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STEC, Inc. (NASDAQ:STEC)

Q4 2012 Results Earnings Call

March 14, 2013 4:30 PM ET

Executives

Mitch Gellman - Vice President, Investor Relations

Mark Moshayedi - President and CEO

Raymond Cook - Chief Financial Officer

Analysts

Rich Kugele - Needham & Company

Kevin LaBuz - Deutsche Bank

Gary Mobley - Benchmark

James Schneider - Goldman Sachs

Aaron Rakers - Stifel

Richard Shannon - Craig-Hallum

Edward Parker - Lazard Capital

Nehal Chokshi - Technology Insights

Operator

Good day, ladies and gentlemen. And welcome to the STEC Fourth Quarter and Full Year 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions)

As a reminder, this conference maybe recorded. I would like to introduce your host for today, Mr. Mitch Gellman, Vice President of Investor Relations. Sir, please go ahead.

Mitch Gellman

Okay. Thanks, Karen. Welcome, everyone, and thanks for joining us today for our earnings conference call. We hope that you’ve had the opportunity to read this afternoon’s earnings release containing the results for our fourth quarter and full year of 2012.

Joining me for today’s discussion of our results, business outlook and the Q&A session are Mark Moshayedi, our President and CEO; and Raymond Cook, our Chief Financial Officer.

But before we begin today’s earnings call, let me mention that our CTO will be participating in a panel discussion regarding the evolution and recent developments in Flash technology at the world’s upcoming Wells Fargo Securities Tech Transformation Summit and that will be in early April.

And as I do each quarter, I need to remind everyone that our prepared remarks and answers to questions will include forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 and are based on management’s current expectations.

These forward-looking statements include, but are not limited to statements concerning growing acceptance, adoption, and qualification of SSDs within the enterprise storage and server markets; demands for high performance access to data and controlling datacenter costs, the launch, marketing qualification and production of STEC’s product and solution initiatives, continued product research and development; the qualification of STEC’s products and other developing technologies; the qualification of STEC’s products and solutions into emerging SSD system vendors, enterprises and non-OEM end-user customers; leveraging STEC’s sales and marketing, and channel-support infrastructure to cater to enterprises directly and develop STEC’s vertical market strategy.

STEC’s key product line initiatives and development; the transition from one product generation to the next; the length of qualification cycles; the capabilities, performance, cost advantages, and benefits of STEC’s products and solutions; the rapidly evolving enterprise storage and server markets; and expected first quarter 2013 revenue and loss per share entail various significant risks and uncertainties that could cause our actual results to differ materially from those expressed in such forward-looking statements.

These risks and uncertainties are detailed in periodic filings with the Securities and Exchange Commission. Special attention is directed to the portions of those documents entitled Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Listeners are cautioned not to place undue reliance on these forward-looking statements which represent our views only as of today. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if the estimates change, and therefore, you should not rely on the forward-looking statements as representing our views as of any date subsequent to today.

Additionally, as we discuss our financial performance, we will be referring to certain non-GAAP financial measures. Please see the reconciliations of our GAAP to non-GAAP measures included in today’s earnings release.

Thanks again for joining us today, and now, I would like to turn the call over to our CEO, Mark Moshayedi. Mark?

Mark Moshayedi

Thank you, Mitch, and good afternoon, everyone. I like to thank you for taking the time to participate in today’s Q4 and full year 2012 earnings conference call. The fourth quarter of 2012 capped off what proved to be a challenging year for the company as we continue to deal with an increasingly competitive market.

But even as we experienced setbacks, there are some silver lining in our performance that suggest we are on the right track, in particular progress made in adopting our new business model.

As we stated throughout the year, we are in the process of expanding the way we reach customers. We are aggressively pursuing end-user customers by expanding our channel and direct enterprise sales force. Our methodology is to provide customers a solution provider approach that leverages our core technologies as apposed to a component provider approach.

Please keep in mind that during the last 23 years we’ve evolved our company several times. I believe that we are making good strides towards doing this again and that there is significant value to be realized in our transition towards becoming an SSD solution provider and driving up the value chain, and as opposed to just being components selling. This is a next strategic step in defining our leadership position in this market. I would like to review some highlights of the progress we’ve made on this front.

We are diversifying our customer base and the types of accounts that our sales teams target. We have shown that we are able to win accounts at the enterprise end-user customers rather than just OEMs.

