Maxim Integrated Products, Inc.

Good day, ladies and gentlemen, and welcome to the Maxim Integrated Second Quarter of Fiscal 2020 Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Kathy Ta, Vice President, Best Relations. Please go ahead, Kathy. Thank you.

Thank you, Jonathan. Welcome, everyone, to Maxim Integrated's Fiscal Second Quarter 2020 Earnings Conference Call. Joining me on the call today are Chief Executive Officer Tunch Deluge and Chief Financial Officer Brian White. As a part of our usual process, we have posted a supplemental financial presentation to our external Investor Relations website. The information in this presentation accompanies the financial disclosures in our earnings press release and on this conference call. During today's call, we will be making some forward-looking statements. In light of the Private Securities Litigation Reform Act, I'd like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear in our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainty and that future events may differ materially from the statements made. For additional information, please refer to the company's Securities and Exchange Commission filings, which are posted on our website. Now I'll turn the call over to Tunch.

Thank you, Kathy. Good afternoon to all our participants. We appreciate you joining us today and your interest in Maxim Integrated. Let me first summarize last quarter's results and our outlook. Our December quarter results met our expectations while also maintaining lean inventory levels. Looking forward to the March quarter, we expect a return to revenue growth for the company from the same quarter last year, driven by growth in communications and data center, industrial, and automotive markets. We continue to be cautious given the persistent macro and trade uncertainty, but demand is improving. Let me provide some color by end market, starting with automotive. In the December quarter, our automotive business was up 5% sequentially with double digit growth in our secular growth areas of BMS and driver assistance systems. Our revenue growth in our overall automotive business fared better than the growth of global car production. We see ample content growth opportunities for Maxim in ADAS applications in power management and point-to-point serial link data communication products. At the Consumer Electronics Show, we held a large number of customer discussions on our BMS, driver assistance, and power management solutions. Our latest generation automotive serial link products transport video, audio, and data at 12 gigabits per second. In recent quarters, we grew our serial link business from Chinese OEM customers. At CES, we showcased our wireless BMS technology and new families of high voltage automotive power solutions that efficiently control and supervise the hundreds of watts of power required for advanced driver assistance systems. In the March quarter, automotive is expected to be strongly up sequentially. We also anticipate automotive revenue to be up from the same quarter last year, driven by driver assistance and infotainment content. Let me next turn to the industrial market. In the December quarter, industrial was up 7% from the prior quarter. We experienced sequential growth in factory automation and automated test equipment markets. Days of inventory in the channel remained relatively similar to the prior quarter. In the March quarter, we expect industrial to be up sequentially. Industrial is also expected to be up from the same quarter last year, driven by automated test equipment, financial terminals, and core industrial, including factory automation. Let me next discuss communications and data centers. In the December quarter, comms and data center was up 25% sequentially. We experienced a strong ramp in demand for 25G optical products for base stations and 100G optical products for data center applications. We are excited about the rapid deployment of our analog laser driver products. Hyperscale data centers and 5G base station uplinks need to move more data while staying within their already constrained power budgets. Maxim's transmitter products address both challenges within the power and cost constraints of our customers. In the March quarter, we anticipate comms and data center revenue to be strongly up from the prior quarter. In the past, our optical business has shown large demand fluctuations based on customer CapEx deployments. We are currently enjoying a period of strong demand. Comms and data center is expected to be strongly up from the same quarter last year in 100G optical for data center and 25G optical for 4G and 5G base station applications. Finally, let me turn to consumer. In the December quarter, consumer was down 15% sequentially with expected weakness in smartphones, and seasonal declines in other customer electronics. The peak of holiday shipments for consumer electronics had occurred in the September quarter. In the March quarter, we expect consumer to be flat sequentially. Gaming grows, new flagship phones ramp, and other customers are expected to be seasonally down. Consumer is expected to be down strongly from the same quarter last year. To summarize, we have built Maxim to be resilient and to position the company to outperform as conditions get better. Market demand is improving and we expect revenue growth in the March quarter compared to the same quarter last year in communications and data center, industrial and automotive. We are executing on our strategy to grow revenue with new design wins in long-lived products in automotive and industrial. Our analog business model and flexible manufacturing strategy enable consistent company profitability and stability. Now I'll turn the call over to Brian.

