Adaptec, Inc. F2Q09 (Qtr End 09/26/08) Earnings Call Transcript

Oct.21.08 | About: ADPT Corp (ADPT-OLD)

Adaptec, Inc. (OTC:ADPT-OLD) F2Q09 (Qtr End 09/26/08) Earnings Call Transcript October 21, 2008 5:00 PM ET

Executives

Nicole Noutsios – IR

Sundi Sundaresh – President and CEO

Mary Dotz – VP and CFO

Analysts

Brian Freed – Morgan Keegan

Michael Cody – B. Riley

Operator

Good day everyone and welcome to the Adaptec second quarter fiscal 2009 earnings conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Ms. Nicole Noutsios. Please go ahead.

Nicole Noutsios

Thank you, operator. During today's call, we will first hear from Sundi Sundaresh, our President and CEO, followed by Mary Dotz, Adaptec's Chief Financial Officer. After Mary's remarks, we will host a brief question-and-answer session.

Some of the comments today will include forward-looking statements regarding future events and our projections of the financial performance of the company based on our current expectations, including a projection of operating results for the third quarter of fiscal 2009.

These statements are subject to significant risks and uncertainties and can cause our actual results to differ materially from those expressed in these forward-looking statements. We refer you to the risk factors section of the documents that Adaptec has filed with the SEC, specifically in our most recent Form 10-Q which contains important risk factors that could cause actual results to differ materially from expectations. In addition, some of the financial measures that are included in this presentation are non-GAAP. For reconciliation of GAAP to non-GAAP measures, please visit our web site at www.adaptec.com, under Investor Relations section.

With that, I would like to introduce Adaptec’s President and CEO, Sundi.

Sundi Sundaresh

Thank you, Nicole. Good afternoon and thank you for joining us for our Q2 fiscal 2009 earnings call.

During this call, we will briefly provide a business overview, details on the newly acquired Aristos Logic and updates on our OEM and channel initiatives. Then I will turn the call over to Mary to outline the progress we have made to improve our fundamentals and provide further information on Aristos Logic.

We continue to make progress on our revenue growth strategy as well as maintaining a conservative expense structure. Our second quarter revenues were $31.7 million which is above our guidance range. Our gross margins dropped a bit from last quarter to 44% on a non-GAAP basis, but it is still a large improvement from 36% we reported in the prior year second quarter.

As we take proactive measures to streamline our business, the expense reductions continue to flow to Adaptec’s bottom line. I am pleased that we are able to report positive net income once again this quarter. Further, the company continues to make progress on its growth initiatives. In the quarter, we introduced Intelligent Power Management and successfully completed Aristos Logic acquisition to further round out our product portfolio and provide a foundation for additional OEM opportunities.

To maintain our competitive advantage, Adaptec must continue to innovate and create leading edge products. In the past few quarters, we have been very focused on delivering to a strong product roadmap. Last month, we successfully launched Intelligent Power Management, the industry’s first and only RAID controller-based power management solution for SATA and SAS Storage. Integrated into all of our Series 5 and Series 2 Unified Serial RAID controllers, it allows system OEMs, integrators and IT managers to easily configure storage systems to reduce power consumption by up to 70% without sacrificing performance.

In the quarter, we also completed the acquisition of privately-held Aristos Logic, a provider of industry leading RAID solutions. Mary will discuss the financial implications of this acquisition, but I would like to provide a strategic framework. We are very excited about this acquisition for a number of reasons.

First, Aristos brings to us a strategic customer base to help drive new OEM revenue opportunities for Adaptec. Since the acquisition, we announced that IBM is integrating our RAID Storage Processor Technology into IBM BladeCenter S, creating the industry’s first fully redundant, shared blade storage system.

Second, Aristos technologies and customers will also enable us to expand into adjacent high-growth segments including blade servers, enterprise-class external storage systems and performance desktops. The IBM announcement is a perfect example of this. Market research firm, IDC, reports that blade servers are the fastest growing segment of the server market with annual growth rates exceeding 25% and that IBM is a recognized blade server market leader.

Third, as we build out our I/O strategy, advancing I/O performance while integrating additional controller-based functionality beyond RAID, the assets we have obtained through this acquisition becomes especially valuable to us.

