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(NASDAQ: CY)
Q4 2018 Earnings Conference Call
January 31, 2019, 4:30 p.m. ET” data-reactid=”23″ type=”text”>Cypress Semiconductor Corporation (NASDAQ: CY)

Q4 2018 Earnings Conference Call

January 31, 2019, 4:30 p.m. ET

Good afternoon and welcome to Cypress Semiconductor fourth quarter 2018 earnings release conference call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Colin Born, Vice President of Corporate Development and Investor Relations. Sir, you may begin.

Thank you, Brandon. Good afternoon and thank you for joining our Q4 2018 earnings conference call. With me today are Hassane El-Khoury, CEO, Thad Trent, CFO, and Mike Balow, Executive Vice President of Worldwide Sales and Applications. Hassane will make some introductory remarks. Thad will provide a financial overview and then we will take your questions.

All information discussed in our earnings release and on this call is based on preliminary unaudited results and we encourage you to review our 10-K once it is filed. During the call, management will make statements about our first quarter guidance, our long-term financial model, and other future matters that should be considered forward-looking.

Actual results might differ materially from the results anticipated in our forward-looking statements. Please refer to our earnings release, the risk factors in our most recently filed 10-K with the SEC, and our other SEC filings for a more detailed discussion of risks and uncertainties that could cause these differences.

All forward-looking statements are based on the information available to us as of today and individuals are cautioned not to place undo reliance on our forward-looking statements. In addition, we undertake no obligation to update these statements. Please note the financial measures to be discussed by management today are non-GAAP measures, unless they are specifically identified as GAAP measures.

Reconciliations of non-GAAP measures to their most comparable GAAP measures and other certain limitations of non-GAAP financial measures are included in our earnings release and our investor presentation deck, both of which are dated today and available on our website at investors.cypress.com.

I will now turn the call over to Hassane.

Thank you, Colin and thanks to everyone for joining us today. 2018 was a solid year for Cypress as we continued to execute on our Cypress 3.0 strategy focusing on the higher growth markets of automotive, industrial, and IoT. In spite of some headwinds that arose toward the end of the year, we successfully grew the business by 7%, which is within our stated long-term growth target of 7% to 9%.

This increase was fueled by the continued expansion of our content and the automotive market, which was up 13% in a year when automotive units are expected to increase approximately 1%. In addition, we saw 11% growth in our industrial business well above our targeted 3% to 5% range, thanks to our world-class portfolio of connect and compute IoT solutions. Our enterprise business was up 8%, largely driven by the continued buildout of 5G infrastructure.

We were successful in achieving our gross margin targets, exiting the year at 47.8%, an improvement of 1,080 basis points since we launched our Cypress 3.0 strategy in 2016. We are extremely proud to have hid these targets, which resulted from a lot of hard work, including rationalization of our supply chain, moving from two factories to one, the introduction of critical new products at or above our gross margin targets, and a restructuring of our memory business to exit lower margin commodities and focus on more stable and predictable specialty storage products serving the automotive, industrial, and enterprise end markets.

The pending joint venture with SK Hynix Systems IC is another step in this transformation and aims to further reduce our exposure to volatility in the commodity memory market, especially consumer, which is about half of our NAND revenue today. After closing this JV, we expect over 90% of our specialty storage revenue will come from automotive, industrial, and enterprise, where pricing has been stable over the last couple of quarters. We expect this stability to continue in 2019.

2019 was also an excellent year of new product execution for Cypress. We introduced our next gen PSoC 6 MCU, which delivers ultra-low power and secure computing for IoT applications. Our Traveo 2 triple core and secure MCU architecture, which greatly expands our automotive feature set and addressable market at a significantly improved margin profile, our new family of 28-nanometer Wi-Fi/Bluetooth combos, offering the industry’s lowest power connectivity and most advanced 11ax Wi-Fi 6 connectivity.

We introduced our Semper NOR Flash for automotive and industrial application, adding compute to our specialty storage solution, and finally, a variety of new USB-C products tailored for specific high-growth platforms.

We further enhanced our software offering through the launch of our ModusToolbox and Cirrent platforms. ModusToolbox supports IoT developers with the most compelling ecosystem of combined MCU and connectivity tools, SDKs, and services. Cirrent Software and cloud services uniquely improves the Wi-Fi setup experience for end customers, thereby enhancing our connectivity, products, appeal to OEMs, and creating a new revenue opportunity for Cypress.

Cypress is significantly stronger, exiting 2018, which is timely, as it appears we are heading into some challenging time in the industry. Thad will discuss the specifics of our outlook later, but I want to provide some insight into how we are approaching these challenges.

The outlook remains uncertain, as there continues to be a fair amount of cautiousness in our channel, especially those serving China, where end demand has clearly been impacted. In the rest of Asia, the US, and Europe, we broadly felt the impact as customers cautiously navigate the uncertainty surrounding the trade, tariffs, as well as the disruptions related to factory relocations.

We have been more cautious with our inventory management in the channel, ensuring we release shipment against backlog only as we get more visibility on end customer demand as we balance sell-in and sell-through. While backlog for the second half of the year seems to be stabilizing and cancellations remain within normal limits, I remain cautious in our outlook until we have a more stable environment to count on.

