Cirrus Logic, Inc. (CRUS) Earnings Call Transcript & Summary

So welcome to the Cirrus Logic session here at the Stifel 2022 Cross Sector Insight Conference. My name is Tore Svanberg. I'm a senior semiconductor analyst, and I cover analog, connectivity and processor semiconductors. And it's my great pleasure to introduce Cirrus Logic. With us, to my immediate left, we have John Forsyth, who's the company's President and Chief Executive Officer; right next to him, we have Venk Nathamuni, who's the company's Chief Financial Officer; and here in front, we have Chelsea Heffernan, who is VP of Investor Relations and ESG; and Natasha [ Asar ], who is Manager of IR. So the particular format for this session is Q&A. So with that, I'll sit down and get started. I would like this session to be interactive. So if you do have any questions, just raise your hand, and then we'll go from there. Thanks.

So John, and thank you so much for coming. As we always start up these things, could you just give us a little bit of a general overview and introduction of Cirrus Logic, especially to those investors that may not be as familiar with the company?

Yes. Yes, I'd be happy to. Thanks, Tore. And first of all, thanks for inviting us, and thank you, everybody, for coming and joining this session. It's really nice to see a lot of familiar faces in 3D after all this time. So for those of you who don't know Cirrus Logic, we're a mixed-signal fabless semiconductor vendor, headquartered in Austin, Texas. Our -- what we're known for is principally audio-focused silicon. So we've been very successful in the smartphone space, in particular, with a fruit-themed company based out of California, but also increasingly in the Android space as well. With our audio products, principally, those are codecs and boosted amplifiers. But we have been on a path -- journey from being very focused and concentrated on audio to expanding that into other areas of mixed signal, which we call high-performance mixed signal. And we've been, over the past few years, hitting milestones on that journey of delivering -- building on our audio base to deliver haptics drivers and camera controllers, and most recently, power conversion chips, kind of demonstrating that our mixed signal engineering expertise is very applicable to other fields. And we see that as being an important driver of our long-term growth. In terms of size, we're give or take, around 1,600 employees. Most of that is R&D and engineering based mainly either here in the U.S. or the U.K. And our fiscal '22 closed at $1.78 billion revenue, which was an all-time record for us.

And I'll just add, just from a financial perspective, just in terms of the model, John just talked about the revenue. In terms of profitability, I mean, our gross margin is about 50%. That's our long-term model for gross margins. And then on the operating margin side, we're right now in the mid-20s, and our long-term goal is to get to about 30% as we increase the revenue scale and get the operating profitability up based on leverage. And finally, on a free cash flow basis, we're now roughly about 20% free cash flow margin.

Great. Thank you for that introduction. So maybe on that point, Cirrus recently reported a record Q4 and also record revenues for fiscal '22 with revenue growth of 30%. Could you please walk us through the main drivers of this strong growth, especially in light of a weakening consumer spending? And what especially also when considering the challenging supply environment because that's obviously topic du jour for semiconductor executives.

That has been the topic du jour for about 1.5 years now. So you're absolutely right about that. And to be clear, we -- if you look over that period, fiscal '22, we were supply constrained. That's by no means unique to us. I think probably most semis will say something similar. But on the demand side, I mean I think during fiscal '22, we saw very strong demand and the consumer products, particularly the ones where we have the most content, were received very well. And so that drove -- that was one of the drivers of our strong revenues. There were some other factors as well and not least in those -- the progress we made in the high-performance mixed signal segment. So that was reflected really in a couple of things. One is, I mentioned camera controller chips that we make. Those -- they can number more than one per phone because obviously, phones have a number of cameras and then across different price tiers of phones, you get different specs for the camera functionality and so on. So we saw the attach rate for camera control is increase in the back half of fiscal '22. And then most significantly, we had a new piece of silicon in a very, very popular smartphone, which we call the power conversion and control chip. That was really meaningful for us, in that -- that's our first big custom silicon in the power space, very close to the battery is doing some stuff that is not -- we didn't displace anything. There was new content and new functionality in the phone and that represented a significant step up in content. In addition to that, fiscal '22, we had a couple of other revenue contributors to a lesser extent than what I've just described, but also meaningful we had revenue from fast charging, which came through an acquisition we did of a company called Lion Semiconductor during the year, and we had more growth in revenue than we anticipated in the PC, in particular, the notebook market as well, and that was based around audio.