Thanks, Tunch, and thank you to everyone on the call today. Revenue for fiscal Q2 was $551 million, up 3% sequentially, and $6 million higher than the midpoint of our forecast range entering the quarter. Compared to the same quarter a year ago, revenue was down 4%. A revenue mix by major markets in Q2 was approximately 30% industrial, 26% automotive, 24% comms and data center, and 20% consumer. Now let me turn to our distribution channel. Distribution comprised 51% of Maxim's revenue in Q2. We ended the quarter with just 49 days of channel inventory, up one day from the prior quarter and well below our long-term target of 60 days. Our lean channel inventory was enabled by our tight inventory management combined with stronger than expected resales for optical and BMS products. Turning to the P&L, Maxim's gross margin excluding special items was 66% up 100 basis points from the prior quarter and above the midpoint of our guidance, with the increase driven by favorable manufacturing efficiencies. Operating expenses excluding special items were $188 million, up approximately $3 million from the prior quarter, reflecting the full quarter impact of annual merit increases for employees and an increase in variable compensation due to higher profitability. Q2 GAAP operating income excluding special items was $176 million. Operating margin was 31.9% of revenue, up 160 basis points from the prior quarter due to higher revenue and improved gross margin. The Q2 GAAP tax rate excluding special items was 13% and equal to our current outlook for the remainder of this fiscal year. Gap earnings per share excluding special items was 56 cents, 3 cents above the midpoint of our guidance range. Turning to the balance sheet and cash flow, total cash, cash equivalents, and short-term investments were $1.8 billion, down $10 million from the prior quarter. Q2 inventory days ended at 109, down 6 days from Q1. and inventory dollars were down 5% from the prior quarter. Capital expenditures were $14 million. Trailing 12-month free cash flow, defined as cash from operations less capital expenditures, was $737 million, or 34% of revenue. Free cash flow per share was $2.70, and our free cash flow yield is 4.5%, at yesterday's closing stock price. For capital return, share repurchases totaled $108 million in Q2 as we bought back approximately 1.9 million shares. Dividends totaled $130 million in the quarter. Based on yesterday's closing stock price and our quarterly dividend of 48 cents per share, our dividend yield is 3.2%. Total return of cash through dividends and share repurchases was 126% of free cash flow on a trailing 12-month basis. Now I'll turn to our outlook for the March quarter. Our beginning fiscal Q3 backlog was $456 million. Based on this beginning backlog and expected turns, we forecast Q3 revenue to be between $555 and $595 million, up 4% from the prior quarter and up 6% year-over-year at the midpoint. Q3 gross margin, excluding special items, is forecasted at 65.5% to 67.5%, up 50 basis points from the prior quarter at the midpoint on higher revenue. Q3 operating expenses excluding special items are expected to be up approximately $2 million from Q2, driven by higher variable compensation on increased profitability. Fiscal Q3 capital expenditures are expected to be approximately 3% of revenue, and our tax rate excluding special items is expected to remain at 13%. For Q3 gap earnings per share excluding special items, we expect the range of 57 to 65 cents. In summary, we're pleased to see improving business trends with an outlook for continued sequential revenue growth in the March quarter, along with a return to year-over-year revenue growth. That growth, combined with our strong financial model, enables us to generate increasing profits, cash flows, and shareholder return. With that, I'll turn the call back over to Kathy.

Thanks, Brian. That concludes our prepared remarks, and we will now open the call for questions. We'd like to continue the same Q&A process that we've used in previous calls. We'll take one question from each caller so that we can get to as many people as possible. Jonathan, could we please have our first question?

Certainly. Our first question comes from the line of Ross Seymour from Deutsche Bank. Your question, please.

