Oclaro Inc's CEO Discusses F3Q 2013 Earnings Results - Earnings Call Transcript

| About: Oclaro, Inc. (OCLR)

Oclaro, Inc (NASDAQ:OCLR)

F3Q 2013 Earnings Conference Call

May 7, 2013 4:30 PM ET

Executives

Jim Fanucchi – IR, Summit IR Group, Inc.

Alain Couder - Chairman and CEO

Jerry Turin - CFO

Analysts

Ameet Prabhu - RBC Capital Markets

Stanley Kovler - Morgan Stanley

Operator

Good afternoon and welcome to the Oclaro third-quarter fiscal year 2013 financial results conference call. As a reminder, this conference call is being recorded for replay purposes through May 14, 2013. At this time, I will turn the call over to Jim Fanucchi of the Summit IR Group. Please go ahead, sir.

Jim Fanucchi

Thank you, operator, and thanks to all of you for joining us. Our speakers today are Alain Couder, Chairman and CEO, and Jerry Turin, Chief Financial Officer of Oclaro.

Statements about management's future expectations, plans, or prospects of Oclaro and its business including statements about future financial targets and financial guidance, Oclaro's plans for future operations, together with the assumptions underlying these statements constitute forward-looking statements for the purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include, but are not limited to, statements concerning financial targets and expectations and progress toward our target business model including financial guidance for the fourth quarter ending June 29, 2013 regarding revenue, non-GAAP gross margin, and adjusted EBITDA, expectations related to the ongoing integration of Opnext into Oclaro following the closing of the merger on July 23, 2012 and our market position, economic conditions, product development, and future operating prospects in our ongoing customer relationships.

There are a number of important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements including the risk factors described in Oclaro's most recent annual report on Form 10-K, most recent quarterly report on Form 10-Q, recent Form 8-K's, and other documents we periodically file with the SEC.

The forward-looking statements discussed today represent Oclaro's views as of the date of this conference call and subsequent events and developments may cause Oclaro's views to change. Accordingly, actual results may differ materially from those indicated by these forward-looking statements. Oclaro does not intend and is not required to update any forward-looking statements as a result of future developments.

In addition, today we will be discussing non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. A table that outlines the reconciliation between the non-GAAP financial measures to GAAP financial measures is included in our earnings release which we have filed with the SEC and I refer investors to this release.

I would now like to turn the call over to Alain.

Alain Couder

Good afternoon. The results for March were within guidance but at the lower range. The optical competent sector has not yet seen a tangible upside from the positive news that we got from carriers on their capital spending that they announced in the recent two months. The enterprise datacenter is strengthening, according to some of our last customers (visits) but as I said, not the telecom side at this point in time.

This quarter I think we completed successfully the transfer in Japan from the earthquake-damaged building to a new earthquake-safe building and we are now back in full production. Therefore the disruptions that the team had, that is behind us. We started also to shift our first flight of products that we have been transferring from Shenzhen to Venture in Penang. So, significant results in the restructuring of the Company around those two points.

That's basically the summary of the quarter. Let me now turn to the customer and product momentum. At OFC we had a positive experience. Although the general industry sentiment was cautious, we received very positive feedback on our product direction and certain specific products on display, for instance the 100G line side, CFP, which is basically the 100G, pluggable, for the coherent network 100G, using our photonic integration capability we have been able to show a mockup on this 100G line side of CFP. The important thing about that is that we have two packages there; one that includes a DSP and one without the DSP and that expands our addressable market because, whether the customer owns their own DSP as a differentiation or whether they use a market DSP to integrate for them, we can sell it both. Basically, as a result of this photonic integration effort we can now address the total 100G market whether the customer owns or doesn't own their DSP.

Another example is the 10G tunable SFP-plus which is a follow-on product for the tunable XFP. It's a pluggable 10G, much smaller, and we have demonstrated the first working model in SFP-plus form factor while our competition was demonstrating with the slightly larger form factor. This is exactly the result of the strategic reasons for the merger between Oclaro and Opnext. This is a combination of the design of a pluggable module out of the Japanese team together with the tunable chip out of our UK team.

So, product and technology are the cornerstone and, as we will discuss, the confidence in the future of Oclaro. We have the same from our customers. I want to take this opportunity also to thank the customers for their support during these challenging market conditions. We had several customers who have really been helping us. Market conditions, as I mentioned before, the telecom market continues to be soft. The announcements like AT&T or China Mobile are promising but are not translating yet into anything significant business pickup.

The Datacom market is on the other hand is having good traction from some of our large customers and we see, with our new products coming out of our data communication team in Japan, some positive traction.

