Microsemi Corp. Presents at UBS Global Technology and Services Conference 2011, Nov-15-2011 03:30 PM

Nov.15.11 | About: Microsemi Corporation (MSCC)

Microsemi Corporation (NASDAQ:MSCC)

November 15, 2011 3:30 pm ET

Executives

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

Analysts

Unknown Analyst -

Unknown Analyst -

Hey, everybody, thank you very much for coming. We're very pleased to have Steve Litchfield, the Chief Strategy Officer for Microsemi presenting. He's the architect of such successful transactions as Zarlink and Actel of recent history and I'm sure we'll see a lot more from him. So Steve?

Steven G. Litchfield

All right, thanks, Pat. Thanks for having us here today. I'll walk you through a few slides with regard to Microsemi and a few questions afterwards. So our standard disclaimer. And just to give you a little bit of color around Microsemi, this hasn't changed too much, but we are very focused on Defense & Security, Aerospace, Enterprise, Communications and the Industrial & Alternative Energy markets.

So we do have probably the industry's broadest technology portfolio out there. We like to focus on things that are difficult. We like to focus on applications where we can solve very difficult problems. That's what we do best, where performance really matters, where we can really differentiate our product portfolio, where we can ultimately help our customers solve those difficult problems.

So on this slide, we've kind of highlighted our end market base today. So today, about 35% of our revenues goes into the Defense & Security market, 19% Enterprise & Communications, 26% Aerospace and 20% Industrial & Alternative Energy. I'll probably just take a brief moment and kind of highlight. So we just completed the transaction of Zarlink, as Pat mentioned, in kind of late October. So this changes a little bit, so the mix of business, our -- what ultimately -- our Enterprise & Communications, about 19% of revenues today will move up to kind of 33% to 34% potentially; and then Defense & Security probably comes down to kind of 25%, 26%; Aerospace probably moves closer to 20-ish percent; and then Industrial & Alternative Energy stays around the 20% level.

I think the important thing to point out here is, as Microsemi continues to grow, and I'll highlight, in fact, maybe I'll take the opportunity to switch to the next slide here. If you'll notice here -- so Microsemi's been very focused on expanding its SAM, this shows kind of a 10-year chart of how we focused around growing from a $500 million SAM up to a $4.1 billion. This enabled us to get to this $1 billion revenue run rate. As Microsemi -- as we sit here today, our focus and my focus, specifically, is how do we get to $2 billion. In order to do that, we've got to look at new areas, new focuses for the company. So you've seen us acquire a handful of companies, a handful of new technologies, several of our acquisitions have been technology plays. And so you've seen more penetration into SoCs, anti-tamper capability. You've also got some Rad Hard capability that we haven't had in the past, and then even going as far as kind of board-level systems as well. So this ultimately enables us to drive potential growth up into that $2 billion level. So this is where our real focus around putting more communications infrastructure in place such as focus around some of the Zarlink's product offerings and ultimately drive that SAM from $4.1 billion up to kind of $6 billion, $7 billion.

So again, this slide just kind of highlights our very comprehensive portfolio and we really do have a very, very wide range and breadth of technology. So you see in the middle there, where we actually do have programmable analog, processing on sense and control and configurable logic. This is something that's somewhat unique to a analog, mixed-signal company. This came through our acquisition of Actel about 16 months ago now. But it's a very wide range and this is -- our whole goal in life is really to take more Silicon on the board.

So I'll go through each of our end markets. So here I've highlighted the Enterprise & Communications space, it's about 19% of our revenues today. This has been, historically, a big focus for the company. We do have a strong IP position. Historically, we've talked a lot around kind of POE, LED backlighting, these are some of the -- a couple of the areas that we've focused on. You see on the bottom some of the customers that we participate with today. Huawei, Juniper, Cisco, Alcatel-Lucent. As you would expect also, I'll highlight here that the addition of Zarlink, these are all customers that those guys are focused on today and thus will become a bigger customer to Microsemi.

