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Executives

Bob Travis - Director, Investor and Industry Analyst Relations

Dan Smith - President and CEO

Paul Brauneis - Chief Financial Officer

Analysts

Subu Subrahmanyan – Sanders Morris

Sycamore Networks Inc. (OTCPK:SCMR) F4Q09 Earnings Call September 14, 2009 8:30 AM ET

Operator

(Operator Instructions) Welcome to the Sycamore Networks Fourth Quarter 2009 financial results conference call. I would now like to turn the conference over to Bob Travis, Director, Investor and Industry Analyst Relations.

Bob Travis

Good morning everyone and thanks for joining Sycamore's Fourth Quarter Fiscal Year 2009 Earnings Call. The speakers on today's call are Dan Smith, Sycamore's President and CEO and Paul Brauneis, our Chief Financial Officer. As a reminder, today's press release was distributed prior to market open at approximately 7:30am via Business Wire and is also available on our website at Sycamorenet.com.

In addition, we wish to caution you that certain matters discussed today may constitute forward looking statements that involve risks and uncertainties. The company's actual results could differ materially from those stated or implied in forward looking statements due to a number of factors, which are identified in today's press release and discussed in detail in the section entitled “Factors That May Affect Future Results” in the company's most recently filed reports on Form 10-Q, 10-K and other reports filed by the company from time to time with the Securities and Exchange Commission. The company disclaims any intention or obligation to update or revise any forward looking statements whether as a result of new information, future results, or otherwise.

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

Dan Smith

This morning Sycamore reported fourth quarter revenue of $17.2 million compared with $15.1 million for the fourth quarter of fiscal 2008. Our revenue for fiscal year 2009 was $67.4 million compared with $115.5 million for fiscal year 2008. GAAP net loss and net loss per share for Q4 was $34.9 million or $0.12 per share. Non-GAAP net loss for Q4 was $6.5 million or $0.02 per share. We ended the fiscal year with $926.8 million in cash. Following my opening remarks Paul will cover our Q4 and full year results in greater detail. After that we’ll be happy to take your questions.

As discussed in recent calls we’re operating in a challenging business environment. Our Q4 and full year results reflect the impact of reduced capital spending and the service provider segment, unfolding within the backdrop of a global economic downturn. We believe this weakness in capital spending has compounded the already existing challenges and unpredictability associated with the highly concentrated customer base particularly for our core switching product.

These factors were the prime drivers behind disappointing revenue levels during the fiscal year and necessitated certain actions to reduce our cost structure and better position the company for long term success. In addition to the previously announced workforce reduction of approximately 30%, we continue to exercise disciplined expense control as we navigate through current market conditions. These actions will allow us to streamline operations across the company, ensure our resources are effectively aligned to meet our customer commitments, and continue to deliver excellence in customer service and support for which the company is known.

Sycamore has built an impressive customer base, maintaining and expending this customer base remains a key area of focus as we enter the new fiscal year. We are pleased with the progress made in penetrating new opportunities in a variety of market segments that rely on resilience and flexible communication systems to support mission critical bandwidth management needs. These market segments include large financial institutions, wireless operators, international gateway service providers and energy generation and distribution companies.

With the competitive access solution based on our multi-service DNX platform we successfully added new customers in each of these segments during the past fiscal year. While the access projects tend to be more modest in size we believe they affirm our product strengths, our excellence in customer support and represent an expanding base of significant customers who we believe present future opportunity for expansion of our business.

Technology highlights during the fiscal year included the addition of an innovative multi-grade Ethernet card for our SN 9000 intelligent multi-service switching platform as well as the successful demonstration of on demand broadband services in a global interoperability event sponsored by the optical inter-networking forum. This event, which included a demonstration at Verizon Labs in June, allowed Sycamore to showcase its leadership in intelligent control plane technology while demonstrating the practical application of dynamic end to end service creation in a multi-carrier and multi-vendor environment.

