Monday, July 30, 2007

RACK is Back: Rackable Gets Nose Up

As I've reported in the past (See my RACK page) in 2005 Rackable Systems was a small but rapidly growing company taking market share mainly from Dell, HP, and Sun. When they got big enough to be noticed, in 2006, they found themselves being underbid on contracts for their racked Internet server systems. This led to a nasty dilemma: bidding low enough to keep building market share meant losing money on a deal. The situation hit bottom in Q1 2007 with revenues sinking to $72 million, the lowest since 2005, and losses of $0.36 or $0.13 per share, depending on whether you prefer GAAP or adjusted accounting.

On Thursday Rackable reported that Q2 2007 revenues had risen sequentially to $82.2 million, though that was still down 7% from year-earlier. GAAP EPS was a loss of $1.42, but non-GAAP EPS worked out to $0.02.

Better still, much of the GAAP and even non-GAAP expense was non-cash. In Q2 cash and equivalents increased by $10.5 million, ending at $180.6 million. That is an astonishing 53% of RACK market capitalization today.

There is a new management team in place, too.

One drag on the quarter was a $20.6 million write-down of obsolete inventory. This had to do mainly with two issues: DDR1 memory becoming obsolete more quickly than expected, and the shift towards Intel CPUs, leaving some AMD components (not necessarily AMD processors) dead in the water. That sounds like bad new for AMD, but management pointed out that the new Barcelona chips are being certified this quarter and interest in them appears to be strong. Rackable had a successful collaboration with Oracle and is also introducing servers ready for virtualization in Q3.

Management expects growth to accelerate in the second half of 2007 and to be in the black on a non-GAAP in the second half of the year. GAAP gross margins should turn positive as well.

Storage revenues increased to 10% of the total; this is a relatively new area for Rackable. They also have not done much on the international front, with only 6% of sales outside the U.S.

They continue to differentiate their product in order to prevent Dell and HP from undercutting them with pricing. They are integrating their RapidScale technology into new products and hope to see some results from that as well.

They are optimistic enough to be hiring sales staff and already increased their engineering headcount by 20%. The resulting increase in operating expense will make the nut needed for profitability bigger, but management realizes they have little choice but to grow or fold.

It is too early to confidently bid up the stock price, which only about 50 cents above its 52-week low. However, with one more quarter of increased revenues and increased EPS, I think current investors will see renewed interest in this innovative company.

More data:

Rackable investor relations page

Thursday, July 26, 2007

Is Celgene Undervalued?

It is good to have some good news on a day the stock market is tanking; a little while ago the Dow was down 300 points.

Celgene reported robust revenue growth this morning for Q2 2007. This biotechnology company saw an 18.6% growth in revenue in a single quarter. Using year-over-year comparisons, revenues are up 76.4%.

Celgene is in a sweet stage. After years of work getting its cancer drug Revlimid, currently approved for multiple myeloma, discovered, tested, and approved, sales are going wild. And it is a good thing: this is not some marginal cancer drug, it has very real benefits for patients.

Some investors and analysts were concerned that Revlimid would simply be substituted for Celgene's (now) number 2 drug Thalomid. But Thalomid is maintaining sales while Revlimid sales grow rapidly.

The great thing is Revlimid sales are very likely to continue to grow quickly. The next spurt will come as it is sold in Europe; it received approval for that recently. Sales outside the Europe and the U.S. will come on line next, funding growth in 2008.

Physicians and patients seem to like the drug, so it will be moved up in the regimen (used 2nd instead of 3rd or 1st instead of 2nd). Meanwhile a huge array of clinical trials are being conducted or are planned for using Revlimid with various other drugs and on other forms of cancer. Revenues for this are not guaranteed, of course, but many preliminary results look good, so we could see further expansion of use in the 2009 to 2012 time frame.

Further out there is a pipeline that includes two limid class candidates as well as a class of anti-inflamatory agents.

This is a high-multiple biotechnology company so there are the usual risks:

Another drug, from another company, could become preferable to Revlimid.

Used on larger populations of patients, some safety concern could arise that was not seen in the clinical trials.

