November 4, 2009
Company Report Change in Recommendation
STEC, Inc.
STEC: $15.76 Semiconductors
Hold STEC: Believe Competition And Pricing Imply More Downside; Downgrade To Hold THINK ACTION: STEC reported September-quarter results ahead of the Street. But, revenue guidance for F4Q09(Dec) at $102M is below the consensus of $106M. STEC attributed weak guidance to Zeus Inventory at EMC. Also, STEC said it will probably take through 1Q10 to clear out inventory. We believe new competing solutions in 1Q/1H10 could make ZeusIOPs a tougher sell, with solutions at SAS, PCIe from Seagate, Micron, SMOD, Pliant, FusionIO, Samsung, and Intel and alternative solutions from the storage OEMs Sun, NetApp. We got this one wrong, and lower our rating from Buy to Hold. KEY POINTS: STEC reported September-quarter revenues/EPS of $98M/$0.50 versus the consensus of $94M/$0.47. Revenues grew 14% Q/Q and gross margins flat at 49.8% versus 50% last quarter. STEC did $67M in ZeusIOPS SSD revenue in the September quarter with $55M from EMC. STEC also saying now qualified at EMC, IBM, Sun, HPQ and Hitachi. STEC guiding December quarter to $101-103M versus consensus of $106M. Company saying weaker guidance due to inventory of ZeusIOPS storage solutions at EMC as it has not been able to sell through all the solutions. STEC saying the slower sell through on the ZeusIOPS has been due to customer perception of a longer payback period on the more expensive SSD investment. STEC is therefore setting up a sales team to jointly market the SSD solutions with EMC and other storage OEMs to potential customers. We believe 1) the fact that the ZeusIOPs SSD has not been able to sell through on its lower cost of ownership merits could imply more pricing pressure on the Zeus solutions, which combined with higher marketing expense make for a less profitable enterprise opportunity. 2) STEC also saying could take through 1Q10 to clear out the ZeusIOPs SSD at EMC, which could enable the competition to close the technology gap. 3) By 1Q/1H10, we believe there would be multiple solutions in the market from Seagate, Micron, SMOD, Intel, Pliant, FusionIO and Samsung for both the Server and storage markets in SAS and PCIe to compete with ZeusIOPS FC SSDs. 4) We believe the competitive offerings could imply market share and pricing risk for STEC, also 5) other Storage OEMs not as keen on SSDs. Given the increasing competitive pressures and risk of pricing, market share, inventory risk, continuous pressures on lowering cost of ownership from competing solutions the risk to the downside. While we believe STEC has an extremely large market opportunity ahead of it, we believe the competition is catching up with the slower market adoption of existing solutions and other Storage OEMs almost a year behind EMC in adopting SSDs. Lowering our 2010E from $489M/$2.28 to $435M/$1.96. We believe a per-share fair value on STEC shares is $15, with $2.54 in net cash per share and tangible book of $4.77.
Vijay Rakesh 312-201-3133,
[email protected] Christopher Eberle 212-468-7010,
[email protected]
Changes
Current
Rating
FY09E REV (M) FY10E REV (M) FY09E EPS FY10E EPS
Previous
Hold
Buy
$350.2E $435.0E $1.62E $1.96E
$350.9E $489.2E $1.54E $2.28E
52-Week High: 52-Week Low: Shares O/S-Diluted (M): Market Cap (M): Average Daily Volume: Short Interest: Debt/Total Cap: Net Cash Per Share: P/E (12-month forward): Est. Long-Term EPS Growth: P/E/G: Fiscal Year-End: After-market price REV (M) $
Mar Jun Sep Dec FY CY FY P/S CY P/S EPS $
Mar Jun Sep Dec FY CY FY P/E CY P/E
$42.50 $3.42 50.0 $788.0 4,848,763 16.5% 0.0% $2.54 13.0x 20.0% 65% Dec
2008A 50.7A 56.2A 63.7A 56.9A 227.5A NA
2009E 63.5A 86.4A 98.3A 102.0E 350.2E NA
2010E 95.0E 105.0E 112.0E 123.0E 435.0E NA
3.5x 3.5x
2.3x 2.3x
1.8x 1.8x
2008A 0.07A 0.09A 0.10A 0.05A 0.31A NA
2009E 0.17A 0.42A 0.50A 0.52E 1.62E NA
2010E 0.43E 0.49E 0.50E 0.54E 1.96E NA
50.8x 50.8x
9.7x 9.7x
8.0x 8.0x
Please see analyst certification (Reg. AC) and other important disclosures on pages 5-6 of this report.
