SSTI - Individual Investor
Article mentions SNDK, see below, could this be the same reason why SNDK has languished after record earnings?
AzLuke
SSTI--Monday July 24, 1:00 pm Eastern Time
Individual Investor
Silicon Storage: Song Remains the Same
Research Analyst: Christopher Conry (07/24/00)
Silicon Storage Technology's (NASDAQ: SSTI - news) second-quarter results were
nothing less than phenomenal.
Nearly every item on the income statement obliterated comparisons from 1999's second
quarter, and even the results from just one quarter ago. Total revenue came in at $103.2
million, a 66% sequential advance. The gross margin, at 44.7%, improved over 300
basis points from the previous quarter, and more than doubled year-over-year.
Operating margins showed similar, if somewhat less astounding, expansion.
Meanwhile, SST's share earnings of $0.71 blew the doors off of the Wall Street
consensus, and even some of the highest ``whisper'' numbers that had been circulating in
the investment community. That's compared to a $0.15 per-share loss for the year-ago
period.
In addition, the revenue mix by product application appears to show healthy
diversification, which would enable it to better withstand a demand shift in any one area.
Check out some of these numbers:
Digital consumer applications revenue (47% of the second quarter total) are up 474%
year-over-year Networking (17%) -- +580% Wireless Communications (10%) --
+2668% Internet Computing (26%) -- +175%
Management indicated strength across a wide range of products, including set-top boxes,
digital TVs, computer peripherals (CD-RWs, DVD-ROMs), network switches and
routers, pagers, among others.
But, since last week's earnings release, the stock has languished.
What gives?
It primarily has to do with one fact that many individual investors underemphasize when
weighing an earnings release against the stock's current valuation:
The numbers are backward-looking.
In the case of SST, most of the investment community had anticipated an upside surprise
for the quarter. Granted, the extent to which it beat expectations should factor somewhat
into a valuation adjustment.
But what Wall Street was really looking for was some clarity as to the health of its future
prospects. Specifically, what the flash memory market and its business will look like
going forward.
While management should be applauded for its strong level of guidance, and frank
discussions during the conference call, as well as its stellar performance to date, the
dialogue brought as many lingering questions to the table as it did answers. The picture
through the end of the year, though, seems to be pretty clear: SST's strong operating
performance should continue.
Management indicated it is looking for better than 25% sequential revenue growth in both
the third and fourth quarters. Gross margins, however, should remain relatively flat, as it
expects to encounter increased costs to ramp up manufacturing at geometries of 0.18
microns and below, which is necessary to produce higher-end, higher-density (16 Mb
and above) chips.
In addition, earnings will be fully taxed beginning this quarter. The new tax rate in the
range of 33%-35%, compared with a 26% rate in the second quarter, and just 4% a
year ago, will likely mute earnings growth for the third quarter, then accelerate in line with
revenue growth through the year's end.
Currently, SST faces little competition in its strongest product segment - flash memory
with densities of 2Mb and below, which accounted for 80% of the company's unit
shipments in the second quarter. In fact, management stated that demand is more than
double the supply of many of its products, which should ensure that both order growth
and pricing will remain firm. Moreover, the question of whether or not flash memory
prices are flattening in the spot market should not materially affect SST. That's because
nearly 100% of its chip shipments are contracted through Original Equipment
Manufacturers (OEMs), and most of which will continue to pay premium prices while the
chips are still in short supply.
So what's the catch?
Well, none, really. But the extent to which SST can rake in the profits in 2001 and
beyond is still quite cloudy at this stage. Here's why:
The sweet spot in the 2Mb and below flash memory market will ultimately give way to
technology that requires flash memory with increasing complexity and density. When the
majority of SST's business shifts toward chips with densities of 16Mb and above, they
enter the arena where some large and powerful competitors operate.
The list includes Advanced Micro Devices (NYSE: AMD - news), Intel (NASDAQ:
INTC - news), ST Micro (NYSE:STM - news) , Atmel (NASDAQ: ATML - news)
and others. In fact, AMD and Intel are already aggressively promoting the adoption of
more complex chips over lower-end solutions to its customers.
A move further into the high-density mass-data-storage market would bring competition
from SanDisk (NASDAQ: SNDK - news) and M-Systems (NASDAQ: FLSH - news),
which are already established players here.
The industry is rushing to bring new capacity online. Starting in 2001, the influx of new
capacity may well start to balance the supply/demand picture, while it would likely
intensify competition and potential pricing pressure.
In this scenario, order bookings should also be watched closely. Typically, in a market of
undersupply, companies desperate for a product will overbook orders with a number of
suppliers, in hopes that most or all of its needs will be fulfilled. Overbooking likely exists
in many flash memory orders, which may lead to a sharp number of cancellations once
new supplies actually reach the market.
Also, SST is a ``fabless'' flash producer; it depends on foundry agreements with Sanyo
(NASDAQ: SANYY - news), Taiwan Semiconductor (NYSE: TSM - news), Seiko,
Samsung, and National Semiconductor (NYSE: NSM - news) . In a tight-supply
environment, SST may not be able to produce the quality and quantity of chips it desires
through third-party manufacturing channels.
Going forward, further margin improvement may well prove difficult for SST. Silicon
wafer prices were up 5% to 8% in the second quarter, the first such increase in years,
and management stated that more price hikes are likely on the way. In addition, the shift
in mix toward higher-end chips should increase production costs beyond the company's
year-end guidance.
That's not to say SST's future beyond the year's end is all doom and gloom.
For one, SSTI's SuperFlash technology seems to have a number of competitive
advantages, in terms of cost, scalability, reliability, and the flexibility for use in both
low-density and high-density flash applications. As a result, any erosion of SST's current
customer base may be minimal, provided it can produce the necessary product in
sufficient quantities.
Licensing revenue, which only generated about 1% of second-quarter revenue, should
receive a boost on the heels of its new deal with Apacer, a subsidiary of Acer Inc., the
Taiwanese firm best known for its line of PCs. Through the agreement, Apacer will
exclusively use SST's proprietary SuperFlash ATA controller and firmware in its
products (including set-top boxes, network computers, PDAs, cell phones, etc.)
beginning with shipments next month.
Furthermore, the company announced it had begun firmware shipments for a new Intel
PC chipset in material quantities, which may further boost revenue through 2001.
Management also indicated it is working on removable flash memory solutions to support
applications for the emerging Bluetooth short-range wireless standard and
third-generation (3G) wireless phones. SST is currently working with Qualcomm
(NASDAQ: QCOM - news) and Samsung on chipset and handset solutions,
respectively, for the cellular phone market, which only represents about 2% of total
revenue to date.
Nonetheless, we remain firm on our admittedly controversial downgrade of SST shares
for now.
Remember, we first recommended SST on 3/10/99 for our April 1999 Special Situations
Report newsletter at just $3.06 a share. SSR subscribers who invested in SST then have
hauled in a whopping 2,643% return in the 17 months leading up to our downgrade on
July 6, at $83.94 a share.
In addition, SST was recommended for this year's Magic25 portfolio back on
November 9, 1999, at $23.75 a share - a 253% return in eight months.
To put it simply, the risks just seem to outweigh the potential rewards to leave these
kinds of profits on the table at this juncture.
It's nothing personal.
Recommended on 12/11/99 at $37.50
Updated on 7/24/00 with SSTI at $76.25
(The Magic 25 is a diversified portfolio of stocks that Individual Investor believes will
outperform the market over the course of the year. In 1999, the Magic 25 portfolio was
up 79.3%. On average the portfolio has risen 31.6% annually.) |
