Earnings Call Transcript - CRUS Q4 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cirrus Logic Fourth Quarter Fiscal Year 2023 Financial Results Q&A session. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the conference over to Ms. Chelsea Heffernan, Vice President of Investor Relations. Ms. Heffernan, you may begin.

Chelsea Heffernan, Vice President of Investor Relations

Thank you, and good afternoon. Joining me on today's call is John Forsyth, Cirrus Logic's Chief Executive Officer; and Venk Nathamuni, Chief Financial Officer. Today, at approximately 4:00 p.m. Eastern Time, we announced our financial results for the fourth quarter and full fiscal year 2023. The shareholder letter discussing our financial results, the earnings press release, and the webcast of this Q&A session are all available on the company's Investor Relations website. This call will feature questions from analysts covering our company. Additionally, the results and guidance we will discuss on this call will include non-GAAP financial measures that exclude certain items. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in our earnings release and are all available on the company's Investor Relations website. Please note that during this session, we may make projections and other forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially from projections. By providing this information, the company expressly disclaims any obligation to update or revise any projections or forward-looking statements, whether as a result of new developments or otherwise. Please refer to the press release and the shareholder letter issued today, which are available on the Cirrus Logic website and the latest Form 10-K as well as other corporate filings registered with the Securities and Exchange Commission, for additional discussion of risk factors that could cause actual results to differ materially from current expectations. Now I'd like to turn the call over to John.

John Forsyth, CEO

Thank you, Chelsea, and thank you, everyone, for joining today's call. As you have seen in the press release, in FY '23, Cirrus Logic delivered record full fiscal year revenue of $1.9 billion, up 7% year-over-year driven by higher sales of components shipping in smartphones. Venk is going to discuss those results in greater detail shortly. But before we get to that, I'd like to take a moment to highlight the progress we've made on our long-term growth strategy over the last year. The three key pillars of that strategy include: one, maintaining our leadership position in smartphone audio by continuing to deliver world-class products and outstanding execution to the strongest customers in the market. Two, increasing high-performance mixed-signal content in smartphones to build a growing footprint of products outside of audio. And three, leveraging our strength in audio and high-performance mixed signal to expand into additional applications and markets over time with new and existing components. Looking at the first pillar of that strategy, Cirrus Logic remains a clear leader in smartphone audio. Today, 17 of the top 20 smartphone devices in DXOMARK audio quality rankings used Cirrus Logic audio components. In Q4, several Android customers introduced flagship devices that utilize our boosted amplifiers and we anticipate a number of new smartphones using our audio components to be launched later this calendar year. During the year, our team also began design of our next-generation custom boosted amplifier and our next-generation 22-nanometer smart codec, both of which are now in advanced stages of development. We anticipate that these next-generation audio components will not only extend our leadership position in smartphone audio, but also deliver significant revenue for many years following their introduction. Turning to the second key element of our growth strategy, increasing high-performance mixed-signal content in smartphones is critical for our success as it substantially expands our addressable market beyond audio. We believe that this product line represents a significant opportunity to grow and diversify our revenue. And to that end, in the past year, we saw both our R&D investment and the number of opportunities we're pursuing in this area increase. Over the last year, progress with our HPMS products included growing our penetration in haptics and Android, along with the introduction of an updated camera controller in Q2 FY '23. Indeed, since our first camera product was introduced in FY '21, we have grown the average content of our camera controllers in each subsequent generation of smartphones. More recently, in Q4, we completed the successful production qualification on our next-generation camera controller, which is expected to ship in the second half of this calendar year, continuing to build on our track record of innovation in this critical area of the user experience. The ultimate measure of successful execution of our HPMS strategy is revenue. And over the past four years, we have seen revenue derived from HPMS solutions increase from 12% to 38% as a proportion of total company sales and from $145 million to $726 million in dollar terms. We continue to believe that we are on a path where our HPMS business can generate at least half of our annual revenue in the future. That said, among the HPMS opportunities we have discussed, a new product that we mentioned in previous shareholder communications is being scheduled for introduction this fall is no longer expected to come to market as planned. As we have limited visibility of our customers' future plans for this product at this time, we're removing the revenue associated with this component from our internal model to reflect this change in our expectations. And while this is undeniably a setback, we are proud of our execution in this program, and we continue to believe that our strategy of expansion through HPMS products provides us with many exciting opportunities. I'd also note that our customer relationship remains very strong, and we continue to collaborate on a range of technologies and products across both the audio and HPMS domains. The third pillar of our strategy is to leverage our existing products, intellectual property, and capabilities in order to enable new applications and penetrate new markets, thereby unlocking further opportunities for growth. We've spoken about the PC market as being one of these areas, which, despite its present cyclical softness, remains a largely greenfield opportunity for us, where we believe a number of secular trends can act as favorable tailwinds in the coming years. During the year, we continued to gain momentum with customers in this market, increasing the number of models we're designed into and sampling our first boosted amplifier and codec products that are optimized specifically for laptops to our customers. We expect the first end products with these components to start to come to market in the second half of FY '24. More recently, we taped out our first laptop-focused power solution. We continue to view the laptop market as a promising opportunity in the coming years as we look to capitalize on the favorable trends and expand our share. We also continue to evaluate further markets where our world-class expertise in mixed-signal innovation can benefit both new and existing customers. In summary, we're proud to have delivered record revenue in FY '23 as we continued to execute on our strategic initiatives. With a pipeline of products coming to market over the next couple of years and our continued design innovation in both existing and new product areas, we believe Cirrus Logic is well positioned to continue to diversify our product portfolio and to expand our addressable market. And with that, let me now turn the call over to Venk to provide an overview of our financial results for our fiscal Q4 FY '23 as well as guidance for Q1 FY '24.

