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Executives

Sundi Sundaresh - President & Chief Executive Officer

Mary Dotz - Vice President & Chief Financial Officer

Analysts

Brian Freed - Morgan Keegan

Mike Crawford - B. Riley

Adaptec Inc. (OTC:ADPT) F2Q10 Earnings Call October 29, 2009 5:00 PM ET

Operator

Good day, ladies and gentlemen and welcome to the second quarter of fiscal year 2010 Adaptec Inc. earnings conference call. My name is George and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call Ms. Mary Dotz, Chief Financial Officer. Please proceed.

Mary Dotz

Thank you, George. Good afternoon everyone and thank you for joining for Adaptec second quarter of fiscal 2010 earnings call. With me on the call today Sundi Sundaresh, President and Chief Executive Officer of Adaptec, I will start the call with the review of our financial highlight and then I will turn the call over to Sundi for an update on our business.

Our remarks will followed by 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, anticipated demand for our current and future products and our ability to grow in the future.

These statements are subject to significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. We refer you to the risk factors section in the documents that Adaptec has filed with the SEC, specifically our most recent Form 10-Q, which contains important risk factors that could cause our actual results to differ materially from our expectations.

Additionally some of the financial measures that are included in this discussion today are non-GAAP exclusive of certain non-cash or non-recurring charges are discontinued operation as maybe noted. I encourage you to refer to the reconciliation of GAAP to non-GAAP results that is included, but today’s press release and posted on our website at www.adaptec.com, under the Investor Relations section.

Now, and our financials, given the economic backdrop Adaptec performed reasonably well in the second quarter. The overall business environment appears to be stabilizing. However over the impact of decreased IT spending from prior period combined with constraints on credit availability for small and medium businesses continues to effect Adaptec’s revenue.

Our net revenues were $18.4 million for the second quarter of fiscal 2010 well with in our guidance range. The decline from first quarter of fiscal 2010 was driven by our previously announced decreased in our legacy OEM revenues, which we believe will continue to decline next quarter. Our channel customers represented 61% of net revenues for the second quarter including our top distributors Ingram Micro at 13% and Bell Micro at 11%.

The remaining 39% of net revenues came from our OEM customers with IBM representing 22% of net revenues. Our legacy OEM revenues will continue to decline in the future. On a non-GAAP basis gross margin were 50% for the second or slight decline of 1% from the prior quarter. This decline was the result of fixed supply chain cost spread over smaller revenue based and I expect this to an ongoing factor until we achieve more scale.

Our non-GAAP operating expenses increased by approximately $1 million from the last quarter, excluding one time expenses such as the professional fees we spend to support our consent revocation solicitation regarding our proxy. Our non-GAAP operating cost would remain relatively flat with last quarter. Due to the lower revenue and associated lower gross profit we have non-GAAP net loss of $1.8 million to the non-GAAP EPS loss of $0.01 per diluted share for the second quarter of fiscal 2010.

During the quarter our cash and investment increased by $2.9 million. We generated cash from operation from continuing operations of $4.9 million, which was offset by nearly $1.8 million of stock repurchases during the quarter. Our receivables collections, continues to be strong and our net inventory is down to $2.9 million as of the end of the fiscal quarter.

Turning to our outlook now for the third quarter of fiscal 2010; our forecast is based upon current business expectation and current market condition and reflects our non-GAAP presentation. While we believe the economy has begun to save a life, predictability of close rates remains somewhat limited. As previously indicated, our legacy OEM revenue will continue to decline. As such we expect net revenue to be between $15 million and $17 million for the third quarter of fiscal 2010.

As our pipeline of new products continues to grow, we are expecting slight up tick in our revenue in Q4. Our gross margin should be in a mid to high 40s, considering the lower revenue spread over fixed costs. Based upon our lower top line, we will be looking at additional cost reduction opportunities in Q3 and Q4 of fiscal 2010. We expected the third quarter non-GAAP EPS to be in the range of a loss of $0.02 to $0.04 per diluted share. We expect our cash loss to be slightly negative.