Thanks for letting me ask the question, and congrats on the strong quartering guide. Tunch, I just wanted to go back to last quarter and compare it to this quarter. A quarter ago, I think stabilization was the operative phrase you used to describe the business. It seems like things have gotten better across the board, given your guidance. Can you just give us an update on either geographically or buy-in market? Do you think it's true-in-demand getting better, or is it that 49 days of inventory in the channel, which is still very low, just starting to refill as you look into the March quarter?

Yeah, so I'll summarize what I said in the prepared remarks. But essentially, you know, considering our Q3 guide, what we're seeing is a few things happening. Number one, we have some good growth, you know, really end market demand driven growth in our automotive products and in our optical products for both data center and 5G. So that's strong demand we're seeing from our customers with nice growth. On the other hand, on the industrial side, we've not really seen a full recovery, I'd say, to like two-year-ago levels, but both Q2 and Q3 had some growth compared to the same periods last year. So what we're seeing there is reasonable demand coming from customers, And in all of this, we've been able to also maintain lean inventory levels in the distribution channel. So I think one of the questions that we got last quarter was, was the growth really coming from refilling the inventory and distribution? And that's not what we did. So essentially, it's very strong growth in some areas that I mentioned, in automotive and comms data center, but we're seeing a broadening increase in demand.

Great. Thank you.

And geographically, I guess geographically maybe Brian can answer that piece.

Sure. Geographically, particularly as we look at resales through distribution, the Asia region continues to be the strongest with particular strength in China. And in terms of software areas, Europe continues to be a little bit weak.

Thanks, Brian.

Thank you, Russ. Thank you. Our next question comes from the line of Harlan Sir from J.P. Morgan. Your question, please.

Good afternoon. Solid execution on the quarter, guys, and good to see the return of year-over-year growth this quarter. It's a little bit hard to calculate exactly because of the revenue segmentation change in fiscal 19, but it looks like your auto business had another year of outperformance. I think it was flat to maybe slightly up in calendar year 19 versus last auto production that was down about 5% to 7%. This year, the outlook is for a flattish auto production growth, and within that, I think China EV production is targeted to grow about 8%. So, given your exposure to some of the faster growing segments like EV and ADAS with some of your serial link and BMS products, do you think that this segment can approach kind of low teens percentage year-over-year growth as the year unfolds?

Okay, so let me take that one. So essentially, with what you summarized there well, with our exposure to EVs, which is a faster-growing segment, estimated to grow about 20% per year, and our good market position with our BMS products, and also in ADAS, we have a lot of design wins we've had in the past few years, and those are ramping into production. So those two segments, We believe we're going to grow at much better rates than our average. Infotainment is more tied to growth than the car units, but that's doing pretty well too recently. So it's really hard to exactly predict, but I think we continue to believe that we can grow faster than car production units globally. A, because contents growth is faster than car production units. And B, because we've invested and have great products and technology for, you know, two of those segments that are in kind of, I would call it in hyper growth globally. So, yes, it will grow. You know, you stated a number. You know, I'm a little reluctant to give a number, but we believe for this year, but long term, we do expect an automotive to grow in the low teens. Yep.

Thanks, Tunch. You're welcome.

Thank you, Harlan.

But you are next question coming to the line. I have Ambrish Vastava from BMO. Your question, please.

Hi, guys. Thanks for the question. This is Jameson calling in from Ambrish. So I was hoping just to continue touching on auto. Well, I appreciate the fact that you outgrew AutoSAR, and I believe you said that auto grew 5% sequentially. I believe last quarter you had guided it to be up strongly. So first, was this below your previous expectations? And second, can you talk about the broader auto market? demand environment, and what gives you confidence in the guide for the end market to be up strongly in the March quarter? Thank you.

