Intersil reported March quarter results and new guidance above current estimates. The company's management suggested June quarter revenue up 4-6 percent sequentially from the previous quarter. The sequential revenue growth is likely above levels reported by peers due to the increasing Xicor revenue, and an overcoming of the apparent trough in revenue that appeared in the months after Intersil and Xicor first combined. We believe Intersil (with Xicor) is no longer underperforming its peer group in terms of revenue growth. Our reservations regarding the company's growth opportunities are fading as sales growth in the distribution channel and new products that target broader markets begin to take hold. We are upgrading our rating to Buy from Hold.
March Quarter Results
Intersil reported a "beat and raise" March quarter, with revenue of $128.1M (a sequential increase of 0.8%) compared with consensus of $124.9M. The gross margin increased from 55.2% to 55.3% sequentially driven by better product mix and more outsourcing of fabrication. Intersil has room to grow to achieve the company's goal of 58 to 60 percent gross margin and operating income of 27 to 28 percent.
As we have talked about in the past, Intersil's revenue from computer markets was down 10.4 percent sequentially and down 13.9 percent from the same quarter last year, but still accounts for 24 percent of company revenue. We view these results positively given the seasonal nature of the computing market and the company's ability to start diversifying away from the low margin desktop products.
We view the company's communications business, which was up 5.2 percent quarter-to-quarter, as a positive sign that DSL inventory has been consumed.
The company's book-to-bill ratio was "comfortably" above one, with turns of about 45 percent (signaling backlog of about $74M). Management commented that bookings grew close to 10 percent quarter-to-quarter. In the company's recently filed 10-K it disclosed the lay-off of an additional 100 employees in the Palm Bay factory.
June Quarter Outlook
Intersil expects June quarter revenue to be up 4-6 percent over the March quarter, with revenue between $133.2M and $135.8M versus consensus of $129.5M. We are forecasting the gross margin for the quarter to increase to 55.5 percent, a quarter-to-quarter increase of 20 basis points.
Intersil attributed its guidance to increased traction in the flat panel and handset markets, as well as broad strength from communications and industrial accounts. The percentage of turns orders (orders that are booked and shipped in the quarter) required to meet the June guidance remains at 45 percent, the same as that achieved in the March quarter, as lead-times are expected to hold steady at four to six weeks. Should the present strong order pattern continue, we believe our June mid-point estimates may prove conservative.
The 2005 Earnings Outlook
We are increasing our earnings estimates for CY05 resulting from a higher revenue base growth and lower operating expenses. Our fiscal 2005 estimates for the company may prove conservative when the dust clears as our revenue growth estimate for calendar 2005 was 2 percent ob the pervious year (and below our view of the overall analog market).
Our increased estimates are slightly above the mid-point of the company's revenue guidance, but at the high end of the earnings expectations for the June quarter. Our estimates are at the high end of the range because we believe cost cutting efforts are under-estimated by management. We believe Intersil's consensus numbers are likely to increase while peer group companies are more likely to meet Street estimates. Therefore we are upgrading Intersil to a Buy from a Hold rating as growth in distribution and standard products could drive higher than average growth rates in the next three to four quarters.
The Bulls Will Point to:
- Intersil's improved competitive position post the Xicor acquisition.
- The seasoned engineering and management talent gained from the Xicor merger.
- Product line diversification and increase in new product introductions.
- The reduced capex requirement (FY05 $15M) as a result of the increased fab outsourcing.
- The stable turns order requirement for the June quarter of 45% with bookings growing faster than revenue.
The Bears Will Point to:
- Intersil's market share loss in 2003 and 2004; year-to-year revenue growth of 6.7 and 5.5 percent compared to 12 and 15 for other analog companies in the SIA.
- Weak end market growth in core end markets of PC, DVD, and DSL.
- Visibility into the June quarter and beyond remains limited with lead times of four to six weeks.
- Gross margin and operating margin improvements took a large step backwards and are well below target levels.
- Tangible book value is well below intangible book due to high priced acquisitions.
Why Upgrade Now?
Simple question with a complex answer. To start with, we believe that the company is leaner, stronger, and better versed in the high performance analog market. We believe Intersil is doing a good job of moving away from past core end markets, and should be able to offer good products at slightly lower price points to a growing population of medium-sized accounts where BOM costs are important.
When the Xicor acquisition was announced, we were long-term positive on the move but knew it would take several quarters for change to take hold. We now believe we are in the first few quarters where increased distribution mind share should start to take hold. We are aware that Intersil has senior engineers on the road, holding distribution training, which has resulted in increased design win claims. These wins have not yet contributed to increased sales in our opinion (but will). The last unique reason relates to the increased output of new products in recent months that shows management is clearly focused on revenue growth through new products. While this is a simple concept, it is often poorly executed as new product efforts are often delayed by on-going production issues.
With the upgrade of Intersil we are stating that ISIL no longer deserves the discount to it peers with less downside risk than upside potential reward. The general downside to the call is a retracing to recent lows due to lower global demand factors. There are three potential negative issues that are only relevant to Intersil.
(1) the Xicor acquisition caused disruption to the supply chain and pushed revenue levels below actual demand; thus, the recent growth is a return to past revenue levels.
(2) The continued outsourcing and transferring of wafer fab caused customers to over order to ensure supply during the transition - again increasing present growth metrics.
(3) Avnet's purchase of Memec - both of which are distributors for Intersil - could cause a short period of excess inventory in the distribution chain with Avnet and Memec combining inventory in coming months. This issue should not have a large impact as Intersil only claims a sale on sell-out of US distribution. It may cause an issue on the international portion that is sell-in. Memec, however, has less than 2 percent distribution in international markets and Intersil is also distributed by Arrow, which would likely pick up any customers that choose not to purchase from Avnet.