MRV Communications, Inc. Q3 2008 Earnings Call Transcript

MRV Communications, Inc. (MRVC)

Q3 2008 Earnings Call Transcript

October 30, 2008 4:30 pm ET

Executives

Anne-Marie Frisch – IR

Noam Lotan – President and CEO

Guy Avidan – CFO

Analysts

John Harmon – Needham & Company

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MRV Communications third quarter 2008 selected preliminary results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Thursday, October 30, 2008. I would now like to turn the conference over to Anne-Marie Frisch from the Investor Relations department. Please go ahead, ma'am.

Anne-Marie Frisch

Good afternoon, everyone, and thank you for joining us today to discuss MRV's third quarter 2008 selected preliminary financial results. I am joined today by Noam Lotan, President and CEO, who will provide you with an overview of our third quarter results. Also joining today’s call is Guy Avidan, CFO, and Chris King, VP of Finance, who will be available for the Q&A session.

Earlier this afternoon, the company issued a press release reporting selected preliminary financial results for its third quarter and nine months ended September 30, 2008. This call is being recorded. A replay of this call can be accessed by phone and will be available approximately two hours after conclusion of this call and will be available for one week. You may access this replay by dialing 303-590-3000 and entering passcode 111203088.

This call is also being webcast live and a web replay will also be available. Additionally, there is a presentation on the Investors section of the MRV website that corresponds with today's call. The press release, web replay, and presentation are available on the Investor Relations section of MRV’s website at ir.mrv.com. While you are there, you may view our new corporate website at www.mrv.com.

We would like to remind you that during the course of today's call, MRV's management may make forward-looking statements about financial and business guidance, product introductions, customer development, and the plans and objectives of management for future operations and the company's future economic performance. These statements, which can be identified when they are in the context of words such as may, will, expect, intends, plans, believes, targets, estimates, forecasts, and variations of these words or use of these words of similar import, reflect management's current judgment on those issues. Because these statements deal with future events, they are subject to risk and uncertainties that could cause the actual results to differ materially.

In addition to the factors that may be discussed during this call and those contained in the press release issued earlier today, important factors that could cause actual results to differ materially are contained in the company's Forms 10-Q and 10-K, which are on file with the SEC and are available on our website. By discussing the current perception of our market and making these forward-looking statements, we are not undertaking an obligation to provide updates in the future.

Any future product feature or related specification that may be referenced in today's call are for information purposes only and are not commitments to deliver any technology or enhancement. MRV reserves the right to modify future product plans at any time. Additional risks not known to us may also impair our business or results of operations, and may prevent us from realizing our current expectations.

Additionally, as previously announced, on June 5, 2008, MRV’s Board of Directors has appointed a special committee of independent directors to conduct an internal review relating to the company’s historical stock option grant practices and related accounting, and MRV’s accounting for earn-out and profit sharing in two European subsidiaries. The review is prompted by the determination of management that accounting measurement dates for certain stock option grants differ from the measurement dates previously used for such awards.

As a result, MRV expects to restate its financial statements to record the effect of additional compensation expenses. Therefore, the financial statements and related reports of its independent public accountants, earnings press releases, and similar communications previously issued by MRV should not be relied upon as a consequence for the pending restatement of its historical financial statements. For further information, please see our current report on Form 8-K filed with the SEC on June 6, 2008.

In addition, as review of the special committee is ongoing and not yet complete and because of the current expectation that MRV may be restating its historical financial statements, we have not included financial statements in our Q3 release. As we previously stated, MRV will refrain from commenting further on this subject matter of the review, its progress or any litigation relating to matters that are or may be the subject of the review until that has been concluded.

Since the adjustments to MRV's historical financial statements have yet to be determined, it is important to understand that current financial results and comparative information from 2007 and 2008 have been included in the press release and in my prepared remarks only to provide a context in which to assess our performance for the current period. Any related disclosure regarding trends and guidance must be considered preliminary and subject to change. And such changes, if made, could be material.

I’d now like to turn the call over to Noam Lotan, MRV's President and CEO.

Noam Lotan

Thank you, Anne-Marie. Good afternoon and thank you, everyone, for joining us today on our third quarter call. Before I begin the review of our third quarter preliminary results, I would first like to address a few questions that I know several of you had throughout the quarter that we have not been able to answer. This includes an update on the Board’s special committee review into our historical stock option granting practices, our listing status with NASDAQ, and finally the Source Photonics IPO.

