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Technology Stocks : Vitesse Semiconductor -- Ignore unavailable to you. Want to Upgrade?

To: Robert Schwartz who wrote (2726)	7/13/1999 10:09:00 PM
From: A. Edwards	Read Replies (2) \| Respond to of 4710

Analysis of June Results Salomon Smith Barney July 13, 1999 As we have highlighted in our last several write-ups about the company, Vitesse has faced an unusual situation compared to other Internet IC suppliers such as AMCC and PMC-Sierra. Vitesse was supply-constrained for most of 1998 and recently ramped a new Gallium Arsenide (GaAs) plant in Colorado Springs. During the period of supply constraints, Vitesse had enjoyed exceptional book-to-bill ratios and an unusual degree of backlog visibility. With the new plant in full production, delivery lead times have compressed into the 6-8 week range. As is common in most such situations, orders have slowed as customers re-calibrate their order horizons to match the shorter lead times, as well as working off any excess component inventories which may have been stockpiled during the shortage period. Coincident with the shortening of delivery lead times, Vitesse's largest customer (Lucent) has started to out-source more production to contract manufacturers such as Solectron and Flextronics. This move has also temporarily distorted the order visibility. Importantly, fundamental demand has NOT slowed - in fact, every independent indicator suggests that the optical networking and ATE markets have accelerated over the last three months. However, changes in lead times often can mask the nature of true demand. With the completion of the June quarter, we believe these negative forces have largely played themselves out. Lead times have stabilized in the 6-8 week range, and the qualification process at Solectron has been completed. As a result, visibility is no longer deteriorating, and preliminary indications from Lucent indicate that the December quarter could represent a significant uptick in business. As a result, we believe Vitesse's prospects for the second half of the year are exceptionally good. What is happening in ATE? Most ATE vendors such as Teradyne have been openly talking about the rebound in the ATE market. As a result, we believe there was some expectation that Vitesse would be an immediate beneficiary of the ATE recovery. Unfortunately, we believe most automated test equipment manufacturers still have excessive component inventories, and it may take a few more quarters to bleed off the surplus. Based on an evaluation of component inventories at the automated test equipment manufacturers, other ATE component suppliers such as Analog Devices, Applied Micro Circuits, Maxim, and Semtech have cautioned against expecting dramatic recoveries in their ATE chip sales. Since Vitesse had suffered a slowdown in ATE somewhat later than its peer group, it might be expected to see a recovery a little later than the others. In any case, while we had expected ATE to grow in low-single digit terms for Vitesse in June, the fact that sales were actually flat is not a significant disappointment in our view. Eye on the Ball We are buyers of Vitesse because of the company's broadband communications exposure, and that thesis remains intact. Communications sales grew 12% sequentially in June, up 73% from a year ago, and we believe a growth rate above 50% should be sustainable into next year. In addition to industry leader Lucent, Vitesse sells products to Fujitsu, Cisco, Tellabs, Ciena, and Alcatel. The company maintains a large position in the OC-48 SONET market, which has become the workhorse Internet backbone technology for MCI, AT&T and many others. While OC-192 chip sales are only 4% of communications sales for Vitesse, that figure should double over the next few quarters as the market moves more into the mainstream. On top of its traditional strength in physical layer ('PHY' or 'Layer One') devices, Vitesse is also adding more higher-layer optical networking chip offerings such as framers and switches. More than 10% of its communications sales were non-PHY chips in September, and we expect that figure will continue to rise. Many higher-layer processing functions can be handled in silicon, which helps explain why CMOS production already accounts for 7% of Vitesse's communications sales (up from 3% in March). Roughly 60% of Vitesse's design engineers are now working on silicon-based design, moving the company further away from its Gallium Arsenide roots. Fibre Channel and Gigabit Ethernet have captured investors attention, and Vitesse is also well-positioned to play upon the FC/GbE markets. FC/GbE sales rose 35% sequentially in June, and another 25-30% sequential figure appears in the works for September. Maintain BUY We are maintaining our 1H (BUY, High Risk) rating on Vitesse, with an $80 price target. We believe the negative distractions covered above should fade over the next few months, and the focus will return to the company's high growth prospects (50%+ this year), blue-chip customer base and high quality track record.