It probably sounds like a double-whammy to consider a stock that is exposed to both the semiconductor cycle and the enterprise/carrier spending cycle as well. For better or worse, that's the situation for PMC-Sierra (Nasdaq:PMCS) as the veteran semiconductor company continues to leverage itself to emerging growth opportunities in storage and cloud computing while balancing out its legacy businesses in optical networking and wireless infrastructure.

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Another Chip Company with Tough Q4 Numbers
It's not exactly challenging to find semiconductor companies that had some weak spots in their December quarter reports. Consequently, PMCS is not exactly in rare company with a quarterly report that was just a little light.

Revenue fell 2% compared to the prior year and 13% when compared to the prior quarter. All of the company's major business lines were down as reported, with sales in the mobile category down the worst.

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With chip companies, it's commonplace for lower sales to herald lower margins. Gross margin did erode a bit sequentially (by about half a point), though they improved on a year-over-year basis. Operating income was down more sharply, falling 46% from the third quarter and 39% from the prior year. Despite 2011 being a difficult year, PMC-Sierra was solidly in the black with its free cash flow. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

Weak Guidance Will Take Its Toll
Investors likely wouldn't have cared much about PMC-Sierra's report had management given guidance that basically confirmed where sell-side analysts already were. Unfortunately, management's target for the first quarter was about 15% below the prior average estimate.

Management specifically targeted weaker storage markets as the culprit. With the ongoing hard drive shortage being the primary factor at play, it's worth speculating that this means a challenging first quarter for IBM (NYSE:IBM) and Dell (Nasdaq:DELL) in their storage businesses. Although NetApp (Nasdaq:NTAP) may have some residual exposure, EMC (NYSE:EMC) has managed this supply disruption better than anyone else and may gain even more share as a result of these disruptions to the lower end of the market. (For related reading, see Tech Giants: Are Blue Chip Tech Stocks A Smart Way To Go?)

A Pause, but Not a Break
Odds are that the first quarter disruption will be pretty much limited and not drag down the entire 2012 performance. Accordingly, investors shouldn't get too down about this, nor ignore the progress the company has made in competing with LSI (NYSE:LSI) in the storage space.


The fate of the company's growth initiatives in optical networking is a little less certain. PMC-Sierra has some good new products here, but also plenty of competition from the likes of Broadcom (Nasdaq:BRCM), Marvel (Nasdaq:MRVL) and Qualcomm (Nasdaq:QCOM) after its acquisition of Atheros. It also doesn't help much that the carrier spending environment has been so rubbish lately; everybody expects a recovery at some point, but the "when" is hard to pin down.

The Bottom Line
If PMC-Sierra's greater focus on storage plays out as hoped, the company's growth could definitely improve with this upturn in the chip cycle. At the same time, while progress against LSI is a good sign, there is that risk of the networking side taking longer to deliver hoped-for results.

PMC-Sierra has been delivering good free cash flow conversion of late, and there's no pressing reason to believe that will reverse. If the company can live up to the growth recovery expectations that the Street has in place (even adjusting for the disappointing Q1 guidance), there is definitely enough value in their shares for potential investors to take a closer look.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.