Sycamore Networks, Inc. (OTCPK:SCMR) F2Q08 (Qtr End 1/26/08) Earnings Call February 28, 2008 8:30 AM ET
Ladies and gentlemen, thank you for standing by and welcome to the Sycamore Networks second quarter financial results conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded Thursday, February 28, 2007. I would now like to turn the conference over to Bob Travis, Director of Investor and Industry Analyst Relations. Please go ahead, sir.
Thanks Claudine. Good morning, everyone and thanks for joining Sycamore's second quarter fiscal year 2008 earnings call. The speakers on today's call are Dan Smith, Sycamore's President and CEO and Paul Brauneis, our new Chief Financial Officer. As a reminder, today's press release was distributed prior to market open at approximately 8 a.m. via business wire and is also available on our website at www.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 will turn the call over to Dan Smith.
Thanks, Bob. This morning Sycamore reported second quarter revenue of $41.5 million compared with $39.6 million for the second quarter of fiscal 2007. GAAP net income for Q2 was $9.7 million and earnings per share were $0.03 on a GAAP basis. Non-GAAP net income was $11.5 million or a non-GAAP income of $0.04 per share.
Before I turn the call over to Paul, who will take you through the details of our second quarter financial results, I would like to take a few minutes to share some thoughts on our recent business progress and the value proposition that distinguishes our solutions.
We are very pleased with our second quarter results, which included strong margin performance and overall strong operating results along with sequential and quarter-over-quarter revenue growth. In addition to expanding our business in core switching accounts, our second quarter financial results also reflects sequential growth and access. A particular note, we also achieved success in cross selling our multiservice access solutions into one of our existing Tier 1 carrier comp in Asia.
Our solid progress during the quarter reflects continued customer demand for intelligently managed service capacity across the broadband network infrastructure. The content wrench, dynamic IP applications fueling this demand are also driving a dynamic mix of circuit and packet traffic in both fixed line and mobile networks.
To address the demands that come with network transition, service providers must cost effectively support a variety of service types without adding operational complexity or abandoning legacy services.
Migrating from TDM to Ethernet services from ring to mesh architectures, and from static to dynamic provisioning of service capacity, are some of the key transition challenges that operators face in the networks. These challenges are being met while competitive market forces and operational realities dictate that network operators must do more with less, add more capacity, increase network resiliency and introduce new value added services, with tighter budgets, smaller operations staff and fewer resources. Our focus remains on solving these critical challenges and we believe our comprehensive portfolio of multi-service switching solutions and end-to-end networking intelligence uniquely positions us to deliver compelling value to our customers, as their networks transition and as their complexity of managing diverse services across multiple network layers increases exponentially.
Second most proven expertise in leadership and intelligent networking and services management software continues to be a key differentiator for our solutions and I'd like to take a minute to expand on this topic, as it remains an important factor in our customer and prospect engagements.
From an architectural perspective, support for diverse protection and restoration options in carrier class mesh networks depends on the robust and resilient implementation of common software intelligence, share between switching nodes and management resources.
Our proven success with large scale optical mesh deployments at Tier 1 operators such as Vodafone, KT, NTT, Neuf Cegetel, and Telkom South Africa represents the value of the advanced control plain intelligence embedded in our switching portfolio.
Our industry leading ASON GMPLS powered broad leafed networking software and SILVX network management formed a proven foundation for selling capital and operational cost reductions.
With real world deployment data validating significant operational savings. As networks transition, the value of end-to-end networking intelligence strength leads directly into increased operational efficiencies, enhanced capacity utilization of simplified service provisioning in performance management.
This is what, empowered connections. As our customers have discovered, you don't need an army of certified technicians to run a Sycamore Network. Sycamore Solutions dramatically simplify provisioning and service management to the point we are today. A minimal operation staff can operate and maintain a nationwide and indeed global optical mesh infrastructure. Distributed intelligence and automated capacity planning, performance management and provisioning tools significantly accelerate service test and turn up resulting in decreased times of revenue and enhanced customer satisfaction.
