAQ:HITT)

Q1 2014 Earnings Conference Call

April 24, 2014 05:00 p.m. ET

Executives

William W. Boecke – VP, CFO and Treasurer

Richard D. Hess – CEO and President

Analysts

Erik Rasmussen – Stifel Nicolaus & Co.

Quinn Bolton – Needham & Company

Ben Z. Rose – Battle Road Research

Joe Hanzlik – Confluence Investment Management

Amit Chanda – Wells Fargo

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hittite Microwave Corporation’s First Quarter 2014 Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions). This conference is also being recorded today Thursday April, 24, 2014.

I would now like to turn the conference over to Mr. Bill Boecke, Vice President and Chief Financial Officer. Please go ahead sir.

William W. Boecke

Thank you. Ladies and gentlemen, good afternoon, and welcome to Hittite Microwave Corporation’s First Quarter 2014 Conference Call. Before we begin the discussion, I would like to review the Safe Harbor statement. Please note that statements made in this conference call about Hittite’s future expectations, plans and prospects constitute forward-looking statements for the provisions -- for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. For information about these factors, I refer you to the earnings release that we issued earlier today and to our most recent Form 10-K filed with the Securities and Exchange Commission.

The earnings release along with other financial and statistical data that we may discuss on the call and copies of our SEC reports are available in the Investor Relations section of our website at www.hittite.com. You may also obtain copies of our SEC reports and a copy of our press release furnished under Form 8-K from the SEC’s website at www.sec.gov.

I would now like to turn the discussion over to Rick Hess.

Richard D. Hess

Thank you, Bill. Good afternoon to everyone. I will review our Q1 performance and give some highlights of the quarter. Bill will then go through the details of the financial results for Q1 and I will end with an outlook and discussion of Q2, 2014.

I'm excited to announce that Hittite achieved record bookings and revenues for the first quarter of 2014. Bookings were strong in the majority of our markets, which confirms the success of our new products.

Hittite delivered revenue of $70.6 million in Q1, which was above guidance and represents a 4.3% growth over Q1 of 2013. We continue to see strong growth in the site of the infrastructure market, driven by LTE spending in China and the U.S. Microwave communications market was solid and the test and measurement market was stronger than in the previous quarter. Military revenues were similar to Q4 2013, as expected.

Gross margin remained at the lower end of our range, as forecasted, due to the product and market mix and funded development programs. Net income for the quarter was $16.4 million, up $0.9 million from Q4 of 2013. Earnings were $0.52 per diluted share for the quarter. We continue to generate strong cash flows from the business, and the first quarter net cash flow was $19.8 million.

Board of Directors has approved the quarterly dividend of $0.15 per share, payable on June 27, 2014, to shareholders of record as of the close of business on June 4, 2014. On a geographic basis, 39% of our first quarter revenue was from domestic customers and 61% from international customers.

Plastic revenue was down 7.9% year-on-year, 1.9% sequentially. International revenues were up 14.2% year-on-year and up 5.9% quarter-on-quarter. First quarter three of our eight markets accounted for approximately 78% of our total revenue, these markets are military, microwave and low millimeterwave communications and cellular infrastructure. The remaining markets, test and measurement, automotive, broadband, fiber optic and space, accounted for 22% of our revenue.

Q1 revenues in the cellular infrastructure, microwave communications, test and measurement and automotive markets showed sequential growth. Fiber optic, broadband and military were essentially flat. And space was down sequentially due to the cyclical nature of that business.

We had several highlights in Q1 and I'd like to mention a few of them. We entered in a definitive agreement to buy substantially all of the assets of the Keragis Corporation, a provider of extremely high-powered wide band amplifier modules, located in San Diego, California.

This acquisition fits well with our strategy of leveraging our IC capability in both gallium arsenide and gallium nitride into a higher level of assemblies. Keragis has developed a unique power combining capability allowing them to build devices that replace tube amplifier technology with solid-state devices.

This offers customers the opportunity to both replace existing tube amplifiers as well as design solid-state amplifiers into new systems. These devices provide a substantial, reliability and lifetime improvement to the existing technology used.

