Sycamore Networks, Inc. (OTCPK:SCMR) F4Q08 Earnings Call September 5, 2008 8:30 AM ET
Welcome to the Sycamore Networks Fourth Quarter Financial Results Conference Call. (Operator Instructions) It is now my pleasure to introduce Bob Travis, Director of Investor and Industry Analyst Relations.
Good morning everyone and thanks for joining Sycamore's fourth quarter fiscal year 2008 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 8 am 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.
Following my opening remarks I’ll turn the call over to Paul who will cover our financial results in more detail. This morning Sycamore reported fourth quarter revenue of $15.1 million compared with $38.0 million for the fourth quarter of fiscal 2007. Our revenue for fiscal year 2008 was $115.5 million compared with $156 million for fiscal year 2007. GAAP net loss for Q4 was $14.1 million or $0.05 per share, non-GAAP net loss was $7.8 million or $0.03 per share.
We were clearly disappointed in our fourth quarter and year over year revenue levels which reflect the challenges we have spoken about many times concerning high customer concentration in a modestly sized market. We remain focused on opportunities at existing customers, expanding our customer base and advancing our technology differentiation.
Now I’d like to take a moment and highlight some of the progress we’ve made in these areas. During the past fiscal year we were pleased with the progress we made in new customer acquisition. In fiscal year ’08 nearly 25% of our Access business and approximately 30% of our Core Switching business came from new customers.
Although the size of our Access deals are typically much smaller than our Core Switching business during fiscal year ’08 we were successful in penetrating a significant number of new DNX based multi-service access opportunities in a broad range of market segments including utility operators, government agencies, and network service providers.
With respect to our Core Switching business we were pleased in Q4 to add China Netcom to our list of global customers further strengthening our leadership in carrier class optical mesh solutions for tier one service providers. China Netcom selected Sycamore’s SN 16000 Intelligent Optical Switch and SILVX Network Management System as a foundation for its broadband infrastructure network in Jilin province.
Sycamore’s intelligent control plane technology which is shared across our comprehensive optical switching portfolio was again a key factor in our success and will be used by China Netcom to simplify end to end provisioning and facilitate the delivery of flexible and highly scalable bandwidth services.
In addition to supporting a broad range of voice, video and data services for both consumers and businesses the Sycamore ASON-Powered Optical Mesh Network will also enable China Netcom to dramatically reduce operations costs through rapid provisioning and improved capacity utilization. These capabilities were also critical factors in our success for other new core switching customers during the past fiscal year including Telecom South Africa and Media Extreme.
End to end control plane intelligence serves as the cornerstone for operational efficiencies and service resiliency in optical mesh networks. We are seeing increased interest in the benefits of optical mesh and other vertical markets including the federal market space.
In addition to expanding our sales resources in the government space we also recently announced that SN 9000 Intelligent Multi-Service Switch successfully completed interoperability testing with the US Defense Information Systems Agencies Joint Inter-Operability Test Command or JITIC. During the JITIC evaluation Sycamore’s SN 9000 successfully pass the battery of standards conformance and systems performance tests involving a variety of broadband optical and electrical interfaces including procedures for traffic capacity and stress response, failure recovery, traffic protection and rerouting and verification of data and control planes.
This recent milestone is evidence of our ongoing commitment to address the rapidly evolving communications requirements of Defense agencies and our ability to meet these needs with what we believe is the industries broadest portfolio of JITIC certified multi-service switching platforms. As a strategic supplier to the US Department of Defense and other Defense related agencies Sycamore has a proven track record in delivering mission critical government networking solutions.
As we move into the new fiscal year our focus in this space will be to penetrate new multi-service switching market opportunities while leveraging our established success and ongoing focus on customer satisfaction. With the addition of the SN 9000 to our portfolio of JITIC certified switching products we believe Sycamore is well positioned for these opportunities.
