Company:Cirrus Logic, Inc.
Event:Pacific Crest Global Leadership Technology Forum
Participant:Thurman Case- Chief Financial Officer
Date:August 13, 2013
John Vinh
Good morning, everybody. My name is John Vinh. I cover semiconductors here at Pacific Crest and we are pleased to haveThurman Case, CFO of Cirrus Logic with us. Welcome, Thurman.
Thurman Case
Thank you.
John Vinh
Maybe we can just kick off. I think customer concentration for you guys has been both kind of benefit and concern for investors. Maybe can you just update us on how you try to manage this going forward? Are you looking at diversify your reliance on kind of this one major customer or are you kind of contend with just focusing on supporting and growing with this customer?
Thurman Case
I think one of the things that we'll talk about -- I mean throughout the discussion this morning is that, for us, it's all about innovation. So if we're not seeing innovation in the marketplace then we're not somebody who can drive 30 percent margins and high volumes and things like that with a customer because our business model really is we have to invest a lot in R&D. And ahead of time, we have to really develop products either in conjunction with a customer or sometimes we're developing them ourselves and then we go out and sample these with the customers.
So I think when you talk about diversification, for us, it really depends on who's going to be involved in the next wave of innovation and product that we were going to be targeting. So can we diversify from this customer? Probably not in the short term. I mean if you look at that size, they're somewhere close to 80 percent of our revenue for us to be able to diversify in a very short period of time, short of a significant acquisition of some sort, we're not going to be able to do that.
So for us, what are the products that we're working on? We would expect that our customer could be driving some of that innovation into the markets and we'll talk, I think, probably a little more about the voice and audio, and how important that is as a market that is really emerging for us. They could be a big player. And if they are, then diversification is not going to happen if we're doing development with them and they're driving some of our revenue. If it's somebody else, then our products are certainly we're able to sell into other competitors of theirs or other filmmakers or people that maybe playing into that market then that could drive a certain amount of diversification.
But I think realistically, we stay focused on maintaining that relationship and we think it's a good one.
John Vinh
Great. This is a follow up to that new recently announced shifting into another tier-1 OEM Smartphone customer. Can you talk about the types of solutions that is in this other Smartphone? Is this a premium audio codec solution similar to your other customer or is this more of a basic catalog part that gives you kind of a building block to kind of build upon going forward?
Thurman Case
Yes. This is, although it's a proprietary part, its proprietary to our technology and we developed it. It really is an audio converter and so it's not a codec or to the level of a proprietary design or development that we've done to some of the customers. It really is a more standard or as you kind of termed "catalog part" which really means that although its proprietary technology for us, we can sell it to anybody.
Where we see this is providing us opportunity so the first step is to have that relationship with another tier-1 phone maker, although there's really right at this point in time there's obviously two major players in the phone market but this is somebody that has been in the phone market before. They're a very large company. They're a tier-1 type of company and we see this as an opportunity for us to establish an engineering relationship with this company. We might be able to look at and pursue other opportunities to expand our content.
Again, it's always dependent on whether or not any of these companies actually are able to sell the phone. I mean if you look historically for tablets and phones, there's been a lot that are introduced and designed, and some of them sell and they don't. So a lot of that will depend on how successful they are. We hope that they are and we hope that this is the start of a relationship that we can expand our content and that drive some diversification. And we could look that as a great opportunity.
John Vinh
Great. On that note, Motorola and Google have kind of released a teaser of the Moto X Smartphone and it's demoed some very extensive, advanced kind of audio capabilities. I know you haven't announced kind of who is this tier-1 customer is but are you seeing interest in demand from other Smartphone OEMs for these types of solutions? Do you think this becomes kind of a new trend within the Smartphone industry?
Thurman Case
Well, we think that the voice technology really is what is going to drive innovation. There's a lot of discussion that the phone market has matured and that you're seeing some changes in there, you're seeing a slowdown of the ability to innovate the wild factor when new phones are introduced. But we really think that voice is going to help drive more innovation in the phone. It's going to be a portable device at least from our standpoint that is going to be the centric in terms of networking your home, your car and so forth. And connecting that and activating many different devices with voice, and really running your life a little more with voice as opposed to touch or other manual processes.