Going beyond point-and-click provisioning of service routes in network capacity, Sycamore’s industry leading network intelligence delivers value across the network lifecycle. Allowing further operational efficiencies by automating planning and configuration tasks that were previously very manually intensive. This networking intelligence also allows operators to harness raw capacity and transform it into high value broadband offerings such as bandwidth-on-demand and scheduled bandwidth services.
It also provides the foundation for sustainable value by providing a proven software framework that can easily absorb best of breed innovations and optical components technology and rapidly transform these advances into value for our customers without requiring fork lift upgrades or complex and costly reconfiguration for optical mesh networks. We will continue to enhance our industry leading control plain management capabilities to help our customers further reduce network complexities, cost efficiently scale capacity and simplify provisioning of diverse service pipes from traditional low order and high order TDM to dynamic carrier-class Ethernet. We look forward to sharing more news with you about our ongoing innovations in these areas over the course of the year.
While we are still in the early stage of bringing SN 9000 into market, we are also pleased with the initial progress we’ve made. Introduced last fall the SN 9000 expands Sycamore's comprehensive portfolio of intelligent multiservice switching solutions. This versatile carrier grade platform extends all the advantages of Sycamore’s networking intelligence and unprecedented configuration flexibilities of regional and metro core networks.
During the quarter we expanded the deployment of the SN 9000 in Vodafone Netherlands nationwide optical mesh network which today supports the full breadth of Vodafone’s industry leading mobile and data services. As another example we have successfully installed the product in the mission critical government application. Like commercial service providers, government agency infrastructure networks are also undergoing dramatic transformation, as they migrate from TDM to next generation pack of solutions, such as connection or Ethernet transport.
The SN 9000 is a compact hybrid packet and optical switching platform, designed to allow fixed line and mobile operators to pragmatically transition network core in regional networks, while providing a simple, flexible and cost effective means to scale in terms of capacities and service mix. Unique features, such as any-service-any-port flexibility and innovative pay-as-you-grow bandwidth licensing have resonated well with our customers and prospects and we are confident in our ability to expand upon our initial successes for this product. While SN 9000 extends our multiservice switching portfolio into the network core and regional applications, the SN 16000, MC 1024 solidifies our competitive differentiation in the optical core.
The ASON GMPLS powered SN 16000, MC 1024, delivers an unprecedented 2.5 terabits of multiservice switching capacity in the industry’s smallest footprint, allowing new and existing customers to optimize our transmission networks for cost effective scalability, non disruptive migration and a flexible mix of Ethernet and TDM services.
We are pleased with the progress of making and expanding the range of our intelligent multiservice switching solutions, all of which share a common networking and service management intelligence within powers simplified and end-to-end provisioning and dramatic improvements in operational efficiencies.
Now despite our achievements during this past quarter, we remind investors that we continue to compete in a challenging market with intense competition coming from large incumbent suppliers with broad product portfolios and well established carrier relationships.
In addition, as we have frequently highlighted in the past, due to a highly concentrated service provider customer base, our results can fluctuate from quarter-to-quarter due to a wide variety of factors.
Lastly, we remain watchful with regard to the macroeconomic challenges that have been noted by others in the industry. We strongly believe however that the broadband trends, reshaping consumer and enterprise communications will continue to drive strategic transformation in wireline and wireless networks. The pace of this transformation will vary depending on the carrier, but we're confident in investments in network transition will continue. We're also confident in our ability to compete for targeted opportunities by delivering state-of-the-art multiservice switching solutions that offer compelling value and strategic next generation architecture initiatives as well as tactical new term applications from multiservice access to the optical core.
Now at this point, I will turn the call over to Paul and then rejoin you for some closing comments before re-open the call up to questions-and-answers.
