Thread;
This run down by Morgan Stanley:
Subject: Wrap-Up- Read Rite: Keep Watching and Waiting...
Date: July 16, 1998
Industry: PC Peripherals Type: Sales/Earnings Analysis
______________________________________________________________________
Rating: Neutral Price: 10
52-wk Range: 30-7
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FY Ends ----EPS----
Septemb Curr Prior P/E
er
97A $1.87A -- --
98E ($3.01)E ($3.08)E NM
99E ($0.39)E ($0.06)E NM
______________________________________________________________________
Qtrly ---- 1Q ---- ---- 2Q ---- ---- 3Q ---- ---- 4Q ----
EPS Curr Prior Curr Prior Curr Prior Curr Prior
97A $0.12A -- $0.48A -- $0.64A -- $0.65A --
98E $0.02A -- ($1.29)A -- ($0.89)A($1.20)E($0.84)E($0.61)E
99E ($0.19)E($0.11)E($0.14)E($0.06)E($0.02)E $0.06E ($0.04)E $0.05E
______________________________________________________________________
Shares Outst.: 48.7MM Mkt Cap.: $464MM
______________________________________________________________________
KEY POINTS:
- Last night, Read-Rite (RDRT, $10, Neutral) reported a CQ2:98 loss
per share of $0.89. While the loss was lower than the street mean of
($1.02) and our ($1.20) estimate, the company had already pre-released
(on June 10, 1998). At that time, RDRT gave little guidance. In our
opinion, the results were not an upside surprise.
- RDRT's Y/Y revenue trends continued to be negative as CQ2:98
revenue fell 41% Y/Y to $184MM (down 2% Q/Q) due to tough industry
pricing and oversupply conditions, customer order weakness (a large
backlog at the beginning of the quarter was rapidly worked and
adjusted down about 5 weeks into the quarter), continued trends toward
fewer heads per disk drive, and ongoing backlash due to weaker product
positioning as the company transitioned from thin-film into MR
products.
- RDRT management suggested that the recording head market
environment remains difficult, and that it is still hard to forecast
when RDRT's revenue trends will improve. Competition in recording
heads has been very fierce in recent months as large U.S. disk drive
manufacturers have lowered build plans significantly, and Japanese
vendors such as TDK and Alps have aggressively increased capacity.
- 2.1GB per platter MR recording heads continued to be the majority
of RDRT's production in CQ2:98. However, these products will likely
start to tail off in CQ3 and CQ4. We suspect that 2.5-2.8GB per
platter production will be limited with the exception of a
qualification at Samsung. RDRT continues to work to gain new
qualifications on 3.2-3.2GB per platter and 4.0+GB per platter
designs, however, we expect these to ramp industry-wide in late CQ4,
with some limited volume in CQ3. This could cause some difficult Q/Q
revenue trends in CQ3 and CQ4 if RDRT can't backfill its declining
2.1GB per platter volume.
- RDRT worked to rationalize its operations and reduce
inefficiencies in the manufacturing process during the quarter. As a
result, the company was able to lower the gross loss to $15M from
$30MM in CQ1:98. Opex of $32MM rose 21% Y/Y and was down 4% Q/Q.
RDRT is targeting a break-even revenue run rate of $200MM. As part of
this effort, RDRT took a $93.7MM one-time charge in CQ2:98 to
rationalize operations, shut down its Malaysian operations, and write
off excess assets at other manufacturing locations (partly due to
improved asset utilization).
- The balance sheet was controlled but still concerning. RDRT's
CQ2 cash drain was nearly $20MM Q/Q, bringing cash to $150MM (down
from a peak of almost $300MM just 3 quarters ago). The cash portion
of the one-time rationalization charge was $15MM. However, accounts
receivable fell $35MM Q/Q to $84MM (DSOs fell to 41 from 48) and
inventory fell slightly more than $1MM Q/Q to $60MM (inventory turns
were flat in comparison to CQ1). RDRT is currently in negotiations
with its bank group with regard to its credit facility (the company is
in violation of one of its covenants).
