Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Finisar Corp. (NASDAQ:FNSR)

F3Q09 Earnings Call

March 5, 2009 5:00 pm ET

Executives

Jerry Rawls – Chairman, President, and Chief Executive Officer

Stephen Workman – Chief Financial Officer, Senior Vice President of Finance

Eitan Gertel – Chief Executive Officer

Analysts

Paul Bonenfant – Morgan Keegan & Co.

John Harmon – Needham & Co.

Natarajan Subrahmanyan – Sanders Morris Harris Group

Daniel Morris – Oppenheimer & Co.

Ajit Pai – Thomas Weisel Partners

[Raul Canmulkin] – Jefferies & Company

Operator

Welcome to the Finisar third quarter financial results conference call. Jerry Rawls, President and Executive Chairman of the Board for Finisar, Eitan Gertel, Chief Executive Officer for Finisar, and Steve Workman, Chief Financial Officer, will be hosting this call. (Operator Instructions) Mr. Rawls, Mr. Gertel, and Mr. Workman, you may begin your conference.

Jerry Rawls

We appreciate you taking the time to tune in to our conference call today. A replay of this call should appear on our website within eight hours. An audio replay will be available for two weeks by calling 800-642-1687 for domestic or 706-645-9291 for international. Enter the ID #84169293.

I need to remind all of you that any forward-looking statements in today’s discussion are subject to risks and uncertainties, which are discussed at length in our most recent quarterly SEC filing. Actual events and results can differ materially from those forward-looking statements.

In our discussions of revenue today, we will breakdown our revenues between two business segments, optics and network test equipment. In addition, we will discuss our optics revenues in terms of distance and their applications with optical transceivers designed for short distance data center applications as LAN/SAN, and optics products designed for longer distance applications referred to as either metro telecom or analog and CATV.

We will also identify those products capable of transmission speeds greater than 10 gigabits per second, which has been and is expected to be the higher growth segment of this business over the long-term. You can see a summary breakdown of our revenues by going to the investor relations portion of our website and looking under financial information.

Now, turning to Finisar’s results for the third quarter of fiscal 2009, which ended on February 1st, we previously announced that revenues for the third quarter were going to be lower than we originally anticipated at about $137 million. The final total was $136.4 million. That is down $23.2 million or 14.5% from $159.5 million in the previous quarter.

However, it is still up $23.6 million or 20.9% from $112.7 million in the prior year due primarily to the merger with Optium. In fact, revenues from the traditional Finisar products were off only about 5% compared to the prior year.

The impact of the recession has been greatest in the Telecom Sector. For example, let’s compare our current results with the record setting revenue for both Finisar and Optium for the quarter ended July 2008 right before our merger. In that quarter, revenues for the combined company totaled $176 million.

In comparison, revenues of $136.4 million for the most recent quarter are down almost $40 million or 22.5% in just two quarters with revenues for telecom applications off 37% and IT enterprise based revenues off 17%.

Network test revenues decreased $10.3 million down $1.5 million or 12.6% from $11.8 million last quarter. But this was still up 5% from $9.8 million one year ago as customers continue to push the development of new products for 6gig SAS and SATA, 8gig Fiber Channel and 10gig Fiber Channel over Ethernet.

As usually, we had only one customer that represented more than 10% of total revenue in the third quarter. Our top three customers on a combined basis accounted for 30.1% of total revenues as compared to 29.9% last quarter.

While our top ten customers on a combined basis represented 59.9% of total revenues compared to 59.4% last quarter. While revenues for the top ten were down a little more than $10 million on a sequential basis, about half of the decrease came from just one telecom customer.

At this point, I’ll let Eitan provide a little more color on our optics revenues this last quarter. Eitan?

Eitan Gertel

Optics revenue of $126.1 million were down $21.6 million or about 15% from $147.7 million in the previous quarter, but were up $23.1 million or 22.5% from $103 million in the prior year, primarily due to the Optium merger.

Of the quarter-to-quarter decrease, $10.3 million or almost half was due to lower revenues for short distance LAN and SAN applications less than 10 gigabit per second. About $5 million was due to decrease in revenue from all 10 and 40 gigabits products and about $2.6 million was due to lower revenues from ROADM products, while the rest about $3.7 million was due to lower revenues from other products from metro, telecom and cable TV.

In fact, there were really only two bright spots in the quarter. Revenues from 10 gigabits Ethernet LAN applications and 4 gigabit SAN applications were actually up on a sequential basis. Here is the breakdown by markets.

LAN and SAN revenues totaled $53.4 million in the quarter down $10 million or 15.7% from $63.3 million last quarter, but down only $1.9 million or 3.5% from $55.3 million one year ago. Within LAN and SAN revenues for 10 gigabit applications increased slightly from $8.9 million last quarter to $9.2 million this quarter, while this was down about 7% from $9.9 million in prior year.

