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PMC - Sierra, Inc. (NASDAQ:PMCS)

Signing of Definitive Agreement to Acquire IDT's Enterprise Flash Controller Business Conference

May 29, 2013 5:00 pm ET

Executives

Jennifer Gianola

Gregory S. Lang - Chief Executive Officer, President and Director

Steven J. Geiser - Chief Financial Officer, Principal Accounting Officer and Vice President of Finance

Analysts

Ruben Roy - Mizuho Securities USA Inc., Research Division

Harlan Sur - JP Morgan Chase & Co, Research Division

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Sundeep Bajikar - Jefferies & Company, Inc., Research Division

Betsy Vanhees

Operator

Welcome to the PMC conference call. My name is Adrienne, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Jennifer Gianola, Director of Investor Relations. Jennifer Gianola, you may begin.

Jennifer Gianola

Good afternoon, and thank you for joining us today to discuss our announcement of the definitive agreement to acquire IDT's Enterprise Flash Controller business. The press release announcing the transaction was issued after market close today and is available on our website at www.pmcs.com, along with a companion slide deck to reference during management remarks. With me on the call today are Greg Lang, President and CEO; and Steve Geiser, Vice President and CFO.

Before we begin, I would like to point out that during the course of this conference call, we will be making forward-looking statements, including statements regarding the expected benefits of the transactions to the company, market segment expectations and the company's plans for the acquired business that are subject to risks and uncertainties. Actual results and events may differ materially from these projections. The potential risks and uncertainties include, among others, that the transaction may be delayed or may not be consummated at all, the company may not successfully integrate the acquired business or its personnel, that relevant market segments may not develop as expected and that the company's offerings may not prove attractive to customers in those market segments.

During the call, there are also risks and uncertainties regarding any forward-looking statements that management may make in response to questions. The company's SEC filings describe factors that may affect the company's business and results generally, including PMC's limited revenue visibility due to variable customer demand, market segment growth or decline, orders with short delivery lead times, customer concentration and other items. The company does not undertake any obligation to update the forward-looking statements.

At the end of management's prepared remarks today, we will open the call up to questions. Thank you, and I'll now turn the call over to Greg Lang.

Gregory S. Lang

Good afternoon, and thank you for joining us on short notice. I'm very pleased to announce that we signed a definitive agreement to purchase the Enterprise Flash Controller business and certain PCI Express Switch assets from IDT. We believe that this acquisition is a game-changing event that will accelerate PMC's entry into the rapidly growing SSD marketplace and will position PMC as the market -- as a market leader in enterprise SSDs. I'd like to first summarize the key points of the announcement, then we'll provide more detail about the team and products we're acquiring, as well as the value we believe we can create for our shareholders. During our call, I'll be referring from time to time to the slide presentation that we posted to our website.

So on the announcement. Under the terms of definitive agreement, PMC will require IDT's Enterprise Flash Controller business and products, PCI Express Switch technology and intellectual property and approximately 75 patents related to both Flash controller and switch IP. Additionally, we will be offering jobs to approximately 50 employees, the majority of which are currently based in San Jose. This acquisition complements PMC's organic efforts in the 12 gig SAS Flash controller market segment and then accelerates our time to market in PCI Express Flash Controller segment by approximately 2 years, and that leverages a $40 million to $50 million R&D investment already made. The team, as we'll describe you today, secured several impressive design wins for their award-winning PCI Express controllers, and these wins are in marquee accounts that span the hyperscale data center, NAND vendor, SSD vendor and OEM customer basis. We believe this business will be a strong complement to our existing 12 gig SAS SSD controller offerings and a combination of newly acquired IP with PMC's existing storage IP will open up the potential to participate in new markets.

As most of you know and know well, there's a major disruption underway in storage driven by the increased use of Flash technology, perhaps the biggest in a decade. At the core, this disruption is a dramatic increase in performance that Flash memory of forward system designers when compared to traditional rotating disks, delivering about 2,000x performance in I/Os per second and 100x improvement in latency. You can see this dramatic performance improvement on Slide # 4 of the slide presentation. The NAND industry exploded with the emergence of the iPad, followed by mass adoption of Flash-based smartphones. It has continued to grow into the mobility space with the pioneering use of SSDs in notebooks and now the broader ultrabook segment.

In terms of market size, IDT projects the worldwide of SSDs to total more than -- to more than double from $6.7 billion in 2012 to $13.7 billion in 2016. Of that $13.7 billion in 2016, roughly half of the revenue is forecasted to ship into enterprise applications. These are the applications that map directly in the PMC's target markets, storage systems and servers, and we view this is a huge opportunity for us.

