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Sycamore Networks, Inc. (OTCQB:SCMR)

F2Q09 (Qtr End 01/24/09) Earnings Call Transcript

February 19, 2009 8:30 am ET

Executives

Bob Travis – Director, IR

Dan Smith – President & CEO

Paul Brauneis – CFO, VP Finance and Administration, & Treasurer

Operator

Welcome to the Sycamore Networks second quarter 2009 financial results conference call. (Operator instructions) As a reminder, this conference is being recorded Thursday, February 19th, 2009.

I would now like to turn the conference over to Mr. Bob Travis, Director of Investor. Please go ahead, sir.

Bob Travis

Thanks Suzie. Good morning everyone and thanks for joining Sycamore's second quarter fiscal year 2009 earnings call. Speakers’ on today's call are Dan Smith, Sycamore's President and CEO and Paul Brauneis, our Chief Financial Officer.

As a reminder, today's press release was distributed prior to market open at approximately 8 am via Business Wire and is also available on our website at sycamorenet.com. In addition, we wish to caution you that certain matters discussed today may constitute forward looking statements that involve risks and uncertainties.

The company's actual results could differ materially from those stated or implied in forward-looking statements due to a number of factors, which are identified in today's press release and discussed in detail in the section entitled “Factors That May Affect Future Results” in the company's most recently filed reports on Form 10-Q, 10-K and other reports filed by the company from time to time with the Securities and Exchange Commission.

The company disclaims any intentions or obligations to update or revise any forward-looking statements whether as a result of new information, future results or otherwise.

Now I’ll turn the call over to Dan Smith.

Dan Smith

Thanks Bob. Good morning everyone and thank you for joining us today. Following the summary of our second quarter results, I would like to take a moment to share some thoughts in the current business environment as well as highlight recent enhancements to our customer solutions.

I’ll then turn to Paul, who will cover our Q2 financial results in greater detail. We’ll be happy to take your questions during the Q&A session at the end of the call.

This morning Sycamore reported second quarter revenue of $11.7 million compared with $15.4 million in the preceding quarter and $41.5 million for the second quarter of fiscal 2008. GAAP net loss for Q2 was $10.1 million or $0.04 per share. Non-GAAP net loss was $8.3 million or $0.03 per share.

We ended the quarter with $935.6 million in cash. Like many others in our industry, we are operating in an increasingly challenging economic environment. Our second quarter results reflect these challenges rising from the impact of reduced capital spending in both our domestic and international customer base.

While we continue to pursue new customer opportunity and look to expand our business with existing customers’, the pace of this activity had slowed in light of the economic downturn. Many carriers around the world are in the process of making adjustments to their business models and network deployment plans, adding to the uncertainty in our markets. We believe that market conditions are unlikely to improve meaningfully in the near term of share [ph] and revised forecast – forecasts issued by industry analysts who follow the bandwidth management market segment.

As a result, we will continue to monitor our current and planned R&D initiatives to ensure our results are effectively aligned to meet the needs of our current and perspective customers’.

As you may recall, during our Q4 call last August, we discussed an anticipated increase in R&D expenses this fiscal year to address emerging opportunities in the area of packet and optical conversions. We continue to bring solutions to market that are optimized for near-term applications requiring converts, packet and circuit functionality.

Due to the economic environment and evolving customer carrier strategies, we will pace our future investments to match the slower-than-expected rate of adoption of new technologies. As we navigate through current market conditions, we will continue to prudently manage our expenses in all areas of the company, while maintaining a sharp focus on executing against critical customer needs.

We will maintain the competitive strength in our products and solutions, while ensuring that we preserve our financial strength. As I just mentioned, one area of focus has been the addition of packet optimized features on our switching platforms.

Earlier this week, for example, we announced Ethernet enhancements for our SN 9000 Intelligent Multiservice Switching platform with the addition of a new flexible and cost efficient Multirate Ethernets service module.