November 4, 2009
Company Report Change in Recommendation
VALUATION: We believe a per-share fair value on STEC shares is $15 based on 8x our 2010 EPS estimate of $1.96, in line with STEC's EPS growing 20% Y/Y. We believe that is a significant earnings deceleration versus the 400% EPS growth in 2009. STEC shares have historically traded between 10x and 20x forward P/E, our discount P/E primarily the result of increasing new competition from multiple new players could affect market share, gross margins and proprietary value of STEC's solutions. INVESTMENT RISKS: STEC competes in a cyclical, technologically intensive industry and sells to a concentrated customer base. Its ability to meet our financial expectations and achieve future growth is subject to a number of risk factors, including, but not limited to, the following: Market Risks • STEC's continued success of its research and development efforts and timely execution of its new products; • STEC has a high customer concentration with Cisco, at almost 40% of revenues; • Cyclical growth in semiconductor demand and production, as well as growth in key consumer electronics markets; • Competition and pricing pressure from other low-cost OEMs, ODMs, and suppliers and possible new market entrants from Asia-Pacific, including China and Taiwan; and • Unexpected changes in legal and regulatory requirements, tariffs, and exchange rates, political and economic stability, staffing and management issues, and potentially adverse tax consequences for its international operations. Technology Risks • Potential loss of its intellectual property; • Startup costs and execution on the Malaysian manufacturing facility; • NAND-based solid state drive competition from upstream NAND majors; and • Commercialization of competing technologies. COMPANY DESCRIPTION: STEC, Inc. designs, develops, manufactures, and markets custom memory solutions based on flash memory and dynamic random access memory (DRAM) technologies in the United States and internationally. Its flash products include ZeusIOPS solid state drives that provide enterprise-class data storage solutions; Zeus solid state drives, which are designed to meet the data storage requirements of a range of industries, including defense and aerospace, automotive and transportation, industrial, and communications industries; and MACH solid state drives, which are small form factor storage solution for mission-critical systems in a variety of industries.
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Exhibit 1: STEC Inc. Income Statement (in $ 000s, except per-share data) 2008 Mar Q1
Year
Jun Q2
2009E Sep Q3
Street Consensus (Thomson First Call) THINK Difference 86,350
95,770 2.6% 98,293
2010E
2010E
Year
Mar Q1-E
Jun Q2-E
Sep Q3-E
Dec Q4
Year
109,550 (6.9%)
358,530 (2.3%)
112,630 (15.7%)
119,210 (11.9%)
126,940 (11.8%)
135,020 (8.9%)
478,150 (9.0%)
102,000
350,179
95,000
105,000
112,000
123,000
435,000
REVENUES
227,465
Cost of Goods Sold GROSS PROFIT