In terms of future growth, the key to our future growth over the upcoming quarters is really around 100G, whether it's on the Telecom side, on the line side, in Datacom, on Client side, that's where we have the deepest and broadest portfolio of products for these markets. Really, our deep expertise in photonic integration and small packages is really critical for what I would call the second generation of 100G.

I'm expecting the 100G market to be the same as the 10G market. This is a speed that is there to last for a long time and you have seen the 10G customers' action and shrinking of size going on for years. The same thing is going to happen with 100G. I think we are about to see the second generation of 100G products.

Let me give example of those active program with product in development, even some of them started shipping. At the component level we have the micro iTLA, which is in narrow line width laser for coherent modulation. We have the 100G modulator, now with lithium niobate and later on with indium phosphide. We have the next generation of uncooled and multi-chip pumps. At the module level, you have the QSFP+, that's 40GLR4; 100G CFP, second generation; 100G CFP2; 40G CFP. I'm not expecting you to know about all of those technical products but that's a lot of 100G products both at the component and the module level.

Also, at the substantive level we have what's needed to support the coherent network. Mostly based on 100G with the Raman amplifier and line card, some special gain blocks on those same networks, and some ROADM line card for those same networks. So, very nice momentum on these new, what I call, second generation of 100G products.

If we look ahead, as I started to mention last quarter, we are actively working on product-line divestiture opportunities and we are currently undergoing due diligence with several bidders. This will serve as the financing mechanism for implementing the corresponding changes. This will serve as catalyst for achieving the break-even objective by the end of upcoming fiscal 2014. This will simplify the Company and make it a lot easier to manage.

I cannot provide you with specifics at this time. However, we see the new form of financing that Jerry will discuss further as the validation of both the course we're on but also of the continuation activity undergoing a detailed planning to a restructure Oclaro toward a profitable Oclaro. We expect to act vigorously to establish a profitable business at the current revenue level as soon as we complete the sale of this product line. This will serve as a foundation for the deriving the long term value of our product and technology proposition that I described before.

So, in summary, Oclaro has the potential for significant long-term success. With the cash from the divestiture that I just discussed we'll rationalize the cost base to break even at current revenue levels. Second, we will be driving the top-line growth by focusing on these 100G catalysts. Even while we battle with short-term challenges, I'm very encouraged about the future of Oclaro.

Let me now hand the call over to Jerry for the financial details of the quarter. Thank you.

Jerry Turin

Thanks, Alain. Revenues for the quarter ended March 30, 2013 were $141.6 million, down from $159.5 million in the quarter ended December 29, 2012. Revenues were expected to be seasonally down in March. However, our revenues for the quarter were near the bottom end of our guidance range. As we exit March and enter the June quarter, we believe the overall demand environment for our product is softer than in the December quarter. This is particularly true in the Telecom market.

In general, our results were largely consistent with revenues coming in at the low end of expectations for the March quarter. Revenues in amps, filters, and optical switching were down $10.4 million quarter-on-quarter. Approximately $3 million of this decrease was due to selling our thin film filter and interleaver product lines in the previous quarter. Otherwise, the decrease was proportional across the remaining product areas in this category; amplifiers, tunable dispersion compensation, and wavelength select switching.

10G and lower transmission modules were down $5.5 million quarter-on-quarter. The decrease was generally proportional across the various products in this category. Other product categories were flat to slightly down quarter-on-quarter.

Non-GAAP gross margin for the quarter was 10% compared to 16% in the December quarter. Less revenue scale over our fixed costs, higher inventory reserves consistent with the lower demand forecast, and the impact of annual price reductions being weighted most heavily to the March quarter were all relevant factors in this quarter-on-quarter decline.

Adjustments from GAAP gross margin are detailed in the tables in our earnings release and include $545,000 of stock compensation and $800,000 of costs associated with the transition of our back-end assembly and test from Shenzhen to a contract manufacturer in Malaysia.

Non-GAAP R&D expense for the quarter was $25.2 million compared to $25.8 million in the December quarter. Non-GAAP SG&A was approximately $22.5 million compared to $22.9 million in the December quarter. Decreases in both categories were primarily due to favorable currency rates in certain countries as well as a continuation of cost reductions initiated partway through the prior quarter.

March SG&A also included the cost of our annual major trade shows for both communications and for our industrial and consumer markets. Stock comp included in R&D and SG&A were $431,000 and $810,000 respectively in the March quarter.

Our flood-related income was $11.6 million in the quarter reflecting the receipt of additional insurance proceeds of $12 million in March. While we continue to work on and expect further insurance proceeds and settlements, we cannot estimate the remaining amounts or timing at this time.