Within our multi-service access product suite the addition of an integrated circuit and packet module set which brings a unique IP forwarding engine to our DNX platform allowed us to significantly expand our business with one of the largest wireless providers in the United States. We are seeing growing customer interest in the deployment of this capability with other customers.

Although we remain cautious in our outlook at this time we remain steadfast in our commitment to our customers in supporting their network and service needs. In one on one meetings with our customers around the world I’m reminded time and again not only of the excellence of our products but also of our excellence in delivering world class customer service and support. Our employees have consistently demonstrated an outstanding commitment to our customers. It is this dedication and commitment that has allowed Sycamore to become a strategic supplier to leading Tier 1 network operators the world over. We will continue to leverage this critical asset as we move the business forward.

With that I’ll now turn the call over to Paul.

Paul Brauneis

Before I begin let me once again remind you that current or historical results are not necessarily indicative of results to be expected for any future period. That predictability of future quarter operating performance remain difficult. Our revenue stream fluctuates from period to period due to customer concentration and large project orientation primarily in our core business. Additionally, carriers and service providers alike have been affected by the current economic environment as evidenced by a prolonged slowdown in previously planned capital expenditures.

Our gross margin percentage also fluctuates from period to period based on the split between product and service revenue, core versus excess product revenue and channel mix. Gross margin may also be affected by the level of provisions for warranty, scrap, rework and adjustments to reduce inventories to their estimated lower costs and market. Furthermore, certain operating costs mainly R&D project expenses and cost recoveries related to the concluded stock option investigation matter have varied significantly from period to period.

Now let’s look at the Q4 and annual results. GAAP net loss and GAAP net loss per share for the fourth quarter of fiscal ’09 were $34.9 million a $0.12 loss per share compared to a GAAP net loss of $14.1 million or $0.05 loss per share for the fourth quarter of fiscal 2008. For the 2009 full year period, GAAP net loss was $53.6 million or $0.19 per share compared to a GAAP net loss in fiscal 2008 of $0.1 million or basically break even.

GAAP results include a non-cash impairment charge in Q4 of $24.2 million, $23.1 million associated with the book value of goodwill and intangible assets and $1.1 million with certain fixed assets. The charge results from an impairment assessment and valuation required to be conducted periodically taking several market and economic factors and assumptions into consideration.

Fiscal ’09 fourth quarter and full year periods also include non-cash charges for stock based compensation of $1.1 million and $4.7 million respectively and pre-impairment amortization charges of purchased intangibles of $0.2 million and $1.2 million respectively. At the beginning of Q4 we announced the decision to reduce the workforce over several quarters by approximately 30%. Restructuring charges recorded in Q4 totaled $2.9 million consisting of $2.3 million for costs associated with certain workforce reductions made in April of Q4 and $0.6 million related to lease costs associated with our decision to exit our New Jersey facility.

For the full fiscal year restructuring charges were $4 million consisting of $2.9 million in Q4 plus $1.1 million of employee related costs associated with our action in Q1 to realign and refocus certain sales, marketing and general and administrative functions and consolidate certain manufacturing activities.

Step two of the previously announced reduction was implemented in August. The cost arising from that action which approximates $3.3 million will be recorded as a restructuring charge in Q1 of our fiscal 2010. Workforce reductions have affected all functional organizations and virtually all geographic locations. In addition, we anticipate that Q1 fiscal 2010 restructuring charges will also include an additional $2 million associated with the early termination of our New Jersey facility lease.

During fiscal 2010 all functions, with the exception of sales and service, will be consolidated in Massachusetts, Connecticut and China. Total Q1 fiscal 2010 restructuring costs are currently expected to approximate $5.3 million.

For the remainder of the call references to our results, unless otherwise indicated, will relate to financial measures excluding the previously discussed impairment charge as well as charges related to stock based compensation, pre-write down amortization of purchased intangibles and restructuring and will be referred to as non-GAAP results.

