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Oplink Communications, Inc. (NASDAQ:OPLK)

F2Q 2014 (Qtr End 12/29/2013) Earnings Call

January 29, 2014, 5:00 PM ET

Executives

Stephen Welles - Senior Vice President and General Counsel

Joseph Liu - Chairman and Chief Executive Officer

Shirley Yin - Executive Vice President and Chief Financial Officer

Peter Lee - President and Chief Operating Officer

Analysts

Christopher Longiaru - Sidoti & Company

Hamed Khorsand - BWS Financial

Dave Kang - B. Riley & Company

Operator

Welcome to the Oplink's second quarter fiscal 2014 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Steve Welles, General Counsel of Oplink. Please go ahead, sir.

Stephen Welles

Good afternoon, everyone, and thank for joining us on today's call. This call is being simultaneously webcast on our Investor Relations section of our website at oplink.com. On the call today are Joe Liu, Chairman and CEO of Oplink; Shirley Yin, CFO of Oplink; and Peter Lee, President and COO of Oplink.

Before we get started, I'd like to remind you that the following discussion contains forward-looking statements that involve risks and uncertainties and that Oplink's actual results may vary materially from those discussed here. Risk factors that could cause the actual results to differ can be found in Oplink's periodic filings with the SEC. Forward-looking statements made on this call are based on current expectations and Oplink does not intend to update or revise them, whether as a result of new developments or otherwise.

Now, I'd like to turn the call over to Joe Liu, Chairman and CEO.

Joseph Liu

Thank you, Steve. Thanks to all of you for joining us today, as we report our second quarter fiscal 2014 financial results. Revenue for the quarter was $50.4 million, near the high end of the guidance we provided last quarter. This was down from $54.8 million in the prior quarter due to some softness we're seeing from a small number of larger customers.

But we remain very optimistic about the longer-term demand trend in the optical industry, and we believe that we are well-positioned to capitalize on this trend with our competitive product portfolio and efficient cost structure. We have several design wins and the projects underway with key customers that we believe will lead to future revenue growth. Tellabs and Huawei were again our largest customer in the quarter, making up about 29% of revenue, down slightly from the prior quarter.

We're also excited about our new security business. Our software-defined mobile security cloud solution and service provides disruptive multiple parallel video alarm, calling alerts and other rich security and monitoring features at less than half of the cost of incumbent security service providers like ADT or telecom cable carrier like Verizon and Comcast. Our integrated security product and service are now available at OplinkSecurity.com, Fry's Electronics and selected retailers. And we look forward to share more news on the business in the future.

With that, I will turn the call over to Shirley for financial review. Shirley, please go ahead.

Shirley Yin

Thanks, Joe, and thanks to all of you for joining us today. Revenue for the quarter was $50.4 million, down from $54.8 million in the prior quarter and up from second quarter fiscal 2013 revenue of $45.1 million. Net income was $1.3 million or $0.07 per diluted share, down from $2.2 million or $0.11 per diluted share in the prior quarter and $3.5 million or $0.18 per diluted share, reported for the second quarter of fiscal 2013.

Non-GAAP net income for the second quarter was $2.4 million or $0.12 per diluted share, down from $4 million or $0.21 per diluted share reported in the prior quarter and $4.6 million or $0.24 per diluted share reported for the second quarter of fiscal 2013.

A GAAP to non-GAAP reconciliation is included in our earnings press release. Our calculation of non-GAAP net income for the second quarter is based on effective tax rate of 20%.

Our non-GAAP gross margin in the second quarter was 31.8%, down from 32.6% in the prior quarter, due mostly to lower utilization, resulting from lower revenues, offset somewhat by a more favorable product mix. For the March quarter, we expect gross margins to be down slightly due to lower ASPs resulting from annual price negotiations.

Turning to our operating results. Total non-GAAP operating expenses were $13.1 million, up from $12.7 million in the prior quarter, due primarily to an increase in sales and marketing expense for our mobile interactive business. For the March quarter, we are expecting operating expenses to remain at about the same level as the December quarter.

Total expenses incurred by our mobile interactive division was $2.5 million, up slightly from $2.3 million in the prior quarter. We expect mobile interactive spending in the March quarter to be at about the same level as the December quarter.

Total headcount at quarter end was 3,900, up slightly from the prior quarter, due mostly to additions in manufacturing labor. We closed the quarter with cash, cash equivalent and investments of $176.2 million, up from $174 million in the prior quarter. We generated $4.7 million of cash from operations, up from $4.4 million in the prior quarter.

We spent $4.5 million in CapEx during the second quarter consisting mostly of new capital equipment for our optical business, including equipment for our 100G product. We expect total CapEx for fiscal 2014 to be in the $15 million range, up from the total of $7.6 million in fiscal 2013.