In addition to expanding our presence with federal customers our sales team continues to engage with a broad set of fixed line and mobile network operators on a global basis, to deepen our understanding of evolving optical network requirements of our targeted customer base. These interactions have strengthened our belief that the optical network has reached a critical inflection point in the way operators architect their network for scale, reliability, security and increasingly complex mix of multi-service traffic.
While it is clear that the proliferation of content rich multi-media end user applications and always on connectivity represent the underlying force of change for today’s infrastructure networks the architecture and business model challenges that infrastructure operators face as a result of these forces are increasingly complex, with critical implication that touch every aspect of converge service delivery, from service resiliency and traffic scalability the network security and real time performance management.
These trends are driving a new level of convergence between the packet and optical layers of the network. We believe significant opportunities for a new class of high capacity intelligent bandwidth management products will emerge in the coming years as a result of this transformation, with compelling value being offered through the seamless interaction between layer zero, one and two of the network.
Sycamore has increased and will continue to expand our R&D investments in this fiscal year to address these opportunities while leveraging proven technology assets, improving scalable systems and architectures, integrated switching and transport, intelligent control plane capabilities and carrier class Ethernet. We believe that our technology capabilities and presence in tier one carriers around the world position us well to capitalize on these emerging opportunities.
At this point I’ll turn the call over to Paul and then rejoin you for some closing comments before we open the call up to questions and answers.
Before I begin let me remind that current or historical results are not necessarily indicative of results to be expected for any future period and that predictability of future operating performance remains difficult since our revenue stream has historically fluctuated from period to period making visibility into future periods limited. This is due to customer concentration, large project orientation and long sales cycles in our core business.
These factors make the timing of customer orders and results in revenue difficult to predict. Our gross margin percentage also fluctuates from period to period based on the split between product and service revenue, the distribution of product revenue between core and access, the mix of products within those businesses as well as the level of provisions for warranty, scrap, rework and excess obsolete or slow moving inventory.
Operating costs primarily R&D project costs and external costs related to the recently concluded stock option investigation matter have also varied from period to period. Now for the Q4 results.
We reported a GAAP net loss and GAAP net loss per share for the fourth quarter of $14.1 million or $0.05 per share compared to GAAP net loss of $6.1 million or $0.02 per share for the fourth quarter of fiscal 2007. For the full fiscal year ended July 31, 2008, GAAP net loss was essentially break even at $0.1 million compared to a GAAP net loss for the fiscal 2007 annual period of $13.2 million or $0.05 per share.
GAAP results for the Q4 period include charges for stock based compensation of $1.3 million and the amortization and impairment of purchased intangible assets of $0.8 million and $4.4 million respectively. The impairment charge relates to certain identifiable intangible assets which were written down to currently estimated realizable value in accordance with the company’s annual assessment of such as required by GAAP.
For the remainder of the call all references to our results will relate to financial measures excluding these charges and will be referred to as non-GAAP results. Note that costs net of recoveries incurred or realized with regard to the recently concluded stock option investigation matter were $11,000 in Q4 and $1.4 million for the full year 2008 and are included in the non-GAAP results as presented in the non-GAAP statement of operations in our press release.
Non-GAAP information should not be considered superior to, in isolation from or as a substitute for GAAP results. 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 for Q4 for fiscal year and the prior comparative periods is included in the table in our press release and can also be found in the investor relations section of our website.
Our non-GAAP results for the 2008 Q4 and fiscal year period resulted in an operating loss of $15.9 million and $24 million respectively. This compares to a non-GAAP operating loss for the comparable Q4 and full year periods of fiscal 2007 of $5.3 million and $19.3 million respectively.
Non-GAAP net loss and net loss per share for the current Q4 ’08 period was $7.8 million or $0.03 per share compared to non-GAAP net income of $6.3 million or $0.02 per share for the comparable Q4 2007 period. Non-GAAP net income for the full 2008 period was $13.8 million or $0.05 per share compared to non-GAAP net income and net income per share for the 2007 full year period of $26.5 million and $0.09 per share respectively.
Shares outstanding used to compute current quarter and full year EPS were 283.4 million and 282.5 million respectively.
