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Semtech Corporation (SMTC - Snapshot Report) reported third-quarter fiscal 2014 earnings of 27 cents per share, in line with the Zacks Consensus Estimate. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Revenues

Semtech’s total revenue was $141.0 million, down 14.5% sequentially and 12.4% year over year. Reported revenues were within management’s expected range of $135.0 million to $145.0 million.

Direct sales represented approximately 58.0% of the total third-quarter revenue, while distribution brought in the remaining 42.0%.

Bookings

In the quarter, though bookings were soft across all end markets, it improved sequentially, resulting in a book-to-bill ratio of just below 1.

Revenues by Geography

In the third quarter, Asia remained the largest contributor of Semtech’s revenues, with a share of around 71% versus 72% in the prior quarter. North America accounted for 16% of the revenues, down from 17% in the prior quarter. Europe contributed the remaining 13% of the revenues, up from 11% in the prior quarter.

Margins

Reported gross margin for the quarter was 59.2%, down 180 basis points (bps) sequentially and 100 bps from the year-ago quarter. The decrease in gross margin was due to lower IP revenues, a higher mix of lower margin products and lower manufacturing volumes.

Semtech reported operating expenses of $70.1 million, which were 9.2% lower than the year-ago quarter’s $77.2 million. The decrease was due to lower payroll-related expenses for increased work hours and new product expenses.

As a percentage of sales, selling, general & administrative (SG&A) expenses decreased from the year-ago quarter, while product development & engineering expenses increased. The net result was an operating margin of 9.4%, down from 12.2% in the year-ago quarter.

Net Income

On a GAAP basis, Semtech recorded net income of $12.5 million (18 cents per share) compared with $16.6 million (25 cents per share) in the year-ago quarter.

On a pro-forma basis, Semtech generated net income of $18.8 million compared with $30.9 million in the year-ago comparable quarter. Pro-forma earnings per share came in at 27 cents compared with 46 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Semtech ended the third quarter with cash and cash equivalents (including temporary investments) of $237.4 million versus $237.1 million in the previous quarter. Accounts receivables were $74.1 million, up from $80.6 million in the prior quarter. Days sales outstanding were 50 days, up from 44 days in the last quarter, primarily due to lower revenues.

During the quarter, cash flow from operations was $28.9 million, capital expenditure was $7.2 million and free cash flow was $21.8 million.

In the last quarter, the company spent $15 million to buy back approximately 485,000 shares of stock at an average price of $30.92.

Guidance

For the fourth quarter of 2014, management expects revenues in the range of $132.0 million to $144.0 million, down 2.1% sequentially at the midpoint. Gross profit margin is expected in the range of 58.8%–60.0% on a GAAP basis and 59.2%–60.2% on a non-GAAP basis.

SG&A expense is expected in the range of $31.0 million–$32.0 million and research and development expense is expected in the range of $30.8 million to $31.8 million on a GAAP basis. The company anticipates stock-based compensation expense of $7.3 million, amortization of acquired intangible assets of $8.0 million, transaction and other integration related expenses of approximately $1.0 million and interest and other expense of $1.8 million.

Accordingly, based on a share count of 68.5 million, GAAP earnings per share is expected in the range of 9 cents to 18 cents and non-GAAP earnings per share is expected to be 29 cents–37 cents.

Also, for the fourth quarter, tax rate is expected to be 2.0% on a GAAP basis and 13.0% on a non-GAAP basis. Capital expenditure is expected to be approximately $8.0 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 weak quarter, with earnings coming in line with our expectations but both revenues and earnings were below the prior-year figures.

In the quarter, the company’s book-to-bill ratio was below 1, reflecting slow growth ahead. Though we remain encouraged by the company’s new design wins and various product introductions, Semtech stated that a reduction in demand and challenges in several key end markets will likely weigh on the near-term growth prospects.

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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