The good news is that customers continue to invest in developing new products using Cypress Solutions. Overall design wins at Cypress in 2018 were up 24% year over year, 37% of which were from new products. Design win growth was led by MCD, which was up 32% year over year. As an example, the design win funnel for our Traveo 2 automotive product I mentioned earlier has reached $1.2 billion in the last three quarters since we sampled the product. Highlighting the products competitiveness in this market, I will also add this funnel is highly accretive to our automotive margin.

While low power and secure connect and compute technologies are rapidly being added to many of the electronics in our everyday lives, we believe we are still in the very early phase of the IoT buildout. As an example of our expanding addressable market, penetration of IoT technologies and smart home and appliances is only 20% today and expected to double by 2022.

Wi-Fi has become the de facto standard for the IoT and Cypress is well-positioned to capitalize on this trend with industry-leading 11ac Wi-Fi/Bluetooth combos. Also, Wi-Fi gen 6 for 11ax is coming very soon and Cypress is ready. Gen 6 is not only faster than 11ac, but also adds more advanced spectrum management and scheduling technologies, which improve overall network capacity and efficiency.

We expect the first generation of Wi-Fi Gen 6 solutions to be deployed in phones and routers in 2019. With this infrastructure in place, the stage is set for Cypress to capitalize on the billions of Wi-Fi clients and edge devices that will soon follow. In fact, the advanced Wi-Fi technologies are already being designed into connected cars with RFDB solutions.

Finally, Cypress continues to be in a poll position for the continued ramp of USB-C. During 2018, we shipped our two-billionth USB device, regaining our number one share. And in 2019, we expect USB-C to continue its march toward ubiquity as it moves into more devices, chargers, docks, automobile, PCs, phones, and cables. At the end of the fourth quarter, 592 platforms are in production with Cypress USB-C solutions, up from 490 last quarter.

In summary, we had an excellent year in 2018 with financial and product execution that has strengthened our company. While Cypress has not been immune to the recent economic malaise, we maintain our focus of delivering our targeted operating income as we remain well-positioned to win within some of the most compelling trends across high-growth automotive, industrial, and IoT business, and design activities supporting our strong positioning in many of the key mega trends happening in 2019 and beyond. That gives us a lot to be excited about for the years ahead.

With that, I will turn it over to Thad and then we can take some questions.

Thanks, Hassane. I’ll start out with providing an overview of results for the full year 2018, then step through the Q4 results, and wrap up with guidance for Q1.

Starting with 2018 — 2018 was another exceptional year as we executed our Cypress 3.0 strategy. In spite of the headwinds that emerged toward the end of the year, we achieved many new milestones as we structurally changed Cypress to be more stable and predictable. Our 2018 revenue was an all-time record at $2.5 billion, increasing 7% over 2018. Our automotive business increased 13% year over year, growing ten times faster than worldwide automotive units as we continue to gain content in the connected car of the future.

Our gross margins for the year improved 460 basis points to 46.8% and we exited the year achieving our target of 47.8% in Q4. Since embarking on the Cypress 3.0 journey, gross margins have improved 1,080 basis points.

In 2018, Cypress achieved 22.8% operating margins, delivering $1.36 in earnings per share, which increased 53% year over year and 8 times faster than revenue, demonstrating the leverage in our model. On cash flow, we increased our free cash flow 16% over 2017 and our net leverage ratio is now 1.0 as compared to 4 times in 2016.

This is now giving us flexibility on our balance sheet and as part of our ongoing effort to return capital to shareholders, we augmented our dividend by reinitiating our share buyback activities in Q2. In 2018, we repurchased 2.3 million shares for $35 million. We also announced the divestiture of our highly commoditized NAND business through a joint venture with SK Hynix Systems IC. This transaction is expected to close by the end of Q1 and provides an ongoing cash flow stream through 2023. These results are only possible with the dedication of our worldwide team focused on execution and delivery.

Moving to results from the fourth quarter, revenue was $604.5 million, representing an increase of 1.2% year over year and a decrease of 10.2% sequentially as compared to normal seasonality of down 3% to 4% in the fourth quarter. The primary reason for the shortfall was slowing China consumer and industrial revenue, although we started to see some softening in other regions. We are also reporting another quarter of record automotive revenue, increasing 3% sequentially and 19% over Q4 of 2017.

Inventory in our distribution channel, which accounted for 71% of revenue in Q4 decreased from 7.7 weeks to 7.2 weeks of inventory. On a dollar basis, inventory in the channel decreased 14% as we actively managed replenishment orders to match in demand. We continue to see our Asia Pac distributors remain cautious in a wait and see approach to the market uncertainties.

As I mentioned, Q4 gross margin came in at 47.8%, an increase of 240 basis points from Q4 2017 and up 80 basis points sequentially even with a lower revenue base. Gross margins improved in both divisions sequentially and utilization of Fab 25 increased in Q4 to 85%. In addition to the gross margin expansion, we also managed spending in line with the revenue decline, resulting in operating margins of 24.5% and non-GAAP EPS of $0.35 for the quarter.

So, turning to the divisions, MCD revenue was $355.8 million, slightly down from Q4 of 2017 and down 14% sequentially from Q3. We saw broad declines across most business units offset by auto MCUs and USB-C, both growing low single-digits sequentially, despite headwinds at our major handset customer. Excluding this handset customer, 2018 USB-C revenue increased 52% over 2017 as adoption of this new standard continues to accelerate.