I know that our shareholders are anxious to receive more information on the performance of our business and the status of the investigation. Believe me, we are eager to share the results with you and I regret the limitations on what they can say at this point in time. We were hoping to provide you an update on the special committee review today, but we are not able to do so and hope to issue a press release with an update in the near future.

With respect to NASDAQ, we are using the avenues provided to us by the NASDAQ rules to appeal the notice of deficiency. We have had a hearing with NASDAQ, and the special committee is following up this week with additional information that the NASDAQ panel requested. We believe our submissions to the panel provide a strong basis for granting temporary relief from the NASDAQ continued listing standards to permit our shares to remain listed, while we complete the work to regain compliance. However, the panel has yet to render its decision.

With respect to Source Photonics, our basic goal remains unchanged, and the timing of the contemplated IPO is unclear. The deferred payment obligation will be either settled through the IPO or through other means such as cash or issuance of shares or a combination thereof. These payments may be reduced by up to $18 million as it provides for in the merger agreement. The purchase agreement of Fiberxon is public information and can be found as an exhibit on Form 10-Q filed on March 31, 2007 and the subsequent amendment filed on Form 8-K on July 2, 2007.

Now moving to the review of our third quarter results. In today’s call, we will begin with our topline growth, then we will briefly review the performance of each business segments and highlight a few of our new products, and finally we’ll discuss our strategy to navigate and emerge as a strong leader through this recessionary period and the guidance and the outlook for the fourth quarter.

Beginning with our topline growth; although I’m dissatisfied that we did not achieve our original revenue expectations for the quarter, I’m pleased by our continued growth, especially in our network equipment segment. Consolidated revenue for the third quarter was $131 million, an increase of 13% over the third quarter of last year. For the first nine months of the year, revenue increased 30%, ahead of the first nine months of ’07.

For the past 11 quarters, we have delivered double-digit year-over-year revenue growth, surpassing the market growth. Certainly our goal is to try to continue this trend, but obviously MRV does not operate in a vacuum. We are confident that we can navigate through this recession by maintaining gross margins and controlling expenses.

In general, our products are viewed by our customers as providing a compelling value, making them even more attractive in tough times. We believe we can continue to gain market share in the long-term, and the long-term prospect for our principal markets remain attractive. On a geographical basis, growth was driven by the Americas, which increased 29% over the same quarter last year. Growth was across the board with no particular customer concentration.

Network Equipment. The network equipment segment posted another strong quarter with $31 million in revenue. This is a 30% increase over Q3 of last year and a 29% growth for the first nine months of the year. I’m pleased that our network equipment segment has grown above the carrier Ethernet market and faster than our major competitors. Clearly, we continue to gain market share in network equipment, especially in North America.

Our growth is driven by the strength of our product, and the overall demand for small deployment of metro Ethernet in both domestic and international markets. We are still on track with our goal to increase revenue while leveraging our existing operating structure and maintaining cost and headcount for this division. Even with 30% revenue growth, our headcount at the end of Q3 was 500 employees in this segment compared with 508 in the same quarter of the previous year. As we have previously noted, historically our network equipment business has always been our highest gross margin segment. And therefore, growth in this business unit has the potential to make a significant impact on the bottom line.

Network Integration. Our network integration business grew 5% year-over-year and 11% for the first nine months of 2008. Revenue in the division was lower than expected primarily due to currency exchange rates.

Optical Components. Optical components revenue grew to $49 million in the quarter, reflecting a year-over-year growth of 11%. For the nine months year-to-date period, optical components grew 66% to $155 million, partially reflecting the acquisition of Fiberxon on July 1, 2007. In the quarter, we had strong customer demand for optical components, but had delayed shipments resulting in lower than expected revenue due to the time it took to bring our new manufacturing facility on line. Approximately $8 million of our total revenue shortfall was associated with these delayed shipments.

There were several unanticipated challenges we faced in consolidating our three China based facilities into a brand new facility in Chengdu. The majority of the consolidation has been completed. We are now busy training new employees, qualifying new production lines, and transferring manufacturing of sub-assemblies from Shenzhen, which is a relatively high-cost manufacturing area, into Chengdu.

