Opnext, Inc. F2Q09 (Qtr End 3/31/09) Earnings Call Transcript

May.19.09 | About: Opnext, Inc. (OPXT)

Opnext, Inc. (NASDAQ:OPXT)

F4Q09 Earnings Call

May 19, 2009 9:00 am ET

Executives

Doug Dean – Vice President, Investor Relations

Gilles Bouchard – President, Chief Executive Officer

Robert Nobile – Chief Financial Officer

Analysts

Paul Bonenfant – Morgan, Keegan

Ehud Gelblum – J.P. Morgan

Ajit Pai – Thomas Weisel Partners

Todd Koffman – Raymond James

Operator

I would like to welcome everyone to the Opnext fourth quarter earnings conference call. (Operator Instructions) Mr. Dean, you may begin your conference.

Mr. Dean

Good morning and thank you for joining us today. I'm Doug Dean, the Vice President of Investor Relations for Opnext. Today we'll discuss our financial results for the fourth quarter ended March 31, 2009 and provide some commentary regarding market conditions and business outlook.

We'll begin with remarks from Gilles Bouchard, President and Chief Executive Officer of Opnext along with Bob Nobile, our Chief Financial Officer and then we'll take your questions.

As always in our prepared remarks, and our responses to your questions, we will rely on the Safe Harbor exemptions under the rules and regulations of the Securities Act, our Safe Harbor Statements and the company's filings with the SEC. And now let me introduce Gilles Bouchard.

Gilles Bouchard

Good morning everyone. I'd like to start by saying that this was a particularly tough quarter. Much has been expected. We continue to see deteriorating demand from our customers in part due to the efforts to manage inventory levels in a difficult economic environment. We were also confronted with the continuing effects of a weaker dollar relative to the Yen without significant hedging benefits realized in the December quarter.

In addition, we were impacted by pricing pressure in part due to year end contract negotiations, unfertile product mix and lower optical chip that have since been remedied. We also discontinued an early generation 10G fiber product line, resulting in a $4.4 million charge that impacted both our GAAP and non-GAAP results.

And finally, we incurred almost $100 million of non-GAAP items related to the StrataLight acquisition. Bob will provide more details of the various charges and costs in his remarks.

Revenues for the March quarter were $83.6 million, an increase of 19% from the December quarter, and an increase of 15% from the March 2008 quarter. The revenue increase from last quarter included $37 million revenues attributable to StrataLight partially offset by decreasing revenue across all of our major product lines with the exception of XFP products which were essentially unchanged.

Earnings on a GAAP basis were negative $1.39 per diluted share, reflecting the various charges and costs that I just mentioned. On a non-GAAP basis earnings were negative $0.22 per share including a $0.05 negative impact from our decision to discontinue the early generation multimode fiber products.

Despite the tough earnings quarter, there were several bright spots. The introduction of StrataLight into the Opnext family is proceeding very well and StrataLight contributed very nicely to this quarter's results.

We also began to realize the positive impact from several of our cost reduction initiatives. While cost reduction efforts started to materialize as we were able to reduce inventory levels even as sales declines and we have a very healthy funnel of sales opportunities.

Now, let me turn it over to Bob to review the details of our fourth quarter performance.

Robert Nobile

Good morning everyone. As Gilles just mentioned, for the quarter ended March 31, 2009 we generated sales of $83.6 million representing an increase of $13.1 million or about 19% as compared to the previous quarter.

Sales for the quarter included $27.8 million from the acquisition of StrataLight communications that we completed on January 9, 2009. Sales of our 40G products increased $34.6 million to $39.7 million due to StrataLight, while sales of our 10G and below products decreased about 31% to $41.2 million and Industrial and Commercial product sales decreased 50% to $2.27 million.

The decline in sales of 10G and below products occurred in most major product categories with the exception of XFP product sales that were flat as compared to the previous quarter. Compared to the quarter ended March 31, 2008, our sales increased $10.9 million or 15% from $72.7 million. Sales of 40G products increased $29.9 million while 10G and below products decreased $17.3 million or 29.6% and sales of Industrial and Commercial products decreased $1.7 million or 38.6%.

For the quarter ended March 31, 2009 sales to Alcatel-Lucent, Cisco and Nokia Siemens Network, or NSN represented approximately 68% of total sales as compared to about 63% in the previous quarter, giving pro forma effect to the acquisition of StrataLight. Sales declines with Alcatel-Lucent and Cisco were offset by increased sales to NSN during the March quarter.

Starting with the March quarter, we have changed our communications sales reporting from the categories of 10G and above and less than 10G to 40G and above and 10G and below. Also, we will no longer provide individual customer revenue percentages due to customer sensitivity.