Great. And I think John, since you came on board as CEO, you've definitely implemented a strategy of product diversification. You talked about the mixed signal business, and I believe high-performance mixed signal now is about 1/3 of the revenue. I think you're targeting eventually sort of a 50-50 split between audio and HPMS. Could you just talk about the dynamics for each segment over the next few years? How we should think about growth? Where is it going to come from unit versus incremental features or content or what have you?

Right. Yes. Yes. Thank you. So yes, within our strategic planning horizon, we can see HPMS getting to 50% of overall revenue. And just to be clear, that's not by shrinking audio revenue, that's hopefully growing both, but growing HPMS at a higher clock rate. And maybe the easiest way to answer the rest of your question is just to think about our kind of 3 strategic pillars. First of all, it's -- the most important thing is kind of look after the business you've got today to maintain leadership in smartphone audio. That's where the bulk of our revenue comes from today. So we've got to invest and make sure we do that. But we are in so many of the key sockets in smartphone audio at this point that's less about driving growth and more about maintaining really solid business and revenue. Secondly is target key profitable segments or segments that we believe can be profitable for audio beyond the smartphone. So I've mentioned the notebook segment. For us, not every audio market is going to be a really profitable one. And one of the reasons for that is we're really at the leading edge of mixed signal engineering. It means we're on advanced processes for mixed signal stuff. That comes with a cost. It's -- you need really high skilled engineers to do that. Everything to do with wafers and tape-out becomes more expensive. You need to get paid for that for people to pay for that, they need to want the benefits, like really small packages, very, very high power efficiency and so on. So only some markets are really appropriate for that. We believe the laptop market is evolving into one where that can be an additional growth driver going forward for us in the audio space. But then the third pillar is driving an expansion of our product portfolio in the high performance mixed signal space into these adjacent areas around haptics, cameras, power. And we believe that there is more substantial headroom for innovation there and more substantial room for growth in the longer run. And so if you think about the early years of -- and I know you were covering the company back then, sorry, but in the early years of codecs and so on, those were iterating and being updated quite frequently. The rate of innovation was very high that consumed a lot of R&D resources. I think that's where we are in the power space, for example. So the moment we were done with the first power conversion control chip, there was a conversation about what comes next and what's the wish list for the next generation. So I think the -- to summarize, I think we've got great solid revenue in smartphone audio. We've identified some areas where we can continue to grow in audio beyond the smartphone, and we have these really exciting growth engines, which I think are going to be propelling most of the growth that we believe we can deliver in future years.

Got it. And as a follow-up to that for you, Venk, I know you don't report financially by the two segments, right? But if we think about gross margin and operating margin between the two segments, like John just said, I mean, it sounds like you're investing more R&D in HPMS, so theoretically, the operating margin there would be lower. But -- any color you could share with us on that?

Yes, I think that's exactly right. So the bulk of our investments are happening in the HPMS space because, as John pointed out, we have lots of opportunities, especially to expand content as you've seen already with what the company has done and predominantly an audio supplier for all these years. And then over the last 2, 3 years, expanded dramatically into power management and haptics and camera controls and so forth. And the line of sight that we see into expanding into HPMS is pretty long and pretty attractive. So that's where we're going to do the bulk of our investments. And we don't break out, as you pointed, we don't break out the gross margin by separate segment, but it's fair to say that our corporate average is about 50% and give or take.

Got it. Okay. And back to you, John. And like you said, I've been covering the company for a long time. And I always got this question, why wouldn't the codec get sucked into the apps processor? And obviously, there's a lot of reasons why, but when we think about high-performance mixed signal, it is more digital in nature than, let's say, an audio codec. So as we think about these new products in HPMS that you've now have gotten designed in, would there be more risk for potential integration with other components? And if not, can you explain why?

