Opnext's CEO Discusses F4Q 2011 Results - Earnings Call Transcript

| About: Opnext, Inc. (OPXT)

Opnext, Inc. (NASDAQ:OPXT)

F4Q 2012 Earnings Call

May 15, 2012 04:30 pm ET

Executives

Harry Bosco – Chairman & Chief Executive Officer

Bob Nobile – Chief Financial Officer & Senior Vice President

Steve Pavlovich – Vice President, Investor Relations

Analysts

Patrick Newton – Stifel Nicolaus

Dave Kang – B. Riley & Co.

David Berger - Investor

Operator

Good afternoon. My name is Doris and I will be your conference operator today. At this time I would like to welcome everyone to the Opnext F4Q earnings conference call. (Operator instructions.) Thank you. I would now like to turn the call over to our host, Mr. Steve Pavlovich, Head of Investor Relations. Sir, you may begin your conference.

Steve Pavlovich

Thanks, Doris. Good afternoon and thank you for joining us. Today we will discuss our financial results for F4Q 2012 ended March 31st, 2012. We’ll begin with Harry Bosco, our Chairman and Chief Executive Officer for an overview of the quarter, followed by Bob Nobile, our Chief Financial Officer who will provide additional detail on the financial results. Then Harry will return to talk about operational plans, market trends and our expectations for the future; and then of course followed by Q&A.

As a reminder, the matters we will be discussing today include forward-looking statements, including but not limited to those related to expected recovery of production capacity, expected improvement in orders for certain products and our expectations regarding our future revenues. These statements involve risks and uncertainties that may cause actual results to differ materially from those set forth in these statements. Among other things, our outlook for the future is based on preliminary estimates and assumptions we believe reasonable but that are beyond our control, and the market in which we operate is volatile and our strategies may not achieve the desired impact.

Other factors that could cause our future to differ from current expectations include the ongoing impact of the flooding in Thailand, the possibility that insurance might be inadequate to compensate us for our losses in Thailand, our difficulty in closing or the failure to close our proposed merger with Oclaro. These factors are not a complete list of risks and uncertainties that may affect our business. Additional information regarding these and other factors can be found in the reports we file with the SEC included under “Risk Factors,” “Management Discussion and Analysis of Financial Conditions,” “Condition and Results of Operations,” and “Forward-looking Statements” in our Form 10(k) filed on June 14, 2011; as well as our press releases and other filings with the SEC.

In providing forward-looking statements we disclaim any obligation to update them whether in light of new information or future events except as required by law. In connection with the proposed merger between Opnext and Oclaro, Oclaro filed documents with the SEC on May 8, 2012, including a registration statement on Form S(4) containing a joint proxy statement and prospectus. Investors and security holders are urged to read these documents carefully and any other documents filed in the future by either company with the SEC relating to the proposed combination as they will contain important information about the proposed transaction.

Finally, let me mention that throughout this conference call we will be referencing both GAAP and non-GAAP financial measures. A complete reconciliation of the non-GAAP financial measure to the applicable GAAP financial measure including a reconciliation of adjusted EBITDA to EBITDA can be found in the press release we issued today which is available on our website in the Investor Relations section. So with that I’ll turn it over to Harry.

Harry Bosco

Thank you, Steve, and good afternoon everyone. Let me start by giving you an update on the manufacture recovery status in Thailand. Manufacturing restarted at Fabrinet’s Pinehurst campus in February and capacity was added through March as new equipment was received. At the end of March the overall 10 G manufacturing capacity reached the same level as before the flood, although the production ramp for February and March was slower than anticipated because of some equipment and site preparation delays.

I want to thank our partners at Fabrinet for working with us to expedite our delivery and our operating teams in the US and Japan for their tireless efforts. I would also like to thank our customers who supported us during the transition period and who are now working together with us to restore our awarded share of business as fast as possible.

Let me now highlight a few key items for the quarter. Our revenue this quarter of $67.6 million was up 27% sequentially. Our 40 G and above revenues were up $12 million or almost 60% and consistent with our prior guidance. Orders for our 100G products continue to be strong, and our 100G coherent module is now being qualified by seven different customers. Current production has been limited by supply constraints and we’re working with our suppliers to solve them. As I mentioned before in the last quarter, we have and will continue to see [according] fluctuations in the 40G and above demand while the overall growth trajectory is intact.