Now, I’d like to turn the call over to Sundi, to discuss our business.

Sundi Sundaresh

Thank you, Mary and thank you everyone for joining us today. Our revenue this quarter of $18.4 million was made up of almost 48% in new product revenues, compared that to our exit RAID at the end of last fiscal year, a new products were about 31% of revenue and the exit RAID of year prior, it will only seen 14% for new products. This demonstrates the execution on our new product pipeline over the past few years at Adaptec.

This past quarter, we introduced our Data Conditioning Platform strategy and launched our MaxIQ SSD Cache Performance Solution. Our Data Conditioning Platform is the foundation that positions of Adaptec’s for future growth and with the release of our first MaxIQ product we are realizing the benefits of our R&D execution and our innovation roadmap.

The Adaptec Data Conditioning Platform is that the core of the company’s strategic goal of lowering costs, maximizing performance and achieving green IT objectives in next generation enterprise and cloud data centers. Leveraging its 28 years of I/O innovation, Adaptec developed its Data Conditioning Platform to serve as the foundation for intelligent high payback I/O solutions, that protect accelerate and optimize data as it moves through the I/O pack.

Adaptec customer solutions based on the Data Conditioning Platform provide data center managers, system integrators and OEMs with optimal hardware and software utilization simplified non-inclusive technology integration and minimal risks and performance hits traditionally associated with incorporating new data.

Validation of our progress is reflected in our recent announcement for win that A.T. Works. A.T. Works is Japan’s premier internet service provider and the manager of the country’s largest server farm. They selected Adaptec Series 2 and Series 5 RAIR controllers for their hosted specialized servers, as well as for various other general use servers.

Following an in-depth evolution of several competitive devices, Adaptec’s controller was the only solution to meet all key criteria critical to A. T. Works, including stability, scalability, performance, and Linux support, as well as Adaptec’s strong Japanese technical support capabilities.

Mr. Katsuyuki Okubo of A. T. Works said this “We put many RAID controllers through a thorough testing process. Adaptec RAID controllers met all of our requirements. More than any other vendor, Adaptec proved excellent in terms of compatibility and RAID features, and guaranteed extensive support under Linux in open source. Adaptec controllers also exhibited top sequential read/write performance while offering the stability that is essential for our hosted specialized servers.”

The Adaptec MaxIQ versus the cash performance solution represents the next pace in Adaptec Data Conditioning Platform strategy. It is an innovative approach to delivering business value to data center managers by intelligently routing, optimizing and protecting data as it moves through the I/O path.

MaxIQ is the industry’s first solution for building and managing High-Performance Hybrid Arrays or HPHAs. Our Storage Arrays that use both Solid State Drives or SSDs and hard disk drives in commodity servers. With the anticipated growth in the utilization of enterprise SSDs, our MaxIQ SSD Cache Solution is poised to capitalize on that growth.

High-Performance Hybrid Arrays built with the Adaptec MaxIQ SSD Cache Solution, can deliver up to five times more input/output operations per second when compared to hard disk drive only arrays. MaxIQ can also provide capital and operating cost savings of up to 50% by improving system resource utilization and providing a scalable Hybrid Solution that can deliver the highest I/Os per dollar at the lowest dollars per gigabyte.

The MaxIQ SSD Cache performance solution deliver the dramatic acceleration in application performance, elevating the bottleneck that can occur between server processors and hard drives allowing data center managers to increase the number of users hosted per IT dollar, reduce the need for additional equipment acquisition and significant cut data center energy costs.

This product introduction was one of our best launches ever based on the present web coverage and we’re also pleased with the customer interest and pipeline build up. So early in a cycle among server farms Internet data centers etc. that make up the heart of the cloud computing infrastructure.