Thanks Dan and good morning every one. Before, I begin to review our results for Q2 let me remind you the current historical results are not necessarily indicative of results to be expected for any future period and that the predictability of future quarterly operating performance remains difficult since our revenue stream has historically fluctuated from period-to-period and in many cases our visibility is limited due to extended sales cycles and the large project orientation in our core business.
These factors make predicting the precise timing of customer orders and their resultant shipment very difficult. Additionally our margins may fluctuate from period-to-period based on the mix between foreign access products as well as the sales mix between chassis and line cards within our core business. Lastly certain operating costs primarily R&D project costs and costs related to the ongoing stock option investigation matter may vary from period-to-period.
With this in mind we continue to encourage you to consider our performance over the longer term or on an annual basis. Now lets look at the Q2 results. GAAP net income and GAAP earnings per share for the second quarter of fiscal ’08 were $9.7 million or $0.03 per share compared to GAAP net income of $3.4 million or $0.01 per share for the second quarter of fiscal ’07. for the six months ended January ’08, GAAP net income was $16.7 million or $0.06 per share compared to a GAAP net loss for the comparable six month period of $13.8 million or $0.05 per share.
GAAP results include charges for stock-based compensation, amortization of purchased intangibles and other acquisition-related expenses, asset impairment, restructuring and certain other unusual or frequently occurring charges. For the remainder of this call, all references to our results will relate to financial measures, excluding these charges or credits and will be referred to as non-GAAP results. It should be noted that costs incurred with regard to the stock option investigation matter are included in the non-GAAP results as presented in the non-GAAP statement of operations in our press release.
Such information should not be considered superior to, in isolation from or as a substitute for our 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 detailed comparative reconciliation of GAAP to non-GAAP net income is included as a table in our press release and can also be found in the Investor Relations section of our website as well.
Our Q2 and year to date results from the three and six months ended January 2008 were strong in most key financial areas including revenue, gross margin contribution and operating costs, resulting in a non-GAAP operating profit of $0.9 million. Non-GAAP net income and net income per share for the second quarter was $11.5 million or $0.04 per share, compared to $10.4 million or $0.04 per share on the proceeding quarter and $4.1 million or $0.01 per share in the comparable second quarter of fiscal 2007.
Fully diluted shares outstanding were approximately $285 million for the second quarter. Our total revenue for the quarter was $41.5 million, up about 9%, from $38 million in Q1 and up about 5% from the $39.6 million recorded in Q2 of fiscal ‘07. There were two customers who each accounted for greater than 10% of total revenue during the quarter. Of the total revenue in Q2 about $34.9 million or 84% was product related, while $6.5 million or 16% came from service. Product revenue grew about 11% from Q1, while service revenue declined minimally.
In Q2, our core switching business contributed $33.2 million to total revenue, up approximately 5% from the prior quarter and 15% from the second quarter of last year. Our multiservice access business contributed $8.3 million to total revenue this quarter, compared to $6.5 million in Q1 and $10.7 million in the prior year of second quarter. Total revenue for the 26 weeks ended January was $79.4 million, compared to $74.4 million for the comparable period in fiscal ’07. Our book-to-bill ratio this quarter was lower than one. Our gross margin for the second quarter continued strong and approximately 49% down slightly from 50% in the preceding quarter and up from 40.8% in Q2 of 2007.
While, we continue to believe that gross margins over the longer term, will range between 40% and 50%. We've been experiencing margins at the higher end of that range, over the last few quarters. The strong recent margin performance compared to the prior year is indicative of a favorable product mix of line cards to chassis in the core business, as well as the overall mix between access and core products and direct versus indirect sales.
Additionally, service revenues, which consist of installation and maintenance from the entire margins, which have continued strong. Gross margin will fluctuate from period to period depending on product and channel mix, volume and pricing as well as the level and timing of routine provisions for warranty, rework, spares, routine inventory provisions and material purchase price adjustments from our contract manufacturers.