In fact during the second half of 2012 one of our non-OEM customer generated over 10% of our revenue. Also noteworthy is that the revenue from non-OEM accounts were $36 million in 2012, up from $19 million in 2011 and approximately 90% growth rate.

As a percentage of total revenue, non-OEM sales increased to approximately 22% from approximately 6% in 2011. These are important points because they indicative that our transition is underway and we are fully expecting the shift towards the healthy balance of non-OEM and OEM revenue will continue for the foreseeable future.

We have also been busy recruiting some of the storage industry’s top talent to bolster our sales and marketing efforts. The sales force is getting in position to target key high growth verticals, such as cloud service providers, Web 2.0, oil and gas, and financial, and coming weeks we’ll be hearing much more about some of the new leadership that we’ve hired to strengthen our storage financial, as well as new marketing messages to customers as we further establish our brand with enterprises.

We firmly believe that as markets continue to develop our combination of SSD, storage and application expertise will define, redefine our role. As an example, the integration and certification of our hardware with software solutions by variety of partners have further strengthened our total solution value proposition as -- and followed us to participate in deals we are offering near components would not win the business.

Looking ahead as our guidance for this quarter suggests transition like this happens over time. But we are confident that with our employees, expertise, new markets and channels, and vision for the future will guide us through success in the near future.

Thank you. And I will now turn the call over to Raymond to discuss our financial results.

Raymond Cook

Thank you, Mark, and welcome everyone. The net revenue for our fourth quarter of 2012 was $35.1 million, which was below our guidance of $36 million to $40 million for the quarter.

The net revenue by major product categories was as follows. Our Flash-related products accounted for $33.8 million or approximately 96% of total revenue and DRAM-related products accounted for $1.2 million or 3% of total revenue. The Flash-related revenue was comprised of ZeusIOPS of $25.3 million, MACH products of $5.3 million and embedded SSDs and other flash products of $3.1 million.

Net revenue for our full year 2012 was $168.3 million as compared to $308.1 million for our full year 2011. International sales comprised 30.4% of our total revenue in the fourth quarter of 2012.

For the fourth quarter of 2012, our GAAP gross profit margin was 32.2% as compared to 37% in the third quarter of 2012. Our non-GAAP gross profit margin was 32.8%, as compared to 37.5% in the third quarter of 2012.

The decline in gross profit margin was primarily attributable to an increase in fixed production overhead and labor cost as a percentage of total revenue and a decrease in the average selling price of certain SSD products, partially offset by a decrease in Flash component costs.

GAAP gross profit margin for the full year of 2012 was 35.6%, as compared to 43.6% for the full year of 2011. Our non-GAAP gross profit margin was 36.1%, as compared to 43.8% for the full year of 2011.

Our Q4 2012 GAAP sales and marketing expense was $7.3 million. GAAP general and administrative spending was $11.8 million, and GAAP research and development spending was $16.1 million.

Total GAAP operating expense for the fourth quarter of 2012 was $35.3 million and non-GAAP operating expense was $28.5 million.

Our non-GAAP results for the fourth quarter of 2012 excluded stock option compensation expense of $3.7 million, IT litigation costs of $1.8 million, SEC litigation and litigation costs of $1.1 million, and securities litigation-related cost net of discount of $8,000 and employee severance costs of $430,000, net of tax impact of $51,000. The non-GAAP adjustments are detailed in our fourth quarter of 2012 earnings release that was issued earlier today.

Our provision for income taxes was booked at an effective tax rate of approximately 9.4% for the year ended December 31, 2012. The increase in our GAAP effective tax rate to 9.4% for the 12 months ending 12/31/2012 from 0.8% for the 12 months ending 12/31/2011 resulted primarily from the establishment as a full non-cash valuation allowance against all of our net U.S. deferred tax assets during the second quarter of 2012.

The establishment of a full non-cash valuation allowance does not have any impact on our cash nor such an allowance preclude us from using our tax losses, tax credits or other deferred tax assets in future periods.

To the extent that we are able to generate taxable income in the future to utilize our deferred tax benefits, we will be able to reduce our effective tax rate by reducing the full non-cash valuation allowance.

Our GAAP diluted loss per share was $0.50 for the fourth quarter of 2012. Our non-GAAP diluted loss per share was $0.35 for the fourth quarter of 2012, which was within our non-GAAP loss per share guidance of $0.31 to $0.35.