That's a great question. I think the first thing to understand about how we think about this is I think it's really important for us to be very realistic about what might get sucked into the AP. There's no point in kind of telling yourself kind of comforting, but possibly not true stories about that. And for us, the outcomes razor, the dividing line is, look, does this function really need to be close to the analog digital boundary? And there are various reasons why it might really need to be. One might be because the latency constraints are so extreme. And this is the case, for example, with the camera controller, you're doing thousands and thousands of corrections to the position of elements in a camera and receiving all the sensor data at the same time. There just isn't the opportunity to round trip that to the applications processor. So things like that, we think, are very defensible. There's utterly compelling logic for keeping that as close to the analog boundary as you possibly can. There are other reasons as well. Another example of reason is, although digital transistors are free on the applications processor compared to on a 55 or 22-nanometer process, they are also, by and large, general purpose. And if you know -- if you're designing an [ ASIC ] for a particular function, let's say, the control -- the digital control stuff around the power space, you can put logic into gate. So it may be digital, but it doesn't need to be general-purpose digital architecture. It can be far more efficient than that. And in power, the efficiency is king and being able to provide really fine grain control at the digital level, combined with the analog there in a single chip makes a lot of sense to us and more importantly to our customer.

Got it. And maybe zooming into some of the specific products. So in the last more than a decade, you've been selling the codec, amplifier different [indiscernible] domain. And that gave you pretty good sustainable growth over that time period. Now we're looking at 4 or 5 different products so on the HPMS side. So how should we think about sustainable growth kind of historically with 2 products versus now versus 4 or 5 products? I know you mentioned, hey, like it feels now in HPMS, how you were in audio, maybe 10 years ago where you just had more features and more content that you can benefit from. So if you could...

And that's certainly part of it. Yes. I mean, I think it's a great question. And I would say if you look across -- okay, so we've got this much broader range of products now, including several new or relatively new areas of high-performance mixed signal. I think the first thing that, that is done, which is worth pointing out is giving us product and socket diversity just from the point of view of the risk attached to any one socket, if you got one socket in a big customer, that really looks and feels like a dangerous situation. The more sockets in different areas you have, the less risk attached to any one of them. So I think that's been very beneficial for Cirrus and our investors. But in terms of the -- how I think about the growth opportunities or the opportunity for sustainable growth that we get out of that I think I've explained what I think about audio. There are possible ways to see incremental growth in audio, but it's closer to the top of the S curve in terms of its evolution. Within our most significant kind of new categories of high-performance mixed signal, we have pretty aggressive road maps. And those are areas where there's a very high cadence in the communication with customers and as I mentioned, a hunger for starting on test silicon for the next version before you're even done with this one. So I think there is -- there's a lot of reasons for us to feel like that can stock -- those dynamics can help stock a pipeline that will deliver potential for value growth over time for multiple years. And certainly, one of the benefits of some of our customer relationships is a really good line of sight for several years out. That's how we think about those areas. But I would say that one of the biggest things that's happened to the company in the past few years is that we have maybe not in everybody's mind yet, but I think in the minds of some of our investors and key customers, we have crossed the [ Rubicon ] from being audio-focused an audio company to being a high-performance mixed signal engineering company, and that opens up a lot of domains. So I don't -- from my perspective, I don't want us to be done yet with those bits of HPMS content. I think there's -- I think traditionally, nobody doubted our engineering talent, nobody doubted our ability to execute. We've got a phenomenal track record of execution and not letting our customers down. But now we have credibility in our ability to go and deliver that engineering excellence in an entirely new domain. As long as it kind of looks mixed signal shaped, has demanding requirements that kind of fit with our expertise, then I think there are more doors which are open to us.

