Oplink Communications, Inc. F2Q09 (Qtr End 12/31/08) Earnings Call Transcript

Oplink Communications, Inc. (OPLK)

F2Q09 Earnings Call

January 29, 2009 5:00 pm PT

Executives

Joseph Liu – President and Chief Executive Officer

Shirley Yin – Chief Financial Officer

Analysts

Mike Crawford – B. Riley & Company

John Harmon – Needham and Company

Paul Bonenfant – Morgan Keegan

Carlo Cannell – Cannell Capital

Sven Eenmaa – Thomas Weisel Partners

Hamed Khorsand – BWS Financial

Sam Kingston – Unidentified Firm

Presentation

Operator

Welcome to the Oplink Communications second quarter fiscal 2009 earnings conference call. (Operator Instructions). I would now like to turn the conference over to Mr. Matthew Hunt.

Matthew Hunt

Thank you for joining us on today's conference call to discuss Oplink's second quarter fiscal 2009 financial results. This call is being simultaneously webcast on the Investor Relations section of the Company’s website at oplink.com. Joining me on the call today are, Joseph Liu, President and CEO of Oplink and Shirley Yin, CFO of Oplink.

Before we get started, I would like to remind you that the following discussion contains forward-looking statements that involve risks and uncertainties and that Oplink’s actual results may vary materially from those discussed here. Information concerning factors that could cause actual results to differ from forward-looking statements can be found in Oplink’s periodic filings with the SEC.

The forward-looking statements and risks stated on this conference call are being based on current expectations, and Oplink assumes no responsibility to and does not intend to update or revise them whether as a result of new developments or otherwise.

Now, I would like to turn the call over to Joseph Liu, President and CEO of Oplink.

Joseph Liu

Thank you for joining us on the call today as we report our second quarter fiscal 2009 financial results. We reported $37.6 million in revenue for the second quarter, which was down from the prior quarter, but at the high end of our expected range. Due to favorable product mix and yield improvements, gross margin came in stronger than expected excluding the impact of Nortel revenue deferral mentioned in our press release. We were also effective at controlling expenses and reported non-GAAP EPS for the second quarter of $0.12, which was above our expected range of $0.03 to $0.07.

Reductions in operating expenses were made across the business in the second quarter, and as a result, we generated $3.4 million in cash flow from operations. We repurchased $2.3 million in stock and closed the quarter with $146.8 million in cash equivalents and investments maintaining our strong balance sheet. We continue to closely align our operating expense with near-term revenue expectations and will place a high emphasis on generating cash flow from operations in the March quarter and future quarters.

In the second quarter, our 10% customers were Tellabs and Huawei. In addition, we continued to have a diverse customer base with several significant contributors to revenue, and our 10% customers were Alcatel, Nortel, and Cisco. We are also continuing to work with customers on several design initiatives for the future, and we have progressed with design wins for 40G and 50 GHz opportunities, but these will take time before they yield revenue.

We are confident that we will emerge from this more difficult market environment as a stronger passive and OMS supplier. We are cautioned about the uncertainty of the telecom capital spending and the current macro climate. We are therefore planning for revenue in the March quarter to be in the range of $28 to $32 million. We are considering all options to make our business more efficient during these tough times. Fortunately, Oplink does not have heavy fixed overhead such as a wafer fab to be concerned with during these times. As a senior team, we are experienced at creating cost effective business and are prepared to further scale cost to revenue placing a high emphasis on cash preservation.

I will now turn the call over to Shirley for a more detailed review of financials for the quarter of 2009.

Shirley Yin

Revenue for the second quarter was $37.6 million, down as expected from $43 million reported in the prior quarter. Revenue in the second quarter excluded $805,000 which was deferred as the result of bankruptcy filing of Nortel. This $805,000 related to shipments to Nortel and one of its contract manufacturers for which payment had not been received prior to Nortel’s bankruptcy filing.

Net loss for the second quarter was $10.5 million of $0.51 per share, which included a $10.9 million charge primarily related to the impairment of goodwill associated with the OCP acquisition, $1.2 million in stock-based compensation expense, and $954,000 in amortization of intangibles. This compares to a GAAP net loss of $3.4 million or $0.16 per share reported for the first quarter of fiscal 2009. On a non-GAAP basis, net income was $2.6 million or $0.12 per diluted share as compared to $3.2 million or $0.15 per diluted share reported in the prior quarter.