149,935 77,530
38,233 25,303
43,105 43,245
49,368 48,925
51,000 51,000
181,706 168,473
49,400 45,600
54,600 50,400
59,920 52,080
67,035 55,965
230,955 204,045
19,804 13,647 20,210 53,661
4,772 3,876 5,520 14,168
5,031 5,749 5,423 16,203
5,162 5,616 6,569 17,347
5,300 4,500 6,300 16,100
20,265 19,741 23,812 63,818
5,900 4,700 6,500 17,100
6,100 5,000 6,800 17,900
6,500 5,400 7,200 19,100
6,800 5,800 7,800 20,400
25,300 20,900 28,300 74,500
OPERATING EXPENSES Sales & Marketing G&A R&D TOTAL OPEX
63,536
2009E Dec Q4-E
OPERATING INCOME
23,869
11,135
27,042
31,578
34,900
104,655
28,500
32,500
32,980
35,565
129,545
INTEREST INCOME Interest Expense Other Income/(Expense) Total Other Income
1,280 0 0 1,280
(12) 0 0 (12)
614 0 (560) 54
14 0 0 14
210 0 0 210
826 0 (560) 266
220 0 0 220
225 0 0 225
230 0 0 230
235 0 0 235
910 0 0 910
PRETAX INCOME TAX EXPENSE
25,149 9,449
11,123 2,636
27,096 5,796
31,592 5,570
35,110 7,514
104,921 21,516
28,720 5,744
32,725 6,545
33,210 6,642
35,800 7,160
130,455 26,091
Pro-Forma Net Income
15,700
8,487
21,300
26,022
27,596
83,405
22,976
26,180
26,568
28,640
104,364
DILUTED SHARES (000's)51,130
49,063
50,702
52,239
52,639
51,161
52,839
53,039
53,239
53,439
53,139
EPS (Fully Diluted)
$0.17
$0.42
$0.50
$0.52
$1.62
$0.43
$0.49
$0.50
$0.54
$1.96
$0.39 27.7%
$0.45 16.5%
$1.39 16.2%
$0.48 (9.4%)
$0.51 (3.2%)
$0.54 (7.6%)
$0.56 (4.3%)
$1.95 0.7%
270,452 50,034 37,244 $0.74
305,094 73,930 58,329 $1.14
CY09E 350,179 104,655 83,405 $1.62
381,643 122,020 97,894 $1.88
400,293 127,478 102,774 $1.95
414,000 128,880 103,320 $1.95
CY10E 435,000 129,545 104,364 $1.96
40.4%
41.6%
42.1%
41.1%
41.6%
41.6%
41.6%
40.6%
49.8% 5.3% 5.7% 6.7% 32.1% 32.1% 26.5% 17.6%
50.0% 5.2% 4.4% 6.2% 34.2% 34.4% 27.1% 21.4%
48.0% 6.2% 4.9% 6.8% 30.0% 30.2% 24.2% 20.0%
48.0% 5.8% 4.8% 6.5% 31.0% 31.2% 24.9% 20.0%
46.5% 5.8% 4.8% 6.4% 29.4% 29.7% 23.7% 20.0%
45.5% 5.5% 4.7% 6.3% 28.9% 29.1% 23.3% 20.0%
46.9% 5.8% 4.8% 6.5% 29.8% 30.0% 24.0% 20.0%
13.8% 14.5% 2.6% (2.3%) 21.1% 16.8% (97.7%) 16.6% 22.2% 18.6%
3.8% 3.3% 2.7% (19.9%) (4.1%) 10.5% 1,400.0% 11.1% 6.1% 5.2%
(6.9%) (3.1%) 11.3% 4.4% 3.2% (18.3%) 4.8% (18.2%) (16.7%) (17.1%)
10.5% 10.5% 3.4% 6.4% 4.6% 14.0% 2.3% 13.9% 13.9% 13.5%
6.7% 9.7% 6.6% 8.0% 5.9% 1.5% 2.2% 1.5% 1.5% 1.1%
9.8% 11.9% 4.6% 7.4% 8.3% 7.8% 2.2% 7.8% 7.8% 7.4%
$0.31
Street Consensus (Thomson First Call) THINK Difference Trailing Twelve Month Data Net Revenues Operating Income Net Income Diluted EPS
240,301 29,704 20,387 $0.41
35.8% Street Margin Consensus (Thomson First Call)
Margin Data Gross Margin 34.1% 39.8% 50.1% Sales and Marketing 8.7% 7.5% 5.8% G&A 6.0% 6.1% 6.7% R&D 8.9% 8.7% 6.3% Operating Margins 10.5% 17.5% 31.3% Pre-Tax Margin 11.1% 17.5% 31.4% Net Margin 6.9% 13.4% 24.7% Tax Rate 37.6% 23.7% 21.4% Q/Q Growth Revenue 11.6% 35.9% Cost of Goods Sold (0.7%) 12.7% Sales and Marketing (0.6%) 5.4% G&A 13.3% 48.3% R&D (8.1%) (1.8%) Operating Income 166.7% 142.9% Interest Income (85.2%) NMF Pre-Tax Income 171.7% 143.6% Net Income 236.8% 151.0% EPS 247.0% 142.9% Source: Company reports & ThinkEquity LLC estimates