Total operating expenses in Q2 were $19.5 million essentially flat with preceding quarter and bettered the $21.9 million incurred in the Q2 period of fiscal 2007. Stock option investigation costs incurred during the quarter and included in operating expense, were $1.4 million compared to $1.3 million in Q1 and $2.9 million in Q2 of last year.
Research and development expenses were $11 million in Q2 up approximately $500,000 from Q1 and essentially flat with Q2 of '07. We continue to invest in R&D with roughly half of our work force dedicated to product development. R&D expense as a percentage of revenue declined to 26% from 28% in the first quarter. The decrease is a direct result of our Q2 revenue growth rate exceeding the rate of growth of development costs. A major factor is the continued success with the expansion of our lower cost Shanghai-based development center. We believe that investment in domestic and offshore R&D initiatives will enable us to compete more effectively for near and longer-term opportunities.
Sales and marketing expenses for the second quarter were $5 million flat with Q1 and down slightly from $5.3 million in the year ago quarter. We believe that continued investment primarily in sales resources is essential to fuel organic growth. General and administrative expenses for Q2 were $3.5 million compared to $4 million last quarter and down approximately $2 million from $5.5 million in Q2 a year ago. The reduction from Q1 of this year relates primarily to the recovery of certain costs previously expensed while the year-over-year reduction is related to this recovery plus lower quarterly costs associated with the stock option investigation matter.
Costs incurred in that stock option investigation matter during the quarter as I previously mentioned were $1.4 million versus $2.9 million in Q2 last year. We reported a non-GAAP operating profit of $900,000 in Q2 compared to an operating loss in the previous quarter of $0.5 million and operating loss of $5.7 million in Q2 of last year. Excluding the costs associated with the stock option investigation matter operating income for the quarter would have been approximately $2.3 million compared to a $2.8 million operating loss in the fiscal ‘07period, a positive swing of $5.3 million.
Our total headcount at the end of the quarter was 439. Interest income which is the main component of other income in the condensed statement of operations was $10.9 million compared with $11.4 million last quarter and $11.5 million a year ago. The reduction in interest income in the current quarter is mainly attributable to lower short-term interest rates being earned on our average portfolio balance as compared with prior periods. We will continue to maintain our traditional preservative investment positions within our significant investment portfolio. Let me emphasize that we hold no auction rate securities direct investments and structured investment vehicle.
Therefore, our exposure to SIV risk is minimal. Because of our strong liquidity position, our investments although readily available for liquidation if needed are generally expected to be held to majority thus reducing significant market risk. We recorded a current quarter tax provision of $227,000 associated with U.S. alternative minimum tax, paid taxes and foreign income taxes and profitable jurisdiction. And in Q1 we adopted the provisions of FIN 48 which specifies how public companies account for uncertainties in income tax reporting. Application of this standard had no significant impact on the company’s reported results. We ended the quarter with total cash, cash equivalents, short and long-term investments of approximately $933.6 million an increase of $10.8 million from Q1, of which $1.7 million represents unrealized gains on securities which are mark-to-market.
The unrealized gain is reported in our financial statements as a direct credit to equity and not as an element of one that to profit or loss. Capital expenditures during the quarter were $3.1 million. Accounts receivable total $40.9 million and represents a DSO or days outstanding of approximately 90 days up slightly from 86 days in Q1. However, let emphasize that our DSO should be viewed as an indicator of the distribution of product shipments and total billings throughout the quarter, rather than an indicator of collectability.
Historically, the company has not experienced nor do we anticipate any significant current collection issues. Inventory at quarter end was $14.3 million. A decrease of approximately $1.4 million from last quarter. And inventory turns were about 5.1 times. This compares with 4.1 times than the previous quarter and represents the second consecutive quarter of favorable experienced. We're committed to a continued focus in this area and on working capital management in general.
However, due to our inherently long sales cycle and related unpredictability with regard to the timing of orders and related shipments particularly in our core business coupled with long lead times for certain materials and component types from our contract manufacturers inventory levels and related turns can fluctuate significantly from quarter to quarter. Other current liabilities including accounts payable, accrued expenses and restructuring costs declined $3.8 million, reflecting the planned payment during the quarter and certain settlements, which were previously provided for.
