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Micrel, Inc. (NASDAQ:MCRL)

Q2 2014 Results Earnings Conference Call

July 24, 2014, 04:30 PM ET

Executives

Raymond Zinn - Chairman, President and CEO

Robert DeBarr - CFO

Analysts

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Operator

Greetings and welcome to the Micrel Semiconductor Second Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. Ray Zinn, President and CEO. Thank you. You may begin.

Raymond Zinn

Well, thank you and welcome to the Micrel Semiconductor second quarter 2014 conference call. I am pleased to have with me today Bob DeBarr who is our Chief Financial Officer, Mansour Izadinia who is our Senior Vice President for Timing and Analog Business units; as well as David Schwartz, our Worldwide Vice President of Sales.

At this time, I would like to turn the time over to Bob DeBarr to present the quarterly results. Bob, go ahead.

Robert DeBarr

Thank you, Ray. In conjunction with this conference call a number of supplemental charts will be made available on Micrel’s website during the following prepared remarks. To access these charts, please go to Micrel’s website and click on the link that will take you to the second quarter 2014 conference call slides. We’ll begin today’s call with the Legal Disclaimers and Safe Harbor statements.

All material contained in the webcast is the sole property and copyright of Micrel Incorporated with all rights reserved. Certain statements in this conference call which are not historical facts may be considered forward-looking statements that involved risks and uncertainties.

Forward-looking statements includes statements regarding future business results, future levels of sales and profitability, product and technology development, future customer demand, inventory levels and economic and industry projections. Various factors could cause actual results to differ materially from what is set forth in such forward-looking statements.

Some of the factors that could affect the company’s results had been set forth on our press release dated July 24, 2014 and are also described in detail in the company’s SEC filings including but not limited to, our Annual Report on Form 10-K for the year ended December, 31, 2013. Listeners who do not have a copy of our second quarter 2014 earnings press release may view the press release on the company’s website.

We will first review our financial results for the second quarter ended June 30th, 2014 and then discuss our outlook for the third quarter of 2014. Our prepared remarks will be followed by a question-and-answer session with the financial community.

Let’s now turn to an overview of Micrel’s 2014 second quarter financial and operational highlights. We are pleased with the revenue for the second quarter was up 4.1% to $62.3 million, our highest revenue and sequential increase in the last two years.

Second quarter revenue benefited from improvements across all product groups, particularly for products from Discera acquisition where many design wins have enabled Micrel to stay at the forefront of MEMS technology.

Operationally, second quarter gross margin improved sequentially to 52.6% from 52.2% in the first quarter. We are pleased with this improvement in gross margin. We were also encouraged by our ability to reduce operating expenses in the quarter despite our higher sales volume. This help to expand operating margins to the highest levels in the past year.

While the rather slow pace of the macroeconomic recovery continues to create headwind for the semiconductor industry, we are encouraged by the strength of the Micrel's bookings which again yielded a book-to-bill ratio above one for the second quarter and on the year-to-date basis.

Micrel continues to operate from a position to financial strength. Cash flow from operating activities was $13.2 million in the second quarter. As of June 30th, 2014, our cash, cash equivalents and short-term investments balance was approximately $100.4 million or $1.75 per diluted share.

Our strong balance sheet continues to provide Micrel with significant financial flexibility to invest in our business. During the quarter, Micrel invested $2.9 million to repurchase approximately 300,000 shares of common stock. And year-to-date, we have invested $5.9 million to repurchase approximately 600,000 shares.

At June 30th, 2014, we had approximately $19.9 million remaining under our current repurchased authorization. Since 2001 the company has spent $459 million repurchasing Micrel common stock. These repurchases helped to reduce the diluted shares outstanding over this period by more than 50%. We believe that Micrel stock repurchase program is one of the highest when looked at on a percentage basis in the industry.

