Microsemi Corporation’s (MSCC) third quarter earnings for fiscal 2011 beat the Zacks Consensus Estimate by a penny.
Revenue
Microsemi reported revenue of $216.7 million, up 4.4% sequentially, 59.3% year over year and within management’s expectations of a 3-5% sequential increase.
Revenue by End Market
Following the announcement of the Actel acquisition, end markets generating Microsemi’s revenue have now been classified as Defense & Security, Aerospace, Enterprise & Commercial (formerly mobile/connectivity and notebooks/LCD TVs/display segments) and Industrial & Alternative Energy (formerly Industrial/Semicap and Medical segments).
The largest chunk (35%) of Microsemi’s quarterly revenue came from the Defense & Security market. Microsemi gained from the growing electronic content in military applications and increasing its dollar content over time, which helped drive sequential and year-over-year increases of 3.9% and 39.4%, respectively, in the last quarter. Management also stated that the company had several years of backlog in foreign military sales.
Aerospace was the second largest contributor, with a 26% revenue share and sequential and year-over-year growth rates of 5.3% and 107.1%, respectively. Microsemi’s strength in this market is a big positive, since the commercial air market (including both new and reconditioned aircraft) continues to pick up post recession, with revenues continuing to benefit from increasing passenger and cargo traffic, as well as increasing electronic content within aircraft.
Defense was steady in the last quarter. Satellite billings and bookings were both strong. This is one of the most recession-proof markets with the highest barriers to entry.
The Industrial & Alternative Energy market saw its second straight quarter of very strong growth. Revenues from the end market generated 23% of total revenue, up 12.3% sequentially and 115.6% from last year. Microsemi saw broad-based strength across several categories, although welding, plasma-cutting and medical power products were particularly strong. Solar remained a soft spot and is likely to remain so in the near term, given the ongoing inventory adjustment in that market.
Enterprise & Commercial accounted for the remaining 16% of revenue. Volatility in commercial markets, weaker consumer appetite for spending and management’s decision to leave some lower-margin revenue on the table resulted in the 5.0% sequential decline in revenue. However, revenue continued to grow from the year-ago quarter (up 10.8%).
Management remains optimistic about the second half of the year and 2012, when Microsemi’s RF power amplifiers and POE products are expected to gain momentum. TV backlighting and solid-state lighting solutions are also expected to strengthen.
Microsemi’s book-to-bill ratio again exceeded unity. The bulk of Microsemi’s business is high-lead time. The defense/aerospace business usually has lead times in the 15-26 week range, with satellite even longer (in the 36-week range). The rest of the business is usually shorter lead time (around 10-12 weeks), with some variations depending on specific product lines.
Margins
The pro forma gross margin was 57.1%, up 52 basis points (bp) from the previous quarter’s 56.5%. The gross margin was up 865 bps from the year-ago quarter. Management attributed the improvement to strong revenue and operating efficiencies.
The operating expenses of $77.7 million were higher than the previous quarter’s $71.4 million. The operating margin dropped 89 bps sequentially, while increasing 403 bps year over year to 21.2%. The sequential decline was entirely on account of higher SG&A expenses (as a percentage of sales), although R&D also increased slightly and cost of sales came in flat.
However, R&D was up significantly from last year, as was SG&A, although they were offset by significantly lower cost of sales. Opex has been increasing over the last few quarters, as the addition of White Electronics increased the opex base for Microsemi.
Net Income
The pro forma net income for the fourth quarter of 2010 was $36.7 million or 16.9% of sales, compared to $30.8 million, or 14.8% of sales in the previous quarter and $27.9 million, or 20.5% of sales in the year-ago quarter. Including inventory adjustments, restructuring charges, acquisition-related charges, amortization of intangibles and other items that were excluded from the pro forma calculation, the GAAP net income was $30.6 million ($0.35 per share) compared to a loss of $16.9 million ($0.20 per share) in the March 2011 quarter and a profit of $33.0 million ($0.40 per share) in the June quarter of 2010.
Balance Sheet
Microsemi has a strong, debt-free balance sheet. Inventories increased 3.7% in the last quarter, with inventory turns flat at around 2.6X. The inventory increase was related to raw materials and the impact of recent acquisitions. DSOs went down from 43 to around 41. DSOs have shown great improvement over the past 4-6 quarters, indicating much-improved collection patterns.
The cash and investments balance at quarter-end was $246.2 million, up $28.9 million during the quarter. Cash generated from operations was $59.3 million and capex was $7.2 million, netting a free cash flow of $59.3 million. Microsemi also spent $5.6 million on acquisitions in the last quarter.
Guidance
Microsemi provided guidance for the fourth quarter of fiscal 2011. Accordingly, revenue is expected to grow 3-5% sequentially, both R&D and SG&A expenses to go up $2-2.5 million and non-GAAP earnings per share to come in at around $0.47-$0.49.
Management also maintained the long-term operating margin target at 30% and stated that the non GAAP tax rate would trend down to 18% over the next few quarters.
Recommendation
Microsemi had another good quarter, delivering consistent results in the face of continued market uncertainties. We think this has been possible because of the company’s end-market focus, which includes areas like defense, aerospace and industrial, which typically make for greater stability. Additionally, the business is highly non-cyclical and even seasonal variations are muted.
Microsemi is also insulated from the concerns related to the computing/consumer segment, since it has limited exposure in these areas.
The company has shown relative stability in margins and cash flow remains attractive. Strategic acquisitions have also helped to expand the portfolio and generate incremental growth.
However, the stock is a good defensive play and we don’t really see material upside in the next few months. We therefore have a long term Neutral rating on Microsemi. Our short-term view is also Hold, as indicated by the Zacks Rank of #3. Peers Monolithic Power (MPWR), Maxim Integrated Products (MXIM) are also ranked #3 at peresent.