Our adjusted EBITDA for the quarter was negative $24 million compared to negative $13.2 million in the December quarter. The decrease was primarily due to lower revenues as well as other contributing factors described earlier in the gross margin area.

Our weighted average shares outstanding at the end of March were 90.3 million and we expect this to be approximately 92.6 million for the June quarter.

Moving on to the balance sheet; cash, cash equivalents, short-term investments, and restricted cash were $80.5 million at the end of March compared to $96 million at the end of December.

Short-term investments at the end of March include $3.9 million for an equity investment in a private company that we sold in April and so was reclassified to short term investments and out of other non-current assets as of the March quarter end.

Restricted cash at the end of March was $16.9 million versus $17.8 million at the end of December with the difference primarily due to changes in quarter-end yen translation rates.

Borrowings under our line of credit were $40 million at the end of March versus $40.7 million at the end of December.

Accounts receivable were $106 million at the end of the March quarter compared to $120 million at the end of December. Our DSO's were relatively consistent at 68 days for each quarter.

Inventories were $133.6 million compared to $151.3 million at the end of December. Approximately $10 million of the decrease was due to currency rate fluctuations quarter-on-quarter and E&O reserves.

Our CapEx for the quarter was $2.6 million compared to $4.6 million in the prior quarter. We plan to continue to manage CapEx tightly while demand continues soft. At this time, we expect CapEx to remain in the $2.5 million to $4.5 million range accordingly.

In regards to other cash flow items we expect interest and taxes to run in the $3 million per quarter range, capital leases in the $1.5 million per quarter range, and restructuring and related costs in the $2 million to $4 million per quarter range.

As mentioned earlier, as of the end of March we had drawn $40 million under a line of credit facility. In addition, earlier today we closed a bridge loan with Providence Equity for $25 million within the structure of that existing credit facility. The term of the loan is approximately one year. The loan was issued at an 8.5% discount. The loan and the corresponding amendment to the credit agreement required the expeditious conclusion of certain asset and product line sales that we have actively underway and the repayment of the corresponding borrowings under the credit agreement from the proceeds of those sales, with the opportunity to re-borrow up to $20 million of the existing line of credit under certain circumstances.

We issued 1.87 million warrants in connection with the financing. The warrants have a strike price $1.50 and a one-year life. Further details on the financing will be provided in our Form 10-Q, which will be filed in a couple days.

As Alain mentioned earlier, we remain focused on developing and implementing a plan for achieving a profitable operating model. Our recent results of operations would not be sustainable at these levels. We believe that sales of certain assets or product lines can be a catalyst for refining, and are necessary for the financing of, any corresponding plans.

During our prior-quarter earnings call we indicated that we were evaluating alternative approaches to such plans. We said we'd communicate specific actions on future calls or as otherwise appropriate as we execute those actions. While we don't have specific announcements on these asset sales fronts to make today, we do have the announcement of the bridge financing itself and we can say we are continuing to apply great focus on these efforts.

The results for the March quarter and our guidance for June emphasize the significant importance, from a liquidity point of view, of executing on these efforts and these plans.

Now, let me reiterate guidance for the quarter ended June 29, 2013. We expect revenues to be in the range of $132 million to $144 million, non-GAAP gross margin in the range of 9% to 13%, adjusted EBITDA in the range of negative $30 million to negative $17 million.

Operator, please open the line for questions.

Question-and-Answer Session

Operator

Yes, sir. We'll now begin the question and answer session. (Operator Instructions). Mark Su, RBC Capital Markets.

Ameet Prabhu - RBC Capital Markets

Thank you, this is Ameet Prabhu calling on behalf of Mark Su. I was wondering if you could provide additional color in terms of demand trends in geographies, any areas that you thought were particularly strong or weaker. How should we consider, reconcile that in terms of the demand ahead and take into consideration the guidance?

Alain Couder

I think in terms of demand by geography, there is not much change. I think we see a strengthening in North America by Verizon and AT&T but that doesn't translate into a massive uptick. Europe continues to be fairly weak and Japan as well. China is okay but the growth has been slowing there. So, overall in the Telecom side we don't see any overall pick up at this point in time. As I said, we have several customers which are on the Datacom or enterprise data center side are seeing some increased traction which is good news for our new products coming out of our Japanese team. That's basically where we are and I think the guidance is in line with these demand trends.

Ameet Prabhu - RBC Capital Markets

In terms of annual pricing declines. I maybe missed it but you said they were in line with expectations, sort of 5% to 10%, 10% to 15%. Sort of trying to get a sense of them.

Jerry Turin

We spoke to the expectations back in January that we would be closer to probably the 12% range in terms of 12% to 15% historical annual range. We probably came in there about.

