Thursday, August 17, 2006

Calls of Note Part 3

- Merrill Lynch notes PMC-Sierra (NASDAQ:PMCS) filed form 10-Q for Q206 two days after the company announced delays in filing due to option grant related errors. The company also filed 10-K/A for 2005 and 10-Q/A for Q106 with restated financials last night. PMCS announced previously that its audit committee, chaired by NVLS's CFO Mr. William Kurtz, found no evidence of deliberate misconduct by the company's executives or staff.

However, the committee concluded that PMCS used incorrect measurement dates for certain grants prior to 2001. As a result of these errors, PMCS has restated its balance sheets as of 12/31/2002 and all subsequent periods. On the positive side, there were no restatements of income statements or statements of cash flows.

HP accounts for almost 10% of PMCS' sales and the firm views HP's Q3 results as a positive for the stock. In particular, PMCS has high exposure to color laser printers and EVA line of storage systems, which HP highlighted as areas of strength.

Despite the near term set back at Passave, they continue to like PMCS for its exposure to high growth markets such as FTTx and China 3G. PMCS core business should continue to benefit from stable telecom spending and 4Gb transition in storage. Firm expects Passave revenues to stabilize in Q4 and begin to grow again in Q107. Valuation is compelling at 14x CY07 FCF estimate. Reiterates Buy with a $10 price target.

Notablecalls: Expect to see some buy interest already in the pre mkt.

- William Blair comments on Sonic Corp (NASDAQ:SONC) after the co announced its intent to repurchase up to 25.5 million shares (about 30% of shares outstanding) at a price of between $19.50 and $22.00 via a modified Dutch auction for a total of up to $560 million, with the auction expiring on September 22.

The repurchase is contingent upon the completion of new credit facilities to both facilitate the repurchase and replace current credit lines. Firm had initially estimated the transaction would be accretive up to a 7.5% interest rate on the debt. With details provided yesterday in an SEC filing, it appears the new credit lines will likely be above that rate, resulting in EPS dilution to firm's fiscal 2007 estimates.

Specifically, management is projecting a $675 million term facility with an interest rate of LIBOR plus 200 to 225 basis points (about 7.625%) and a $100 million revolver at LIBOR plus 175 basis points (about 7.25%). Importantly, all of the company's existing debt of $120 million will be refinanced at the higher rate, versus a current rate of LIBOR plus 50 to 100 basis points.
As such, if the entire repurchase is consummated at $22 per share, the company will use the entire $675 million term facility as well as $12 million under the revolver, resulting in an increase of net-debt-to-capital from 27% to approximately 80%. The impact to fiscal 2007 is therefore likely to be dilutive by approximately $0.09 to $0.12, bringing firm's number to a pro forma $0.91 to $0.94 versus current estimate of $1.03, although the impact would obviously be less extreme should interest rates reverse course. Firm's number excludes a projected $0.015 penalty related to early extinguishment of debt.

Firm continues to believe Sonic is on track to meet August quarter expectations for a 3% to 5% comp yielding EPS of $0.28 to $0.29. A particularly hot summer is likely to bolster high-margin ice cream sales, in firm's opinion, and they note that dairy costs remain very favorable (down about 19% year-over-year). Continues to believe Sonic is one of the most proprietary and well-run concepts within the quick-service space, with industry-leading financial returns and the opportunity to double its restaurant base.

Maintains Outperform.

Notablecalls: So the repurchase is dilutive to 2007 EPS? And the stock is trading around $22, the high end of the auction range? Think it will come down somewhat.

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