Total revenue for Q4 and fiscal 2008 was $15.1 million and $115.5 million respectively compared to $38 million in Q4 of ’07 and $156 million for the full fiscal year 2007. The decline in both quarterly and annual year over year revenue primarily relates to significantly lower orders one of the company’s major customers.
There were two customers who each accounted for greater than 10% of total revenue in the current Q4 quarter and two customers who each accounted for more than 10% of total annual revenue. The annual 10% customers were Sprint and Nokia Siemens. In Q4 approximately $8.5 million or 56% of total revenue was product related while $6.6 million or 44% came from service. For the full year the product versus service breakout was 77% and 23% respectively.
Core switching revenue was $7.5 million and $88 million for Q4 and FY08 while access revenues for the quarter and full year period were $7.6 million and $27.5 million respectively. For the full year domestic versus international revenue was split 52% and 48% respectively. Our book to bill ratio was less than one.
Gross margin for the Q4 quarter was 28.7% down from 47.2% in the preceding quarter and from 47.6% in the comparable Q4 period of 2007. The lower gross margin percentage results primarily from a provision in Q4 of approximately $2.3 million to reserve against certain inventory parts and components which were determined to be excess of currently foreseeable demand and to a lesser extent the relationship of certain fixed operations and service related costs to lower revenue base.
Excluding the $2.3 million charge overall gross margin for the quarter and full fiscal year approximated 44% and 48% respectively. Product gross margin for Q4 and fiscal ’08 was 38% and 47% respectively while service gross margin for both the Q4 and annual period was 53%. Total operating expenses in Q4 were $20.2 million compared to $18.4 million in the preceding quarter and $23.4 million incurred in the comparable Q4 period of fiscal ’07.
The lower Q3 level benefited from a $2 million recovery of certain stock option investigation costs recorded as a reduction of operating costs in Q3. Recoveries of approximately $200,000 were recorded in Q4. Excluding these recoveries Q4 operating expenses were flat with the preceding quarter. I will provide further detail and the net affect of stock option investigation costs and related recovery in a moment when I address the fluctuation and G&A costs.
Research and development expenses were $12.4 million in Q4 compared to $11.8 million in Q3 and $12.1 million in Q4 ’07. We are continuing to invest in our R&D with a view toward conversions and the next generation of optical products to support it. As part of that increasing investment we continue to expand our Shanghai based development center and expect a number of engineers and facility space there to double during the coming year.
We believe this investment in both domestic and offshore R&D initiatives will provide a portfolio of products to address an evolving market allowing us to compete more effectively for both near term and long term opportunities.
Sales and marketing expenses in Q4 were $5.2 million compared with $4.7 million in Q3 and $5.8 million in Q4 ’07. The sequential quarterly increase is related to the cost of various trade shows attended in Q4 and certain employee related costs. General and Administrative expenses net of recoveries for Q4 and the preceding Q3 quarter were $2.6 million and $1.9 million respectively. This compares to $5.5 million in Q4 ’07.
External stock option investigation costs incurred before giving effect to any recoveries in the Q4 ’08, Q3 ‘08 and Q4 ‘07 period were approximately $0.2 million, $0.6 million and $2.3 million respectively. If we exclude the net effect of stock option investigation costs and the related recoveries our Q4 ‘08 G&A cost declined both sequentially and year over year.
As announced in our July press release the FCC investigation regarding this matter is now concluded and settled with no monetary penalty to the company. Some analysts inquired about the impact of currency or the weakened dollar on financial results. For the most part currency fluctuations have not had a significant impact on the company’s business or its reported results of operations.
International sales are generally denominated in US dollars and manufacturing costs primarily incurred in the US. We do have minimal currency exposure in China for the costs associated with our development center in Shanghai.
Our total headcount at July 31, 2008, was 492 compared to 463 at the end of Q3.