And finally, this acquisition will provide us a strong ASIC roadmap necessary to develop next generation 6-gig RAID controllers. This will in turn help us pursue new OEM partnerships and expand our channel offerings, enhancing the roadmap for our Unified Serial SATA and SAS products.

Obtaining OEM and channel sales engagements is another key growth driver for the company. We are now well-positioned to expand our OEM customer base. As I just mentioned, Aristos will provide us a healthy OEM business and with the new IBM partnership I just outlined, we have taken a significant step in strengthening our OEM revenues.

The combined Aristos Adaptec teams have already started an active marketing program to further bolster opportunities with OEM customers. And with our strengthened technology portfolio, we anticipate other significant OEM wins in the future.

We continue to make solid progress in the channel. While the US has faced softness because of the current economic conditions, we have continued to enjoy great success in Eastern Europe and Asia. We’ve seen the strongest growth in emerging markets. We also continue to take share in the channel. Our product performance and Intelligent Power Management have proven to be two significant differentiators on top of the traditional value-add Adaptec brings to our customer base. As a result, the company has shown steady improvement in our Serial products over the last several quarters as evidenced by the fact that demand for our Serial products grew 13% quarter-over-quarter and 59% year-over-year.

With that, I will turn the call over to Mary to provide a more detailed financial overview.

Mary Dotz

Thank you, Sundi, and welcome everyone. Before I start, I’d like to reiterate that all the comments here today are based on non-GAAP financial measures, exclusive of discontinued operations and exclude results from the Snap business unless otherwise noted. I encourage you to refer to the reconciliation of GAAP to non-GAAP financial results that is included with the press release and posted to our web site.

During the second quarter of our 2009 fiscal year, we’ve continued to make progress on a number of fronts. We completed the acquisition of Aristos Logic that will contribute to our products’ strength and mix and we’ve continued to maintain our tight fiscal control.

Further, our balance sheet remains strong and a core asset as we execute on our growth initiatives. Our second quarter net revenues were $31.7 million which is above our guidance of $27 million to $30 million. We are very pleased with this accomplishment. Our revenues are up slightly from the $31.5 million we reported in the first quarter of 2009. This was attributed to strong growth in our channel business and a slowdown in the runoff of our OEM business.

Our acquisition of Aristos Logic occurred near the end of the quarter and only provided a very modest amount of revenue to our top line. Although we had a very solid contribution from our OEM business this quarter, we are still facing decreasing revenues in our traditional product lines as our OEM revenues decline. However, we anticipate that our new OEM capabilities will provide long-term revenue growth for Adaptec.

We are expecting the ramp to take place over the next several quarters. We are excited for the IBM win and anticipate further progress on our OEM initiatives in the coming quarters. In terms of customer concentration, our top customer IBM represented 36% of our net revenues for the second quarter. While our largest distributors, Bell Micro and Ingram Micro, represented 13% and 10% respectively.

We had non-GAAP gross margins in the second fiscal quarter of 44%, down slightly from 47% in the first quarter of the year, but up from 36% reported last year. This slight decrease is due to a change in our product mix and some operational variances. Our long-term goal is to drive strong product mix and maintain healthy margins.

Cost containment has been a key priority for Adaptec since the Sundi joined as CEO. During the first quarter of 2009, we initiated a small restructuring effort. In order to complete this effort, during the second quarter of 2009 we incurred additional restructuring charges of $1.6 million. Our improvements are being realized in our non-GAAP net income and EPS. For example, in Q2 ’09, our non-GAAP income from operations which is exclusive of discontinued operations was $4 million. This compares to a loss of $1.5 million in Q2 of ’08, an income of $4.8 million in Q1 of ’09.

During the second quarter, our non-GAAP EPS was a $0.03 income per diluted share which was above our guidance. This is compared with $0.01 loss per diluted share for the same period last year, and a $0.04 income in the first quarter of 2009. Additionally, we had a profit from operations exclusive of interest income for the second quarter in a row. We had positive operating cash flows from continuing operations of $5.8 million during the second quarter driven by our operating profits.