Geographically, revenues in North America represented 34% of our total sales while Europe represented 47%, Japan 8% and the rest of Asia was approximately 11%. In increase in Europe sales this quarter was associated with the increased sales to NSN as a result of the StrataLight acquisition.

Gross margin was 8.7% as compared to 22.1% for the quarter ended December 31, 2008 and includes a 460 basis point negative effect from non cash charges and costs associated with the acquisition of StrataLight.

Excluding these effects, as well as the impact from stock based compensation expense, non-GAAP gross margin was 13.5% as compared to 22.3% for the quarter ended December 31, 2008 including the 530 basis point negative effect from our decision to discontinue early generation multimode fiber products as well as unfavorable optical chip and TOSA yields neither of which we expect to re-occur. Also, average selling prices were slightly worse than expected.

Research and Development expenses increased $11.4 million to $22 million from $10.6 million in the quarter ended December 31, 2008 including $3.8 million of non cash charges and costs associated with the acquisition of StrataLight. Excluding these items as well as the impacts from stock based compensation expense, non-GAAP Research and Development expenses were $18.1 million or 21.6% of sales. The $7.8 million increase from the prior quarter primarily results from the acquisition of StrataLight as well as higher R&D related material and outsourcing costs.

Selling, general and administrative expenses increased $6 million to $20.8 million from $14.8 million in the quarter ended December 31, 2008 including $8 million of non cash charges and costs associated with the acquisition of StrataLight. Excluding these items as well as the impact from stock based compensation expense and class action related litigation expenses, non-GAAP selling, general and administrative expenses were $11.7 million or 14% of current quarter sales as compared to $13.1 million or 11.6% for the prior quarter ended December 31, 2008.

The $1.4 million decrease from the prior quarter primarily results from the reversal of bonus and bad debt accruals reported earlier in the current year, partially offset by the additional costs resulting from the acquisition of StrataLight. Excluding the reserve reversal effects, non-GAAP SG&A expenses would have approximated 16% of current quarter sales.

While we will not realize the benefit from accrual reversals during the June quarter, we will realize some benefit from cost reductions.

Operating loss for the current quarter was $118.9 million and included $98.8 million on non-GAAP expenses associated with the acquisition of StrataLight. Included in the $98.8 million are non recurring charges of $62 million to write of 100% of the acquisition related goodwill and $1`5.7 million to write off 100% of the acquisition related in process research and development costs.

In connection with the StrataLight employee liquidity bonus plan, approximately 16% of the total consideration will be distributed to the participants through January 31, 2010. Approximately $11 million of these costs are included in the current quarter.

We also incurred $6.9 million in amortization charges for purchased intangibles and costs of sales includes $1.8 million of expense resulting from the excess of historical cost over fair value of inventory acquired from StrataLight on January 9 and sold as of March 31.

During the past quarter, we incurred $1 million in restructuring costs including dormant facility and severance related charges and we incurred approximately $0.5 million of miscellaneous business integration related costs.

Excluding the $98.8 million of StrataLight acquisition related items as well as stock based compensation and class action related litigation expenses, non-GAAP operating loss was $18.5 million for the quarter including $3.56 million from unfavorable foreign currency exchange fluctuations.

From the December quarter, the average Yen rate decreased from about 96 to 94 Yen. However, the 11 Yen benefit realized from the December hedge program did not re-occur. For the June quarter, we have hedged about 60% of our exposure at 99 Yen to the dollar.

Net loss was $118.8 million or negative $1.39 per diluted share as compared to a net loss of $14.5 million or a negative $0.23 per diluted share for the quarter ended December 31, 2008.

Non-GAAP net loss for the quarter ended March 31, 2009 which excludes non cash charges and costs associated with the acquisition of StrataLight and stock based compensation and class action related expenses, was $18.5 million or negative $0.22 per diluted share including the $0.05 negative effect from our decision to discontinue the early generation multimode fiber products.

Cash and cash equivalents decreased by $37.1 million to $168.9 million at March 31, 2009 as compared to $206 million at December 31, 2008 primarily as a result of $26.2 million used in connection with the acquisition of StrataLight.

Cash used in operations was $13.1 million while working capital improved by $8.8 million primarily from our ability to reduce 10G module inventory levels even while sales declined.

During the quarter, short term debt increased $6.6 million while $2.6 million was used to pay capital lease obligations and $1.7 million was used primarily to upgrade equipment in our factories.

And now let me turn it back to Gilles to discuss our operation plans, current view of market conditions and guidance.

