Thursday, January 14, 1999

Adaptec Inc.
(Nasdaq: ADPT)
Phone: 800-462-5179
Website: http://www.adaptec.com
Price (1/13/99): $24 1/2


Adaptec makes products that increase the data transfer rates between personal computers, servers, peripherals, and networks. Unfortunately, the company's revenue data were so ugly for most of 1998 that the main thing being transferred was dollars out of shareowners' hands. Serious cost-cutting and the launch of new products, however, have helped this May Trouble adapt into a Double.

A year ago, Adaptec shares got hit by an earnings warning. A disk drive glut was hurting sales of its controllers. The rise of the sub-$1,000 PC also meant its high-speed Small Computer Systems Interface (SCSI) (pronounced "scuzzy") host adapter boards were quickly losing out on the desktop to the cheaper Integrated Drive Electronics (IDE) products made by others. Cost-cutting measures and a management change followed. Amidst the fall mayhem, the shares dipped below $8.

Still, interim CEO Larry Boucher has refocused Adaptec by completing four divestitures. The company's high-end peripheral technology business was sold to Texas Instruments (NYSE: TXN). Adaptec moved its satellite networking technology into the newly created BroadLogic. It transferred its fibre channel technologies to Jaycor Networks for a minority equity stake. And it worked a similar deal with Chaparral Technologies for some of its external storage technologies. Adaptec has also announced plans to sell its semiconductor design group.

These moves have helped accelerate cost-cutting while allowing Adaptec to concentrate on growth opportunities, especially in the high-end server market. The company is wasting no time. On January 4, it announced the first 64-bit RAID solution that doubles the input/output of conventional controllers, meaning data from servers can be transferred faster. Dell (Nasdaq: DELL) has adopted the product.

Two days later, Adaptec made a preliminary announcement that earnings per share for the third quarter (ended December 31) would be $0.20, far below the $0.38 per share reported in the year-ago period but a whopping 43% above the consensus earnings estimate of $0.14 per share.

Although total revenue should be about $183 million ($24 million from now discontinued operations), down from $254 million a year ago, the unexpected earning gains resulted from a pickup in demand for Adaptec's core SCSI adapter products, "strong initial shipments" of the new RAID product, and better-than-expected expense reductions. Investors liked the news, and pumped the stock up $5 5/16 to $24 7/8.


Based in Milpitas, California, Adaptec provides bandwidth management technologies. Its high performance input/output (I/O), connectivity, and network products are used by major computer and peripheral manufacturers.

As a result of its divestitures, Adaptec has taken in $4.6 million (of $8.6 million total) from Texas Instruments. It will generate another $73 million from the sale of its peripheral technology solutions (PTS) group, which designs semiconductors for sale to disk drive makers, to STMicroelectronics (NYSE: STM).

As of the last proxy, insiders owned just 3% of the stock.


Income Statement*
12-month sales: $782.3 million
12-month income: $61.7 million
12-month EPS: $0.53
Profit Margin: 7.9%
Market Cap: $2734.2 million
(*Excludes one-time charges. Based on 111.6 million shares, which excludes outstanding options.)

Balance Sheet*
Cash: $613.6 million
Current Assets: $830.5 million
Current Liabilities: $107.4 million
Long-Term Debt: $247.6 million
(*As of September 30, 1998)

Price-to-earnings: 46.2
Price-to-sales: 3.5


The Fool's Alex Schay offered the bull case for the company in his midyear review article: Adaptec's management had the experience and the company had the financial resources to reposition the business.

Though a 10 million share buyback program approved last January had been suspended while the company negotiated an acquisition, it was reinstated in July when that deal fell apart. Some 8.3 million of those shares were acquired during the September quarter at an average price of $11.77. On October 16, the board approved a new $200 million buyback. All of that was powerful evidence that the board considered the stock undervalued.

Also, turnarounds often depend on a top-level management change, and that came on July 30 when Chair/CEO Grant Saviers was replaced by interim CEO Larry Boucher and former Adaptec Chair and CEO John Adler joined the board. Press releases issued in September indicated the company was making progress with its cost-cutting efforts.

Q2 results announced October 22 suggested the company had bottomed. Sales fell 48% to $144 million; gross margins contracted to 56.2% from 62.4% year-over-year; and operating earnings were almost nonexistent. Still, that was better than the penny per share loss analysts had expected. Morgan Stanley raised its rating from "neutral" to "outperform."

That news, alongside the Fed's surprise mid-October interest rate cut, suggested that the worst might be over for Adaptec, the company and the stock. Judging by the stock's recent spike, though, no one expected the company's fortunes to recover so much so soon.


While Adaptec hasn't abandoned its strengths in the server and workstation I/O market, it is now looking to growth areas such as CD recordable software, RAID solutions, and networking products. The rise of the Web should foster demand for its products in the Windows NT market.

Meanwhile, the stated goal of the recent cost-cutting is to reduce operating expenses to less than 35% of revenue. That could leave operating profits in the mid-teens. Investors will want to look closely at the final Q3 results, to be released after the market closes on January 25, to see whether new product sales or cost-cutting played a larger role in the strong numbers.

What's clear is that the preliminary Q3 report has analysts raising their earnings estimates. Daniel Niles, semiconductor analyst at BancBoston Robertson Stephens, bumped his FY99 (ends in March) number to $0.52 from $0.45 a share and his FY00 estimate to $1.15 from $1.00. His new twelve-month target is $30. Wellford Dillard of Friedman, Billings, Ramsey also boosted his target price to $30.

The high-side earnings estimate for next year now stands at $1.25 per share, putting the stock at just 20 times earnings 14 months off. If the company's turnaround is for real, that's cheap. There's also the $3.30 per share cash net of debt before the sale of the peripherals group. If shareholders are lucky, though, the board has been using some of that cash to buy back more shares. Techies comfortable in the world of SCSIs and RAIDs might want to take a closer look.

Related articles:
Adaptec Adapts, 1/4/99, Fool On The Hill
1998 Midyear Market Review: Adaptec
Adaptec, 5/26/98: The Daily Trouble

-- Louis Corrigan

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