GAAP net interest and other income was $5.8 million for the quarter, inclusive of a one-time gain of $1.3 million on the repurchase of a 138 million of our 3.25% convertible bond. Our balance sheet continues to be a core strength and we ended the second quarter with $457 million in cash. The decrease from last quarter is due to the repurchase of the bonds and the purchase of Aristos Logic. We will continue to make bond purchases that are financially beneficial for the company and we’ve been purchasing our bonds when available at attractive prices. It is currently our expectation that all of our outstanding bonds will be put to us in December of this year. Further, in October, we have purchased another 52 million of our 3.25% convertible bond. This placed approximately 35 million of our bonds outstanding.

Now I would like to provide you with guidance for the third quarter of fiscal 2009. The general market conditions have impacted IT spending and we are anticipating a slowdown over the next several quarters. As a result, we expect revenues to be in the $28 million to $32 million range. With challenging economic conditions, long-term outlook is hard to predict. We still expect to experience significant decreases in out legacy OEM revenues in the next six to nine months. This should be partially offset by growth in our channel business and our new OEM opportunities from the Aristos acquisition.

We will continue to make improvements in SG&A expenses and expect to remain flat even with the combined Aristos logic SG&A expenses. R&D will increase due to the Aristos logic acquisition. However, we've made reductions in R&D in our traditional products to offset some of these combined expenses.

As Sundi has mentioned in prior calls, we have a very healthy product pipeline and we need to continue to make strategic investments to maintain our competitive advantage. Further, with the acquisition of Aristos logic, we feel that we have a long-term opportunity that we need to foster for future revenue growth. Taking into consideration the economic climate and our additional R&D investments, we expect in fiscal Q3 to report non-GAAP EPS near breakeven per share or to a loss of $0.02 per share and our operating cash flow should be breakeven to slightly negative. Now I would like to turn the call back to Sundi to briefly summarize our comments.

Sundi Sundaresh

Thank you, Mary. As we look to the future, we must remain cautious given the challenging economic environment. However, we feel that we have created a solid foundation for future growth. We have a strong product portfolio in the channel and continue to take share. We expect new designs from our OEM business that will help us drive revenue in the coming quarters. We have been seeing steady growth in emerging markets. And finally, we have a very solid balance sheet that supports our growth initiatives and provides us a solid foundation during uncertain economic times. With that, I'd like to open up this call for questions.

Question-and-Answer Session

Operator

(Operator instructions) And we do have a question today from Brian Freed, Morgan Keegan.

Brian Freed – Morgan Keegan

Good afternoon. Thanks for taking my call. A couple of quick questions primarily related to the IBM opportunities. With the xSeries design win rolling off and the blade server design win from the Aristos Logic acquisition coming on, can you give us some sense what you think is the relative magnitude of those design wins? Do you feel like the blade server opportunity is comparable in size or is it significantly smaller?

Sundi Sundaresh

On a relative basis, the blade server opportunity is smaller than the System x opportunities that is just driven by its volume; if you look at IDC, data blade servers has low unit volumes than rack and pedestal servers. That said, the ASPs on one tend to be a little higher than the others. So on a relative basis, blades will drive lower revenue than the System x.

Brian Freed – Morgan Keegan

Okay, so in terms of the ASP per system, does it tend to be higher on the blade servers than the System x or lower?

Sundi Sundaresh

Could you repeat that question, Brian?

Brian Freed – Morgan Keegan

In terns of the revenue contribution on a blade server versus the System x pedestal servers, is the contribution higher or lower on a per unit basis?

Mary Dotz

Actually, let me think about that. I'm not quite sure exactly on – in terms of, if you're talking about contribution but –

Brian Freed – Morgan Keegan

Yes, I guess, is the opportunity per server higher in dollar value for you guys with the Aristos product given the greater complexity than say the current x series product or is it – I'm just trying to pick up kind of relative ASP.

Sundi Sundaresh

Okay. I got it. I understand the question better now. The opportunity per server is higher.

Brian Freed – Morgan Keegan

Okay.

Sundi Sundaresh

Okay.

Brian Freed – Morgan Keegan

And secondly, Aristos obviously gives you some opportunity to attack some of the external storage and potentially the mass market with this technology, do you see it as a pretty significant opportunity for your long-time, longer term to go down that avenue?

Sundi Sundaresh

We definitely see an opportunity in design wins with external storage system vendors and we are pursuing opportunities and working with some as we speak and when the time is appropriate we will announce them.

