Chips That Make Beautiful Music - June 21, 2005

Chips That Make Beautiful Music
NEW YORK - SigmaTel makes integrated circuits (ICs) for audio applications in a wide range of electronic products.

Nearly all of its revenues are derived from Asia, primarily Taiwan, Hong Kong, China and Singapore. Customers consist of original equipment and design manufacturers, such as A-MAX Technology, Tai Guen Enterprise, MSI, Philips Semiconductors, AVC, Samsung and Creative Technology (nasdaq: CREAF - news - people ).

We added SigmaTel (nasdaq: SGTL - news - people ) to our recommended list on May 16, 2005.




The company's product offerings consist of portable audio systems on chip (SoCs) and audio codecs. SoCs house most or all of the circuits of a system or subsystem on a single chip, thereby optimizing application performance.

Portable audio SoCs, which generated 95% of first quarter sales, integrate standard digital components such as microprocessors and memory with proprietary technologies, including analog-to-digital converters, power converters and audio signal amplifiers. These chips are used to enable and enhance audio quality on portable devices such as mp3 players, and on desktop and notebook computers. Audio codecs are ICs that allow audio signals to be converted from analog to digital and vice versa. They provide record and playback functions on PCs, notebooks and consumer audio devices such as digital televisions, DVD players and set-top boxes.

SigmaTel benefited during the past year from the popularity of mp3 players and similar devices. The rising use of computers as an electronic music storage and playback appliance is also boosting the company's prospects. Furthermore, SigmaTel is cashing in on the growing demand for cheaper and more efficient portable devices since the key advantages of its all-in-one design are smaller size, better power management and lower production costs.

Revenues and net income in 2004 rose 94% and 138%, respectively, to $194.8 million and $19.5 million or 52 cents per share. Revenues for the first quarter of 2005 more than tripled from a year ago to $99.3 million. Sales of portable SoCs rose 28% from the fourth quarter of 2004.

Higher-margin products, productivity enhancements and cost-cutting boosted the gross profit margin by 435 basis points from a year ago to 57.42%. The operating profit margin improved by 16.74% to 38.13%. Net income nearly quadrupled to $25.5 million or 68 cents per share.
The possible introduction by a rival of a cheaper or more effective product could erode sales. This presents perhaps the greatest investment risk. Yet the company's near-term prospects are excellent. SigmaTel's 3500 product line is expected to be the leading volume contributor in 2005.

The 3600 line, a next-generation portable multimedia system that offers superior performance and lower power consumption, should launch in the third quarter. SigmaTel should also benefit from the recent launch of 9220 and 9221-8 channel high-fidelity audio codecs for PCs and convergent home entertainment applications.

The company has taken several steps to exploit growing demand in key geographic markets. It expanded its Hong Kong engineering center and opened new offices in Taiwan and Singapore. It also plans to open offices in China, Korea and Japan. In fact, the company hired 75 new employees in the first quarter, increasing its headcount by 31%. Excerpted from the June 2005 issue of Forbes Growth Investor.