Applications include military radar, weather radar, air traffic radars, as well as many other high-powered opportunities. In addition, we delivered multi-channel up and down converter modules for ship or navy demonstrator program. These devices achieve significant performance improvement and offer the possibility to be used across multiple future platforms on military programs.

We launched the HMC6980, a 10 megahertz to 20 gigahertz power amplifier module. It's ideal for EW electronic countermeasure radar, fiber optic and test equipment applications. Again demonstrates the strength of Hittite to offer extremely wide band devices with excellent performance characteristics.

We launched the HMC7056, the Ka-Band Block Upconverter with High Power Amplifier with its internal local oscillators it can convert an IF frequency range from 1 to 2 gigahertz up to 29 to 31 gigahertz. This product can be used for commercial or military satellite communications applications. A high frequency and a high-powered performance of this device sets Hittite apart in this market.

We received an initial production order for new generation of E-Band Microwave Radio Chipsets from a Tier 1 customer. The performance of this chipset allows our customers to offer substantially better solutions for wide band backhoe applications. The E-Band radio market has significant growth potential over the next few years, driven by the rollout small cells in the mobile infrastructure market.

We also introduced a highly integrated IF solution for microwave radio, which is gaining traction at multiple Tier 1 customers. This will assist our customers in decreasing size and cost of their radios and all of the microwave backhoe band.

We released the HMC7271 multi-chip module solution with cellular repeated systems and we are ramping the production volumes today. This provides a much-needed integrated solution for our Tier 2 customers.

The increase in our R&D spending over the last three years is starting to pay benefits that will drive our growth. Based on our new products and design and status, coupled with our record orders in Q1, I continue to be encouraged about our future growth prospects.

I will now turn the call over to Bill Boecke, our Chief Financial Officer, to give you a deeper view of the Q1 financial performance.

William W. Boecke

Thank you, Rick. The key financial points for this quarter are revenue of $70.6 million, a 2.7% increase sequentially, and 4.3% year-over-year increase. As Rick noted, this is also a record quarterly revenue for the company.

A gross profit margin of 67.4%, up 10 basis points from the prior quarter. Operating profit margin of 35.4%. Net income of $16.4 million or $0.52 per diluted share, a 5.4% increase sequentially, and a 6.5% decrease year-over-year.

Positive cash flow of $19.8 million and an ending cash balance, including short-term investments of $492 million. A return on capital employed of 41.2% in an annualized rate and as Rick noted, a quarterly dividend of $0.15 per share payable in the second quarter of 2014.

In the first quarter of 2014, our revenue was $70.6 million, an increase of $1.8 million or 2.7% from the prior quarter Q4, 2013 and an increase of $2.9 million, 4.3% over the prior year Q1, 2013.

As Rick mentioned, this sequential change was due primarily to growth in telecoms, in both of our cellular infrastructure and millimeterwave communication markets, as well as in our test and measurement markets.

These gains were slightly offset by weaker demand in space. The other markets were relatively flat quarter-over-quarter. The quarterly revenue growth was above our high end of our guidance.

Gross profit and margin for the quarter was $47.6 million, or 67.4% respectively, compared to 67.3% in the prior quarter, and 73.7% in the prior year. This gross margin this quarter, similar to Q4 in 2013, is a product of the current mix in market and product demand, and to a lesser extent, the impact of several lower margin and primarily military development contracts.

The gross margin was in line with our guidance and at the low end of our operating range. These development contracts are new projects we choose to participate in. In the past these development programs have grown into production contracts, with greater revenues and higher margins. We expect similar results from these current programs.

R&D expense for the quarter was $11.9 million or 16.8% of revenue, compared with $11.8 million in the prior quarter, and $13.2 million in the prior year. The R&D costs represent a continued investment in the development of new products and product lines, which is the principle long-term growth driver of the company.

Sales and marketing expenses in the quarter was $6.9 million, or 9.8% of revenue, compared with $6.1 million in the prior quarter, and $5.8 million in the prior year. The increase in sales and marketing expenses sequentially is attributable to travel, as well as other marketing costs related to the incremental higher revenue.

