PMC-Sierra Growth Questioned

PMC-Sierra Inc. (Nasdaq: PMCS) stock was down 25 percent today as unsteadiness in the passive optical networking (PON) market is opening up questions about the company's growth prospects.

On its earnings call yesterday, PMC noted that revenues from Passave, the PON chip vendor acquired in May, will drop next quarter, to $13 million compared with $16 million the previous quarter. (See PMC Preps PON Plans.)

Small numbers are a big deal here, because Passave was expected to be the growth engine for PMC, according to Stanford Group analyst Tim Kellis, who downgraded PMC to Sell from Hold this morning.

"We had been concerned about the lack of growth within the legacy business and the new storage business, but this was supposed to be offset by the growth in the Passave business unit," Kellis wrote in his report.

PMC shares closed down $1.84 (26.36%) to $5.14 today, a startling drop even to Kellis. "I didn't think the stock was ready for a 25 percent haircut," he told Light Reading. It didn't help that the Nasdaq was making a new 14-month low.Kellis notes that PMC's original business -- telecom chips -- is generally on the decline, as the company didn't join the IP/Ethernet bandwagon in time. And he has doubts about the storage products acquired from Avago Technologies Pte. , as he thinks PMC still lags in the serial attached SCSI (SAS) and serial ATA (SATA) markets. (See PMC Bites a Bit of Agilent.)

That left PON as PMC's great hope -- but now, that's hit a stumbling block.

The problem comes from Japan, where NTT Communications Corp. (NYSE: NTT) wants to use fewer optical line terminals (OLTs), the boxes that sit on the central-office side of PON connections. NTT has been deploying roughly one OLT per four subscribers but wants to use a one-to-eight ratio -- resulting in fewer OLTs in the short term, PMC CEO Bob Bailey said on yesterday's earnings call with analysts. "We had not anticipated this lower level of activity from Japan earlier in the quarter," he said.

What worries Kellis is that this kind of thing keeps happening. Passave's revenues have bounced around in the range of $10 million to $16 million per quarter for most of the past two years. So even though this past quarter was an all-time high, Passave isn't showing the straight-line growth path investors were hoping for.

On top of that, Kellis thinks competition from Centillium Communications Inc. (Nasdaq: CTLM) and Teknovus Inc. could eventually bruise PMC's PON business with NTT. (PMC sells PON chips to vendors like Mitsubishi Electric & Electronics USA Inc. , which sell PON gear to NTT.)"Those guys spent $300 million for Passave -- seven times revenues. When you spend that kind of money, you have to have a growth rate to justify it," Kellis says.

PMC remains unfazed, citing the overall growth trend for PON. "We are as excited about this business today as we were when we announced our intentions to acquire this business," CFO Alan Krock said on the call.

PMC had already taken a beating earlier this month, when it updated its earnings forecast. (See PMC Sags on Earnings Update.)

For its second quarter, which ended July 2, PMC reported losses of $31.3 million, or 15 cents per share, on revenues of $118.8 million, compared with losses of $14.3 million, or 8 cents per share, on revenues of $87.8 million the previous quarter. (See PMC Reports Q2.)

For its second quarter a year ago, PMC reported net income of $500,000, or zero cents per share, on revenues of $71.5 million.PMC's non-GAAP earnings of 9 cents per share matched the consensus analyst forecast reported by Thomson Financial .

PMC expects its third-quarter revenues to be between $122 million and $124 million. Analysts polled by Thomson were expecting $120.6 million.

Separately, PMC officials noted they're seeking a replacement for CFO Krock, who recently announced his pending retirement. (See PMC CFO Departing.)

Craig Matsumoto, Senior Editor, Light Reading