They’re focused on enabling our OEM and channel integration partners to deploy storage solutions with our products optimize for performance and energy efficiency. This represents a significant growth area for the company, as well as a solid area for innovation and differentiation in the marketplace.

The strategic decision to partner with Intel, underscores Adaptec’s commitments to developing easy to integrate standards based I/O solutions to meet large scale computing challenges in demanding IT environments. Adaptec’s MaxIQ underscores that potential that we see for significant future management and conditioning of data through the I/O path, which central to our new Data Conditioning Platform strategy.

Our intelligent power management solutions are battery less backup or zero maintenance cash protection products and now our MaxIQ SSD Cache products. Provide evidence to the return to product innovation that Adaptec has long been known for. Combined these Green IT products with our award winning Series 1 through Series 5 RAID products and our portfolio of new products gaining traction in the marketplace is clear.

With several virtualization and cloud computing driving growth in the next generation data center, Adaptec has poised to capitalize on these market trends. Customers are looking everywhere for budget relief and to preserve capital and our current product line offers up those exact solutions.

System integrators are aggregating customer demands and looking for best of RAID solutions to help them offer enterprise class IT and extremely comparative prices. Our compelling economics and simplified data management enables them to compete more effectively in these new business environments.

While our new products continue to ramp, they’ve yet to reach the levels of offsetting the decline in our portfolio of legacy products. We continue to manage our operating expenses, remained committed to our innovation road map and are driving strategic customer engagements to help drive our future.

Thank you for time today and I will now turn this over to George to open this up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Freed - Morgan Keegan

Brian Freed - Morgan Keegan

So, in the context to this whole proxy battle I appreciate kind of the commentary you made around your new products, but could you kind of share what is your vision for desk pack over the next, to say 18 to 24 months. What’s you try to build, what’s you try to create just kind of and brief of explanation as you can?

Sundi Sundaresh

I think I described that as our Data Conditioning Platform. So let’s look at in three phases. The first phase is with the product addressing this cloud computing and server infrastructure to really drive a business through channel integration partners to these internet data center server farms is our primary near term growth driver.

The second phase is some of the value proposition here of course appeals to OEMs as well, but as you know we’re not the primary design in most of these OEMs. So we see an opportunity to be qualified as option cards with a number of OEMs as the second phase and the last phase is with the technologies that we have acquired with our silicon capabilities, a number of the value-added that we have now developed software running on our controllers.

We’ll also bring some of those capabilities into our next generation silicon and really use that intersect the OEM opportunities in a much broader way. At the out of hit the strategies all about addressing the growth of servers in cloud computing deployments and making sure that we can deliver the performance and energy efficiency in those environment.

So we’re taking advantage of two primary things. One is the shift in deployment to the cloud. The second is the benefits you get from enterprise class SSDs, both which are growing by dramatically. The cloud server deployment as growing at a 28% cager from a little under a million units a year. SSDs from a smaller base are growing about 85% a year.

So those are big growth drivers and of course underlying that, the classic things we do at the I/O technology level of moving speeds and feeds, the next generation will go from 6 to 12 gigs and the next generation of PCI etc. So those are normal and ordinary as the foundation of the value-added is really around how we best and intelligently use our I/O capabilities to drive performance and energy efficiency.

Operator

Your next question comes from Mike Crawford - B. Riley.

Mike Crawford - B. Riley

Couple of quick one. First, how much revenues you generated from Aristos in the quarter?

Mary Dotz

A little less than 10%

Mike Crawford - B. Riley

Is that still just from the one, I think you said there were two clients shipping products now…?

Sundi Sundaresh

Yes, the two clients shipping products and as I mentioned in the revenue ramp there has been less than exiting to-date, but the two OEMs are shipping.

Mike Crawford - B. Riley

How many employees or engineers, Aristos today versus when you acquired them just over a year ago?

Sundi Sundaresh

Most of them are there. When we acquired then we had about 60 and we have pretty close to that same number today. We did have some very minor turnover early in the integration cycle, which have been replaced, so we’re almost at the same strength.