General and administrative expense in the quarter was $3.7 million or 5.3% of revenue, compare with $3.4 million in the prior quarter, and $3.8 million in the prior year. The resulting operating income and margin for the first quarter was $25 million or 35.4%, compared to 36.3% in the prior quarter, and 40.1% in the prior year.

Operating income for this quarter included equity compensation expense of $3.5 million and intangible asset amortization expense of approximately $500,000. Our markets change constantly and we continue to manage our business to maximize the financial results in our operating income.

The provision for income tax in the quarter was $8.6 million or an effective rate of 34.4%. The effective rate was impacted by the mix of international revenue and pre-tax profitability. We expect our effective tax rate for the year 2014 will be approximately 34% as a result of this shift in mix of international business.

Net income for the quarter was $16.4 million, $0.52 per diluted share, a 5.4% increase from the prior quarter, and 6.5% decrease from the prior year. The net earnings was in line with our guidance. In review of our financial position at March 31st, 2014, our total assets were $673 million, a net increase of $16.4 million from December 31, 2013. The increase in totals assets in the quarter was primarily cash and short-term investments. A closer analysis of our financial position – total cash and short-term investments at March 31 was $492.4 million, an increase of $19.8 million from the prior quarter.

The increase in cash is comprised primarily of $27.2 million of positive cash flow from operations offset by $1.8 million of capital expenditures, $4.7 million in dividends paid and $0.9 million in net tax payments related to equity compensation. Our cash is held primarily in the United States and is invested primarily in short-term U.S. government securities.

Total accounts receivable was $39.1 million, an increase of $2.9 million, and represents approximately 50 day sales outstanding. Net inventory was $77 million, an increase of $1 million from the prior quarter. Our advanced buy inventory decreased $2.8 million to $35.2 million.

Gross inventory turns for Q1 was approximately 1.2 times on an annual basis comparable with prior quarter. Excluding the advanced buy inventory, our turns would be 2.2 times. As we continue to work this inventory level down, we expect to see our total turns ratio return to our model of more than 3 times annually.

Capital expenditures in the quarter were $1.8 million, and total net assets at March 31 were $38.2 million. From the perspective of financial returns, our return on assets and return on equity were approximately 10% for the quarter and on an annual basis, and our return on capital employed was 41% annualized.

I’ll now turn the discussion back to Rick.

Richard D. Hess

Thank you, Bill. Q2 guidance, Hittite Microwave Corporation expects net revenue in the second quarter ending June 30, 2014 to be in a range of $74 million to $76 million and net income to be between $17.6 million and $18.4 million, or $0.56 to $0.59 per diluted share.

Our Q2 forecasted net income is based on a few important factors. First, an estimated gross profit margin of 68%, as we see margins starting to move toward our normal range. Second, in Q1, we expect operating expenses to be up slightly due to continued R&D and sales and marketing investments. And, third, as Bill pointed out, a tax rate of approximately 34%.

In Q2, we expect the cellular infrastructure business to continue to be strong. We see the microwave backhaul market growing. We expect the test and measurement market to show modest growth. We are also seeing signs the military business is starting to pick up.

We’ll continue to invest in our new product development and expanding our penetration into new products and markets. And I remain excited about the growth of the company. I would now like to invite our listeners to ask questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from the line of Tore Svanberg with Stifel, Nicolaus. Please go ahead.

Erik Rasmussen – Stifel Nicolaus & Co.

Actually Erik Rasmussen calling in for Tore. Wanted to -- you'd mentioned the development contracts and eventually those turn into production contracts. Wanted to get a sense, though, when -- how successful are those development contracts in that conversion over to production contracts? Do you have any sort of historical sense that you can kind of give us to maybe think about when we're looking at this pick up in development contracts, since it's been pretty significant.