The annual increase in CapEx is largely due to the construction of the third dormitory in Zhuhai that will provide housing for up to 1,000 employees. When the new dorm is completed, we will be able to provide housing for all of our Zhuhai manufacturing labor, with some room for growth.

Shares outstanding at the end of the quarter were 19.4 million. Accounts receivable at the end of the second quarter was $31.4 million, down from $40.8 million in the prior quarter, due to lower revenues, shipment patterns and early payment from a large customer with long payment terms.

DSOs were 57 days, down from 68 days in the prior quarter. Inventory was $40.5 million, up from $36 million at the end of last quarter, as we continue to build inventory to meet customer demand for shorter lead times. We expect inventory levels to increase slightly in the March quarter.

In summary, we are currently experiencing some softness in revenues, due mostly to lower order levels with a small number of larger customers. But we are optimistic about demand trends and we continue to invest resources to meet this potential demand.

For the March quarter, we expect revenue to be in the range of $48 million to $52 million. GAAP net income is expected to be in the range of zero to $0.06 per diluted share. Non-GAAP net income is expected to be in the range of $0.06 to $0.12 per diluted share. GAAP and non-GAAP net income per diluted share assumes an income tax rate of 20%.

Now, we will take your questions through the operator. Please go ahead, operator.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is from Patrick Newton with Stifel Nicolaus.

Unidentified Analyst

This is Robert sitting today on for Patrick, and a couple of questions. First of, Joe, if you could perhaps provide some color on Huawei and Tellabs, and specifically wondering if you're seeing any impact in demand from Tellabs, as a result of the kind of purchase by Marlin Equity Partners?

Joseph Liu

We have not seen a major pattern change and I think the consolidation is eminent, and they already conclude that. Looking forward that we will see probably benefit from both combined entity. So with that regard to the Tellabs, I think we're positive on that. Huawei, we already saw some benefits out of these 4G LTE deployment grabbing the release. So we will see a continued trend from Huawei. So that's probably the current situation.

Unidentified Analyst

And then kind of in regards to your large data center customer, I know last quarter you had mentioned you've been having some issues with a co-supplier that were delaying kind of progress or orders with that. Just wondering if you could provide kind of an update to that status, has the issue been resolved or when that is going to turn around?

Joseph Liu

Yes, that issue have been resolved. However, the purchasing pattern hasn't really change. There are some other reasons for the weakness. When I say weakness, they jump from zero in four quarters to the 7% to 8% level. I think that is amazing. So I am not surprised that they probably need some time to reorganize and get the order pattern in line with the forecast.

Unidentified Analyst

Just kind of a question on margin. So I know in the last couple of quarters we've seen some pressure on gross margin, seems like 2Q kind of mix last quarter. I know that you said that was going to happen this quarter, but mainly kind of labor fixed cost absorption. I'm wondering if you have any kind of ideas or thoughts or when potentially you should see through that pressure lift, and kind of return to possibly the levels from last fiscal year.

Shirley Yin

Well, gross margins declined in the current quarter, primarily due to lower revenue. Our primary focus is to grow our topline and margin will improve from there, as we have the operating leverage as revenue growth. I think we will continue to take measures to improve efficiencies and improve gross margin and our midterm target still is the 35% level.

Unidentified Analyst

Your midterm target is 35%?

Shirley Yin

Yes.

Unidentified Analyst

And Shirley just in general, do you have any kind of addition to the 35% target operating model that you're looking at as far as like what kind of revenue level would get you there, 35%? And what the operating margins will look like there?

Shirley Yin

Depending on the mix, I'm saying at least we need to see about $50 million to $60 million revenue range to be able to reach 35% margins.

Unidentified Analyst

And on the operating margin side?

Shirley Yin

Operating margin, it is very large, but mostly it's based because of revenue change and also the spending increase in the mobile interactive business. Our target is here to be able to maintain a 10-plus percentage point.

Unidentified Analyst

It's my last question, Joe. We've kind of talked over last few quarters on what your expectation are for being able to recognize revenue for mobile interactive with the products now being sold on Amazon, Fry's and on OplinkSecurity.com. Do you have any more clarity as to when potentially you could start seeing those sales impact your results?

Shirley Yin

I will take the third part of your question, and then Joe can answer the rest. During this quarter actually we made some shipments to the retailer and other customers. However, the number of packages shipped is not significant and most of it has been reported as deferred revenue, approximately about $200,000.

So in terms of revenue recognition, it is work in progress. I mean we need to revaluate the term in each of the contracts and make adjustments to revenue and making accordingly. So when we are ready to recognize the revenue, we will be closing separately. And Joe, any comment to this.