Venkatesh Nathamuni, CFO

Thank you, John, and good afternoon, everyone. I'll start with a summary of our financial results for both our fiscal Q4 and full year fiscal '23 and then provide guidance for our fiscal Q1 '24. As John mentioned, we delivered record fiscal '23 revenue of $1.9 billion, which is up 7% from a year ago. The strong growth during the fiscal year was driven by higher ASPs as well as the continued benefit from prior year content gains in smartphones, which were partially offset by a softening in general market and smartphone demand. Fiscal fourth quarter revenue was $372.8 million, down 37% quarter-over-quarter and down 24% from a year ago, but came in slightly above the midpoint of our guidance range. The year-over-year and sequential decline in revenue reflects a reduction in smartphone volumes. The year-over-year decline was also due in part to the launch of a lower-priced smartphone in Q4 fiscal '22, which did not reoccur in Q4 fiscal '23 as well as lower sales of our general market products. Turning to gross margin. Non-GAAP gross profit for fiscal '23 was $958.2 million and non-GAAP gross margin was 50.5%. Gross margin decreased year-over-year due to an increase in supply chain costs, partially offset by higher ASPs. Non-GAAP gross profit in the quarter was $186.7 million, and non-GAAP gross margin was 50.1%. On a sequential basis, gross margin was roughly flat. On a year-over-year basis, gross margin decreased as Q4 fiscal '22 included the benefit of selling through lower cost inventory built prior to price increases taking effect as well as higher ASPs. Non-GAAP operating expenses for the full fiscal year were $486.4 million, up 7% year-on-year, and non-GAAP operating income for fiscal '23 was $471.8 million or 24.9% of revenue. For the quarter, non-GAAP operating expenses were $119.8 million, at the low end of our guidance range as we continue to control discretionary spending. On a sequential basis, the decline in operating expense was primarily due to a reduction in variable compensation and discretionary spending, which was offset by higher product development and employee-related expenses. On a year-over-year basis, OpEx declined primarily due to lower variable compensation and an increase in R&D incentives. This was offset by higher product development costs. Now let me turn to a couple of special one-time items this quarter that impacted our GAAP results. Number one, during the quarter, we reevaluated our intangible assets recorded in purchase accounting associated with the acquisition of Lion Semiconductor. The prolonged weakness in the China smartphone market has had an adverse impact on sales of our general market, battery, and power products associated with the Lion acquisition. As a result, the acquired intangible assets were written down by $85.8 million. Notwithstanding this intangible impairment, we continue to believe that this technology is relevant in other applications and we're focusing our investment and resources in pursuit of these opportunities. Number two, we've been focused on improving operational efficiency and accordingly have taken a number of steps, including reducing our global real estate footprint, product prioritization as well as some restructuring actions. As such, during the fourth quarter, the company recorded $10.6 million of lease impairments and restructuring charges. As previously mentioned, both of these charges were excluded from non-GAAP operating expenses. Non-GAAP operating income was $66.9 million in the fourth quarter or 17.9% of revenue. As expected, due largely to a tax rule effective from the start of our fiscal year 2023 that requires companies to capitalize and amortize R&D expenses rather than deduct them in the current year, our fiscal year '23 non-GAAP effective tax rate was 23.5% for the full year. And finally, on the P&L, non-GAAP net income for fiscal '23 was $367.4 million, or $6.42 per share. Non-GAAP net income in the fourth quarter was $52.6 million or $0.92 per share. Let me now turn to the balance sheet. Our balance sheet continues to remain strong, and we ended the fourth quarter of fiscal year '23 with approximately $517.3 million in cash and cash equivalents. Our ending cash balance was up roughly $9.6 million from the prior quarter, primarily due to strong cash flow from operations, partially offset by stock repurchases during the quarter. We continue to have no debt outstanding. And also at note, we