RF Micro Devices (RFMD) is a designer and manufacturer of radio frequency products and solutions that are commonly found in mobile handsets and base stations. While the company's products have a multitude of uses across numerous industries, cellular communications is its most important market, accounting for almost 80% of total revenues. Mobile devices use radio frequency channels to establish connections with base stations. The wireless infrastructure market relies on these base stations which are equipped to receive and transmit radio frequency signals to and from mobile devices across vast geographic areas.
RFMD also provides products and solutions that address the needs of many other markets. For example, WiFi is a technology used for short-range applications. WiFi is a booming market that relies on radio frequency solutions. The broadband market, which includes cable television, benefits from RFMD's amplifiers. RFMD also provides solutions for utility companies that allow them to read meters without having to enter their customers' homes. Finally, RFMD's solutions can be found in radar equipment and satellite communications used by the aerospace and defense industries.
Although the business is diversified across multiple markets, as previously mentioned, the company's largest and most important market is the cellular telephone industry. This market is characterized by large unit volume sales, significant changes in product mix, high barriers to entry and short product lifecycles. RFMD's solutions for the cellular market focus on the front end, which covers the area between the transceiver and the antenna. The company's solutions are particularly useful in third and fourth generation (i.e., 3G and 4G) devices.
Suppliers to the cellular industry are having to contend with the transition from 2G to High Speed Packet Access (HSPA) and Long Term Evolution (LTE) interface standards. While RFMD is still shipping in large volumes for 2G, that market is rapidly decreasing as a percentage of total handsets. Newer tablet computers and smartphones, which rely on more advanced interface standards, require more radio frequency content than did previous generations of cellular phones. This development bodes well for RFMD, which expects its business to grow faster than the overall growth in the handset market. In fact, the company's stated strategy is to deliver the best-in-class radio frequency solutions and technologies to a diversified set of customers and markets. Management argues that it can best boost revenues and profits through this strategy of diversification.
The company does a substantial amount of business abroad. In fiscal 2013 (which ended in March), international revenues accounted for 69% of total revenues. Based on ship-to addresses, approximately 36% of revenues came from customers in China and 19% came from customers in Taiwan. Of course, end-users could have been anywhere, yet this breakdown provides an indication of the strong demand in Asia for the company's leading edge technologies.
Samsung (OTC:SSNLF) was RFMD's largest customer in fiscal 2013, accounting for 22% of the company's revenues. No other customer accounted for more than 10% of revenues that fiscal year. However, without naming names, management stated that its two largest customers during the first quarter of fiscal 2014 were the top two smartphone manufacturers. Based on the latest available information, those two customers would have to be Samsung and Apple (AAPL). In fact, a recent "teardown" by iFixit of the new iPhone 5S revealed increased content from RFMD. Not surprisingly, shares of RFMD surged more than 5% when Apple said it had sold 9 million iPhones during the first weekend.
Of course, an investment in RFMD involves a number of risks. First, this is a low-priced stock and, as a result, it can be quite volatile. Furthermore, revenues and earnings can also vary significantly from quarter to quarter. Sales are particularly susceptible to changes in business and economic conditions. Management has tried to reduce the variability of the financial results by diversifying across product categories and markets served. However, quarterly results will likely continue to exhibit a high degree of variability.
The industry in which RFMD operates is subject to rapid technological changes and new advances by competitors could make the company's products and solutions obsolete. While RFMD invests heavily in research and development to remain at the forefront of its industry, there is no assurance that it will be able to advance or even maintain its market-leading position. Profits in future periods depend heavily on the company's ability to introduce new and innovative products that can command high prices, as well as management's ability to reduce manufacturing costs as average selling prices fall as they inevitably will.
The company's fortunes rest on its ability to remain a major supplier to industry-leading smartphone manufacturers. However, due to the competitive nature of the cellular market, today's leaders could be tomorrow laggards. For example, just a couple of years ago, Nokia (NOK) was one of RFMD's largest customers. Today, Nokia is only a small player in the cellular handset market. Fortunately, RFMD has been successful in securing new customers and becoming a major supplier to Samsung and Apple, the current market leaders. However, there is no telling what the future holds or which company will dominate the handset market.
Another significant investment risk involves the company's convertible debt, which matures in April 2014. The conversion price on this debt is $8.05 per share. Of course, shareholders would be happy to see the stock price go higher, but if it rises above the conversion price, the convertible bondholders will have an incentive to convert their bonds into common stock, which would dilute the ownership interests of existing shareholders.
RFMD went through a period of declining revenues and profits, but business appears to have turned around. This was most evident when the company reported financial results for fiscal Q1 2014 (which ended in June). Revenues surged 44.6% on a year-over-year basis to $293 million. The gains were driven primarily by increased demand for 3G and 4G cellular radio frequency solutions, as well as strong demand for WiFi products. Still, the company continued to see strong, albeit waning, demand for 2G applications. The gross margin during the fiscal quarter improved on a GAAP basis to 31.9% and on an adjusted basis to 35.9%. Research and development was the company's most significant expense. While spending on research and development has negatively affected the bottom line, it should ensure higher profits in future periods.
Management recently said that the company's average dollar content per handset is up 40% over the past two years. Based on the recent teardown of the new iPhone, that number should grow. The company has also made concerted efforts to expand into the low-tier market, which moves RFMD closer to its goal of becoming the industry's most diversified supplier. Management plans to continue diversifying the business across customers, product categories, market segments and air standards. While profits are still being depressed by lower average selling prices, revenues are rebounding strongly. Profit margins should improve as the industry transitions to 3G and 4G continues, and as RFMD's content grows in market-leading smartphones and tablet computers. Despite the stock's recent run up, it could run higher when management announces fiscal Q2 financial results, which should happen during the third week of October.
Additional disclosure: I hold RFMD in my portfolio and in the portfolios I manage at Greenwich Wealth Management, LLC. RFMD is on the recommended list of my investment newsletter, Money Masters Stock Report.