While our 10G and below products increased almost $3 million from the December quarter, we fell about $5 million short of our expectations. This shortfall was due to the slower than anticipated ramp of our 10G production during the quarter. The manufacturing capacity ramp was difficult to predict exactly since it was dependent on site preparation completion and test equipment deliveries. Despite the flood and fluctuating demand for our higher-speed products, we are still confident in the future of the optical component industry. The market continues to point to high demand for more bandwidth and our new product portfolio addresses those high growth segments of the market.

Based on industry analysts’ forecasts, our primary addressable market is predicted to grow more than 20% through 2015 and the 40G and above is predicted to grow more than 40% in the same timeframe. Now let me turn it over to Bob to discuss the financial results.

Bob Nobile

Thanks, Harry, and good afternoon everyone. Revenue in the quarter ended March 31, 2012, was $67.6 million, an increase of $14.6 million or about 27% compared to the December quarter; but down 29% compared to F4Q ended March 31, 2011, primarily due to the effects of the Thailand flood. 40G and above revenue was $32 million in the March quarter, an increase of $11.9 million or 59% compared to last quarter and down $6.2 million or 16% compared to F4Q last year. Demand was strong across most products and in particular, 40G DQPFK modules. As we said in the past, 40G and above demand will fluctuate depending upon the time of service provider deployments of next generation systems.

10G and below revenue increased $2.7 million or 10% to $28.9 million compared to the December quarter, and was down $20 million or 41% compared to F4Q last year due to the effects of the flood. As Harry mentioned, we restored 100% of our pre-flood 10G module production capacity by the end of March.

Revenue from industrial and commercial products sales was flat compared to the December quarter and was down $1.5 million or 18% compared to the quarter ended March 31, 2011. As we mentioned last quarter, the year-over-year decline was primarily due to an inventory buildup at our Japanese industrial laser customers after the March earthquake.

This quarter, Cisco, FiberHome and Nokia-Siemens represented 10% more of total revenues. Combined, these customers represented 47% of total revenues compared to 43% in the December quarter. Revenues in the Americas represented 34% of our total revenues this quarter, while Europe represented 19%, Japan 24%, and the rest of Asia was 23%.

Gross margin was 7.5% in the quarter ended March 31, 2012, compared to 3.8% in the previous quarter. Non-GAAP gross margin of 15.7% was up 8.6 percentage points from the December quarter as 40G and above product revenue increased as a percentage of total revenue and our ability to produce and ship 10G products out of Fabrinet’s facility in Thailand improved throughout the quarter.

In addition to acquired developed technology amortization and stock-based compensation expense, non-GAAP gross margin does not include $4 million of flood-related requalification costs and manufacturing inefficiencies. Looking forward, and consistent with our pre-flood operating model, we expect to realize a 40% non-GAAP gross margin on incremental revenues.

Turning now to our operating expenses, R&D expense was $13.9 million in the March quarter compared to $13.2 million in the December quarter, while non-GAAP R&D expense increased to $13.4 million from $12.9 million. These increases primarily resulted from the timing of prototype builds. Non-GAAP R&D expense does not include $200,000 of direct flood-related expenses.

SG&A expense of $13.8 million in the March quarter increased from $12.9 million in December while non-GAAP SG&A expense decreased to $11.5 million from $12.2 million in December. Non-GAAP SG&A expense does not include $100,000 of direct flood-related expenses and $1.5 million of costs incurred connected with the Oclaro merger. Looking forward we expect our non-GAAP operating expenses in F1Q to be consistent with the March quarter.

Operating loss for the March quarter was $21 million compared to $46.2 million in the prior quarter. You’ll recall that last quarter’s operating loss included inventory and equipment write offs resulting from the flood of $10.9 million and $9.7million respectively, and about $400,000 of direct flood-related expenses. The December quarter also included a $2.1 million charge to discontinue the 10G product. The current quarter operating loss includes $4.3 million of flood-related requalification costs, manufacturing inefficiencies, and direct expenses; $1.5 million of transaction costs incurred in connection with the Oclaro merger, and a $1.6 million benefit from the sale of inventory that was previously deemed damaged by the flood.