have $300 million undrawn on our revolver. Inventory was $233.5 million, up from $152.4 million sequentially, and days of inventory was 114 days in Q4 as we built product to support our customers' new product ramps. I'd note that our inventory position has been substantially below normal levels over the past couple of years due to supply constraints. And as indicated in our prior quarter's earnings call, we've been increasing our inventory position in order to shorten delivery times. Looking ahead to Q1 fiscal '24, we expect inventory to increase from the prior quarter as we begin to build ahead of seasonal product launches in the second half of the calendar year. We expect inventory to remain above historical levels over the next couple of quarters as we balance anticipated product demand and wafer purchase commitments that required us to build inventory on a more linear basis. I'd note that our current silicon products tend to ship for multiple generations of our key customers' end products. Turning to cash flow. Cash flow from operations was $339.6 million for fiscal year '23 and CapEx was roughly $36.7 million, resulting in free cash flow for the year of $302.9 million. Free cash flow margin for the 12-month period ending in the March quarter was 16%, thanks to the excellent execution as well as collections performance by the team. Cash flow from operations was $48.3 million in the March quarter, and CapEx was roughly $11.6 million, resulting in free cash flow for the quarter of $36.6 million. Free cash flow margin for the March quarter was 10%. On the share buyback front, in fiscal '23, we utilized $191.4 million to repurchase approximately 2.4 million shares of our common stock at an average price of $81.16. In Q4, we utilized $35 million to repurchase approximately 338,000 shares of our common stock at an average price of $103.70. As of the end of Q4 fiscal '23, we had $501.1 million remaining in our share repurchase authorization. Subsequent to Q4 fiscal '23, the company utilized $23.9 million to repurchase approximately 274,000 shares at an average price of $87.1 under the Rule 10b5-1 share repurchase plan. We expect to continue to return capital in the form of stock repurchases, which we believe will provide a long-term benefit to shareholders going forward. And now on to the guidance. For Q1 of fiscal '24, we expect revenue in the range of $260 million to $320 million reflecting lower smartphone units and weakness in general market product sales. We expect gross margin to range from 49% to 51%. Non-GAAP operating expense is expected to be down sequentially in the range of $114 million to $120 million due to higher R&D incentives and lower variable compensation partially offset by higher employee-related expenses. I'd note operating expense includes the full impact of our annual merit increase, which took effect at the beginning of the fiscal year. We will continue to control discretionary spending while investing strategically in product development to drive long-term growth. Our fiscal '24 non-GAAP effective tax rate will continue to be unfavorably impacted by the tax rule that requires us to capitalize and amortize the R&D expense, and we expect foreign tax credits to decrease. As a result, we expect our fiscal '24 non-GAAP tax rate will be approximately 24% to 26%. We continue to anticipate that the impact of capitalized R&D will become less unfavorable over time as additional years of R&D expenses are amortized for tax purposes. We also note that bills have recently been introduced in both the House and the Senate with bipartisan support that would restore full tax deductibility of R&D investments if passed. In closing, we had a strong Q4 fiscal '23 and the full year fiscal '23 as we executed well to deliver these results. Going forward, we remain focused on improving operational efficiencies, exercising fiscal discipline, and increasing shareholder value. Furthermore, we intend to continue to invest strategically in new product development as we see ongoing opportunities to increase our content and enable the company to grow both revenue and profitability over the long term. And before we begin the Q&A, I'd like to note that while we understand there is intense interest related to our largest customer, in accordance with Cirrus Logic's company policy, we will not discuss specifics about our business relationship. With that, let me now turn the call to Chelsea to start the Q&A session.