Yeah, so I'm going to do a little bit from memory, and I think Kathy can help me here. We did guide to strong growth. I think we were maybe a little bit under that, but not a large number. So I think that we came pretty close, maybe slightly lower in the previous quarter. This quarter, we are seeing very strong demand, especially for our products that go into ADAS systems. So that's the strong growth driver for us. And we've got some good design wins in China OEMs, which I mentioned in the call. So there's some specific areas in automotive that are doing really well for us. And as we had spoken last time, some of the The slowing growth we saw in automotive, we've attributed to maybe inventory digestion as car production slowed last year. So the fact that we're also believing that we're seeing that infotainment will be another growth, so it seems like that is maybe confirming that maybe some of that inventory is now being digested by car manufacturers. So we're feeling pretty good about the demand we're seeing in automotive for this quarter. Thank you. You're welcome.

Thank you, Jameson.

Thank you. Our next question comes in the line of Vivek Arya from Bank of America. Your question, please.

Hi, this is Blake Freeman on for Vivek Arya. I was just curious how we should think about the virus impact in China's growth, Q1, and if there is any impact, which end markets specifically you see that having more of an impact versus others. Thank you.

Yeah, so obviously this development about restrictions and travel and so on have occurred pretty recently. So to get a full assessment on which market it will affect, you know, having a comprehensive view on that is pretty short, frankly, to be able to figure that out. There is, in the areas that are affected, there are some of our optical module makers are in that region, and they have communicated that they will shut down a bit longer than the normal lunar year shutdown. So there will be some effects on that. We don't believe it's going to be a large effect on us, but that's the only customer information that we have some specifics on so far. We don't believe that's going to have an impact on our total revenue for the quarter.

Got it. Thank you.

Thank you, Blake.

Thank you. Our next question comes from the line of John Pitzer from Credit Suisse. Your question, please.

Yeah, good afternoon, guys, and congratulations on the solid results. I'm just kind of curious about the backlog coverage you're bringing into the March quarter. It's about, you know, at the midpoint of your revenue guide, about 79%, which is as high as I think I've seen it. So help me understand, other than trying to take a conservative stance because there is still some macro uncertainty out there, is there anything specifically – that's driving the backlog coverage to be this high versus what's usually kind of in the low 70s? Is business mixing to end markets that are more backlog-oriented than turns? Or just help me understand why turns couldn't be better in the quarter.

Hey, John, this is Brian. That's a great observation. And as Tudor mentioned, we've had very strong demand for our optical products. And so what you're seeing is the effect of a higher than usual amount of optical orders in our backlog that we don't expect to ship all of which this quarter.

Perfect. Thank you. Thank you, John.

Thank you. Our next question comes from the line of Craig Huttenbeck from Morgan Stanley. Your question, please.

Yes, thank you. Just to follow up on your comments about wireless BMS at CES, can you just talk about kind of the developments there and just, you know, gauge the timeline in terms of product introductions and then, you know, over what period of time could you see those products eventually come to the market?

Yeah, so wireless BMS is, you know, a technology that we have been working on. Essentially, what we developed in a nutshell was a way to be able to connect all of our individual, essentially, metrology chips that are on the packs to talk to a central control unit through wireless technology. We demonstrated that it can be done. Obviously, we need to do more work to make sure that it is as robust as wired technology. And as you predicted, that's going to take a little bit more time. It's hard for us to really tell exactly when it will gain enough customer acceptance in terms of how robust it is as a complete system. But revenues from this is not on the horizon for multiple years. So it's really just a technology that we're showing, but we have to productize it in a way that's equivalent to our ASIL-D solutions that we have in our wired products right now. So revenue-wise, multiple years in the future.

Understood. Thanks. Thank you, Craig.

Thank you. Our next question comes from the line of C.J. Muse from Evercore. Your question, please.

Hey, guys. This is Matt Prisco on for C.J., I just wanted to dig a little more into the comms and data center side of the business. Strong unexpected this quarter, great guide next quarter. So can you just kind of dig into a little bit more of what's driving that uptake across both 25 gig and 100 gig, and how sustainable are those trends as we kind of think through all of calendar 20? Thanks.