We have made a lot of progress in addressing these issues and are well on our way and continue to increase capacity and meet demand. Bringing our new facility on line will allow us to reduce our dependency on contract manufacturers and ultimately increase optical component gross margins. This new facility will provide a 4X increase in manufacturing space, and we are excited about the investment we’ve made and the operational leverage and efficiency it will provide in the future.

Maintaining one facility as opposed to three in different regions will be easier and cheaper and more efficient to maintain and manage. We continue to work to further improve operating efficiencies to turn them into bottom line results and add value to our shareholders. Our goal has been and remains achieving consistent profitable revenue growth to drive sustained shareholder value.

We ended the quarter with $70 million in combined cash, cash equivalents, timed deposits, and short-term and long-term marketable securities, a decrease of $6 million from the prior quarter. During the quarter, we spent approximately $2.5 million in attorney, accounting and consulting fees for the special committee review of our historical stock option granting practices.

Now I would like to discuss some product milestones for the quarter. In August, we launched an optical media converter for carrier Ethernet service demarcation applications that delivers managed optical Ethernet demarcation for bookend pair applications between the central office and customer networks. This module delivers the next generation in MRV’s overall strategy to add more intelligence and remote management to media converters in order to ease the management and reduce OpEx in dense carriers, MSO and enterprise applications.

During the quarter, we announced a new Serial Attached SCSI, SAS, and Serial ATA, which is also called SATA, which stands for serial advanced technology attachment, storage interface modules for our media cross-connect physical layer switch. Storage networking vendors are facing a significant technology evolution that puts pressure on their ability to increase efficiency and throughput in order to meet product shipment goals.

With the addition of these new pluggable SFPs, MRV continues its market leadership position by offering a complete set of interface solutions for storage industries test lab environment. Also about storage, in the third quarter MRV partnered with the Storage Networking Industry Association as official infrastructure sponsor at the Storage Developer Conference. Storage Developer’s Conference has become the leading venue for developers in the storage industry to gather for advanced technical sessions. As the official infrastructure sponsor, MRV has an opportunity to show off the versatile architecture of our switches, power management systems and new SAS/SATA interface with the media cross-connect.

I’m happy to say that we continue to make progress also with our marketing efforts aimed at increasing our presence and image among our customers. Earlier this week we launched our new MRV website that makes it easier for our customers to navigate and has a better look and feel. I am pleased with the effort, work, and result that our marketing team had put into revamping MRV's window to the world, and I would encourage you to take a look.

Going forward, we have a clear strategy and strong legacy of innovation that we’ve been building upon and believe we will be successful in reaching our long-term goals by continuing to gain market share through this recession. As we mentioned in previous calls, we spent the last couple of years developing a mature and experienced sales force and support organization. As you may recall, this was one of our primary objectives in 2007 and we believe the investment will help us to stay close to our customers, anticipate their needs, and help them succeed through this rough economic period.

We believe our network equipment products provide exactly what our customers are looking for in these tough times. Our customers are challenged with meeting increased demand for capacity and bandwidth at lower price points. MRV solutions can help carriers achieve this and reduce their operating cost by providing innovative solutions that add value at no hidden cost.

For example, our wireless backhaul solutions allow carriers to substitute multiple T1 lines with carrier Ethernet access solutions as wireless traffic grows. Similarly, in wireline applications, MRV has the best set of metro E solutions. Our superior product solutions help carriers perform traffic management and full diagnostic and recovery from central offices and network operating centers while avoiding costly truck rolls. MRV is an established player in this market and provides a rich suite of product solutions at our competitive price and well supported worldwide.

With respect to network integration, we see strong upside during an economic slowdown. In tough times, carriers and enterprise customers may cut back on new CapEx, but need to get more from their existing infrastructure. And this is what our network integration business does and does well. We stay close to our customers in good and bad times, and help them reach their infrastructure goals and needs.

That being said, since all of this business is in Europe, we will see pressure on our consolidated revenue due the weakening of the euro, but the integration business is fundamentally strong. Source Photonics is actively pursuing a strategy of becoming the most integrated and the lowest cost producer of high-end optical components.