Brian Freed – Morgan Keegan

Okay. And then if you look at Aristos, I know you guys published an 8-K today with some of their historics, but in terms of what should we think of as the incremental quarterly impact in terms of increases to operating expense and revenue from Aristos at least for the quarter you are guiding, the December quarter.

Mary Dotz

In terms of the next quarter, we don’t expect much in terms of a top line contribution yet. We just gave the announcement of the design and as I mentioned we expect it to ramp later in the year. On the expense side, what you can expect as I have mentioned is that, our G&A expenses, we are going to keep those flat even with the addition of the Aristos efforts and then on the R&D front, I would encourage to refer to that 8-K for some of the Aristos information. However, we did undertake as I mentioned a restructuring effort this past quarter. So we have reduced our operating expenses in terms of some of our traditional products as they have ramped down.

Brian Freed – Morgan Keegan

Okay, great. And then lastly, the question, I think people are most concerned about given your cash balance, we have seen the Aristos acquisition, do you feel like you've made the necessary acquisitions to position yourself going forward? Do you think there are still pieces either a technology or design perspective you need to acquire to be appropriately competitive in the current environment?

Sundi Sundaresh

The Aristos acquisition is clearly strategic one for us and as I have said in the call, it addresses a number of key drivers from giving us access our customer base and core technology to help us with our road map. Right now, we are focused on integrating that acquisition and making that successful. That said, the market conditions and climate right now, I think there are bunch of interesting assets that are coming up at diminished values and we will review them opportunistically.

Brian Freed – Morgan Keegan

Okay, great. Thanks for your time.

Mary Dotz

Thanks, Brian.

Operator

(Operator instructions) We will go next to Michael Cody with B. Riley.

Michael Cody – B. Riley

Thank you, good afternoon, just a quick follow-up on one of the Aristos questions, regarding revenue contribution in the December quarter not from the recent IBM design win but from Aristos’ legacy business, they did have some revenues, do you expect a contribution from those revenues or are any of those revenues that were highlighted in the 8-K today declining or falling off?

Mary Dotz

Thanks Michael. Good question. Yes, in the December quarter, from their legacy products, we do expect to see a minimal amount in terms of a revenue contribution.

Michael Cody – B. Riley

Okay, fair enough. And then on the gross margin, it is nicely up year-to-year but it was relatively significant dip sequentially and with the strength in the channel business, I was little bit surprised to see that. You mentioned OpEx being flat and that is great considering the Aristos acquisition and the restructuring you are doing, but any indication where the gross margin will be?

Mary Dotz

I would expect that gross margins, again, will be fairly flatter in middle of what you have seen for the company going forward.

Michael Cody – B. Riley

Okay. And in terms of Aristos and previous design wins, it would appear that they were pretty far along with IBM when you acquired them on maybe a number of things, where are you in terms of announcing, I don’t expect a definitive date, but are there things that Aristos had gone that you don't need to integrate into Adaptec in order to announce another design win, or will it require some further work before you are able to get that done?

Sundi Sundaresh

Pretty much if you think about Aristos' technology and their OEM engagements and actions to date, none of those require real integration with Adaptec, most of those are ASIC and software sales if you will. So, they have been executed independent of Adaptec. Now going forward, we clearly have a desire to tie our road maps together and pursue opportunities we see jointly. But that will happen in the future, so there’s a bunch of activity in the pipeline that was in place prior to the acquisition that is now being enhanced with the acquisition with our sales and marketing efforts and those can be driven just with the Aristos road map.

Michael Cody – B. Riley

Okay. Thanks. That’s clear that up very nicely. I think that’s it for me now. Thank you.

Mary Dotz

Thank you, Michael.

Sundi Sundaresh

Thanks you, Michael.

Operator

(Operator instructions) There appear to be no further questions. At this time, I would like to turn things back over to Mr. Sundaresh for any additional or closing comments.

Sundi Sundaresh

Thank you everyone. I’d like to thank the Adaptec team for delivering a successful quarter and thank you all for listening. We’re poised to take advantage of our acquisition and our solid product line to execute in the future.

Operator

That does conclude today's conference call. We’d like to thank you for your participation and you may disconnect at this time.

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