Gilles Bouchard

Let me start by saying that we have put together an aggressive plan that we believe will provide break even cash flow from operations at a revenue level of $95 million assuming an exchange rate of 100 Yen to the dollar.

Let me share with you the four key elements of our plan. First, fixed cost reductions. The actions announced on April 1 were designed to reduce the fixed cost structure of the company and expected to provide $25 million in annualized benefits. We started to realize some of these savings during the March quarter and they will continue to ramp during the first half of our fiscal year.

Second, variable cost reductions. We are also working to reduce our variable costs with a goal of outpacing price reductions. On this front, key actions include consolidating suppliers and centralizing our negotiation efforts, improving terms with our key suppliers including VMR arrangements, expanding double forcing of critical parts and improving processes and shortening cycle times. These efforts will also help us improve our investor returns.

Third, accelerate design wins. Our customers are more focused than ever on stable suppliers like Opnext. We believe we offer our customers a compelling value proposition. First of all, we are the partner of choice for leading edge technologies like 40G and 30G. We also provide the capability to ramp up in volume, quality and lower cost as this technology emerges thanks to our technology and manufacturing, heritage of Japanese quality and experience in the actual costs and volumes, and a financial strength to build a future supply and investments.

We believe Opnext has a unique competitive advantage by offering customers all three elements. For example, in our 40G business, we are currently qualified in 23 product slots across 16 customer and we have over 50 additional opportunities at various stages with 28 customers.

The first element of our plan is to continue to invest in leading edge technologies and products. We intend to maintain our unique plan at a rate of $16 million to $18 million per quarter. In this context, we are pleased to already see strong interest in our 100G development both clients and onsite.

And now, I'd like to conclude our prepared remarks by addressing our revenue outlook. We expect our June quarter to reflect continued market softness. While we see down in 10G sales as the effects from in country adjustments taper off, we also anticipate that 40G sales will return to more normalized levels after a slightening demand in the March quarter following the major product transition.

With that in mind, we expect revenues to be $80 million to $90 million for our first fiscal quarter ending June 30, 2009.

And with that, I'll now turn it back to Doug to begin the Q&A portion of our call.

Doug Dean

That completes our prepared remarks. Now we'll be glad to take your questions. The operator will now provide instructions on how to submit your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Bonenfant – Morgan, Keegan.

Paul Bonenfant – Morgan, Keegan

I think you said that at a run rate of $95 million and a 100 Yen exchange rate, you would be break even. Was that on a free cash flow or an operating cash flow basis?

Robert Nobile

Cash flow from operations.

Paul Bonenfant – Morgan, Keegan

Did you mention your 10% customers in the quarter on an individual basis?

Robert Nobile

No we did not. As I indicated, there's been some customer sensitivity related to that, so going forward, we will just aggregate the sum of our three major customers

Paul Bonenfant – Morgan, Keegan

Some competitors have suggested that the market bottomed in the first calendar quarter or the March quarter, yet you're citing continued market softness. Is this customer specific? Is it related to inventory adjustments versus improving your end user demand? Do you have a sense for the puts and takes here?

Gilles Bouchard

I think what we're seeing is the March quarter was very tough because you had a combination of lowering demand and some major inventory adjustments in the supply chain. What we're seeing right now is the supply chain effects are tapering off so from a demand point of view we're seeing some uptick, but we believe that is mostly due to supply chain effects and we're not sure yet that the actual end demand has changed all that much. So those are the assumptions that are built into our plan.

Paul Bonenfant – Morgan, Keegan

Regarding the margin trends, it seems there was a lot of one time items this quarter. I know you're not giving EPS guidance, but can we assume that we'll see some margin improvement in particular in gross margin in June and throughout the rest of the calendar year?

Robert Nobile

The point I made in the specific comments was that we don't expect the negative impacts from yield as well as from the discontinued products to re-occur.

Paul Bonenfant – Morgan, Keegan

So that would bring you back to these mid to low 20's in terms of gross margin.

Robert Nobile

Yes. If you do the math on those percentages, correct.

Operator

Your next question comes from Ehud Gelblum – J.P. Morgan.

Ehud Gelblum – J.P. Morgan

In your guidance of $80 million to $90 million revenue for next quarter, are you assuming StrataLight is roughly the same as it is this quarter or up or down?

Gilles Bouchard

It will be down. As I mentioned, in the last quarter there was a spike in demand following a low quarter in the December quarter. So I think to look at the forward-looking real demand for the StrataLight products, you almost have to average out the last two quarters which will bring you to a $30 million plus or minus revenue looking forward.