Revenues for less than 10 gigabit applications for this sector totaled $44.2 million in the quarter. That was down $10.3 million or about 19% from previous quarter. Metro and telecom revenues totaled $69.4 million this quarter down $11.6 million or 14.4% from $81 million last quarter, but up $33.5 million or 70% from prior year due to the Optium merger.

Of the $69.4 million, about $40 million was from the sale of products for 10 and 40 gigabits applications with another $6.2 million from the sale of ROADM products. The remainder was for application less than 10 gigabits per second. Of the $11.7 million sequential decrease, about $6.6 million was due to lower sales for 10 gigabits metro and telecom applications, while another $2.6 million was from lower sales of ROADM products.

Revenues from the sale of 10 and 40 gig products for all applications totaled $49.1 million, which was down $4.9 million or 9% from the $54 million in the previous quarter. Again, keep in mind that this compares to 10 and 40 gigabit revenue of just a little over $29 million one year ago. The increase of $20 million in revenues compared to the prior year for this high speed application was due entirely to the Optium merger.

Analog and CATV revenues of $3.3 million were about the same as last quarter, $3.4 million. Although I will point out that this is down 53% from revenues realized by Optium one year ago for this market application.

I’ll turn the call back to Jerry for some color about macro environment before we discuss our thoughts about the next couple quarters.

Jerry Rawls

As we think about the future, I put in my order for a new high tech crystal ball but it hasn’t arrived yet so I guess we’ll just have to make use of the old low tech one. First, the passage of the economic stimulus package promises to boost demand for fiber optics $7.2 billion has been set aside to expand this country’s broadband infrastructure.

That money is earmarked for expenditure by September 2010 and should benefit a broad ecosystem of companies tied to data storage, data warehousing and equipment for networking and telecom transport. Unfortunately, we don’t think that money jump starts demand until late this calendar year when you take into consideration the process and lead times involved for spending the money.

We have always felt that the data storage sector would hold up better than most other areas of our business during difficult economic times. Installed data storage capacity continues to grow at a phenomenal rate. Virtualization of that storage should save infrastructure and operating cost while promoting the use of additional fiber optic links needed to deploy this new technology.

But even that sector saw weakness this past quarter in the midst of a deer in headlights response by many IT departments as they seek to recalibrate their plans for investment this year. Thus our LAN/SAN revenues for the third quarter were down 16% from the prior quarter.

But we think many of these postponed IT projects will get started in the next couple of quarters as the underlying premise for making that investment is mostly unchanged. It’s no secret that the Telco carriers and the CATD MSOs, that is the multiple system operators, have cut their CapEx spending.

Even so, we believe the Telco’s and the MSOs have to continue to build out new fiber access networks to compete more effectively for next gen services business. Only 6% of all households worldwide are passed by fiber to the business or fiber to the home networks and most of these are in the Pacific realm.

With mobile operators offering broadband at speeds and prices equivalent to entry level ADSL subscriptions, Telco’s cannot procrastinate very long. After losing the voice market to mobile operators in the last few years, fixed line operators are not about to let the same thing happen with their broadband business, which has kept them afloat while voice revenues have declined.

While CapEx overall looks to be down year-over-year, we believe there will be increased emphasis on new services like Verizon Spyros and AT&T’s U-verse. AT&T also just announced plans to invest $1 billion under its global enterprise initiative in 2009.

AT&T’s initiative will feature various advanced services including virtual private networking, teleprescence and data center hosting. We think all this Telco activity ultimately spurs additional spending by the CADD operators who cannot sit idly by.

At least two dozen cable operators around the world are exploring, testing or building fiber to the premise systems or extensions. MSO is investigating fiber-based deployments in North America include Time Warner, Cox Communications, Bright House, Rogers and Cable One.

Wireless networks are also being upgraded in order to meet the bandwidth demands being created by a proliferation of mobile devices. Verizon Wireless has just announced that Erickson and Alcatel will be its primary network vendors for its long-term evolution or LTE network deployments in the US.

These two vendors are expected to build the underlying infrastructure that will enable Verizon Wireless to become the first wireless company to offer commercial LTE base service in the United States starting in 2010 and it’s based on 4G technology.

Cellular news just predicted that global mobile traffic will increase 66-fold between 2008 and 2013 with a compound growth rate of 131% to two Exabyte’s per month. What’s that? That’s two times ten to the eighteenth bits per month or two billion gigabytes per month. That’s serious data.

The growth will be a direct result of 4G services, which will enable consumers to view more mobile video and access a variety of mobile broadband services. We think the pressures are building to enhance the bandwidth capabilities of these networks even in these difficult economic times.