Pursuant to our focus on maximizing shareholder value, we are pleased to report that Micrel’s Board of Directors has once again authorized quarterly dividend of $0.05 per share of common stock to shareholders of record as of August 14, 2014. The payment of the second quarter dividend will be made on August 28, 2014 reflecting a yearly dividend yield of approximately 1.8% based on the current stock price. Since the dividend program began in 2007; we have paid out approximately $69 million in dividends.

Let's now take a closer look at Micrel second quarter financial results. Our revenue growth was up nicely in the second quarter. As mentioned earlier, we recorded revenues of $62.3 million, up 4.1% from $59.9 million in the first quarter.

Our second quarter sales mix product area was as follows: Linear and power 53%, timing and communications 24%, LAN 20% and other 3%. Micrel sales remain diversified with our top 10 direct customers accounted for 14% of sales for the second quarter.

We believe Micrel has one of the most diversified product lines and markets for its size in the industry. This is a hallmark of Micrel's deliberate low-risk strategy for managing the business.

Revenue by end market for the second quarter was as follows: Communications was 18% of total revenue compared to 18% in the first quarter, industrial is 51% compared to 52% in the previous quarter, as expected wireless handsets were down to 9% of total revenue in the second quarter compared to 10% in the first quarter. Computing was at 17% in the second quarter compared to 16% in the first quarter. And other at 5% remain relatively unchanged from the first quarter

Second quarter sales by region were as follows: North America approximately 20%, Asia 66% and Europe 14%.

Continuing with our income statement, SG&A spending for the second quarter was roughly $12 million or 19.2% of revenues, down from $12.4 million or 20.8% of revenues in the first quarter. Research and development expenses were $15.4 million or 24.8% of revenue, roughly consistent with $15.5 million or 25.9% of revenue from the first quarter.

R&D expenditures continued to result in expansive new product introductions. We are quite pleased with the early traction many of these products are receiving in the marketplace.

Operating income for the second quarter was $5.4 million or 8.6% of revenues, up from $3.3 million or 5.5% of revenues for the first quarter. Operating income as a percentage of revenues was at the highest level in the year.

Micrel recorded an income tax expense of $1.9 million in the second quarter compared to $1 million in the first quarter. During the second quarter, the company's effective tax rate of 35% reverted to the statutory rate. For comparative purposes, Micrel's effective tax rate was 31% in the first quarter.

Finally, GAAP net income was $3.5 million or $0.06 per diluted share and non-GAAP income was $0.09 per diluted share. This compares to first quarter net -- GAAP net income of $2.3 million or $0.04 per diluted share and non-GAAP income of $0.07.

Now, turning to the balance sheet, our liquidity position continues to remains strong. Cash and short-term investments were $100.4 million at the end of the second quarter compared to $90.2 million at the end of the first and $88.6 million at 2013 year-end. Cash flow from operations for the quarter was $13.2 million compared to $6.4 million in the prior quarter and $2 million for the second quarter of 2013.

Second quarter capital expenditures was $2.5 million, a bit higher than our normal capital expenditure run rate of $1 million to $2 million per quarter. The increase is due to the company ramping manufacturing capacity for MEMS products.

Accounts receivable balances decreased by $1.2 million in the second quarter to $34.7 million from $35.9 million in the first quarter. As a result, days sales outstanding were 51 days at the end of the second quarter, down from 54 days in the first quarter. The company does not have any significant collection issues.

Net inventory remained flat at $42 million during the second quarter and days of inventory on hand decreased slightly to 129.5 days from 132 days in the previous quarter or 127 days of inventory on hand netting out an end of life one-time purchase of material remaining from quarter three 2013.

Micrel is constraining fab utilization in an effort to reduce inventory to our target level of 120 days. At the end of the second quarter, total channel inventory weeks of supply (technical difficultly)

Operator

Excuse me everyone for having the interruption, just a moment.

Our speakers are now reconnected. Thank you for patience.

