Cypress Semiconductor (CY) Q1 2016 Results - Earnings Call Transcript

| About: Cypress Semiconductor (CY)

Cypress Semiconductor Corporation (NASDAQ:CY)

Q2 2016 Earnings Conference Call

July 28, 2016 04:30 PM ET

Executives

Rahul Mathur - Vice President of Finance

Hassane El-Khoury - Executive Vice President of Programmable Systems Division and Software

Dana Nazarian - Executive Vice President-Memory Products Division

Joseph Rauschmayer - Executive Vice President of Worldwide Manufacturing

Thad Trent - Chief Financial Officer and Executive Vice President of Administration

Michael Balow - Executive Vice President of Sales and Applications

Badrinarayanan Kothandaraman - Executive Vice President of Data Communications Division

Analysts

Christopher Hemmelgarn - Barclays Capital

Vijay Rakesh - Mizuho Securities.

Craig Hettenbach - Morgan Stanley

Rajvindra Gill - Needham & Co

John Pitzer - Credit Suisse

Harlan Sur - JP Morgan

Operator

Good afternoon and welcome to Cypress Semiconductor Second Quarter 2016 Earnings Release Conference Call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Rahul Mathur, Vice President of Finance at Cypress Semiconductor. Sir, you may begin.

Rahul Mathur

Thank you, Mark. Good afternoon and thank you for attending our Q2 conference call. All information discussed in our press release and on this call is based on preliminary unaudited results, and we encourage you to review our 10-Q once filed.

I would like to remind everyone that during the call, management will be making statements that should be considered forward-looking, and as such they are subject to a number of risk and uncertainties that could cause actual results to differ materially from result anticipated by the forward-looking statements.

Please refer to our earnings release, I would say the risk factors in our 10-K filed with SEC and our other SEC filings for a more detailed discussion of these risks and uncertainties. All forward-looking statements are based on the information available to us as of today. We undertake no obligation to update these statements. Please note that the financial measures to be discussed by management today are non-GAAP measures unless they are specifically identified as GAAP measures. Reconciliations of all non-GAAP measures to their most comparable GAAP measures are included in the earnings press release issued today.

Joining me today are Hassane El-Khoury, Dana Nazarian, Joe Rauschmayer and Thad Trent, who make at the office of CEO, as well as Mike Balow, EVP of Sales and Applications and Badrinarayanan Kothandaraman, EVP of our Data Communications Division.

The order of our call today will be as follows. CFO, Thad Trent will make some introductory remarks and provide a financial overview and then we’ll end with Q&A.

I’ll now turn the call over to the Thad Trent.

Thad Trent

Thanks Rahul. So let me start by discussing the critical focus areas for the company including the demand environment, our margin trajectory and additional details on our financials. First, the demand environment, we believe the semi market remains soft and relatively stable. Our non-GAAP revenue for Q2 was $456.4 million in line with our guidance for the quarter as we continue to execute as expected.

The revenue estimated we provided for Q3 of $510 million to $514 million reflects our base business growing seasonally and roughly 3%, as well as $55 million to $60 million in revenue from the acquisition of Broadcom’s Wireless IoT business, reflecting the growth we anticipated from these products.

Next, I would like to discuss the gross margin trajectory. Our gross margin improvement plan is enfolding as expected. The Q2 margin was 37.8% roughly in line with our expectations. Excluding our Emerging Tech Division, core margins were 38.1% up from Q1, as we continue to maintain low factory utilization as part of our lean inventory initiatives.

We’ll continue to keep utilization and our internal fabs but low natural demand due to access inventory, we had at the time of the merger with Spansion. While this has put pressure on our margins and EPS in the short-term is in effective way of generating cash flow and improves our pricing and profitability going forward. We expect gross margins to improve in Q3 to roughly 41% with higher utilization, a seasonal revenue increase and contribution from the wireless IoT business at roughly 50% gross margin.