Consistent with past practice cost and our cost recoveries associated with the concluded stock option investigation matter are included in G&A expenses in both the GAAP and non-GAAP results where applicable. Recoveries in Q4 of ’09 amounted to $0.1 million.

Non-GAAP information should not be considered superior to, in isolation from, or as a substitute for GAAP results. Rather we believe that these non-GAAP measures provide useful information to investors, analysts and shareholders alike in assessing the core operating performance of our business. A comparative reconciliation of GAAP to non-GAAP net income or loss as applicable for the current quarter and year to date is included as a table in our press release and can be found in the investor relations section of our website as well.

Non-GAAP results for the Q4 and fiscal year periods ended July 31, 2009, include an operating loss of $10.1 million and $37.7 million respectively. This compares to an operating loss for 2008 Q4 and fiscal year period of $15.9 million and $24 million respectively. Non-GAAP net loss for the Q4 and fiscal year 2009 periods was $6.5 million and $19.5 million or a per share loss of $0.02 and $0.07 respectively. This compares to a non-GAAP net loss in Q4 of the prior year of $7.8 million or $0.03 per share and non-GAAP net income for the full fiscal year 2008 of $13.8 million or $0.05 per share.

The significant shift in the full year comparative net income or loss relates primarily to the year over year revenue decline primarily in four products and declining interest rates on average invested capital balances over the preceding several quarters, resulting in significantly lower interest income in fiscal 2009 compared to the prior year.

Total revenue for Q4 and full year were $17.2 million and $67.4 million respectively compared to $15.1 million and $115.5 million in the fourth quarter and full year periods of the preceding year. There were three customers who each accounted for greater then 10% of total revenue in the quarter and two customers namely Sprint and Verizon, who accounted for greater then 10% of total annual revenue.

Of the total revenue in Q4, approximately $11.3 million was product related while $5.9 million was service. Core switching revenue was $9.6 million and access revenue $7.6 million in the current Q4 period. For the full fiscal 2009 period product revenue was $42.6 million and service revenue $24.8 million. Core switching revenue for the full year period was $35 million while access revenue totaled $32.4 million.

Domestic versus international revenues for Q4 were 30% and 70% respectively. For the full year domestic revenues were 35% and international revenues 65%. Our book to bill ratio was less than one.

Gross margin on a non-GAAP basis for the fourth quarter was 42.1% compared to 55.3% in the previous quarter and 28.7% in Q4 of the prior year. Gross margin was negatively affected by an inventory provision of $2.3 million to reserve against certain inventory parts and components determined to be in excess of foreseeable demand. The charge was partially offset by a reduction in warranty reserve of $750,000. Excluding this charge and credit Q4 gross margin was 51.5%.

Gross margin in the prior year Q4 ’08 period was also negatively affected by a provision of approximately $2.3 million and to a lesser extent the relationship of certain fixed costs to the lower Q4 ’08 revenue base. Excluding that provision Q4 ’08 gross margin was approximately 44%. Gross margin for fiscal year 2009 was 44.3% compared to 46.3% for fiscal year 2008. Excluding the unusual provisions in credit, normalized gross margin was 47% and 48% for the fiscal ’09 and fiscal ’08 periods respectively.

Product gross margin for the Q4 and full year period was approximately 33% and 35% respectively or 46% and 39% adjusted for the unusual provision in credit. Service gross margin approximated 60% for both the quarter and full year periods. Research and development expenses were $12.2 million in Q4 compared to $12.5 million in the preceding quarter and $12.4 million in Q4 of the prior year. Full year research and development costs were $48.1 million compared to $45.6 million in fiscal year 2008.

Sales and marketing expenses for the fourth quarter were $2.9 million down from $3.4 million in Q3 and $5.2 million in Q4 of fiscal ’08. For the full year, sales and marketing costs amounted to $13.4 million a reduction of $6.5 million from the $19.9 million in fiscal ’08. General and administrative expenses including stock option investigation costs and recoveries were $2.2 million in Q4 and $6.1 million for the full year period. This compares to $2.6 million and $12 million in the comparable prior year Q4 and annual periods.

