Altera: Second Quarter EPS Beats Consensus

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Altera reported second-quarter EPS of $0.41, $0.04 above our and Street estimates. Revenue of $491.5 million was $8.4 million above our estimate, largely driven by strength in the telecom and industrial businesses. Gross margin was 30 basis points below our estimate and in line with guidance. Management guided third-quarter sales to be down 2% to up 2% sequentially, lower than Street expectations of 2.2%, with strength from networking, computer, and storage. The company exited the June quarter with more than $70 million in 28 nm solutions (30% sequential growth, according to management), lower than that of Xilinx [XLNX $41.26; Market Perform] ($130 million in 28 nm revenues, which were adversely affected by inventory buildup).

While investors may conclude that business has bottomed for Altera and the company is on a recovery path, our concerns of the company’s weakness on 28 nm combined with potential delays on the 14 nm FinFET override any short-term euphoria. In addition, on the 28 nm front, we believe the company’s market share was artificially high as XLNX was adversely affected by inventory buildup. On the product front, we believe that Altera continues to be behind competition. Some of the areas where we believe the company lags the competition include lack of a 20 nm high-end offering, lack of stacked silicon 3-D platforms, and ARMbased solutions.

In addition, given the choppiness in demand from China (and highlighted by management on the call), combined with the unpredictability about FTE licenses to companies like China Telecom and China Unicom, we believe our Underperform rating is warranted. Revenue of $491.5 million grew 6.6% sequentially and exceeded the high end of management’s first-quarter guidance of 6% as well as Street expectations of $481 million. Sales in the networking/computer/storage market (15% of sales) were up 2% sequentially, missing our estimate by about $2 million and the Street’s estimate by $4 million. Industrial, military, and auto (21% of sales) grew 2% sequentially and was above the Street’s estimate of $101 million, while telecom and wireless (46% of sales) grew 9%, driven by larger-than-expected growth from non-China geographies, and beat the Street’s estimate of $225.3 million.

Sales of 28 nm products were roughly $70 million, up over 30% sequentially by our estimate, and the company expects growth in the third quarter. Gross margin was down 10 basis points sequentially, to 67.0%, in line with the midpoint of management’s guidance of 67%. The relatively flat number was largely attributable to a similar shift toward lower-margin segments and away from higher-margin segments seen last quarter. This mix shift can be seen in the strength in wireless as well as weaker-than-anticipated sales in the networking, computer, and storage market. Altera reported operating expenses of $182.6 million, up 4.5% sequentially and nearly $6 million below our estimate. Management’s ability to tightly control operating expenses allowed the company to come in at the bottom end of its guidance range, and this had a positive impact on the bottom line.

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