Adaptec Inc. Q4 2008 Earnings Call Transcript

| About: ADPT Corp (ADPT-OLD)

Adaptec Inc. (OTC:ADPT-OLD) Q4 2008 Earnings Call May 8, 2008 1:45 PM ET


Subramanian Sundaresh - President and Chief Executive Officer

Mary Dotz - Chief Financial Officer

Nicole Noutsios - Investor Relation


Brian Freed - Morgan Keegan


Good day, everyone, and thank you for joining the Adaptec Quarterly Earnings Release Conference Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Ms. Nicole Noutsios. Please go ahead, ma'am.

Nicole Noutsios – Investor Relation

Thank you, operator. Good afternoon. During today’s call you’ll first hear from Sundi Sundaresh, 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/or projections of the financial performance of the company based on our current expectations including projections of operating results for the first quarter of 2009. These statements are subject to significant risk and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. We refer to you the risk factor section of the documents that Adaptec has filed with the SEC specifically in our most recent Form 10-K and 10-Q which contain 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 a reconciliation of GAAP to non-GAAP measures please visit our website at under the investor relations section.

With that I’d like to introduce Adaptec’s president and CEO Sundi.

Subramanian Sundaresh – President and Chief Executive Officer

Thank you Nicole, good afternoon, and thank you everyone for joining us. During this call we review our latest quarterly results, market developments that impact our business, product leadership updates, and the continual progress we have made to improve our operating results. As my first order of business, I am happy to introduce Mary Dotz as Adaptec's new Chief Financial Officer. I am extremely pleased she has chosen to join our team. She has an extraordinary breadth of finance experience and business leadership and has been an immediate asset to Adaptec.

Let me move to an overview of the execution of the company during fiscal Q4. In addition to executing from a technology innovation perspective, we made considerable strides improving our business fundamentals. As we wrap the fiscal year, Adaptec net revenues for the fourth fiscal quarter was $39.9 million at the high end of our guidance range of $35 million to $ 40 million. The recorded non-GAAP income from continuing operations net of taxes of $0.04 per diluted share which exceeded the high end of our guidance of $0.01 profit per share. This is the second quarter in a row we have been profitable on a non-GAAP basis.

In addition, we are pleased to report that our gross margins are been showing steady for 2008 from 32.9% year ago to 42.5 % in the current fiscal quarter nearly a 9% point improvement year-over-year. While we still have work ahead of us, I am pleased with our progress on this front.

Let me now shift to a discussion of our businesses, beginning with an update on SSG. Although we received positive reviews of our products in the storage solutions group, I am disappointed that this has not translated to revenue growth. We reported net revenues of $4.5 million in SSG this quarter. We are seeing the effects of both macro economic trends and competitive pressures in this segment of our business. Managing our assets to deliver returns is critical for me and we have been taking steps to minimize losses, such as cutting expenses. Despite OEM driven top line challenges, Adaptec continues to make progress with our DPS business. We have solid traction with our unified serial products, delivering sequential revenue growth and taking share in the channel.

Further, international markets have been robust for these products and we acquired new customers in eastern Europe, Russia, China, and Korea. Additionally, from a technology innovation perspective, we have made considerable strides with the very successful global launch of our Series 5 Unified Serial Rate Controller family on March 3. This family includes the industry's first-rate controller solution, offering up to 28 port connectivity with both internal and external ports to achieve audio performance up to five times faster than competitive products. Engineered to deliver the most cost effective solutions for increasing data storage access and scalability, these new controllers allow up to 256 SATA/SAS drives to be seamlessly connected to a single system providing approximately 200 terabytes of storage capacity.

They allow Adaptec to meet the demanding requirements of a wide range of growing storage critical bandwidth intensive applications such as web hosting, digital video surveillance, medical imaging and communications. The Series 5 global launch has been extremely well received by Adaptec customers and partners. More than just positive widespread coverage, the Series 5 has debuted to truly rave reviews.

For example, in a Tom's Hardware article entitled Adaptec Turns Up the Heat on Unit 5 Serial Storage that compared our new controllers with our competitors, its conclusion was definitive. Adaptec's Series 5 8 port RAID controller 5805 clearly dominates all of our I/O performance benchmarks at almost all command queue depths. Adaptec Series 5 cards are clearly going to have an impressive career, as they will find their way into SAN appliances, NAD servers, and other storage servers. And in another competitive RAID controller review in Maximum PC, another member of the Series 5 family stole the show. Adaptec's 5405 controller dominated every critical benchmark in our testing process, save one.