- Our CQ3:98E EPS estimate is ($0.84) (down from EPS of $0.65 in
CQ3:97) on revenue of $166MM (down 48% Y/Y), gross margin of (7)% and
a 0% tax rate. The First Call mean was ($0.64E). Our F1998E EPS is
($3.01) vs. $1.87A in F1997, on revenue of $798MM (down 31% Y/Y),
gross margin of (4)% and a 1% tax rate. The First Call mean was
($2.85E).
- Our F1999E EPS is ($0.39) on revenue of $712MM (down 11% Y/Y),
gross margin of 16%, and a 20% tax rate. The First Call mean was
$0.09E.
STOCK CATALYST:
RDRT faces a number of issues as we enter C2H:98. First, the company
has a revenue issue with one or two upcoming quarters of uncertain
revenue flow as 2.1GB per platter products (currently the majority of
volume) tail off and the company finds itself trying to improve its
position on products that the industry plans to ramp in the near-term
(2.5-2.8GB per platter).
Second, RDRT needs to improve its longer-term product positioning. We
believe that on a longer-term basis, there is good news in this
department as RDRT has renewed its R&D efforts and made some key new
technology hires. Additionally, efforts to reduce cycle times and
become more flexible to quick changes in the process should help in
longer term product positioning. We believe that RDRT has a good
chance of improving its positioning on 3+GB per platter and 4+GB per
platter products.
Third, RDRT needs to continue its operation rationalization process.
We believe that the company can continue to cut costs and reduce its
gross losses even in the current environment. However, recording
heads is a volume business and the key for the company is again
driving new product positioning and revenue growth.
Finally, RDRT faces the prospect of a tougher competitive position on
programs from its largest customer, Western Digital (WDC, $13,
Neutral) (est. @ 50% of revenue) as WDC begins to transition to more
IBM-designed desktop disk drives, and therefore IBM heads in early
C1999. RDRT believes that it can make up potential lost volume by
qualifying on WDC's value desktop disk drive product line and on WDC's
enterprise product line. However, we believe that it is prudent to
take a cautious stance with regard to RDRT's volume with this
customer.
For now, while we believe many of these factors are in the stock, we
also believe that the risk/reward profile still favors risk for RDRT.
However, we do believe that this is a story that should be watched
over the next several months as an uptick in revenue trends could
quickly drive profitability and earnings leverage for the company. We
continue to rate RDRT shares Neutral.
Table 1
RDRT CQ2:98 at a Glance:
Reported Reported MS Reported
CQ2:98 Estimate CQ2:97
Revenue($MM) $184 $187 $310
Rev. GrowthY/Y (41)% (40)% 30%
Gross Margin (8)% (15)% 23%
Operating (26)% (32)% 15%
Margin
Tax Rate 0% 0% 23%
EPS* ($0.89) ($1.20) $0.64
Shs. Out.(MM) 48.7 48.5 49.0
*Primary Operating EPS
DETAILS:
Revenue Basics - Depressed by tough industry environment and order
push-outs
RDRT reported CQ2:98 revenue of $184MM (down 41% Y/Y, down 2% Q/Q).
Per RDRT, the company started off CQ2 with a large backlog which fell
rapidly roughly 5 weeks into the quarter as disk drive industry
conditions remained weak and customers pushed out orders.
Additionally, the trend to fewer recording heads per disk drive
continued in CQ2. We also believe that RDRT's revenue run rate
continued to be negatively impacted by weak product positioning on
near-term products.
Revenue by Customer. RDRT's three largest customers were Maxtor,
Samsung, and WDC, and these three represented 93% of sales, or $171MM
in CQ2:98 (up from 92% of revenue in CQ1:98).
Revenue by Product. RDRT shipped 15.2MM HGAs in the quarter (up from
15.0MM units in CQ1:98, and down significantly from the 28.2MM units
in CQ2:97). Head Stack Assembly (HSA or assemblies of HGAs) unit
shipments were 3.6MM (down from 3.3MM in CQ1:98 and down from 4.3MM
units in CQ2:97). Of HSA units, 3MM were MR-based.
RDRT exited CQ2:98 at an 89% MR run rate and indicated it will no
longer break out MR production because it believes that the transfer
to MR is complete.