Cost recoveries in Q4 ’09 were $0.1 million compared to zero in Q4 ’08. Total cost recoveries for the full fiscal year 2009 amounted to $3.7 million compared to net costs of $1.4 million in fiscal year 2008. Excluding these costs and recoveries normalized G&A expenses were $2.3 million in Q4 slightly below the $2.4 million incurred in the previous quarter and $2.6 million in Q4 of the prior year. On a full year basis normalized G&A expenses were $9.8 million in fiscal 2009 compared to $10.7 million in fiscal 2008.

In the aggregate total normalized operating expenses excluding the stock option investigation and expense recoveries declined to $17.4 million in the current Q4 period compared to $20.2 million in the comparable prior years Q4 and to $71.3 million for the full fiscal 2009 period versus $76.2 million for fiscal year 2008.

As we entered fiscal 2009 we expressed an expectation of year over year growth in non-GAAP operating expenses expected to be driven by expanded domestic development net of cost reductions and other discretionary expense areas and continued expansion of our Shanghai development center. This was reaffirmed in our Q1 call as we began to see the benefits from certain planned efficiencies and reductions in certain discretionary spending.

At that time, we indicated that the timing of significant incremental development spending as lagging our initial expectation and that we were proceeding cautiously in light of then emerging economic and market conditions. In our Q2 call we affirmed that market conditions had worsened and given rise to a global economic slowdown in which cut backs in capital spending by major carriers and other service providers were generally occurring and were expected to continue for some time.

Accordingly we began to cautiously pace the more aggressive development strategy originally articulated. We have continued to proceed cautiously and have targeted our spending to high probability and profitable market requirements with a more measured approach toward future offerings. We announced further cost reduction plans at the beginning of Q4 to take place over several quarters.

Workforce reductions were them implemented in Q4 and again last month at the beginning of Q1 fiscal ’10. When fully implemented we anticipate that the annualized cost savings associated with these actions will approximate $19 million. These actions were designed to streamline our cost structure while maintaining the resources necessary to provide an ongoing level of excellence and superior customer support and to prudently advance existing product offerings.

At the same time, we maintain a structure which will continue to enable us to explore new opportunities both organic and strategic. We expect to begin to see the significant benefit of these actions as we enter fiscal 2010. Total employee headcount at the end of the quarter was 405 compared to 463 at the end of Q3 and 492 at the close of last fiscal year. Upon completion of the actions discussed employee headcount will approximate 300.

Interest and other income was $3.1 million for Q4 ’09 of which $2.9 million is interest. This compares to interest income of $3.8 million in Q3 and $7.9 million in Q4 ’08. On a year to date basis interest income declined to $17.8 million compared with $38.8 million in fiscal 2008. The reduction in the current quarter and year to date periods is directly attributable to significantly lower interest rates being earned on our average portfolio balance as compared with prior year periods.

In light of current economic conditions and volatile market conditions we continue to maintain conservative investment positions within our significant investment portfolio. Other income in Q4 also includes approximately $230,000 gain associated with the disposition of a long term asset investment.

We ended the quarter with total cash, cash equivalents, and short and long term investment of $926.8 million a decrease of $5 million from our Q3 balance of $931.8 million and a year over year decrease of $15 million from $941.8 million last year. The decrease for the quarter includes a reduction in unrealized gains of approximately $1.1 million.

Unrealized gains at the end of Q4 were approximately $1.4 million compared to $2.5 million at the end of Q3 and represent the positive affect of marking to market certain longer term securities carrying slightly higher interest rates then current markets. The increase or decrease in the unrealized gain is recorded in our financial statements as an adjustment to equity and not an element of profit or loss.