So here's a slide that just kind of goes through some of our communication strategy. And if you start kind of from the bottom left-hand side, you'll see that we began this about 5 years ago to really grow this piece of our business with an acquisition of power design where we focused on Power over Ethernet. But since then, we've added a number of new product offerings, so we have what we call our customizable SoCs. In that next box it's really focused around sensor control, power conversion, wireless LAN. Wireless LAN is something that has been doing very well for us lately. We've seen tremendous amount of growth around reference designs with now Qualcomm, Atheros and most recently, Broadcom, and that's actually driven a lot of growth as of late. And then, now with the acquisition of Zarlink, you're seeing the network timing and synchronization business as well as voice processing, Voice over IP, fiber-to-the-home are some of the key drivers from potential applications for our technology.

So here's another slide that just kind of highlights the communications portfolio and where we play. So this highlights in a DSL application and a hybrid cable fiber-to-the-home application. A lot of the product offering that we have -- and it spans everything from PoE, power management, WAN, LAN, line circuits, timing and sync and Voice over IP.

So this slide highlights some of our Power over Ethernet Solutions. This is something that we highlighted on our conference call just last week, actually. And we've been getting a tremendous amount of traction with the top 2 players in this market who have been customers of ours but more in a small way, historically, starting to get some more traction here. This is a market that we sell ICs as well as what we call these midspan devices, both of which have been widely adopted. And we expect to see over the next kind of 12 to 18 months this continue to grow nicely.

So here I just mentioned briefly before our wireless LAN business, but this is an area that we participated in for some time with front-end modules. And you'll see on the right-hand side there, the front-end module that we participated in, we bought a small, little technology a few years ago and then invested in silicon germanium, but we're now the only person that can do a monolithic front-end module and silicon germanium. There are silicon germanium solutions out there, but a complete solution that we now have is the first 4G solution out there. So I'm very excited about the capability and we expect to continue to broaden this as we go forward.

So Defense & Security. So as you can see about 35% of our revenues come from Defense & Security today. Some of the drivers, I mean, there's a lot of turmoil going on here, a lot of questions around what's going on in Defense & Security. We've got the supercommittee, hopefully, trying to make a decision at some point in time. I think at the end of the day, Microsemi is encouraged by some of the drivers that continue to be out there and that's electronic content, our continued growth and our own footprint. Foreign military sales, this is something that has been a big driver over the last year and we expect it to be over the next 2 to 3 years despite whatever happens with our own DoD budget, we're seeing more and more international market growth. The interesting thing about that is that, as we do sell more products through foreign military sales, they're actually being sold with more anti-tamper capability, which is something that is fairly unique that we've developed over the years and we have multiple areas from crypto or even physical anti-tamper capability that we haven't had in the past. And that is a big driver of growth going forward.

In this market, we've also really pursued more of a subsystem path so that we not only sell components but we're also selling subsystems, modules. In this particular market, unlike a lot of our commercial markets, we are able to hit the margin targets, the gross margin targets, specifically, in this area. And so as our customers often approach us and ask us to build an entire system, it's a great opportunity and it's a great revenue driver that we don't have in a lot of our commercial businesses.

So this is just one example of kind of a particular application within the Defense business that's growing nicely. UAVs, I'm sure you've seen a lot of this on the news, but it is one of the drivers within our business. There's such a breadth of products that we sell into a UAV. I mean, everything from engine control, communications, Millimeterwave transceivers, RF transceivers, voice, video, flight control, sensor control, SoCs, FPGAs, there's a breadth of product offering here. And, as you guys all know, I mean, there's a wide variety of UAVs. There's huge UAVs out there as well as tiny little UAVs as we go forward. So it's hard to tell the content, but it is a big growth area that we expect to see kind of a CAGR of about 20% over the next several years.

So head on Aerospace a little bit. Aerospace, first of all, to Microsemi consists of 2 things. One is Commercial Air, and the other is Satellite. So it's about 26% of our revenue today. A lot of the reasons for the growth, fuel efficiency within the Commercial Air markets are becoming more and more critical, and then we've also got a lot of avionics, radar, power control, TVS applications, that are driving content. So as newer planes come out, there is more electronic content in the newer aircraft, so that's also a big driver for Microsemi. On the Satellite side, we've continued to see a lot of good market growth, content growth as well. I'll talk about this a little bit further in a few minutes. But we see as much as $2 million of content per satellite. This is a great end market but it's probably a bigger market opportunity to continue to grow silicon within one particular satellite.

