How PMC-Sierra Has Managed To Carve Out A Position In The Stiff Chip Market.
stockhouse.com
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StockHouse spoke with CEO Bob Bailey, moments after PMC-Sierra reported record second quarter income, about the company's history of meeting market expectations, maintaining strength in a fierce market, as well as its competitive advantage in the industry.
PMC-Sierra [PMCS] provides advanced semiconductor solutions for high speed transmission and networking systems that provide the underlying networking pipelines for the global information infrastructure. PMCS participates in the flourishing communications market segments of wide area network infrastructure, local area networking and remote Internet access.
On July 15, Vancouver based PMCS beat the street and issued net income of $0.22 per share for the second quarter. Income of $16.1 million showed an impressive gain over the $9.9 million, or $0.14 per share, recorded in the second quarter of 1998.
Equipment suppliers such as 3Com, Alcatel Telecom, Ascend Communications, Cisco Systems, Lucent Technologies, and Nortel Networks rely on PMC Sierra's networking semiconductors in asynchronous transfer mode (ATM), frame relay, remote access and switching solutions.
To view the PMC website, visit www.pmc-sierra.com..
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StockHouse: You have consistently either met or exceeded analysts' expectations for earnings. Once again, you have exceeded them in the second quarter. How are you doing this?
Bob Bailey: We have done that in the last three years. Before that, we had a parent company, Sierra Semiconductor, that was more in the PC modem / graphics market. It was a lot more difficult back then and we re-structured the company to focus on broad band communications. We knew it was a growth market and we knew we had a lead and nobody else seemed to care about it back in the 1995 time frame.
We continued to invest very, very aggressively, adding head count as fast as we could, growing our businesses. We were increasing our silicon content in those systems which at the time were low volume and now they are being deployed in pretty modest but growing volumes.
I think they are going to be high volume over time, and so we are riding that wave and we have never lost a customer. They seem to like doing business with us because we provide them with cutting edge technology at a good price and with excellent technical support and quality.
StockHouse: PMC-Sierra is up against some heavy competition in this league with Intel, Lucent and Motorola. How are you managing to maintain your strength while staying competitive at the same time?
Bob Bailey: We have weathered several waves of competition. Texas Instruments [TXN] made a big push in ATM chips and now they are pretty much out of it. IDT [IDTC] and Cypress [CY] made a big push to try to do similar chips and they got out of it. Now you have Lucent [LU], and Motorola [MOT] and even Intel [INTC] trying to do that, even though they don't really do the same kind of chips that we do.
We are specialists and we know the stuff better than anybody. Some of these companies, the market research they do is to read our Website to see what we are doing. By the time they see it there, it is two years old in terms of the idea stage. Knowing what that network looks like, even before the customers in some cases, and the architectures puts us at least a year ahead of many other companies.
StockHouse: Since March you have outperformed all of the big players. You are doing something right.
Bob Bailey: Part of it is market related. Our PE ratio has expanded. Obviously people are getting more bullish about our prospects than they were six months ago. But, if you look at just the earnings in general, I think that people want to bet long term on the Internet but they are scared to death to bet on .com companies. I'd say, sort of tongue in cheek, that we are a value play in the Internet space, because there are real profits and revenues associated with us.
StockHouse: What level of growth are you expecting to maintain?
Bob Bailey: We have a long range plan of $1 billion in annual revenues in 2003.
StockHouse: How is PMCS set to capitalize on what seems to be a new era of communication with IP telephony?
Bob Bailey: IP telephony is one piece of it. Another piece of it is SONET, as well as all these web sites going up needing millions of T1 lines. The other piece of it is wireless.
All of sudden you have a lot more data communications on top of voice. We have put all the pieces together [into] an arsenal of technology that we have developed and/or acquired over the course of the last six years. and now we have a critical mass and many other chip companies don't. As a result we have become very important to our customers, helping them re-architect their systems.
Our people are more systems people, who know how all these systems and networks work and we embody that knowledge in silicon chips. It is very different from traditional vertically integrated semi-conductor companies that don't really know much about the system, but they know a lot about chips and then they just ask the customers what they want and they will just make it for them. That's a critical difference, because in this Internet economy speed is everything, and the fast will devour the slow.