Another thing to note was that GAAP EPS was $0.13 (on net income of $54.9 million), a drop of 1 cent from Q1, but up from just $0.03 a year ago. This lack of sequential EPS growth was because of SG&A (marketing) spending needed to get everything in place to sell the drug in Europe. Of course the company also continues to spend a fair amound of money on R&D.

Against that the company gained $207 million in cash in the quarter. That is over three times reported net income, showing that many of the expenses leading to the EPS were non-cash.

I own a bit of this stock and plan to accumulate it if the price does not go up too quickly.

For a more detailed account see my summary of todays Celgene analyst conference.

More data: Celgene Investor relations page

Wednesday, July 25, 2007

Semiconductors Mixed, but Texas Instruments Rebounding

When Motorolla (MOT) warned of disappointing results, and then turned in revenues that were sequentially down 7.5% and down 19% from year earlier, it created some profound worries about the health of the semiconductor industry as a whole. [See my 7/19/2007 MOT summary] Now that more companies have reported, in particular Texas Instruments (TXN) on Monday, July 23rd, it seems that on the whole the industry is not in bad shape. The inventory correction from the second half of 2006 does seem to be over, although different companies are coming out of it with different timings.

A lot of detail about the industry can be gleaned from the TXN analyst conference held July 23. Texas Instruments revenues were also down, in this case 7%, from the year-earlier. But they bounced up 7% on a sequential basis and hit the midrange of management guidance. They said they turned away some unprofitable business at the low end of the cell phone market. Motorola, of course, makes cell phones; their failure to be able to market low end phones profitably really hurt them. Texas Instruments makes parts for the phones; that is working out better, at this moment. Orders were up 8% sequentially, inventories are in good shape, and 3G (high-end) mobile phone demand is growing. In order to meet the demands of the low-end market TI has brought out LoCosta (yep!) integrated cell phone chips that should start generating revenue in 2008.

Keep in mind that Microchip warned that it would only grow 2% sequentially, Xilinx was only up 1% sequentially, Altera was up 5%, AMD and Intel had mixed results. To me the overall picture is one of recovery with a real possibility of relative strength in Q3 due to the leanness of inventories. As individual companies win and lose contracts or consumer interest there will continue to be a lot of volatility against the general trend. This is particularly true of semiconductor chips used in the telecommunications sector. Right now analog chip design needs seem to be growing at a faster pace than digital; getting all these communications protocols right seems to be tougher than moving forward in digital processing.

In fact, it is time to start worrying about 2008. I believe that growth is going to be good due to continued rapid expansion in Asia and healthy expansion in Europe. The United States market is still a concern due to issues outside of semiconductors, notably housing, employment, and consumer willingness to spend.

More data:

Motorola investor relations page
Texas Instrument investor relations

Monday, July 23, 2007

Xilinx Looks to Future Products

Xilinx (XLNX) has a dissappointing Q2 (fiscal Q1 2008) 2007. Revenues were up just 1% from Q1, to $445.9 million. That is down from 7% from $481.4 million year-earlier. As part of its April 25, 2007 analyst conference management had given a guidance of a 1% to 5% sequential revenue increase.

What is going on? Are programmable logic devices (PLDs) becoming less relevant? Or is one of its competitors gaining market share?

Even at the current level Xilinx is profitable. It had net income of $84.3 million, which is actually up 2% from a year earlier due to cost-cutting measures. Diluted EPS was $0.28, up 17% from year-earlier largely because of a reduced share count from share buy backs.

This time around, at the July 19 analyst conference, management guided to flat to slightly down revenues for this new quarter. Partly this is normal seasonality; Europe essentially shuts down for much of the summer.

Management said they failed to reach their expectation because of weak European demand. This is somewhat odd because other companies, and general economic indicators, have shown Europe to be doing well.

Xilinx is known for its large scale PLDs known as FPGAs and CPLDs. 45% of their revenues in fiscal Q1 were in the Communications sector. Communications spending has been eratic for years.

New products are being shipped, notably the Virtex-5 line. Management is hoping these will help gain market share as the year goes forward.

A big rival of Xilinx is Altera. They will be releasing results after the market closes today. I'll be listening to the analyst conference and posting my notes (follow this link) at OpenIcon.

It is hard to tell but PLDs compete to some extent with custom-designed chips and off-the-shelf components. If Altera sales were also weak, it might indicate at least a short-term shift.