Robert DeBarr

Thank you. At the end of the second quarter, total channel inventory weeks of supply were 16.3 weeks, up from the first quarter of 15.4 weeks primarily due to the restocking of channel inventory in anticipation of growth in the second half of 2014 and an increase of lead times. Second quarter depreciation and amortization was $3.4 million, down slightly from $3.5 million in the first quarter.

Before turning to our outlook for Micrel and the industry, we would like to provide some highlights of new and exciting products that we have introduced. Our linear and power solutions group, LPS, has released to the market, one of the smallest solution size LED drivers in the market. This highly efficient driver takes only three tiny external components to power flash LEDs or infrared LEDs for smartphones and tablet camera module applications.

We have also started sampling some of the smallest power modules in the market. Market acceptance of our recently introduced power modules has been very encouraging from a wide range of customers. Some customers have already designed these parts in the products schedule to go to production later this year.

Micrel's timing and communications group, TCG, introduced the MX55/57 family of ultra high performance oscillators as part of the expansion strategy of the FUSION product line. These products deliver industry-leading phase jitter performance with multiple standard footprints.

The MX55/57 family of oscillators support a wide range of applications that drive next-generation connectivity in datacenters, cloud computing, high-definition video, networking and wireless mobile.

The devices meet stringent clocking requirements for demanding standards in data communication; optical communications, fibre channel, SAS and PCI-Express Gen1, 2, 3. In addition, these devices implement Micrel's proven assembly process, enhancing readability and time-to-market in comparison to competing ceramic (inaudible) oscillators.

Our LAN solution group augmented the KSZ84xx EtherSynch Family with a three-port switch and controller products that support fibre links. Micrel's EtherSynch Family targets time-sensitive industrial control applications requiring determinist Ethernet.

The highly integrated solutions combined IEEE 1588 Version 2 distributed synchronization and Precision GPIO with energy efficient capabilities in a single chip. We are also seeing demand expansion to new applications such as mobile base stations and power substations.

Complete voice-over-IP system and software solutions based on the KSZ83xx Family will release in target, migrating analog devices in embedded applications to digital IP with voice capability thereby enabling cloud management -- cloud base management and services. Micrel voice-over-IP solutions can now seamlessly integrate with analog designs in medical, security, intercom and other markets.

Now let's turn to the outlook for the semiconductor industry and Micrel for the third quarter of 2014. In order to assist the investment community in better understanding the complex and ever changing dynamics of the semiconductor industry, Micrel frequently provides data relevant to industry economic conditions and outlook.

That being said, we want to remind everyone that the following information is not specific to our company. It is with this backdrop that we once again provide our industry view and outlook.

Looking at slide one, which is Micrel's well-known semiconductor barometer, nearly one year ago Micrel predicted that conditions in the industry will begin to improve around February 2014. In fact, our predictions for lead times, pricing, inventories and utilization came in exactly as predicted for quarter two.

Please note that we have extended barometer out for quarter two of 2015 to include the next four quarters. What the barometer shows is that with the business generally improving, conditions will remain rather than sunny through quarter four of 2014. Then things get a little cloudy going into quarter one 2015.

For the second half of 2014, we anticipate conditions for the industry will continue to improve with lead times stretching out, inventories remaining in check and pricing stabilizing.

We do not believe that global demand for semiconductor is strong enough for us to show a rosy outlook for virtually all of 2015. We expect the industry will continue to go through its normal seasonality, with business beginning to drop-off toward the end of December 2014 and business to remain soft through Q1 of 2015, before we gain momentum again in Q2 of 2015.

We want to remind you again that it is our belief the semiconductor industry growth is correlated to U.S. GDP growth. We are predicting that the U.S. GDP growth will still remain some 4% for the next couple of years. This would suggest that all semiconductor revenue growth will most likely to be in the mid to high single digit range.

Now let's turn to slide number two, which is our semiconductor industry cycle chart. You will note that the industry continues on the long-term growth trend line, an approximately 10% compounded annual unit growth.