Non-GAAP gross margin for the second quarter was 24.5%, as compared to 25.4% in the prior period. Excluding the impact of the Nortel revenue deferrals, non-GAAP gross margin would have been 26.1%, up from the prior period primarily related to favorable product mix and yield improvements. We expect gross margins in the March quarter to be down from this level primarily due to lower utilization.

During the second quarter of 2009, we were successful in reducing our operating expenses by approximately $780,000. Total head count at the end of the second quarter was down 432 across all functional areas. In addition to lower headcount costs, R&D expenses were down as we continued to transfer our remaining OCP R&D to lower cost regions in China and sales and marketing expenses reflected lower commission expense.

In the March quarter, we expect operating expenses to be down slightly from the December quarter. Interest and other income for the second quarter was $808,000 down from $927,000 in the prior quarter. Our provision for income taxes was a benefit of $15,000 for the quarter.

Turning to the balance sheet, we generated $3.4 million in cash from operating activities in the second quarter. We repurchased $2.3 million in common stock. Absolute shares outstanding at the end of the second quarter were 20.5 million shares. We closed the second quarter with $146.8 million in cash, cash equivalents, and short and long term investments. All of our cash is safely invested, and we have no liquidity issues.

Accounts receivable at the end of the quarter was $27.9 million, down from $32.7 million in the prior quarter. DSOs were 67 days. Inventory was $21.8 million, down from $24.1 million in the first quarter. As Joe discussed, we are taking a very cautious approach to our outlook given the certainty about carrier spending combined with the overall economic climate.

For the March quarter, we are planning for revenue in the range of $28 to $32 million. GAAP net loss will be in the range of $0.06 to $0.11 per share, and our non-GAAP net income will be in the range of breakeven to $0.05 cents excluding amortization of intangible assets, stock-based compensation, and other non-cash or non-recurring items. We expect to continue to place a high emphasis on generating positive cash flow from operations and maintain a solid balance sheet.

Now, we will take questions through the operator.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Mike Crawford from B. Riley & Company.

Mike Crawford – B. Riley & Company

Could you please share the rough breakout between Oplink Core, OCP, and ROADM for this quarter and then your thoughts on that for March given the guidance you have just given us?

Shirley Yin

For this coming quarter, ROADM revenue is about $5 million, and for the active piece, it is approximately the same as last quarter.

Mike Crawford – B. Riley & Company

Would you expect much change in the relative mix in March? Are there any particular areas of strength or weakness?

Joseph Liu

The ROADM will probably have a slight drop, and there will be probably more reduction on the active as well as the OMS.

Mike Crawford – B. Riley & Company

Did you say who your 10% customers were?

Shirley Yin

The 10% customers for the current quarter are Tellabs and Huawei.

Mike Crawford – B. Riley & Company

The final question relates to your thoughts on the industry. Since you have acquired OCP, there have been several other acquisitions, but it seems to me there are still too many component providers out there. There are 10 or 12 of you guys that comprise three-fourths of the market. What are your thoughts on consolidation? Don’t you think that needs to happen for component vendors to have a stronger business model?

Joseph Liu

I think so. You are absolutely correct here. I think that further consolidation is unavoidable.

Mike Crawford – B. Riley & Company

It would seem that you have the balance sheet to make it happen, so maybe, we will have a conference call one of these days coming up besides the regularly scheduled call.

Operator

Our next question comes from the line of John Harmon with Needham & Company.

John Harmon – Needham and Company

Maybe I will just have to elaborate on the prior question, Oplink has probably the highest amount of net cash and one of the highest figures for any the public companies. You must certainly be getting a lot of companies that want to come to you and sell. Have you seen an increase in either the number of companies that have been coming to you? Are you looking at more things, and do you think the valuation for private companies are starting to come down to realistic levels?

Joseph Liu

There was some activity, John. I am speaking for the board. I think our board is very active in looking at opportunities, both target to acquire and also open to strategic alternatives.

John Harmon – Needham and Company

Secondly, in prior years, this has not been an issue, but just curious with the Chinese New Year this week, how does that affect your Zhuhai facility? Do you close down, do you give your employees leave in shifts, and have you noticed any changes there recently?

Joseph Liu

Certainly, as we speak, they are currently enjoying the Chinese New Year, but there is a consistent pattern with the New Year. We may have some generic or natural attrition. We don’t know at this point, but the impact would probably be less than 5% of the direct workforce.

John Harmon – Needham and Company

Regarding your sales to Nortel, given they are being in chapter 11, how does that work from now on? I mean do you just ship to them for cash, and what are the prospects of recovering what they owe you?