As a leader in the data storage ecosystem, Adaptec works to ensure its products are compatible with all major IT environments. Virtualization is a growing factor in many of our customers' environments. To meet their needs, we also recently announced that all seven products in the Adaptec Series 5 unit 5 serial controllers family have been certified with VMware ESX server 3.02 and 3.5 through AppLabs, the world's largest independent testing and certifications Solutions Company.

The Series 5 family has created a solid foundation of products for Adaptec and we expect a very robust pipeline of I/O products in the second half of this calendar year. We look forward to more successful innovations in a similar vein. With that, I will turn the call over to Mary to provide a financial overview for the fourth fiscal quarter.

Mary Dotz – Chief Financial Officer

Thank you, Sundi. And welcome everyone. I am very excited to be joining Adaptec. I've had an opportunity to spend time with the team and the board and feel a great deal of synergy in the way they think about the company's strengths and long-term opportunities.

Before I start, I'd like to reiterate that all of the commentary today is based on non-GAAP financial measures 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 website. While the year was difficult from a top line perspective, we feel there are a number of items worth reflecting positively on. We've had several financial highlights during our fourth fiscal quarter and have made progress on a number of operational fronts.

As Sundi indicated, we have strong gross margins in the quarter and the improvement we have seen in just one fiscal year has been an encouraging indicator. Further, we have taken considerable actions in managing the business to align expenses with revenue.

The expense reductions are showing in Adaptec's bottom line. And for the second quarter in a row, we were positive on a non-GAAP EPS basis. And finally, our balance sheet, which is core strength for this company, affords us a lot of flexibility. We ended the quarter with over $626 million in cash. We are pleased to note that we have been steady increasing our cash over the last two years as we have been very focused on improving our working capital.

Moving to our income statement for the fourth fiscal quarter, our fourth fiscal quarter net revenues were $39.9 million and included $35.4 million of revenues from our DPS business and $4.5 million from our SSG business.

Our top customer, IBM, represented 30% of our net revenues while our largest distributor, Ingram Micro, represented 10%. Our gross margin in Q4 was 42.5%, more than a 3 percentage point improvement quarter-over-quarter compared to Q3 as we continue to lower our product component costs and have had a favorable product mix. As Sundi mentioned, we had a 9 percentage point gross margin improvement in fiscal Q4. 2008, when compared to the same period for the prior year.

As mentioned in prior earnings calls, we continue to face decreasing revenues as our OEM revenues decline amid a continued transition of parallel SCSI technologies to serial solutions. Despite our declining revenues, we continue to create more operational efficiencies and maintain very tight fiscal control in order to manage this transition and the impact it has on Adaptec P&L.

Our tight fiscal control and expense reductions among other actions have resulted in improvements to our operating expenses and bottom line. As a reminder, three fiscal quarters ago we reduced headcount and expense levels in the OEM portion of the DPS business. We started to see the benefits in the prior two fiscal quarters, but the largest impact on expenses was realized this fiscal quarter.

We want to emphasize that although we are trying to run a lean organization, we are a technology company and we need to strategically allocate investments in areas where we see opportunities for growth. Our progress is being realized in our non-GAAP net income and EPS. For example, in Q.4 '08 our non-GAAP net income was $5.7 million in comparison to a loss of $2.7 million for the same period last year.

Moving to non-GAAP profitability is an important milestone for us as we continue to carefully manage the business. In fiscal Q4, our non-GAAP EPS was a $0.04 income per diluted share compared with a $0.02 loss per share for the same period last year.

Now moving to our balance sheet, despite the P&L challenges in the last three fiscal years, our working capital has improved significantly and cash has increased by nearly $100 million. In just the last year alone, our total cash and investments increased by nearly $54 million. We had operating cash flow of 23 million during the fiscal Q4, primarily driven by a large tax refund of $14.6 million.

Net interest and other income was $7.1 million for the quarter, inclusive of $1.4 million of translation gain due to the weakening U.S. dollar. I also want to note that none of our investments are in auction rate securities and the majority of our investments are in short term conservative instruments.

We have also received numerous inquiries on our outstanding three-quarter percent notes and our intentions for them at the end of the calendar year. The investors in the convertible notes have a put option they can exercise in December of this year. So for planning purposes, we have made the assumption that nearly all of the bonds will be tendered for payment.

