Microsemi's EPS Lags, Outlook Weak

Microsemi Corporation’s ( MSCC - Analyst Report ) adjusted earnings per share (EPS) for the first quarter of fiscal 2013 came in at 41 cents, missing the Zacks Consensus Estimate by 2 cents.

Revenues

Microsemi reported revenues of $247.6 million, down 5.9% sequentially but up 2.8% year over year.

Revenues by End Market

Microsemi generates revenues from the Defense, Aerospace, Enterprise & Commercial, and Industrial markets.

Around 31% of Microsemi’s quarterly revenues came from the Communications market. Management attributed the 5.9% sequential decline to broad-based weakness in the market rather than any weakness at Microsemi’s own projects or customers. In fact, management tone was positive about increasing design wins for its timing and synchronization products. There are also signs of improving demand across other product lines and management believes that key customers, such as A&T ( T - Analyst Report ) will generate steady demand.

The Defense & security market generated 31.0% of sales as revenue increased 4.1% sequentially to $76.8 million. While budget cuts and increasing focus on electronic content have taken a toll on many companies serving the federal defense segment, Microsemi is gaining from this trend. This is because in addition to its traditional products, the company has increased focus on cyber security. The company is developing system on chip (SoC) solutions that have the potential to generate market share gains according to management.

The Aerospace segment declined 10.0% sequentially to 19% of revenue, which management attributed to the lumpy nature of the market. Microsemi continued to benefit from the two major satellite programs that took off over the past year. Management is also upbeat about bookings growth in the space segment.

The Industrial market generated 19.0% of sales, representing a 10.6% sequential decline to $47.0 million. Management attributed the broad-based weakness to increased caution at customers, reflecting the trends we have seen at other companies serving the market. However, Microsemi’s ultra low power radio ramp is expected to drive revenues from Medtronic ( MDT - Analyst Report ) over the longer term. Design win activity for its SmartFusion product line (for industrial automation applications) also continued in the last quarter.

Margins

The reported gross margin was 57.6%, up 43 basis points (bps) from the previous quarter’s 57.2% and 541 bps from the year-ago quarter. The gross margin expansion was due to a growing percentage of new high-margin products in the mix, as well as operational cost reduction.

The operating expenses of $117.1 million were lower than the previous quarter’s $123.8 million. The operating margin expanded 19 bps sequentially and 1059 bps year over year, touching 10.3%. Both R&D and SG&A expenses increased sequentially as a percentage of sales, which partially offset the higher gross margin.

Net Income

The total net income for the first quarter of 2013 was $14.2 million or 16 cents per share compared with $11.6 million or 13 cents a share in the previous quarter and ($44.6) million, or (52) cents a share in the year-ago quarter.

Excluding these special items, the pro forma net income was $37.0 million (14.9% of sales) compared with $26.7 million (11.1%) in the year-ago quarter and $41.5 million (15.8%) in the previous quarter.

Balance Sheet

The cash and cash equivalent balance at quarter-end was $203.3 million, down $1.0 million during the first quarter. Cash generated from operations was $28.1 million and capex was $8.5 million, netting a free cash flow of $19.6 million.

Inventories decreased 0.1% to $158.9 million from $159.1 million in the previous quarter. Days sales outstanding (DSOs) increased to 58 days from 53 days in the last quarter.

Guidance

Microsemi provided guidance for the second quarter of fiscal 2013. Revenue is expected to decline 4–8% and non-GAAP earnings per share are expected to be around 37–43 cents. The Zacks Consensus Estimate for the next quarter is 43 cents, at the high end of the guided range. Non-GAAP gross margins are expected to be within 55.5–56.5%. The tax rate is expected to be 7.0%.

Our Take

Microsemi reported a disappointing first quarter and the guidance also fell short of expectations.

The company is seeing weakness across most major served markets, although its R&D program remains on track. Management is focusing on security and increasing the electronic content per device and customer, which will eventually boost its market share.

However, uncertainty in short-term defense programs owing to apprehensions over the ‘fiscal cliff’ could temper the effects of increasing electronic content in defense applications.

Microsemi has a Zacks Rank #4 (Sell)

Investors should look out for some other technology stocks that are slated to report this earnings season with positive Zacks Rank and Expected Surprise Prediction or ESP (Read: Zacks Earnings ESP: A Better Method).

Yahoo Inc. ( YHOO - Analyst Report ) has a Zacks Rank #1 (Strong Buy) with an ESP of 14.8% and ON Semiconductor Corp ( ONNN - Analyst Report ) has a Zacks Rank #2 (Buy) with an ESP of +14.3%.