Is a Low-Cost iPhone Behind This Company’s Decline?

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It was the briefest of commentaries from CEO Jason Rhode that I’ve witnessed in my time covering Cirrus Logic (NASDAQ: CRUS). I had doubts that the company was losing its wheels, and its recently released first-quarter report didn’t do anything to clear my suspicion that something is terribly wrong at Cirrus.

Primarily known as an Apple (NASDAQ: AAPL) supplier, from whom it had derived 85% of revenue in the fourth quarter last fiscal, Cirrus is probably feeling the ill-effects of depending on just one major source of revenue. When Apple was doing well, so was Cirrus and vice versa. But now, it looks like the house is not in order.

After Apple posted decent results in its fiscal third-quarter, one could have expected Cirrus to follow suit the next day when it was supposed to report earnings. But, Cirrus’ earnings report was enough to doom the stock as it crashed 14% after releasing results. Surprisingly, the company couldn’t even meet the already low revenue expectations.

Nail in the coffin

Although revenue grew an impressive 57% from the year-ago period to $155.1 million, it was woefully short of the $160.4 million consensus estimate and below the mid-point of the company’s own guidance range. However, the company did deliver a terrific bottom-line performance, earning $0.56 per share while analysts had expected $0.49 a share. But then, this didn’t matter much as Cirrus’ earnings are expected to go downhill from here.

The guidance, again, was well-below what analysts were looking for. Cirrus sounded out that it expects $170 million-$190 million in revenue in the ongoing quarter, behind the $190 million estimate at the mid-point. Also, the company is looking at depressed gross margins going forward, beginning with the current quarter where gross margin is expected to crash to a range of 46%-48% from 51% in the last quarter.

A value trap

So, with this guidance, Cirrus’ days of rapid growth have now officially come to an end. If Cirrus manages to achieve its revenue guidance next time, it would be well below the revenue of $194 million that it had earned in last year’s second quarter. Hence, if you thought that it would be a good time to pick up shares of the company trading at just 9 times earnings, then you would be falling into a value trap.

It looks like Cirrus is losing its Apple-earned money. Earlier, management used to single out the amount of revenue that it used to generate from its largest customer, but such a statistic didn’t come out this time. Instead, the company talked more about its other initiatives and also stressed diversification.

There were signs of desperation on the conference call, as well. Cirrus is looking to “identify future product opportunities” and is “selling products into several additional mobile phone manufacturers” according to management. It is also focusing on its LED business, which generates around 20% of overall revenue and fell in the previous quarter from prior-year levels. Cirrus management focused on diversification of its revenue streams on the call, but isn’t it a bit too late in doing so?

What Apple giveth, Apple taketh away

The unexpected decimation of Cirrus’ business would lead one to believe that it is probably losing hold of its Apple account. After all, Apple’s previous quarter was better than expected and, ideally, Cirrus shouldn’t have disappointed either given the close relationship between both companies. However, Apple’s lower average selling price of $581 last quarter for the iPhone, which was quite some way off the $613 in the March period, does tell me that Cirrus’ drop in revenue and a weak guidance was logical.

As Apple transitions from a high-growth company to a more mature, blue-chip company, Cirrus will undoubtedly feel the pain. Apple has been pushing its old iPhone 4 to increase sales, and this seems to be hurting Cirrus the most since it relies on Apple for the majority of its products. So, even though iPhone sales jumped 20% from the year-ago period, Cirrus wasn’t able to capitalize as older iPhone models are still selling well, and this might be pressuring its margins.

Going forward, there is yet another logical reason why Cirrus might face a period of depressed margins. CEO Jason Rhode had stated at the Barclays conference in May that Cirrus’ gross margin would hover in the mid-40s in the long run, and a low-cost iPhone might have something to do with it. According to Jefferies analyst Peter Misek, the production of a lower cost iPhone is already underway and the company might be retailing it for somewhere between $300 and $400, which is at the mid-point of my own estimate.

So, if Apple evenly splits its production of 25 million to 30 million units between the iPhone 5S and a cheaper version as Misek suggests, then suppliers like Cirrus will probably have to sell more low-margin content as well.

The takeaway

Going by analyst estimates, Cirrus’ days of supersonic growth are over, and the possible product moves of its biggest client suggest that more margin woes are on the way. However, once Cirrus achieves the new normal of its business, which would be undoubtedly below where it is presently, then it might be worth a look again. 

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Cirrus Logic. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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