Ameet Prabhu - RBC Capital Markets

Okay, great. One final quick thing. Any thoughts on the lead times in the industry and inventory levels? How would you characterize those?

Alain Couder

I'm not sure I understand the question on the inventories.

Ameet Prabhu - RBC Capital Markets

Just in terms of at S&M level or even lead times, would you say that lead times in the industry fairly consistent with the cycle trends? Have you seen the lengthening of cycles? Anything that you could to talk to us?

Alain Couder

I think we don't see any change in lead times or our relationship with customers on that. We have not seen any inventory buildup at this point in time but usually customers tell us at the very end so we cannot be sure of that either. Right now, no change around that topic.

Ameet Prabhu - RBC Capital Markets

Okay, great. Thank you.

Operator

(Operator Instructions). Stanley Kovler, Morgan Stanley.

Stanley Kovler - Morgan Stanley

Thanks, I'm calling in for Ehud Gelblum. I just wanted to start off with a question about the guidance. It looks like, if you take the mid-point of the guidance, for down $4 million approximately from where you wound up this quarter. Just curious, it seems like the environment in Telco is relatively weak but Datacom is stronger. What exactly is weakening into the following quarter to lead you down to another $4 million decline in revenue? If you can just parse that through, maybe, in somewhat greater detail. Is that the continuation of the decline in 10-gig or amps? Where is that weakness concentrated?

Jerry Turin

I don't know that it's concentrated in a product area. I think it's fairly consistent across Telecom, kind of similar to our results this quarter where you saw a little softness across the products. Our Communications business is about 85% of the business and the substantial majority of that is Telecom. Our Datacom is a relatively small percentage of that so we are fairly broadly exposed to Telecom and I don't know that it's specific within a 10-gig or a 40-gig or 100-gig sort of categorization, although 100-gig would be certainly more stable and stronger than 10 and 40.

Stanley Kovler - Morgan Stanley

Got it. In terms of just the trends in some of the growth of your products with (inaudible) and run on products, WSS; what's going on there in terms of the brand? Other competitors, I think, have also reported numbers in those categories that were pretty good despite the annual price declines. Where is the disconnect in terms of this being a growth area and maybe what some of the trends that you're seeing? Is it the end customer trends, share loss, dual sourcing, where can we find that difference?

Jerry Turin

Well, I think only one of our competitors has announced so far this quarter, I think we have a number of competitors announcing very late in the quarter. My visibility to that competitor is that, in the optical communications part of their business, they guided flat to down adjusting for one non-communications product that was part of the business. So, I don't that we see, at least from an announcement point of view, anything different from our peers thus far in terms of market conditions or product momentum.

Stanley Kovler - Morgan Stanley

Okay, understood. When you think about -- you mentioned that customers were helping you. You specifically called out several customers that were helping you through this process, difficult quarter. What about the supply chain and is it going to come to a point where some of these customers or supply chain partners are now part of the credit facilities that you're getting or helping you in terms of the financing but in a different way? We're not really seeing that in terms of the DSO or DPO movements in a major way so I'm just wondering if we can get some more color on that.

Jerry Turin

I'm not sure. I think I kind of lost the train of your question. It sounded like you were asking whether customers or suppliers played a direct role in the credit facility. Did I have that question?

Stanley Kovler - Morgan Stanley

Not yet. No, not yet, but you said they're helping you. So, that could affect, at least from what we can see, our visibility is only to DSO and DPO. In the future, if you need more credit or credit facilities available to you more from financial institutions or are you getting to the point where maybe customers and suppliers are going to help you in that regard as well?

Alain Couder

I think what I was trying to say is that I think we have a very close discussion and relationship with our customers both on current products and future products. But, we do not disclose anything which is customer-specific on that topic.

Stanley Kovler - Morgan Stanley

Okay, understood. Then just in terms of housekeeping, did you have any 10% customers this quarter? Who were they?

Jerry Turin

Shame on us. I actually have that at my fingertips. Jim, you wouldn't happen to have --

Jim Fanucchi

I don't have it.

Jerry Turin

We'll follow up with individual analysts on that. But, there should have been no substantial change in our general mix of customers or what we would have expected quarter-on-quarter from the folks that tend to be in the low or 10% area.

Stanley Kovler - Morgan Stanley

Okay, that's helpful. Thank you.

Operator

Mr. Fanucchi, I show that we have no further questions in the queue. I'd like to turn it back to you.

Jim Fanucchi

Alright, operator. Thank you and thanks to everyone for joining us today. We look forward to speaking with you again when we report our financial results for the June quarter, Thank you and have a good day.

Operator

Ladies and gentlemen, this concludes the conference call. We would like to thank you for your participation and you may now disconnect.

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