This isn't an earnings season for crushing expectations. Almost every major tech company has stepped up to the plate and whiffed: Intel, IBM, Microsoft, even Apple (NASDAQ:AAPL) slid the day after earnings.
Take this trend to the next level, and you see even weaker conditions in the semiconductor space. The Semiconductor Industry Association (SIA) just released industry data showing chips sales were still off 1.8% in September compared to the same month last year. Industry giant Texas Instruments (NASDAQ:TXN) reported guidance for the fourth quarter that at its midpoint saw sales almost 10% below analyst expectations.
Against this backdrop, you'd have to figure a company not only forecasting monster sales growth next quarter, but easily topping analyst estimates would see huge gains the next day. Yet, chip maker Cirrus Logic (NASDAQ:CRUS) delivered delivered just that yesterday, and its shares fell as much as 16% this morning!
Let's take a look at what's going on.
Big results, big worries
For the just-finished quarter, Cirrus Logic reported sales of $193.7 million, above the top end of its guidance, while adjusted earnings went from $0.22 per share last quarter to $0.79 in the current quarter. Looking ahead to next quarter, things get even better, with sales projected between $270 million and $300 million. That's a big jump, and it easily surpassed analyst expectations of $238 million.
Cirrus has expanded its relationship inside Apple products with teardowns confirming it's moved beyond an audio CODEC in the iPhone 5 to also include an audio amp and signal processor. That means while other Apple suppliers are riding the wave of record iPhone 5 sales, Cirrus gets the afterburners of increased content in the phone. Not only that, it benefits from being across Apple's entire product line.
So, what's the bad news holding shares down? The problem appears to be margins. Every quarter, Cirrus publishes a shareholder letter on its investor relation site, and inside that letter, CEO Jason Rhode noted gross margins will move off their historical norm in the mid 50s down into "the low 50 percent range for the foreseeable future."
The trend can be illustrated by this accompanying chart from the shareholder letter. Note that past margins in the low 50% range came from an inventory writedown.
This shift in margins clearly struck a nerve on Wall Street as the subsequent conference call featured a deluge of questions focusing in on the company's reduced margin forecast.
The concern is understandable. Cirrus Logic collected a stunning 79% of its revenue from Apple last quarter. With that kind of concentration, companies face two major threats. First, losing the customer. Cirrus has done well in that respect by not only keeping Apple, but expanding its relationship and getting more design wins in Apple products.
The second threat is that Apple could use its dominant position over Cirrus Logic to squeeze margins. Last quarter, Apple witnessed its own disappointment on margins as it ramped iPhone 5 production. The logical thought would be, if Apple's having to target lower margin opportunities like the iPad mini, and iPhone margins are declining, could it put the squeeze on suppliers to relieve margin pressures?
That's a realistic concern. However, a shift of a few percentage points in margins when vastly expanding the company's presence in the iPhone shouldn't come as a huge surprise. More the the point, I'll take a huge jump in iPhone business and an expanded presence inside the phone for the sake of a few percentage points of margin erosion.
The long-term concern would be that margins will continue declining, but Cirrus generally stresses conservatism in its guidance, highlighting their inability to forecast market trends. My post-earnings feel is that the company will be able to stay in their post-earnings margin range, and investors bailing out in the mid-$30s today will regret that decision six months form now.
Cirrus is a volatile and risky stock, but nothing revealed yesterday screams at me to cash in and head for the hills. In fact, with the recent drop, I might just do the opposite and pick up some more shares.