Sierra Semiconductor Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SERA)") else Response.Write("(NASDAQ: SERA)") end if %>
2075 North Capitol Avenue
San Jose, CA 95132
(408) 263-9300

UNION CITY, Ca., September 3, 1996/FOOLWIRE/ --- Sierra Semiconductor held a conference call last week where they announced that they had made the decision to exit the modem chipset business. This decision, they estimate, will result in a $50-80 million charge for the current quarter. Their plan is to continue to operate the product line, providing full and complete customer support during the selling process. They believe the reserves taken should adequately cover any liabilities regardless of the outcome. If they are unsuccessful in executing a sale, they will wind down the modem chipset business. Although the charge to earnings is significant, they expect the impact on cash, even without a sale, to be neutral to slightly positive. Obviously, any proceeds received from a sale would have a favorable impact on cash. They expect the selling process and/or wind-down to take place over the next several quarters.

Over the past several quarters they have continued to express caution over the near-term outlook, all centered around the modem chipset business. Their concern was driven by two factors: excess inventory in the channel and excess capacity in the supply base and what impact these factors might have on the business. What has and is happening is prices are declining rapidly resulting in corresponding decreases in margin. In fact, in recent months they have declined much faster than Sierra anticipated and than they experienced earlier this year. They believe this will continue for the forseeable future.

In their view, the modem chipset has become a commodity. The key to success, if there is any, would be low-cost manufacturing. As a fab-less semiconductor company, low-cost manufacturing is not Sierra's strength. Since the market will not pay for features, they feel they could be facing a sustained period of what they call profitless prosperity -- high volume with low margin. Given this assessment of the situation, the decision they face is do they continue to invest heavily in the modem chipset business or do they bite the bullet now, exit the business, and make their investments in the balance of their product line -- infrastructure and networking.

Although not an easy decision to make, they believe the correct decision is clear. Their infrastructure and networking product lines offer a far greater potential for return than do modem chipsets. Due to the explosive growth in the Internet, today's WAN infrastructure and local area networks need to be upgraded with higher-bandwidth technologies. They believe Sierra, through its subsidiary, PMC Sierra, is well positioned to participate in this explosive growth. They have leadership technology and leadership products to bring to this market. This is where they intend to focus their energies, their resources and their investments going forward. In addition, they will continue to support their non-networking businesses -- Apple graphics and custom products.

As they mentioned in the press release, the company is estimating a special charge of $50-80 million will be included in Q3 results for the company. In their determination of the components of this charge, they are including such things as provisions to write down inventory values, to write down certain capital assets and other operating assets to their estimated economic realizable value. Any accruals and provisions they deem necessary related to the personnel costs that are necessary to complete the programs and to support the modem products during this transition.

Given their current position, they believe the cash impact from the future operations of the modem business during this period would be neutral to slightly positive. They will have more analysis of the required provision in the charge when they complete the current quarter, but the current estimate is a wide range as they still need to resolve several open issues which have a broad range of possibilities. Their intent is to accrue an amount in Q3 which is sufficient to provide for the cost to exit the modem business. In order to understand the financial impact and magnitude of this announcement they also provided some historical amounts of the various segments of their business and shared their model of the business going forward.

HISTORICAL FINANCIALS AS THEY RELATE TO THIS NEW CHANGE

Their revenues should be looked at as coming from 3 principal sources. First and foremost would be PMC Sierra which encompasses the local area and the infrastructure markets and is the centerpiece of their communications strategy. Second is the group of multimedia and other communications products which they plan to continue to sell and support on an ongoing basis. This would include their Apple graphics business, their custom and various other telecom-type products. And third is the modem chipset revenue stream which is the product line they plan to exit in the near future.

In 1995, they reported consolidated revenues of $188.7 million. Included in that was the modem chipsets which was about $56.7 million. This leaves about $132 million of other revenue that came from PMC ($39.4 million) and their other businesses ($92.6 million).

For the first half of 1996 on a consolidated basis they reported $117.4 million in revenue. The modem chipsets represented $45.6 million of that which leaves $71.8 million of other revenue.

Gross margins would be higher than previously reported when the modem product line is excluded. In fact, in 1995, gross margin on the other businesses (excluding modem chipsets) were at the 55% level and were in the 60% range in the first half of 1996 as the PMC product lines became a larger relative percentage of the revenue mix.

Of course with operating expenses and, specifically, R&D and SG&A it is very difficult to break out the historical spending by these different product lines since there were many comingled activites that were shared and allocated across many product groupings. It is probably better to look at these categories in light of the model for the company going forward.

In their new model, based on the new product mix, they are looking for the gross margins to be in the 60% range in the near term. PMC's gross margins are slightly higher and the other products are slightly less than the model, but in general the model they are looking at for the mix is about 60% at the gross margin level. They also plan to operate with a 15% target for R&D spending and a 15% target for the SG&A spending. This would result in a pre-tax profit at the 30% level.

It's currently uncertain what their actual tax rate will be in the near term given the deductibility and the timing of the special charges related to exiting the modem products. But it is probably safe to assume no more than a 35% tax rate in the near term. After-tax net income would be at the 20% level assuming a 35% tax rate.