But the question we are challenged with upfront is when does this log jam start to breakup? Of course no one really has the answer to that. It’s a little like asking an economist when the recession’s going to come to an end. They can only answer after it’s happened.

While these are unprecedented times, history can provide us with some insights. If we go back to the tech bubble, that era that came to an end during the first calendar quarter of 2001, in two quarters our revenues fell by 47% and then began to increase once again shortly thereafter.

In fact, after that we grew 20% per year through fiscal 2008. The quarter ended July 2008 marked a record for both Optium and Finisar. Our combined revenues in that quarter on a pre-merger basis reached $176 million. Two quarters later, we’re down 22.5% from that high.

We think it takes at least two quarters before you can touch the bottom and any sort of correction. Given that the economic downturn didn’t become visible to us until the very end of our second quarter, which ended in October, we think the upcoming quarter ended April 30th probably marks the low point of this correction.

Of course, Finisar is also more highly diversified than it was back in 2001 and the industry supply chain carries less inventory than it did back then thanks to the proliferation of adjusting time inventory hubs at many customers. So in some ways we think that we’re better off this time around.

In contemplating revenue for the next couple of quarters, we consider many data sources including our customers forecast as well as our own order and backlog trends. While our customers have trouble forecasting in this environment, the one thing that we can do to help mitigate the affects of the economic downturn on Finisar is to work to get new products qualified and as many new customer platforms as possible.

I’ll let Eitan walk you through that part of our story, as well as our revenue outlook for the next couple of quarters. Eitan?

Eitan Gertel

As noted in our press release, we continue to make progress getting customers to qualify a number of our new products. Among those products qualifications this past quarter were 40 gigabit per second LAN/SAN transponders with three new customers, 40 gigabit per second client size transponders with four customers, XPAK-SR, X2-LRM and Xenpak-SR transceivers for short distance 10 gigabit per second Ethan connection with two customers, X2-LR and Xenpak-LR transceivers for long distance 10 gigabit Ethernet connection with one major customer, 50 gigahertz ADA channel WSS ROADM line card with one new customer, and also 50 GHz and 100 GHz WSS devices with four customers, pluggable, tunable 10 gigabit per second transponders with two customers and the new low cost 1310 nanometer product line for cable TV, which was qualified with one customer.

These product qualifications should normally translate into additional revenue within a quarter or so after being qualified. In the case of X2 and Xenpak transceivers, we have already started to see the flow of revenues from those new products.

At this point, we think our revenues for the upcoming fourth quarter ending April 30th will be down another 6% to 15%. This would put our revenues in the range of $115 to $128 million. Revenues from network tools are expected to decrease from about $10.3 million to approximately $9 million in the fourth quarter, while optics will range from $106 to $119 million as compared to a $126 million last quarter.

A large portion of the expected decrease in our optics revenue for the upcoming quarter is, again, due to revenues from LAN and SAN application as data rate below 10 gigabit per second. Revenues for all 10 gigabit per second applications are expected to be down only about 5% as demand for those products continue to be more robust than other than other parts of our business.

Finally, we expect revenues from short distance 10 gigabit per second Ethernet applications to actually increase in the upcoming quarter. We think current levels of demand for our products are being impacted by some customers reducing their inventory levels on top of a decline in their end user demand.

Those changes in demand tend to get amplified where we operate in the food chain. As that process runs its course, there should be a bounce back in demand. We think upcoming quarters mark the end of those inventory adjustments, which should put us in a position to see a return to a top line growth in the following quarter ending July ‘09. But like the economist, we’ll know for sure after it happens.

To understand what all of this means in terms of our profitability and cash flow, I’ll let Steve walk you through the P&L and balance sheet. Steve?

Stephen Workman

First turning to our results under non-GAAP, gross margins were 31.4% this quarter compared to 35.6% last quarter. Our original guidance here was for gross margins of 34% but that was on higher revenue levels. The decrease from the prior quarter was mostly related to manufacturing variances associated with lower production levels.

I would point out that most of the early synergies to be realized in the Optium merger are going to be visible at the operating expense level not in costs of goods sold. The synergies impacting COGS and gross profit will start to have an impact beginning in the first quarter ending July of 2009.

Operating expenses this quarter totaled $39.8 million down $4.2 million or 9.7% from $44 million last quarter. And it’s important to note that the prior quarter only included the impact of the Optium merger for two months, which probably benefited the prior quarter to the tune of about $3.4 million. So the real reduction on a full quarter basis was down more like $7.6 million or 16%.

Of the OpEx savings versus prior quarter, about $3.1 million of the total savings are in R&D, about $1.7 was in sales and marketing, about $2.9 million was in G&A. The $7.7 million of lower expenses is $31 million or so on an annualized basis. But the current quarter also benefited from the holiday shutdown at the end of December and a few other items.

