SSTI--individualinvestor.com
Magic 25: SST Blows Away Third-Quarter Estimates
Research Analyst: Christopher Conry (10/16/00)
Silicon Storage Technology Inc. (NASDAQ: SSTI - news) preannounced an exceptional third quarter back on September 26, with management indicating that revenue would increase more than 45% sequentially, well above previous guidance of 25%. At the time, management also said that earnings would come in at more than $0.35 a share, well above the then-prevailing consensus estimate of $0.28.
As is the case with most preannouncements, SST left some room for additional upside when the final report was released late last week. In the third quarter, revenues climbed 59% sequentially, to $163.7 million, while earnings rose 54% to $0.37 per share on the same basis.
But once again, investors greeted what appeared to be another excellent quarter with a fairly lukewarm response.
It's hard to find fault with the numbers. Third-quarter revenues were equally strong across SST's four primary markets: digital consumer applications, networking, wireless communications, and Internet computing. Gross margins improved only slightly, but that was expected given management's previous guidance that the ramp-up of activity at a new facility would crimp margin expansion in the September quarter. And despite the short-term hiccough on the gross margin line, a large portion of the top-line growth did ultimately drop to the bottom line.
In addition, royalty revenue from the licensing of its SuperFlash technology appears to be accelerating. Management alluded to strong royalty upticks through foundry relationships with Sanyo (NASDAQ: SANYY - news) and Taiwan Semiconductor (NYSE: TSM - news) , the latter of which has more than 50 customers using SST's embedded flash design. SST anticipates that licensing revenues will reach $30 million next year, roughly doubling this year's expected tally.
SST also recently settled a patent lawsuit, confirming that Winbond, a Taiwanese electronics manufacturer, must pay past due and ongoing royalties to use SST's SuperFlash technologies, which should further bolster the company's license-revenue stream.
SST is showing a strong and growing presence in the PC BIOS market, which includes sales of its 4Mb chipsets, based on a licensed Intel Corp. (NASDAQ: INTC - news) design, to PC mother board makers. Shipments shot up almost tenfold, to 4.8 million units from just 0.5 million units in the second quarter. What's more, management makes no bones about its designs on being the world's number-one PC BIOS supplier. Their goal is to roughly double SST's market share, from 25% to 50%, in 2001.
Unfortunately for SST, it all comes down to the goings-on in the markets around it.
For one, prices for flash memory across many types and densities have been dropping sharply. As we noted in our recent report on the flash memory market, over-optimistic forecasts for wireless handsets, which generate one-third of total flash memory demand, appear largely to blame. A combination of lower-than-expected handset replacement rates and key component shortages has driven worldwide unit-shipment forecasts to between 410 million to 420 million, from earlier estimates of 500 million in 2000, and to about 550 million for 2001, markedly lower than expectations of 600 million to 650 million published earlier this year. As a result, it appears that handset makers are sitting on an excess supply of flash chips, which is wreaking havoc on sales and pricing.
However, SST is not directly affected by the surplus, as it only generates 1.5% of revenues from cell phones. The concern is that competitors who abandoned the company's low-density flash niche will return in an attempt to keep pace with growth and profitability targets, a situation that existed in the last two semiconductor down markets.
In addition, it appears a substantial slowdown in PC sales may take place over the next year. Earnings warnings from PC chip giant Intel, along with boxmaking giants Dell Computer (NASDAQ: DELL - news), whose stock price is currently establishing new 52-week lows, and Apple Computer (NASDAQ: AAPL - news) all cite an ongoing slowdown in traditional PC sales. While SST's chipset sales are not directly affected by Intel's current woes, forecasts of about 9% PC revenue growth in 2001, compared with rock-solid annual growth rates of 17%-18% for the past 10 years, will likely mute SST's near-term ability to fully exploit opportunities in the PC BIOS market in terms of both pricing and market share.
There also appears to be uncertainty over which primary technology will become the standard for next-generation electronic devices. SST generates over 90% of revenues from low-density NOR-type code storage flash, used in a host of simpler communications devices. It's uncertain, however, if NOR flash will remain a primary component going forward, or if the newer mass-data-storage NAND-type flash, which often contains some NOR flash, will become the new dominant standard.
SST has done well to develop a number of new products based on its proprietary flash technology, in an attempt to decommoditize its business from one of merely chip sales. It's difficult to ascertain how well SST will hold up against a new wave of capacity due to come on line in the second half of next year, and if its newer ``combo flash'' (NOR flash and SRAM) and NAND products will gain critical market traction to compete effectively.
This all leads to the most daunting question - is the global economy in the early phases of an extended cooling period? If it is, in fact, the case, sales for end-products like digital music players, PDAs, digital cameras, and others would probably slow along with, and affect, the entire semiconductor sector.
Management expects SST to earn approximately $2.90 a share in 2001, which would translate to a price-to-earnings ratio of just 7.6 based on the current share price of $21.81. However, it appears that investors have priced in the broader-market concerns mentioned above, and SST's own admission that supply and demand for its flash memory products may reach equilibrium in about 12 months.
The best possible scenario for SST would be that current flash market conditions is in the midst of a market correction, based on severe foundry capacity shortages, which is crimping the ability of key end-product makers to produce sufficient supply quantities. If so, the entire semiconductor industry may soon enjoy one more substantial wave of buying across the board. As a result, SST's business and stock price would surely benefit.
But until the longer-term direction of SST's markets becomes more evident, we remain cautious on the near-term prospects for the stock, and reiterate our ``sell'' rating.
Updated October 16, 2000 with SSTI trading at $21.81.
Recommended December 10, 1999 at $12.50.
(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.) |