Yeah, so there are really two components to the strong growth in comms and data centers. One of them is in data center where we're selling products that are 100G or 4 by 25G lanes. We have a strong presence and good design wins on the laser driver portion for which we basically have an analog solution. And that, if you recall, we had strong growth in that about a couple of years ago. And then there was a lot of inventory built at our customers. And the module makers took us a while to drain that down. And now it's back for the last two quarters. So that's the story there. I think we're getting to a healthy level of consumption on those products as the cloud customers essentially are deploying more data transport capability in their data centers. So that's what's driving that. So it's really a recovery from an inventory correction last year. On the 25G front, it's a one-lane-by-25 transceiver IC plus some transimpedance amplifier products and like a system management chip for a module. So it's kind of a set of products that we sell into that. And that solution is very popular for 5G and I guess 4G installations that are trying to be made 5G ready for base stations. And that we're seeing a strong growth, especially now coming from China, because we have, again, a popular solution that everybody liked. And these designs were won probably about a couple of years ago. So that's what's ramping. As long as the 4G, 5G rollout continues, I think we're going to continue to sell these products because of our strong market position. But as I said in my prepared remarks, both of these businesses, and especially the 25G connections, this business is kind of lumpy. And right now we're enjoying a good spot, but Those of you that have followed these markets always remember in the past that there are times when there's some inventory digestion that happens and so on. But I think right now, fundamentally, long term, even if we get these lumpiness, I think these are good growth markets because of the amount of data that's being moved, both in data centers and in wireless.

Thank you.

Thank you, Matt.

Thank you. Our next question comes to the line of Rich Stephens from RBC Capital Markets. Your question, please.

Hey, I actually wanted to focus a bit on the consumer side. It looks like that's seeing a lot more pressure than we thought, at least near term. Can you walk through what you guys expect for maybe the full year out of that business in terms of like the calendar year? Is this like company specific or do you think this is like an industry-wide issue that we'll see, particularly since Apple reported numbers are pretty solid in the quarter?

Yeah, so just to remind everybody, I mean, our consumer business, if you walk back a few years ago, was pretty concentrated on one, our largest customer. Our strategy has been for multiple years to diversify the business, to go into multiple other customers, as well as other markets, even at the same customers. So we've been executing on that plan. If you look at our guidance into the current quarter, basically we have our large customers ramping a new flagship phone. We've got good demand for our gaming products. But many of the other products really go into a seasonally weak period after the holiday season. So we're seeing that. Our seasonality is definitely changing, and maybe it's already changed, to be more heavier in Q1 than it used to be, basically, in our Q2. In our Q3, sorry. So it's going to be heavier in the Q1 of the next fiscal year. Now, your question about are we seeing something that's particular to Maxim? Yeah, our content has gone down at our largest customers. So you are seeing the effects of that. But we are seeing good demand from other customers, but it takes a while for this all to balance out.

Thank you, sir. Thank you.

You're welcome.

Thank you, Mitch.

Thank you. Our next question comes to the line of Blaine Curtis from Barclays. Your question, please.

Hey, guys. This is Tom O'Malley. I'm from Blaine Curtis. Congratulations on the nice results. Looking at March here, you guys have obviously come from levels with you know, some weaker trends, and you're seeing above average growth in terms of seasonality. Can you remind us what normal seasonality for June is? I know you just finished talking about how consumer is a little bit different than historically, but what's the right way to think about the entire business into the fourth fiscal quarter? And do you think just coming from a lower base that you could outgrow that?

Yeah, I assume you asked about the March quarter, not June seasonality, correct?

March seasonality and for the rest of the fiscal year, if that's okay.

Okay. So I don't have the seasonality numbers in front of me, but I'm sure Kathy's gonna help me out here.

