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3/4/2003
02:07 PM
William Schaff
William Schaff
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Taking Stock: RF Micro Devices Must Focus On Profitability

The issue is the steep decline in RF Micro Devices' gross margin

Tech stocks have had an incredible run during the last two months, logging gains of more than 14% for the year. For most, the rally didn't start until mid-March, with the Nasdaq composite jumping almost 22% from its low of 1,253.22. But not every company is faring equally well. RF Micro Devices Inc.'s stock continues to languish. It recently slumped to a five-year low before rebounding somewhat to $5.47 per share.

RF Micro Devices is one of the world's leading manufacturers of power amplifiers and transceivers used in cell phones. It also designs chips for wireless local area networks using the 802.11 standard. Power amplifiers are by far its largest business, accounting for 94% of revenue last quarter, while wireless LAN chips accounted for the remaining 6%. The company sells to the largest cell-phone makers in the world but is particularly dependent on Nokia, which accounted for 65% of its 2002 revenue. Other large customers include Motorola, at more than 10% this year, and LG Electronics, which is close to becoming another 10%-plus customer.

Revenue this quarter decreased 5% from the prior quarter to $138.3 million, but the real issue was the steep decline in RF Micro's gross margin, a measure of a company's efficiency in turning raw materials into income. RF Micro's gross margin declined from 37.3% in the fourth quarter of last year to a dismal 29.5% on $138.3 million in this year's first quarter, ended March 31. Gross margin was 40.7% in the last quarter a year ago on revenue of $100.4 million.

The product mix is clearly shifting toward less-profitable units, which RF Micro confirmed recently. The company sold more lower-margin GSM power modules at the expense of higher-margin products using other wireless standards. This shift is driven by fewer orders for handsets from big U.S. wireless carriers such as AT&T Wireless and Cingular but also by lower handset sales in South Korea, where subsidies are being phased out. There's concern that some of the Asian handset producers are building inventory too fast, which might cause a future dip in revenue as inventory works through the channel. Meanwhile, RF Micro's wireless LAN business is seeing price erosion at a faster rate than competitors, probably due to the company shipping products that aren't quite cutting edge. More competitive products will arrive later this year, but the revenue impact could be muted for the time being.

RF Micro's gross margins have seen volatility before. This time, though, more stars need to be aligned for gross margins to improve meaningfully. The company is undertaking a transition from 4-inch to 6-inch semiconductor wafers at its manufacturing facility, which should yield improvements in gross margin in the next three to nine months as production ramps up. The company also has to reverse the mix of products, but this is somewhat beyond its control. It also must continue to introduce higher-margin products.

RF Micro is running at a loss, and the timing for a return to profitability is uncertain. With several operational and competitive challenges ahead, RF Micro Devices will most likely lag other semiconductor stocks in a potential recovery.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com.


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To find out more about William Schaff, please visit his page on the Listening Post.

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