Richard D. Hess

Yes. There's no -- Erik, we don't have any exact statistics on the conversion. But in general, most of them do turn into long-range programs. There are some that don't. But the majority of them I would say turn into long length programs. But the size of their success and how big the programs are does vary. And the timing when that happens can be anywhere from two years to three or four years. So it is variable as far as the timing. And again the majority of them do turn into long-term programs. But some of them don't get funded to move forward.

Erik Rasmussen – Stifel Nicolaus & Co.

Thank you. And its nice to see the gross margin picking up a little bit. Then is it safe to -- with the 68% outlook for the June quarter, is it safe to assume then that that's kind of a good base run rate to see further improvements the remainder of the year and how does that maybe gross margin profile look exiting the year? Can we even see the year be at 70% on an annual basis?

William W. Boecke

So, Erik, yes. As we've said in the past. We look at our operating range as about 68% to maybe as high as 72%, 73%, which you've seen in the past as well. We do expect to see some rebounds slowly improving as our mix improves, as well as some of these development contracts move through. So I think by the end of the year, we could be back up to the range, somewhere in the mid-point and hopefully with a 70% on it.

Erik Rasmussen – Stifel Nicolaus & Co.

Okay. That's helpful. And maybe just real quick on the stock-based competitors, can you just give us that?

William W. Boecke

Yes. Stock-based comp was approximately $3.5 million. Do you want it broken down by function?

Erik Rasmussen – Stifel Nicolaus & Co.

Please. That would be helpful.

William W. Boecke

Sure. So inside of cost of sales was about $781,000, in R&D $950,000 and sales and marketing $868,000 and G&A about $879,000.

Erik Rasmussen – Stifel Nicolaus & Co.

Thanks. And can I just ask one more, on the inventory translation, can you just provide us an update on kind of where that is? When you think inventories will start to normalize. Thank you.

Richard D. Hess

Some of these inventories are long-term inventory. So I don't think you'll see it change within the next one or two years. But I do suspect over the next two to three years, it will come down. And I would say by the third or fourth year, it should be back down to normal, where we would start a see our turns at about a three plus times per year.

Operator

Thank you. And our next question comes from the line of Quinn Bolton with Needham & Company. Please go ahead.

Quinn Bolton – Needham & Company

Hey, guys, just wanted to ask a couple of questions, first on the cellular side of the business, obviously very strong, is that mostly China and TD-LTE or are you seeing broader strength across other geographies?

Richard D. Hess

Yes, Quinn, it is mostly China LTE. We are seeing some opportunities from our customers that are U.S.-based, for U.S. rollout. But the majority of it is China LTE rollout.

Quinn Bolton – Needham & Company

Okay. Great. And then on the military business, it sounds like that looking at the June quarter you're starting to see some signs of life. Is that across both the long-term programs, as well as the broad-based components business? Or is it really more a function of the broad-based components starting to come back. I know that was soft into year-end.

Richard D. Hess

No, it is. It is both areas that are coming back, different levels. But both areas are looking stronger and we are seeing a lot more opportunity in both sides.

Quinn Bolton – Needham & Company

Okay. And the military development contracts it sounded like they were sort of peaking in the December and March quarter in terms of their impact on the gross margin. Is that still the case?

Richard D. Hess

Q2 a little bit into Q3 is how I see it at this moment.

Quinn Bolton – Needham & Company

But in terms of the -- I mean I guess sort of the greatest amount of revenue being recognized for those development contracts back in December and March and we're now kind of sloping down, is that the right way to think about it? Or is it sort of maintaining a similar level that Q4 and Q1?

Richard D. Hess

Sloping down slightly. But at the same time there are some new opportunities that we're looking at as well, although we haven't made decisions on them.

Quinn Bolton – Needham & Company

Okay. And then just to clarify. It sounds like the development contracts, if it takes two to four years to turn to revenue, that's revenue out that would be sort of 2016 to maybe 2018, before you'd really see that in the income statement is that right?

Richard D. Hess

Yes. But there are some development contracts from one, two years ago that could turn into potential in the next year or so. So there is a portfolio of them.

Quinn Bolton – Needham & Company

You have a cue of programs that could start. Got it. Okay. Last question. I know it's one of the smaller businesses, but seems to be a lot of activity still in the 100 gig optical space. I was wondering if you could make any comments on the outlook for your fiber business, heading into the June quarter.

