ROBERT STEPHENS - ADAPTEC INC (ADPT)
CEO Interview - published 01/10/2002

DOCUMENT # NAW212

ROBERT N. STEPHENS is Chief Executive Officer and President of Adaptec, Inc. He joined Adaptec as Chief Operating Officer in November 1995, became President in October 1998, and CEO in April 1999. Before coming to Adaptec, Mr. Stephens was the Founder and Chief Executive Officer of Power I/O, a firm that developed serial interface solutions for high-speed data networking. Power I/O was acquired by Adaptec in 1995. Prior to founding Power I/O, Mr. Stephens was President and CEO of Emulex Corporation. During his tenure there, he refocused the company’s operations to develop core ASIC technology and networking products. His restructuring efforts helped create rapid growth for the company’s networking division, and led to the spinoff of its SCSI business as QLogic. Before Emulex, Mr Stephens was Senior Vice President, General Manager, and Founder of the Microcomputer Products Group at Western Digital Corporation. His career began at IBM, where he served over 15 years in a variety of management positions. Mr. Stephens holds a Master’s Degree from San Jose State University.

Sector: Networking & Communications Equipment

TWST: Could we start with a brief overview of the history and evolution of Adaptec, Inc.?

Mr. Stephens: Adaptec has been a provider of value-add and high-performance peripheral connection products going back 20 years, so it’s a well-established company. Our products have primarily addressed three markets: the desktop market, the server market, and in the last five years, the networking space.

TWST: Could you expand on some of the lead products and services you provide today?

Mr. Stephens: Adaptec is best known for its SCSI products that span many generations of technology. But today, the company is also a leader in iSCSI — in other words, storage over Ethernet. The convergence of storage and networking has generated an opportunity to use Ethernet as a storage fabric. To use the Ethernet effectively for storage networking, you must offload the TCP/IP protocol stack from the server processor. We’re the only ones today with integrated silicon that allows TCP/IP to be fully offloaded from the server processor and put into hardware. Without offload technology, TCP/IP processing can consume up to 70% of a server’s processor at data rates of 1 gigabit/sec. And at 10 gigabits, where the industry is headed, you would need three processors dedicated to TCP/IP processing. So, if you are to effectively use Ethernet as a storage fabric, you must do something with TCP/IP. By offloading TCP/IP, our ASICs free up the server CPU to perform other functions. We are the only ones to date that have announced design wins in this space.

TWST: Who would you describe as your nearest competition?

Mr. Stephens: Our competitors today are planning to provide what I would call discrete implementations, that is, individual components on a board with a general purpose processor, or something similar that really doesn’t effectively address either the cost side or the performance side of TCP/IP processing.

TWST: As you look out ahead over the next few years or so, what specific trends do you see developing in the markets that you serve that are going to steer the focus of Adaptec down the road?

Mr. Stephens: What we see today is a very significant change in the server landscape. Take a look at server growth, year over year. What you find is that the conventional pedestal server space has actually decreased 9%. At the same time, rack-mounted 1U dense servers have grown 50%. So it’s a huge change. Storage in a 1U server is very limited, and as a result, what you’re finding is that storage is going outboard in 2U and 3U configurations. Today, most of that is attached directly to the server, so even though it’s outboard from the server, it is still utilizing the server itself for the management of that storage. But increasingly you’re going to see the storage being managed through an external RAID controller. It is going to sit on the network — which we believe will be Ethernet for the mainstream market. Storage is going to be more and more distributed. It is going to be managed as though it’s centralized, but it’s going to be distributed across the network. What this allows for is enhanced scalability and very cost-effective capacity. We are right in the middle of this transition today. We think this is a significant growth opportunity for us, and the industry.

TWST: Is there any specific opportunity to take advantage of near term that will put you in an even better position to take advantage of that environment?