Turning to full year 2012, our GAAP diluted loss per share was $2.27, as compared to earnings per share of $0.50 for the full year 2011. Our full year non-GAAP diluted loss per share was $1.03, as compared to earnings per share of $0.70 for the full year of 2011.

Form a balance sheet perspective, the following are select accounts with interest for the fourth quarter of 2012. Cash and cash equivalents decreased $28.0 million for Q3 -- from Q3 2012 to $158.2 million. Accounts receivable increased $350,000 from Q3 2012 to $13.5 million. Net inventory decreased $2.8 million from Q3 of 2012 to $41.8 million. CapEx was $1.8 million for the quarter, offset by $3.5 million of depreciation and amortization.

Current liabilities decreased $6.2 million for the quarter to $58.4 million, due primarily to the timing of accounts payable payments to suppliers and we had no long-term debt outstanding as of the December 31, 2012. Net cash used in operating activities for the three months ended December 31, 2012, was $21.3 million.

Turning now to our guidance for the first quarter of 2013, we expect our revenues to be in the range of $21 million to $23 million, with non-GAAP diluted loss per share to range from $0.40 to $0.42.

I’d like to thank you for joining us today. This concludes our prepared remarks. I will now open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Rich Kugele from Needham & Company.

Rich Kugele - Needham & Company

Thank you. Good afternoon. I guess I will just keep it to one main question. Can you just talk to us a little bit about the potential for channel conflict as you’ve been increasing your direct sales force to go directly at these customers? I mean I would assume that some of the VARs have previously been or some of the channel players have been incorporating the products through other means. So are you finding that that’s one of the reasons why the sales transition is slow, or can you just elaborate on why you think it might be taking longer?

Mark Moshayedi

We do not see it in channel conflict. As a matter of fact, I think what’s going to happen is a lot of times, when we go to these end-user enterprise customers and work with them, they are using other supplier’s servers or storage boxes and they will be incorporating our solution as part of that solution that they are buying, let’s say from an IBM or a Dell or a Lenovo or HP, one of those guys.

So what has been happening is that, when we work with the customer and they qualify our product and they see the value proposition that we offered and the mandate is actually the product to be incorporated by the OEM. And that becomes a pull-through on the OEM side, so we then get pulled in on the OEM side and have to close the deals with OEM as well. So this is actually -- it works both ways and this model has been improving and it works and we are not seeing more and more traction from the customer base that also creates these demands on the OEM side.

Operator

Thank you. And our next question comes from the line of Sherri Scribner from Deutsche Bank.

Kevin LaBuz - Deutsche Bank

Hi, guys. This is Kevin LaBuz on for behalf of Sherri. Just a question about the cash balance and your outlook. Last quarter, you said that you felt that you had adequate cash to meet your operating needs for the next 12 months, and obviously you burned some this quarter. It looks like you’ll burn some next quarter with the lower sales outlook. So are you still comfortable with the level of cash that you have? Thank you.

Raymond Cook

Yeah. Hi, Kevin. I think from an accounts perspective, we believe that the cash that we have on hand is more than adequate to meet the operating requirements of the company for the foreseeable future. We have a significant cash position, both domestically and internationally and based upon our models, we do not see that as being an issue.

Operator

Thank you. And our next question comes from the line of Gary Mobley from Benchmark.

Gary Mobley - Benchmark

Hi, guys. Could you give us a sense by how much your direct sales force has grown as of the end of the year or even today versus from where you started? And with revenue now about 25% of the previous peak and you burning about as much in cash from operations, you’re generating revenue, can you give us a sense of where your restructuring plans stand and what the break-even target is on a quarterly revenue basis? Thank you.

Mark Moshayedi

So we’ve grown the sales team for about 45 people now and they’re targeting -- these are of course some sales guys, some SEs that go out and marketing folks as well that are helping in the enterprise end-user sale? On the financials?

Raymond Cook

Yeah. So, Gary, what we are doing is, we are taking at look at operating cash flow and the structure that we have in place. We recognized the fact that we need to build out our enterprise sales and marketing teams, even more so than we have. But at the same time, we will continue to look at the cash burn and the structure we have in place. We currently have about a $70 million break-even model as you are aware and we will continue to monitor that as we go forward.

Mark Moshayedi

And again, the sales guys that we have, they all have bogeys that they have to hit and so pretty quickly those guys are cash generating for us.

Operator

Thank you. And our next question comes from the line of James Schneider from Goldman Sachs.