Okay. And just to add to that, somebody who's been relatively new to the company, I see that in terms of just the diversification of the product portfolio and also the engagement on so many different fronts. And it's not just with our top customer, but we're able to leverage the technology across other markets and other customer opportunities as well. So I think that's part of the diversification strategy. Clearly, with the top customer, we started out with audio, but now, as you can see, it's a multitude of products that we ship, and there's several more in the pipeline.

Right. And maybe on that note, so talking about sort of application diversification or market diversification and you look at the two businesses or the products within each business, I mean, how realistic is that? Because I mean, obviously, you're targeting a very, very big market, right? You have a very, very large top customer. So how realistic is it for you to see proliferation of your products, your existing products into things like laptops, wearables, AR, VR, so on and so forth.

Yes. I mean I'm excited about that. I think when you have a kind of a target-rich environment in smartphones, I mean, just getting to the point of prioritizing the other stuff is always part of the challenge, right? But having this broader array of IP and technologies that we can -- where we can develop products, I think, does open up meaningful additional opportunities for market diversification from the point of view of revenue. So for example, you mentioned notebooks. We've talked about notebooks mostly from the point of view of audio content, but there is more than that. There's haptic content. There's also, we believe, in time, power and charging content. And that was one of the reasons we were very attracted to the Lion team. In fact, it was less about getting more exposure to smartphones and more about where we felt that technology could go. And we saw -- and they saw opportunities in laptops and beyond in other markets, which we're not necessarily going to talk to today, but we do believe are out there. So I think that's true in laptops. AR and VR are definitely areas where we want to play. Historically, we've done a lot of audio for AR and VR devices. But when you think about the more -- the broader range of capabilities we have, well, AR and VR are going to be -- devices are going to be incredibly power-sensitive, incredibly sensitive to the physical size. So again, that favors really advanced engineering and mixed signal space. And they also -- they have a lot of optical components and content, for example, there's probably some power considerations in there. So we'll certainly be looking very closely at how we participate more in those markets, leveraging these HPMS technologies.

Got it. And I know you typically don't want to talk about your largest customer for obvious reasons, you don't want to preannounce their product road map and so on and so forth. But I'll try a question anyway and see where we go. But based on my assessment, your largest customer, at least historically, has always been behind when it comes to things like fast charging, a lot of it with the battery. And my understanding is because they've always prioritized the health of the battery as opposed to offer features like fast charging and things like that. With some of the new battery technology that you're offering them, is that kind of part of the way for them to perhaps be able to deliver both the life cycle of the battery, but also features like fast [indiscernible]. I have to try. So...

So you can't not ask and I can't answer. So what I will say is this, and I'm going to dodge the question, but hopefully, in a way that -- because I never want to talk about our customers' products before they're around. But -- but what I do think is this between the fast charging acquisition we did, at the time when we were bringing to market this power conversion and control chip. And I fully appreciate that power conversion and control is not hugely communicative or specific description. That chip is mostly focused on battery health and managing the battery health over a long period of time. We believe that these things are highly complementary. And I'm feeling my way around to an answer here that may give some color, which is that if you can really do an incredibly good job of -- first of all, the metrology, and this requires really good analog design and ADCs and analog mixed signal engineering to detect what's going on in the battery to a high degree of precision, and you can use that to inform how you charge the battery and how you manage its discharge over time. You can optimize for different things. So you can optimize for the fastest charging, you can optimize for, hey, I want the smallest battery that lasts, that gives linear performance for years on end or something in between. And I think that -- so from our perspective, it's about building a toolkit where we can help our customers achieve their particular goals.

All right. That's -- I'm satisfied with that answer. That's great. I don't know who wants to address this question, but can you elaborate on the GlobalFoundries capacity and reservation agreement that you have. I believe it was $50 million nonrefundable reservation fee, and then you had a prepay of $175 million for future wafer purchases. And I think we're talking about -- was it $1.6 billion total obligation and that this is going to be basically staggered from fiscal '23 to fiscal '27. So let me ask you this, why was the agreement structured this way? And should we assume that the contract can be updated every year?