This card leverages our extensive expertise in Ethernet technology and expands a rich diversity of service interface supported by the SN 9000 to include Ethernet line rates from 10 Megabits to 10 Gigabits. The ability to cost-effectively meet diverse service needs and capacity requirements in a single platform allows our customers’ to dramatically improve utilization of service bandwidth and lower operational costs by simplifying provisioning and management of multiple of services.

These benefits resonate strongly with our customers, especially given the cost reduction pressures network operators facing on a daily basis. These new product enhancements reflect the continued hard work of the talented Sycamore team.

Before handing the call over to Paul, again I would like to take this opportunity to thank our employees for their unwavering commitment to technical excellence and their steadfast dedication to our customers’.

With that I will now turn the call over to Paul.

Paul Brauneis

Thanks Dan and good morning everyone.

Before I begin, let me remind you that current or historical results are not necessarily indicative of results to be expected for any future period. And that predictability of future quarterly operating performance remains difficult since our revenue stream fluctuates from period to period due to customer concentration in large project orientation primarily in our core business.

Further more, the effects of the current economic environment are being seeing by businesses across the board including carriers and service providers, many of whom have publically signaled curtailment of planned capital expenditures for their current fiscal years.

Our gross margin also fluctuates from period to period based on the split between product and service revenue, the distribution of product revenue between our core and access businesses, and the product and channel mix within those businesses.

Gross margin is also affected by the level of provisions for warranty, scrap, rework and those which may be taken for excess or slow moving inventory. Lastly, certain operating costs mainly R&D project expenses and costs and cost recoveries related to the previously concluded stock option investigation matter have also varied widely from period to period. Now, let me give you an overview of the Q2 results.

GAAP net loss and GAAP net loss per share for the second quarter of fiscal ’09 was $10.1 million or $0.04 per share compared to GAAP net income of $9.7 million or $0.03 per share for the second quarter of fiscal 2008.

For the six months ended January 2009, GAAP net loss was $15.9 or a $0.06 loss per share compared to a GAAP net income for the comparable six-month period of fiscal 2008 of $16.7 million or $0.06 per share.

GAAP results during the quarter and six months period include charges for stock based compensation of $1.2 million and $2.4 million.

Amortization of purchased intangibles of $0.3 million and $0.6 million $4.4 million respectively and restructuring charges of $0.3 million and $1.1 million. The aggregate restructuring charge consists primarily of employee related cost resulting from our previously decision in Q1 to realign and refocus certain sales and marketing and general and administrative functions. And to consolidate certain manufacturing activity, this consolidation was completed during Q2.

For the remainder of the call, all references to our results will relate to financial measures excluding these charges and will be referred to as non-GAAP results. Consistent with past practice, cost and cost benefit of insurance recoveries related to the now concluded stock option investigation matter are included in the G&A line item in the non-GAAP results unless and otherwise noted.

Non-GAAP information should not be considered superior to, in isolation from or as a substitute for GAAP results. Rather, we believe that these non-GAAP measures provide useful information to investors, analysts and shareholders’ alike in assessing the core operating performance of our business.

A detailed comparative reconciliation of GAAP to non-GAAP net income for the current quarter and year to date is included as a table in our press release and can be found in the Investor Relations section of our website as well.

Non-GAAP results for the Q2 year-to-date period ended January 24th, 2009 include an operating loss of $13.2 million and $22.2 – $22.7 million respectively. This compares to operating profit in the comparable Q2 and year-to-date periods of fiscal 2008 of $0.9 million and $0.3 million respectively.

Non-GAAP net loss for the Q2 and six-month period of fiscal 2009 were $8.3 million and $11.7 million, compared to non-GAAP net income in the comparable prior year periods of $11.5 million and $22 million respectively.

Total revenue for the current quarter and year to date was $11.7 million and $27.1 million, compared to $41.5 million and $79.4 million for the second quarter and year-to-date periods of the preceding year. There were three customers who each accounted for greater than 10% of total revenue in the quarter.