So a little bit of the growth opportunity for us in our Satellite application, we, historically, had great penetration within the bus, but we've had very limited opportunities within the payload. There's a variety of reasons for that. But, primarily today in the payload, they're using more of an ASIC solution. But as we move forward, we completely expect to see our customers kind of shift, so between reliability and some of the performance requirements, I believe that Microsemi can now penetrate this payload application with some of the newer products that are just being released in this current year. Now granted that'll start to drive revenues in another 2 years, just given the time that it takes to get from a design and before a satellite is actually launched. But this is a big growth driver for us. The market size for the payload is about 3x the bus so you're going to continue -- I mean, you see a lot of upside as you look out 2 years in this particular application.

So Industrial & Alternative Energy. It's about 20% of our revenue today. So this covers a wide variety of products, everything from welders, plasma cutters to solar inverters, to medical products. So that's kind of a, somewhat of a gamut. Well, I guess, the one I would add to that is Smart Grid. So Smart Grid is something that's been ramping for us. We sell into the likes of Itron as well as another very large supplier into the Smart Grid space today. It's a recent design one. So we see that growing nicely. One of the negatives that we've seen over the last couple of quarters, and expect to see the impact from over the next few quarters, is the solar market. Solar market, as all of you probably know at this point, has been very tough. We expect that to continue. There's a lot of inventory out there. There's a couple of bright spots just for more of the industrial side or the commercial side rather than the residential side, but nonetheless, we don't expect to see a huge change in that in the next couple or 3 quarters.

Other opportunities here, we do see solar, wind, battery applications and even down-hole drilling, we would put into this category as a potential opportunity for Microsemi, where we're bringing products to market that have higher performance, higher reliability solutions, that play very well in these particular end markets.

So one of the aspects is Medical that fall into the industrial market. So one big driver in the coming year, I think, will be the RF portion of an ICD that Zarlink was previously selling into the likes of St. Jude and Metronics. So we think one of these guys is going to start to set ramp-up in the second half of this year. But it's probably much more meaningful in 2013 than 2012. But ICDs are definitely a big play here. The Zarlink low-power radio is really one of the best if not the best in the business and we think that we can not only leverage it within more and more medical wireless applications, but also into some potential M2M applications going forward.

Microsemi also participates, and we highlighted this a little bit on our call the other day, is in the MRI space. We have seen a lot of content growth as these systems move from 1, 1.5, to 3T and now 7T. So our content continues to grow each time and so while the market is kind of a 4% to 5% grower a year, our content growth can be 2x and 3x that.

So this is the slide that gives you a little bit of overview of what we're doing in solar. And although this is a tough market, we do think that it's going to grow nicely over the next 3 to 5 years, and we're playing in various components, everything from discrete to IC components, as well as control components with some of our SoC solutions.

So I'll briefly go through the financials. So here, fortunately -- so our revenues, you can see it kind of moving nicely up into the right. We just completed the most recent quarter. Operating margins also kind of moved up to that 26%, 27% range. Our gross margin targets are 60%, our operating margin targets are 30%. So this just kind of goes through the model and actually highlighted here is the target model of revenue growth of 15%, gross margin's at 60% and operating margin's at 30%. Most recent quarter, we completed $227 million in sales at 57.3% gross margin and 26.3% operating margin.

So it's a bit of an eye chart here, but it does give you a little bit of a highlight on the cash flow in the balance sheet. One thing that we're particularly pleased with is the cash flow generation. I'd go back to about 2 years ago, we were running less than $100 million of cash flow generation a year. On our call last week, John Hohener highlighted that kind of in the coming year, once Zarlink is fully integrated, we would expect that number to be in the $200 million to $250 million range of cash flow from operations. So that gives us a lot of comfort around some of the debt that we took on with our Zarlink acquisition. I guess one other thing to highlight here, I mean, our DSOs in the most recent quarter -- well, you can actually see here it's moved from kind of 46 down to 42. So in the last quarter, it's come down nicely. And days of inventory as well has actually moved down from a high of 153, at least, in the last 5 quarters down to about 134 this last quarter.