So we can probably only lay claim to about $24 million in annualized savings as a result of cost reduction actions. And as an FYI, while some companies exclude litigation expense in their non-GAAP results, we do not as it affects cash and seems to be a recurring item, although I remain hopeful in that regard.

Our non-GAAP G&A expenses this past quarter included approximately $900,000 in litigation costs, which was up just slightly from the prior quarter. Combined with the lower gross profit and lower shipment levels, our non-GAAP operating income decreased to $3.1 million of 2.3% of revenues.

Net income on a non-GAAP basis was $2.3 million or breakeven on a per share basis. By the way, you’ll see the full impact of the Optium merger this quarter in terms of shares outstanding, which increased to about $475 million. Total depreciation and amortization was $7.9 million, which means that we still generated over $11 million of EBITDA.

While that’s down from $20 million last quarter, it was still in excess of our capital expenditure requirements, which also decreased to $5.1 million this past quarter. And we should see CapEx continue to decrease certainly over the next couple of quarters.

We excluded certain non-cash or non-recurring items from our non-GAAP results. In light of the continuing deterioration in the macroeconomic environment and a much lower market cap at the end of the quarter, we recognized a non-cash charge for the impairment of goodwill totaling $46.5 million. Goodwill on the balance sheet now stands at the end of January at just under $14 million.

Other items excluded from our non-GAAP results include a non-cash credit of $1 million for slow moving and obsolete inventory, a $4.1 million gain as the result of repurchasing $8 million in principal amount of our 2.5% convertible notes at a discount, $4.1 million in stock compensation expense, $2.5 million for an amortization of intangible assets related to prior acquisitions, and about $600,000 in reduction and forced cost.

So including these items under GAAP, gross margins remain unchanged compared to last quarter of 30.2%, and the loss was $47.4 million or $0.10 per share. A complete reconciliation between GAAP and non-GAAP is including in our earnings release and is also available on the investor relations portion of our website.

Our cash balance at the end of January represented by cash and short-term investments, as well as long-term debt securities, which can be readily converted into cash, totaled $35.3 million, that’s down from $51.9 million last quarter. The decrease of $16.6 million was primarily the result of a reduction in accounts payable totaling $23.7 million.

That’s in addition to using $4 million of our cash to buy back a portion of our convertible notes. With respect to decrease in accounts payable, one of the reasons for the large decrease was due to the fact that we merged our IT systems at the end of October. It turns out that there was a considerable portion of the IT balance from Optium that was already past due.

As a result, we probably paid out an extra $10 to $12 million during the past quarter. After doing so, our accounts payable days outstanding or DPOs was just under 34 days for last quarter. That’s down from 44.5 days at the end of the previous quarter. This 34-day level is where we would normally expect to operate going forward and we demonstrated that in the past.

In fact, DPOs, prior to the merger, ranged to 32.6 to 33.8 days over two quarters, and I would also point out that DPOs is just a proxy for paying our bills, as it represents the amount of accounts payable outstanding, as compared to total costs of goods sold and operating expenses on a non-GAAP basis, which includes labor and depreciation items, which have no impact, of course, on accounts payable.

Also in terms of cash, we paid out $5 million last quarter to the formal shareholders of K-Lite as required under the acquisition agreement with Optium, but that was also funded by a drawdown under the secured line of credit with Silicon Valley Bank totaling $5 million. DSOs for the quarter came in about 55 days up from 54 days last quarter.

Net inventories finally turned around this quarter decreasing by $4.8 million. It’s difficult to turn the supply chain shift following a change in direction, but we were finally able to do so toward the end of last quarter, and anticipate further inventory reductions in the upcoming quarter in getting inventories realigned with demand. This turnaround should also greatly help our cash flow in the future.

And with respect to our borrowing arrangements with Silicon Valley Bank, again we drew down $5 million under the secured credit line during the quarter to facilitate the K-Lite payment, but we have already paid that down since the end of the last quarter. So we currently don’t have anything drawn under that secured line of credit.

In addition, we have approximately $10 million available to borrow under other unsecured lines of credit with the bank. In response to general economic conditions, we have undertaken a number of additional cost reduction actions, and some of those are outlined in our earnings release, including a further reduction in U.S. personnel, suspension of the company’s 401(k) matching contribution, and a reduction of 10% in the salaries of officers, directors and employees in excess of $50,000.

I mentioned earlier that we have recognized about $24 million in annualized cost reductions through the end of last quarter. For the upcoming quarter, we should see OpEx decline by another $2 million or $8 million on an annualized basis.

Following that in Q1 and Q2 of next fiscal year, we should see the impact of additional cost reductions totaling $12 million on an annualized basis or about $3 million per quarter. Those savings should benefit gross profit as opposed to OpEx.