So before I dive into the financials, let me give you an update on our CEO transition. Our Board continues to diligently evaluate internal and external candidates. In the interim, our business is operating as expected. Our Q2 financials were in line with our expectations and we continue to exceed the Spansion synergy plan. Additionally, we closed the acquisitions of wireless IoT assets on July 5th as schedule. Taking orders on day one and shipping on day two. So on behalf of the office of the CEO, I’m proud of the foreign exaction by our team worldwide.

Now let me give you some details on our financials. In Q2, PSD revenue was $166.8 million, as we continue to see growth in our automotive, microcontroller, and PSoC solutions. Overall, the industrial and automotive segments represent 58% of total revenues versus 52% in the same quarter of last year. It's important to note that the legacy Cypress automotive business has growing 47% year-over-year and we see our cross selling opportunities continuing to grow.

As a point of reference, our automotive design wins have doubled since the same quarter of last year. MPD revenue was $244.3 million, as we saw our typical seasonal increase in memory, particularly in our Flash business. As a reminder, Q3 is the last quarter we'll receive a quarterly payment of $6.25 million from a premerger licensing arrangement that cannot be recognized as GAAP revenue due to purchase accounting treatment.

Moving onto DCD, DCD revenue was $25.5 million, as we saw growth in trackpad and our USB Type-C business as we expected and we continue to see strong design win momentum in our Type-C products. Our Emerging Tech Division has revenue of $19.7 million for the quarter with gross margin of 30.9% as we saw lower foundry revenue.

Emerging Tech revenue has grown a 156% year-over-year and was once again profitable as we expected contributing a $0.01 of EPS. We continue to monitor our customers closely and track weeks of inventory in the channel. We entered the quarter with eight weeks of inventory in the channel and exited roughly flat at 8.1 weeks and this is within our targeted range of six to eight weeks, which is what we desire.

So, let me give you some additional numbers for you models. Our operating expenses for Q2 was a $123.3 million in line with our expectation and the lowest amount for the combined company's in six years. In the quarter, we recognized $41.4 million of synergies from the Spansion merger or a $165.5 million on an annualized basis. This is broken down to $10.6 million in cost of goods sold, $28.9 million in operating expenses and $1.9 million in interest and tax. We continue to expect the $180 million in Spansion synergies by the end of this year.

Our OIE and minority interest was $5.9 million and tax expense in Q2 was $3.2 million. This resulted in net income of $40.2 million or $0.12 per share in line with our guidance. During Q2, we repurchased a negligible number of shares, to-date we have bought back 239 million of the $415 million buyback that we announced in the fourth quarter of 2015. While our commitment to our dividend remains, we expect to use additional cash flow to pay down debt related to wireless IoT acquisition. Our diluted share count for Q2 was 339.7 million shares and we ended the quarter with 320.8 million shares outstanding.

So turning to the balance sheet, cash and short-term investments totaled $189.3 million and we had $173 million undrawn on our revolver. Cash increased by $102 million as we closed the $287 million convertible note prior to closing the IoT acquisition and we used the 163 of these proceeds to pay down the revolver.

Our GAAP results included a non cash good will impairment charge of $488.5 million related to our Programmable Systems Division. This charge has a $1.56 per share adverse impact on our GAAP results. A goodwill impairment charge resulted from the combination of factors including decreases in our forecasted operating results when compared to the expectations of the PSD at the time of the Spansion merger. Primarily in consumer markets, we increased our focus on the automotive and industrial segments.

This noncash charge has no direct effect on our current cash balance or operating cash flows. Our current long-term outlook for revenue and earnings for the company remain unchanged as we continue to position the company in high growth market such as automotive, industrial and IoT.

Our EBITDA for the quarter was $68.9 million, our accounts receivable into the second quarter was $325.1 million resulting in DSO of 65 days. We continue to bring through excess inventory since the merger reducing our net inventory by $168 million or 43%, to $221 million currently in drained an incremental $5 million in Q2 and we expect utilization will improve in the second half of the year as we match natural demand and migrate products into Fab25. Our CapEx was $12.8 million, depreciation was $19.6 million for the quarter.