Chelsea Heffernan, Vice President of Investor Relations

Thank you, Venk. We will now start the Q&A portion of the call. Operator, we are now ready to take questions.

Operator, Operator

Your first question comes from the line of Matt Ramsey with TD Cohen.

Matthew Ramsay, Analyst

I would like to ask about the agreement you have with GlobalFoundries regarding supply. I've seen some disclosures tonight about Lion Semiconductor in China and the challenges in the Chinese smartphone market, along with your comments on the expected content increase from your largest customer this year, which may not occur now. I'm curious if fluctuations in your revenue levels due to these factors are typical in business and what that means for your commitments. Can you explain if there are any potential impacts on margins in the medium term, or do you believe there is enough flexibility to avoid affecting the P&L, allowing other products to compensate? I'm trying to grasp the implications of revenue growth and the specifics of that agreement.

John Forsyth, CEO

Yes. Thank you, Matt, for that question. I'll just say upfront, there are pieces of this, which are work in progress right now. But what I would say regarding our relationship and agreement with GlobalFoundries is that we have a pretty broad number of products using the same underlying process technology at Global, including amp, haptics, and power all of which are very long-lived products. And we have products shipping from that process to multiple customers. And many of those products, we anticipate shipping for a fair amount of time. So that gives us some level of flexibility with how we prioritize wafers, meet our ongoing purchase commitments and manage through the change of plan. Near term, obviously, we're working closely with our customer and foundries to balance those commitments with the slightly changed pattern of demand, but that's broadly the picture.

Matthew Ramsay, Analyst

I understand that the situation is fluid and sensitive. As a follow-up, I know this is delicate, but I believe the company has excelled in discussing the investments being made in new programs, particularly custom ones for specific customers. These investments are typically made only when there's a strong expectation that the products will be adopted. I don't think that has changed, and I view this as a unique situation. I'm curious about the implications on the backend, specifically regarding potential compensations from customers due to late changes in plans for these programs. Considering this is likely a custom product, are there measures in place to help compensate the company for the investments made? Additionally, a discussion on the overall philosophy regarding this would be appreciated.

John Forsyth, CEO

Yes, thank you. I will avoid discussing specific live topics with the customer for obvious reasons. However, I want to emphasize the confidence we have communicated regarding our investments, particularly in custom silicon with our largest customer. Over the past 15 years, we have established a remarkable track record of innovation and execution, developing everything from codecs to boosted amplifiers, haptics, camera controllers, and more recently, power conversion and control. This has occurred within the framework of a very strong relationship. The current situation is truly an anomaly, as we've not encountered anything like this before. I view it as a temporary setback that does not alter our plans, strategy, or confidence in the relationship, nor our eagerness to seize the growth opportunities we see there.

Operator, Operator

Your next question comes from the line of Tore Svanberg with Stifel.

Tore Svanberg, Analyst

I have a question about HPMS, particularly regarding the write-down of Lion. In your prepared remarks, you mentioned wanting to apply some of that technology in different areas. I'm curious if there are still significant opportunities for power in smartphones, or if the focus is shifting more towards notebooks for that type of device.

John Forsyth, CEO

Thank you, Tore. Leaning much more towards the latter. I think the smartphone opportunities around power, I think the larger opportunities for us there in the custom silicon space. We have obviously some Lion technology shipping today into Android smartphones. I think we've seen both with the softness of the market there and the rise and possible preference for domestic Chinese suppliers in that space. That's a fairly tough place to be. By comparison, we've seen some pretty exciting opportunities around charging and power conversion in the laptop space for the future and some possible other markets in due course as well. So definitely tilting much more towards those other markets.