Interest income which is the main component of other income was $7.9 million for the quarter compared with $8.6 million in Q3 and $12.2 million in Q4 of last year. For the full year, interest income was $38.8 million compared to $47.1 million in 2007. The reduction in interest income is directly attributable to lower interest rates being earned on our average portfolio balance as compared with prior periods.
Despite currently lower interest rates we continue to maintain our traditional conservative investment and low risk positions within our investment portfolio. We recorded a current quarter tax benefit of $0.2 million to adjust our full year tax provision to $1 million. Our tax provision was associated with state taxes and foreign income taxes in profitable jurisdictions. In Q1 we adopted the provisions of FIN48 which specifies how public companies account for uncertainties in income tax reporting. Application of this standard has had no material impact on the company’s reported results.
We ended the quarter with total cash, cash equivalents, short and long term investments of $941.8 million, a decrease of $8.1 million the previous quarter end resulting primarily from negative operating cash flow, capital expenditures of approximately $2.2 million and a decrease in unrealized appreciation of securities of approximately $1.2 million.
Accounts receivable totaled $8.8 million and represents a DSO (Day Sales Outstanding) of 56 days. Inventory at quarter end was $23.8 million an increase of approximately $1.2 million from Q3 and net of the $2.3 million provision previously discussed relating to our estimate of certain parts and components currently believed to be in excess of foreseeable demand. At this level and because of our currently lower revenue volume our inventory turned approximately 1.8 times.
The increase in inventory is related to the significantly lower level of previously anticipated Q3 and Q4 shipments when considered in light of inventory acquisition lead times and purchase commitments required by vendors and contract manufacturers in order for them to support anticipated demand. It’s our belief that currently valued inventories will be fully utilized to meet future shipment demand.
Other current liabilities of $14 million includes accounts payable accrued expenses and restructuring costs and represents a decline of $7.5 million from Q3 reflecting lower payables at quarter end primarily for inventory related purchases. Deferred revenue both current and long term totals $19.1 million compared to $20.4 million at the end of Q3. Deferred revenue on product shipments is approximately $5.3 million and represents shipments for which revenue recognition criteria has not yet been met.
Deferred revenue on service approximates $13.8 million representing the unearned portion of customer maintenance and support agreements which will be accreted into services revenue over the terms of their related contractual service periods.
As we have shared with you in the past due to our historic reliance on a concentrated group of large customers primarily in the core switching area and a lack of visibility as to the exact timing and extent to which one particular customer may return to a more historic network build out pattern we are maintaining our policy of not providing forward revenue guidance. We do see an expanding number of opportunities within our pipeline including a small number of significant core opportunities. Although time to close and size remain difficult to predict.
We also see a growing number of smaller customer opportunities whose requirements are while potentially significant in the aggregate when taken individually are not likely to dramatically influence our top line revenue. While our top line visibility is limited at this time as Dan mentioned we’re committed to invest in the future of optical networking with planned additions to our product line resulting in a new generation of optical products focused on the convergence of the optical layer with packet layer networks.
While we’re maintaining our policy of not providing forward revenue guidance we can share the following with you which we believe you may find helpful in thinking about our business going forward. We anticipate increasing total non-GAAP operating expenses in FY09 between 8% and 12% over FY08. On a GAAP basis that increase would approximate 2% to 3%.
The difference relates primarily to the anticipated reduction of approximately $7 million in FY09 of the excluded GAAP charged recorded in fiscal ’08 namely for impairment, restructuring, amortization of intangible assets net of an increase and stock based compensation. The primary drivers of this growth will be the expansion of our Shanghai development center and other expanded domestic development initiatives.
We anticipate achieving reductions and other discretionary expense area although we expect these will be counteracted by the growth in our development investment resulting in the overall growth in operating expenses. We continue to believe that with sufficient volume our gross margin percentage can range between 40% and 50% but would expect to be on the lower side of that range for the fiscal ’09 year.
In closing, let me 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.
While we continue to face a number of challenges in our existing business our long term strategic direction remains focused on delivering best in breed technology solutions aligned to evolving market requirements, an unwavering commitment to helping customers achieve their business goals through technology innovation and service excellence.