More data:

My Xilinx page (includes links to past analyst conference summaries)
My Altera page
Xilinx Investor relations page
Altera Investor relations page

Saturday, July 21, 2007

AMD Ambitions Still Burn

A humbler but unbowed AMD management reported Q2 2007 results to analysts on July 19 and answered questions. There is no doubt that AMD is on the ropes and Intel, just 3 years ago a complacent, fat, slumbering giant, is wide, awake, mad, and pounding the hell out of them. But that does not mean that AMD investors are out of the money in the long run. At least there is a referee now; Intel's mafia-goon tactics from the 1990's are being watched by courts and regulatory agencies around the world.

Despite Intel's bluster at its own analyst conference on Tuesday (see my detailed summary), it appears that AMD actually gained overall market share again in Q2. We'll have to wait until independent results are released to be sure.

But there was a lot of bad news at the AMD conference (see my detailed summary). Earnings were highly negative at a $600 million loss or $1.09 per share. Even if you pull out $130 million in one-time charges, they lost $470 million in the quarter on revenues of $1,380 million.

They also wrote off $30 million in obsolete processor inventory. What I believe happened is that they sold a lot more obsolete stock that went into low-end desktop and notebook computers. Given the price war between AMD and Intel, even up-to-date stock may have been sold at less than the cost of production.

So are the folk at AMD committing suicide? Maybe not, but they are taking a gamble. Intel has immense depth in resources; they are far more able to play the price war game than AMD. In 2005 that was okay, because AMD processors were acknowledged as superior in the industry. But in 2006 Intel brought out a new generation of processors that are roughly on par with AMD, so pricing became a serious issue. Intel in Q2 2007 had almost as much net income as AMD have revenue, making it seem like back in 1997 when AMD was allowed to live only so that Intel could not be accused of being a monopoly.

Now the good news for consumers and maybe even AMD investors: blood still flows in AMD veins. Management still plans to beat Intel in the long run, and it is still a credible story. You see this in three areas: the release of Barcelona processors due this quarter; the minimization of layoffs; and the coming push at the graphics market.

Intel now has a long history of spending a lot of money to convince people that its processors are wonderful, but doing inelegant engineering that does not really serve the end customers well. AMD continues to take a different approach: they are relatively quiet about their upcoming processors. Because, I believe, secrecy serves them well: if they announce what they are doing, the engineers at Intel will start copying them. Like they did with the transition to 32/64, with dual core, with energy efficient chips, and with on-chip memory controllers.

Lots of IT departments and consumers still have not bought anything with an AMD chip in it. Some people are just conservative, or own Intel stock. They did not by Opteron server processors or Athlon desktop chips when they had a clear lead on performance, performance per price, and performance per energy use. Some people are just going to stick with Intel.

But Toshiba, one of the last holdouts, is now offering computers based on AMD processors. AMD would not say exactly how much impact this had on Q2 revenues; I suspect almost none. Most Toshiba notebook and desktop pcs will still run on Intel chips, but it is still a gain for AMD and a loss for Intel.

In fact the PC makers like having two sources to play off against each other.

Intel laid off 12,000 employees in the last year; AMD has laid off some 500. Intel cut fat, which is good for everyone except the fired employees; AMD can only cut lean, so it is trying to do no cutting at all.

AMD is also in a tough fight with NVIDIA. AMD bought NVIDIA's traditional rival, ATI, which was doing poorly in many ways, and which has been a major factor contributing to AMDs recent string of losses. But again, there is reason behind this short-term madness.

AMD only made computer chips (and memory, but it divested that) in the past. There can be benefits to specialization, but we are in an era of consolidating more function into less silicon. ATI makes "chip sets" as well as graphics chips. Chips sets are the glue on computer motherboards. Intel was already making processors, chipsets, motherboards, and low end-graphic chips. Now AMD has a full set of solutions for computer assemblers. At the same time AMD has made it clear that it will keep its solutions "open" so that they will work with chips from NVIDIA and other makers. Computer manufacturers can make the best design for their customers.

If you don't own any AMD stock I would not advise buying any at this point unless you like a very high risk factor. I own AMD stock. But take a good look at Barcelona when it comes out; that is the real key to the short-term value of AMD stock.