Richard D. Hess

Yes. We still see the fiber optic business as a very strong business for us. Again it is one of our smaller businesses, but we still see a lot of growth opportunity there. The 100 G market has been a little bit in fits and starts and hasn't been a steady growth. But we are seeing a lot of activity there and again we continue to push very hard in that market and introduce more products and we see it still as a bright spot going forward.

Quinn Bolton – Needham & Company

I am sorry, I will try and squeeze one more question and just any comments from Hittite's perspective, as TriQuint and RFMD come together, they'll have a fairly, substantial infrastructure and military business when those two businesses are combined. How do you think it changes the competitive landscape if at all?

Richard D. Hess

I don't think it's a dramatic change in the landscape. Again they're in different parts and different products than we're in a lot of cases. And they're both in the market. So, I don't see it a change in the landscape dramatically.

Quinn Bolton – Needham & Company

Good. Thank you very much.

Richard D. Hess

Yep. Thanks, Quinn.

Operator

Thank you. And our next question comes from the line of Ben Rose with Battle Road Research. Please go ahead.

Ben Z. Rose – Battle Road Research

Good afternoon. Rick, just to ask to probe a little bit on the -- what sounds like an uptick in the military -- in the turns portion of the military business, is there anything that you can say with regard to color on the kinds of products that you're seeing an uptick on and whether -- I realize that by definition, it's a short-term visibility type of business, but whether that can continue into the second half of the year?

Richard D. Hess

It's pretty broad based across a lot of different products and a lot of different customers as that business is. So we're seeing -- it's not specific programs. It's kind of a broad based.

And again as I said at the previous calls, we kind of expected that. We thought that was a little better pent-up demand of people not being sure about where the market was going. And I think now there does seem to be better confidence in the market. And -- so, I think we're just seeing more of a return to normal in that business. So, I would expect to continue as we move forward.

Ben Z. Rose – Battle Road Research

Okay. And also in the automotive business, I realize it's still a small portion of your business and is there anything going on there that would make that kind of a sustainable uptick from your perspective?

Richard D. Hess

It's actually been a pretty -- again as we said, it's a pretty small piece of the business. But it's been pretty steady, I would say, over the last year of increasing opportunities. But again, we still don't see it as a huge opportunity for us in the future. But it's been solid and it keeps growing and keeps going up. So, it's still a good opportunity for us. But again, we don't see it challenging some of the bigger markets.

Ben Z. Rose – Battle Road Research

Okay. Thanks very much.

Richard D. Hess

Yes. Thanks Ben.

Operator

Thank you. And our next question comes from the line of Joe Hanzlik with Confluence Investment Management. Please go ahead.

Joe Hanzlik – Confluence Investment Management

Hey, guys. Congrats on the acquisition made this quarter. I'm just curious how much that might change R&D for the next few quarters. Do you expect to stay around that $12 million range or what do you expect to have happen there?

Richard D. Hess

It will have a minor effect on R&D. But it's not a significant amount that will change R&D. So, it will be a slight uptick, but it won't be significant.

Joe Hanzlik – Confluence Investment Management

Great. And then, secondly, just as far as your longer term sales growth rates, I know you guys have that sort of 10% to 15% longer term target, obviously, a very nice growth projector for Q2. What's your thoughts, do you still expect to be able hit the low double-digit sort of revenue growth for 2014 and possibly for 2015 now? Are you getting any more visibility?

Richard D. Hess

We're not -- again, we don't predict beyond the first quarter out for our exact guidance. But, again our model stays the same. So, our long-term model is still in that double-digit percentage growth. But we're not going to project what 2014 is exactly.

Joe Hanzlik – Confluence Investment Management

Got it. Thank you.

Richard D. Hess

Yes.

Operator

Thank you. (Operator Instructions) And our next question comes from the line of Mark Delaney with Goldman Sachs. Please go ahead.