And total annualized savings at that point will have reached $44 million and we are already evaluating additional savings that will accrue as a result of a number of R&D projects that will enable us to manufacture certain components internally versus paying a higher price for those components in the merchant market.

If we translate all that to guidance for the next quarter, lower revenues for next quarter ending April 30th of $115 to $128 million are likely to mean gross margins will move down slightly to a range of 30% to 31% from last quarter.

In terms of OpEx, we expect spending to be down another $2 million due to the cost reductions recently announced, which would mean we would operate somewhere near the breakeven level in terms of operating income, and at a slight loss on a net income basis when you add the additional interest expense, which probably means an EPS loss of anywhere to $0.005 or it may round to $0.01 in that case.

I would point out that even at the lower levels of revenue being projected for the upcoming fourth quarter, with approximately $8 million in depreciation expense we will still generate $7 to $8 million of EBITDA, which is still in excess of our capital expenditure requirements. Those requirements should decline to the $4 million level or less. Combined with a further reduction in inventory means our cash position at the end of next quarter should be about flat or perhaps even increase next quarter.

We think it’s important to realize that at the end of the day we generate cash flow, at least as defined by EBITDA less CapEx. Based on the cost savings we have identified and the cost structure that should be in place by the end of the second quarter ending October of this year.

If we were just to get back to Q3 levels of revenue or about $136 million, it would mean that we would generate over $16 million of EBITDA as compared to the $11 million we generated last quarter in our results. That’s $64 million on an annualized basis which, in any normal credit market, should translate to some degree of debt capacity.

Admittedly the credit markets are challenging right now, but we don’t expect that’s going to, it’s going to remain that way for the next two years. In terms of our results going forward under GAAP, I would expect to incur additional non-cash or non-recurring charges of the type that we described earlier, which would normally be in the range of an additional $7 to $8 million. And that would, of course, exclude any additional impairment charges. Jerry?

Jerry Rawls

In the midst of an industry downturn, we are pushing hard to get new products developed and qualified. At the optical fiber conference, the most important trade show in our industry, which is just a couple of weeks from now, we will be demonstrating a new 120 gigabit parallel optic solution, and we’ll be delivering samples of that product to customers at about the same time.

In addition, we will demonstrate a new 100 gigabit Ethernet optical link, 16 gigabit Fiber Channel link, and a 43 gigabit DQPSK transponder for telecom applications. We continue to work very hard on all of these R&D projects for new products drives revenue for us.

And now with that, I’m going to turn this back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Harmon - Needham & Company.

John Harmon - Needham & Co.

A couple of questions, Steve, could you please talk about the debt situation. I know there’s certain information you can’t give in a public forum, but talk about the most likely scenario about how this plays out in your view and add whatever you can just to let us know the steps you’re taking to be in control of the situation rather than being driven by what the capital markets are doing.

Stephen Workman

Well, I’d like to lay out the roadmap in detail. I will just tell you that we have a number of alternatives, which we’re looking at to address the convertible debt market in both volatile and less volatile markets. And ultimately we’re going to make a decision that will try to balance all of the various constituencies here at the end of the day.

Again, I would repeat that we do generate EBITDA. We do have debt capacity and the size of that obviously depends to a certain degree on revenue levels, as well as our success in continuing to reduce costs. I don’t think I can be too much more specific at this point in time.

John Harmon - Needham & Co.

Earlier on you had expected to be up sequentially in terms of revenues in the April quarter mostly due to new design wins, and you talked about a couple new products that are shipping already. About how much revenue do you think you might be getting from new product wins in your fourth quarter?

Jerry Rawls

Less than what we expected.

John Harmon - Needham & Co.

And just finally, looking at your short reach SAN/LAN transceiver line, currently that this product category ought to be growing less fast than other products and probably has the highest degree of pricing pressure. Is in this type of product category EBITDA positive and what can you do over the remaining lifetime of these products to keep it that way?

Stephen Workman

I’m sorry. We’re talking about the 10gig?

John Harmon - Needham & Co

No. Short reach SAN/LAN transceivers. Are they profitable enough?

Stephen Workman

I think 10gig is very profitable. Then again that was the one area that was up on a sequential basis this past quarter and we look for that to be up again. And if you look at the market forecasts, of course, we all know those are wrong, but directionally speaking, if you look at the volumes for short distance 10gig, there’s a phenomenal amount of growth that is expected.

And perhaps that’s driven to some extent by Fiber Channel over Ethernet but, we don’t normally calculate EBITDA on a product line basis, but I can tell you that that is an extremely important part of our growth story going forward.

Operator

Your next question comes from Daniel Morris - Oppenheimer & Company.

Daniel Morris - Oppenheimer & Co.

