Thursday night, after the close, Occam Networks (OCNW) reported extraordinarily strong December quarter revenues and earnings.
In my previous article on Occam Networks, I suggested that the fourth quarter would be more or less a mirror image of the third quarter, meaning about $25 million in revenues and just around breakeven in earnings. Instead, the company reported $31.7 million in revenues and $.07 in earnings per share. The only fly in the ointment was the forecast for seemingly disappointing first quarter revenues of approximately $20 million. So, what gives here?
The answer is simple. Revenue recognition at Occam can be a bit of a lumpy affair. The company derives a significant portion of its revenues from contracts funded by the Rural Utilities Service (RUS). These contracts are accounted for on a completed contract basis, meaning that the recognition of both revenues and associated expenses are deferred until the contract is 100% complete, and then they are all recognized at once, leading to potentially large variations in quarterly revenue. The best way to look at Q4 results and Q1 guidance is probably to average the two together. Assuming that the current quarter is about $20 million, this means a two quarter total of $52 million, somewhat better than the $50 million that Jefferies analyst George Notter was predicting.
While the company’s forecast of $20 million or so in Q1 revenue is obviously plausible, I bet there is a good chance that actual results can come in substantially better. Why? Because the accounting for a significant portion of their revenue stream is done on a completed contract basis, short term revenues can be somewhat difficult to forecast. Just look at this quarter, where revenues came in more than 25% greater than the mid-point of guidance. Revenues can’t be recognized until the contract is completed, and even a small delay of a week or so can result in a very significant variation in revenues for the quarter.
In the past, the company has erred on the side of extreme conservatism, and I suspect they are doing so again. For example, in mid-October 2006, they suggested that revenues for the year (remember, they were more than 85% through the year at that point) would come in around $68 million. Actual revenues were more than $75 million. Giving me somewhat more confidence in this perspective is the fact that the company’s deferred revenue line built by $3 million sequentially. Essentially, in addition to recognizing $6 million more in revenues than anticipated, the company also shipped an additional $3 million of product for which it did not recognize revenues. This deferred revenue is a form of backlog that will be recognized in future quarters. Any way you slice it, it was a very very strong quarter.
While the company cited “some slowdown” in bookings as well as “additional order delays,” I am not particularly concerned. While it’s easy to blame the macro economy for such a “slowdown,” I wouldn’t be surprised if carriers were simply holding off in front of the stimulus program. After all, why deploy all-out now when you can wait 90 days and have the government foot the bill for up to 80% of your deployment? In either case, the stimulus bill was enacted into law just ten days ago. The carriers haven’t even had a chance to digest it. When they do, they will come out spending. There’s just no two ways about it.
So, the bottom line is that the company will do about $52 million in the December and March quarters combined, and this is somewhat better than analyst estimates. The real story is what lies ahead according to Joan Engebretson, writing in Telephony Online.
$2.5 billion in RUS stimulus has to be disbursed by September 30, 2009. If that’s true, then a whole lot of money is coming even quicker than I thought.
The company did not give guidance for 2009, and this neither surprises me nor disappoints me. Given all this going on, I think it would be near impossible to give accurate guidance. You have the deepest recession in nearly two generations offset by $6.5 billion of highly targeted stimulus. I know how it will turn out, but I can’t pinpoint the timing. My best guess is they will see the first trickle of stimulus business in Q2, but it may be Q3 before it kicks in strongly. Given the completed contract nature of the accounting, it may not show up in the income statement in a big way until Q4, but you can bet it’s coming and the stock market will anticipate it. In the mean time, there’s Fairpoint (FRP), which keeps getting bigger and better.
FAIRPOINT: NOW IT’S GPON AS WELL
In my previous article, I talked about the potential for the large Fairpoint contract to contribute as much as $40 million in revenues for 2009 and 2010. I also linked to Andrew’s Schmitt’s excellent analysis of this contract.
On their earnings conference call, the company announced that they had been chosen as well as the sole provider for Fairpoint’s GPON based fiber deployment. Make no mistake about it, this is a separate and incremental piece of business, entirely apart from and in addition to what Andrew analyzed.
Last year, this product was awarded Internet Telephony’s Product of the Year award.
That’s nice, but what really counts is whether customers are using your product and the answer here is clearly yes. The company began trial deployments of GPON products in only the second quarter and has thus far announced twenty-five customers. That’s a pretty good number compared to their total customer count of 300.
I am told that the Fairpoint GPON contract is worth in the range of $30 million over the next three years, starting sometime in the third quarter of this year. Just as with the initial Fairpoint contract, this will put Occam on the map for GPON. It’s an important and high profile win, and it was done in competition with a number of other providers. Occam has best in class technology for both fiber and copper deployments, and there is no doubt in my mind that they are gaining and will continue to gain share.
EXAMINING THE QUARTER
Other than the significant revenue beat, there are two aspects of the quarter that stand out.
First, as I noted earlier, deferred revenues increased by $3 million, which essentially means that the company shipped an additional $3 million worth of product, likely under a RUS contract, which it was not able to recognize in the quarter. In other words, actual product shipments were closer to $34.7 million. By way of comparison, the company shipped an average of $24.6 million of product in each of the prior two quarters.
Second, Fairpoint contributed only $2.3 million in revenue, which means that the base business was extraordinarily strong. As you can see below, the non-Fairpoint business has grown almost 50% since the first quarter.
click to enlarge
This is an important point, as while the Fairpoint contract is important because it’s large, the real gauge of how they are doing is their base business.
The company now has $2.20 per share in cash, $2.85 in book value and $3.27 per share in working capital. There is no debt. At the current price of $3.07, what’s not to like?
Adjusting for the lumpiness in revenue recognition, business is about 5% ahead of analyst estimates, and that’s before the stimulus plan kicks in.
In my previous article, I postulated some pretty significant revenue growth for Occam based upon the Fairpoint contract and the stimulus plan. I see no reason to back off those figures. If anything, the announcement of the Fairpoint GPON win makes those numbers a little bit easier to achieve.
Disclosure: long OCNW