Okay, so hey Tom, this is Kathy. So of course we're only guiding one quarter at a time, but we do usually see that the first half of any given calendar year is better for industrial and automotive. And historically, as Tinch outlined in his last question and answer, We have historically benefited from a ramp in smartphone revenue in June quarter, but that's changed now because of the lower content that we have at that customer. So Samsung is a much smaller part of our revenue, and so we should not expect that to recur this year in our June quarter. And then finally for comms and data center, given the lumpiness of optical, it's hard to predict. There's not really a seasonality that we can point to there.

Thank you.

Yep, sure.

Thank you. Once again, ladies and gentlemen, as a reminder, if you have a question at this time, please press star then 1. Our next question comes from the line of Jeremy Kwan from Steveville Nicholas. Your question, please.

Yes, and let me add my congratulations on a solid quarter. The question on the automotive side, you mentioned battery management, ADAS, those are growing very nicely as a product. you know, they're your key drivers in that segment. Can you give us a sense of how big that is relative to your, you know, maybe the legacy or the larger auto business?

Yeah, so let's see. If we took Q3 as an example, roughly half the business, half of automotive is infotainment. And if you look at BMS and ADAS, they're Probably in the range of the mid-teens of automotive each. So that kind of gives you an idea. I mean, these numbers vary because the mix changes quarter over quarter. So half infotainment, mid-teens for BMS, and probably around mid-teens for ADAS, roughly. Did that answer your question?

Yes, that's very helpful. And where do you see that going in the next three to five years, that proportion?

Yeah, it's hard for us to predict that, but higher would be the obvious answer. I mean, they're clearly growing. If you look at some of the numbers we quoted, double digits and so on, and clearly they will grow pretty quickly. Just to give you an example, similar calls a year or two ago, we used to say infotainment was 60% to 70% of the business. So the rest of it's grown pretty nicely.

Great. Thank you.

Thank you, Jeremy.

Thank you. Our next question comes from the line. Your question, please.

Yes, hi, and congratulations on the quarter. I'm not sure if this question has been asked, if you've addressed this, but Intel on their call talked a lot about very strong data center dynamics over the first half, but then they're kind of expecting a slowdown second half. I know it's very early on, and I don't even know if you have the visibility, but... Do you have any thoughts on that particular topic?

Honestly, I don't think we're going to add anything to what Intel knows. They know the customers better than we do. And remember that we're one or two farther away from them because we're selling to mostly our data center customers or module makers. that are selling to cloud customers. And I don't think we can say anything that either confirms or denies what Intel is saying. My recommendation would be to go with whatever they're projecting. Sorry I couldn't help you on that one.

That's fair, Tej. Thank you. My follow-up is on the channel inventory. So it's obviously below your target And I'm just wondering what the dynamics are there. Is it mainly because of shortages or is just, you know, customers kind of being gun-shy about visibility? You know, just trying to understand why it's running still quite a bit below your long-term target.

I want to make sure I understand your question. Your question was about China inventory?

No, channel inventory. Channel, channel, not China.

Oh, channel. Channel inventory. So, well, I mean, essentially, channel inventory, as you know, is running below our model. And our desire is to bring it back up to what our model levels are. And we actually said that in the last call. But we saw, as you stated, we saw a stronger demand for the optical products, especially, and that caused us not to be able to completely catch up to what we wanted. You know, our read is that the end demand for these parts are pretty strong, so they're basically being consumed, you know, pretty soon after we ship them. And there's not much inventory because of strong demand more than anything.

And I'll just add to that, Tori. Oh, sorry, I'll just add to that, Tori. This is Kathy. So we also highlighted last quarter that we're starting to ship serial link products to Chinese OEMs. in automotive, and that goes through DISTY, we saw strong resales of those products as well. So there are some Maxim-specific products that are doing quite well in resales through China DISTY.

That's very helpful. Thank you very much.

Yeah, thanks, Tori.

Thank you. This does conclude the question-and-answer session. I'd like to hand the program back to Kathy for any further remarks.

Okay, thank you, Jonathan. That concludes today's conference call. Thank you for your participation and for your interest in Maxim.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program.

Everyone have a great day.