Microsemi Corporation’s (MSCC) third quarter earnings for fiscal 2010 exceeded the Zacks Consensus Estimate by 11 cents.
Revenue
The company reported total revenue of $136 million, up 15.1% sequentially and 27.1% year over year and much better than management’s expectations of a sequential increase in the range of 3% to 5%.
Revenue by Product Line and End Market
Microsemi’s Analog/Mixed Signal products cater to three end markets—mobile/connectivity, notebooks/LCD TVs/display and industrial/semicap.
The mobile/connectivity business (16% of revenue in the last quarter) grew 14.6% sequentially and 126.0% from the year-ago quarter. The business continues to be driven by the WLAN and POE product lines. Management believes that the rapid adoption of POE technology is expanding Microsemi’s share in this market. POE enabled port penetration will come close to 20% of the total switching port market in 2010. Management noted the market is moving beyond early adopters and into a period of high growth, adding that increased standardization of the technology, coupled with share gains, will continue to drive strength.
Notebooks/LCD TVs/displays generated 7% of the total revenue, representing a sequential increase of 6.8% and a year-over-year increase of 78.0%. Segment performance was driven by the TV business, which increased 11% sequentially. This was offset to a great extent by ongoing softness in the notebook market. Management expects the TV business to remain a driver for the rest of the year and record wins at tier one players, such as Samsung, Sony Corp (SNE) and Sharp, as well as tier two OEMs and ODMs. Although 2010 results will most likely be driven by lower-end products, Microsemi is already in the process of sampling higher-end products, which should contribute to revenues in 2011.
The industrial/semicap market continued its turnaround, increasing 46.1% sequentially and 133.0% year over year. The segment generated 11% of third quarter revenues. Particularly, the company’s traditional semiconductor capital equipment products witnessed increased demand, –which was complemented by mix improvements and a growing customer base. As part of the continuously unfolding growth opportunities in emerging energy technology markets (solar, wind and battery), the last quarter saw Microsemi shipping intelligent metering solutions into a smart grid project. Going forward in 2010, this market should be one of the strongest for Microsemi.
The High Reliability product line also caters to three end markets—defense, commercial air/space and medical.
The defense segment generated 40% of second quarter revenues, up 23.2% sequentially and 27.1% year over year. The sequential increase was largely driven by the first quarter of contribution from White Electronic Designs Corporation, in which Microsemi has acquired a majority share. The general strength in the business was attributable to an increased demand for all products and particularly, production ramp of the SecureWave RF subsystems. The long-term driver for the segment remains the increased electronic content in defense equipment, necessary for tracking and safety operations.
The commercial air/space markets generated 20% of revenues, up 6.5% sequentially and 1.7% year over year, as rising fuel costs combined with increasing air traffic pushed demand for more fuel efficient aircraft. Demand was fairly broad-based, across Asian, Middle-eastern and North American carriers. The strength at Boeing is currently being driven by the light jet segment. Microsemi has been seeing fairly strong order growth over the last couple of quarters, which is now converting to revenues. Order momentum continued in the last quarter, according to management, so the strength in the business should continue. The satellite business is also robust, with increased spending on both defense and commercial satellites, which is expected to create opportunities for the company to boost its dollar content.
The medical segment (6% of revenues) had a considerably bad quarter, declining 21.3% sequentially and 49.2% from the year-ago quarter. Microsemi remains dependent on a handful of large ICD customers. Consequently, the negative mix of sales at these customers seriously impacted results in the last quarter. There was however some progress at developing the MRI customer base. Management stated that the new products targeted at this market resulted in a few customer wins in the last quarter. Of course, the continued recovery in the medical equipment market remains a positive, since this is one of the few areas within medical that was negatively impacted by the recession. Increased spending on MRI equipment is an indication of credit availability and the improved financial health of customers, since MRI equipment is a capital expenditure for them.
Orders
Management did not provide any specific information regarding orders, backlog or lead times, although they did mention that bookings continue to grow and backlog remains healthy. The book-to-bill ratio again exceeded unity.
The bulk of Microsemi’s business is high-lead time. Normal lead times for the analog/mixed signal business are around 10-12 weeks, with some variations depending on specific product lines. The high-reliability business usually has lead times of around 20-30 weeks, with the satellite business at around 36 weeks. Since this recession has been different from previous ones, the company actually saw customer lead times shrinking over the last few quarters, as channel partners struggled to meet demand.
Margins
The pro forma gross margin was 48.4%, up 104 basis points (bp) from the previous quarter’s 47.4%. The gross margin was up 608 bps from the year-ago quarter. Around half of the improvement was related to higher volumes and an improving mix, management attributed 50 bps of the sequential improvement to continued efficiencies at Scottsdale. Management currently expects to shut down Scottsdale by February 2011 and expects cost savings from the transition to continue over the next few quarters.
The operating expenses of $42.4 million were higher than the previous quarter’s $36.4 million. The operating margin increased 66 bps sequentially and 746 bps year over year. Despite the higher volumes, management continued to invest in new products, which along with additional R&D expenses from the White acquisition, increased quarterly R&D expenses (as a percentage of sales) both sequentially and year over year. However, offsetting these increases were continued reductions in COGS and SG&A (as a percentage of sales).
Pro forma net income for the third quarter of 2010 was $27.9 million or 20.5% of sales, compared with $16.5 million, or 14.0% of sales in the previous quarter and $9.3 million, or 8.7% of sales in the year-ago quarter. Including inventory adjustments, restructuring charges, acquisition-related costs and amortization of intangibles that were excluded from the pro forma calculation, GAAP net income was $33.0 million (40 cents per share) compared with $12.2 million (15 cents per share) in the March 2010 quarter and $7.8 million (10 cents per share) in the June quarter of 2009.
Balance Sheet
Microsemi has a strong, debt-free balance sheet. Inventories increased 20.5%, as management built up stock to service the much higher level of demand. As a result, inventory turns dropped off slightly from 2.5X to 2.4X. DSOs went down from 54 to around 50. DSOs have shown great improvement over the past year or so, indicating much-improved collections.
The cash and investments balance at quarter-end was $188.2 million, down $104.3 million during the quarter. Cash generated from operations was $36.4 million and capex was $3 million, netting a free cash flow of $33.4 million.
Guidance
Management reiterated their guidance for the fiscal fourth quarter. Accordingly, revenue is expected to grow 7% to 9% and non-GAAP earnings per share are expected to come in at around 33 cents to 35 cents.
Agreement with Cisco Systems Inc. (CSCO)
During the quarter, Microsemi entered into an important IP patent transfer and licensing agreement with Cisco with respect to its POE patents. Microsemi remains focused on the POE opportunity. Management is optimistic that the agreement with Cisco could help the company expand into new areas, such as network cameras, access control devices, laptop computers, PDAs, fire sensors, alarms, audio and video remote monitoring systems and residential gateways.
We reiterate our Neutral rating on Microsemi shares.
Read the full analyst report on "MSCC"
Read the full analyst report on "CSCO"
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