Wireless IoT declined more than seasonal due mainly to weakness in consumer end markets and declines at Nintendo. Despite the macro headwinds in Q4, non-Nintendo revenue increased 20% in the second half, demonstrating the strength in our broad wireless IoT penetration.

MPD revenue was $248.7 million, up 3.5% over Q4 2017 and down 4.2% sequentially from Q3. We saw a fairly dramatic decrease in NAND of 32% sequentially, due to over-supply and price declines many of our competitors in the market have also reported. However, unlike our peers in the NOR market, Cypress’ NOR business saw 7% sequential growth thanks to out focus on the high-end, high-density specialty storage applications at customers serving automotive, industrial, and enterprise infrastructure.

In fact, during 2018, Cypress’ average NOR density per chip increased by 15% year over year and is currently over 4 times higher than the average for the overall NOR market. It is also worth noting that over two-thirds of our 2019 NOR business is already under a long-term contract providing improved visibility.

Let me give you some additional numbers for your models. Our Q4 operating expenses were $141 million or 23% of revenue. OpEx was down $9 million from Q3 as we actively controlled spending as we saw the market softening. Q4 operating income was 25%, increasing 23% over Q4 2017 to $148 million. Our OIE was $10.8 million, flat from Q3. Our non-GAAP tax expense in Q4 was $6.3 million, up from $2.8 million in Q3, primarily due to true ups associated with newly issued tax regulations on the US tax reform.

Our diluted share count was 374.9 million shares. This includes 1.5 million shares for the in the money portion of our convertible notes. Please note that we updated the convert dilution reference table on our IR website to assist you with calculating the share impact at various stock prices. This resulted in net income of $131 million or $0.35 per share at the high end of our guidance range.

Turning to the balance sheet, cash and short-term investments totaled $286 million and we have $540 million undrawn on our revolver. Accounts receivable was $324 million, resulting in DSO of 49 days. Cash from operations was $142 million or 24% of revenue. Net inventory increased $3 million sequentially to $292 million and days of inventory increased to 84 days due primarily to the abrupt market downturn.

We expect inventory days to increase once again in Q1 due to the current market conditions as well as an inventory build to support our ongoing optimization and consolidation of our manufacturing footprint. Our Q4 adjusted EBITDA was $165 million or 27% of revenue. Total debt was $936 million and approximately 80% of our debt is now fixed rate with the converts and interest rate swaps we have implemented. Our net debt is $650 million as we have been increasing cash on the balance sheet.

As I mentioned earlier, our net debt to EBITDA leverage is now 1.0 times on an LTM basis. CapEx was $5 million, which included the benefit of $5 million for a building cell executed in Q4 and depreciation was $17 million for the quarter. We repurchased $15 million in shares during Q4 and have $176 million remaining on our authorized buyback. As a reminder, our long-term model is to return 50% of free cash flow to shareholders through the dividend in the buybacks.

So, turning to guidance for the first quarter, taking into account the market uncertainty, we were expecting Q1 revenue of $520 million to $550 million. This assumes a full quarter of NAND revenue at $25 million to $30 million for the quarter. We again entered the quarter over 90% booked. But as I mentioned earlier, we will manage our distribution backlog and shipments to closely match end customer demand. The book to bill declined from 0.8 in Q3 to 0.77 in Q4 with both divisions below 1.0.

Consistent with normal seasonality, we expect Q1 gross margins to decline to be in the range of 46% to 46.5%. This also includes the dilutive impact of the NAND business in the range of 40 to 60 basis points. As always, gross margins will vary with product and customer mix. We expect Q1 operating expenses between $141 million and $143 million for the quarter as we continue to control spending.

Net OAE will be approximately $10 million. Tax expense will be approximately $4 million. CapEx is estimated to be $13 million and depreciation of approximately $17 million. We anticipate the fully diluted share count to be 377 million shares. As a result, earnings per share is expected to be in the range of $0.22 to $0.26 for the quarter.

To wrap things up, in spite of the headwinds facing the business, we remain optimistic about the opportunity to increase shareholder value over the long-term by continuing to execute our Cypress 3.0 strategy. We have restructured our business over the last two years to enable us to be successful in any environment with differentiated products serving in many of today’s most exciting megatrends.

With that, I’ll turn the call back over to the operator to begin Q&A.

Questions and Answers:

Thank you. We will now begin the question and answer session. When your line is open, please limit yourself to one question and one follow-up question. Our first question is from Vivek Aria with Bank of America Merrill Lynch. Your line is open.

Thank you for taking my question. Hassane, for Q1, can you give us some color on what you’re seeing in different end markets versus seasonal trends? Of course, macro impact seems to be broad-based, but if you could walk us through your different products in end markets, where you see trends seasonal versus non-seasonal. And as part of that, if you could specify the NAND contribution for Q4 and Q1.

Yes. I’ll give you a little bit on the trend and then pass it over to Thad. So, if you listen to our commentary, there’s still a lot of uncertainty outside, but looking at it, China consumer, a little bit on the industrial, we’re still seeing softness and a wait and see from customers. What this is causing us to do across all of our markets is to be very cautious about when we ship into the channel. What you saw is channel inventory has been coming down.