Joseph Liu

Well, there are two pieces there. One is that we already shipped before the announcement. Post announcement, I think the business would be as usual, although we are discussing with them on the possible terms, but earlier you mentioned that we probably have a stronger balance sheet. We probably will enjoy more business relationship with Nortel on an ongoing basis, and the portion that is impacted that we cannot recognize as revenue for the quarter is less than $1 million dollars; in fact, it is only $800,000 and I believe that we have received quite a bit of that during the quarter, so the impact is fairly minimum for Oplink.

John Harmon – Needham and Company

Thank you, and finally one for Shirley please. I am looking at your GAAP EPS guidance. It looks like you are expecting some kind of non-cash charge in the March quarter. Is that true and if so what are you looking for?

Shirley Yin

That is just the usual one we have for every quarter from primarily the stock comp and also the amortization of intangible assets.

Operator

Our next question comes from the line of Paul Bonenfant with Morgan Keegan.

Paul Bonenfant – Morgan Keegan

First one is a housekeeping question. I am going to try again with 10% customers. Could you tell us where the two 10% customers came in, as a percentage of revenue in the quarter?

Joseph Liu

Huawei came in at 15 plus percent, and Tellabs came in with 18 plus percent.

Paul Bonenfant – Morgan Keegan

Coming back to your forecast calling for a 15% to 26% sequential decline, I guess, if we include the revenue from Nortel that is less than $1 million, that would be 17% to 27%, obviously more than we were expecting. Is this a broad-based weakness or is it specific to any particular geography or customer or product set?

Joseph Liu

I would probably classify it as primarily Northern America weakness. We have obviously across the board softness of the market, but I think the European, the Chinese as well as the Japanese markets hold up for the forecast for the quarter; only North America slowed down the most for us.

Paul Bonenfant – Morgan Keegan

Okay, in terms of the forecast, Shirley, you said OpEx would be coming down sequentially, gross margin would be coming down sequentially. Can you give us a sense for the magnitude for gross margin? Are wer talking about several hundred basis points for OpEx? Are we talking about the degree of decline that we saw sequentially in the December quarter?

Shirley Yin

Yes, well, it is always very hard to forecast the gross margin accurately, so that is why we just give out the guidance. It will be down from the December quarter levels, but we give out the top line guidance and we give out the bottom line and the direction of the OpEx. You should be able to use all this information and put together a range of gross margins.

Paul Bonenfant – Morgan Keegan

When you talk about aligning operating expenses, looking at options there, would that include potentially shutting unprofitable or less profitable business segments?

Joseph Liu

Especially in this downturn, we are seriously reviewing our gross margin. On the low gross margin businesses, we tend to choose not to participate, and mainly, I think that currently the ones that are on the evaluation would be the short-range transceivers. The data com side of the business is very competitive.

Paul Bonenfant – Morgan Keegan

Would it be fair to say that the visibility into the June quarter is limited?

Joseph Liu

I would stress it is probably very limited, although we normally do not give out guidance of over a quarter, but I can stress that it is very limited.

Operator

Our next question comes from the line of Kyle Haas from Cannell Capital.

Carlo Cannell – Cannell Capital

This is Carlo Cannell filling in for Kyle. My first question is more of a capital structure question, and I am not sure if many of the listeners on the call have the benefit of reading my letter to the board and your reply, but it goes like this. If you have a lot of cash, it is a dampener on return on equity. If you don’t have a lot of cash and you are performing, the return on equity and most of the other characteristics are quite stellar. So, I would like to know why doesn’t the company make a very large dividend and return the cash to the owners. You don’t need a lot of capital. This is not a semiconductor capital equipment business, you’re not building large rigs to drill in the North Sea; why not just send the cash back to its owners?

Joseph Liu

Carlo, you’re not the only one to ask that question. From time to time, I have been grilled by the question when we were having $240 million in cash and doing smaller business than we are now. Many of us, including myself, felt that with the cash we are a stronger company, and if we do distribute the cash, we would be probably no different than some of the companies that have negative enterprise values. So with that in mind, I think as an operator and a manager here, I would like to see the company come out of this downturn and be a stronger company. At least we have accomplished number one in the passive space, which is in between the transceiver we have a leading market share position. Without the cash or without the strong balance sheet, we may not enjoy some of the benefits of doing business with the leading-edge equipment or system companies.

Carlo Cannell – Cannell Capital

How much cash do you think you need in order to run the business in that excellent fashion?