We are building a sophisticated large central manufacturing facility in one of the most attractive high-end manufacturing areas in China. We have added about 300 people to the 1,000 people we already have in China and are forming a world-class manufacturing center there. The new facility allows us to reduce cost by bringing key sub-assemblies in-house. Combined with R&D operations in California and our large automated fab in Taiwan, we aim to be the most competitive Tier 1 supplier of optical components.

Moving on to our outlook for the fourth quarter of fiscal ’08, as we stated before, our three reporting segments, Equipment, Integration, and Optical Components, provide us a level of stability resulting from both product and geographic diversification, which helps reduce the company’s exposure to the ups and downs of the global economy, and help provide growth opportunities.

That being said, we are not immune to the macroeconomic environment. And although we continue to see strong customer demand and continued revenue growth, we are cautiously optimistic given the current macroeconomic environment and anticipate a reduced growth rate over the next few quarters compared with the third quarter.

We are guiding revenues to be in the $130 million to $144 million range. This compares with $141 million in the fourth quarter of 2007. The broader guidance reflects the increased volatility in foreign exchange rates so far this quarter and the increased uncertainty of the macroeconomic environment and the impact that it may have in our consolidated results.

While we are delighted with our growth, consistent execution and profitability remain top priorities for MRV. Going forward, we will work hard on further expanding revenue in our higher gross margin segments while keeping operating expenses in check and improving our execution. This will be the key to our success. As stated before, this balanced approach will allow us to leverage our position in the market into bottom line results.

With that said, let me now turn the call over to the operator for Q&A. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And our first question comes from the line of John Harmon with Needham & Company. Please go ahead.

John Harmon – Needham & Company

Hi, good afternoon.

Noam Lotan

Hi, John.

John Harmon – Needham & Company

A couple of questions, please. I believe you said your cash decreased $6 million in the quarter and you spent $2.5 million on professional fees. Can you talk about where the rest went?

Noam Lotan

Okay. First, correction here. Our cash, we ended the quarter with $73 million in cash, not $70 million. I must have swallowed the three. Well, the rest basically – Guy, do you want to comment on it?

Guy Avidan

I think the rest was really across the board, across segments and subsidiaries. There was no other concentration like the $2.5 million.

John Harmon – Needham & Company

Well, let me ask you this way. Was there a big capital spending at your new plant, or did it go into working capital?

Noam Lotan

Both.

John Harmon – Needham & Company

Okay. Thank you. Secondly, maybe you can qualitatively talk about your fiber-to-the-home business.

Noam Lotan

Well, it’s still very strong, although there’s still price pressure on this product line. And projections that we have from our principal customer, mainly the Tellabs, Alcatel and Motorola, shipping into Verizon and others, is that there is still pretty much of a strong demand for the product. I’ll give you an example where we shipped north of 200,000 triplexers during the quarter, and the projections for the next fourth quarter are at about the same rate.

John Harmon – Needham & Company

All right. Great. Thank you. And just finally, in China, have you stopped using your contract manufacturers yet, or are you still using them over the transition while you get everything set up in Chengdu?

Noam Lotan

Yes, we are still using them and we will add the substantially more headcount in order for us to take over the work and bring it in-house. So this is going to be done gradually and it will basically, hopefully, be a non-event as far as impact on our revenue, but a more much stronger impact on our gross margin. So this is what we can process right now, but we are still using two of our main principal contract manufacturers in China.

John Harmon – Needham & Company

Okay, thank you very much.

Noam Lotan

Thank you, John.

Operator

(Operator instructions) I do not show any further questions at this time. Please continue.

Noam Lotan

Well, should we wait a couple more minutes just to see if anybody wants to ask a question? I guess I’ll give you another 30 seconds. Okay. I suppose we’re showing no further questions. So let me just thank you, operator. And I want to thank everyone else for being on the call today, a very lively call I must say. Although we still have a lot of work ahead of us, I think we definitely made great strides during the quarter, and we anticipate the continued success going forward. And with that, I want to thank you all and wish you a great afternoon. Thank you very much for being on our call and see you next quarter. Thank you. Bye-bye.

Operator

Ladies and gentlemen, this concludes the MRV Communications third quarter 2008 selected preliminary results conference call. You may now disconnect. Thank you for using AT&T conferencing.

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