Joseph Liu

We are working with several major retail distributors and have signed agreement with them to help us merchandize our boxes. So I think that work in the progress and we're pleased with the progress so far. And as a result, I think we are not only dealing with the retail chain, but also deal with the other value-added retailer, including professional lines. And we also have a licensing strategy, where we pretty much like our ODM solution that we provide, the software license, the cloud service as well as hardware solution.

So those are our future goals and we will introduce new product in the next quarter for other line of security related or alarm and alert related, including fire alert as well as care for senior citizens, if they fall or if they're in a panic situation. And also we will introduced a series of video-only solution that's basically just for monitoring and to some extent to build same platform making across platform, to buy individual sensors to increase their functionality. Those are kind of the strategy in the coming quarters.

Operator

Our next question is from Christopher Longiaru with Sidoti & Company.

Christopher Longiaru - Sidoti & Company

So first I'm going to jump on, so Tellabs and Huawei seem to be shortening their lead times, I'm sure that modeling had something to do on the Tellabs side. Are you seeing this across the board with your other customers that are as big? And what's your visibility right now and how are lead times trending?

Joseph Liu

I would probably characterize this pretty normal. And our book-to-bill is 0 on 1. So nothing really substantial, but we normally would like to see some growth and you will see that book-to-bill higher than 1. But as we're sitting here, our book-to-bill ratio is right around 1, so that kind of will summarize your several question here.

Christopher Longiaru - Sidoti & Company

And what's your utilization rate now in the fab antenna?

Joseph Liu

I would say selectively, our average is probably like 0.7, 0.75.

Christopher Longiaru - Sidoti & Company

And just in terms of you talked about kind of a gross margin uptick as revenue comes up, at this point in order to get to that 35% target that you talked about, what would your utilization rate have to be around, assuming kind of a similar product mix to what you saw in the December quarter?

Joseph Liu

Well, Shirley just mentioned that it could be somewhere around $55 million to $60 million a quarter to take us back to the 35%. My view is that probably closer to 60% that we will get back to that 35% range, judging from the new price and other consideration.

Christopher Longiaru - Sidoti & Company

So that's procured around 85% utilization?

Joseph Liu

I would that's total.

Christopher Longiaru - Sidoti & Company

And then just in terms of the security business, you've listed some goals for some new products. What about some new retail partners. Do you have an expectations for that this fiscal year or in 2014 calendar year for adding some new retailers?

Joseph Liu

We certainly do. We have several major ones in discussion or in finalization of the distribution agreement. So I'm very confident. We're first in the industry to introduce this cloud-based basically, the packet-switching system, so we're very pleased with where we are in the market, but we just came to see that surely will great reception. Some of the major brands came to us and showed their willingness to work with us.

Operator

Our next question is from Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial

But can you guys describe what you're seeing from the datacenter customers as far as percentage of revenue and what are you talking about as far as Q1 goes in price?

Shirley Yin

I'll answer the percentage questions. It's around 20%.

Hamed Khorsand - BWS Financial

And as far as pricing goes, are they going to negotiate down in Q1?

Joseph Liu

That's different from the telecom customer. The telecom customers, at least half of them giving us yearly price negotiation. Datacom customer tends to negotiate mostly kind of a random, and we'll have the long-term contract commitment. They give us long-term forecasts, but no lasting price. I think to make a long story short is that the price gets to be very, very competitive.

Hamed Khorsand - BWS Financial

And just looking at pricing and guidance, I mean it seems like you guys are either selling really well or the ASP declines from negotiations is that sounds like it was last year. Could you just give some little bit color on that?

Joseph Liu

I think all your question was datacom related. I think that our margin is still reasonable. On the telecom side, I think I would summarize you that the price is still reasonable. And if you look at overall, we have to attribute to the price negotiation at the early of the year, beginning of the year, in fact probably more as time goes on. Our efficiency in the automation will kick in and that would offset some of them, the earlier disadvantages.

Hamed Khorsand - BWS Financial

And are you seeing, from your prepared comments, is this literally datacom customers are pulling back orders or is it a mix of telecom and datacom?

Joseph Liu

Earlier, Shirley mentioned that overall datacom customer is less than 20%. In short there are natural and [indiscernible] still dominate the bulk of the revenue base. So I think that impact our topline that -- we were not necessarily strong in the datacom arena, but at the same time we were very strong at the telecom side, which is naturally enough. We are classified enterprise as part of the datacom customer.

Operator

And our next question is from Dave Kang with B. Riley & Company.

Dave Kang - B. Riley & Company

First question is regarding MI stuff, so investments were about $2.5 million and you're guiding flat for the current quarter, but with all the new products and new retailers, how is the $2.5 million going to ramp up going forward?

