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Semtech Corporation (SMTC - Snapshot Report) reported fourth-quarter fiscal 2014 earnings of 18 cents per share, missing the Zacks Consensus Estimate by a couple of cents. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Revenues

Semtech’s total revenue was $126.5 million, down 10.3% sequentially and 16.0% year over year. Reported revenues were below management’s expected range of $132.0 to $144.0 million and the Zacks Consensus Estimate of $128.0 million. The sequential decline was due to the ongoing weakness in capex spending in the optical long-haul communications infrastructure market and the seasonal softness in the consumer market.

Direct sales represented approximately 53.0% of the total fourth-quarter revenue, while distribution brought in the remaining 47.0%.

Bookings

In the quarter, bookings improved sequentially, resulting in a book-to-bill ratio of above 1.

Revenues by Geography

In the fourth quarter, Asia remained the largest contributor of Semtech’s revenues, with approximately 73% share versus 71% in the prior quarter. North America accounted for 15% of the revenues, down from 16% in the prior quarter. Europe contributed the remaining 12% of revenues, down from 13% in the prior quarter.

Margins

Reported gross margin for the quarter was 42.5%, down 1,660 basis points (bps) sequentially and 1,590 bps from the year-ago quarter. The decrease in gross margin was due to higher inventory reserves of approximately $15 million, fixed asset write-downs of approximately $4.3 million and $1.7 million in contract commitments.

Semtech reported operating expenses of $220.5 million, soaring 192.0% from the year-ago quarter’s $75.5 million. The significant increase in operating expenses was due to the impact of various one-time special charges.

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 (131.8%), down from 8.3% in the year-ago quarter.

Net Income

On a GAAP basis, Semtech recorded net loss of $210.8 million ($3.12 per share) compared with net income of $12.5 million (18 cents per share) in the prior quarter.

On a pro-forma basis, Semtech generated net income of $11.9 million compared with $18.8 million in the prior quarter. Pro-forma earnings per share came in at 18 cents compared with 27 cents in the prior quarter.

Balance Sheet & Cash Flow

Semtech ended the quarter with cash and cash equivalents (including temporary investments) of $243.2 million versus $237.4 million in the previous quarter. Accounts receivables were $66.3 million, down from $74.1 million in the prior quarter. Days sales outstanding were 51 days, up from 50 days in the last quarter.

During the quarter, cash flow from operations was $30.6 million, capital expenditure was $6.4 million and free cash flow was $24.2 million.

In the last quarter, the company spent $15 million to buy back approximately 550,000 shares.

Guidance

For the first quarter of 2015, management expects revenues in the range of $127.0 to $133.0 million, while the Zacks Consensus Estimate is pegged at $133.0 million. Gross profit margin is expected in the range of 58.5–59.6% on a GAAP basis and 59.0–60.0% on a non-GAAP basis.

SG&A expense is expected in the range of $30.8–$31.8 million and research and development expense is expected in the range of $27.7 to $28.4 million on a GAAP basis. The company anticipates stock-based compensation expense of $7.0 million, amortization of acquired intangible assets of $6.4 million, restructuring charges in the range of $0.5 to $0.7 million and interest and other expense of $1.8 million.

Accordingly, based on a share count of 68.0 million, GAAP earnings per share is expected in the range of 10 to 14 cents and non-GAAP earnings per share is expected within 28–32 cents.

Also, for the first quarter, tax rate is expected in the range of 14–16%. Capital expenditure is expected to be approximately $9.0 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 both earnings and revenues missing our expectations.

Though we remain encouraged by the company’s new design wins and various product introductions, Semtech stated that a reduction in demand remains a matter of concern.

Additionally, the company plans to reduce its investment in the long-haul optical market due to weak capex spending. These include reducing worldwide headcount by approximately 6%, terminating certain new product developments associated with the long-haul optical market and suspending some discretionary spending.

Though we remain encouraged by the company’s constant focus on reducing its operating expenses, challenges in several key end markets will likely weigh on the near-term growth prospects.

Currently, Semtech has a Zacks Rank #5 (Strong Sell). Other stocks that are performing well at current levels include On Semiconductor (ONNN - Analyst Report), M/A-Com Technology Solutions Holdings, Inc. (MTSI - Snapshot Report) and Maxlinear Inc (MXL - Snapshot Report). All of these carry a Zacks Rank #2 (Buy).

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