Of the total revenue in Q2, approximately $5.6 million was product related, while $6.1 million came from service. Core switching revenue was $6.9 million and access revenue was $4.8 million. For the six-month period, product revenue was $15.6 million and service revenue was $11.5 million.

Core switching revenue for the six-month period was $15.7 million, while access revenue was $11.4 million. Domestic versus international revenues was 65% and 35% respectively. Our book to bill ratio was greater than one.

Gross margin on a non-GAAP basis for the second quarter was 29.8% compared to 49% in Q2 of the prior year. As mentioned in the opening remarks, our gross margin fluctuates from period to period depending on product and channel mix, volume and pricing as well as the level and timing of routine provisions and material purchase price adjustments from our contract manufacturers.

The Q2 margin was negatively affected by a net inventory provision of approximately $900,000. Excluding that provision, gross margin for the quarter was approximately 38%.

Gross margin is also negatively affected in a period under certain customer arrangements with pricing for product shipments is bundled with various services. In such cases, the full payer value of these services is deferred until a later period when such services are performed.

The remaining value is then recorded as product revenue in the current period against which 100% of the product related costs are applied. Such situations have the effect of reducing product in overall gross margin in the period of sale. Excluding the $900,000 net inventory provision, product gross margin this quarter was 16%, while service margin was 57%.

Research and development expenses were $12.4 million in Q2 compared to $11million in both the preceding quarter in Q2 of the prior year. Year to date, research and development costs were $23.4 million, compared to $21.5 million for the first six months of fiscal 2008.

Sales and marketing expenses for the second quarter and first six months were $3.3 million and $7.1, down $0.4 million from Q1 and down $1.7 million and $2.9 million respectively from $5 million in the year ago second quarter and from $10 million for the first half of 2008.

General and administrative expenses were $930,000 in Q2 and $2.2 million for the six-month period, compared to $3.5 million and $7.5 million in the comparable prior year periods.

Stock option investigation recoveries in the Q2 and the current year-to-date periods were $1.7 million and $3 million respectively, while option investigation costs in the prior year’s Q2 and six-month periods were $1.4 million and $2.8 million.

Excluding these costs and recoveries, normalized G&A expenses were $2.6 million in Q2, compared to $2.5 million last quarter and $2.3 million in Q2 of the prior year, which amount also excludes the favorable impact of $0.3 million recovery of other non-option costs.

On a year-to-date basis, normalized G&A expenses were $5.2 million, compared to $5.1 million last year. In the aggregate, our total operating expenses excluding the previously quantified expenses and expense recovery were $18.4 million in the current Q2 period, compared to $18.3 million in the prior year and $35.6 million for the year to date versus $36.5 million for the comparable year-to-date period of the prior year.

In our Q4 ’08 call, we indicated an expectation of increased year-over-year growth in non-GAAP operating expenses of 8% to 12% driven primarily by continued expansion of our Shanghai Development Center coupled with expanded domestic development, net of cost reductions and other discretionary expense areas.

This was reaffirmed in our Q1 call, as we began to see the benefits from planned efficiency and reduction in certain discretionary spending. Although, we indicated then that the timing of any significant incremental development spending was lagging our initial expectation as we proceeded very cautiously in light of emerging economic and market conditions.

Since then, market conditions have worsened and given raise to a global economic slowdown in which curtailed capital spending by major carriers and other service providers is generally occurring and expected to continue for some time.

Accordingly, we are cautiously pacing the more aggressive development strategy that we articulated at the beginning of the fiscal year, as we reassess the implications to our customers and ourselves of the anticipated lower and slower customer spending.

We will continue to proceed cautiously and target our spending for known opportunities with a more measured approach toward spending for future market requirements.

And our total headcount at the end of the quarter was 470, compared to 479 at the end of Q1 and 492 at the FY’08 year end in July.

Interest income which is the main component of other income in the condensed statement of operations was $5 million for the quarter compared with $6 million last quarter and $10.9 million in Q2 of fiscal ‘08.