Venkatesh Nathamuni, CFO

And Tore, I'll just add to what John said. In terms of the HPMS technologies that we have for our key customers, that has been primarily homegrown technology. And the IP that we had from Lion has been primarily focused on the China smartphone market, which, as you all know, has been in a pretty tough spot over the last several quarters. So the underlying technology and architecture is still pretty relevant. I mean, we're focusing the Lion IP more towards the laptop opportunity, but the entirety of the HPMS products that we've built for our top customer and others has been based on homegrown IP and homegrown technology.

Tore Svanberg, Analyst

Very good. And as my follow-up, I just wanted to sort of understand the content opportunities you still have for the second half in spite of the setback that you mentioned. So you did mention a new camera controller. So I'm just wondering if that's primarily the content increases that we should be expecting for the second half of this year.

John Forsyth, CEO

In the smartphone space, yes, yes, Tore, that is the kind of highlight from the content perspective in the second half of this year. And then obviously, we're pursuing content opportunities in both the Android space and other markets as well.

Operator, Operator

Your next question comes from the line of Blayne Curtis with Barclays.

Blayne Curtis, Analyst

I would like to ask about the general seasonality for June. It appears to be one of the sharper declines, especially considering how much March decreased. Can you discuss this? Is there any element related to customer inventory that needs to be reduced? Although it's challenging to address regarding your largest customer, what accounts for the more pronounced seasonal decline in June?

Venkatesh Nathamuni, CFO

Yes, Blayne, this is Venk. Let me respond to that. So if you look at the guidance that we provided for the June quarter, I think the two major elements that contribute to that. One is there is a reduction in the smartphone volumes, but I would say there's also a significant contribution from the general market. So as you know, we have a fairly decent exposure to the general market, and that is highly correlated to macro and that's where we see some weakness in addition to the overall weakness in smartphones. But both of those are factored into our guidance, and that's what's driving the number.

Blayne Curtis, Analyst

Apple reported stronger iPhone sales, which is a significant part of our business, so the overall weakness in the market doesn't fully account for that performance. Could you provide more details on this?

Venkatesh Nathamuni, CFO

Yes, Blayne, I think there's always some timing mismatches between what our customers report and obviously, how we build to the customer forecast and such. So I'd say at a high level, you could attribute it to the smartphone volumes being down relative to prior years, and then there's also a contribution from general market sales that's not insignificant.

Operator, Operator

Your next question comes from the line of Christopher Rolland with Susquehanna.

Christopher Rolland, Analyst

Qualcomm reported last night that more flagship purchases by OEMs were moved to March, which may create a gap for June and September. I would like to know if this aligns with any patterns you are observing and how we should anticipate sequential changes for your company moving forward.

Venkatesh Nathamuni, CFO

Yes, Chris, this is Venk. Thanks for the question. So yes, we did see the Qualcomm report from yesterday. And in general, again, every company has a different dynamic based on the specific parts of the ship and the lead times and such. So I wouldn't make a general comment, especially about our top customer based on a competitor's announcement. But suffice it to say that as we see it, we are clearly modeling a reduction in smartphone volumes overall. And then in response to Blayne's question, there's also the general market sales that's having an impact. So couldn't call specifically the dynamics for one of our competitors and how that relates to their outlook for the year and for the quarter.

Christopher Rolland, Analyst

Sure. I have a follow-up question. Could the weakness observed in June also continue into September? Additionally, regarding your non-lead customer revenue and general market revenue, it seems that it might be at an all-time low, at least in certain years. Can you explain the factors affecting this? Are we likely to see a recovery from this low point? Do you anticipate that this month will represent the lowest point, or will June show either a significant decline, a slight decline, or even an increase in general market revenue for your company?