On a non-GAAP basis, the operating loss for the March quarter was $14.3 million compared to $21.5 million in the December quarter. In summary, the decrease in non-GAAP operating loss primarily resulted from the increase in 40G and above product revenue as a percentage of total revenue, and the improvement throughout the quarter of our ability to produce and ship 10G products at a Frabrinet facility in Thailand.

Net loss was $21.8 million or (-)$0.24 per diluted share compared to a net loss of $46.3 million or (-)$0.51 per share in the December quarter. Non-GAAP net loss was $16 million or (-)$0.18 per fully diluted share in the March quarter, which compared to a loss of $21.6 million or (-)$0.24 in the December quarter. EBITDA was (-)$14.7 million compared to (-)$38.9 million in the December quarter, and adjusted EBITDA was (-) $10.4 million compared to (-) $16 million in the December quarter.

Cash and cash equivalents at March 31 were down $9 million from December 31, 2011, and we ended the quarter with $76.2 million of gross cash and $58.1 million net of short-term debt. During the quarter we used $5.2 million of cash from operations, $1.8 million to fund capital expenditures, and $2.7 million to fund capital lease obligations. During the quarter we also entered into $10.3 million of new capital leases to replace equipment damaged in the flood and we realized a $900,000 benefit from the conclusion of contingencies associated with the prior sale of technology assets.

Looking forward to the June quarter, we expect our working capital requirements will increase to support expected revenue growth while funding for CAPEX and capital lease obligations are expected to remain consistent with the March quarter. We also expect the June quarter to benefit from the settlement of flood-related insurance claims. Now I’ll turn it back to Harry to discuss our outlook for the June quarter.

Harry Bosco

Thanks, Bob. So before we open it up for questions let me summarize where we are. We are pleased with the proposed merger with Oclaro and are excited about the future growth potential for the merged company. The resulting company offers a broad portfolio of products and [compos] from day one, while having the critical core technologies to address future needs. The closing is on track for the July/August timeframe. In the meantime, we are focusing on the June quarter. With production capacity back to pre-flood levels our 10G and below business is expected to continue to recover in the June quarter as we gain back the revenues associated with the awarded market shares.

The 10G market remains very important to us. We have delivered working samples of our tunable XFP and plan to be in mass production by September. Our LR4 module, a multi-wavelength 40G transceiver and CFP package began shipping last quarter, and a QSFP+ version is expected to start shipping to customers this quarter. The QSFP+ has applications in datacenters for power, density and cost – our key factors for success. We view all these as significant growth opportunities. Our 40G and above business is expected to continue to grow and our efforts are focused on removing any supply constraints in parallel with ongoing cost reductions via vertical integration.

The industrial and commercial business continues to work through the post-earthquake laser inventory build at customers in Japan. The [BiOp] laser is starting to gain traction in the industrial and commercial markets, and we anticipate this along with a multi-beam laser for high speed printers will provide the growth engine for the future. While we’ve returned to full production capacity following the flood recovery process and our new product flow is very encouraging, giving the timing associated with the recovery of our awarded market share and some supply constraints around our 100G products we expect the F1Q revenues to be between $70 million and $80 million.

So with that I’ll turn it back over to Steve for the Q&A portion of the call.

Steve Pavlovich

Okay, thanks Harry. That completes our prepared remarks and now we’ll take questions. Doris, do you want to go ahead?

Question-and-Answer Session

Operator

Certainly, sir. (Operator instructions.) Your first question is from the line of Patrick Newton of Stifel Nicolaus.

Patrick Newton – Stifel Nicolaus

I have a couple questions on the manufacturing side and then a couple I guess on the segment side. I guess, Harry, to start on the prior call you talked about using a second contract manufacturer in the March quarter, and I heard you mention Fabrinet several times but where are you in the process of adding a second contract manufacturer and can you help us think about your manufacturing mix between your contract manufacturing base and also between California and Japan internally?