Capital expenditures during the quarter were $175,000 and $4.4 million for the full year. Accounts receivable totaled $12.9 million and represents a DSO (Days Outstanding) of approximately 72 days. Inventory at quarter end was $16.1 million a decrease of approximately $3 million from the previous quarter of which approximately $2.3 million was associated with the inventory provision previously discussed.

Other current liabilities including accounts payable, accrued expenses and restructuring costs totaled $14 million. We expect that cash payments associated with our Q4 ’09 and Q4 fiscal 2010 restructuring actions and the early termination of our New Jersey lease will approximate $7.8 million and will be substantially disbursed by mid-2010.

Deferred revenue both current and long term totals $15.5 million compared to $16.4 million at the end of Q3. Of that, deferred revenue on product shipments is approximately $0.8 million and represents shipments for which revenue recognition criteria has not yet been met but which we expect to meet over the next few quarters. Deferred revenue on service approximates $14.7 million representing the unearned portion of customer maintenance and support agreements which will be accreted into services revenue over the terms of the related contractual service period.

We will continue our practice of not providing forward looking revenue guidance. With regard to gross margin we continue to believe that at current revenue levels and with anticipated savings from cost reductions, gross margin would be in the mid 40% range.

Earlier in the call I reemphasized that we will continue to cautiously pace our development expenditures and should realize substantial annualized costs savings from the workforce reduction and other cost containment measures undertaken. We anticipate that full year fiscal 2010 non-GAAP operating expenses will range between 70% and 80% of fiscal 2009 normalized levels, which exclude option investigation recoveries.

On a GAAP basis fiscal 2010 operating expenses will range between 60% and 66% of fiscal 2009 GAAP operating expenses. We will continue our exploration and evaluation of potential strategic opportunities.

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

I’ll now turn the call back to Bob for questions and answers.

Bob Travis

We would like to begin the Q&A session at this point.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Subu Subrahmanyan – Sanders Morris

Subu Subrahmanyan – Sanders Morris

On the headcount reductions you talked about getting down to a number of 300 and annualized cost savings of $19 million. Can you tell us at what point we should start seeing a full quarter of these benefits and what quarter should we start seeing that? Then a question on the revenue side, do you expect in the intermediate term to be somewhat equally split between access products and core switching products, I’m wondering in terms of revenue contribution how you’re seeing that going forward?

Paul Brauneis

I would expect that we will see the lions share on a quarterly basis as we complete our fiscal Q2.

Subu Subrahmanyan – Sanders Morris

In Q3 you should see that.

Paul Brauneis

I would say by Q3 we should be seeing 100% of the full anticipated quarterly benefit.

Dan Smith

With respect to the revenue I think that I would expect the relationship will still have core slightly exceeding the access side. That being said, there are a number of large projects we work on with respect to the core but that number could swing significantly because the access kinds of projects tend to be more modest in size so it’s a little difficult to project that at this point in time. I think that’s our view at this moment.

Subu Subrahmanyan – Sanders Morris

The last couple quarters there was a sharp fluctuation in revenues given timing of some projects and so on when you look at July do we continue to see timing of projects, timing of revenue recognition creating some lumpiness or are we seeing more of a steady state revenue in the July quarter?

Paul Brauneis

Recall that in the third quarter we had mentioned that I think about $5 million in total of our third quarter revenue had come in from deferred which had been hanging out there for some time. Currently the deferred product revenue is less than $1 million so I think the quarterly revenue will be more impacted just by the timing of projects then certainly by the impact of deferrals this year.

Operator

There seems to be no further questions at this time. I will now turn the conference back to you.

Bob Travis

We’d like to thank all of your for joining us today. As a reminder an audio replay of this call will be available for 48 hours beginning tomorrow morning on the investor relations section of our website at Sycamorenet.com. Thanks again for joining us, have a good day.

Operator

That does conclude the conference call for today. We thank you for your participation. We ask that you please disconnect your lines. Have a great rest of the day.

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Source: Sycamore Networks Inc. F4Q09 (Qtr End 07/31/09) Earnings Call Transcript
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