As you may remember from our last earnings call, we described how PMC has been winning business in hyperscale data centers segment of the server market. I'm now referring to Slide #5 of our presentation. This is by far the fastest growing segment of the server market, and PMC is directly participating in this growth through our silicon, as well as our Adaptec RAID controller solutions. We work closely with the architects and key engineers of these companies and noted the increasing interest in PCI Express base SSDs in server applications.

In x86 server architectures, the PCI bus is now directly fed into the CPU, allowing the shortest path to the processing units in the server, committing I/Os to experience the lowest latency when compared to other interface options. Consequently, we see hyperscale customers choosing to deploy PCI Express SSDs in an accelerating pace.

For traditional storage applications or external storage applications, we expect SAS SSDs to be the primary solution, as they address many of the traditional storage solutions challenges, such as hot plug ability, external cabling support, data protection and security features such as T10 DIF and encryption.

I'd like to now turn our attention to the position the IDT team has established in PCI Express SSD Controllers. I'm now referring to Slides 6 and 7 of the presentation. The team at IDT has a strong heritage in PCI Express switching and identified early the trend towards high-performance PCI Express Flash solutions and servers. They very effectively translated this activity into a time-to-market product advantage, delivering the world's first PCI Express NVMe Flash Controller, and we believe IDT has a 2 to 4 quarter lead over the nearest competitor. I'm pleased to say that I'm quite familiar with this team at IDT that design these products, and I can say with confidence that they are an exceptional team. They've been together for several years now building 3 generations of PCI Express switches and 2 generations of SSD controllers, working on their third generation as we speak. They have a deep understanding of high-performance controller design, complex SoC design, NVMe protocol design and also switching design, all critical competencies for building leading edge SSD controller products.

On the design win front, with great products should come an impressive list of design wins, and this team has delivered. As you can see on the Slide 9, they have secured design wins at 2 top tier NAND vendors, design wins with 3 branding SSD vendors and 2 Tier 1 OEMs, in addition to 2 very prominent hyperscale data center customers who are choosing to build their own PCI Express SSDs, and also 1 all-Flash appliance vendor. We're impressed with the list of wins, as well as the pipeline of new opportunities upon which the IDT team has actively working today, and we see this as an opportunity to converge our 12-gig SAS roadmap so customers can leverage one firmware investment across from both SAS and PCI Express Flash Controller segments.

Of that $7 billion enterprise TAM that I mentioned on Slide 10, we believe that PCI Express SSD segment of the market will occupy almost $3 billion. You'll see that most of the balance of the market will be consumed by SAS or roughly $2.5 billion.

At the silicon level on Slide 11, we believe that the total available market for enterprise SSD controllers, including SAS and PCI Express, is on the order of $0.5 billion by 2016.

Another key element of this purchase are the patents and intellectual property related to PCI Express Switches. While not the primary driver of the purchase, we feel that's extremely valuable to own the team and IP related to the PCI Express Switches as the world evolves to more and more PCI Express drives. As you may know, PMC is the world's leading supplier of switches that connect large numbers of SAS or SATA drives called SAS expanders. In the future, we see the need for PCI Express Switch with storage features like an expander. We feel the addition of these team in IP position PMC to be the world leader in the next generation of these PCI Express Storage Switches.

So in summary, we see the transaction we're announcing today as a 2-year accelerator for our roadmap of SSD controller products, expanding our presence into the PCI Express segment of the enterprise Flash Controller space, essentially doubling our market opportunity in that window. The acquisition brings to PMC award-winning product portfolio, approximately 75 patents covering innovations and Flash Controllers and PCI Express Switches, 10 design wins with marquee customers and a very talented team of individuals. In addition, we now have the opportunity to pursue market adjacencies with the PCI Express Switch assets included in the transaction.

In summary, our industry is in transition and the application of Flash memory storage architecture is creating a once-in-a-decade disruption. We feel this acquisition enables us to capitalize on this opportunity in a very strategic way, positioning PMC to be the category leader in the next generation of enterprise SSD controllers, creating value for our customers, as well as our shareholders.

At a company level, that provides PMC another major new product cycle for 2014. PCI Express and SAS Flash Controllers, 12 gig expanders and controllers, OTN and Metro networks and Radio Head solutions in the second half of 2014. We're excited to see these investments start to come to fruition.

And with that, I'd like to invite Steve to provide a few comments related to the financial implications of the transaction.