So that's the end of the presentation. I'm happy to take a couple of questions here, or we can move to the breakout.

Question-and-Answer Session

Unknown Analyst -

[indiscernible] With the debt you've recently taken on, you have to be a little bit more aggressive in sort of planning downside for the supercommittee. If we start getting sequestering -- what are you guys thinking if we start getting sequestering on your Defense revenue? I know it's only a part of the Defense and Aerospace, but how should we think about that in terms of revenues and margin and your target model?

Steven G. Litchfield

Sure. So we're absolutely very cognizant of the debt levels. I mean, just maybe as a point of clarification, after the Zarlink acquisition, we've got about 2.9x debt to EBITDA ratio right now. We would like to see that trend down to 2, and I think, as a comparison, I mean, we do see some of the other guys that you have debt in this market up at 5x and 6x, which we are not comfortable with. But you're absolutely right, as we look at some of the things that are going on in the defense industry, the supercommittee. As that rolls out, we actually have been managing the defense piece. We do -- we've actually seen a variety of things going on. We believe that some of the uncertainty, and we highlighted this last week as well, some of the budget uncertainty that's going on in the market right now ends up being as problematic as even the cuts themselves. Right now, with the uncertainty, a lot of decisions aren't being made, and we're kind of not able to move the ball forward. We're actually -- we'd like to see some decisions get made so that we can actually start putting some more orders on the books because right now we see customers pushing out and waiting for decisions rather than making decisions. So we're being very prudent with our cost, we talked about this last week as well. We did some cost-cutting on the SG&A side as well as on the R&D side, and very prudent with this market environment.

Unknown Analyst -

[Question Inaudible]

Steven G. Litchfield

So the total number is -- I don't know the exact number, Jim, it's about $750 million.

Unknown Analyst -

[Question Inaudible]

Steven G. Litchfield

7 years. Yes, that's correct and the interest rate's 5.75%.

Unknown Analyst -

[Question Inaudible]

Steven G. Litchfield

So the plan -- so right now, I mean, historically, a lot of questions around do we want to pay down the debt, do we want to hold on to the debt. I mean, I think in the end, if this interest rate can kind of stay at these levels -- if we can continue to find good acquisitions, we will consider doing using that money for acquisitions. But right now, our real focus on getting this product integrated. Zarlink had -- I mean, if we can talk a little bit of the financial targets around Zarlink. Zarlink was running about 52% gross margins and about 10% or 11% operating margins. We are targeting to be, within 6 months, to have that up to 60% gross margins and 30% off [ph] margins. So a pretty aggressive target, but very focused again on increasing that cash flow quickly and driving down that debt. So that's what we're focused on, we're not looking to extend that further at this point in time. And then as we go forward, I mean, as we look out 12 months, acquisitions are absolutely a part of our strategy. We're not going to shy away from that. But we're going to consider that if we can find an acquisition that can deliver $0.25, $0.30 of accretion at the right price, we might do that deal or if we can't find that, we'd absolutely pay down that debt, either one.

Unknown Analyst -

[Question Inaudible]

Steven G. Litchfield

Cash flow from operations, correct.

Unknown Analyst -

[Question Inaudible]

Steven G. Litchfield

CapEx runs about $25 million to maybe $30 million a year. So relatively lean, we're a fab-light model. More and more, everything that we do now is, has gone fab-less. So we're using more and more foundries. It's probably 30% to 35% of our business today goes through our internal fabs, which are fully depreciated. And if we did need to extend that because of just demand, we could do that relatively easily.

Unknown Analyst -

So it looks like there's 18 seconds left.

Steven G. Litchfield

18 seconds left? So...

Unknown Analyst -

Steve, Rob, thank you, guys, very much. We've got a breakout starting in now 6 seconds. So thank you, guys, very much. I appreciate your continued support.

Steven G. Litchfield

Thank you.

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