Cypress Semiconductor Corp. (NASDAQ:CY) Barclays Capital Global Technology, Media and Telecommunications Conference December 6, 2018 1:30 PM ET
Hassane El-Khoury - President and CEO
Thad Trent - CFO
Tom O'Malley - Citi
Great. So good morning, everyone. I'm Tom O'Malley on the Barclays semiconductor team. I'm here with Hassane El-Khoury, the President and CEO; and Thad Trent, the CFO of Cypress. Thanks for being here, guys. We really appreciate it. I guess, to kick things off, we obviously saw pretty cool announcement this morning with Cirrent and that's going to be in your IOT segment. Could you just maybe elaborate on what that is and maybe explain to some people what your plans are with that?
Sure. So if you think about Cypress 3.0 strategy and being able to provide customers with the complete and comprehensive solution, you've heard me talk about a [bump] overlap, a [bump] coverage approach to the market and software being a very important component of it. Now if you take that and you move software up to the stack and up the chain where more and more value gets created that's where Cirrent comes in.
If you think about what problem we are trying to solve and why I talk about it as value added software? If you think about connectivity, connectivity is brought, connectivity will go over deployment, when it's easy to use, when it you buy a widget and it gets connected. Think of a washing machine, there's a lot of loss in connectivity because people like a lot of us here are now going to connect to washing machine because I'm not going to start the washing machine when I'm not home, but that's not really where the value comes.
The value comes in from the manufacturer, which has have access to the data, the diagnostics and the serviceability of that washing machine, and that could be in any different segment. Having that access, you need to have that widget be connected. And when you get to a home and you are able to connect to Wi-Fi without having to go through and do the Wi-Fi password and so on so, that's a seamless connectivity.
When you have that seamless connectivity, more and more items get connected, more and more items get deployed; and that generates the content that we all get to enjoy as far as selling or IoT, both content and the silicon. And that creates also a diversification of our revenue stream because the monetization of that comes from a connection point, but also from the services that connection point gives to our customers.
So, again, it puts us more into that upper stack of value, and in a very seamless, in order to allow the proliferation of IoT to happen more than we have seen it before. I'll give you my personal example got 30 light switches in the house that are all connected. Think about the day I have to change my Wi-Fi password, then you have to go to every single connected device in your home and do that, and that is actually a dating item from the proliferation of these connected devices.
What if were able to remove that while maintaining the security of the password, that's what Cirrent does, the brokering of -- that's how we work with the Comcast of the world where you get to access that Wi-Fi, you get the access of security and it's brokered by the Cirrent's agent.
Q - Tom O'Malley
Great. Obviously, you've put that up this morning. Could you just frame for us what you think the size of that opportunity is? Obviously, that falls into the greater IoT envelope, but just wrapping some members around, what you think that market is in and how much it could attack?
So, if you think about it, that market in unit is going to be equal to the same member of unit people talk about it as far as connected devices. So, that's -- it's a very large opportunity, and the more devices that get's connected especially the devices that don’t have a UI, which are the majority of them today, that agents is what's going to allow that connectivity. Think about the smart home where you have an explosion of content and more and more things getting into the smart home ecosystem, that's going to be the content. We are very unique in that ability.
And obviously for a meaningful size revenue from that, it's not going to move the needle in '18 and '19, but think about in the '20 as those things get deployed as that connectivity happens, and when you have a software-as-a-service than that starts to be almost an annuity as you go through it and that will start diversifying our revenue stream while maintaining a big focus on because we need good connectivity on the silicon side in order to enjoy this seamless connection on the software, both of those together are what’s going to enable that power of cross-selling. So, now we’re cross-selling not just on silicon, but you hear me talk before, we’re cross-selling on software as well.
Very interesting. So, I guess, focusing on the broader IOT business, it's been a great growth driver for you guys for past couple of years, a great acquisition from Broadcom. Can you just talk -- you’re seeing some of the first seasonality here into the December quarter, can you just walk through the puts and takes of what's causing that step down into December? And do you still think that you lay out like 17% CAGR going forward for that business? Do you still see that growing over the next couple of years at that same rate?
That's a very good question. So, you're right, it's a great acquisition. The talent that we've acquired, the products that we acquired, we’ve proven over the last few years what the value of those products are for our customers. Just to remind everybody, we acquired the business in the second half of '16, and it was 189 million in an LTM basis. This business now is over 450. So, you can see the momentum that business built, and both, Thad and I have said from the beginning, there's a lot of momentum behind that.