Okay. So first of all, and you may want to speak to this as well, Venk. If you step back from it, we're at a supply crunch. We have a lot of business where we feel when we win a socket, for example, in our largest selling -- customers' largest selling products, those tend to run for multiple years. So we have actually good line of sight within a range of units and, of course, we want to give our customers confidence about supply and enough confidence that they can look at us and want to give us more business over time. So at that point, we also had a very, very strong, arguably too strong cash position at that moment in time. It was a great opportunity to leverage that for good wafer pricing, security of supply over multiple years and, in fact, an increase in supply successively over several years. So that was the big picture. Of course, we didn't want to extend that indefinitely because there are new sockets, you've got to go and win and you don't want to carry a huge liability before you won them. But we have a long-running partnership with Global. We are talking, if not daily, then certainly weekly, about what the picture looks like further out as well as what the opportunities are for more supply before that the agreement expires because we -- if we could get more supply, we would certainly do that.

Yes. And I think just to add to what John said, I mean, the fact that we're able to sign a 5-year agreement with GlobalFoundries just talks to the visibility that we see in terms of the opportunity for multiple sockets over time. And then in terms of just the profile of the agreement, the first couple of years, we're at a fairly high level. And then we want to have the optionality to be able to update the agreement as well as add additional resources as we need. And so just having that flexibility and optionality is very important to us as well.

Great. So we're starting to run out of time. I just want to make sure I check to see if you have any questions. No? No questions on the GlobalFoundries agreement? Well okay. So let me sneak one in on that same topic. So I believe there's also an option to reserve specified portion of the capacity in calendar '23. But I believe you pulled some of that into fiscal '22. Maybe I'm correct, maybe I'm incorrect. But I just want to make sure that we cover sort of the timing of revenue, meaning if you do pull in stuff right now, does that mean there could be a potential air pocket later on?

Right. Okay. Let me just maybe untangle, right? I understand you correctly, untangle a few different threads here. So first of all, really truly pulling in a lot of a meaningful number of wafers right now. It's not possible because every single wafer that comes like that's as many as they can make, right? So the big picture, that's what's going on. When we talk about pull-ins, and I think, if not on the last earnings call, the one before, I did talk about pull-ins, which are important for us as a proxy for customer demand. If they're very impatient about it arriving in this week versus the following week, that's a good sense of -- they're probably not sitting on a ton of inventory. But very, very -- to the extent that we do that, very, very few pull-ins will actually traverse a quarter boundary. So it doesn't change the big picture of the revenue, a great deal. And then when you think about the global agreement, I think really, if I'm thinking of what you're thinking or referring to there in the agreement, really, there's -- there are various provisions and statements in that agreement, which basically say and if we can get more, we'll take it. And that's something that Global and Cirrus continue to work on together daily and weekly.

Right. And I can see why you would be a priority for them given who your largest customer is. So let me wrap up with this question. And it tends to be a little bit of the elephant in the room when it comes to Cirrus Logic, right, which is customer concentration. There's no secret that your largest customer as being roughly 80%, 85% of revenues in any given quarter, any given year. I know you've tried actively to diversify into the Android space. But just again, just given the analog HPMS product portfolio, I mean, how realistic is customer diversification at this point?

Okay. First of all, our first priority is profitable growth. That's what we prioritize. And I would not understate the benefits of doing business with our largest customer when it comes to -- when they commit to something going into the product, that can be years out and the track record on that actually getting there, shipping and delivering for multiple years is incredibly strong. So we view that as a great asset. What -- and then diversification, I think this goes back to my point about there are some opportunities in audio, but kind of we're shipping audio into everybody in Android or most of the key sockets in Android at this point. The long-term -- longer-term path for us, I think, is to continue to expand this collection of this portfolio of products and technologies we have in HPMS and use those as springboards to address other markets because I believe having that really compelling technology and products in power and so on, give us more opportunities for that.

And I'll just add one thing to that. I mean, we do have a strong balance sheet with $450 million of cash. We generate a lot of free cash flow, and we will be very prudent about using that for diversification from the standpoint of additional technologies and products as well.

Makes sense. All right. So with that, we've run out of time.