The issue that remains is what is going to happen to ASPs. While ASPs appear to be somewhat stable, we expect some continuing erosion through the second half of 2014, and therefore continue to maintain our projection of 5% to 7% revenue growth for the industry for 2014. This assumes an ASP erosion of 3% to 5% for all of 2014.

Now turning to Micrel for Q3, 2014. We expect continued revenue growth for the company in quarter three, driven by improving conditions at all of Micrel's end markets with some acceleration in handsets.

We expect Europe to be typically slow in Q3 as Europe generally takes vacation in the third quarter. We are also expect to amend the terms of our contracts for certain distributors during the third quarter which will enable us to recognize revenue at the point of shipment to the distributors rather than deferring revenue recognition until they have resold our products to their customers.

As a result of these changes, we expect to recognize revenue in the range of $3 million to $5 million for the inventory held by the distributors on the effective date of the amendment. We intend to move to a similar model with all of our distributors over the next year.

We anticipate our GAAP revenue in the third quarter including this one-time impact of $3 million to $5 million to be in the range -- up 7% to up 14% on a sequential basis. Excluding this one-time impact for comparison purposes, we expect our revenue to increase by 1% to 6% on a sequential basis from the second quarter of 2014.

We expect GAAP gross margin in the third quarter including the one-time revenue related costs of goods sold impact to be in the range of 53% to 54%. Excluding this one-time impact, we expect GAAP margins would be between 52% and 53%. We anticipate our non-GAAP gross margin to also be in the range of 52% to 53%.

We expect GAAP earnings for the third quarter, including the aforementioned one-time impact, in the range of $0.08 to $0.12 per diluted share. For comparative purposes, we expect GAAP earnings will be in the range of $0.06 to $0.09 per diluted share, excluding this one-time impact. We anticipate our non-GAAP earnings will be in the range of $0.09 to $0.11.

The company continues to execute well on all fronts, both in terms of new product development and controlling expenses. We continue to be optimistic about Micrel's growth potential for the next couple of years. Our new products are gaining traction, and our new acquisition of Discera is paying dividends.

Thank you. And now we'll turn to the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions)

Our first question comes from Tore Svanberg of Stifel. Please proceed with your question. Your line is live.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Yes, thank you. A few questions. First of all, I was hoping you could talk a little bit about this concession you're having with some of your distributors. Just trying to understand the timing. I know accounting rules will probably eventually force all companies to move to this new method, but just wondering if there was anything behind Micrel's particular timing.

Raymond Zinn

So, Tore, as you know, we do have both POP and POS distributors right now. And as we go through our contracts and start to change them up, we’re moving our small distributors over for a combination of reasons. But a lot of it is to streamline just the accounting administration that we have here and improve some of the controls.

So, we're in the process of doing that. We have been doing it for over a number of months now. And -- but it just so happens that it coincides with the fact that they are changing rules coming out down the road, so we'll be set for that. But it's not necessarily the reason why we did it.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Okay, sounds good. And if I look at the extent, $3 million to $5 million, now I think you mentioned that's primarily for small distributors. I'm just trying to understand how big of a percentage is that in relation to your distribution revenue? Because I assume whatever you gain now is probably something that you will see a decline in later on. So, just for modeling purposes, just trying to understand how we should treat this $3 million to $5 million going forward?

Robert DeBarr

Just quickly, Tore, I know you didn't mean it. It's not a $3 million to $5 million expense. It's a $3 million to $5 million revenue.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Yes, yes, no. I understand that, but obviously, as you get that benefit this quarter, obviously, you're not going to have that benefit the following quarter. So, I'm just trying to understand how big this is in relation to your distribution revenue.