Now if I turn over to the guidance we published in our press release today. We entered the third quarter with greater than 80% of the quarter booked in our base business and the book-to-bill was 1.1 consistent with last quarter. We expect Q3 revenue in the range of $510 million to $540 million in line with normal seasonality in our base business and reflecting our acquisition. We estimate consolidated gross margins to be 41% and as always margins will vary with utilization product and customer mix.

We expect approximately $175 million in annualize synergies or an incremental $9.5 million in Q3. This will result in Q3 operating expenses between $147 million and $150 million for the quarter, reflecting roughly $25 million incremental expenses associated with the acquisition of IoT business. This remains below our target model of 30%.

Moving onto net interest expense will be approximately $16 million reflecting the incremental debt related to the transaction. We expect minority interest benefit of approximately $900,000 associate with our sub, the tax expense of approximately $4.1 million, CapEx is estimated to be $21 million and depreciation is also estimated to be $21 million for the quarter.

We anticipate the fully diluted share count to be [352] (Ph) million shares. As a result, earnings per share is expected to be in the range of $0.12 to $0.16 for the quarter. So the wrap things up, the demand environment continues to unfold as we expected and our margin trajectories is in line with our plans for the year. We’re executing well and continue increase our leadership in the embedded systems.

So with that, I’ll now turn the call back over to the operator.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of Christopher Hemmelgarn from Barclays.

Christopher Hemmelgarn

Thanks very much for let me ask a question and congrats on the solid quarter guys. I guess, first of all, I was hoping you could talk a little bit about some of the moving pieces in your Q3 guide, both the core segments and then specifically what exactly are you guys baking in from the Broadcom IoT business into hat guide.

Thad Trent

So, in that guide Chris we've got $55 million to $60 million of revenue related to the IoT business and the gross margin for that business is roughly 50%, so if you think about the impacts of the consolidated gross margin it's about 1% bump in the overall margin. And the core business or the base business that I would call it is growing roughly at seasonality which is about 3%.

Christopher Hemmelgarn

Very helpful, thanks. I guess given all the moving pieces in terms of M&A last 12 to 18 months, can you remind us what the business you have today, what you see fourth quarter historical seasonality as.

Thad Trent

So, it's consistent still with what we've seen historically. The IoT business is growing, so if we look at our base business Q4 is typically down 3% off of the Q3 number. With the IoT business approximately 30% of it is auto and industrial. So we think that would follow a normal seasonality, but that business is growing. So we expect that to be up slightly in Q4.

Christopher Hemmelgarn

Thanks very much guys. I'll jump back in the queue there.

Thad Trent

Thanks.

Operator

Next question is from Vijay Rakesh. You may ask your question and please state your company name. Vijay your line is open.

Vijay Rakesh

Yes. Thanks, Mizuho. Just on the automotive, industrial and IoT, what is the mix of revenues, I know you said automotive, industrial at 57%, how much is IoT all combined?

Thad Trent

So, I think you are asking what is the breakdown between the industrial and the automotive. The IoT business is coming across is roughly 10% automotive today. 20% being industrial. On the base business of Cypress, it's roughly half and half between auto and industrial for the quarter, that make up that 58%.

Vijay Rakesh

Got it and then the gross margin it’s obviously a good guide for the third quarter, can you lay out what the gross margin roadmap looks till the end of the year and as you get next year? how is the Minnesota Fab closing and how is that tracking. Thanks.

Thad Trent

So I'll take the gross margin and then I'll let Joe comment on that on the Minnesota Fab. So the gross margin is consistent with what we expected and what we've been telegraphing to you throughout the year. It's laying out nicely as we expected, where we expect to exit the year is consistent than we would exit the year just below 40% on the gross margin side. Obviously you have got a down quarter seasonally and that will put pressure on the margin. But we're right in line with where we had expect to be. I'll let Joe comment on that, the Minnesota Fab.

