A Step Back For Atmel, But The Potential Is Interesting

By Stephen D. Simpson, CFA | February 11, 2013 AAA

It's another one-step forward, one-step back quarter for Atmel (Nasdaq:ATML), as this mid-sized microcontroller specialist continues to struggle with increased commoditization in its touch controller market and a weak environment for chips in industrial and automotive markets. While these shares are likely to stay quite volatile on rumors of socket wins and losses, the company's technology is interesting and the valuation is not so demanding at present.

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Fourth Quarter Results Not so Impressive
The fourth quarter was not so great for Atmel, due in part to weak volumes and prior contract commitments.

Revenue declined 10% from the year-ago level, or about 8% adjusted for the Serial Flash business. Microcontroller revenue increased 6% from the year-ago level and squeaked out a small gain compared to the third quarter, and it is likely that touch controller revenue increased at a mid-single digit rate. The RF/auto business was weak, however (down sequentially at a high single-digit rate), and the ASICS business saw revenue drop by one-third from last year and 6% from the prior quarter.

Atmel's reported profits weren't so great either. Gross margin declined 10 points from the year-ago level, due to weak volumes and a nearly $11 million loss on a take-or-pay supply agreement. Even after netting out that bad contract, gross margin still fell a point and a half from last year, but did improve slightly on a sequential basis. With that pressure on the gross margin line, Atmel reported an operating loss by GAAP accounting, but even non-GAAP accounting shows a nearly 50% decline in year-on-year profits.

SEE: A Look At Corporate Profit Margins

Atmel Announces More Wins, but Not the One That Really Matters
As is usually the case, Atmel management ran through a list of product launches that include their touch controllers - including ultrabooks from Dell (Nasdaq:DELL) and Hewlett-Packard (NYSE:HPQ) and phones from Samsung, Nokia (NYSE:NOK) and Kyocera (NYSE:KYO).

Unfortunately, there weren't many details about these launches (including ASPs). More importantly, management said nothing about the controller socket "bake-off" at Samsung. The new Galaxy S4 is on the way, and analysts generally believe this socket came down to Atmel and Synaptics (Nasdaq:SYNA), with the latter likely offering serious price competition. With Atmel having lost several high-profile placements in the past year (including the Galaxy S3), a big win on a higher-end smartphone is important not just for sales and margins, but investor perceptions as well.

What to Make of Guidance?
Atmel shares have sold off in the wake of the quarterly report, likely due in large part to disappointing first quarter revenue guidance. Against an average analyst target of $333 million, the midpoint of Atmel's guidance came in about 4% lower at $319 million.

Management talked about inventory issues around Win8 ultrabooks, and that's certainly a concern. Microsoft's (Nasdaq:MSFT) Windows 8 launch hasn't gone especially well, and the uptake of ultrabooks seems to be slower/lesser than hoped - a disappointment for Atmel shareholders given the touch functionality of these new PCs.

I do wonder, though, if the sell-off is also due in part to worries about that aforementioned Samsung socket. If the S4 is going to launch late in the first quarter, there should be orders and chip shipments in the first quarter, and it wouldn't surprise me if investors were taking management's guidance as a sign that Atmel did not win this business (or at least not the majority of it).

SEE: Can Earnings Guidance Accurately Predict The Future?

The Bottom Line
Atmel has a tough row to hoe. Asian competitors are willing to sell functional touch controllers for less than a buck a chip, and Atmel can't compete with companies like Broadcom (Nasdaq:BRCM) that can combine touch control with a variety of other system functions on a single chip. While new technologies like xSense are indeed interesting, it's up to Atmel to really sell phone and tablet makers on why the higher prices are worth it to the customer.

There's certainly upside to Atmel shares if the company can get its revenue and margins moving again, and the expiration of that take-or-pay deal in 2013 will certainly help the latter. It only takes about 4 to 5% revenue growth and high single-digit free cash flow growth to generate an attractive price target for Atmel. The key, as it has long been, is for management to execute on that potential and deliver the socket wins and revenue growth.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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