Cirrus Logic

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Cirrus Logic is a fabless semiconductor company specializing in audio and voice signal processing components and solutions for mobile and consumer applications.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Cirrus Logic (CRUS) operates in the mixed-signal audio and voice semiconductor market. Here is a breakdown of the business:

  • Revenue Streams: Primarily derives revenue from selling audio and voice integrated circuits (ICs), which are used in a variety of consumer products, including smartphones, laptops, tablets, and other portable devices. Key product lines are:
    • Mobile audio: Consists of components for mobile devices, like smartphones. This includes audio codecs, amplifiers, and voice-processing chips.
    • High-Performance Mixed Signal (HPMS): This segment mainly encompasses products designed for audio processing, particularly in the automotive industry, industrial equipment, and smart-home devices.
    • Other Product Revenue: Includes a variety of products not otherwise included in its core business.
  • Industry Dynamics: *The electronics and semiconductors industry is known for its high pace of technological change. This means that product cycles can be short, and competition can quickly lead to price declines if a company cannot establish some type of switching cost advantage, or network advantage. The focus on AI will drive new hardware innovations. *The supply chain and the availability of raw materials (especially from Asia) has been a big issue in recent years, therefore, supply chain management can make or break companies. *Demand for personal electronics devices, like smartphones, is heavily dependent on customer appetite and the global macro situation. As demand increases, prices might increase, while as demand slows or is low, margins might decrease as the competition starts to compete on pricing.
  • Competitive Landscape: The semiconductor industry is highly competitive with several major players like Qualcomm, Realtek, and Analog Devices. Many specialized companies like Cirrus Logic are facing increasing competition from these larger chip makers. Competition is based on: *The features and performance of the chips. *The reliability and quality of those chips, because any component failure can result in significant downtime and large losses for manufacturers and ultimately the clients that use the products. *Price-competition is especially significant in markets where products are relatively more of a commodity.
  • What Makes CRUS Different: The company’s focus on specialized audio and voice components, with decades of experience in this niche, allows it to target specific customer needs and provide a high value product. They also focus heavily on R&D and try to incorporate the latest and greatest technology in their hardware. They also are considered innovators in audio and voice processing and try to provide new and relevant technologies in their products.

Financials Deep Dive:

  • Revenue Trends:
    • Cirrus Logic’s revenue has shown growth over the past years, driven by the adoption of its products in various consumer devices. More recently, however, supply chain issues and global macroeconomic conditions have caused some volatility. For the fiscal year 2022, revenue was $1.71 billion, marking a significant increase compared to $1.47 billion in the previous year. For fiscal year 2023, it was $1.84 billion.

The first quarter of FY24 is usually slower for the company than the later parts of the fiscal year, due to typical seasonality in sales. For the first quarter of the fiscal year 2024, the revenue was $370 million. For the second quarter of the year, the guidance ranges from $400 million to $460 million.

  • Gross Margins: Cirrus Logic has maintained a decent average gross margin during the past few years, although there have been minor variations. Most recently, 46.4% in 2023 and 46.8% in 2022. This level is important for CRUS because, as it is a fabless semiconductor company, it does not need to invest in capital expenditures related to manufacturing of the chips.
    • The management wants to maintain gross margins between 49% to 52% for the long term.
  • Operating Expenses: Research and development (R&D) expenses are significant, reflecting the company’s focus on innovation. The company’s R&D expenses in FY23 were $480 million, which is 26% of total revenue. Management has also spent significantly on SG&A. In 2023, SG&A expenses was $369 million, which was 20% of total revenue.
    • This shows that management is willing to invest in both future growth and existing infrastructure, but this also causes operating margins to suffer, as expenses are more than a third of revenue.
  • Profitability: Net income for 2023 was $352.6 million, marking a significant decline compared to $418 million in 2022. In Q1 2024, however, net income is $85.6 million.
  • Balance Sheet: The balance sheet seems very strong. The company has $577 million in cash and cash equivalents, and no long-term debt, at the end of FY23. It has been increasing cash reserves over the past years, making the company financially stable. Moreover, it has significant liquid assets. However, the company is burning through cash and has a negative free cash flow for the past quarters.
    • Inventory has increased over the past year. It has increased from $114 million in march 2022, to $235 million by march 2023.

Moat Analysis:

Cirrus Logic’s moat is very narrow and questionable and has a rating of 2 out of 5. Here is a breakdown:

  • Intangible Assets: While the company possesses some proprietary technology, it is constantly challenged by newer innovations, which quickly diminishes the value of older patents. While they hold a number of patents on their existing tech, those are not a big differentiator on its own. It can not command significant pricing power in the industry and their brand is relatively unheard of outside their niche.
  • Switching Costs: Some of its products like its reference design or embedded firmware make switching more costly for customers, which creates some lock in effects for short durations, however, this is not enough for a long-term competitive advantage, as the data in the previous documents does not indicate a high retention rate of customers.
  • Network Effects: There is little to no network effect for CRUS, as its products are generally hardware chips and the more or less value is not dependent on the number of users of those chips.
  • Cost Advantages: The company does not have a cost advantage. While it uses some outsourcing, many other competitors also use outsourcing, and it has high R&D costs and significant personnel costs. They also don’t have the economies of scale of bigger players like Qualcomm.

Risks to the Moat and Business Resilience:

  • Technological Obsolescence: Fast paced technological innovation could make CRUS’s products outdated at a rapid pace, leading to less profits and losses in revenues.
  • Intensified Competition: Increased competition from larger semiconductor manufacturers can put pressure on the company’s margins.
    • As new players also try to enter and compete in the market it may also damage the moat and profitability of the company.
  • Macroeconomic Conditions: As the demand for consumer electronics is tied to overall economic conditions, the macro situation could directly affect revenue.
  • Supply Chain Disruptions: Any significant disruptions to its supply chain or access to raw materials might lead to production delays and lower revenues and profits. This can be especially relevant for a fabless company like Cirrus Logic, because it relies entirely on other parties for the production.
  • Customer Concentration: The company relies on a small number of large clients, therefore, the loss of one or two big customers would be detrimental.

Understandability:

The company’s business model is moderately complex, with specialized technical aspects in the design and manufacturing of the hardware, which might make it difficult for non-technical investors to understand, this is why I give it a 3 out of 5 rating. However, the industry it is operating in, is quite easy to grasp for most average investors that follow the technology space.

Balance Sheet Health:

The balance sheet is strong with its large amount of cash and low debt, but negative free cash flow has been concerning to investors. Based on these factors, it is given a rating of 4 out of 5.

Recent Concerns & Management Response:

  • The management noted on earnings calls in May 2024 that they are seeing softness in sales from some android markets, partially due to inventory depletion.
  • Management also sees the Android market as more volatile and they have limited visibility into the sales of the next few quarters.
  • They have identified several challenges in the short term that they are going to be focusing on, which are the “supply chain, manufacturing efficiency and sales mix”.
  • The company has been trying to shift more focus on the HPMS segment and are developing custom products for their customers in other segments, which they believe will improve performance.

Conclusion:

Cirrus Logic is a business with a narrow and questionable moat that relies on its specialized products for value creation. It is financially strong but faces challenges of technological obsolescence, increasing competition, supply chain problems, and customer concentration. The company is still operating in a relatively attractive industry with good growth opportunities, especially in the AI sector. While it might have potential, the company needs to be very careful about the changing landscape of technology in the coming years. It also needs to continue to improve its internal processes and try to gain more pricing power.