Joseph Rauschmayer

This is Joe Rauschmayer.On the Minnesota Fab what we found as we go through this process is the equipment set is in very high demand from our Minnesota Fab based on today's tool market. We're in very advanced discussions with interested parties to disclose the FAB and we expect to make an announcement in the near future.

Vijay Rakesh

Got it and just one last question on the inventory effect how much of that is still left and do you expect that to get through that in the third quarter? Thanks.

Thad Trent

So, we expect to continue to drain it down, there is some excess inventory left. There is also kind of a mix component. So, you got to have the right mix going through the end of the year. But as we turn the Fabs back up in later in the year we'll start to build inventory again but you can expect inventory decline slightly through the rest of the year.

Vijay Rakesh

Great. Thanks a lot.

Operator

Next question is from Craig Hettenbach. Your line is open and give me provide your company name.

Craig Hettenbach

Yes. Thank you. It’s Morgan Stanley. So question on the IoT business. Just looking at that rate versus the trailing 12 months, which arguably could be a little bit stale, but it seems like a nice inflection out. So can you just talk about kind of the growth that you are seeing as a business gets - round for you and from a quarterly basis given it’s early stage maybe it’s not seasonal. But just any color in terms of how you see things progressing through the calendar year?

Badrinarayanan Kothandaraman

Okay. My name is Badri and I run DCD. So I’ll give you an overall color on the acquisition. So we are actually be happy with the acquisition of Broadcom’s Wireless IoT business. Like what Thad said, we had a seamless day one of operation and we started shipping product on day two. With regarding customer feedback, many customers are actually very happy that this business is in the hands of somebody who values broad customer base. So we have had nothing, but positive responses.

From a product portfolio perspective, Cypress did not have Wi-Fi, Zigbee and the classic Bluetooth, so now we have that with the state-of-the-art Broadcom portfolio. With regarding the growth question that you asked. This is in the embedded system space and we believe the market growth is in the order of 17% and which is what we guided in our April 28 call. So we expect year-on-year growth in current with the market and our Q3 revenue estimate of $55 million to $60 million is within that guidance.

Thad Trent

Yes. I would just add, this I Thad, there is a lot of momentum behind this business, as Badri said, we’ve got a lot of positive response from customers. There is a lot of design momentum behind the business and that continue as we close the acquisition. So we’re very excited about having that on the family.

Craig Hettenbach

I appreciate all the color. And then just as my follow-up. Understand that you characterize things are soft but it’s stable at this point. Can you talk to any end market, what product sets that maybe you are doing a little bit better or worse in Q2 or Q3?

Michael Balow

This is Mike Balow, EVP of Sales. So in terms of segments, automotive continues to be very strong for us right now. Not only in terms of revenue shift, but designs that we are also winning. Consumer in Q3 generally is a strong quarter for us as well, but we are generally seen very good bookings and results across most of the segments.

Operator

Our next question comes from the line of Rajvindra Gill. You may ask your question and please state your company name.

Rajvindra Gill

Needham and Company and congrats on good execution. On the longer term financial target, the goal of 43% gross margin and 28% OpEx and 15% operating margin or roughly about $400 million of EBITDA. Wondering where we are on the roadmap to achieve those metrics especially with the IoT acquisition and the added expenses there, if maybe you could talk a little bit about some of the puts and takes on how we should think about the longer terms targets?

Thad Trent

Yes Raj, let me just clarify. So the long term model is 50/30/20, 50% gross margin, 30% OpEx and 20% operating margin. So, obviously we are already below the OpEx target, today we're at 27% on the base business even as you pull in the IoT which has incrementally about $25 million of OpEx per quarter, we're still below that 30% target. So, we're definitely on-track on that side of things.