Wednesday, July 18, 2007

Intel An Indicator for AMD?

Yesterday Intel (INTC) reported results for Q2 2007. Tomorrow rival AMD (AMD) will report results. What was only a few years ago a battle between a David and a Goliath has settled into a a long war between two giant companies (with Intel still being several times larger than AMD by any measure).

Despite the enormous progress AMD made between 2002 and 2006, becoming the clear technology leader and gradually eating into Intel's overwhelming market share, AMD investors are little better off than they were a few years ago. Long-term relationships are hard to sever; just when AMD looked like it had done the job in 2005, Intel finally was nearly ready with new microprocessor technology that had similar capacities to AMD's (and Intel fans claim its chips are superior). And let's face it: AMD got cocky too early. They bought troubled graphics maker ATI at about the same time that Intel introduced its Core Duo processors; they failed to maintain a clear lead in technology.

Intel's not very secret weapon was, and is, being ahead in fabrication technology. This is usually referred to by the scale of the lithography used, with smaller being better. Thus when Intel had 65 nm (nanometer) chips, AMD was still using 90 nm. Now that AMD is using 65 nm, Intel is ready to introduce 45 nm, which AMD won't be able to match until late in 2008. Smaller scale means more transistors (or gates) per chip.

All this meant that the inefficient processor design that Intel had evolved over two decades was able to keep roughly on par with AMD's better design (notably its on-chip memory controller). In Intel's defense it has to be said that rather than staying with the legacy designs it had planned to move to the all 64 bit Itanium processor, which is a great piece of technology that never caught on because of the enormous task of re-writing computer programs to work on it. AMD's scheme to evolve towards 64 bit processing (using chips that can run both 32-bit and 64-bit software) eventually had to be copied by Intel.

In 2006 and into 2007 profits for both companies plunged as they competed on price as well as technology. AMD has to gain market share or it will not be able to make the investments it needs to stay ahead of Intel in this race. Intel needs to defend its market share. As a result PC makers and end customers have gotten great deals on processors.

Yesterday Intel's revenues were down sequentially, but well up from its disastrous Q2 2006. It has been doing well selling pseudo quad-core server chips. AMD made the mistake of waiting until it could bring out true-quad core chips, which should happen in Q3.

The mid term future (6 months to a year) value of AMD versus Intel depends heavily on how good AMDs new chips are. As with all complex technologies, there will be room for differences of opinion. As has been the case in the past, Intel's vast advertising budget will mean that most reviewers will give Intel at least the benefit of the doubt on any issue. Also, the Intel chorus will sing "Don't buy AMD, wait until the next generation of Intel" loud and sweetly, a ploy that has worked well thus far.

You can read my detailed summary of the Intel results and analyst conference at Intel July 17, 2007.

It is generally believed that tomorrow's AMD results will a continuation of a disaster story, if possibly not quite as bad as Q1. You might want to read up on my summary of AMD's Q1 results and conference.

It is possible, given Intel's report, that AMD did better than expected in sales of low-end notebook and desktop chips. This is not necessarily a good thing. It keeps AMD market share while AMD waits to introduce new high-end products, but it may mean bad margins and lower than expected earnings (already expected to be deeply negative).

Intel did well with its quad-core server chips; that might really hurt AMD. Its dual-core Opteron servers had been the mainstay of its profitability.

Another thing to look for tomorrow is how well its graphics chip division (formerly ATI) did. NVIDIA has been kicking ATI around for a couple of years now. AMD has promised a turn around, but I doubt they were able to accomplish that in Q2.

If you don't own Intel or AMD already (I own AMD) neither stock looks like a solid bet right now. AMD's low stock price may be attractive, but as long as the processor price wars continue, it is the stockholders of Sun, HP, Lenovo and Dell that will benefit.

More data:

My Intel page
Intel Investor relations page
My AMD page
AMD Investor relations page

Monday, July 16, 2007

Intel, AMD and Motorola: How Good Is Guidance?

This week earnings season begins in earnest. Among the semiconductor chip stocks I follow Intel (INTC), AMD (AMD) and Motorola (MOT) will be reporting second quarter results and holding analyst conferences.