When I look at your, I guess that this next quarter’s going to be the bottom, what I kind of read into that is that may be predicated on inventory reduction actions coming to a close. First, if you could provide a little more color on that, if that’s the case. And if there’s any metrics you could point to, in terms of we know where your inventories are, but how much do you think is in the channel still?

Jerry Rawls

I don’t know how we would estimate exactly what’s in the channel, but we have seen customers using up some of their inventory and we think we’re going to get to an end this quarter. But one of the things that we look at, obviously as our customer forecast and our customer forecasts are up for next quarter.

Our sales folks are forecasting an increase in sales for next quarter and importantly we have seen in recent weeks an increase in our order rate, and actually a pretty impressive increase in our order rate. So all of that indicates to us that maybe this thing is bottoming out and there really is an upward trend that we can expect from here. Now it’s too early to call this the end, but we have a number of optimistic signals for it in our business.

Daniel Morris - Oppenheimer & Co.

Just to follow up on that last comment about orders being up and, I guess, you’re referring to February. Could you talk a little bit about how the linearity of orders was during the January quarter?

Jerry Rawls

Well, we saw orders at a much diminished rate in December. They came back a little bit in January but have recovered quite nicely in February and even this week.

Daniel Morris - Oppenheimer & Co.

Then just switching gears a little bit, Steve, you had mentioned some optimism towards maybe litigation not being a recurring expense in the future. Do you have any update there on the litigation with Direct TV?

Stephen Workman

Only that the lawyers continue to bill us at a recurring rate. I don’t know. Jerry, do you want to comment on the status of litigation? I think some of these cases are on hold to some extent. I don’t know that we’re looking for those to necessarily come to an end next month.

Jerry Rawls

The Direct TV case is still very active. It has been remanded back to the federal district court in Beaumont and there will be a new hearing or a trial that will start in the fall of this year.

Daniel Morris - Oppenheimer & Co.

And should we expect any increased OpEx in that quarter then?

Jerry Rawls

Well, I would say probably. If it goes to trial and all the lawyers bring a team to town to fight the war and generally your expenses go up a little bit.

Operator

Your next question comes from Natarajan Subrahmanyan – Sanders Morris Harris Group.

Natarajan Subrahmanyan – Sanders Morris Harris Group

I have two questions, first is a detailed question. Steve, you had mentioned in this quarter the OpEx partly benefited from some unusual low expenses due to shutdowns and so on. And then you talked about a $2 million decrease in OpEx next quarter. So what should be the base of which that $2 million decrease will happen.

And then on the issue of inventories, I just wanted to understand clearly the revenue rates you were talking about imply some inventory consumption. Is it possible to try to quantify what the run rate of consumption would be if there was no inventory consumption.

And Jerry, finally, I wanted to clarify you mentioned orders having improved since the month of February. Given that your lead times are relatively short for a lot of products. I don’t understand why revenues in optical comps would be down as much if orders have started improving starting the first month of the quarter.

Stephen Workman

Well, to answer your question with regard to OpEx savings. So the $39.8 million for this past quarter in OpEx you should see that decline, even though there were some benefits in Q3. You should still see that decline to the $38 million level for the upcoming fourth quarter.

And as far as inventory, at this point, we think that there could be as much as $10 million additional reduction in inventory in the fourth quarter. Obviously, as the higher revenues are the easier that becomes, but it’s on the order of $10 million. Is there more to be gained after that, I think it gets a little bit harder. But for sure there’s certainly $10 million or so in the very near-term.

Natarajan Subrahmanyan – Sanders Morris Harris Group

My inventory question actually was more on the customer’s side. I was trying to figure out if you look at your revenue number and some of its depressed because you’re customers are consuming from inventory rather than buying from you, and I’m wondering if there was any way to quantify that. And also leading to the order question of, if you’re orders were strong starting the beginning of the quarter, why would optical comp revenues be down as much as you’re forecasting?

Jerry Rawls

I don’t know if we have a quantification of customer inventory. The customer inventories that we understand very well are in the datacom or enterprise sector where for the networking equipment companies, we maintain a vendor managed inventory for most all of the large customers. So we own the inventory. We know exactly what’s there. It is on a min-max basis. It doesn’t get out of control and generally it turns roughly 12 times a year, so it’s moving.

Inventory that is problematical tends to be on the telecom side where we don’t have that much visibility. We don’t know exactly what our customer has in inventory in terms of either of the components that we supply or in systems that they’ve built.

So it’s difficult for us to quantify there, and their success at burning it off depends a lot on their success in gaining new deployment wins. So I don’t know exactly how to quantify that one, but we’re working through that and historically those have taken a couple of quarters to get through for us.

With respect to our orders improvement, the issue for us is the reason we had to preannounce this last quarter was that our orders dropped off in December and January and we just didn’t have enough orders coming in to be able to meet the quarter. Now, as I said, orders have picked back up this quarter.