On the gross margin, it's consistent with what we've been saying over quite a few quarters here. Our goal is to drive up the margins over a three year period and we said we would exit 2018 at a rate just right around 48% I think and our annual stands about 47.9% to be precise. We're still executing our plan, the IoT business which is accretive to gross margin by about a point, helped accelerate that a little bit, but I would still expect it to be kind of in that timeframe as we execute on these plans.

We've always said, hammering on these gross margin on the Flash side is a lot of work, takes a lot of time and I can tell you as we work on it every day, things are unfolding in line with what we had expected. So, we're on that trajectory, we're holding onto that and that's the model that we'll execute towards.

Rajvindra Gill

I was referring just more of that a medium-term goal not necessarily a long-term goal, those numbers that I quoted to apologize for that. But in terms of the excess inventory from Spansion, if I remember correctly you had said that you would enter the year with about $60 million of excess low margin Spansion inventory and there was about $40 million left to burn through the remainder of the year that was in the first quarter. If you could quantify, how much excess inventory that still exist with Spansion and how should we think about burning that inventory through the year?

Thad Trent

There is still about $25 million to go between now and the end of the year between kind of the growth what has been written off in the net, combination of the two is about $25 million that we'll burn between now and end of the year.

Rajvindra Gill

Okay thank you. so last question on IoT. Clearly with this asset you get a lot of the connectivity technology, Bluetooth launch, [indiscernible] WiFi, et cetera. currently I think the strategy to sell through discreet radios, one from your portfolio to the BLE and then one with a low power WiFi from Broadcom’s business. What is the product roadmap in terms of integrating connectivity into a microcontroller or offering a broader portfolio of connectivity solutions to the customer. How should we think about the actual integration roadmap going forward?

Badrinarayanan Kothandaraman

So my name is Badri. I'll be answering the question. Basically from a short-term perspective what we are going to do is to create IoT platform based solutions, which means we combine our microcontrollers, our flash memories and the wireless connectivity standalone chips into a solution, which is supported with Broadcom's WICED platform. WICED is the software development environment and that’s stands for wireless Internet connectivity of embed and devices.

So short-term, it’s very simple, we are going to be selling all products of Cypress and we are going to use wireless connectivity as an enabler - as a catalyst in order to do this. From a product roadmap perspective, we are looking at combining the piece of architecture into WiFi and especially WiFi and Bluetooth combos and we are finalizing those roadmaps and we expect to launch those products shortly.

Rajvindra Gill

Thank you.

Operator

Thank you. Our next question comes from the line of John Pitzer. You may ask your question and please state your company name?

John Pitzer

Its Credit Suisse, thanks for letting me ask a questions. Congratulations on a good results. Thad I guess my first question if memory serves me correctly, you entered the June quarter with the book-to-build about 1.1 and you translated that into about 7% sequential revenue growth. I think you said in your prepared comments book-to-bill coming into the September quarter 1.1 and yet you are only guiding to 3%. Can you just help me understand the discrepancy and/or that 3% sequential growth, is it pretty evenly distributed across the major divisions or are there some up, some down, how do I think about that?

Thad Trent

Yes. So the book-to-bill is 1.1, last quarter I believe it was 1.09, so basically run in line. But what we are seeing is with the industrial and automotive customer, they attend to book out longer right. So we’ve entered the quarter with 80% of the quarter book, but we’re also looking beyond just Q3 with those types of customers. So that’s the benefit of moving into that more stable customer base and so you get better visibility into your business. So that’s part of the reason that you are seeing 3% growth versus the 7% growth. Your second question was…

John Pitzer

The 3% distributor costs of major division.

Thad Trent

Got you, yes. So you have seen more growth in PSD and DCD. And obviously MPD will be call it relatively flat for the quarter, but we expect base what we are seeing right now is more strength in the growth business with the PSD and DCD.

John Pitzer

That’s helpful. And from my follow-up just on the distribution side. It looks like all the growth in the June quarter was through distribution, direct was actually down sequentially. Any detail you can give me on that. And if I remember correctly, part of your distribution is sell in part is sell through. So I’m just kind of curious, if I missed it I apologies. Did you make any commentary about distribution inventory exiting the June quarter?