Steven J. Geiser

Thanks, Greg, and good afternoon, everyone. A few additional comments on the financial elements of this transaction as it relates to both the balance sheet and P&L. As Greg stated earlier, we have agreed to acquire IDT's Enterprise Flash Controller business, PCIe Switch technology and related patents for $100 million, subject to certain purchase price adjustments. To fund the transaction, we intend to access the attractive debt market to maintain operational flexibility. The acquisition has been fully approved by IDT and PMC's respective Board of Directors. We expect the deal to close in the third quarter of 2013, subject to regulatory reviews and other customary closing conditions.

Based on the current product status, we expect the new generation of Flash product to ramp late in the year. Combined with the first-generation ASIC, we anticipate incremental revenues in the range of $2 million to $4 million in 2013, but expect the revenue to be back-end loaded.

The Enterprise Flash Controller revenues, including both IDT's current design wins plus SAS, are expected to be in the range of $20 million to $40 million for the full year of 2014. There is no change to our Q2 outlook provided on April 25, 2013. In addition, we expect no change to our OpEx outlook for the second half of 2013. As a reminder, on our April 25 call, we said that we expect our quarterly expenses in the second half of '13 to be in the low to mid-$70 million range. We expect to absorb the added expenses of this transaction by offsetting our internal Flash Controller plans. We expect to provide additional financial guidance for the second half of 2013 during our quarterly earnings call to be held in July of 2013.

With this acquisition, PMC adds another major product cycle for 2014, which we expect will drive outsized growth in company revenues relative to the markets that we serve. At current market prices, we believe our company is undervalued, and we expect to aggressively repurchase our shares using the existing $150 million stock repurchase authorization.

In summary, we see this transaction as an exceptional opportunity to acquire a team that has established a market leader position in PCIe SSD controllers with a robust pipeline of design wins with marquee customers. And the addition of this business accelerates our revenue and time-to-market by about 2 years, roughly doubling our market opportunity in that window and providing excellent R&D leverage to PMC to serve the SAS and PCIe SSD controller market segments.

That concludes my comments, and I will now turn over the call to the operator so that we can begin the Q&A portion of the call. Operator, please proceed.

Question-and-Answer Session

Operator

[Operator Instructions] And we have Ruben Roy from Mizuho Securities in line with a question.

Ruben Roy - Mizuho Securities USA Inc., Research Division

Congratulations on the transaction. Steve, I wanted to start with just -- I'm trying to understand some of the numbers that you threw out. It sounds like the existing ASIC is shipping and we'll generate that $2 million to $4 million for 2013. And the new gen chip, it sounds like will go into production late this year, Q4 of '13. So when you look at that $20 million to $40 million for 2014, can you give us sort of how you're looking at that -- the split between SAS and the PCI Express controller?

Gregory S. Lang

Yes. We're not -- this is Greg. We're not going to necessarily break out the PCI Express and SAS. But I think it's fair to say, given that this product -- the first generation product that you mentioned, it sounds like you have some awareness of this already, but first-generation was in ASIC for one major customer, the next generation's kind of a general purpose market product, SSD product. We expect that to ramp up at the end of this year, and we expect that to be the biggest piece of revenue for 2014. The 12 gig SAS products will start to ramp in 2014, but I think that they're lagging behind from a demand standpoint, probably 1 quarter or 2 because the rest of the ecosystem for 12 gig is in that spot, it's kind of lagging behind a bit. So I would say, next year, we'll see PCI Express being kind of the lead revenue generator, SAS being the second and then the ASIC being the third.

Ruben Roy - Mizuho Securities USA Inc., Research Division

Okay. And do you expect all 10 of the design wins that you mentioned, those customers, all 10 to ramp in 2014?

Gregory S. Lang

Yes, we do. One is -- one we'd like to ramp this year, and then the others, we think, will ramp in 2014.

Ruben Roy - Mizuho Securities USA Inc., Research Division

Okay. And then just finishing out, in terms of margin, I suspect that the gross margins, we could think about similarly to your current enterprise storage margins. And then just to finish out, on the OpEx commentary, the offset this year, are there tape-outs or other things we should think about in 2014, or is this just too early? I'm just trying to figure out if you do expect some sort of ramp in OpEx related to these efforts in 2014, as you try to capitalize on the market opportunity?

Steven J. Geiser

So first, in response to the question as to the margins for the business, margins for this business are going to be typically a little lower than our corporate market average, but still in a healthy level, 60%-plus type of margins. So still healthy but a little below our corporate averages, the current expectation for margins in those business. As it relates to your second question around OpEx, we had development plans internally for PCIe-based product, and so we are going to be offsetting what would otherwise have been increased expenditures in support of that business with the expenses that we're absorbing as a result of this transaction. So we anticipate that we will largely be able to neutralize those expenditures with offsetting reductions in our internal development plans.