Ehud Gelblum – J.P. Morgan

So in that case that's around $30 million, so we'll get a $50 million to $60 million for Opnext proper.

Gilles Bouchard

Now remember the StrataLight business is also quite lumpy in the lifetime business, so there will quarterly variations in any case.

Ehud Gelblum – J.P. Morgan

Okay, but we should still be looking for roughly $30 million next quarter?

Gilles Bouchard

Yes. That's about the average of natural demand for this business.

Ehud Gelblum – J.P. Morgan

I hear that you're not putting out numbers on consumers anymore individually but all three are still 10% customers, is that correct?

Gilles Bouchard

Definitely.

Ehud Gelblum – J.P. Morgan

And since this was actually your fiscal fourth quarter, in the 10-K should we actually see a breakdown by customers for the year?

Robert Nobile

Not necessarily indicating a specific customer.

Ehud Gelblum – J.P. Morgan

So you're not under obligation to report them for the year individually.

Robert Nobile

We're not specifically required to name names.

Ehud Gelblum – J.P. Morgan

But will you actually have numbers even if you don't have names attached to customers?

Robert Nobile

You'll see on our 10-K.

Ehud Gelblum – J.P. Morgan

What I'm getting at, it just sounds like we'll get the information one way or the other. The gross margin for StrataLight could have parsed out StrataLight separately. StrataLight is clearly inclusive to gross margin. Can you give us a sense of what StrataLight's gross margin was this quarter?

Robert Nobile

We're not going to break out the margins on our specific business.

Ehud Gelblum – J.P. Morgan

Is it true that historically before you purchased them they were in low to mid 30's margin?

Robert Nobile

That's correct.

Ehud Gelblum – J.P. Morgan

Is there any reason for us to believe that especially since they had a relatively strong quarter that they were in the mid 30's?

Robert Nobile

We're not going to give specific percentages. But there are trends you should anticipate will have continued and there will also be volume softness.

Ehud Gelblum – J.P. Morgan

So volume can only help those margins in any case.

Robert Nobile

Taken from their business, the majority of their new products are manufactured outside of their internal factories so there is a trend in the StrataLight business where the amount of fixed cost is deteriorating as a percentage of the total as they've transitioned to the new product line.

Ehud Gelblum – J.P. Morgan

So you're saying it's not that much of an uplift.

Robert Nobile

That's correct.

Ehud Gelblum – J.P. Morgan

But there's no reason they should have a downdraft. So should we assume stable gross margins or in the ball park.

Robert Nobile

That's your assumption.

Ehud Gelblum – J.P. Morgan

You didn't break out 40G versus 10G, or did you break that out?

Robert Nobile

40G revenue for the quarter was $39.7 million.

Ehud Gelblum – J.P. Morgan

But that includes StrataLight, right?

Robert Nobile

Correct.

Ehud Gelblum – J.P. Morgan

Is StrataLight entirely 40G?

Robert Nobile

The majority of it is.

Ehud Gelblum – J.P. Morgan

So if we take out StrataLight, then we [inaudible].

Robert Nobile

Your have a solid understanding of the situation.

Ehud Gelblum – J.P. Morgan

I&I moved down relatively significantly. Is there a driver there?

Gilles Bouchard

I&I was down by 50%. In fact it was our most impacted business. If you look at which segment they play, they play into automotive, construction, Japan manufacturing, so they are playing into depressed markets right now so henceforth the 50% reduction in business.

Ehud Gelblum – J.P. Morgan

And in your guidance you're not specifically saying they'll stay at the new level?

Gilles Bouchard

Our assumptions for them is they will stay pretty low for one to two quarters and then we'll see some uptick because they're getting into some new markets, the financial markets in particular and we also expect some inventory effects to help them in some traditional markets.

Ehud Gelblum – J.P. Morgan

Is the write down on the multi, what was that? What comprised that and why was that decision made?

Robert Nobile

These were products that we talked about in the past that were a drag on our historical margins. During the later part of the quarter, there were also some additional technical issues that came up with those products and we then looked forward to the future with them and decided to discontinue them.

Ehud Gelblum – J.P. Morgan

And those are products that used to be in, how large were they in the prior quarter?

Robert Nobile

We're not going to give our specifics here, but they were part of our 10G business.

Operator

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

Ajit Pai – Thomas Weisel Partners

You mentioned pricing negotiations this quarter. Could you give us some color in terms of how much you are seeing on average in the quarter and which product areas were most impacted?

Gilles Bouchard

The reason why we mentioned this is for many customers in Europe, our pricing is negotiated on a yearly basis, and those contracts take effect on January 1. Obviously you see a major impact in the first quarter of the year so that's across the board with all our electronic customers, and as you noticed a lot of the mix moved more towards telecom so that effect was amplified because of the mix change as well.