Motorola already warned that things were not going to be good. Their July 11 Press Release estimated revenues at between $8.6 and $8.7 billion and GAAP earnings from continuing operations to be negative $0.02 to negative $0.04 per share. After Q1, at the Motorola April 18, 2007 analyst conference (See my MOT summary) management projected Q2 revenues to be about flat at $9.2 to $9.3 billion, with GAAP earnings negative $0.07 to $0.09 per share. Apparently missing on revenues actually saves them on lost earnings. Apparently cell phone handsets are not selling well, and unlike Apple, there is not a healthy margin built in for Motorola. Management will be clarifying all this (or maybe obscuring it) on Thursday, July 19, at 7:30 AM Eastern Time, which is at 4:30 AM here. I don't earn Motorola stock or cover it for a client, so I'll probably sleep in and catch the taped replay. I do own Marvell, which is about to compete in the high-end cell phone microcomputer market, which has me worried.

Intel reports Tuesday at 1:30 PM Pacific Time (See my Intel page for summaries). They have an easy year-over-year comparison because last year they were still at the losing end of their battle to retain market supremacy over AMD, retaining share with inferior products mainly through price cuts. Since then they brought out Core Duo processors and spent truckloads of money advertising at sites that review PC's, so their reputation and revenues have climbed. They were ahead of AMD in changing to smaller (in 2006, 65nm) technologies, so when they did succeed in imitating some of AMD's inovations, they managed both a cost and overall technology advantage. Tuesday will be about how well they did and what their road plan is for crushing AMD in the future.

AMD reports Thursday at 2:00 PM Pacific Time (See my AMD summaries page) and management will doubtless mix pain with optimism. AMD has actually done well these last 5 years, but comparisons with 2006 are going to be very bad. In addition to Intel finally making some decent processors, in 2006 AMD bought graphics processor maker ATI, which was failing to keep up with rival NVIDIA. The costs of this acquisition are still showing up and everyone believes AMD has lost market share to Intel while having to sell processors at unhealthy margins. The only good news for Q2 is if the distribution problems we saw in Q1 got fixed. If they did, and if the newest Opteron technology is really going to ship in Q3, the stock may move up on optimism about the future. I own AMD stock and after calling things right in 2003 to early 2006, was overly optimistic this last year. So I am not expecting much at this point.

On the software side we will also hear from Yahoo (YHOO) on Tuesday, then Google (GOOG) and Microsoft (Microsoft) on Thursday.

More data:

Mototola Investor relations page
Intel Investor relations page
AMD Investor relations page

Thursday, July 12, 2007

Genetech's Pipeline

Genetech (DNA) blew past most people's expectations with its Q2 2007 report on July 11th. Pundits feared that a need to add a warning about possible allergic reactions to Xolair, combined with the results of a study saying that a lower dosage of Lucentis may be as effective as the recommended dose, would take the wind out of Genetech's sales. But Xolair sales grew from $111 million in Q1 to $120 million in Q2, and Lucentis sales were only off to $209 million from $211 million in Q1. Overall revenues were up 7% sequentially and an amazing 37% from Q2 2006.

There have also been questions about whether growth can continue without a stronger pipeline. Note that today Genentech's P/E ratio was 33 (per Nasdaq); while typically a company growing revenues at 37% per year would have a higher PE ratio, it still assumes growth will be strong over the next few years. Biotech pipelines are the stuff of long waits: from the beginning of a Phase III trial to first revenues (presuming the drug does not bomb out, which many do) can take years (3 is about the minimum). As to drugs entering Phase I trials, you are looking closer to a decade out.

Genentech, however, has some successful drugs that can generate more revenue through label expansion. Companies often seek very narrow indications for approval, especially of cancer drugs. You don't get approval for "breast cancer;" you get approved for some very narrow subtype of breast cancer, or lung or liver or whatever form of cancer. But once you have that, if it looks like your drug is more broadly applicable, you go back and do trials on closely related indications. In Genentech's case it is seeking label expansion for Herceptin, which is currently approved for "metastatic breast cancer in HER2 overexpressed tumors; as part of a treatment regimen containing doxorubicin, cyclophosphamide, and paclitaxel, for the adjuvant treatment of patients with HER2-positive, node-positive breast cancer." It has completed Phase III trials and has applied to the FDA for approval in "in adjuvant HER2-positive breast cancer," which means in a less specific regimen than the current label. In another Phase III study it was combined with Avastin; and other varieties of Herceptin Phase III studies have been initiated.

