This earnings season has produced a reasonable number of surprises and the after-earnings market reaction has been equally surprising for some of the stocks. Well, for Altera (ALTR, Financial), which reported an earnings beat, the drop of 2.2% might not have been completely expected. On the other hand, though, the soft guidance given by the company might have been the culprit behind this slide. Before we go on to analysing the prospects of Altera, let me point out that Altera has received an average recommendation of “Hold” from 16 brokerages that are currently covering the company. As such, it is a good time to understand if the stock is worth investing.
Decoding the results
On October 23, Altera announced its third-quarter results wherein the sales came in at $499.61 million, comfortably beating analyst estimate of $499.40 million. Third quarter net income was $118.0 million, $0.38 per diluted share, compared with net income of $127.0 million, $0.41 per diluted share, in the second quarter of 2014 and $119.4 million, $0.37 per diluted share, in the third quarter of 2013. In the said quarter, gross margin came in at 66.8% which compares to 68.5% achieved in the prior year period. One of the reasons that investors were disappointed with the results was the contraction in gross margins.
The company has also announced that it expects a gross margin to be in the range of 66-67% which is lower when compared to analyst estimate of 67.8% for the same period. This was the fourth consecutive quarter for Altera to miss the analysts’ gross margin estimates, hence, negatively impacting the investors’ sentiments about the company’s ability to sustain profitability. The good news is that management has identified changes in the product mix to be one of the reasons for a weak gross margin. Though we have to go by management’s word for now, it will be completely clear in the next quarter if the implemented product mix will be able to improve the company’s margins.
Beefing up product portfolio
The primary reason behind this revenue beat was the solid traction of the newly launched product and gains in 28 nm FPGAs. Additionally, the company has been receiving considerably good feedback from early access customers of its first-ever FinFET-based FPGAs, the high-end Stratix 10 family. The company has already released the early access design software for Stratix 10 FPGAs and SoCs, the industry’s first design software targeting 14 nm FPGAs. The Stratix 10 FPGAs and SoCs are designed to deliver advanced performance applications in fields like communications, military, broadcast and computer and storage markets. Also, the Stratix 10-enabled devices will allow the customers to achieve approximately 70 percent power reduction in power consumption compared with Stratix V FPGAs.
Speaking of the Stratix V FPGAs, it is significant for investors to know that Altera and Baidu, China’s largest online search engine are collaborating on the use of FPGAs and convolutional neural network (CNN) algorithms for deep learning applications. In key search functions, such as image classification and recognition tasks, CNNs are considered to be state-of-the-art and provide record-setting accuracy. To dramatically simplify the implementation of parallel processing applications, Baidu (BIDU, Financial) is leveraging Altera's Stratix V FPGAs and the Altera SDK for OpenCL.
Takeaway
In the third quarter, Altera was able to achieve a revenue growth across all its segments except one, which is the Networking, Computer and Strorage segment. For this segment, the revenue declined 5 percent and the management expects the year-over-year decline to continue in the fourth quarter as well. Also, the wireless leg of the Telecom and Wireless segment declined because of lower TD-LTE shipments in China. However, for the fourth quarter, the company expects wireless to be flat sequentially as FTD-LTE shipments in China and 3G and 4G shipments in other geographies make up for the continued decline in China TD-LTE shipments. This is a positive development since three months ago; the wireless segment was expected to decline.
Altera is currently beefing up its product portfolio and strengthening its ties in China to benefit from the FTD-LTE deployment. Besides this fundamental strength, the company is also financially sound compared to its peers. Altera finished the third quarter with cash and short-term investments balance of $2.81 billion, flat on a quarterly basis. Long-term debt amounted to $1.49 billion. The company generated cash flow from operating activities of $515.4 million. Therefore, my take is to invest in Altera after the small dip because the stock is poised to gain on fundamental and technical strength.