We believe the investments we are making to expand our solution offerings will be effective in positioning Sycamore for long term success as market demand for more intelligent, packet capable optical networking equipment evolves in the coming years. We believe we have the talent, proven technology assets, tier one customer relations and financial resources to capitalize on this inflection point in the market and we remain excited by the opportunity that lay ahead.
We’ll now open the call up to questions.
(Operator Instructions) Your first question comes from Paul Silverstein - Credit Suisse.
Paul Silverstein - Credit Suisse
Two part question on the same topic which is the traditional topic of the demand environment. With respect to your traditional optical core switching business can you talked about a small number of core opportunities. Is that new and different what was around three months ago or nine, 12 months ago?
In terms of the new products that you’re developing is this a market opportunity that you see a year out or are we talking about something where you want to put a stake in the ground but we’re really talking about an opportunity that’s not going to worth talking about from a revenue standpoint for another two to three plus years.
With respect to the opportunities in the core switching side as you know there are large opportunities that take a long time to develop. There are some significant ones that are moving in their analysis decision process but they remain very difficult to predict as to timing but they are significant. There are others that are of smaller size that are moving through so I would put it on an aggregate basis of the revenue potential as a slight up tick on that side but not a huge difference between three months ago.
With respect to the new product initiatives I would say they’re more medium term probably 18 to 20 months away kind of thing from a revenue perspective.
Paul Silverstein - Credit Suisse
My traditional question, can you tell us the two customers for the quarter, the two 10% what were they in the aggregate as a percentage of revenue?
In the aggregate?
Paul Silverstein - Credit Suisse
Unless you want to tell us what they were individually?
In the aggregate the two of them represented about 25%.
Your next question comes from Subu Subrahmanyan - Sanders Morris.
Subu Subrahmanyan - Sanders Morris
On strategic side and perhaps you guys have evaluated strategic opportunities given the lower revenue levels how does that affect your strategic review process does it create a need to do this sooner, later, how are you thinking about that. The second question some of the numbers, can you repeat the numbers you talked about the revenue splits between switching and access and product and service.
I’ll ask Paul to cover the second part of the question with respect to the revenue breakdown between the access and switching then I’ll come back and talk about the strategic question.
$8.5 million, 56% was product and $6.6 million or 44% was service. For the full year product was 77% and 23% that would be of the $115 million. Core revenue was $7.5 million and $88 million for quarter and for the full year. Access revenues for the quarter and full year were $7.6 million and $27.5 million. The split between domestic and international was 52/48.
With respect to the strategic thinking it’s really in the fabric of what we’re doing both on the short term and long term basis so it remains something that is at the forefront of our thinking. I can say that the fluctuating revenue level has changed that to a more urgent thinking process than it has in the past.
Subu Subrahmanyan - Sanders Morris
In terms of that process have you in general gotten any closure in terms of termination in direction of acquisitions areas where you’d be more interested, obviously understanding that you can’t talk about your domains or anything like that.
As we talked about in my comments in our discussions with our tier one customers across the world I’m encouraged by the fact that it’s pretty clear what direction they would like to go into. We think that we’ve got a lot of the assets that can help to build upon our product line to address those needs and with that clarity the areas of interest in terms of clearly there’s an internal work that goes on but then looking at external opportunities to add to our portfolio continues so that the convergence between the packet and optical that those are the kinds of technology areas that we would be interested in.
Subu Subrahmanyan - Sanders Morris
On a quarter to quarter basis you’re not providing any revenue guidance because of the fluctuations but last year you tried to address a year over year expectations for revenue going to ’09 versus ’08 any broader benchmarks you’re looking at that you can share with us?
We’ve really concluded that for the reasons we’ve stated that it would be extremely difficult to do that and the three primary reasons I tried to highlight in my portion of the script. One is the open question with respect to one of our major customers and their return to a more traditional or more normal network build. Second and thirdly, as Dan mentioned we do have a couple very large core opportunities that we have been pursuing so to the extent that those came in or didn’t come in could have a significant view towards next year.