Venkatesh Nathamuni, CFO

Yes. There are two parts to address. First, regarding guidance beyond the June quarter, we aren’t providing that at this time. However, looking at trends from the past year, there tends to be a buildup of our customers' products in the second half. Currently, we don’t see any changes in that pattern. Second, in terms of the overall market, we have observed some stabilization. As mentioned, the general market has been weak recently, affecting not just us but others in the semiconductor sector, who have all pointed out issues related to inventory and production. We are seeing some stabilization in our general market sales, but we aren't ready to declare that we have hit the bottom yet. We do anticipate improvement for the rest of the year, but it’s challenging to predict when that turning point will occur.

Operator, Operator

Your next question comes from the line of Ananda Baruah with Loop Capital.

Ananda Baruah, Analyst

I guess, yes, two, if I could. Guys, going back to the prepared remarks, you were talking about controller content, sort of in the past increasing sort of on an annual basis. Can you just unpack a little bit what it is that allows the controller content to increase? Or what has been allowing it to increase on an annual basis? Is it purely the innovation that you guys are doing? Is it innovation you're doing that's connected to other innovation that's happening on the product? Any context there would be helpful. And then I just have a quick follow-up.

John Forsyth, CEO

Absolutely. There are three main factors driving the growth in value. Firstly, we have observed an increase in the attach rate of camera controllers over time, largely due to the adoption of multiple cameras. Secondly, as more advanced camera systems with additional cameras and enhanced stabilization become available in different tiers, we have seen multiple generations of devices being released simultaneously, featuring more of our camera controller content. Lastly, we are innovating with the camera controllers ourselves, which have been updated to enhance processing speed and overall capabilities related to stabilization and autofocus, allowing for new features within the camera system. All these factors contribute to the significant increase in value that I mentioned in my initial remarks.

Ananda Baruah, Analyst

That's really useful information. Thank you. I have a quick follow-up, Venk. I know you won't provide guidance beyond the June quarter, but could you share what factors we should monitor that may impact gross margin as we progress through the year? That's all from me.

Venkatesh Nathamuni, CFO

Yes. Thanks, Ananda. I'd say at a high level, as you've seen us over the last several quarters, we've been kind of in the 49% to 51% range. It's been more towards the high end. And as we see things right now, there's nothing that will cause us to change that range. So again, not providing guidance beyond the June quarter, but our plan is to be in the 49% to 51% range so that we can optimize between revenue growth and profitability.

Operator, Operator

Your next question is a follow-up from Blayne Curtis of Barclays.

Blayne Curtis, Analyst

I just wanted to ask a follow-up on Matt's question. I think the new product, given cycle times, you probably started it. So I'm just kind of curious how to think about, is there going to be a product that's going to live on the balance sheet? And I know it's fluid and so you can figure out if there is a future product it goes into. But I mean, how do you think about that dynamic? Because I would assume you started wafers before you figured out it wasn't going to be in the phone.

Venkatesh Nathamuni, CFO

Yes, Blayne, this is Venk. You're absolutely right. We began producing wafers based on lead times and production ramp schedules, and we are in discussions with our customer regarding the next steps. We'll provide an update as soon as we can. Overall, I want to emphasize that our inventory levels are significantly below normal. As mentioned in the previous call, we've been increasing our inventory, and we expect that trend to continue as we need to produce products ahead of our customers' ramp-up schedules. Additionally, it's important to note that, aside from the product we discussed that won't continue, our current silicon products generally remain viable across multiple generations of our key customers' end products, which deviates from a traditional model. In summary, we are in talks with our customer about how to proceed with the product that is no longer being shipped.

Operator, Operator

And with that, we will end the Q&A session. I will now turn the call back to John for his final remarks.

John Forsyth, CEO

Thank you, Chelsea. In summary, we're pleased with our progress in FY '23 as we executed across our three areas of strategic focus: first, maintaining our leadership position in smartphone audio; second, increasing high-performance mixed signal content in smartphones; and thirdly, leveraging our strength in audio and high-performance mixed signal to expand into additional applications and markets with new and existing components. We remain very excited about the opportunities that we see in front of us, and we thank you all for your continued interest in Cirrus Logic. Before we close, I'd also like to note that we will be participating in the Cowen Conference in New York on May 31 and the Stifel Conference in Boston on June 6. Please check our investor website for the details. I'd like to thank everyone for participating today. Goodbye.

Operator, Operator

This concludes today's conference call. You may now disconnect your lines.