Our weeks of inventory has also gone down. What we are trying to prevent is us shipping and the lack of visibility causing the POS not to happen. That’s across primarily China, consumer, and some of the industrial. We’re seeing some of that cautiousness in other regions, not to the extent of China, but it’s not specific to a market or submarket as we’ve always been used to. That’s on top of the normal seasonality that you’ll see, which is Q1 is typically down, then you see Q2 up, Q3 up, then the four quarters slightly down for after the holiday goes. We’re not seeing any changes like that. It’s just on a different level.

I made a comment the second half of the year. I would say backlog is balanced. But the cautiousness from our side is more visibility on the end demand across these markets before we start shipping at a normal rate, which today leads you to believe if you hear my comments properly, we’re not shipping in the normal run rate that the backlog is at. We’re throttling until we see visibility on a one-to-one sell in and sell through.

Vivek, this is Thad. On the NAND business, we saw a steep roll-off in Q4, primarily because of oversupply and price declines there. The revenue was down 32% sequentially. As we look forward to Q1, we expect the revenue to be $25 million to $30 million for the quarter. We expect more pricing pressure. We expect it to be dilutive to overall gross margins. That’s where I said it would be 30 to 60 basis points lower on a consolidated basis. So, for Q4, you can think about the dilutive impact as that rolls off, there are a couple pennies on EPS.

Hassane, autos was a strong driver for you last year. Give us a sense of what happens if you get into a negative unit situation this year. I understand content is what drives growth, but do you think it can be strong enough to offset the unit headwinds. Could you give us some color around what you’re seeing around automotive markets in the different geos?

To answer your first question, yes, our content story — I’ve been mentioning our content and not one-to-one alignment with units for the last few years. Now, the units are flat to probably going backwards in 2019. With that, we’re still very bullish on our automotive position. We have been bullish through 2018 and outgrew the market 10x the unit growth. I see that happening in ’19 as well, regardless of what the unit is going to be.

If the unit is actually in decline, if we see going backwards on a unit, Cypress Automotive is still expected to grow not at the same rate as we did, but think about it as a slight lower growth from us. Our long-term target for our auto business is 8% to 12% that I’ve outlined on analyst day of 2017. That was based on low-single-digit unit growth. If the units go flat or slightly down, you’re going to see mid to high single-digit growth in our automotive business.

That’s the visibility we have specifically on Traveo 2 that I gave you some data points on. I’m very comfortable with where automotive is. I’ve always been comfortable with our position through the last two years and moving forward, I have the same comfort. What the market does, the market does. Our focus is on growth and playing in the new content that didn’t exist a few years ago.

Our next question is from Karl Ackerman with Cowen and Company. Your line is open.

Hassan or Thad, I know you don’t want to guide quantitatively beyond one quarter. I’m curious whether you endorse the broader view from your peers that we should want to see demand acceleration in the second half. As a follow-up, would you expect the order headwinds within distribution to abate by the second quarter and more importantly, when would you expect a plethora of design wins you’ve announced in the second half of 2018 to manifest into revenue? Thank you.

I’ll give you my view of it and then have Thad add to it. Overall, yeah, I see a different backlog, different demand, different order trend in the second half of the year, even slightly before that. That puts comfort for us. However, there’s still the uncertainty in the market, although cancellations are within normal limits, that’s not what causes the cautiousness on my side. It is the potential pushouts.

If there’s more disruption, although the orders are there, nothing prevents outside of the change window we have with customers to push it out over a quarter boundary. That’s where we can’t have inventory be trapped because we are recognizing revenue on selling. We don’t want inventory to be trapped in the distribution channel, we want to see visibility on the customer pole. That’s when we ship into channel, so it goes straight to the customer after that. That latency that we are looking for, that’s the cautiousness you hear from me.

But from an order, Thad mentioned we’re walking into the quarter 90% booked. That’s not what I’m worried about. It’s not whether or not we get the order. It’s whether the orders will get released. The view of backlog I do share with the peers. It’s a better view in the second-half of the year than it was in Q4 and Q1 as far as the slope or direction of the backlog. Half the problem is behind us, potentially. The second half is is demand going to follow through with it.

I mentioned the inventory in the channel was down 14%. If you look at our revenue in the channel in Q4, it was down about 12%. We clearly are under shipping natural demand. In terms of what’s happening out there, I think both our distributor customers as well as direct customers are ordering late. They’re very cautious. I think that pattern, everybody’s adjusted to that new order pattern. I think it’s too early to tell what’s going to happen here. There’s still too much uncertainty.

The second part of your question — you mentioned when do we start seeing the revenue of the design wins we have announced in the second half of 2018, we’re starting to see them at a run rate basis. In 2018 those contributed to half a year of a ramp or slightly below that because of a softer ramp up. We’re going to see that on an annual basis in 2019. We’re seeing those in the first quarter. We’re seeing those in the backlog in the order pattern. We just will start shipping those and getting them on an annualized basis.

Our next question is from Suji Desilva with Roth Capital. Your line is open.

Hi, Hassane. Hi, Thad. Can you give us some sense of what you think the outlook is near-term for MPD versus MCD? I do understand the NAND is a headwind in MPD. Any color there would be helpful.

So, Q1 is normally seasonally down. That’s going to be across the divisions. The strengths, one thing, if you compare MPD, I would caution everybody not to compare to the MPD peers because I think we have proven over the last two quarters we’re not trending like our peers. The bottom has fell with some of our peers in commodity memory. We are not. We are growing.