Genetech is awaiting FDA action on its submission for Rituxan for Rheumatoid Arthritis (RA) and is preparing a submission for Avastin for first-line metastatic renal cancer and first-line metastatic breast cancer (first line means used as a first therapy; second line means using after a different therapy has failed to halt the progress of the disease). Rituxan already had $582 million in sales in Q2 for the indications it is already approved for.

Such is the size of Genentech's pipeline that this article could become quite a hefty volume if I discussed each pipeline drug in even minimal detail. So instead I will point to a different category: drugs that are not yet generating money for Genentech. These drugs can be anywhere in the clinical trial timeline from Phase I to Phase III. Keep in mind that each phase can take years; ten years from the beginning of a Phase I trial to approval by the FDA is not unusual. Also the field narrows as you go through trial sets; as a general rule you might want four or five candidates entering Phase I to get a single approved, marketable drug.

At the top of the list, in Phase III, we have Ocrelizumab, an anti-CD20 humanized monoclonal antibody. What that means is they are hoping to cure diseases caused by the human immune system attacking the human body. Phase III trials in rheumatoid arthritis have started and Phase III trials in lupus nephritis, systemic lupus erythematosus and relapsing remitting multiple sclerosis (yep, that is what the President had in West Wing) are planned.

At the base of the pyramid we have a slew of Phase I candidates. There's a bunch more anti-CD20 drugs. There are drugs for solid tumors, myelomas and lymphomas, anti-IFN apha for lupus, a variety of cancer therapies with strange designations, PARP inhibitor for malignant melanoma, and a systemic Hedgehog antagonist (Hedgehog is ... well, another time).

The picture I am painting here looks like this to me: a varied and in-depth pipeline covering the spectrum from Phase I to Phase III. Lots of earning potential just from adding to the labels of current successes.

So I think the PE ratio of 30 is a bargain. Genentech management plans to continue to invest heavily in R&D. They are also not shy about buying a drug from another company when they think it has potential. They kept saying they are looking for drugs that will be first in class (the first approved for a disease) or best in class (better than anything already on the market).

I don't own Genentech, but covering the company makes me want to buy some stock. Before you make any decision I suggest, at minimum, you read my summary of the Q2 2007 analyst conference that took place July 11th.

More data:

Genentech Investor relations page
Genentech pipeline page
My Biotechnology Investor Research Help page

Tuesday, July 10, 2007

Marvell Releases 10-Q with Fiscal Q1 2008 Results

Marvell released a 10-Q giving its results for the quarter ending April 28, 2007 (Fiscal Q1 2008) yesterday. In the press release of Q1 results, and at the analyst conference (See my summary), only the revenues had been reported due to the ongoing stock option accounting restatement. The filing of the 10-Q confirms that the process is complete and accounting issues have been resolved.

If you have been following the Marvell story the 10-Q confirms what has been broadly guessed. Revenues were $635 million, up 2% sequentially from $622 million in Q4 2007 and up 22% from $521.2 million for fiscal Q1 2007. This annual increase of revenues was largely due to two major acquisitions, Intel's XScale division and Avago, a specialist in chips for printers.

Also mainly due to the acquisitions earnings swung from a healthy profit of $77.6 million year-earlier to a substantial loss of $52.9 million. This was expected because the larger acquisition, XScale, was losing money when acquired and is not expected to become accretive to earnings until calendar 2008.

Cash from operations was $54 million, up from $47 million year-earlier. Contrasting this with the GAAP earnings shows that many of the charges against earnings were non-cash.

The real question is, what does the future look like? The XScale processors are meant to compete in the high-end cell phone market. They were not chosen by Apple for the iPhone, though at least one chip by Marvell was. However, even under Intel the revenues from XScale were growing at a good pace. By combining the XScale processor with other highly-regarded Marvell analog and digital components, it is possible (but not guaranteed) that traction will be good. By increasing XScale revenues and decreasing production costs through outsourcing, Marvell expects to make the XScale business profitable some time next year.