James Schneider - Goldman Sachs

Good afternoon. Thanks for taking my question. Relative to the Q1 outlook, can you maybe talk about whether all that decline is constituted by the OEM customers falling off. And do you expect further declines from those same OEMs going into Q2?

And then maybe as a clarification, can you talk about your degree of confidence that the insurance receivable of $21 million you book on the balance sheet, you’ll be able to recognize this cash this quarter. Thank you.

Raymond Cook

Yeah. So from an overall revenue perspective, we’re going through a transitionary phase as you know from going purely OEM to what we talked about in the second half of 2012 and how big or large are the 10% customer that was enterprise-based customer. And as we move forward that transition will continue to increase our enterprise customer base.

In the current quarter, what we’re seeing though is that we’re still building out that enterprise. We’re very much in the infancy stage of the enterprise customer development. And we’re still committed to our OEM customers as well. So in the evolutionary phase and that we will continue to build out both the enterprise customer as well as our OEM phase.

Operator

Thank you. And our next question comes from the line of Aaron Rakers from Stifel.

Aaron Rakers - Stifel

Yeah. Thanks for taking the question. So, kind of, sticking with the theme on the guidance front, here we sit on March 14, kind of, thinking about what is almost a completed quarter. It might be helpful to help us understand maybe how you are thinking about the June quarter? And in that context, how we should think about the gross margin and cash burn dynamics of the model here over the next couple of quarters?

Raymond Cook

Yeah. Hi Aaron. So what we’ll do is and as you know is we project one quarter at a time. And we’re providing color around Q1 as well as our Q4 actuals. So in generality, as we move forward, we’re going to look more and more to our enterprise customers as we continue to build out that model. But as far as getting any color or guidance around Q2, we’re unable to do that at this point in time.

Operator

(Operator Instructions) Our next question comes from the line of Richard Shannon from Craig-Hallum.

Richard Shannon - Craig-Hallum

Hey guys. A question, I guess, following up on the earlier ones regarding your OEM basic customers. I guess maybe I’ll just ask the question in a different way, which is -- any chance of seeing a, kind of, bottoming out in this OEM revenue level or could this decline further? And any commentary you can give on continuing qualifications and discussions with the top three OEM storage buyers out there?

Mark Moshayedi

We’re continually working with these customers to try to expand our sales into these accounts. The sale cycles of course are very long. And there is -- we’re actively engaged with programs and new developments as well or variations of the product for these accounts.

We believe that obviously we’re kind of bottoming out this quarter. They are kind of a cyclical low quarter any way from an OEM perspective. And with the activities that we see, we’re hoping that we can get the number on the OEM side up. But the sales funnel that we see on the enterprise sales side, looks very promising. And we’re hoping that that side, we’ve seen obviously higher gross profit margins.

It’s also associated with it. We’ll come in and make up the differences and you’ll see an upswing in the sales and to eventually get to the break-even point by the end of the year.

Operator

Thank you. And our next question comes from the line of Edward Parker from Lazard Capital.

Edward Parker - Lazard Capital

Hey guys. To the extent that you’re able to, could you maybe comment or address the open letter to the shareholders that was just published here after the close. And maybe just provide any color that you can about the discussions with the Board in response to some of the settlement discussions that were alluded to in the letter? Thanks.

Mark Moshayedi

Continue to reach out to the activist, investors and as a result, this proxy contest and we’re hoping that we could get to a mutually agreeable resolution. That’s also beneficial to the shareholders. That’s all the comment we could make at this time.

Operator

Thank you. And our next question comes from the line of Nehal Chokshi from Technology Insights.

Nehal Chokshi - Technology Insights

Thank you. You mentioned the 22% of revenue came from non-OEM sales for 2012. Can you give us what percent it was for 4Q 2012 and also your thoughts on what it should be for 1Q ‘13?

Raymond Cook

Yeah. So as far as breaking out the color in the current quarter, we don’t provide that level of granularity as you know. But what we have seen is that the OEMs revenue is declining and that we’re seeing our enterprise customer base, starting to increase as to its percentage of revenue for the overall mix.

Operator

Thank you. And we have no further questions.

Mark Moshayedi

Okay. Everyone, I’d like to thank you for joining us today. Again, we’ve been presenting at a number of conferences recently. And with the one coming up, Wells Fargo, and the panel discussion, we hope that if you are attending the conference that you’ll join us there. Thanks everyone for joining us today.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.

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