Harry Bosco

Okay, let me start with the second contract manufacturer. We have engaged a second contract manufacturer; we have not signed the contract yet. We have shipped equipment into there to start producing samples. Those samples will have to go through a qualification with our customers but we do intend to ramp that up on certain products, so we have that underway.

Our California operation right now is doing 100G products and some of the 40G subsystem products, and that’ll continue on for some time right now because 100G products are so complex than the coherent ones that it’s really material costs – it’s not a lot of manufacturing costs in that. And then when you go to Japan right now, Japan is back to normal now. We’ve taken the 10G products that were in Fabrinet out of Japan and they’re all in Fabrinet now. So we’re now focusing Japan on transitioning that manufacturing of modules outside of Japan, so we can go back to the plan we were prior to the flood.

Patrick Newton – Stifel Nicolaus

And your reason for the delay in the second contract manufacturer relative to your prior commentary?

Harry Bosco

It’s strictly because it has to be qualified to our customer base, and a new contract manufacturer is going to go through a much more sophisticated fabrication than Fabrinet.

Patrick Newton – Stifel Nicolaus

Okay, that’s very helpful. And then I guess on the 10G side, you said multiple times that 10G is now back to pre-flood levels and you stated several times that you also anticipate that the share that you’d been awarded in the past will be received. But when I just look at the absolute numbers, your March quarter results were about $53 million below your kind of prior cycle peak in December of 2010 and about $36 million below your September levels. So is this just a matter of your customers have lost share or is it a matter… I understand that about $5 million was pushed out because you didn’t ramp as quickly as possible, but just the implicit guidance, even if increase the results by about $5 million and grew it from there at the rate that you imply you’re still well below those September levels. So could you help us understand that?

Harry Bosco

Let me just go through the transition process. A lot of our customers are not on the same quarter as we are and even if they were on the same quarter lines, they had to preorder from our competitors of course until they were sure that we had the manufacturing capacity installed. So now there’s a process we’re going through now where they have to clean out that inventory and put the orders on us, give us back the fair market share of what we were awarded. So there’s a transition process there, Patrick, and that timing is not real certain but clearly by the end of this quarter we should be back to where we want to be.

Patrick Newton – Stifel Nicolaus

So back to September-type of levels or back to a run rate that would put you there more…

Harry Bosco

We’ll be back to the September-type numbers.

Patrick Newton – Stifel Nicolaus

Okay. That’s implying I think that the 40G should decline sequentially, 40G and above.

Bob Nobile

Patrick, you heard Harry talk about some supply constraints that were experienced on the 100G side, so with that we’re looking to the quarter-over-quarter the 40G and above business will largely be flat taking those into consideration.

Patrick Newton – Stifel Nicolaus

And then I guess last question is just on linearity, specifically focusing on 40G. You’d previously talked about some very solid momentum in the month of December, the month of January. Can you talk about how that trended through February and March? And then I’m also curious about how demand has trended in the month of April just given some chatter about some softening in the market?

Bob Nobile

Yeah, you have to pull out the noise that’s a result of this transitioning back to our awarded share. But once you do that, Patrick, we see the demand consistent with the pre-flood levels – the $80 million, $85 million range.

Patrick Newton – Stifel Nicolaus

Alright, that’s very helpful.

Harry Bosco

I think also, Patrick, we see things like customers coming in and they’ll order 500 units; and then they’ll deplete those out and then come back in again. So that timing is kind of almost like a step function when it comes in.

Patrick Newton – Stifel Nicolaus

Alright, thank you for taking my questions. Good luck.

Steve Pavlovich

Thank you, Patrick. Next question, Operator?

Operator

Yes, sir. Your next question is from the line of Dave Kang with B. Riley.

Dave Kang – B. Riley & Co.

Thank you and good afternoon. The first question is regarding the supply constraints. Which parts are you talking about and how much could you have done without the constraints in F4Q, or how much are you leaving off the table in F4Q?

Bob Nobile

The constraints are several components, Dave, that are affecting both the 100G coherents as well as the 100G CSP products. The impact on the March quarter was not that significant but given where we stand and what the potentials could be for this quarter that’s all been taken into the guidance that Harry gave for the June quarter.