So when you talk about that, we think that we're really starting that innovation and I know that voice activation has been around. We don't really do voice activation but it will be analog to digital mix signal converters that really have to handle and manage these processes.
So we don't do voice activation but we do informing technology. What that does is you may have multiple microphones in a phone and it really focuses in on that voice that needs to be heard and recognized by the device. We also do active noise cancellation which is a technology that we have introduced and we are selling products with that in it. And that really helps them eliminate noise in an environment so that whatever device that you're utilizing.
Now active noise cancellation now means if you're staying in a train station or something like that, you're able to listen on the phone and you can hear the other person better. It allows you to hear their voice better by canceling noise around you. That type of technology really is something that we think will be a very, very important in voice because, again, whatever the devices are, they have to be able to recognize your voice and they have to be able to then process it.
And again, if you have voice activation in a car or even on a phone or other things, you know that now you tend to have to repeat it. And with that technology, although it is progressing very rapidly is not great but we think that that's the area and my boss talks a lot about the Jetsons if you're older like me, you understand the Jetsons and remember the Jetsons cartoon, if not, it's Star Trek, where voice is really driving and managing your life. And we think that we're really just starting to move into that era of audio being extremely born.
And so, for us, that's what we do well. High-end audio, very, very voice clarity, all of the things that are associated with that, we think provide us a significant amount of opportunities because it's innovation that really recapitalize on with our engineering prowess and the things that we do very well.
John Vinh
So you mentioned some of these advanced audio capabilities and multiple microphones, advanced noise cancellation. Are these today mostly features that are showing up in high-end Smartphones and do you think there's an opportunity for some of this technology to proliferate to the midrange?
Thurman Case
Right. And right now, those types of technologies are centric on you being able to hear a voice on the phone or the person on the phone, on the other end being able to hear you. So right now that technology is really centers around that experience talking on a phone. We think that type f technology and innovation will expand out into being able to speak to other devices, again, manage your home, the security issues or all these other things that can surround that type of technology that we can -- it's that innovation that's going to provide much more opportunity.
And that's why when you talk about that the phone or the Smartphone market has really hit a wall in terms of innovation, we would say that there is a significant amount of innovation around voice that will continue in the runway for that in the years because it's not going to happen overnight. It's going to be very difficult and very complex.
And again, for us, if it's a part that everyone can make and it's not very difficult to do, then that's probably not where we're going to differentiate ourselves. It's in a market like this where our engineering prowess will make a difference. We can help differentiate the problem for our customers and that's the niche that really provides us opportunities to expand our business.
John Vinh
Okay, switching gears a little bit. Along those lines, there's been obviously a lot of constraints out there about the market for high-end Smartphones starting to become saturated and where the growth opportunities really lie are in the midrange, low-end where despite the gross profit and the revenue opportunity is a little bit lower, you work along those lines have kind of reset your gross margin targets on the long term to the mid-40s. As gross profits and margins compress when you moved to those midrange segments or even potentially lower, do you feel -- how do you feel about maintaining that mid-40s gross margin target for a longer term, or is there a risk that that could even turn slightly over?
Thurman Case
I think we're confident that mid-40s is a range that is sustainable for us. Again, what we reset when we came out to probably around three or four months when we talked about we were resetting our gross margin model, I think it's a matter of the market change very rapidly and it was a significant change. And we really -- you can ask yourself whether or not you want to be part of the solution or part of the problem, and I think that we recognize where the market was now was driving some of our pricing a little lower and that lower pricing and that pricing pressure was going to result in lower margins.
We still feel very strong that there are different things that we can do to help maintain margins and continue to bolster those margins but we think for investors and for communicating to investors that the best place for us to be was to go out and communicate that the mid-40s is a range that we expected. We will be and we can maintain it at that level. If you really look at margins in our peer group and so forth, even in the mid-40s, that puts us in at least the upper 50 percent of where our bonds are driven.