Seasonality in Q4 is exactly that, it is seasonality. You have the big Q3 quarter for the Christmas built. In Q4, it is seasonally down quarter especially in the consumer. Now what happens with what we are today, this Q4 is, if you look at it from our guide, is lower more than what normal seasonality is because there is obviously we all read the news, there's a lot of uncertainty in the market. And uncertainty for us is, specifically as we talked about in China and is in the consumer, which some of our IOT business is exposed to.
So, it is larger than normal seasonality, but I will just remind everybody with that, with this call it softer than seasonal Q4, that business is still growing double digits in '17 to '18 off of a growth in '17 of 46%. So, it was '16 to '17, 46%, we’re still in the teens growing in our '17 to '18, and that's with what's going on in the Q4 quarter with all the uncertainties that surrounding the market.
So growth is stellar and I’m comfortable with our long-term five-year plan that I've outlined in our analyst day of the 16% to 18% connectivity growth business. We have done it. We actually ahead of it, if you look at the first year, but we're still growing, so that whatever we want to call it that softness that we’re seeing is not slowing down our rent, it is just the growth rate is still in the teen which is stellar, if you look at everybody else in the market.
So I guess we will touch on some of the broader macroeconomic stuff and then you just mentioned, but let just start with the other side of connectivity first, so USB-C. So, you've already described the business that’s an adoption curve and it's proliferating across the bunch of different devices. It’s not very concentrated. You obviously have a larger customer, but it's spread across many -- where are you in that adoption curve? And you've always mentioned that at a certain point, you are going to start to see solutions come in that are cheaper, and when you see that happen, you are going to walk away from that type of business. Can you just update us on where is that adoption curve today? And how long do you think you can see that continue to proliferate without having some of that lower competition coming>
So, we describe it has a multiyear franchise, we have gone through this with USB-1, USB-2, USB-3 and USB-C. So, it's a multiyear, it's not an event, it's a progression, it's a conversion. So that's where we are. I think we are in the first the early inning of that conversion. Over the next five years, this is a $900 million overall business. So, it's big business, it's growing, it's exactly growing where we expected.
Just to give you perspective of why we're excited about it and not why I talk about it in that light. When you compare USB-C to USB-1, USB-2, USB-3, from the time those protocols got launched to now four years, if I use today from the USB-C. USB-C in the four year period since its inception has grown 4x what the prior USB generations have done in that same four year period. So the acceleration is there, the acceleration is in the data, the acceleration is forward looking and forecast.
So we are still in the early stages of hyper growth because now the ecosystem is starting to catch-up. Now you see more printers with type-C. Now you see more power adapters with type-C. Now to answer your other question about I did make the comment at an Analyst Day that as this market kind of gets fragmented, which it does with just like every prior USB, they will be commodity areas in that market that don’t fit our margin profile at 50% and we would not play in those markets, that has not happened yet.
And the reason it has not happened USB-C value is brought in from programmability of the controller and the integration of the controller, and we have been on the cutting edge of both. And what that does for our customers, it enables them to add programmability and more features, which makes them further away from a commodity play of an ASIC or a non-programmable controller. So, we have still got a lot of runway for us to keep going. But ultimately, it will happen, it just -- because it's new, I'm very pleasantly happy with that business and where we are in that maturity of it.
I referenced before a cable where I think the first thing that will happen are the cables we even deployed a brand new product programmable that goes into cables specifically. So even we are still playing in that market and where I thought two years ago we are probably be more on the commodity it's actually they want programmability just like they have on the device and that puts us in the primary spot for just like it is in the general market.
So, I'm just moving more towards your bread and butter here in the auto space. I think that you've seen your exposure to auto grow within your total business, I think since you've really taken over the Company. And from a high level, what areas of the car you are competing in and winning that have allowed us to happen? And as you make that transition obviously you touch the car from a lot of different perspectives in your portfolio. Where are you most excited about that growth in terms of what products you are selling into those vehicle?
Sure. So, we have -- so, if you look at overall auto, our focus is obviously a third of our revenue that comes from automotive, and it comes from that content. Now, if I want to look at the reason we have been growing and we have been growing really in large multiples of unit growth to give you an example. This year 2017 to 2018 unit growth is nearly 1.3%. Cypress we're looking at a growth of 13% about 10x that doesn’t happen when you’re not playing in the areas that are growing and you’re winning in those area.
So what are those areas for us, connectivity as more and more cars get deployed with connectivity it doesn't matter how many units that's content that did not exist before that is now existing, and we’re recapturing that connectivity in the automotive. Instrument cluster where more and more cars are going to digital instrument cluster, digital dashboards from mechanical, so that creates more content. In the last earnings call, I talked about the GM Global B win, which every cluster for the global B GM, which is the platform that goes in our GM vehicle brands in all the Cadillac’s and the GMC and so on.