48.1% 5.8% 5.6% 6.8% 29.9% 30.0% 23.8% 20.5%
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Exhibit 2: STEC Inc. Balance Sheet
Balance Sheet FY Ends December Mar (000's) Q1 Cash and Cash Equivalents 73,669 Marketable Securities Held to Maturity Accounts Receivable 32,064 Inventory 39,272 Deferred Income Taxes 638 Other Current Assets 5,897 Total Current Assets 151,540 Marketable Securities 6,808 Leasehold Interests in Land 2,618.0 Furniture, Fixtures, and Equipment 38,093 Intangible Assets, net 965 Deferred Income Taxes 3,590 Goodwill 1,682 Other Long-Term Assets 1,207 Total Non-Current Assets 54,963 Total Assets 206,503
2008
33,379 43,516 63,985 1,302 8,264 150,446
Mar Q1 62,663 37,897 44,699 1,593 6,637 153,489
2009 Jun Q2 93,703 50,500 37,656 2,992 2,769 187,620
Sep Q3 132,925 51,856 35,555 1,946 8,206 230,488
2,595.0 44,152 775 4,633 1,682 1,698 55,535 220,734
2,587.0 44,406 573 4,407 1,682 1,784 55,439 205,885
2,618.0 42,537 496 4,473 1,682 2,735 54,541 208,030
2,562.0 39,899 419 4,144 1,682 3,544 52,250 239,870
2,551.0 39,056 349 5,669 1,682 4,288 53,595 284,083
40,243 8,070 48,313
22,562 9,612 32,174
13,097 9,795 22,892
10,674 10,648 21,322
10,028 13,875 23,903
17,068 13,529 30,597
875
1,067
1,430
1,494
1,538
2,484
-
-
-
-
-
Sep Q3
Dec Q4
62,847 32,901 78,915 1,980 4,210 180,853
29,359 49,767 80,248 1,652 4,173 165,199
2,607.0 43,169 870 3,644 1,682 1,689 53,661 234,514
22,709 7,184 29,893
Long-Term Income Taxes Payable 862
Current Liabilities Accounts Payable Accrued and Other Liabilities Total Liabilities
Commitments & Contingencies Shareholders' Equity Preferred Stock Common Stock 49 Additional Paid in Capital 126,052 Retained Earnings 49,647 Total Shareholders' equity 175,748 Total Liabilities & Shareholders' 206,503 Equity Check DSO Q/Q Inventory Q/Q Sales Days of Inventory Inventory Turns Current Ratio Return on Equity Return on Sales Return on Assets Net Cash per share TBV/Share Source: Company reports
58 24.5% (4.4%) 108 3 5 2.10% 10.45% 1.84% $1.44 $3.39
Jun Q2
50 134,464 50,812 185,326
50 135,427 52,016 187,493
48 129,670 51,845 181,563
48 130,342 54,824 185,214
49 140,193 74,187 214,429
50 152,287 98,665 251,002
234,514
220,734
205,885
208,030
239,870
284,083
71 1.7% 13.3% 174 2 5 2.72% 12.07% 2.24% $0.57 $3.60
70 (20.3%) (10.6%) 151 2 7 1.37% 7.34% 1.22% $0.66 $3.55
54 (30.1%) 11.6% 106 3 7 4.55% 17.53% 4.08% $1.28 $3.74
53 (15.8%) 35.9% 79 5 8 10.76% 31.32% 8.88% $1.85 $4.20
48 (5.6%) 13.8% 66 6 8 11.93% 32.13% 9.16% $2.54 $4.77
53 100.9% 10.8% 197 2 4 2.40% 11.94% 1.89% $1.23 $3.57
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November 4, 2009
Company Report Change in Recommendation COMPANIES MENTIONED IN THIS REPORT: Company
Exchange
Symbol
Price
Rating
EMC Corporation
NYSE
EMC
$16.55
Buy
Intel Corporation
NASDAQ
INTC
$18.50
Hold
NYSE
MU
$6.65
Buy
NetApp, Inc.