Q1 being a seasonally down quarter, I wouldn’t put a trend on that. Overall, if you look at the design win trend, they are led by MCD and across a lot of their businesses. So, growth long-term will remain from MCD, but MPD is holding its ground because of the stability of the ASP as well as some constrain in demand for high density.

We’re expecting both divisions to be down in Q1, obviously more than seasonal.

Our next question is from Vijay Rakesh with Mizuho. Your line is open.

Just a question on the NOR side, good job on 4Q, it looks like it grew sequentially versus many of your peers in Taiwan. You’ve mentioned 2019, almost two-thirds booked around long-term contracts. Can you give us more color on how the inventory looks there? Are you sole sourced for a lot of these contracts?

Two-thirds are in long-term agreements. They’re very similar to the playbook we’ve had in 2017-2018. I’m not worried about the contracts the customers have seen in the value we provide, both on the high-density and the ability to supply and not be distracted by the low-density commodity shipped bits by the pound-type business. We’ve walked away from that business two years ago. We have stayed the course and when the market turned, we did not want to turn with it. That happened. Everybody went down. We stayed up, both on units and ASPs.

We see the ASPs being very stable through 2019. I will make the call now we have a very different NOR business than anybody else in the market today. The numbers show it. I don’t have to talk about it anymore. If you look at automotive, enterprise, the businesses we are in, those are high-reliability proprietary products that go for years to be qualified into the socket. So, per socket, per project, we are single source and that gives us the confidence and credibility of our outlook specifically for NOR. It’s a very different business that Cypress has. We’ve been saying it for two years and I’m sticking with it.

On the IoT side, as you look at 2019, any thoughts on how you expect the growth there year on year and any thoughts on competition. You mentioned some good drivers. If you could, give us some more color there. Thanks.

I’ll give you the reason I made some of the commentary about the market penetration and the market expansion. We’re still at the beginning of the IoT expansion. The example I gave was the home appliance, the smart home. We’re only 20% penetrated as an industry into that market. That penetration is going to be doubled by 2022. The growth is there. I’m not going to predict growth specifically to that business. We need more time to get that visibility. What I can tell you is I’m very confident in our design wins. Those are the leading indicators.

It’s hard to predict today. We’ve done very well predicting it the last couple of years and we’ve come at or ahead of that. But forward-looking, it’s hard until we get a little bit more visibility where the market or uncertainty is going to land. What I’m focusing on today is making sure the new products and design is there. That’s the reason you hear me talk about the Gen 6 Wi-Fi. That is the second phase.

We see that deployment in the infrastructure, meaning the gateways and home gateways and so on starting at the end of this year, 2019. Think about 2020 and beyond is when the edge devices will start going to Wi-Fi 6. The beauty of it is we’ve already got silicon. We’ve sampled customers and will keep pushing that so when the ramp happens, we will be there already. That’s why the future is what I’m focused on as far as investments and deployment. 2019 is going to be what 2019 is with our market share and growth opportunity we already have.

Thad did mention in a year where we saw a lot of softness toward the second half of the year, that second half of the year, ex-Nintendo, our broad IoT market grew 20% from the second half of ’17 to the second half of ’18 to actually give you an indication of our position and our market share versus competitors in the broad market.

Our next question is from Rajvindra Gill with Needham & Company. Your line is open.

Just a question, Hassane, on the view of the backlog in the second half. You have a better view or the nature of it is better than what you saw in December and it’s kind of similar to what some peers are mentioning. What are the reasons for that? Why all of a sudden is the view getting a little bit better given that the macro economic environment continues to be uncertain, just trying to get a sense of what’s the basis of that comment about the backlog or the order is better in the second half?

What we saw in the September timeframe was very abrupt and the slope of it was way better right after September, although it was still negative, trending down, it was a much slower rate. When I call it now stabilizing and better visibility to the outlook, if you look at it, there’s still demand out there.

We’re not talking about a slowdown in demand. It wasn’t a one-to-one. That’s why you saw us draining inventory in the channel because customers were pulling at a faster rate than what we were putting into the channel. That’s how we chose to run the business to maintain control of weeks of inventory in the channel. We need to be in line with that in and out rate.

The second half, you can think about it as a lot of changes happen in the supply chain from our customer. Some more drastic like moving sites, moving factors. Some are draining some of the inventory that could have been on their shelves. Bottom line, inventory in our channel has been coming down and now, we’re going to start seeing a replenishment at a one-to-one rate of demand.

Demand did not stop as drastically as the backlog did. That’s the cautiousness that we have seen. Call it wait and see. It wasn’t wait and see because demand wasn’t there. It was wait and see about when to order. We see some pull-ins, some last-minute orders. We see that and we’re setting ourselves up to be able to navigate it and manage it.

On the wireless IoT side, how are you thinking about the overall IoT growth rate this year? What are the vectors of growth? How are they different this year versus last year? You’re expecting the new 802.11ax to be in smartphones by the end of 2019 and more of a 2020 story, but before that in the meantime, you’ll have business in the gateway infrastructure on the new standard?

Let me clarify my commentary — first, on the IoT, I’m not going to give an IoT specific. We’re not breaking it up that way anymore. With the uncertainty that is impacting that business with China consumer, I’m not going to give a specific guide for that. What I am talking about is my bullishness on our position in the market.