Operator

And we have Harlan Sur from JPMorgan on line with a question.

Harlan Sur - JP Morgan Chase & Co, Research Division

Is the strategy with this acquisition to continue to be a controller supplier to PCIe customers, who will then focus on the board systems and firmware design? Or is PMC going to come to market with a full-blown PCIe solution, complete with board, Flash memory and software firmware?

Gregory S. Lang

Yes, Harlan, this is Greg. Our first priority is going to be getting the controller to the marketing and helping our partners to be successful there. I think that there will be applications or niches. I think this is a very -- will be a very broad space with a lot of column, semi-custom type of applications where we can leverage some of the Adaptec product family experience and deliver board and software level solutions. One example you could envision is our RAID card with some embedded Flash built into it. So we don't have the details behind what that will look like, but you could expect us to focus on the controller space and fill in where we think there are opportunities that we can serve without competing with our customers.

Harlan Sur - JP Morgan Chase & Co, Research Division

And would you be able to sell your merchants -- your second generation merchant solutions, let's say, to your customers or customers that now use the first generation ASIC solution? Is that going to be part of the customer base?

Gregory S. Lang

We have -- we don't really have any limitations on this, on the second-generation I believe the first one was primarily an ASIC for individual customer. The second, rather, is more of the mainstream general-purpose ASSP product available to everybody.

Operator

And we have Kevin Cassidy from Stifel on line with a question.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

I wonder, could you tell us a little more of the manufacturing strategy? Is there a foundry? Are you using a similar foundry to who you were planning on using for your SAS product?

Gregory S. Lang

Yes. The foundry in this case is TSMC, so we would expect to continue that relationship and just kind of adopt to kind of PMC's foundry strategy over time. But that's very consistent with what we did today. The majority of our wafers come from TSMC today.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And which process node will this be developed in?

Gregory S. Lang

The current product that's being released this year is on 55 nanometer.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then, next year, it's going -- moving to 45 or 40?

Gregory S. Lang

Well, I don't know that, that is a decision that has been made yet at this point. We will migrate -- most of our volume products from last year, for example, on 40-nanometer. We're moving to 28 in our next tape-out, so we probably have either 28 or 40 to choose from at that time. But a decision really hasn't been made yet.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And just one other question is on the Flash -- it's controlling -- is it all that 19-nanometer now, or the 20 to 19-nanometer node? Is the controller flexible enough to move to the smaller geometries on the Flash?

Gregory S. Lang

Well, as you get to smaller and smaller geometries, the biggest -- one of the big changes is that the error correction at the back end needs to get better and better. So I would expect that a transition that we will, in the next generation part, make sure that we can serve the next couple process node of shrinks with the -- continuing to improve on the error correction technology at the back end. And we feel like actually both the team at IDT as well as ourselves has that very well understood. So I think that that's the problem that we feel like we have solved for the next couple of generations.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

And if I can just ask one other question about IDT's decision to sell. Are they maintaining a commercial product, or are they just -- didn't find the synergistic to other products they're developing and fits more in synergy with your products?

Gregory S. Lang

Yes. So we will be picking up all of the Flash Controller products. IDT will continue to sell its PCI Express Switches. However, we've purchased the IP and patents around that with some license back -- that goes back to them so they can continue to sell those existing switches.

Operator

[Operator Instructions] And we have Sundeep Bajikar from Jefferies on line with a question.

Sundeep Bajikar - Jefferies & Company, Inc., Research Division

How should we think about market share, both near-term and long-term, for a merchant Flash controller, such as the one you are acquiring? It seems that, that gets more and more difficult to scale NAND. Wouldn't we expect the NAND suppliers to want to use their own internal controllers at least for their highest end products?

Gregory S. Lang

There's clearly a lot of cooperation that needs to happen at the Flash end of the equation because of the sensitivities between different manufacturers, different process nodes, et cetera. But as highlighted in the material, there's 2 major guys that are already using the technology from IDT, and I think that trend will actually continue. This is a speculation on my part. But I believe that the complexity of building these devices and the cost of building these devices is going to continue to grow and favor more of kind of, I call it, the mass market ASSP model as opposed to everybody rolling around. I think everybody rolling their own works when the costs are low and the R&D investment is low, but I think this is going to scale to the point, just like with RAID Controllers, where everybody can't roll their own. They're going to -- there's going to need to be leveraged in third parties. And I think the other benefit, and this is done, I think, well by the IDT team, is they built a programmable platform. They built a platform that can be programmed, so the secret sauce and the special features that the Flash vendors want to add into the mix, they can do while leveraging kind of a common silicon platform that the investment is spread across others in the industry. So I think that we're on a right path here. Time will tell, but I think this is an area that will evolve much like many of the other semiconductor markets over time where the cost of everybody rolling their own is just too high, and providing that kind of a flexible platform that can be tuned to each manufacturers desires is the right way to go.