Mr. Stephens: We’re doing two things. I mentioned that the TCP/IP piece is absolutely critical; you cannot use Ethernet as a storage fabric without doing something with TCP/IP. But the second piece is that we have launched a very interesting initiative this last quarter in external storage. For all practical purposes, external storage is proprietary. What I mean by that, is that it is not “open” like the PCI bus has opened up the normal computing platform. In this new distributed environment, we think that there is a very interesting opportunity to sell storage in a different way — to make it more open and less proprietary. So we have launched a product that we call DuraStor, that provides almost a terabyte of storage in a JBOD you can externally manage. There is an external RAID controller that we provide, or it can be managed directly from your server. What’s even more compelling, is that we do not provide the drives for the DuraStor offering. The drives are fulfilled within the distribution channel because we believe that as that food chain enjoys margin opportunity, you really can change this dynamic of how storage is sold much more effectively. The distributors, in fact, integrate or provide drives to this configuration. So far we are really pleased with the adoption of the DuraStor solution. It changes the price point dramatically in the marketplace for capacity because the drives provided in our competitors’ proprietary solutions, have very high margin content associated with them. Ultimately, we would like to see the drive enclosure itself be provided as a very standard component, possibly coming out of Taiwan, just like motherboards come out of Taiwan today. This would provide a very open storage environment, analogous to computing platforms.

TWST: Do you feel you are as well positioned as you would like to be as far as the balance sheet and factors like that?

Mr. Stephens: We’re very pleased with our balance sheet. We have had 62 consecutive quarters of pro forma profitability. That’s a long, long time. We have approximately $600 million in cash, and feel like we’re in good shape to make the right investments. You have to have staying power in this market, in addition to the strength of multiple relationships. Ethernet as a storage fabric is getting great traction very quickly. It’s going to evolve much faster than Fibre Channel did, but it’s still going to take several years for it to become well entrenched in this marketplace. We anticipate that during our next fiscal year, we will probably earn somewhere in the neighborhood of $20 million in incremental revenue in the TCP/IP offload area alone. That’s a very fast ramp, but it’s obviously just a piece of the overall opportunity in this market.

TWST: Are acquisitions also on the forefront of plans for growth, or is that not a huge concern at this point?

Mr. Stephens: We don’t feel like we need to do any acquisitions right now to solidify our position in the TCP/IP offload arena. But we have used acquisitions in the past to enhance our strategy and as an opportunity to really diversify sources of revenue. We’ll continue to do that. Our recent acquisition of Platys Communications made a huge impact on our ability to bring TCP/IP offload products to our customers very quickly. We will take advantage of other opportunities to acquire companies that will enable us to ramp our products much faster in this market. Obviously, valuations are right in that regard.

TWST: Aside from the state of the general economy or a softer market, what do you feel are some of the main risk factors that concern you at this point?

Mr. Stephens: Not many, believe it or not. We reduced our annual op ex by $80 million this last year. That’s huge. Our forecast for this year is slightly under a half-a-billion dollars in revenue, even in this depressed market. We believe that we’re bouncing along the bottom in terms of the demand in the market. We haven’t seen expansion of the market, and I think that would be consistent with most companies that you might talk with these days. We’ve adjusted to these market conditions, so we are profitable in a depressed market, and if we have any upswing, there’s great leverage associated with that. It’s been a difficult year, but at the same time we’ve been able to maintain our profitability and manage our R&D investments. So, in many respects, this economy has been helpful to Adaptec in helping the company solidify its position in this marketplace.

TWST: Are you confident that the current management team has the players in place to navigate through this period and execute down the road?

Mr. Stephens: Yes, things have changed a lot in the last two years. Attrition has gone down significantly, and people are happy about just having a job. I am absolutely delighted with the senior team that we have at Adaptec, and really the entire management organization. What happens when this market turns south is that you obviously cull through your organization and the best performers end up being the core of your company. I think that’s what we have today. All of our employees are excited by the vision. Morale inside Adaptec is at its highest in years, and it’s really about driving new initiatives and creating opportunities for our customers. I feel very good about the team and our ability to retain them.

TWST: Where do you find yourself spending most of your time lately as CEO?

Mr. Stephens: In two areas, really. One is ensuring that execution occurs in these critical spaces where we have a significant competitive advantage. It’s no longer an issue about demand from the marketplace or customer relationships in the specific area of iSCSI, it really is about execution and making sure that we realize the expectations of our customers. The other side is what CEOs always spend their time on, and that is ensuring that our strategy is sound for growth. In a market where there are significant opportunities to solidify your position in the industry and in specific segments, you really need to be clear in your direction, so I’m spending a lot of time there.

TWST: If I were a long-term investor sitting down with your financial report, what would you want me to focus on primarily?