The highest volume product in CQ2:98 was the 2.1GB per platter. RDRT
expects this to continue to be its volume product in CQ2:98. However,
the industry is rapidly moving to 2.5-2.8GB per platter products where
RDRT is not as well positioned (the company is currently only
qualified on Samsung). The good news is that the 2.5-2.8 is a bridge
product for most customers that is not expected to have a long life
and RDRT has indeed scrambled to improve its product positioning on
3.2-3.4GB per platter (RDRT is qualified at Maxtor for this product
and is conditionally qualified at another customer) and beyond
products, which may help offset 2.1GB per platter declines. As a
result, we suspect that CQ3 and CQ4 Q/Q revenue trends will be a
careful balance of offsetting 2.1GB/platter declines with this new
product/customer flow.
Table 2
RDRT Unit Revenue by Form Factor Point
CQ2:98 CQ1:98 CQ2:98
Total Revenue ($MM) $310 $187 $184
Y/Y % Change 30% (34)% (41)%
Q/Q % Change 10% (28)% (2)%
HGA (Head Gimble Assy)
Revs. ($MM) $93.1 $16.8 $18.4
as % of revenue 30% 9% 9%
Y/Y % Change 18% (85)% (82)%
Q/Q % Change (18)% (68)% (2)%
HSA (Head Stack
Assy) Revs.($MM) $217 $168 $166
as % of revenue 70% 90% 90%
Y/Y % Change 36% (1)% (24)%
Q/Q % Change 28% (19)% (2)%
* Note that HSA's carry lower gross margin characteristics.
Gross Margin Basics - Cycle time reductions and efficiency help in
weak revenue environment
RDRT has spent a lot of energy working on improving efficiency and
flexibility, and on driving better gross margin trends over the last
several months. The beginnings of these efforts were clear in the
CQ2:98 gross margin, which while still negative, improved a bit Q/Q.
CQ2:98 gross loss was $15.0MM vs. a loss of $30.4MM in CQ1 on
relatively similar revenue. During the quarter, RDRT began actions
to reduce its footprint (in large part as a result of improved cycle
times) and lower its break-even point. Currently the company believes
it can break-even on $200MM in revenue - we are watching to see how
this proceeds.
In fact, we believe that RDRT was able to reduce its cycle time from
roughly 60 days to 35+ days (and has a goal to get its cycle time to
the low 30's). Keeping cycle times low will be a critical asset for
RDRT when/if customer order rates increase.
Operating Expense Basics - Spending on new product development
CQ2:98 opex was $32MM (up 21% Y/Y) versus a 41% Y/Y revenue decline.
The Company indicated that it expects opex to be down slightly next
quarter. S,G & A was almost $9MM (down $600K Q/Q) and R&D was $23MM
(down $500K Q/Q). While RDRT is attempting to be careful with its
spending levels, we believe that the company should continue to spend
strategically on R&D to fuel future product revenue growth. RDRT's
headcount fell roughly 5,300 Q/Q to 18,000.
Balance Sheet Basics - Cash Drain to Slow in CQ3
The balance sheet reflected the results of a challenging CQ2 but was
relatively well controlled nonetheless. Cash fell $20MM Q/Q to $150MM
or $3.07 per share. During the quarter RDRT posted $93.7MM in one
time charges of which $15MM had a negative cash impact. Accounts
receivable fell $35MM Q/Q to $84MM and AR DSO's were 41 vs. 48 (by our
L6M math) in CQ1. RDRT indicated that it feels good about
collectability of its accounts receivable. Inventories fell slightly
more than $1MM Q/Q (or 2%) to $60MM (or 33% of quarterly revenue) and
inventory turns remained constant Q/Q at roughly 12 (by our L6M math).
Capex was $33.2MM for the quarter (depreciation was almost $50MM) and
RDRT expects to spend roughly $180MM to $190MM in capex for F1998.
Current plans call for a spend rate of about $150MM in F1999.
Table 3
RDRT Balance Sheet Basics CQ2:98
CQ4:98 CQ1:98 CQ2:98
Cash (in MMs) $228 $169 $150
Inventory (in $81 $61 $60
MMs)
Inventory as % 31% 33% 33%
of Revenue
Inventory 12 12 12
Turns
Accounts $132 $119 $84
Receivable
AR DSO 41 48 41 |
