RF Micro Devices (UNKNOWN:RFMD.DL) has now reported two very profitable quarters in a row, with revenue, gross margin, and operating margin all surging, handily beating prior guidance. The manufacturer of radio-frequency systems is riding a wave of increasing demand for mobile data, and the merger with TriQuint Semiconductor (UNKNOWN:TQNT.DL), set to close later this year, will give the combined company a better ability to take advantage of this demand.
Beyond the numbers reported in RF Micro's earnings release, management's comments during the company's conference call provided some valuable information for investors. Here are five statements investors should consider.
2G is still king, and that's an opportunity
Nearly half of the world's handsets today are still 2G and contain less than $1 of RF content. That's increasing to several dollars over a multiyear period as handsets move from 2G to 3G and from 3G to 4G.
-- CEO Robert Bruggeworth.
While mobile devices with 4G connectivity have largely become the standard in the United States, allowing for speeds rivaling broadband, 2G is still used by an enormous number of people around the world. The first 2G wireless network was launched more than 20 years ago, and transfer speeds are anemic in comparison to modern wireless networks.
As these 2G mobile users transition to either 3G or 4G devices, the cost of the radio-frequency components required will rise, and that's good news for RF Micro. Even without significant growth in the total number of mobile devices, RF Micro can substantially grow revenue thanks to the move to faster and more expensive wireless technology.
The Internet of Things is in the early innings
Wi-Fi continues its healthy expansion in devices and equipment, and we are still very early in the adoption of 802.11ac. We are capturing incremental growth in automotive, home automation and other broadband connectivity applications comprising the Internet of Things.
Beyond mobile devices, a big opportunity for RF Micro is the inclusion of Internet connectivity in all manner of products, from automobiles to home appliances. Cisco predicts that, by 2020, 50 billion objects will be connected to the Internet, and most of these won't be PCs, tablets, or smartphones.
The market for Wi-Fi solutions will likely grow enormously if this prediction proves even close to correct, and that could be a boon for companies such as RF Micro. This also allows RF MIcro to diversify away from a heavy reliance on smartphones, making winning designs for high-profile phones less important to the company's top and bottom lines. One of the biggest risks facing RF Micro is losing smartphone business from Apple and Samsung, its two largest customers, so investors should welcome any diversification.
Cost-cutting is the biggest driver of profitability
So I'd say, we're just simply using best practices to bring the best products and technologies to the market with a relentless focus on achieving the lowest possible cost structure and -- we took out $150 million of cost over the past 18 months. So that's not coming back. And so that's going to be sustainable margin performance going forward.
-- CFO William Priddy
Over the past decade, RF Micro's gross margin has fluctuated roughly between 25% and 35%. This has changed in the past few quarters, however, with the most recently reported quarter showing a gross margin in excess of 46%. The shift to 4G is a factor, but previous shifts, to 3G for example, did not deliver sustainable gross margins anywhere near this level.
The biggest driver behind this gross margin increase seems to be cost-cutting. RF Micro has gotten its cost structure under control, especially in the past 18 months, eliminating $150 million in expenditures during that time, a significant number relative to the roughly $1.2 billion in annual revenue. While revenue rose nearly 17% year over year in the most recent quarter, cost of goods sold declined by 5% and total operating expenses fell by 3%.
More cost savings are ahead
We have not realized any synergies yet between the TriQuint and RFMD merger. But we're very, very comfortable with the $150 million number and specifically identified all those synergies. So I would continue to put a very strong checkmark in that box.
One benefit of the upcoming merger with TriQuint will be the potential synergies that will allow the combined company to lower its cost structure even further. RF Micro had pointed to $150 million in savings that could be realized, and management reiterated that number during the conference call.
Most of the cost savings will come from bringing in-house operations that one of the companies currently outsources. For example, TriQuint outsources most of its assembly work, while RF Micro does it internally. RF Micro expects the full $150 million in savings to be realized within two years of the merger, and investors should keep an eye on the progress being made going forward.
The path to 50% gross margin
... RFMD has very clear line of sight to 50% gross margin. And it's not beyond the less than 1-year planning horizon.
RF Micro's management expects to be able to achieve a sustainable 50% gross margin very soon, which is only a few percentage points above the gross margin from the most recent quarter. This would be quite a shift from how the company performed during the preceding decade, with erratic profitability and gross margins never exceeding 37%.
It's management's job to be optimistic, and while cost reductions and the cost savings from the merger with TriQuint will certainly help the cause, keeping gross margin above 50% will be difficult. Competitor Skyworks Solutions, which has roughly the same amount of annual revenue as the combined company will have once the merger is complete, only manages a gross margin of roughly 42%, and that company has been far more consistent over the years than either RF Micro or TriQuint.
While RF Micro has clearly made progress in increasing margins over the past few quarters, investors should take management's optimism with a grain of salt.
Timothy Green owns shares of Cisco Systems. The Motley Fool recommends Apple and Cisco Systems. The Motley Fool owns shares of Apple, Skyworks Solutions, and TriQuint Semiconductor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.