Dialog Semi's Q3: Record Revenue, Investment Thesis Still Strong

| About: Dialog Semiconductor (DLGNF)
Last week I wrote an article on Dialog Semiconductor (OTC:DLGNF) prior to their reporting of 3Q results. Based on strong earnings of several of DLG's largest customers, shares had run up into earnings in anticipation of a strong report. Analyst estimates had also accelerated to well above management guidance. Prior to earnings, I believed shares were fairly priced and would only see upside if numbers were truly explosive. With analysts getting ahead of themselves immediately leading up to the report, the risk was certainly to the downside.
Dialog reported a record revenue quarter, but predictably it did not meet analyst expectations and shares sold off almost 8% the day of the report. I used the opportunity to pick up some additional shares since I had been trimming my holdings around €13.50-13.70 ($19.20-19.50) leading up to the report.
Despite not hitting analyst numbers, this was a great quarter for the company from a revenue, margin and product development perspective. Revenue came in at $79.5MM, above the top end of management guidance for the quarter and a record for the company. Revenue could have been even higher, but due to other supplier constraints at some of their customers, some Dialog inventory went unused this quarter. Margins were also solid, with gross margins coming in at 46.3%, which was 1.0% higher than last year. According to my conversations with management, gross margin could have been even better, but because of higher manufacturing costs in Asia due to lower available capacity, they were not able to wring out some additional volume discounts. Despite comments on the call about overstretched capacity utilization, Dialog was on time with all shipments to customers for the quarter.
Dialog maintained a very healthy balance sheet with no debt and a cash balance of $145.6MM. Inventory was a little bit higher than expected, but not alarming given the typical elevation going into Q4 holiday season and due to capacity issues. This need for secure supply is evidenced by the higher finished goods segment of inventory. Below are the summary results for Q3 and a projection for Q4 based on historical results for margins and my expected top line growth:
Click charts to enlarge
Based on latest discussions with the Company, I learned that the pricing analysis provided by iSuppli (main supplier of consumer gadget part pricing to the finance community) that tends to drive analyst projections for Dialog tends to be higher than actual pricing. As these prices are a closely guarded secret, I was told some of the prices provided by iSuppli can be materially higher than the customer cost, because iSuppli does not take into account volume discounts and contract arrangements. As such, I have pulled back on my 4Q assumptions as well as Apple’s (NASDAQ:AAPL) contribution to top line. Below are the new summary numbers for 4Q.
Due to analyst’s tendency to get ahead of reality, Dialog gave guidance for 4Q gross margin, expecting it to remain roughly similar to 3Q based on their conservative stance in the face of capacity constraints. On the revenue side, the company was equally conservative, almost to a fault in my opinion. Revenue guidance was maintained at $290-295MM for the year, representing a growth rate of 34% YoY for the full year. While this is strong growth overall, the Company has already earned almost $210MM in revenue through 3Q. At the high end of guidance, 4Q revenue growth would be only 10.7% YoY compared with around 50% growth for the prior years. For this reason, I am projecting revenue at ~$105MM, or a 36% growth rate YoY.
On the new product (or free option) front, Dialog is making good progress with its low power audio codec, with one customer shipping a consumer device utilizing the chip as well as another product that is in development with the chip. There will be some revenue from the chip in 4Q10, with a more material impact on revenue starting in 1Q11.
On PMOLED, the first products being developed by TDK utilizing the smartXtend chip were debuted at a trade show in Japan this quarter. Dialog is also working with another yet unnamed partner to develop similar technology that is expected to be revealed in 4Q10. The Company is managing expectations on the product, stating that product tests and supply chain development will be ongoing for the remainder of 2010. Early-adopters (2nd tier consumer products companies) will likely bring products to market in late 1Q11 and assuming successful adoption, larger tier 1 players could adopt on a large scale in late 2011.
Finally, the Company announced a key partnership with Intel (NASDAQ:INTC) and a design win regarding its recently launched DA6011 companion chip, which is primarily intended for industrial and automotive usage.
Overall, a great quarter operationally with financial results held back slightly by some capacity constraints at the customer level. Because analyst expectations had been ratcheted up in the weeks prior to earnings, shares fell almost 8% the day of the report, although they have mostly recovered to what I would again call a relatively fair value based on existing operations. Looking forward, Dialog has bright prospects as it takes advantage of top-tier customer relationships while it works to diversify revenue streams and develop new, innovate products. At any level below the current prices, I would look to continue to accumulate shares as long as positive developments continue.

Disclosure: Author is long DLG