On a year-to-date basis, interest income declined approximately 50% to $11 million for the first six months of fiscal 2009 from $22.3 million in the first six months of last year. The reduction in interest income for the current quarter and year-to-date period is directly attributable to significantly lower interest rates being earned in our average portfolio balance as compared with the prior periods.

In light of current economic conditions and volatile market condition, we continue to maintain conservative investment positions within our significant investment portfolio.

We ended the quarter with total cash, cash equivalents, short and long-term investments of $935.6 million, a decrease of only $1.7 million from our Q1 balance of $937.3 million. The quarter ending balance includes unrealized gains of $0.4 million – excuse me of $4 million, representing the positive effect of marking to market, certain longer-term securities carrying slightly higher interest rates than current market rates.

The unrealized is reported in our financial statements as a credit to equity and not as an element of profit or loss.

Capital expenditures during the quarter were $1.5 million.

Our accounts receivable totaled $11.5 million and represents a DSO or days outstanding of 89 days, which is indicative of the distribution of product shipments and combined products and services as billings throughout the given quarter.

Inventory at quarter end was $22.2 million, a decrease of approximately $1.2 million from last quarter. We are committed to a continued focus in this area and on working capital management in general. Although this is our second consecutive quarter of declining inventory, the level remains high and our returns low. We will keenly evaluate our inventory each quarter in light of forecast of estimated demand and we will keenly make provisions for quantities that we believe are in excess of foreseeable demand.

Our other current liabilities including accounts payable, accrued expenses and restructuring costs totaled $13.7 million.

Deferred revenue both current and long term totals $22.7 million compared to $19.2 million at the end of Q1. Of that total deferred revenue on product shipments is approximately $6.6 million and represents shipments for which revenue recognition criteria has not yet been met, but which we expect to meet over the next few quarters.

Deferred revenue on service approximates $16.1 million representing the unearned portion of customer maintenance and support agreements which will be accreted into services revenue over the terms of their related contractual service periods.

Due to factors previously discussed, we will maintain our practice of not providing forward-looking revenue guidance. However, I can give you some thoughts on other areas that you may find helpful. Our non-GAAP gross margin percentage for the first half of fiscal ’09, adjusted for the net inventory provision made in Q2 approximates 40%.

At current revenue levels, we would not expect to exceed that level. Earlier in the call, I mentioned that due to uncertainties surrounding current economic and market condition, we are cautiously pacing the aggressive development strategy articulated at the beginning of the year.

Accordingly, we will continue to proceed cautiously and currently would anticipate that nearer-term quarterly non-GAAP operating expenses exclusive of any unusual future charges would approximate our Q2 spending level, excluding the cost recovery benefit.

With regard to interest income, we would expect that our average return on our average invested balances will decline slightly over the next several quarters as certain longer-term investments mature and are reinvested at current rates commensurate with highly secure investments.

We will continue to pursue additional cost containment measures. We will take advantage of our lower cost offshore development center and continue our exploration and the evaluation of potential strategic opportunities in both existing and complementary or adjacent markets.

In closing, I would like to remind you that Sycamore does not comment on its financial guidance other than through public disclosures and we disclaim any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future results or otherwise.

I will now turn the call back to Bob for Q&A.

Bob Travis

Thanks Paul. We’ll now open the call out to questions. I would like to remind you that please keep to the limit of one question with one follow up. Suzie, with that, we would like to begin the Q&A session at this point.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Mr. Travis, there are no questions at this time. I will now turn the call back over to you, please proceed with your presentation or closing remarks.

Bob Travis

Great. Thank you, Suzie. Thank you all for us joining us today. We appreciate everybody’s time. The call will be – an audio reply on our website for 48 hours starting tomorrow. Thanks and have a great day.

Operator

Ladies and gentlemen, that does conclude the conference call for today.

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Source: Sycamore Networks, Inc. F2Q09 (Qtr End 01/24/09) Earnings Call Transcript
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