Joseph Liu

Earlier, I think the first analyst, Mike, asked a question. From his point of view, Oplink is one of the strongest companies having a balance sheet that would allow it to be flexible in choosing or acquiring target companies that is strong in certain market segments. So, I think that is one of the benefits of having a strong balance sheet rather than distributing the cash to the investors.

Carlo Cannell – Cannell Capital

I am not sure you are really understanding me. Let me try to explain it a different way. What you say may be excellent; in fact, were you to have $7 billion of cash, I am sure that that would impress your customer base and that it might draw in some sales versus some competitors. The point that I am trying to get across is as follows: We are money managers. Your other shareholders are money managers, and we see opportunities for much higher rates of return in other areas, in other industries. We are not wed to this industry, and I am speaking in large part on behalf of many of the shareholders some of which I have talked to, we do not think that this industry can get that type of return, and I don’t think you need that amount of cash. So, I ask you again to make a special dividend, return it to shareholders, to the owners of the cash, and let them decide how to allocate that cash for the benefit of their investors.

Joseph Liu

I think, Carlo, your viewpoint is well taken and has been discussed in our board meeting. I think we gave you an official response in our written response, and so I would like to draw a closure here.

Operator

Our next question is from the line of Ajit Pai with Thomas Weisel & Partners.

Sven Eenmaa – Thomas Weisel & Partners

This is Sven Eenmaa calling in for Ajit. I wanted to ask a couple of questions. First of all, I wanted to ask about the order trends in the January quarter as well as the current pricing environment. How has it changed from the prior quarter?

Joseph Liu

Order trend obviously slowed down in the month of January, and the pricing trend I think is tight, but anytime you have a soft market, price tends not to hold up that well, but since we are in the designing business, so the pricing impact is not so obvious.

Sven Eenmaa – Thomas Weisel & Partners

When do you guys have any significant pricing discussions coming up? Is it the first quarter, second quarter, or how is it distributed through the year?

Joseph Liu

Generally, the March quarter is the weakest in the year. I tend to believe that September and December quarters both are strong for the component and subsystem suppliers.

Sven Eenmaa – Thomas Weisel & Partners

The second question I wanted to ask is, in terms of trends in Europe, in prior quarters you have also discussed Alcatel-Lucent also having a share at Ericsson. How are the trends currently at Ericsson? They do not seem to be a top customer currently.

Joseph Liu

They are not our top customer but they are a consistent customer, and I think earlier last year, they had some inventory surplus issues, but as the quarter went on last year, the calendar third quarter, they already came back. To us, they are fairly normal now.

Sven Eenmaa – Thomas Weisel & Partners

Last question, just wanted to confirm that the actives business for you guys was around $13 million a quarter.

Joseph Liu

Correct.

Operator

Our next question comes from the line of Hamed Khorsand with BWS Financial. Please go ahead.

Hamed Khorsand – BWS Financial

Just had a couple of questions here. When we see your peers provide tough guidance as well for Q1, is there anything Oplink can do to gain market share as a survivor or is it just waiting until the dust settles and just seeing the sequential declines in revenues?

Joseph Liu

I would say right now, it is fairly uncertain across the board, and I think the suggestion may be the latter. When dust settles, we’ll all probably come out ahead, and at this time, I think I cannot claim that we are able to gain market share through the quarter, but that does not mean that we cannot gain additional share through the downturn, but I have not seen the opportunity arise with that because somebody cannot supply that and we got share or we lower our price to get additional share.

Hamed Khorsand – BWS Financial

What kind of cut in production capacity can you sustain and maintain profitability without incurring an expense when business starts to rebound?

Joseph Liu

For Oplink, since we do not owe wafer fabs first of all, I think that part of fixed overhead is not a concern for us. We have our own facility. We have our own capital equipment. The largest expense is personnel, and direct labor is only 5% to our expense, and manufacturing overhead is less than 10%, so we are focusing on reducing material cost. Material alone will probably be highest percentage of expense for the cost of goods sold line, and so cutting the incoming material costs and trimming the manufacturing overhead is probably more important than getting rid of the direct labor. We are able to control the material as well as the manufacturing overhead effectively, and on the direct labor side, we can balance that with no overtime, so we are very careful about sizing our operation to our top line.

Hamed Khorsand – BWS Financial

Lastly, on this announcement of Bookham and Avanex merger, does that entice you to go out there and look for possible acquisitions or are you just going to wait until the clarity gets a little bit better in the industry before you use your cash for acquisitions or possible acquisitions?

