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Yesterday the SEC issued a subpoena to Nu Horizons (NUHC) for documents related to business with Vitesse Semiconductor (NASDAQ:VTSS). The motive for the subpoena is not public, but I suspect it is to understand the mechanics of the transactions between the two companies that enabled Vitesse to engage in bad financial behavior.

I examined the relationship between the two companies in the following articles:

Trickle Down Economics and Channel Stuffing - September 14, 2006
Others Will Feel Vitesse Semiconductor's Pain - December 21, 2006

I’m still negative on Nu Horizons. My personal opinion is that they derive a significant portion of their gross margin from attractive deals placed with suppliers like Vitesse who use distribution as a buffer customer. This buffer allows suppliers to make end of quarter shipments and meet revenue targets. Distributors demand rich margins from suppliers to provide this service.

If this practice were to end, it would have a compelling impact on the financials of all distributors, not just Nu Horizons. It will be interesting to see the outcome of the SEC investigation and if it impacts the accounting behavior of semiconductor suppliers.

My opinion is that Vitesse has rationalized it’s relationship with Nu Horizons. Qualitative information discussed during the Vitesse FQ107 conference call about inventory levels at distributors and revenue linearity supports this conclusion.

Nu Horizons, after 6 straight quarters of revenue and operating income growth, broke the streak in their quarter ending November 30, 2006. Vitesse was the second largest supplier for Nu Horizons FY 2006 (Year End Feb 2006).

Disclosure: Author has a Nu Horizons short position and owns Vitesse Semiconductor equity.

Source: Nu Horizons Receives SEC Subpoenas For Vitesse Activity