StockHouse: What would you say make your products unique?
Bob Bailey: We tend to have a vision of what the system architectures look like, quite often before the customers do. So we add a lot of value to our customers. They see a dramatic repositioning of their products based on our enabling technologies.
I think other people tend to see what's out there and say "I can make you something incrementally better than what you have now." We tend to take quantum leaps in our products with respect to the previous generation of technologies the customers have been using. We have coupled that from day one with a very significant focus of quality, service, and technical support which are just as important as product leadership. Quite often most people don't do that. We make the customers addicted to doing business with us.
StockHouse: Cisco [CSCO] is looking at pushing Internet telephony into Europe and South America. Is PMCS also intendng to enter that market?
Bob Bailey: That's pretty transparent to us, because we make chips for the global networks. For example, SONET is a North American Optical Transport Standard and then the Asian and European version is SDH, which is similar, but different. We will make our chips be able to do both and so once we make the chips, international if you will, or universal, then they can sell the equipment anywhere they want and maybe a little software module will enable it to be applicable to one region or the other.
StockHouse: Are concentrating on any particular markets?
Bob Bailey: Not really. We have a large portion of our sales today in North America, but that is misleading because the purchasing and manufacturing is done in North America and then they ship that product to the four corners of the earth. We have 80% in North America, 20% in the rest of the world.
StockHouse: There are inevitably going to be some mergers down the road. How is PMCS going to stay competitive in this climate?
Bob Bailey: There are not a lot of small companies to buy in our space. In the chip industry, you have to have a 'best in breed product' in every socket.
In the chip business they have a system to get out and they have many chips they have to use and they have to have the best in breed in every single socket. Most of the time it's so competitive you will have the best product in some sockets, and somebody else will have the best product in other sockets.
In the equipment side of things, it's valuable to the customer to buy an end-to-end network. You just hand him the keys and he's got the whole thing and it's running. In the chip business it doesn't work that way. If all it took was cash, then Seimens [SMAWY:OTC:BB] should dominate the whole thing because they have $100 billion, or something like that.
But that's not the issue. The critical resource is broadband system R&D experts and I believe we have more under one roof than anybody.
StockHouse: Tell me about the Saturn Development Group.
Bob Bailey: Saturn Development Group consists of over 40 companies that are sort of the household names in communications equipment. It is part collaborative consortium and part user group.
We will take a lot of our products, and make very complex reference designs with a ton of work done with massive amount of documentation and charts and graphs and schematics. Those are all things that every single customer has to do if we didn't do it. We then basically walk them through it and give them all the tricks of the trade. This saves them months of time, effort and aggravation.
In addition, there are a lot of usually standards-based issues where an interface of a chip or a given protocol is being introduced. We'll pull together the most influential parties and hammer out an agreement on a standard, and then go in as one big block vote and get it through the standards committees. It's a catalyst, an accelerator of the whole standards making process.
StockHouse: You are working in this group with some of your competition?
Bob Bailey: In the standards bodies you do, but the competition is usually not invited to the Saturn Development Group.
StockHouse: What are the biggest challenges facing PMC-Sierra?
Bob Bailey: Managing the growth. Our head count is growing 50% a year.
StockHouse: You have 500 now?
Bob Bailey: 530 plus. We were 60 in 1993, so we are growing pretty fast and that puts a strain on our infrastructure. We had to add all these design centres around the world to help us in that growth. We have something like fourteen sales offices around the world. It's a lot to manage, but we are doing okay.
It's a major undertaking to continue to grow at this rate. And, if we keep growing the way we are, we will be over 1,000 people not too long from now.
StockHouse: What are your current R&D expenses?
Bob Bailey: The R&D for the second quarter was $12.8 million. It's running about roughly 22% of revenue, which is pretty high for the chip business.
StockHouse: Are you expecting that to increase?
Bob Bailey: 22% to 24% is what we expect. That is our model and that is considered very, very high by the rest of the industry, but our model is a bit different and, as you can see, it is a very profitable one, so it seems to be working.
StockHouse: How are you generating new sales?
Bob Bailey: We are coming out with twice the number of products this year that we came out with last year, and the complexity of those products is twice this year what they were last year. The average selling price is higher.
StockHouse: Thank you for your time, Mr. Bailey
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