Now I would like to provide you with guidance for the first quarter of fiscal 2009. We expect to continue to experience decreasing OEM revenues in the transition of parallel SCSI technology to serial solutions and further expect these factors to be partially offset by growth in our channel business. As a result, we expect revenue in the range of $30 million to $35 million. As mentioned earlier, keeping the company at non-GAAP EPS positive and maintaining tight fiscal controls are goals of the company. We will continue to improve expenses and expect to report non-GAAP EPS in the range of break even to $0.02 income per share. Our operating cash flow should be slightly positive.

As has been the case for the last few years, we will continue with our cost reduction measures in order to ensure that our expenses are aligned with our reduced revenue levels.

Now, I would like to turn the call back to Sundi to briefly summarize our comments today.

Subramanian Sundaresh – President and Chief Executive Officer

Thank you, Mary. As we look to the future, Adaptec intends to expand our technology leadership in I/O with a robust and take market share from competitors in the channel. And to regain our traction in the OEM market, we continue to explore tight ASIC partnerships. We also remain focused on improving our operating model and maintaining our tight fiscal controls. The company has made a lot of progress on a number of fronts. I'm very proud of the Adaptec team which has accomplished a lot this year. I would like to thank all of our employees for a very successful quarter. With that, I would like to bring the general comments to a close and turn this over to Q&A.

Questions-And-Answer Session


(Operator Instructions). We will take a question from Brian Freed with Morgan Keegan.

Brian Freed

Hey guys, thanks for taking my call. Welcome, Mary. When you look forward, you talk about some of your road map plans. Some of your competitors are sampling 6 gig SAS. HP is about to start shipping products with 6 gig SAS. You talked a little bit about what your road map is going forward. Do you guys plan to support that, or do you intend to talk a little bit about what your view on the 6 gig SAS market and your participation there?

Sundi Sundaresh

So the 6 gig SAS market is sampling at the OEM level right now. The market reality is probably going to hit the, what I will call the early refresh timeframe which will be the latter part of calendar '09 in the OEM space and as the channel sometime in 2010. So when I alluded to some of the ASIC partnerships, that is where we would expect to get our 6 gig partner to develop our products.

Brian Freed

Okay. Great. And I will go ahead and that's my one question. I will get back in queue.

Mary Dotz

Thank you.


(Operator Instructions) We will take an additional question from Mr. Freed. Brian Freed.

Brian Freed

Thanks. A couple of additional. The $2 million in stock-based comp, can you break that up between COGS, R&D and SG&A for us?

Mary Dotz

Sure. Just a minute there, Brian. Let me grab my notes on that. The amount of stock-based comp that we included in our R&D number is about $800,000. I think in the COGS number it is about $120,000.

Brian Freed


Mary Dotz

SG&A was the bulk of it -- was about $1.1 million.

Brian Freed

Okay. And secondly, Sundi, as you kind of look forward, IBM was 30% of revenue this quarter, but obviously that's going to taper off as they roll out the new X Series. Do you have any better sense that this point in time what the timeline for that roll off will be and as we model out into this year, do you see it spanning several quarters? Or do you think it is kind of done in the September quarter? What's your thought there?

Sundi Sundaresh

If you look at the -- that's always a tough thing to predict in OEM transitions. If you look at the past history of most OEM transitions, there's always a tail of products as they move from one platform to the other, whether it is with the same vendor or whether they switch vendors. So I hesitate to predict exactly when that would be. I think we have given you the general guideline that we do expect OEM revenues to decline and IBM with that. I think you ought to think about this in the context of when the toughly platform actually hits the market and how that ramps in the market.

Brian Freed

Okay. And then secondly, as that rolls off, I know your goal is to try to sustain non-GAAP profitability. But, do you believe that you are in a position to sustain non-profitability in the face of the loss of a 30% customer over the next 12 months or so?

Sundi Sundaresh

Brian, we provide one quarter guidance at that time and we are clearly focused on optimizing the return on all of our assets. You have seen us take actions across last couple of years, and we have made steady progress on that front, even as we have lost a considerable amount of IBM revenues.


Thank you. And it appears we have no further questions at this time. I would like to turn the conference back over to Mr. Sundaresh for any closing or additional comments.

Sundi Sundaresh

Well, thank you everyone for joining us for this fourth quarter conference call. I appreciate all of your comments and have a great.


And thank you, everyone. That does conclude today's conference. We do thank you for your participation. On behalf of today's speakers, I would like to wish everyone a great day.

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