A massive drop of around 26.2% in InvenSense’s (INVN, Financial) share price after the company posted a weak quarter and missed on estimates lured prospective investors on a bargain entry point. Apparently, the analysts downgraded the stock after the poor performance in spite of the company’s dominant position at Apple (AAPL, Financial) and Samsung (SSNLF, Financial). While, both of the InvenSense’s clients occupy a majority share of the smart devices market, the company is reeling under price pressures from both these giants and to an extent, this could have been behind the steep fall in Q2’s gross margin. Currently trading in the range of $15 i.e. approximately a 25 percent discount to its pre-earnings price, let us analyse if InvenSense is a good investment option.
Q2 highlights
In the second quarter of 2015, InvenSense reported net revenue of $90.2 million, up 35 percent from $66.7 million in the first quarter of fiscal 2015. Gross margin determined in accordance with U.S. generally accepted accounting principles (GAAP) for the second quarter of fiscal 2015 was 35 percent, compared with 47 percent for the first quarter of fiscal 2015. As per the company, there were a couple of big reasons that impacted the gross margin in the quarter. First, it recorded an inventory charge related to older products, that led to an impact of approximately 800 basis points on the GM. Second, a shuffle in the revenue mix to lower margin high-volume customers had an impact of approximately 500 basis points on the GM. While InvenSense expects the one-time inventory charge to go off for the third quarter, it has suggested that the pricing mix impact will persist and continue to effect the overall margin in coming quarters as well.
Besides missing on Street estimates in the current quarter results, InvenSense also failed to deliver a robust guidance. It has guided for a Q3 revenue in the range of $108-$115 million and EPS of $0.17-$0.21, both below a consensus of $116.2 million and $0.30 per share. Though the company has suggested that GM would be in the range of 46-47 percent in the upcoming quarter, the anticipated EPS is far below Street estimate, assuming that the range suggested by the company is GAAP EPS.
The relationship with Apple
A primary reason for disappointment over InvenSense’s earnings even after it delivered a record revenue quarter was because the company was expected to report solid profits after winning Apple as a client and that did not happen. As per iFixit’s report on the teardown of Apple’s iPhone 6 and 6 plus, InvenSense supplied MP67B 6-axis Gyroscope and Accelerometer to the giant smartphone vendor. Now, securing a big design win from Apple was being considered as a worthwhile achievement and therefore, the Street expected InvenSense to come out strong on the bottom line.
However, as you saw, that did not happen. Even excluding the impact of one-time inventory charge, the GM would have been impacted by 5 percentage points. As newly hired CFO Mark Dentinger explained, the pricing mix change that took place with Apple on-board was also a cause behind the lower gross margin. He said that the company faced pricing pressure from its biggest customers (i.e., Apple and Samsung), which drove down average selling price. The result was approximately a five percentage point decline. Yet, my concern does not end over here. This is a more permanent problem, and Apple's tendency to lean on its suppliers for the best pricing means that pricing pressure could become an even larger issue in the future if Apple designs become a higher percentage of revenue with the addition of products like Apple Watch and 100% share of iPhones.
Wearable technology: A mine of opportunities
Wearable technology is emerging as the cornerstone of growth for the tech industry and while big vendors like Apple and Samsung are already devoting noteworthy resources to develop their portfolio, a company like InvenSense also stands to gain a lot from this trend. On Tuesday itself, the company unveiled its 6-axis ICM-20645 MEMS SoC, optimized to support on-chip new functions introduced in Android Lollipop. The ICM-20645 incorporates the newest version of InvenSense’s patented Digital Motion Processor™ (DMP) to off-load new Android 5.0 AlwaysOn features such as on-chip activity classifier, tilt sensor, device context gestures, and wake-up sensors. The major advantage with this newest product from InvenSense is that it resolves a basis but challenging issue of excessive power consumption. Since this is a SoC, it performs all the above mentioned functions on a chip and therefore, significantly lowers the system power consumption. In a nutshell, this is a worthy step in the direction of wearable technology wherein it is expected that approximately 22 percent of consumers will own a wearable device by end of 2015 and 72 percent by the end of 2020.
Takeaway
It is true that InvenSense has failed to deliver on the bottom line and to be fair, the company has been in this loop over the last few quarter. Besides other reasons, it is also correct that the company is making huge investments in R&D with an intent to expand its revenue base and foray bigtime into the IoT and smartphone markets. Though clients like Apple and Samsung will have a bit of downside impact on InvenSense’s gross margin but the company has lucrative opportunities ahead which will lead to long-term benefits. As such, the current trading range provides a bargain entry point to prospective investors.