Over the next several quarters, the company wanted to caution that they will be reporting incremental revenue related to the sale of the existing modem inventories and, in connection with their assumptions in the reserves being taken this quarter, they don't plan to report gross profit or pre-tax profit on those sales in the interim periods, but will report a final sale, charge, credit, or whatever when they finalize all the open issues surrounding the exit of the modem business. This would probably be sometime in the first half of 1997. They plan to highlight these revenues and costs when they report their results each quarter so they can understand the PMC Sierra and other parts of the business and how they are progressing against their model and targets.

SUMMARY

Sierra is continuing its strategy of communications products. Within that communications product strategy, they intend to focus on networking markets -- both local area and infrastructure. They will continue to support customers in other parts of the business. The main change in strategy is that they are exiting the modem chipset product line. They believe they have the resources, people, technology, and cash to be successful in this strategy and they are optimistic about their future with the opportunities available to them in this networking marketplace.

QUESTIONS AND ANSWERS

For the first half of 1996 other sales came in at $38 million which seems to represent a decline versus first half of 1995. The company confirmed that it did decline principally related to the Apple graphics products. In the first half of 1995, the other products sales number was $48.9 million. The company was asked, in terms of a model going forward, whether they expected that business to continue to decline at the rate it is and do they expect the PMC business to continue to grow at the same rate it has experienced. The company responded that they can't really forecast how fast PMC revenue is going to grow. In terms of the Apple and other related businesses, they have not been a core strategic area for Sierra and those probably are going to show declines over the future. As they have reported in the past, Apple did come down to something less than 10% of sales where they were at one point up over 20% of sales. That had nothing to do with Sierra, that was driven by Apple's business environment. However, Sierra's area of focus from an investment and resource point of view will be the networking side of the business. That is where they see the future and that is where they are going to invest. And, the custom business they have had in the past is not an area of major investment.

The company was asked to comment on PMC's current business environment and whether they are still seeing the effects of the inventory correction that they talked about earlier in the year and do they expect that business to be up in the current quarter and the December quarter. The company responded that, as they said in their last conference call, they expected the PMC business in this quarter to be flat to up modestly. They still have a long way to go in the quarter, but that is still the current guidance they are providing. They have this one anomaly which is this one customer issue, but in general they think the customer inventory situation with them is working its way down. They expressed the opinion that the customers have gotten extremely spoiled with this environment with semiconductor vendors in general and they are all looking at holding the minimum backlog they can possibly get away with and Sierra is seeing some of that. So they have seen some frecent softness, but it has largely been due to these customer inventory reduction programs and they are wondering if there are some seasonal effects as well. In this environment customers are providing much more turns kind of business than usual.

The company was asked about new products and indicated that they have a pipeline full of new products and there will be several announcements in the next few months related to new products.

They were asked to elaborate on what is going on in the fax/modem market and who do they see entering that market, if there are any new names in addition to the traditional competitors. They were also asked to quantify the pricing declines to some extent. The company responded that, in terms of competitors they think competitors are fairly well known. The traditional AT&T and Rockwell, then Cirrus. They've heard about ESS and Oak, but don't know that they've actually seen them. As far as pricing pressure, they talked about it in their last conference call, how the decline had accelerated from 5% to 10%. They think right now pricing is declining at a rate greater than 10% per quarter. Basically what they are seeing is that the inventory problem in the channel has not gone away and there is excess capacity in the supply base which has also not gone away. So, they have 5 companies all trying to get 40% of the business.

They were asked what level of commitment they have to support the Apple graphics and custom business going forward and is that something that analysts should model trading down to zero or is there some stable level that business will operate at. The company responded that the custom business is clearly a legacy business they have. They do support, at a mimial level, this one particular customer they deal with. The Apple business they have talked about as well, that they continue to support it but that Apple as a percentage has come down. They think that one would have to assume that over time this business will continue to go down. They don't see it going to zero anytime in the near term, but it will continue to decline because they are not investing in that business in any significant fashion.

The company was asked if short-term they would incur any penalty for throttling back on their wafer start requirement. The company responded that as they exit this business over the next several quarters, their wafer demand will go down. They need to sit down with their foundry partners and discuss the overall situation. They intend to remain fab-less. They intend to need these partners going forward. They believe the reserves they've taken will adequately cover any financial exposure.

They were also asked to talk about the landscape in modems as far as whether they saw people going more away from the hardwire solution to a more programmable solution which will support the DSVD videoconferencing solution in addition to text and data. The company responded that you don't need controllers to do DSVD and video conferencing, as they have discussed in the past, both of those are on their roadmap. In fact video conferencing is very soon to be introduced and DSVD probably will follow although they are going to evaluate where they are on those programs. In the meantime, they will continue to support their modem customers and will continue to support the product line while they go through this selling process and/or wind-down.

The company was asked to comment on IBM's announcement that they would be entering the emerging networking markets in terms of where Sierra sees IBM fitting in and where they expect to run into them. The company responded that IBM has a bunch of custom products that they have done in-house and now that their semiconductor business is probably experiencing softness like all semiconductor companies, they are trying to sell those outside. Sierra thinks that is going to be a challenge because most of the networking companies view IBM as a significant competitor and most of their products that they have announced they are going to start selling outside are products that are in areas such as 25 megabit ATM and other areas where PMC has chosen not to participate in the past. So, for Sierra it is not really much of an issue and IBM is a customer of Sierra at the 155 megabit level.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event.

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