Aggregate deferred revenue both current and long-term totaled $14.4 million compared to $16.2 million of the end of Q1. Deferred revenue and product shipments is approximately $2.1 million and represents shipments for which revenue recognition criteria has not yet been met. Deferred revenue on service approximates $12.3 million and represents the unearned portion of customer maintenance and support agreements, which will be accredited into services revenue over the terms of the related contractual service periods.
Due to factors we have previously discussed, which limit our visibility into the precise timing of customer orders and related shipments, as well as the factors which impact the variability of our gross margin, we will continue our practice of not providing specific quarterly guidance in these areas. We continue to believe that the multiservice bandwidth management market in which we participate will continue to grow despite the fluctuations in our quarterly revenues that we have experienced in the past and could see again resulting from the factors previously discussed. We believe that our opportunity pipeline is growing. Over the longer-term it remains our goal to grow annually inline with or better than the market. While we are pleased with our revenue performance in Q2 we remain consciously optimistic that our full year fiscal ’08 revenues will equal or slightly exceed those of fiscal 2007.
In summary, we participate in a growing market in which our product differentiation and value proposition provide the catalyst to fuel organic growth. Our margins will continue to vary from period to period based on product, customer and channel mix, but over the long-term and with growth, should be at the higher end of our 40% to 50% range. We will proactively and prudently manage our operating expenses while at the same time making the investments necessary to advance our product portfolio and to compete effectively for the opportunities in our defined market space.
We will continue to take advantage of lower cost offshore development initiatives. Strategically, we will continue to evaluate and consider alternatives which we believe will enhance shareholder value including strategic or other transactions designed to enhance or broaden our product lines, facilitate the development of new products or the advancement of new features and functionalities for existing products. We also continue to evaluate various recapitalization strategies.
In closing, I would like to remind you that Sycamore does not comment on its financial guidance other than through public disclosures and we disclaim any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future results or otherwise. I will now turn the call back to Dan for a few closing comments before we open the call to your questions.
Thanks, Paul. In closing, we are pleased with our solid results this quarter. Our success represents outstanding contributions across the board and I would like to take this opportunity to once again express my sincere appreciation for the entire Sycamore team for their unwavering focus, commitments and excellence in customer support and ongoing dedication for the company’s success. Despite the challenges we face, we are excited about the opportunities ahead and confident in our ability to execute. And with that we will turn the call back to Bob for a question-and-answer session.
I would like to remind you to please keep the limit of one question with one follow-up. Operator, with that we would like to begin the Q&A session at this point.
Thank you. (Operator Instructions). And our first question comes from the line of Paul Silverstein at Credit Suisse, please proceed.
Paul Silverstein - Credit Suisse
Thank you, a couple of clarifications before a real question. On the customer concentration, did you all tell us, what are those two 10% customers accounted for the aggregate?
Yeah, we don't do that on the quarterly basis Paul.
Paul Silverstein - Credit Suisse
Okay, and so is the first one, but book-to-bill can you give us some sense for how much less than one? Was it slightly less than one? Was it even less than one?
Yeah, again we don't comment on the exact ratio but…
Paul Silverstein - Credit Suisse
I'm not asking for the exact.
I think its fair to say it was slightly less than one.
Paul Silverstein - Credit Suisse
Thank you, I appreciate that. So for the question, Dan in terms of customer activity that you see in the market place on the switching side, forgetting about the multiservice access. Can you give some qualitative commentary in terms of what you are saying, whether in public RPs or privately negotiated deals, can you just give us some sense for how activities looks today versus 30 days ago, versus a year ago?
Yeah, I think qualitatively, we think that there is a more activity at this point of time than there was at those time frames. But again I caution you that these are large projects, which take a long time to come to fruition.