And again, innovation and very proprietary or joint development and the things that we do very, very well can help drive mortgage better in the future but we can't guarantee that the margin profile would be any better over a longer-term period. If we see that improving, we'll talk about it then. We really focus, as a company, on our operating profits and we believe that a 20 percent operating profit is somewhere that we really need to maintain as I noted earlier. It's because if you really have to invest in R&D heavily in order to develop the innovative products and to be able to go out and sample these products with the various OEMs out there that you would expect to engage within, that type of business model is a little different from bigger companies who may say, "We're not out on the cutting edge of innovation but then we'll come in with 10 or 11 products. We'll go and be able to sell those and be able to generate a large amount of those. It's the catalog part."
Customers can pick a part, put it on their board and design around that and it's not really what we do well. And so that helps us maintain the margins and that 20 percent operating profit is an area that we have to live in that zone for us to be successful and for us to be able to drive earnings.
John Vinh
Great.
Questioner
I got a question from ______[0:15:00]. What's your content?
Thurman Case
It's different for every OEM and we don't ever specifically talk about our content. I mean if you looked at, we pretty much allow those who do the teardowns and look at that to make those to go ahead and talk about what they think our content is. But generally, we don't go into that. Content can be different. I mean you can have multiple products. We have amplifiers that we can sell in as well as our codecs and I can drive the content in any particular end product.
So that really depends and definitely content increases when you're doing proprietary work or you're doing joint development with a particular customer then that helps drive your content. We've been able to maintain that with our largest customer over a long period of time simple because we've been able to solve problems and increase that but there's a fine edge between what the innovation is and how we'll be able to drive that in the future.
John Vinh
Along those lines, in the past, you've done a great job of kind of integrating additional content and increasing your average content going forward. We think about it more broadly speaking, given the gross margin reset. Going forward, is that out of a trend that we can think about going forward that you still have opportunities to increase content or should we think about your content more broadly speaking being stable?
Thurman Case
Well, I mean I think content -- being able to increase content really is associated with innovation. If there's innovation, we're not doing anything different then that lowers the opportunity for increased content because you're not differentiating the product. I think, again, as we talk about markets that we're going after where we think innovation is key and provides opportunity for us to solve problems for the end customer then you have that opportunity to maintain or grow content, depending on what that particular customer's vision is for the product. Again, that's our niche so we would expect that. Again, we don't talk about we can always grow content, although every iteration of the product line that we certainly drive to that and we think that if we're differentiating the product then that puts us in the position to be able to do that.
John Vinh
Any other questions?
Questioner
Does the content increase even if a customer or whatever goes down to lower a function?
Thurman Case
That would be unlikely that you would have an increased content at ASP. I'm really asking about ASPs and, again, that's associated with the particular product that they're utilizing and whether or not they're focusing on high-end audio and those things that we really differentiate on. But when you go to a lower-priced product in the end, it really is associated with what features that that particular product may have.
And if they have high-end features then the conflict can be more stable, if not, then it can be differentiated and be a little bit lower. But I think just naturally as you move to lower-priced models, which we've done over time. I mean if you see what our products have been in, the models that are originally, they were moved to lower cost models over time and our ASPs usually go drop a little bit associated with that type of transition.
John Vinh
Any other questions? Okay. And I want talk about your initiatives to move to 55-nanometers. Can you remind me what prices now you're transitioning from? And can you talk about what the drivers are behind that transition is? Obviously, your chips have quite a bit of analog content and typically it don't shrink as well so I'm wondering if it's really cost driven or there's some other reasons that are driving that move to 55?
Thurman Case
Well, I mean the technology that's allowed us to do that I mean really operated on 0.18 geometry for very, very long periods of time. The move to 55-nanometer could have happened much sooner but we just didn't have the technology to do it. It's very difficult. We are now moving into a period where we can move to 55-nanometer. What that does is lower our cost and it lowers the cost for our customers.
And so it doesn't necessarily. I mean one of the questions I get asked a lot is while moving to 55-nanometers going to increase your margin or is that going to decrease your margins? We believe that moving to a new geometry doesn't necessarily change your margin profile but what it does do is allow us to pass on those cost savings into our customers.