Every cluster that is part of the GM Global B moving forward has five Cypress products on it. So even it’s a new platform for us, so there's that growth from a unit perspective, and then there's a 5x growth from a unit to content just on that specific instrument cluster. We have more confidence in that car, but that's a perfect example of cluster getting more content we are number one in that cluster segment, we grow there.
Infotainment is another example with RSDB and connectivity, Real Simultaneous Dual Band. Customers and consumers want the same field that a house of streaming media to your own devices. The car can do that with our technology today, that’s something we are very uniquely offering. And ADAS of course where for autonomous driving, that's a high growth area obviously from a small number, but it is a growth area for us and for that we talked about storage and secured storage because that’s what they value from a system level.
Yes, I think you've done a good job of always explaining, this is not just a unit story, this is a content gaining story as well. But for most of the unit perspective, I think that we've heard from many companies here, there is much debate in terms of what's going with the broader auto and industrial backdrop. And I think that you mentioned on your call that you would actually see some replenishment start to flow. Can you just update what have you seen in terms of broader trends since then? I think that the digital general consensus here thus far has been still some uncertainty, but no one is really ringing for broad improvement. Just give us an update of what you are seeing? And how do you think the broader markets are going?
I would say, I would echo that sentiment too where it's still, there is uncertainty; there is uncertainty on the outlook. We looked at both sell through and sell in. The replenishment orders the decline has slowed down, we saw a precipitous decline into September which we can talk about what that leads to but precipitous is a catalyst driven decline. We all know I think what we can't talk about what the catalyst is, but that slowed down, the meaning is no longer sharp edge.
So, that tells us, okay things, but that's how we walked in the quarter, that has not changed. Because the visibility we have not changed, there is no need for it to change. The behavior of what I think Thad mentioned is to wait-and-see, that’s still there. We see customers, if they need an order they place at the last minute in our cycle, not necessarily just lead time. So we have to work diligently with our customers, which were always engaged with what do you need so when you place the order we're able to ship it, especially if they need it this quarter.
So, that the outlook has not changed both on visibility and the replenishment rate. POS or sell through kind of the same, much slower rate of decline, but that's also I mean it's expected in Q4 anyways because Q4 is a seasonally down. The big question really we all have is, what -- how long and would that lead to a different slowdown? Meaning that forced catalyst driven change in visibility and pattern from a customer order, what happens when the dust settles, is demand is going to go back to what it was, is it going to go back to a new norm?
And that's really the what we are looking at, and we're making obviously the way we run the Company, preparations to make sure that whatever it is, however long ,it is going to last. We are able to keep generating that operating income stability that you've seen us doing over the last two years, and that's really have been our focus where we are very diligent and very cautious about where we invest. We invest in the future, we invest in building momentum. Everything else, we're tightening the belt on in order to keep that operating margin.
As we keep the gross margin expansion that we've guided to even in a down quarter like we did in Q4, we've committed the margin expansion are we going to see delivering that.
Yes, Tom, I would add that. These are unusual times. So, when you look at this slowdown compared to previous slowdown, this was very abrupt, it really appears to be event driven. We see our customers really reassessing their supply chain. A lot of people are talking about getting out of China, moving their supply chains into other regions whether it's Mexico, Vietnam places like that. I think that's early innings, but I as think everybody is assessing what they are going to do, I think irrelevant of whether it's a 10% tariff or 25% tariff. They're looking long-term, right. What we do long-term, there is political instability there. It's not normal pay down. I think everybody is tightening their belt.
Yes, I think to that point on the margin side and you have -- the actions that you can have to this lower top line, you guys have done a really good job thus far meeting all of your margin goals. I think those are the sticking points, the story for a long-time and you're on track to exit the year at your goal. Can you just talk about where do you see those trending in the future? Obviously, you've gotten to a level where you think that you can operate continuously, when you said, we hope to stay in these. Does the broader macro backdrop change that view? And what do you do to help preserve that margin profile, if things slow down from the top line perspective?
So, if you look at what we've done structurally in the Company, right, we've got one fab now it looks fully loaded, right. That’s running at 83% fully loaded to 85%. Through this downturn, we can keep that fab loaded because we manufacture about 35% of our products in house, so we can move from the outside to the inside. So if you look at our guidance for Q4 we've guided down 11%, but we guided gross margins up, right. That's not something historical Cypress could have done.
So -- and then if you think about the structural side of our business and the proprietary nature of our product, it allows us to hold pricing. So, we are not seeing a lot of pricing pressure right now as we go forward. So, as we think how we ride through this downturn, we think we can maintain the gross margins with the level they are at. Our long-term goal is to get to 50% gross margin, we get there by continuing to do the execution, that we've been working on, but it's also ramping in these new products.