Paul Silverstein - Credit Suisse
Then you would attribute the increase in activity, is this just the general trend of carriers recognizing the virtues of a meshed architecture versus bidirectional line switch rings or is it something more than that?
I think its the recognition, the value of mesh architecture, is part of it to be sure. I think carriers are also very interested in some of the inflation points that are coming up and I think that that’s causing a work to be undertaken in that regard looking not only in the current timeframe but for the future.
Paul Silverstein - Credit Suisse
Dan, can I ask you a related question and I will stop here. But if I look at your existing customer base Vodafone and NTT et cetera. Can you give us some sense for what the history has been on follow on business versus the initial foot print? I understand you don't want to disclose any one customer, but generally speaking can you give us some sense for how much revenues flowed following your initial footprint build out from requirements for new capacity for additional nodes et cetera?
Well its very difficult to do it on a broad basis because it really varies by customer and we have seen some customers put the initial network in and expand dramatically over the course of many years and others put the initial footprint in and there is more modest growth just responding to adding incremental capacity. So I think there isn’t one generic template that I could apply any particular customer.
Paul Silverstein - Credit Suisse
What would account for the difference between the two models?
Well for example in some cases in some wireless carriers we have seen significant growth not only with respect to voice but for example high speed mobile data as an example that has caused capacity requirements to be often -- put capacity in place to meet that is an example that I can think of.
Paul Silverstein - Credit Suisse
Great. Thank you.
(Operator Instructions). And our next question comes from the line Subu Subrahmanyan at Sanders Morris. Please proceed with your question.
Subu Subrahmanyan - Sanders Morris
Great couple of clarifications. Did you provide a U.S. international percentage and I think in the past you have guided operating expense range, I just wanted to clarify on that. Then my question really was on guidance, you’ve talked about revenues for fiscal ‘08 being flat to slightly better than better than fiscal ‘07. Do you still feel like your optical switch markets are growing 10% to 15% and access markets are about flat, which would probably imply a slightly higher aggregate growth rate?
This is Paul. Let me take a shot at a couple of those. The split this quarter, domestic versus international, was pretty close. International was about 57% versus 43%, domestically. With respect to -- and again as you know, since particularly in our core business, we are dealing with a relatively limited number of customers, that percentage can flip-flop quite easily from quarter-to-quarter. With respect to operating expenses, we did not give a range this quarter there, as I did note certain things such as our stock option investigation expenses have started to tail down. It’s pretty difficult to put a target on that number at any given point in time. So we have chosen for that and other reasons not to try and bracket that level as we move forward or at least in this quarter.
Then your third question was what, Subu?
Subu Subrahmanyan - Sanders Morris
It’s on the commentary on this fiscal ’08 being flat to slightly higher than fiscal ’07. In the past you’ve talked about a 10% to 15% growth opportunity in the core switching area and a flattish access business which, if kind of aggregate those growth rates you come up with a kind of high single-digit, low double-digit level depending on what you use? So I am wondering if, you still feel those growth rates for the sub-markets are the right numbers.
Let me take a shot at that and then see if Dan has a comment. I mean, I think the message we thrive to get across, is that we think the market that we participate in, is a growing market and that we believe over the longer term we will be able to grow in conjunction with that market. And I think that's really from my perspective, the way to look at this. That you need to think that our business and the opportunities that we see have the capability to grow in some what of the longer term, at least with respect to the growth, the market place. Dan, you have anything to add.
I think other than the -- I think those growth rates are on a longer term basis still appear to us to be consistent.
Subu Subrahmanyan - Sanders Morris
(Operator Instructions). Mr. Travis, I show no questions in the queue, so I'll turn the conference back to you.
Great. Thank you operator. We would like to thank all of you for joining us today as a reminder an audio of this call would be available for 48 hours. Again tomorrow morning on the investor relations section of our website at www.sycanmorenet.com and have a great day everybody.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and we ask you that you please disconnect your lines. Thank you everyone and have a great day.
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