Mike Crawford - B. Riley

If you read the risk metrics and proxy governance reports, they talk about just quoting from those services whereas I guess interviewed Directors talked about, a loss of OEM customers, discussed in August, is that…?

Sundi Sundaresh

That was a misstatement. It was not a loss of an OEM. It was a change in a design opportunity. We had expected a certain level of penetration and attachment on a certain motherboard design and that turned into more often add-on card design, that’s what was discussed. Now that big change is the revenue expectations in a future of year, but that was what we’ve discussed.

Mary Dotz

We still have that OEM…

Sundi Sundaresh

We still have that OEM.

Mary Dotz

We have not lost OEM customer yet.

Mike Crawford - B. Riley

Then you also talked about some, not exactly onetime costs related to the revocation proxy. How much of those were there in September and also so far into October?

Mary Dotz

I haven’t given October yet, but we’ve spent a little less than $1 million. I’d say, around 700 grand on the revocation.

Mike Crawford - B. Riley

You mean title, since it started?

Mary Dotz

No, in the quarter. In the recent quarter.

Mike Crawford - B. Riley

Are you able to handicap that all at this point, which way you think, it will turn out?

Sundi Sundaresh

I think the stockholders can do that, better than we can.

Mike Crawford - B. Riley

You don’t updates from your derivatives; that’s working on this for you?

Mary Dotz

Mark, yes it would be really inappropriate for us to try to handicap that. I don’t think we can sit here and make a guess.

Operator

Your final question comes from Brian Freed - Morgan Keegan.

Brian Freed - Morgan Keegan

So another couple of follow-on, as you look current business model, Sundi, your current revenue run rate, I think obviously needs a little bit more scale to achieve operating profit. So I think you’d agree with that. Do you think you would have developed the technology to achieve that scale or do you think an acquisition would be necessary for using that scale?

Sundi Sundaresh

I think you also heard Mary say that, we are looking at our operating expenses in light of our current revenue levels. I would say that, a part of this depends on your time horizon. In the near term, we could benefit from the scale of an acquisition in the long term, if we look at our business and the potential market opportunity you don’t really need it, so really about how quickly, do you want to get to that scale.

The second part of that is, as you know we’ve looked at a number of things over the years. You have to get something not just for the scale, but also to make sure it makes strategic sense and fits the value parameters.

Brian Freed - Morgan Keegan

I guess the second question I have in the kind of, I would say what time horizon do you think it would take for your current technology set to achieve that kind of scale? Do you think it could be accomplished and say 24 to 36 months?

Sundi Sundaresh

Yes.

Brian Freed - Morgan Keegan

Kind of a follow-on to that, if you look at the new MaxIQ products, can you talk a little bit about the development process, the types of beta customers who were involved in the early date of the product in terms of, I forgot to name them, but at least kind of give some qualitative commentary in terms of what types of customers? This is particularly attractive too? What’s the target at addressable market for the product?

Then thirdly, in terms of the process towards OEM design wins, anything as you walk through things? Do you feel like some of the spec the software stacking embedded in silicon, did you looked at the evolution of this product and it played out as you would hope and how that cycle would work and where we are in?

Sundi Sundaresh

Almost I have to take you back to our Series 5 launch year and a half ago. That product family actually opened a lot of doors, because it was the industry leading product in terms of performance and capability and we have the broadest range, so not only where we getting pulled into through our integration partners into vertical OEMs, and medical imaging and video surveillance and the typical white box integrator.

We also find ourselves getting pulled into some of these, what I call sever farm, web hosting, internet data center type of environment where people needed high performance controllers. As we started getting into some of those in early test and qualification and one of the things that came up over-and-over was that issue of our power were such a big deal for them, the energy efficiency were the big deal.