But we also said was we had a few weeks of orders picking up and what we got to have is 13 weeks of orders picking up. So we’ve got some part of the quarter ahead of us, and right now we’re trying to be conservative with our financial plans to make sure that we are continuing to operate profitably, that we are generating cash and we’re just not being Pollyannaish about predicting recovery here.

So if the current order rates continue through the quarter and, obviously I’m hopeful that they will, revenue line will be pretty good.

Operator

Your next question comes from Paul Bonenfant – Morgan Keegan.

Paul Bonenfant – Morgan Keegan & Co.

I’m wondering if pricing has become more irrational or less rational as the size of the pie that you’re competing for decreases speaking to the lower demand that you mentioned earlier.

Jerry Rawls

I think that our total price change for all our products on optics from quarter-to-quarter last quarter was just a shade over 3%. So that’s not abnormal for us. Now, is that number going to go up or down in the future? One might expect that pricing becomes more difficult, but I’m not ready to predict doom on that one.

For sure we will have some price declines at some customers. But on the other hand, a major part of our growth and our sort of a viability of our revenue stream comes from new products, and new products start out at relatively higher prices and they start out at rolled away higher margins too.

Paul Bonenfant – Morgan Keegan & Co.

I’m wondering also last quarter you spoke to what the Optium contribution would have been for a full quarter, I think that was around $41.5 million. Do you have a sense for what the Optium contribution was in the current quarter or the January quarter?

Stephen Workman

That was close to $30 million.

Paul Bonenfant – Morgan Keegan & Co.

Relative to your cost savings projections for Q1 and Q2, I think you said you would have an additional $3 million per quarter that would hit the COGS. I’m guessing that implicit in that we should assume gross margin would or could increase into fiscal year 2010.

Stephen workman

I think that’s right. Right now our internal projections would show a sequential increase in our gross profit as you go into the next fiscal year.

Paul Bonenfant – Morgan Keegan & Co.

And finally a housekeeping question. You may have mentioned it but did you have any 10% customers in the quarter?

Jerry Rawls

Yes. We had one.

Operator

Your next question comes from the line of Ajit Pai – Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

A couple of quick questions, the first one is just looking at what you said about the impressive sort of increase in [ADR] rates recently. Could you give us some color as to which markets you're actually seeing the increase from?

Jerry Rawls

We'll we've seen – it's actually across the board. We've seen some from the datacom side and some from the telecom side. It turns out that a lot of the strength in the telecom side, some of it's in Europe and some of it's in Asia. I couldn't point to too many really strong points in the U.S.

Ajit Pai – Thomas Weisel Partners

And then when you're looking at the quality of receivables that you have right now, have you watched any change in pattern of your customers in paying their bills recently?

Stephen Workman

There's a little bit of stretching going on and actually the last week of the quarter was basically shut down for Chinese New Year, so we actually had collections impacted in the last week of last quarter. But so far we have not run into too many problems here as far as ultimately getting paid. There's a little bit of, like I say, a little bit of stretching going on, but not too bad.

Ajit Pai – Thomas Weisel Partners

So the impact that they stretched it at the end of last quarter, did you watch those collections come in at the beginning of this quarter which means your cash flow, your receivables will actually look much better this quarter?

Stephen Workman

Those are looking a bit better. Like I say, like I mentioned also we paid down the $5 million draw down under the secured line of credit as well.

Ajit Pai – Thomas Weisel Partners

Right, but the collections that got stretched at the end of last quarter you're seeing that improve at the beginning of this quarter?

Stephen Workman

Yes.

Ajit Pai – Thomas Weisel Partners

Then when you're looking at the options right now that you have for your convert that's coming due I think in 2010, in this quarter you bought back some of the converts but I think it seems like slightly under $0.50 on the dollar. Does your credit facility with the Silicon Valley Bank and also now that you're starting to amortize [emulation] loan far more aggressively, I think it steps up from a quarter million to about a full million now per quarter, do you – are you permitted under that agreement to actually use the credit facility to buyback your converts?

Stephen Workman

Yes. There is not a restriction against doing that per se.

Ajit Pai – Thomas Weisel Partners

And so when you're looking at prioritizing your cash loads on a go forward basis, how would you prioritize it right now? What would be most important then second and then third?

Stephen Workman

I think it would be nice to see some stabilization here. We did nibble away at our converts on an opportunistic basis here in the last quarter. I don't know that – we would prefer to see the credit markets probably settle down a little bit and things stabilize before deciding what we're going to do.

Ajit Pai – Thomas Weisel Partners

Right. And then I think Jerry just talked about a 3% decline blended average in terms of pricing. When you look at the pattern for your new products, particularly 10 gigabits and faster, are you looking at the trends in terms of pricing declines? Are they following a similar pattern to prior new generation products or is the pricing environment for new products slightly better or slightly worse than in previous new introductions?