Unidentified Analyst

Hi. It's Austin [Bowen] calling in for Mark. The test and measurement end market has grown into a key market and has been choppy recently. What are your expectations for this area in 2014?

Richard D. Hess

Yes, Austin. We – as I mentioned, we did see some pick-up in Q1 and we expect it to continue to be roughly the same through the rest of the year. So we're not looking for a big pick-up in 2014. We do think the market will come back and there will be another growth spurt in the test and measurement market. But it's hard for us to predict what that timing is.

So in the meantime, it's returning to its normal way. Again we saw a dip in Q3 and Q4, but it's come back to more of its normal condition. But we expect it to continue, maybe some slow growth but not dramatic growth through the rest of the year.

Unidentified Analyst

Okay. Thank you. And then, maybe as follow-up, after initiating the dividend last quarter, do you have an update on how you're going to manage that going forward? And then, in addition, what are your capital allocation priorities beyond the dividend?

William W. Boecke

Right now the plan is to issue a quarterly dividend of $0.15. We have no immediate plans to make any changes to it. As far as capital allocations, our first priority, obviously, is to be able to invest this in the growth in our business, internally it would be ideal. And to the extent we find opportunities externally, we would take advantage of that.

We will continue to support the dividend. And at certain times we have done a share buyback. We did one during the period 2009-2010. We don't have a program in place at the moment. But we have used it on an opportunistic basis.

Unidentified Analyst

Great. Thank you.

Operator

Thank you. And our next question comes from the line of Amit Chanda with Wells Fargo. Please go ahead.

Amit Chanda – Wells Fargo

Hi. Good afternoon, gentleman. Rick, at a high level can you maybe talk about integration trends in Hittite's product portfolio and what impact this may have on average R&D cost for new products going forward.

Richard D. Hess

Yes. We certainly have for years and continue to see integration, more in some markets than others. But we've continued to integrate our products. It's not going to have a substantial impact on our total R&D. But what ends up happening is, the projects, R&D projects take a little longer.

There each product has higher R&D costs. But a lot of it is just integrating our existing discreet products. And because we have such a broad range of discrete products already, it's not like we have to go out and develop the functions. We have the functions. And it's more a matter of just integrating that together.

So we continue to do that. But again we don't see that having a big impact from an R&D point of view. Now what it does do, I think it gives Hittite an advantage, because we do have such a broad product portfolio, as well as a broad technology portfolio. It gives us an advantage in the marketplace, that we have such a broad portfolio.

It makes it easier for to us integrate, where some of our competitors don't have as broad a portfolio, both from a technology and a function point of view. So it's harder for them to integrate to get to those functions. So we see this giving us leverage as we move forward.

Amit Chanda – Wells Fargo

Great. Thank you for that color. And then as a follow-up question, you know, in terms of new standard product and introductions in 2014, how should we think about that? Should we think about that as in line with what you've typically introduced, roughly into 80 to 100 new standard product range for 2014? How should we think about that?

Richard D. Hess

We don't really use that as a metric as much as we did in the past.

Amit Chanda – Wells Fargo

Okay.

Richard D. Hess

The integration, the number of products that we introduce is going down, number one, because, again, they're higher levels of integration, so there is less individual component parts. On the other side, we're seeing a mix change a little bit to more customized products. So as you integrate more, you tend to do a little more customization for specific customers for specific opportunities, and so some of those products don't get released to the market as standard products. So the number of release standard products has changed over the last few years. And so you won't see it as that same 100 products a year that we used to do back five years ago. So that's really kind of changed in the way we introduce product over the last few years.

Amit Chanda – Wells Fargo

Okay. Thank you.

Operator

(Operator Instructions). And I'm showing no further questions at this time. I'd like to turn the call back over to Rick Hess for closing remarks.

Richard D. Hess

Okay. Thanks, everybody. In closing, I'd like to thank the employees for their support and delivering another record quarter at Hittite, as well as setting the stage for our future success. Thank you very much.

Operator

Ladies and gentlemen, this concludes the Hittite Microwave Corporation's first quarter 2014 conference call. Thank you for your participation. You may now disconnect.

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