Whatever the end market does, we’re going to come out on top because of our position already in the market. So, where is the growth coming from for that 20% ex-Nintendo? It is broad. It is what we’ve been investing in to take that business broad. That business is starting to grow across its market, whether it’s industrial, consumer, and automotive.

On the 11ax specifically, to clarify, we at Cypress are not participating in the cellphone and the routers and the infrastructure. What we are participating in is the edge devices, the smartphone devices, and the gaming devices, and the automotive devices. Those will go to ax, but they will go after the infrastructure is deployed. Our partners will deploy into cellphones, set-top boxes, and home routers and the end of 2019 is when that deployment will start.

Our devices will be in the 2020 because they need to connect to an ax. Although, by the way, our 11ax product is just like our other products, backwards compatible. It does 11ax, ac, whatever letter else you want. It is all backwards compatible, but to take advantage of ax, you need the phone and/or the base station to be ax. That’s what I was referring to.

Our next question is from Blayne Curtis with Barclays. Your line is open.

Hey, guys. Thanks for taking my question. I wanted to follow-up on a prior one. Sitting here in January, have you seen your bookings rate start to recover? As you look to Q2, could you dial us in as to what you consider normal, seasonal? I think you’ve been up high-single or low-double-digits sequentially and then obviously, you have to handicap how you’re going to ship to that. Any color on there would be helpful.

The backlog, I’m going to call it stable because I can’t talk about cautiousness and be forward-looking on the backlog. I’m comfortable with how the backlog is behaving. However, I remain cautious about shipping to backlog until I see the end demand. That’s something I will reiterate. That’s how we’re managing the company — make sure we don’t overbuild inventory and put it in the channel. Number two is maintaining our op-ex within where we need it to be in order to maintain a stable and reliable operating income. Those are the things we can control. We are controlling and executing to what we can control.

What happens on the topline we will adjust up or down. One thing I will tell you is it’s not a rate of decline. It is very stable as far as the backlog. We’re getting orders. Orders are tied to design wins we have had. We’re able to correlate the credibility of the orders. We’re getting more and more comfortable with the backlog. The cautiousness I refer to is purely not shipping and having backlog in the channel over a quarter boundary. There will be some of that for the ramp we expect in Q2, but I’m not going to give a Q2 guide. That’s way too far and would not be prudent.

On the NOR business, you mentioned 15% density growth last year. I’m curious how you think about ongoing density growth in that business. You have two-thirds long-term contracts. Any kinds of thoughts of pricing this year as you have to sign up new contracts? When you look at it more, the consumer-related NOR pricing has come down. How much can you resist that trend when you’re selling to your end markets?

As far as the density, the answer is yes. We do see in forward-looking years, the average density will keep going up. Our plan and our strategy has been to focus on the high-density. Therefore, that delta between the market average density and the Cypress average density will always be a factor larger for us than for the rest of the market.

That keeps that glass ceiling from a lot of our competitors. We’ve already introduced and sampled with customers our 4x-nanometer NOR. We’re ahead on the technology side, not only on the density side. That’s part of the strategy we deployed a couple of years ago. We’re sticking with that strategy. It has paid off. It has paid off compared to our peers more than in the last two years.

As far as the pricing, we see pricing stable. The softness in NOR because of supply and demand started a couple of quarters ago and every one of these quarters we have reported up. Having the LTAs gives us that stability. You don’t hear me talk about consumer NOR anymore, which is where a lot of that pricing fluctuation happens.

Most of our revenue from NOR comes from auto, industrial, and enterprise. Those are inherent long-term pricing curves. Automotive, we give pricing two, three years out and the beauty of it when we won those designs last year and the year before, we started at a higher price than we would have otherwise.

The price trend that we are seeing is normal than any other market we have in a normal market. Call it low single-digit down, which is what we do anyways, where we get more share from a customer, negotiate new. Nothing is different, especially in the automotive market. I lose no sleep about NOR pricing or our position in NOR because we didn’t stumble on it. We drove to it.

Our next question is from Chris Rolland with Susquehanna. Your line is open.

Hey, guys. I think some good commentary you guys had on USB-C — our data points are kind of pointing to inflection in handsets this quarter as well. You guys talked about all those new design wins of products that you had quarter over quarter, which seems like extremely strong growth there. Perhaps talk about where we are in terms of the attach on handsets for USB-C and then your ASPs, how they’re trending. Are they still holding up? Are you maintaining those ASPs? Are you maintaining that share position as well? Thanks.

Sure, Chris. If we look at handset, we have one handset customer that we are a strategic supplier to that customer. So, we’re not a good reference of the attach rate in a lot of the mobile. Our exposure on mobile is very limited because of a strategic relationship. Our exposure to USB-C is in the broad market in the ecosystem — power, cable, docks, monitors, specifically automotive now. That’s why we’re doing type C. So, a lot of our design and the sockets, the number of projects in production with Cypress USB-C is really on the broad market. Attach rate on phone, I’m not a good proxy for it because we’re not exposed to that.

Now, if you look at the growth rates of the rest of the market, we’re still in the early innings. There’s still a lot of the ecosystem that has not converted and that is the opportunity for us ahead. For market share, we expect to maintain our market share. We expect to maintain the number one share in USB overall and in USB-C. We regained that number one market share in overall USB in ’18. We’ll maintain that, driven by the USB-C. That’s where we see it.

