Cypress new Bluetooth Low Energy Pioneer kit. Image source: Cypress Semiconductor.

Cypress Semiconductor (NASDAQ:CY) reported quarterly results last week in line with previously stated estimates. The big news was an improving profit margin over last quarter, a new acquisition announced on July 5, and the first earnings call without founder and longtime CEO TJ Rogers.

The story around profit margins

Revenue for the quarter ended July 3 was at $450.1 million, a 7.4% increase from the last quarter but a year-over-year decline of 7.2%. Industrial and automotive sales were 58% of total revenue, up from 52% last year. Overall, revenue was in line with the company's guidance issued last quarter.

An area of particular interest is gross margin, or the difference between revenue and cost of goods sold divided by revenue. For the quarter, gross margin was 37.8%. This is up from 36.9% last quarter but down from 41% last year. What gives?

Last March, Cypress completed a merger with rival chipmaker Spansion. The goal was to take advantage of synergy and cost savings, with the new combined business generating twice the revenue as either of the businesses generated on their own. The company reported that the synergy and cost savings are ahead of schedule, with operating expenses at $123.3 million in the last quarter and the lowest amount in six years for the combined companies.

While the merger is helping move the new Cypress Semiconductor in the right direction, it is weighing on those gross margins in the short term. At the time of the Spansion merger, the two companies had an excess of inventory. Combine this with a slowdown in demand for semiconductors for the last two years, and suddenly the company had a problem.

One of the first orders of business was to burn through the excess inventory and reduce production of new inventory. This has negatively affected the margins since last year, but an end to the "lean inventory initiative" may be coming to an end. Inventory is down 43% since the merger, and management forecast gross margin to return to 41% next quarter.

A new acquisition

Besides starting to realize benefits from the Spansion merger, gross margin is expected to bump up in part from another acquisition. Cypress completed the purchase of Broadcom's Internet of Things business on July 5. The new division is expected to fetch a margin around 50%, helping offset the lower margin from other areas of the business.

The new IoT segment will get combined with Cypress' second smallest revenue source, the Data Communications Division. It brought in $25.5 million last quarter but is expected to more than triple in size, with IoT adding an additional $55 million to $60 million in the next quarter.

Another notable point on the new revenue front is Cypress' emerging-tech division. By far the smallest unit of Cypress, revenue in the last quarter was at $19.7 million but is up 156% year over year. The division includes businesses outside the core semiconductor business and includes subsidiaries AgigA Tech, Deca Technologies, and the Foundry Business Unit.

Updated outlook for the rest of 2016

Last quarter's earnings report was also the first absent T.J. Rodgers. The founder of Cypress Semiconductor announced he was stepping down as CEO back in April but would remain on the board of directors and continue work on special projects for the company.

Chief Financial Officer Thad Trent, representing the interim Office of the CEO, told investors that the board of directors continues its internal and external evaluation of new candidates. There was no other comment, so shareholders will have to continue waiting patiently for progress reports on the search.

For the next quarter, the company expects revenue to increase to a range of $510 million to $540 million. Subtracting out the $55 million to $60 million expected from the new Broadcom IoT business, the company expects year-over-year revenue to range from 4% down to 3% up.

With gross margin expected to increase to the previously discussed 41%, this should also support profits. Indeed, management guided for earnings per share in the range of $0.12 to $0.165. This would be a 33% to 83% increase over last year.

Cypress has had a lot of headwinds the past two years, but the company has been busy revamping for the future. This was an upbeat quarter and an even more upbeat outlook for the rest of the year. I think it's time for investors to put Cypress on their watch lists.

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