On the access side of the business there really are a number of new opportunities that we continue to pursue although as you know the access business individually is much smaller so in the aggregate that could be a very large number but individually they’re relatively small. Given the wide disparity we really believe that at this point anyways it really isn’t helpful to try and establish a range because it would undoubtedly be very, very broad.
Your next question comes from Scott Coleman – Morgan Stanley.
Scott Coleman – Morgan Stanley
I’m wondering if you could just walk us through what you’re thinking about returning capital to shareholders. I think in the past what you’ve said it is something that is under consideration and being discussed by the Board. If you could give us an update that would be great.
As we said in the past, there’s a wide range of considerations there in terms of different methods of returning capital, stock buy backs, other kinds of activities. We continue to review the appropriateness of any and all of those as we go forward.
Scott Coleman – Morgan Stanley
I understand, but I’m curious what the holdup is. I think it’s something you’ve been certainly considering broadly for many years and it sounds like with a higher degree of focus over the last 12 months or so are there particular things that are holding you back that we should be aware of?
You have to look at this not only a short term basis but also a long term basis. Obviously this industry has gone through significant changes with respect to the customer consolidation and the like. As we look to the future looking at how best do we deploy capital and how it could be utilized and in terms of return capital is one thing, acquisitions of companies account for other things and the internal investments we are making. It comes from an analysis of where we think the industry is going to go. Secondly where the opportunities may be and how we can participate in those.
Once we understand what those are then we can make determinations with respect to the appropriate deployment of capital.
Scott Coleman – Morgan Stanley
Would it be fair for me to reason that comment that you want to keep your power dry because you think the industry environment is going to deteriorate from here and it’s going to create opportunities for you to deploy that cash whether strategically or back to shareholders and you just don’t want to make that decision at this point?
I don’t characterize that the industry is going to deteriorate from here but I would say we think there are opportunities despite the turmoil that’s going on in the market at this point in time and so we are fortunate to have the capital to be able to capitalize on those opportunities. We’ll be careful about how we deploy that capital as we have in the past.
Scott Coleman – Morgan Stanley
Obviously a big area of focus for investors in light of Ciena’s results yesterday are deteriorating order trends elongating decision making cycles and so on. Compared to the guidance that you gave at the beginning of the year it’s clear that the second half of the year for you guys fell short of initial expectations a lot of that driven by one large customer. Are you seeing changes to orders at other customers and is this something that you feel like has changed recently?
There’s a lot of dynamics. We’ve talked about high customer concentration within Sycamore but we’re not alone in that. Every single customer, every single competitor in this industry has high customer concentration, every single one of them. I think what you’re seeing is impact when those large customers slow down what they’re doing for whatever reason it impacts us; it impacts our competitors as well. I think we’re certainly seeing that.
We’ve also seen that for example two customers in North America control an inordinate amount of the CapEx in North America and if they decide to move in different directions it has an outside impact on the people who have large presences with those carrier customers on that side. That’s one factor. I think the other factor as we’ve spoken before there are large projects that take a very long period of time to work your way through the selling process, the testing process, the first office applications and the likes.
They take a long time. I don’t know that I’ve seen dramatic change in that fundamental process. The other part gets down to this is somewhat related to the first comment, it depends where people are in the various network builds in the sense are they at the early innings of it, the middle innings or the ending innings. That varies by customer. There’s really no simple answer on that side.
Also looking at the macro impact of things I would say that we be lagging there but the macro trends they’re weakening out there, are going to have an impact on this industry because for example this year a service provider and you’re losing large numbers of customers it’s going to be hard to articulate that you need a lot to capacity expansion in your network as an example.
There are no further questions at this time. I will now turn the call back to you for your closing remarks.
Thank you everybody for joining us today and please find the appropriate information available on the website. As a reminder an audio replay of this call will be available for 48 hours beginning tomorrow morning on the investor section of our website at Sycamorenet.com. Thanks everyone have a good day.
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