As far as ASPs, I always talk about our USB-C end goal is integration and programmability. The more integration we put, the ASPs will either apples to apples or relative, flat to the prior generation. That’s how we are able to maintain our position and maintain the gross margin trajectory that we would need as a company. We have multiple products for type C and the price ranges go from a quarter to over a dollar.

It’s hard to talk about an ASP for USB-C. The margin has been holding on, meaning we’ve been introducing new products, offsetting any pricing decline within a specific category and we are fending off any competitor that is able to come in with a non-programmable product with our proprietary technology. All of those dynamics are how we are maintaining our number one and I don’t see that changing.

Our next question is from William Stein with SunTrust. Your line is open.

Thanks for taking my questions. Can you explain a comment you made earlier about building inventory in Q1 as you consolidate manufacturing footprint? I thought you were down to one FAB. I’m a little confused by that comment.

Will, it’s Thad. As we’ve been working on our gross margins over the last several years, we’ve been looking at our manufacturing footprint inside and outside. As we go forward, we’re making additional changes to some of the partners we’re dealing with. Sometimes, you’ve got to build inventory to manage through those transitions. That’s what you’re seeing in Q1 — more of what we’ve been doing.

You talked about a 0.77 book to bill. I think Hassane, you talked about the backlog not necessarily being as predictable and customers coming in very late and some concern about whether the backlog will be delivered or if customers will end up cancelling and pushing out orders. Is it fair to say lead times are very short now, almost quoting from stock? Is that the environment we’re looking at now? Thank you.

Yeah, Will. This is Thad again. Not at all. Our lead times have been very stable for probably a year now. They’re in the ranges we want them to be in and will continue to run in that range. We see very little change to our lead times.

Our next question is from Craig Hettenbach with Morgan Stanley. Your line is open.

Thank you. Can you provide the full year 2018 connectivity growth?

No. We’re not breaking it up for the full year. I don’t have it on me. I did the second half of the year because that’s the comment I made in Q3 when I said the second half of the year would be around the 16th to 17th. So, I report it today. But we’re not breaking it up separately as a guide or as backward-looking.

Just for Q1, relative to the sequential guidance, any context by end markets? Looking at industrial, auto, consumer, and enterprise, what markets you think will be in line with the overall guides, what markets would be better or less?

If you look at the three primary markets we’re exposed to, the consumer will have the highest seasonality, but auto and industrial will be in line, lest the uncertainty that we see in the market. So, a lot of the seasonal guide for the midpoint of the first quarter is going to be primarily in the first quarter and driven in China.

Our next question is from Harlan Sur with JP Morgan. Your line is open.

Good afternoon. Thanks for letting me ask a question. Kind of a follow-up on that, Hassane — if I look at the auto business, up double-digits in Q4 and up strongly for the full year, you’ve got 90% revenue coverage. I think you have a good handle on what the auto business is going to look like. I understand your commentary about maybe seeing some slight weakness at the edges, but is this a segment that can still be growing double-digits year over year in Q1?

I don’t have the numbers specifically for automotive in Q1. You’re talking Q1 ’18 to Q1 ’19?

Yeah.

I don’t have that number. I’ll try to find it, but I don’t have it handy on me here. We usually don’t guide specifically for an auto on a forward-looking quarter.

I understand. The business has been consistently growing double-digits.

I’ve always said I look at automotive — just because the nature of the business, I look at it more on an annual basis. That’s why I always report the annual numbers at the end of the year, primarily, because a lot of it is quarters come in and quarters go. The quarter boundary, that’s not really an indication of the actual strength in the business, but I will reiterate my comment from earlier of automotive is going to grow even if the units are flat or down. That’s on a 2019 outlook. Hopefully maybe that helps.

That helps and thanks for the insights there. Let’s look longer term — you talked about your full year design win pipeline being up 24%. As we think about the team’s move to 50% gross margins once we get past this soft period, of the incremental design wins in 2018, what percentage of this mix have gross margins above 50%.

37% of the funnel, as Hassane said in his prepared remarks, are new products. So, you can think about those for sure as being above the corporate average and above the target. There are a lot of other products in that funnel that are at or above, products that have been out for a while. As we focus forward, new products coming out of R&D are at the targeted gross margin and higher. Where our emphasis is designing our products that have low gross margin and swapping them for high gross margin. You think about that funnel as being heavily focused on high gross margin products.

And we’ve maintained our new product development side, exactly what Thad mentioned two years ago. Our focus on new products, products are accretive and are at or above our model. As those start to turn from the funnel into revenue, but more importantly become a larger part of our revenue, those will start moving our margin on the trajectory toward our model.

Our next question is from Charlie Anderson with Dougherty & Company. Your line is open.

Thanks for taking my questions. The first one was on Traveo 2. I know you mentioned the big design funnel there and the higher margins. I wonder if you could remind us how large Traveo 1 is as a portion of the business or maybe just cluster — any commentary there would be helpful and then I’ve got a follow-up.