Joseph Liu

I think Shirley mentioned that we expect that excluding any additional marketing expense, I think that we will stay put at the current level, $2.5 million for the March quarter.

Dave Kang - B. Riley & Company

I mean beyond March quarter, I mean, like June and September, how is that going to ramp?

Joseph Liu

We have not have a concrete plan as to whether we need escalate the advertisement money or additional marketing budget. But at this time I think that we are being the only [indiscernible] and that we already captured some of the retail channel rotation. Hopefully, that we don't need to spend a lot of the advertisement money, but that's just the current position.

Now, as time goes on, you will see a need for commercial ad to ramp up, we may take action. We were talking to PR firms and advertisement firms at this point, but we don't have a firm plan. We have a strategy that through the penetration of the retail store and then joint venture with a partner with the store who have these selected advertisements, and that money will come out of the rebate.

Dave Kang - B. Riley & Company

And then what is the breakeven point for that and when do you expect to achieve that? Is that maybe end of this year or is it more a next year event?

Joseph Liu

Hopefully, that's at the end of this year, calendar year not the fiscal year.

Dave Kang - B. Riley & Company

The December quarter, right?

Joseph Liu

Yes.

Dave Kang - B. Riley & Company

I mean what's the breakeven?

Joseph Liu

We're probably about maybe somewhere around 15,000 to 20,000 passes.

Dave Kang - B. Riley & Company

And you think that's more like December this year?

Joseph Liu

We hope that's the case. As we're gradually gaining the additional retailer, and then hopefully that that kind of strategy that we took, it's hopefully building two or three majors ones, than then we thought, we'll be able to do better.

Dave Kang - B. Riley & Company

And when are you going to break that out that deferred revenue that Shirley talked about when are you going to do that?

Shirley Yin

I think when we get to a significant level, we will definitely disclose that.

Joseph Liu

And I think that will probably happen in this year, calendar year.

Dave Kang - B. Riley & Company

And then, Shirley, I missed your comments on CapEx. Can you go over those numbers, again? What it was and what the forecast is?

Shirley Yin

We expensed $4.5 million CapEx this quarter, mostly in capital equipment relating to the optical business, and particularly the 100G product. Our expectation is build $15 million for the whole year compared to five year in this investment to construct the third dormitory in Zhuhai.

Dave Kang - B. Riley & Company

And then, Joe, that 100G product, can you elaborate, which products you're looking on?

Joseph Liu

Peter, do you know?

Peter Lee

There is two main product lines, one is [indiscernible].

Dave Kang - B. Riley & Company

ECOC, so that's what in September?

Peter Lee

But we're starting the pipeline to design a project [indiscernible].

Dave Kang - B. Riley & Company

And when do we see that ramping?

Peter Lee

Small quality audits amounting $150,000.

Dave Kang - B. Riley & Company

When does that become material, like maybe second half this calendar year?

Joseph Liu

I think the goal is to get exactly qualified in the first half, and as I'm assuming the second half of the year.

Dave Kang - B. Riley & Company

And then you talked about the price adjustment for few years.

Joseph Liu

Well, typically I mean that we're probably experiencing ranging from 6% to 12% on average less that 10%.

Dave Kang - B. Riley & Company

So is it fair to say that passive components price erosion is better than active, because active, you guys talked about 10% to 15%, not 6% to 12%?

Joseph Liu

I think you're right. We're experiencing the same here internally.

Dave Kang - B. Riley & Company

But yesterday one of your competitors talked about severe pricing for their legacy products, and I know they are passive stuff from a Chinese competitors. Are you seeing similar situation with your legacy products?

Joseph Liu

Yes. That means, selected. If we have started the patent protection, then I think it's better off, than we're working on this commoditized competency.

Dave Kang - B. Riley & Company

And lastly on China, so it sounds like Huawei is still up-ticking and then Tellabs, I mean no overlap with Korean. How should we expect Tellabs to behave going forward?

Joseph Liu

Moving forward it's going to be probably just one company. We're talking about Korean-only now. But I think that they are still adapting the same approach, which is a buying from a broad level to reduce the manufacture overheads, driving that we will continue to benefit from that. And on the European side maybe because we are more typical to labors, the change would be gradual, but we're working very hard, trying to use numbers to justify our value.

Dave Kang - B. Riley & Company

And on China, you have talked about Huawei strengthening, I mean, so those two, Tellabs and Huawei were closer to 30%, call it 29%, but I'm assuming Huawei was bigger? Was it significantly bigger or just bigger than Tellabs last quarter and pretty similar dynamics going forward?

Peter Lee

So far that your assessment is correct.

Operator

And I'm seeing no questions. This concludes the conference call for today. Thank you for your participation. You may now disconnect.

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