NASDAQ
NTAP
$27.80
Buy
SMART Modular Technologies (WWH), Inc.
NASDAQ
SMOD
$3.92
Hold
Micron Technology, Inc.
Important Disclosures Analyst Certification I, Vijay Rakesh, hereby certify that all of the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report. I, Christopher Eberle, hereby certify that all of the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report. The analyst(s) responsible for preparing this report has/have received compensation based on various factors, including the firm's total revenues, a portion of which is generated by investment banking activities. ThinkEquity LLC makes a market in Micron Technology, Inc., Intel Corporation, SMART Modular Technologies (WWH), Inc., NetApp, Inc., EMC Corporation, and STEC, Inc. securities; and/or associated persons may sell to or buy from customers on a principal basis.
Rating Definitions Effective October 7, 2009, ThinkEquity LLC moved from a four-tier Buy/Accumulate/Source of Funds/Sell rating system to a three-tier Buy/Hold/Sell system. The new ratings appear in our Distribution of Ratings, Firmwide chart. To request historical information, including previously published reports or statistical information, please call: 866-288-8206, or write to: Director of Research, ThinkEquity LLC, 600 Montgomery Street, San Francisco, California, 94111. Buy: ThinkEquity expects the stock to generate positive risk-adjusted returns of more than 10% over the next 12 months. ThinkEquity recommends initiating or increasing exposure to the stock. Hold: ThinkEquity expects the stock to generate risk-adjusted returns of +/-10% over the next 12 months. ThinkEquity believes the stock is fairly valued. Sell: ThinkEquity expects the stock to generate negative risk-adjusted returns of more than 10% during the next 12 months. ThinkEquity recommends decreasing exposure to the stock. Distribution of Ratings, Firmwide ThinkEquity LLC IB Serv./Past 12 Mos. Rating
BUY [B] HOLD [H] SELL [S]
Count
Percent
Count
Percent
119 54 6
66.50 30.20 3.40
13 2 0
10.92 3.70 0.00
This report does not purport to be a complete statement of all material facts related to any company, industry, or security mentioned. The information provided, while not guaranteed as to accuracy or completeness, has been obtained from sources believed to be reliable. The opinions expressed reflect our judgment at this time and are subject to change without notice and may or may not be updated. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. This notice shall not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any state in which said offer, solicitation, or sale would be unlawful prior to registration or qualification under the securities laws of any such state. This research report was originally prepared and distributed to institutional clients of ThinkEquity LLC.
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November 4, 2009
Company Report Change in Recommendation Recipients who are not market professionals or institutional clients of ThinkEquity LLC should seek the advice of their personal financial advisors before making any investment decisions based on this report. Stocks mentioned in this report are not covered by ThinkEquity LLC unless otherwise mentioned. Additional information on the securities mentioned is available on request. In the event that this is a compendium report (covers more than six ThinkEquity LLC-covered subject companies), ThinkEquity LLC may choose to provide specific disclosures for the subject companies by reference. To request more information regarding these disclosures, please call: 866-288-8206, or write to: Director of Research, ThinkEquity LLC, 600 Montgomery Street, San Francisco, California, 94111. Stocks mentioned in this report are not covered by ThinkEquity LLC unless otherwise mentioned. Member of FINRA and SIPC. Copyright 2009 ThinkEquity LLC, A Panmure Gordon Company
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