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Semtech Corporation (SMTC - Snapshot Report) reported second-quarter 2014 earnings of 46 cents per share, beating the Zacks Consensus Estimate of 41 cents. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Revenues

Semtech’s total revenue was $165.0 million, up 1.6% sequentially and 9.5% year over year. Reported revenues were at the lower end of management’s expected range of $164.0 million to $172.0 million.

Direct sales represented approximately 56% of total second quarter revenue, while distribution brought in the remaining 44%.

Bookings

In the quarter, bookings were soft across all end markets. Book-to-bill ratio was also less than 1. Total bookings accounted for approximately 45.2% of shipments during the quarter, down from 47% in the last quarter.

Revenues by Geography

In the second quarter, Asia remained the largest contributor to Semtech’s revenues, with a share of around 72% versus 73% in the prior quarter. North America accounted for 17% of the revenues, up from 16% in the prior quarter. Europe contributed the remaining 11% of revenues.

Margins

Reported gross margin for the quarter was 61.0%, up 110 basis points (bps) sequentially and 1,160 bps from the year-ago quarter. The increase in gross margin was driven by full amortization of fair value adjustment for acquired inventory as well as higher volumes, partially offset by an unfavorable mix.

Semtech reported operating expenses of $76.3 million, which were 6.2% higher than the year-ago quarter’s $71.8 million. The increase was due to higher payroll-related expenses from increased work hours and new product expenses.

As a percentage of sales, both product development & engineering expenses as well as selling, general & administrative (SG&A) expenses increased from the year-ago quarter. The net result was an operating margin of 14.8%, up from 1.8% in the year-ago quarter.

Net Income

On a GAAP basis, Semtech recorded net income of $19.1 million (28 cents per share) compared with $10.0 million (15 cents per share) in the year-ago quarter.

On a pro forma basis, Semtech generated net income of $31.8 million compared with $24.8 million in the year-ago comparable quarter. Pro forma earnings per share came in at 46 cents compared with 37 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Semtech ended the second quarter with cash and cash equivalents (including temporary investments) of $237.1 million versus $230.4 million in the previous quarter. Accounts receivables were $80.6 million, up from $80.2 million in the prior quarter. Days sales outstanding were 44 days, up from 42 days in the last quarter.

During the quarter, cash flow from operations was $41.2 million, capital expenditure was $12.8 million and free cash flow was $28.5 million.

In the last quarter, the company did not repurchase any shares.

Guidance

For the third quarter of 2014, management expects revenues in the range of $135.0 million to $145.0 million, down 15.2% sequentially at the midpoint. Gross profit margin is expected in the range of 58.7%–59.7% on a GAAP basis and 59.0%–60.0% on a non-GAAP basis.

SG&A expense is expected in the range of $30.0 million–$31.5 million and research and development (R&D) expense is expected in the range of $31.0 million to $31.5 million on a GAAP basis. The company anticipates stock-based compensation expense of $6.4 million, amortization of acquired intangible assets of $7.6 million, transaction and other integration related expenses of approximately $1.0 million and interest and other expense of $2.0 million.

Accordingly, based on a share count of 69.0 million, GAAP earnings per share is expected in the range of 13 cents to 21 cents and non-GAAP earnings per share is expected to be 31 cents–37 cents.

Also, for the third quarter, tax rate is expected in the range of 2% to 3% on a GAAP basis. Capital expenditure is expected to be approximately $10.0 million.

Our Recommendation

Semtech Corporation manufactures a wide range of analog and mixed-signal semiconductors, including Standard Semiconductor Products, Rectifier and Assembly Products and Other Products. The company reported a decent quarter, with earnings exceeding our expectations and both revenues and earnings above the prior-year figures.

In the quarter, the company reported soft bookings with book-to-bill ratio below 1, reflecting slow growth ahead.

However, Semtech stated that a reduction in demand and inventory corrections at several of its largest smartphone customers will likely impact the whole of second half of fiscal 2014. Therefore, the company provided a weak third-quarter guidance.

Over the long term, we believe that the company’s solid prospects, strong execution and its constant focus to reduce operating expenses might pay off.

Currently, Semtech has a Zacks Rank #4 (Sell). Other stocks that are performing well at current levels include SanDisk (SNDK - Analyst Report), Syntel Inc. (SYNT - Snapshot Report) and Silicom Ltd. (SILC). All these stocks carry a Zacks Rank #1 (Strong Buy).

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