XScale is not the only trick Marvell has to pull off. It did so well in creating chips that go in disk drives that it seems unlikely that it can gain much more market share there, and that market itself is not growing quickly. So Marvell is pressed by the need to innovate, winning share in other markets and entering new markets. One area of optimism is chips to improve performance of high-definition displays.

The main danger for Marvell, other than a macroeconomic downturn, is failure to expand XScale revenue. For now Intel is producing the processors and Marvell is obligated to buy them even if it finds itself unable to sell them.

More data:

Marvell investor relations page
My Marvell (MRVL) page

Tuesday, July 3, 2007

Marvell's New Clothes

Marvell (MRVL) is one of the many technology companies that has been under a cloud due to stock option dating issues. The cloud for investors, in most cases, has not been so much the risk of an SEC investigation or related train-wreck scenarios. Rather, while the companies do their accounting restatement investigations they do not release information that make informed investing possible. They do not release earnings; they don't file 10-Q's or 10-K's with the SEC.

On July 2nd Marvell made some of its tardy filings with the SEC. They had already announced the completion of their restatement investigation back in May. The filings included a 10-K covering fiscal 2007 through January 30, 2007. The most recent 10-Q was for fiscal Q3 2007. What we really want to see, of course, are the numbers for the quarter (Q1 2008) that ended April 28, 2007 (See my summary of the May 17 analyst conference for what we know so far).

Still, there is a lot of grist for analysis in the 10-K. For starters, for all practical purposes Marvell made no profit for its year. Out of annual revenues of $2.24 billion (well up from $1.67 billion in fiscal 2006), it lost $12 million, or $0.02 per share. In 2006 it had profits of $199 million, or $0.32 per share.

Time to flee the stock? Sorry, too late. The share price topped out at over $38 back at the beginning of 2006; it ended today at $18.32, and has been as low as $15.25 this year.

Let's try another reality check, since revenues have risen rapidly while earnings have fallen. What happened to cash?

In fiscal 2007 net cash provided by operating activities fell, but not as precipitously as earnings. It was $402 million in 2006, then $337 million in 2007. There was a serious cash outflow, but it was for acquisitions, not for operations.

Marvell made two big acquisitions in 2007: Avago (chips for printers) for $262 million in May and Intel's cell-phone (XScale) microprocessor division for $600 million in November. These acquisitions had serious one-time costs and the Intel division in particular had major ongoing net losses when it was transferred.

Marvell also acquired UTStarcom in February 2006 for about $40 million. According to a neat little chart on page 126 of the 10-K, the acquired businesses, if they had been bought at the beginning of fiscal 2007, would have created an overall loss of $475 million for the year, while bumping up overall revenue to $2.6 billion.

Are these guys stupid? Did the people who created Marvell out of some analog chip designs and built it to a $1 billion business in a few years lose their minds? I don't think so.

They did load up heavily on risk. A good way to get a sense of risk, which is mainly from the Intel purchase, is to use your find function on the 10-K with "Intel" as the search string.

To get back to being heroes for their stock holders Marvell employees have to turn the acquired companies to profitability while continuing to grow their more established business lines. The big bear here is the XScale application processor. Under Intel its revenues were growing, but R&D costs were high compared to revenues, resulting in division losses. Marvell intends to move production from Intel's fabs to its fabless (outsourced) model by mid-2008. That will allow some cost reductions. But mainly Marvell has to rapidly increase sales while keeping prices firm.

These XScale processors go mainly into high-end (3G) cell phones and combine well with Marvell's analog technologies. So Marvell has bought into the cell phone market in a major way. But many other firms, like Texas Instruments and Motorola, are also gunning for the high-margin, high end of that market. The market is expected to grow rapidly, spurred on by the introduction of the iPhone.

Do I know if Marvell can succeed in this market? No, I just don't know. They have a great track record. If they can ramp the XScale business and decrease costs, today's stock price may look way low a year from now. But if XScale tanks, which is a distinct but hard-to-quantify possibility, then today's stock price will seem to have been based on optimism, not solid value.

I own Marvell stock, but I acknowledge the future is hard to see. It would really help if management would break out revenues and costs by division at the next analyst conference.

More data:

Marvell investor relations page
my Marvell page