Dave Kang – B. Riley & Co.

Got it. And then regarding your 10% customers – Cisco, FiberHome and Nokia – are they more 40G, 100G or 10G customers?

Bob Nobile

Yeah, as you know Cisco buys a complete range of products from us, while FiberHome and Nokia-Siemens are generally more 40G and above related.

Dave Kang – B. Riley & Co.

Got it. And then you said you had about seven customers in various stages of qualification for 100G? So when can we expect some revenues from these qualifications? Are we talking about maybe within the next quarter or two or more of 2013?

Harry Bosco

I think what you’re going to see is these kind of early stages of deployment. So they’re putting trials together and I think we’ll see a few more trials from different customers come in. And you’re talking about a six-month process.

Dave Kang – B. Riley & Co.

Six-month, got it. And then regarding the insurance situation, can you give us any approximately how much are we talking about and timing or is this too early?

Bob Nobile

Yeah, let’s break it out into the two pieces. The inventory portion of our claim is directly with our insurance carriers and we’re very close to settling that portion of our loss; and we’re expecting a settlement around the $10 million range for that. The equipment side of our claim as you know is directly to Fabrinet. We’ve made very good progress over the last weeks and months in coming to agreement with them on the extent of the damage to the equipment and the number of pieces of equipment damaged; and we’re now in the process of working on the valuation of that.

Dave Kang – B. Riley & Co.

Got it. And then just a couple more: can you just talk about the pricing adjustment that you guys went through during the March quarter?

Bob Nobile

Yeah, it was about 6% quarter-over-quarter, Dave, which is relatively consistent with historical experience as well as our expectations. And as you know, the calendar year-end transition is always the greatest quarter-over-quarter impact than the rest of the year.

Dave Kang – B. Riley & Co.

Sure. So still within the 10% to 15% annual.

Bob Nobile

Yeah, more close to the 15%.

Dave Kang – B. Riley & Co.

Right, kind of consistent with what others are saying.

Bob Nobile

Yeah, correct.

Dave Kang – B. Riley & Co.

And then lastly, surely you had a nice pickup in the 40G, 100G business. You’ve been talking about especially certain Chinese customers internalizing 40G – any update there?

Harry Bosco

I think they still continue. Certainly two of the largest suppliers in China are making their own client-side cards.

Dave Kang – B. Riley & Co.

And do you expect that trend to continue?

Harry Bosco

I expect it to continue but again, they’ll buy from us also or other suppliers like us.

Dave Kang – B. Riley & Co.

So what do you think the mix will be between make or buy?

Harry Bosco

Well, I think eventually if it grows up it could be 50/50.

Dave Kang – B. Riley & Co.

Grows up to 50/50, so it’s not even 50/50 yet at this point.

Harry Bosco

No, I’m sure it’s mostly internal supplies right now. But as they build up their demand they’ll start bringing in other suppliers.

Dave Kang – B. Riley & Co.

I see, got it. Alright, thank you.

Steve Pavlovich

Alright, thank you. Operator?

Operator

(Operator instructions.) You do have a question from the line of David Berger.

David Berger - Investor

Hi, I’m an individual stockholder of Opnext. I’ve owned you guys for two years. I bought you guys at like $4 a share, and I’m wondering what the value is of you merging with Oclaro that they’re down to $2 a share right now and you guys are down to like $0.93. And I’m wondering how this merger is going to benefit me, the individual stockholder.

Steve Pavlovich

David, it’s Steve. As we’ve spoken in the past, things are moving ahead with Oclaro. It makes a lot of sense, but basically what you should do is you should go in and look at the filings. They cover all of the reasons for the merger in detail. We’re just not in a position to go through this right now.

David Berger

Okay. That’s pretty much the only question I have.

Steve Pavlovich

Okay, great David. Thank you very much.

Operator

(Operator instructions.) There are no further questions in queue at this time, sir.

Steve Pavlovich

Okay great, Doris – thank you very much. So with no more questions that will conclude our call for the day and we look forward to speaking with you in the future. Thanks a lot, bye for now.

Operator

And this does conclude today’s conference call. You may now disconnect.

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