Joseph Liu

I think there is some impact, but will their merger accelerate us to do something? I do not think so. Like I said, our board is always looking at opportunities that bring value to our shareholders.

Operator

Our next question comes from the line of Sam Kingston with (inaudible).

Sam Kingston – Unidentified Firm

First, a few housekeeping items. Can you tell me how many employees the company had at the end of the quarter?

Shirley Yin

We have about 2500 at the end of the quarter.

Sam Kingston – Unidentified Firm

Can you tell me how many were former OCP employees?

Shirley Yin

It’s a little bit more than 100.

Sam Kingston – Unidentified Firm

Regarding the share we purchase, should we expect that to maintain the current pace that you did in Q2?

Joseph Liu

Yes.

Sam Kingston – Unidentified Firm

Regarding 10% customers, do you think we should expect to see significant change there in the coming quarter?

Joseph Liu

No.

Sam Kingston – Unidentified Firm

The tax rate, should we basically suspect no taxes or a slight tax benefit in Q3?

Shirley Yin

We expect that will be very minimal in the next quarter, maybe a similar level as the current quarter.

Sam Kingston – Unidentified Firm

Joe, a little bit of bigger picture, if you could tell me a little bit about how this feels to you compared to 2001-2002 period where I think there were larger inventories at your customers and obviously there are different cross currents, but what is your feeling right now in terms of the lengths of this downturn? Does it feel like it could be a similar length or do you think this could be a shorter length?

Joseph Liu

I think it would be much shorter. First of all, there is no surplus of capacity. There is no glut of inventory. On the contrary, the infrastructure is falling behind. The applications are already rarely available. Sometimes, the decompression or video streaming is at zero cost or it costs very little. I would tend to believe that this time around when the financial markets get some kind of a clarity or stabilize a little bit more, then the carriers will start to spend, and we will benefit. So, I anticipate a much shorter cycle this time around.

Sam Kingston – Unidentified Firm

Lastly, what are you thinking in terms of politics and the effect that might have on your industry? I mean obviously there have been thoughts that it would be beneficial with potential tailwinds coming in the future. What do you think?

Joseph Liu

I think this certainly will help. The new administration is talking about internet backbone. Keeping in mind that Oplink’s core business is in the metro edge, metro core along with the long-haul business. So, if you talk about internet backbone, you are talking about WDM, you are talking about broader bandwidth, you are talking about fiber communication. Any one of them would probably fall into our category. All in all, I think that if the talk about $6 billion indeed is going to be released pretty soon, that will benefit the whole industry.

Operator

(Operator Instructions). Our next question is a followup from the line of John Harmon with Needham & Company.

John Harmon – Needham & Company

This is more a big picture. First of all, the amount of competition you do with Bookham and Avanex respectively is not that high, so I would argue that the merger is probably not going to have much effect on Oplink, but the question is more if this trend continues, we will have some very large optical component companies, and the question is like this common interview question, where does Oplink want to be in 5 years? Do you want to be a supermarket like some of these other companies or do you want to be of a successful niche player? To what extent you can answer this question?

Joseph Liu

Well, there is a short-term strategic goal, and then there is probably a mid range strategic goal. Short term, especially in this downturn, our priority is to preserve cash. We will do everything to make sure that we are profitable. Then, we want to be number one in the passive optic space along with the OMS, trying to use OMS as a support to our passive business. That is our short-term goal, and from a broader scope, we are basically a niche play, and I think we can do well as a niche player, but we are always looking at other opportunities and we are always open to strategic alternatives. In other words, I would tend to think that in the next 5 years, we are not going to sit on the sidelines and do nothing, so you have my word that we as well as our board are actively looking at opportunities as well as strategic alternatives.

John Harmon – Needham & Company

If I can ask you a bit of a personal question, recently you did reduce your level of involvement with the company although you just came back. You do have other things going on in your life, but it would certainly take a great deal of your own personal attention to take the company to the next level. To the extent you are willing to divulge your personal plans, I mean is this something you would be willing to do, or would you be working on building a successor to do that?

Joseph Liu

That has nothing to do with my being player or taking a broader role into a bigger picture. It does not have to be me or another individual. It is really depending on the business. If it is a good deal for the shareholder, good deal for the management team, I think we will go for it.

Operator

That does conclude our question-and-answer session today. Ladies and gentlemen, this concludes the Oplink Communications second quarter fiscal 2009 earnings conference call.

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