The scalability since they will constrained on interfaces supporting more users, but I’ll give a number of servers was imported to them as well, but what we found and did as the result of that was the launch of power management product a year ago and we launched battery less backup as a result of, he was hearing them talk about the maintenance issues. They just didn’t have the ratios of people to servers to be able to support replacing batteries every year, year and a half etc.

Lastly, they were always performance bottlenecked and form themselves either using expensive drives and lots of spindles to get that and so we’re getting some request for, “Can you guys do something with SSDs etc.” That led to our product roadmap a year ago to say, okay.

The rate capabilities are pretty well understood and we can do that just as well as the next one and actually we do that better with our performance and comparability, but the real value going forward in these other areas. So, we built a roadmap around that and started developing those features on our existing controllers.

As you know, we have always said that the part of the market and part of the addressable time is with the OEM and engaging the OEM required underlying silicon, which was the basis for our acquisition a year ago and so as we intersect the work we’ve done with these server farms and internet data centers and say, “Okay, how do we influence the next generation of silicon.” That’s were the merger just comes under silicon roadmap.

So, if you look at our forward timeline in the near term, it’s all add-on cards that go through channel integration and through some OEM cards as a option cards as some customers have already started kicking the tires on this, because it is unique and new and different and then follow on will really be silicon, but silicon has a long and just station cycle. So realistically we wouldn’t see the silicon capabilities or some of our rally RAID showing up in revenue for at least two plus years.

Brian Freed - Morgan Keegan

As you kind of, give some qualitative commentary around that type of customers, who you worked with and developing this beta sites in the early testing. We talk in Tier 1 web services companies, people like a necessarily these names like of facebook or accrual Tier 2, I mean I guess I’m just trying to engage what is the opportunity out there for channel perspective as we look forward to potential OEM design winds in future periods?

Sundi Sundaresh

So the answer to that is the beta sites included some of the Tier 1 guidance, both on the data center front as well as the OEM front. So, as much as a lot of these date center guys that you described tend to source products not just from the well known brands, but also through other integrators.

The brands have also recognized that this is a growing opportunity and therefore are targeting it and so some of those Tier 1, they’ve also started looking at our products and testing them etc. So the betas included both large Internet web data centers as well as some large OEMs.

Brian Freed - Morgan Keegan

Do you currently have any of the MaxIQ products and production environments?

Sundi Sundaresh

We do in a couple of smaller places, so this gets, how the pipeline translates into revenue. Our expectation is that some of the smaller integrators and hosting outlets will move quicker and when say quicker, that typically means in Nevada a one quarter cycle. Some other larger ones will probably take two quarters and the really big ones, my guess would be about three quarters. Before they have kicked the tires and tested and enough to put it in their production environments.

So today we have at least and the numbers we been in, we announced and started shipping in September, obviously we were in data prior to that and so, we have a nice healthy pipeline with a few large ones and a number of small ones and we expect the smaller ones, and when I say small, these are typically less than half a million year accounts. So we expect a number of those to close this quarter and more in next quarter, but the really big ones that you and I would classify the Tier 1s would probably take two to three quarters.

Brian Freed - Morgan Keegan

When you look at the IBM revenue in the quarter, I think you said it was 22%. Can you give us some sense what’s the mix of that, part of that mix to still site of the XSeries serve eight? All the IBM revenues is XSeries serve eight?

Sundi Sundaresh

Correct.

Operator

Ladies and gentlemen, this will conclude our question-and-answer session for today’s conference call. I would now like to turn the call over to Mr. Sundi Sundaresh, Chief Financial Officer and President.

Sundi Sundaresh

Thank you, George and thank you all for attending our second quarter of fiscal 2010 earnings call. I look forward to reporting to you on our progress in the future. Thank you and have a great day.

Operator

Ladies and gentlemen, this will conclude the presentation. You may now all disconnect. Good day.

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Source: Adaptec Inc. F2Q10 (Qtr End 02/10/09) Earnings Call Transcript
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