Robert DeBarr

So, you're correct. We won't have that benefit in the following quarter, and it's about 10% to 15% of our distribution revenue. But we will, from an apples-to-apples standpoint, you could still look at the growth that we show, the 1% to 6% outlook that we have there and that's an apples-to-apples number, but it won't be -- it won't come again, but it doesn't go away, also.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Okay, understood. So, moving on to business, Ray, you sound optimistic about what you're seeing right now in the business climate, when your book-to-bill was above 1. But you also seem to be a little bit cautious about the environment. I don't know if that's in relation to any specific data points, or maybe you could talk a little bit about that, please.

Raymond Zinn

Okay, so we have two parts here. One is optimism for Micrel and the other is just conservatism regarding the way we see the overall business climate. So, my view of Micrel, of course, I'm very optimistic because we have put a lot of energy into these new products, we spent a lot of money on R&D, and we’re reaping the benefits of that. So, I do see some upside for the company specifically.

Now, regarding the overall industry and economy, that hasn't changed any. I've still expressed concern regarding the relationship between the industry and U.S. GDP. I still stand by my prediction of growth for the industry to be in the 5% to 7% range and I haven't changed that for a year.

My view of the current climate, that's another question. So, yes, we’re seeing a little slowdown. It began, probably, the last few weeks. And that does have us somewhat concerned. And so we're not as optimistic as we were let's say, a month and a half ago. But this could be somewhat of correction.

I think the second half of the year is still going to be okay, just not quite probably as rosy as we had originally thought. I'm still staying with my five to seven.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

(Technical Difficultly)

Raymond Zinn

Yeah. You're still breaking up there.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Yeah (Technical Difficultly)

Raymond Zinn

Okay.

Operator

(Operator Instructions) We are trying to correct the audio on the speaker's line. (Operator Instructions)

Raymond Zinn

Okay, okay. Sorry, so -- somebody's got there phone open and it's still feeding back somebody that’s on the call. So, did you hear what I said, I don’t know where I left off, Tore, before we started breaking up.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Yes, no I did. And the only follow-up that I had is, this recent weakness you've seen, I was just wondering if that’s just purely seasonal as the industrial markets, for instance, go into the summer months? Or is this sort of the beginning of maybe more of the macro concern out there?

Raymond Zinn

I don’t know yet. We don’t hear anything specifically from our customers. In other words, as we pull each of the regions and look at the -- at the various markets that we serve, we don’t hear anything. There's nothing that suggest any change that way, except we have seen a little bit of concern from our disti partners as they are now beginning to pull back their inventories. Meaning, they're -- have pulled back their orders and stabilizing inventory, moving say from 16 weeks to 15 weeks, something like that.

So that’s the only thing we see as they are correcting inventory. Maybe the lead-times are not as concerning to them. In other words, that the industry is able to meet its deliveries and this now gives them the ability to just pull back some of the orders that are further out, that would be one idea that I have. It's just that lead-times are not stretching out or at least the industry is able to make deliveries and so there is not that pressure on the customers to hold inventory. That would be my speculation.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

Sounds good. Last question, you spent some CapEx this quarter to ramp your MEMS capacity. Just wondering when we should expect either A, the ramp in production there or B, more meaningful contribution from MEMS revenue.

Raymond Zinn

Okay. So we are getting more meaningful revenue from the MEMS, it's just that we just can't meet the demand. And so that -- we hope to have the cleared up by September and so the equipment has been ordered and we should start seeing it come in within next few weeks and then it will take time for us to get it calibrated and set up.

So -- but, yeah, we are quite pleased with just the reception we received on these MEMS products.

Tore E. Svanberg - Stifel, Nicolaus & Co., Inc.

That’s very helpful. Thank you very much.

Raymond Zinn

Thanks Tore.

Operator

(Operator Instructions) There are currently no further questioners. I would like to turn the floor back to management for closing comments.

Raymond Zinn

Well, thank you. Appreciate you all staying on the call. Look forward to talking you again in October. So, once again thanks for joining us.

Operator

Thank you. Ladies and gentlemen this concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.

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