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Leading analog semiconductor manufacturer Avago Technologies Limited (AVGO - Analyst Report) recorded strong third-quarter fiscal 2014 results (ended Aug 3, 2014) with substantial year-over-year improvements in revenue and recurring earnings on the back of the accretive LSI Corporation acquisition. This is the first full quarter in which Avago and LSI operated as a combined entity after the $6.6 billion acquisition successfully closed in May this year.

GAAP loss for the reported quarter was $164 million or a loss of 65 cents per share compared with net income of $142 million or 56 cents per share in the year-earlier quarter. The significant year-over-year drop was primarily attributable to high operating expenses despite robust top-line growth.

Excluding non-recurring items, Avago recorded a non-GAAP net income of $347 million or $1.26 per share compared with $188 million or 74 cents per share in the year-ago quarter. Recurring earnings for the reported quarter comfortably beat the Zacks Consensus Estimate of 81 cents.

Quarter Details

Net revenue (non-GAAP) for third-quarter fiscal 2014 almost doubled to $1,287 million from $644 million in the prior-year quarter. The surge in revenues was primarily due to synergies from LSI and strength across all the end markets. Net revenue for the reported quarter, however, missed the Zacks Consensus Estimate of $1,334 million.

By target markets, revenue from Wireless Communications accounted for 28% of the total revenue and increased 26% year over year. Avago achieved high penetration levels with Chinese OEMs on the back of its industry-leading film bulk acoustic resonator (FBAR) technology, partially offset by weaker demand in Korea.

Revenue from Wired Infrastructure represented 27% of the total revenue and improved 73% year over year. The revenue growth was primarily due to strong demand from enterprise networking features and service provider routers. Avago generated 13% of its revenue from the Industrial & Other market. Buoyed by resurgence in demand in Asia and particularly in Japan, year-over-year sales were up 10% in this target market.

Quarterly revenues from Enterprise Storage, a new end market for Avago dealing with LSI's hard disk drive and service storage connectivity product lines, accounted for 32% of the total revenue.  

Non-GAAP gross margin for the reported quarter improved to 57% of net revenue from 51% in the year-ago quarter. Operating income from continuing operations (non-GAAP) was $428 million in third-quarter fiscal 2014, considerably up from $191 million in the same quarter last year.

As part of its cost-reduction program, Avago is retrenching 1,100 employees following the completion of the acquisition of LSI for expected annual cost synergies of $200 million. The gradual workforce reduction will take place over the next six quarters (end of fiscal 2015). Avago is currently well on track on this program.

During the quarter, Avago inked a definitive agreement with Intel Corporation (INTC - Analyst Report) to divest the Axxia Networking Business of LSI and related assets for $650 million in cash. The company also entered into a definitive agreement to sell LSI's flash businesses to Seagate Technology Public Limited Company (STX - Analyst Report). The strategic divestments are aimed at augmenting revenues by offloading non-core businesses, as the industry resorts to more consolidation in a challenging macroeconomic environment. Both the transactions are expected to close in the fiscal fourth quarter of 2014 and are included as discontinued operations in the current quarter results.

Subsequent to the quarter end, Avago completed the acquisition of PLX Technology Inc. for approximately $309 million in cash. The purchase complemented Avago's existing server storage connectivity and networking ASIC (application-specific integrated circuit) products that serve the enterprise and data center market.

Cash Flow & Balance Sheet

Avago generated $314 million in cash from operations in the reported quarter compared with $137 million in the prior-year period. Capital expenditures were relatively high at $95 million, up from $65 million in the year-earlier quarter owing to higher spending on FBAR capacity ramp-up.

At quarter end, Avago had $1,277 million in cash and cash equivalents with long-term debt (net of current portion) of $5,472 million. During the quarter, the company paid a dividend of 29 cents per share, which represents a sequential and a year-over-year increase of a couple of cents and 8 cents, respectively. Avago has continuously increased the quarterly dividend since its inception.

Guidance

Along with the quarterly results, Avago provided guidance for fourth-quarter fiscal 2014, based on current market conditions and the accretive effect of the PLX acquisition. GAAP revenue is expected to be up 18%–22%, while gross margin is projected at about 46.5%. Operating expenses are estimated to be approximately $479 million. Capital expenditures are expected to be approximately $220 million.

We are encouraged by the strong quarterly results of this Zacks Rank #2 (Buy) stock and its bullish guidance. Advanced Semiconductor Engineering Inc. (ASX - Snapshot Report) is another well placed stock worth considering in the industry with the same rank as Avago.

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