Thad Trent

We are 8.1 week, the majority of our business is now been converted to sell in, there is just a little bit that’s on a sell through basis but most of its already been converted. In terms of just strength, I think you see kind of just mix and timing for the most part. Do you want to comment Mike?

Michael Balow

Yes. So that’s probably not uncommon to see that much in distribution. We do about 75% or 80% of our business goes to distribution. If you think about where the majority of our sales are Japan is one of our biggest regions. 100% of that business goes through distribution as well.

John Pitzer

And the one last quick one, you talk about utilization gains in the back half of the year. How much gross margin upside do you think, you have from here to kind of optimal utilization. And do you start to see that benefits in the calendar fourth quarter or is that something that really starts to come through in the first half of 2017?

Thad Trent

So we’re running roughly 52% utilize in Q2. If we look forward to the end of the year you can think about that being probably 10% or slightly higher in utilization by the time we exit the year. So you start to get the full benefit into 2017, but you do start to get some of that benefit later in this year and just as a rule of thumb if you think about the 10% increase in utilization across both fabs is roughly 1% of gross margin. So you can think about between now and then you have got about 1% increase in gross margins just from utilization improvement.

John Pitzer

Thanks guys, I appreciate it.

Operator

Thank you. Our next question comes from the line of Harlan Sur. You may ask your question and please state your company name.

Harlan Sur

Hi, JP Morgan. Good afternoon. Thanks for taking my question and nice job on the quarterly execution. You have had the Broadcom IoT business for a month now and so as you look at their design win funnel, I'm just wondering if you can break out how much of the designing pipeline is focused on automotive, industrial, connected home et cetera. Sort of [indiscernible] pipeline, I just want to get a sense as the business continues to grow what end markets are going to be the major drivers?

Badrinarayanan Kothandaraman

This is Badri again, if you look at the current revenue profile, the mix of consumer is about 60%, industrial is about 30%, and automotive is about 10%. However, the design wins that we are seeing we are seeing the automotive percentage go up in terms of design wins, because cars are having or will have WiFi connectivity soon.

For example, there is rear seat entertainment where you have two screens on the back of the car which are actually connected to the head unit in the car. Those are getting popular and we have great technology, which is called as RSDB, Real Simultaneous Dual Band, which means that you have multiple streams of WiFi going from the rear screen into the base unit of the car. So Broadcom is or the Broadcom business that we bought had this product and it is the first of its kind in the market. We are very happy to have that and we have seen strong design win momentum there.

Having said that, we see a lot of frenzy of activity in both the consumer and commercial IoT markets, in the consumer markets, desirable design wins are very strong, the wins in the IP cameras are extremely strong as well. While in the commercial IoT market we are starting to see wins in the retail market and the asset tracking market and then even in the agricultural market, few of those as we see. So that will hopefully will give you the color of what you are looking for.

Harlan Sur

That was very helpful and it sounds like design win pipeline is pretty active and so given that how rapidly can the team get the WICED platform out to your channel partners, your distributors to expand the visibility and breath of the product line to a larger audience or potential customers, when is that going to start to happen?

Michael Balow

This is Mike Balow. It's already started to happen, we just had a worldwide sales conference back in June and we invited Broadcom to come there and do a lot of training. So we've already started deploying it. Our sales people are up to speed, our FAEs are up to speed and we’re actively working designs now with the Broadcom contingent that came over

Harlan Sur

Great. Thank you.

Operator

At this time, we have no further questions on queue. I would now like to turn the call over to Thad Trent.

Thad Trent

So thanks for joining the call today. We are pleased to have reported results that were in line with our expectations and our guidance, and we are executing well as a company and we continue to strength in our position in the market. So we look forward to seeing you on the road at the investor conferences. Thanks again.

Operator

Thank you for participating on today’s Cypress Semiconductor conference call. The conference has now ended. You may disconnect at this time.

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