COMMUNICATIONS

Growth Signals

Sawtek's Signal-processing Components in Great Demand

BY DANIALLE WEAVER

Sawtek, an Apopka, Fla.-based manufacturer of signal processing components, sells inexpensive products, with some going for as little as $3. But the filters, resonators, oscillators and other devices made by the company are vital components for some of the largest telecommunications companies in the world.

Demand is such that Sawtek (Nasdaq: SAWS) is one of the fastest-growing equipment manufacturers in the state. And on Wall Street, investor demand made Sawtek one of the best performing stocks last year. In the seven months that Sawtek was a public company in 1996, its share price climbed just over 200 percent.

Sawtek's customers include the manufacturers spearheading the newest generation of wireless communications services - the emerging PCS industry - such as LM Ericsson, Lucent Technologies, Motorola, Nokia and Qualcomm.

Indeed, through the first nine months of its current fiscal year, Sawtek has generated net income of nearly $14.7 million on revenue of $59.7 million. Sales are growing at a 50 percent annual clip; operating income is not far behind.

The market appreciation is good news for Sawtek's employees, who through an employee stock ownership plan own about 35 percent of the company. In fact, the employee investment was critical to the company's survival a few years back.

Sawtek launched the ESOP in 1990, right after seven venture capital firms, including Tampa's South Atlantic Venture Funds and Atlanta's Noro-Moseley Partners, sold their stakes back to the company.

Fortunately for Sawtek's employees, the venture capital investors exited three years before the market took off for Sawtek's principal technology - surface acoustic wave (SAW) technology. The technology originally was developed for use in radar and electronic warfare. Sawtek was formed in 1979 by four former Texas Instruments employees to supply technology to the Pentagon. The venture firms had invested their money in 1983 and 1984, during the heady Reagan defense buildup, when the entire surface acoustic wave market wasn't yet worth $100 million, estimates Clark Westmont, a Montgomery Securities analyst.

The VCs invested based on strong growth expectations that never materialized. In 1990, 11 years after Sawtek was formed, sales had grown to just $9.5 million - not quite the $400 million anticipated by investors in the early years.

So when two co-founders - Sawtek President and CEO Steven Miller and Neal Tolar, senior vice president and chief technology officer - offered to take out a bank loan and pay back the $4 million, the VCs readily agreed. To buy them out, Sawtek launched a leveraged employee stock ownership plan (ESOP) in January 1991.

Then Sawtek shifted focus to high-growth commercial markets, particularly telecommunications, and saw its business begin to take off.

By 1994, sales grew to $19 million, then to $31 million in 1995. On May 1, 1996, Sawtek did an initial public offering, selling 4.5 million shares. Priced at $13 per share, the stock opened at $16.50 and closed at $21.25 in its first day. In fiscal 1996, sales rose to $57.7 million, up 84 percent.

Growth has remained strong through the first nine months of the current fiscal year.

In the third quarter, (its most recent) Sawtek posted revenue of $21.2 million and earnings per share of $0.25. Analysts figure the company will end its current fiscal year with sales of about $82 million. For fiscal 1998, analysts expect revenue to reach nearly $111 million; they expect earnings to grow from 94 cents per share estimated this year to $1.13 for fiscal 1998.

Sawtek has posted gross margins of 50 percent or more since the IPO. Also, in 1996, the company opened a Costa Rican manufacturing plant and expanded operations near Orlando. The company's financial position is quite strong: Sawtek had working capital of $46.9 million and shareholder's equity of $77.9 million as of June 30.

Market appreciation prompted Sawtek to conduct a secondary offering in June. The company sold 300,000 shares, raising about $10 million. Meanwhile, the ESOP sold about 2 million shares.

Seventy percent of Sawtek's net sales are telecommunications-related, including frequency filters for the base stations in cellular towers and for cell phones. The filters are used in two new digital technologies used for wireless personal communications services - Code Division Multiple Access (CDMA) in the U.S. and Global System for Mobile Communications (GSM) in Europe. Sawtek parts are in digital microwave radios, wireless local-area networks, cable television equipment and various defense and satellite systems. About 15 percent of net sales are military; last year, 54 percent were in international markets.

"Sawtek's high-performance SAW filters have become a virtual staple for CDMA base stations and handsets," says Westmont, the Montgomery Securities analyst. "The company's ability to quickly turn custom, high-performance designs, and subsequently ramp them into production, has led to design wins at all the major CDMA base station vendors." Given the company's broad base of customers, Westmont says Sawtek is "one of the best 'pure-play' investments in the CDMA [wireless PCS] infrastructure buildout."

Sawtek parts, which cost between $5 and $300, are essential in set-top cable television boxes from Scientific Atlanta. They also went to Mars with the Pathfinder transponder.

"I grew up with Steven Miller, and I've known the co-founders since the beginning," says Steve Takaki, supplier business manager for Penstock, an electronics distributor for Sawtek based in Sunnyvale, Calif. "I think highly of them. They tell it like it is - they don't hide anything."

Still, Sawtek's top five customers accounted for 60 percent of net sales in 1996. And some experts suggest high-speed digital signal processors could replace SAW filters for frequency filtering, says Raymond James analyst Shekhar Wadekar. While it is technically feasible, SAW components likely will remain cheaper to manufacture than other semiconductor chips for several years, making them the choice for digital telephone handsets for several years, he says.

Sawtek's competitors include Siemens of Germany, Thomson of France and RF Monolithics Inc. of Dallas. "I've been watching Sawtek with interest for a long time," says Sam Densmore, president and CEO of RF Monolithics. "They were far-sighted in recognizing a need for surface acoustic wave filters in telecommunications applications, and they've done a good job of making the world aware of the technology."

"We generate superior margins because we're a technology leader and can command premium prices," explains Raymond Link, the company's chief financial officer. "We're extremely efficient operators - we've invested $40 million in new plant and equipment in the past two years. And we have more expertise in our employee base than any other [SAW] company in the world."