All the new products that are coming out of R&D have accretive gross margins. So, we feel like we can keep pushing up to that 50%, and we're not going to stop at 50%, we're going to keep pushing through there. This uncertainty is hard to tell what's going to happen in the short-term, but we don't expect other than kind of normal seasonality. We don't expect margins to go backwards and so that's why, I'm saying we can maintain those 20% operating margin through this downturn. And again, that's not something that we could have done historically.
Let's switch gear over to memory. So, you guys announced the JV with SK hynix, let's talk strategy first. What strategically brought you towards that decision and agreement? And then moving forward, obviously, this is the first step in rationalizing a larger memory portfolio. Where do you view next steps maybe in that portfolio? And, obviously, memory strategically fits in with a lot of what you’re trying to do as an overall company. How does that change as we move over the next couple of years, and moving to environment where you are now have this, JV?
So, I will give you the strategy and then Thad can probably go through the details of why from the financial side. But strategically and I've always said, when people ask me about the fit of memory in general, I've always said it's every year, we have a process that we analyze strategic fit, we analyze outlook, and analyze the fit of that with the new business we have as a company.
For NAND, specifically, this year was a time where we act on it. And what I mean by the time is, the markets starting to turn, the NAND market starting to turn and therefore if you forward-look on that business it would be a dilutive to growth and it would be dilutive to margin. Not today, because we were able to get those margins, the market was sustain we could sustain that in the new margin.
But if you look forward looking those margins are going to go back to where they were when you first took that business from expansion of merger, which is in the 20% to 30% highly dilutive. So now was the time and if you look at the mix of that business half that business was from the consumer which also is not fitting in the corporate profile where we are, which is a third is auto, third is consumer and then enterprise, the high end consumer not the commodity.
So if you put these together then you can see that decision being formed and that decision has always been there, it's just went when would the right time be and we decided the right time to be this year just because of the disruption that the supply has created that will soften in the forward looking quarters. Now, on the other side of the business which is the NOR, which is where a lot of the misperceptions are. Everybody talks about, NOR as a single entity.
For two years since our earnings or since our analyst day, I've said our strategy is to move north from the commodity play to high value play, high density, NOR, automotive, et cetera. For two years, we've been doing that. You've heard me talk about walking away from $150 million of commodity business. Where are we today? The truth and the facts are in the data. What we reported in Q3 was a memory business that is up quarter-on-quarter and year-on-year.
Our peers in "NOR" that due to low density have reported down and have year-over-year and quarter-on-quarter, that -- this quarter is now tells you our memory is differentiated. So, when people talk about the NOR or memory in general as a market trend, just like in SRAM, we enjoy 60% margin, 55% to 60% margin. NOR that we have is a very different NOR, is a highly value NOR, is high density NOR our competitors are not there.
So it's not seeing the pricing pressures that our peers are seeing and thus far were growing and the rest of them are not and that’s a different type of memory. So put those two together the JV and the transformation of our memory, after the JV closes are auto, enterprise and industrial. The memory becomes 96% of MPD or 94% of MPD, 6% will be consumer. So, that exposure over 90% exposure to stable, predictable market puts our NOR business in a very different light than everybody else's.
It makes lot of sense. I guess before we are running out of time here, I want sneak in one macro broader question as well, and you guys can team yourself. But essentially you've seen all of these tariffs go through, there's been debate as to what's actually going to roll-on. I think it's causing a lot of uncertainty in the market. Can you talk about to the extent of what's already in play? How those have affected you? And then, with the proposed tariffs on the table, where that may affect you? I know that a lot of times with the derivative effect, it's your customers that change things and that somehow how affects you. And it's hard to quantify exactly, but just your comments on that I think would be really helpful?
So, the direct impact for us is about 2% of revenue. That's revenue originates in China and lands in the United States. So, we don't have a lot of direct exposure. And as we look forward, we don’t believe, there is a lot of exposure on that side. So, you are absolutely right, it’s more of an in-demand issue and second derivative that we're going to be faced what's driving. I think that's where the uncertainty is right down and that we are seeing in the market.
Clearly, there is customers that are concerned out there, our distributors are holding less inventory, replenishment rates are slowing down, customers are waiting for the last minute. I think this is all trade tension tariff related. I don’t think anybody would really wants to get held, stuck with inventory, and exchange rates moved against them as well. So, you have another dynamic there. So, time will tell whether the in demand softens or does it -- is it just kind of that temporary short-term inventory bleed. Too early to make that call at this point.
Great. That's really helpful and I think we are out of time with that. And thanks a lot guys and really appreciate it.