Jerry Rawls

I don't know that we see any difference. New products traditionally start out at a higher price initially and higher margins and as we ramp the volume of production the prices come down relative to the volumes that we're selling, but our costs come down because we're making larger volumes as well. And yes, the margins may come over time, may drift down a little bit, but I don't think we see anything any different today in the new product introduction and pricing or profitability than we've seen in the last year or the year before.

Ajit Pai – Thomas Weisel Partners

And then are any of your competitors acting irrationally in any way right now?

Jerry Rawls

Our competitors always act irrationally.

Ajit Pai – Thomas Weisel Partners

Right, but particularly on the, you know, any one or two of them might not be impacting overall market pricing, but are you watching some of them price far more aggressively than you think is healthy?

Jerry Rawls

Well, the most aggressive are always Chinese suppliers who are not qualified in most of the Western world equipment companies, but walk in and offer ridiculous prices and saying we'll supply you anything, Finisar will, at 20% less. But the problem is they're not qualified and when push comes to shove, they generally can't get qualified. So that's where most of the irrational behavior comes from.

Operator

Your next question comes from Bill Choi – Jefferies & Company.

[Raul Canmulkin] for Bill Choi – Jefferies & Company

This is [Raul Canmulkin] calling in for Bill Choi. My question actually is on 40G technology. Right now where do you see this technology being implemented by carriers? I mean is it implemented at the core of the networks or at the metro area, regionally? And secondly how do carriers go about choosing 40G versus 10G? So what kind of decision making is involved there I would like to know.

Jerry Rawls

Eitan, you want to take that one?

Eitan Gertel

We see 40G actually going in multiple areas. We've seen growth in our 40G client side and we see growth in our 40G line side, whether it's DPSK or DQPSK. In some customers they're very interested to see how well they go through our ROADMs and how many numbers of ROADMs they're going to go through just to demonstrate that basically a metro area, but with longer distances which can represent over 1,000 or 2,000 kilometers. Obviously the client side is a much shorter reach.

So how do they actually deploy it? Obviously the client side can connect between routers and the line side is either on the longer distances within the metro or actually long distance links used either in telecom or on backhaul of facilities and phone.

[Raul Canmulkin] – Jefferies & Company

So right, now what is the price difference between 10G and 40G and what factors beside price carriers to consider in deploying one technology over the other?

Eitan Gertel

Well, it depends on density and it depends on how many – how much data they can fit within one fiber. I mean it used to be years ago that in a 2001, 2002 area that there was a lot of dark fiber. The amount of dark fiber has reduced dramatically and now people try to see what is the most efficient way of transferring the most amount of information without burying new fiber in the ground.

So how do they make a decision is basically how much density do they have and what's the most efficient way of transporting the data and on the other hand if the question is the cost per bits on 10 gigabits and 40 gigabits is it equal or not? I think currently 40 gigabits is still higher cost than 10 gigabits, but we believe that in the next, near future, we should see improvement in that which should allow the 40 gigabits to actually grow much rapidly.

[Raul Canmulkin] – Jefferies & Company

So would you characterize 40G spending by carriers like now as sort of discretionary CapEx where 10G can be good enough for most carriers and they may not – they may want to postpone for this deployment, at least until the economy recovers?

Eitan Gertel

It depends on the carrier and depends what they do, whether they'll long haul or whether they try to integrate to more video which consumes a lot of bandwidth very quickly so it's on a carrier by carrier basis. It's different. I don't know if discretionary is the right word for it, but is it in the beginning? Yes, it id in the beginning and we expect it to be much more substantial part of the markets in the next year or so.

[Raul Canmulkin] – Jefferies & Company

Okay, and my final question is on your synergies, merger synergies, what part of Optium Products do you think you would be moving first to your local destinations? Or could you help us in visualizing the synergies that you are talking about?

Eitan Gertel

I mean we see a lot of what used to be Optium Products made in the West going into our location overseas. In fact the majority of our products will be in our location overseas, whether they're going to be manufactured in Malaysia facility or they're going to be manufactured in our Chinese facility. Either one of those facilities will get different type of product depending on core competency. But if you look at us on the long view you will see that the majority if not all our manufacturing is going to be in our two manufacturing facilities in Malaysia and in China.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing remarks.

Jerry Rawls

Thanks, [Holly], and thank you to everyone for tuning in today. I hope you can join us again next quarter so everybody have a good day.

Operator

Ladies and gentlemen, this does conclude our conference call. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Finisar Corp. F3Q09 (Qtr End 02/01/09) Earnings Call Transcript
This Transcript
All Transcripts