Sundeep Bajikar - Jefferies & Company, Inc., Research Division

That's helpful. A follow-up on your market opportunities. So how should we think of the coexistence between your existing direct attached storage adaptors and this new class of PCI Express SSDs that you would have, particularly in hyperscale data centers? I guess what I'm trying to get at is, to what extent does the PCI Express SSD allow you to penetrate the hyperscale data centers at a faster pace than you could with direct attached storage only?

Gregory S. Lang

Yes, that's a very good question. There's no question that hyperscale data centers really value the performance that's available with PCI Express. So there's, without a doubt, a very strong pull from the large data centers to try to basically knuckle another level of overhead out of these Flash designs and squeeze more performance out. And the best way to do that is to link this closely to the CPU and the PCI Express bus as possible, so this really is getting a lot of appeal here. I think combined with our product family where -- that we've announced over the last 6 months where we have the highest density HPAs to offer into this marketplace, as well as the highest density RAID solutions, as well as caching software, we're really getting very good traction on that front. I think this adds to it, brings us more relevance and more strength in those conversations. So I think it's a very good positive. Now at the end of the day, the solutions will come from -- in Flash device, the SSD, if you will, will come from one of our partners or customers, but I think being able to have that dialogue with these customers will be a powerful addition to our sales kit.

Sundeep Bajikar - Jefferies & Company, Inc., Research Division

Okay, great. And last question for me, just want to double check this. It's pretty clear that longer-term, there would be a substantial opportunity for PCI Express SSDs even in clients or PCs. So the question is, is there any chance you would pursue down that path at all?

Gregory S. Lang

Yes, I think you're right. I think this whole space, the whole Non-Volatile/memory continuum is one that is just starting to play out, and I think there's going to be a lot of derivative areas that we will be able to participate. And we'll have to make those calls one by one. If it looks like it make sense for us to pursue the consumer space, we've got the right assets and potential on it, we'll certainly pursue that. But I think at this moment, it's a little bit soon to tell.

Operator

[Operator Instructions] And we have Betsy Vanhees from Wedbush Securities on line with a question.

Betsy Vanhees

Congratulations on the acquisition. Greg, I was wondering if you could talk a little bit more about the NVM Flash consortium. Can you bring us up to speed as to who's on that consortium? Are those not only potential partners, but potential customers for you guys?

Gregory S. Lang

Yes, the NVMe standard was really started -- I'm sorry, it stands for Non-Volatile Memory Express, so that's what NVMe stands for. That group was put together a couple of years ago. And I think the -- if I recall this correctly, hopefully I won't offend them if I leave their names off, but I think, I believe it was Dell and Intel were kind of the lead big industry guys that pushed it. IDT was there kind of -- and supporting it as a silicon arm. But the real goal behind NVMe's -- NVM Express is really to provide the interface necessary for a standardized solution for this PCI Express-type of adapters, so that standard is in place. The silicon that IDT has delivered is the first silicon to market that supports this natively an integrated ASSP, and we think it's going to really open up PCI Express to a much broader usage space that exist today.

Betsy Vanhees

So basically, you kind of -- going back to the earlier question that was asked, so you guys are going to be providing with the NVM Flash controllers, you got -- you said you're acquiring 75 patents, so with a lot of -- with NVM being a standard product, are the patents line then more with the switches, the gen 2 and gen 3 switches that you're acquiring? Is that where the patents lie?

Gregory S. Lang

Yes, so just to clarify that, there is a standard interface. It's -- maybe the equivalent -- it's not equivalent, but another comparison might be with SAS. So there's an interface that everybody talks to that allows interoperability. But there's a tremendous amount of innovation that goes on underneath that or behind that interface. So maybe one of the best examples in kind of today's generation of Flash controllers is patents around how the error controller is done for Flash life endurance or life expectancy. There's a number of innovative techniques there that people are applying to, to try to get the most out of the Flash devices. And that becomes a bigger and bigger problem as the process geometry shrinks. So while we have a standard interface at the NVMe level, there's a tremendous amount of innovation still left to happen in the balance of these solutions to really get the most out of these sensitive devices.

Operator

[Operator Instructions] And we have no further questions at this time. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect.

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