I don’t have the breakup of Traveo 1 — I don’t think we’ve ever talked about Traveo 1 specifically. We’ve always talked about automotive overall, which Traveo 1 is inclusive of that. But as far as the funnel, I would say behind Traveo and cluster, which Traveo 2 covers both the body electronics, which is a new market for us, and the cluster, a market which is an existing market, but it also expands our market in cluster because Traveo 2 adds a lot of the performance and more on the virtual clusters for us. It’s both a replacement for Traveo 1 but also an expansion of the market. So, it goes beyond.

Then for a follow-up, you guys mentioned the leverage ratio down quite a bit in the last year. Could you maybe characterize your appetite for M&A right now, maybe the strategic importance that you see of M&A going forward? Thanks so much.

Charlie, it’s Thad. As I said, we’re now at a point where we have a lot of flexibility on the balance sheet. We’ve initiated our buyback, we have the dividend. We’re starting to build cash on to the balance sheet. We think that gives us flexibility in terms of firepower for M&A. We are always active. We’re very selective and very disciplined. We continue to evaluate how we can expand our portfolio, but you’ll see us move in a very disciplined process and at discipline valuations if we were to move on something.

Great. Thanks so much.

Our next question is from Harsh Kumar with Piper Jaffray. Your line is open.

Hey, guys. Thanks for squeezing me in. Hassane, I wanted to clarify something — I thought when you mentioned enterprise business, you mentioned 5G. I’m curious what kinds of products you have there and any other color you might have around that segment.

Sure. Specifically, on the enterprise and 5G buildout and bay station, it’s our specialty NOR. The value for those bay stations or that 5G buildout in the infrastructure is very close to our strength in automotive. So, they require high density. They require high reliability, and they require longevity. Those three aspects are what make our NOR very attractive and that’s the reason we are able to grow with that deployment. That’s our focus is primarily on the storage side of it.

It’s odd. The business you got the most grief on in the second half of last year actually held up the best. I’m talking about the NOR business. What kinds of hurdles do the Taiwanese have to try to catch up to you in densities or other metrics that you guys exhibit? Then also, if you could talk about the timing of JB — that’s still on track for the June quarter, right?

Sure. We’ll be here a very long time to talk about barriers of entry, but let me try to summarize it a little bit. We have the technology barrier. We have a very good technology that is able to do high-density at a very attractive cost structure.

But even if that were not the case, for example, our Semper NOR, 45-nanometer that we just introduced has an M0 inside of it. M0 doing a lot of system level to do a reliability and system-level functionality that nobody else has today, meaning they don’t even have a micro controller under the same roof, let alone be able to do the software and all the stuff that is required. We have those, we’re very strong at them.

We combine the two. That is years ahead of where a roadmap, an organic roadmap can bring somebody else in. Those would be, I guess — and of course, it’s a strategic decision from a company that a company has to do to go after a long-term business like we have done. Two years ago, I got even more grief when we said we’re not going to run after the commodity business that was hot in the market.

We’re going to stick with long-term automotive, industrial, and enterprise and we’re going to stick with high-density when the world was on fire on low-density because of OLED and because of all that constraint. We got a lot of grief for that. We never got the credit for that decision. I always reminded everybody wait until the market turned. This is where we are today.

So, on top of all the technical and all we can do on a roadmap on everything, it still remains a corporate decision and corporate strategy to focus on the right long-term. That we have done and we’re very good at.

Thank you. This concludes the question and answer portion of today’s call. It would be my pleasure to turn the conference to Mr. Hassane El-Khoury for any closing comments.

Thank you all for joining us today. I’d like to take this opportunity to thank the Cypress team for stepping up and executing in 2018. During Q1, we will have our analyst day on March 13th at our headquarters in San Jose. We will also be at Embedded World in Nuremberg in February and we’ll be presenting at the 31st annual ROTH Conference in March. We look forward to seeing many of you on the road. Good night.

Thank you for participating on today’s Cypress Semiconductor conference call. You may go ahead and disconnect at this time.

Call participants:

Hassane El-Khoury — President and Chief Executive Officer” data-reactid=”259″ type=”text”>Hassane El-KhouryPresident and Chief Executive Officer

Vivek Arya — Bank of America Merrill Lynch — Analyst” data-reactid=”261″ type=”text”>Vivek AryaBank of America Merrill Lynch — Analyst

Suji Desilva — Roth Capital — Analyst” data-reactid=”263″ type=”text”>Suji DesilvaRoth Capital — Analyst

Rajvindra Gill — Needham & Company — Analyst” data-reactid=”265″ type=”text”>Rajvindra GillNeedham & Company — Analyst

Chris Rolland — Susquehanna — Analyst” data-reactid=”267″ type=”text”>Chris RollandSusquehanna — Analyst

Craig Hettenbach — Morgan Stanley — Analyst” data-reactid=”269″ type=”text”>Craig HettenbachMorgan Stanley — Analyst

Charles Anderson — Doughterty & Company — Analyst” data-reactid=”271″ type=”text”>Charles AndersonDoughterty & Company — Analyst

More CY analysis” data-reactid=”273″ type=”text”>More CY analysis

Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.” data-reactid=”274″ type=”text”>This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company’s SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

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  • Motley Fool Transcription has no position in any of the stocks mentioned. The Motley Fool recommends Cypress Semiconductor. The Motley Fool has a disclosure policy.” data-reactid=”283″ type=”text”>Motley Fool Transcription has no position in any of the stocks mentioned. The Motley Fool recommends Cypress Semiconductor. The Motley Fool has a disclosure policy.

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