Mr. Stephens: Really, it’s what drives valuation. There are two things. One is our competitive position in this marketplace. And the second is how that drives future earnings. The best indicator of our competitive position is really twofold: the trajectory of revenues in emerging product areas, such as our RAID and storage products, and then design wins relative to iSCSI. We are not going to see systems providers shipping iSCSI-based systems until the fall of next year. As a result, the only thing you can evaluate is the strength of the design wins and how they translate into future earnings. As I said, I think we’re really well positioned in these areas.

TWST: What have been some of the prime factors that have either helped or hurt your operating margin of late?

Mr. Stephens: We’re spending 26% of revenues on R&D and still maintaining profitable operations. We made a decision well over 12 months ago that what we needed to do was continue to invest in several key areas. We’re spending double what normal R&D expenditure is as a percent of revenue. Typically, we’ll run R&D at 11%-12%, and here we’re seeing it at 26%. Over the long term, we believe that operating expenses should be at 35 points, but obviously, we’re running significantly higher than that today. I believe this is an environment where you place the bet on the future, and you say: “Look, these are the products that are important. We need to develop them, take advantage of this opportunity, and come out the other end with guns blazing.”

TWST: You mentioned before that one of your main concerns as CEO is making strategic direction clear. Do you think the investment community has a fairly clear understanding as well? Are there any major misperceptions, perhaps, that might still exist?

Mr. Stephens: I think it’s improving. We’re not where we need to be candidly. I think there’s still a segment of the investment population that identifies Adaptec with SCSI and does not identify Adaptec with new initiatives such as Serial Attached SCSI and iSCSI. These are different products than the traditional SCSI host bus adapters that Adaptec has been known for. I think that will become clearer over time. For now, I’m pleased with the progress we’ve made so far. I do think there is one other issue though that we have to be careful of. That is that this isn’t just about iSCSI. We do not want Adaptec perceived as an advocate of just one particular technology. Whether it’s a traditional SCSI product, or whatever, we want to be viewed by investors as a storage solution provider, regardless of the technology or interface. Adaptec is going to be there with its traditional rock-solid products that you can count on for compatibility and a lot of software value. That’s what we need to accomplish this next year in the minds of investors.

TWST: What other top two or three reasons would you give a long-term investor to buy today?

Mr. Stephens: Number one, it really is the position of Adaptec in some very, very key emerging technologies, such as iSCSI and Serial Attached SCSI, RAID products, and a variety of external storage solutions. In short, a very broad portfolio of products is going to drive the future growth of this company. I think the second thing to note is that if you really take a look at the last two years, a lot of nonsense has been removed from the industry overall. And through that whole period, Adaptec has really stayed the course. We’ve enhanced our position in this market. We did not make a lot of acquisitions, but we made very important strategic ones. Third, we’ve enhanced the Board significantly. We have a Board of Directors now that, frankly, is the best Board that I’ve every worked with. My Chairman, Carl Conti, would say the same thing. It has outstanding capability and really augments very nicely the ability of our management team to grow the business.

TWST: Thank you. (AAM)

ROBERT N. STEPHENS
 President & CEO
 Adaptec, Inc.
 691 South Milpitas Boulevard
 Milpitas, CA 95035
 (408) 945-8600
 (408) 262-2533 - FAX
 www.adaptec.com

Investor Relations contact:
DAVID A. YOUNG
 VP & CFO
 dyoung@adaptec.com

Each Executive who is the featured subject of a TWST Interview is offered the opportunity to include an Investors Brief or other highlight material to be provided and sponsored by and for the company. This Interview with Robert N. Stephens, President & CEO, Adaptec, Inc. is accompanied by an Investors Brief containg corporate information.

To ask a question of this or any other publicly traded company, visit QAWire.com


Copyright 2002 The Wall Street Transcript Corporation
All Rights Reserved

The Wall Street Transcript (TWST) interviews are published verbatim, and TWST does not in any way endorse or guarantee the accuracy of any information or opinions expressed herein and all opinions are subject to change without notice. Nothing herein constitutes a solicitation to buy or sell any securities. TWST interviews with CEOs may include include "forward-looking statements", which are based on factors that involve risks and uncertainties. Actual results may differ materially from those expressed or implied. TWST shall have no liability whatsoever for any trading losses arising out of use of this information. Copyright 2002 Wall Street Transcript Corporation. All Rights Reserved.