Ajit Pai – Thomas Weisel Partners

In terms of year over year change in pricing compared to last years renegotiation, was it different? Was it the same, were the price declines steeper, lower, how should I think about that.

Gilles Bouchard

In general, we assume a roughly 15% year over year decline in pricing. As of this year, that trends is probably up by a couple of percent depending on markets and segments and products. But there will definitely be more pressure across the market on pricing.

Ajit Pai – Thomas Weisel Partners

In terms of your planned cost reduction of $25 million, it looks like you are planning to keep R&D spending roughly flat or maybe down $1 million or so. How should we think about how is the rest of the $25 million going to be allocated between the cost of revenue and SG&A?

Gilles Bouchard

It's mostly in the operating expenses actually. Bob can give you more detail on this.

Robert Nobile

You should look at it almost as an 80/20 split or 85/15 split between cost of goods and operating expenses and note that we've already realized some of those benefits in the quarter ended this past March with most of it going to materialized in the June quarter and then the later part of it kind of in the second quarter and beyond.

Ajit Pai – Thomas Weisel Partners

In terms of the current quarter, you have about $1.8 million of reversals in the SG&A right?

Robert Nobile

Yes, that's correct.

Ajit Pai – Thomas Weisel Partners

I wanted to clarify about the 10G product number in the quarter.

Robert Nobile

We're disclosing the 10G and below number which for the quarter was $41.2 million.

Operator

Your next question comes from Todd Koffman – Raymond James.

Todd Koffman – Raymond James

On your customer breakout, since it's your year end and you have a couple of former large customers and there seems to be some pretty dramatic changes in business with one of those customers, without naming names, can you give the percentage that those top three customers individually contributed for this quarter and the year?

Robert Nobile

As we indicated earlier, we're not going to give out the individual percentages of the customers. Our requirements for our 10-K is that indicate which customers by name are in excess of 10% which we've already done, you know the three names, and what the aggregate percentages of those customers were.

Todd Koffman – Raymond James

The reason for even keeping the names confidential but not willing to share the percentages is what?

Robert Nobile

First off, we haven't kept the names confidential. There are three customers; Alcatel-Lucent, Cisco and Nokia Siemens Networks. In the aggregate the three of those customers represented 69% of our revenues in this past quarter. That is the amount of disclosure that's necessary for our 10-K and if we were to discuss it individually, as I said earlier, we've had some sensitivity from the specific customers and we're not going to disclose the individual amounts going forward.

Todd Koffman – Raymond James

Unrelated to the customers that you didn't want to share, the reasoning behind your unwillingness to be more transparent with your results is what? Are you feeling like you would lose the competitive advantage to your performance or is there something I'm not appreciating as it relates to your unwillingness.

Gilles Bouchard

It's much more simple than that. It's that our customers are sensitive to the fact that we disclosed our detailed variation of business with them and sometimes feel like this is more about their business than our so that we want to get away from this. It's that simple. That's what it is.

Todd Koffman – Raymond James

Beyond the customer, there were a number of other questions, the margins with StrataLight that you just didn't want to report and I'm just wondering why is the reporting nature seeming to be increasingly more difficult to figure out what's going on in the business?

Robert Nobile

It's not that it's more difficult for us to figure out, but going forward as we integrate these two businesses, the historical percentages of margins in StrataLight versus what OpEx has traditionally done, will become less and less meaningful as the benefits of utilizing traditionally OpEx parts within StrataLight become more apparent and as we continue to integrate our supply chain as well as our manufacturing operation.

Todd Koffman – Raymond James

You said in your prepared remarks you were going to be changing your reporting structure and I couldn't pick up exactly the new reporting segments will be. Could you just repeat that?

Robert Nobile

In the past, we disclosed 10G and above revenues because at that point in time, our 40G business was a small portion of the total. However, with the acquisition of StrataLight, 40G revenues are now a very significant part of our total. So we will break those out separately.

Likewise, our less than 10G communications business has now become a very small part of our total. So we will combine that with our 10G business and report a number for communications of 10G and below.

Operator

At this time there are no further questions. Mr. Dean are there any closing remarks?

Doug Dean

That concludes our investor call for today. Thank you for joining us this morning. Operator, if you could please provide the replay instructions one more time.

Operator

This call will be available for replay beginning at 11:30 EST today through May 26, 11:59 pm. The conference ID for the replay is 98773238. The number to dial for the replay is 800-642-1687 or 706-645-9291.

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