InvenSense (NYSE:INVN) on Jan. 29 announced quarterly earnings results of $0.21 in earnings per share and $115.86 million in revenue, beating analyst consensus by $0.01 and $3.8 million, respectively. The company also issued revenue guidance for the current quarter of between $95 million and $98 million and EPS guidance of between $0.11 and $0.13 -- the former ahead of a $92.2 million consensus and the latter in line with a $0.12 consensus.
In the trading session following the earnings report and call, InvenSense shares dropped by 6.58%. While it is well reported that investors are worried about InvenSense's continued sub-50% gross profit margin profile (thanks to high revenue concentration at Apple (NASDAQ:AAPL) and Samsung (NASDAQOTH:SSNLF)), should long-term investors panic?
So, about customer concentration...
InvenSense management indicated on the call that during the most recent quarter, the company collected 45% of its revenue from Apple and 24% from Samsung. Given that 81 % of the company's revenue base comes from mobile devices, Apple and Samsung make up over 85% of InvenSense's mobile device-related sales.
This kind of high customer concentration is known to put customers in a position of power over the supplier. After all, if the supplier doesn't want to cut prices at the expense of its own margins, it risks seeing a substantial portion of its revenue and profit base wiped out. It's not uncommon, then, to see suppliers take the margin hit in order to keep the relatively large revenue from its top customers.
Let's talk margins
For the quarter, InvenSense reported non-generally accepted accounting principles gross profit margin of 45.71%, which was a smidge below the low end of the company's prior guidance of 46%-47%. Management said the company's revenue "overperformance" was due to strong sales of products to Samsung and Apple at lower gross profit margins.
The company is also calling for another quarter of between 46% and 47% in non-GAAP gross profit margin, and CFO Mark Dentinger noted the following with respect to gross profit margin over the next several quarters:
We may get a little bit of improvement but it's going to be hard to make a big moves toward our long-term corporate objective of low to mid-50s. So I think with the current profile of products and the customer mix it's realistic to think that we're probably in a flat to maybe slightly improving gross margin environment at least for the next 2 to 3 quarters.
Put bluntly, gross profit margin is expected to remain low for quite some time, which might be why some investors are growing frustrated.
Operating margins and InvenSense
At the end of the day, I believe that what matters most to investors is operating margin. That is, for every dollar of revenue that InvenSense generates, how much of it -- after raw product costs, paying employees, and so on -- does the company keep?
In its most recent quarter, InvenSense generated $10.45 million in income from operations. This was a substantial improvement from the operating loss of $4.84 million in the previous quarter and a $13.1 million loss in the year-ago quarter, but it still translates into just a 9% operating margin.
The reason for this relatively low margin, even with revenue booming, is that InvenSense continues to invest heavily in research and development. To put this in perspective, in the year-ago quarter, InvenSense spent $14.52 million on R&D, but it spent $24.39 million in in the just-reported quarter.
As long as the growth keeps up, this is the right move
InvenSense is competing for relatively large and high-growth opportunities; to serve opportunities that pop up tomorrow, it needs to invest today. I believe that as long as InvenSense is growing its top line at high year-over-year rates, it makes sense to invest aggressively in future products.
That said, at some point, InvenSense must start delivering expanded operating margin to its investors. When a market is "red hot" and growing at high double-digit rates, sacrificing short-term margin for long-term footprint is the right thing to do. However, when the end markets cool down, the company better find a way to boost revenue and gross profit faster than operating expenses increase.
Long-term thesis still looks good, but the short term looks frustrating
In the near term, I don't see much in the way of catalysts to increase the share price meaningfully, but I still like the long-term story's possibilities. If InvenSense can capture more smartphone share outside of Apple and Samsung, defend its position within Apple and Samsung, and increase its software and chip content broadly across its customer base, then the stock could trade significantly higher than current levels over the next few years.
However, this execution is by no means guaranteed, which is why I plan to keep a close watch on the company's developments over the next several quarters.
Ashraf Eassa owns shares of InvenSense. The Motley Fool recommends Apple and InvenSense. The Motley Fool owns shares of Apple and InvenSense. 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.