F4Q09 Earnings Call

December 14, 2009 4:30 pm ET

F4Q08 Earnings Call

January 6, 2009 8:00 am ET

One of our more popular theme pieces (see “Five Misconceptions About the 10G Optical Market“) examined the state of the 10GbE market and sought to identify the gaps between market perception and reality. It’s time to publish an update with the facts we have collected and opinions we’ve formed since then.

Growth? Is That Really You?

The market for optical modules in Enterprise applications (primarily 1/2/4G SFP’s) suffered through years of secular anemic growth, beginning in 2002 when shipments of copper based GigE ports overtook shipments of fiber based GigE ports. The emergence of copper based GigE effectively capped unit volume growth in the optical business while exposing participants to declining prices as they fought for a share of a fixed pie.

After dropping hints in an earlier conference call (see Vitesse Q207 Conference Call Notes) Vitesse announced the sale of a portion of their storage products to Maxim Integrated Products (MXIM). The $63M transaction has a provision for an additional $12M if certain milestones are hit. The company will use the proceeds from Maxim and $30M in new convertible debt to repay the junk debt to Tennenbaum Capital (see Tennenbaum and Vitesse).

Three months ago I expected the sale of the entire storage unit to fetch 3.5x revenue. Subsequent research and discussions led me to believe this estimate was inaccurate, something reflected in comments I made (see here).

MRV has much in common with Vitesse Semiconductor (VTSS.PK), a company currently targeted by the activist fund ChapCap partners.

Chapman said it expected to file a Schedule DEFN14A with the SEC initiating the process of soliciting proxies from shareholders of the Company today.

VTSS 1-yr chart:

The networking industry may be about to hit a hidden speed bump as the number of semiconductor companies actively involved with developing products to support SONET/SDH, PDH, and other TDM-based technologies can now be counted on one hand.

Lee thinks this is a big problem. This is not a problem at all. It is the only logical solution to the madness of the past six years.

As announced during the Company’s first quarter earnings conference call on April 25th, 2007, PMC-Sierra completed a review of its expanded global distribution arrangement with its largest distributor, Avnet, Inc. (AVT) As a result of completing this review, PMC-Sierra determined it was appropriate that all future revenues generated through Avnet be reported on a ’sell-through’ basis and therefore deferred until inventory is sold to the end customer.

Sell-through provides a more accurate picture of the health of the business and reduces the ease of which distributors can be used to perform channel stuffing.

The explanations for the decline were painfully detailed. The company covered quarterly revenue by product line and provided explanations for each of the shortfalls. The revenue information was welcome as it allowed a clear picture of quarterly product trends to be assembled. I don’t believe this level of detail was possible without the explanation on Friday's call as it allowed some information gaps from previous quarters to be sewn shut.

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Robert L. Chapman, Jr., Managing Member of Chapman Capital, commented,

My biggest concerns going into the call were inventory and cash management, and the company executed well in these areas in the face of declining shipments.

• No cash burn. This was particularly impressive given reduced product shipments and a bigger decrease in Accounts Payable [AP] over Accounts Receivable [AR].
• Inventory reduced. Shipments were down $2M Q/Q, but inventory was still down in this environment.
• AR days outstanding are at an industry low. Lack of capital forces discipline and it shows here at Vitesse. PMCS AR turnover is 35 days, AMCC 42 days. Vitesse is at 15 days. This is the best indicator that the sins of channel stuffing are washed away, as customers don’t pay quickly for product they don’t need.
• Opex down significantly from $28M to $22.6M. This was achieved through the use of multi-project wafers [MPW], as well as higher levels in the previous quarter due to bonuses paid. Assuming 200 engineers were paid $5000 (numbers I am pulling right out of the air), that would account for a $1M reduction, and mask savings were at least another $1.5M. MPW’s are not without drawbacks, as they slow prototyping and increase production costs. Given the long ramp to volume production in telecom products, this is a sensible trade off for Vitesse to make.

I examined the relationship between the two companies in the following articles:

• Consumption was 60-62M. Historically I take the midpoint number for all calculations, yielding the following product line growth:

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Expect to see other semiconductor companies investigating their accounting practices. Board members of these companies are probably scrambling in an ass-covering frenzy as I write this.

The shock and awe portion of the release were the 9 accounting sins committed by the company. I will not list them here, read the release.

In mid-2005, Radnor Holdings Corp., a supplier of foam cups to restaurants, was losing money and struggling under a pile of debt. When plans for an initial public offering fizzled, it began searching for $50 million in fresh capital.

The 13D is filled with correspondence between him and Vitesse execs over the previous months, specifically calling for the removal of Lou Tomasetta and Jim Cole from the Vitesse Board of Directors. I must admit that I was disappointed - I expected more shock and awe in his correspondence. Chapman outlines what he believes are conflicts on interest between Jim Cole, Lou Tomasetta, and Gene Hovanec. There’s little here that wasn’t already in the public domain, but he chose to amend his 13D. I do not understand why.

My feeling that the market was too pessimistic on cash burn was vindicated. Following the call in July, most believed Vitesse (VTSS.PK) would shortly become insolvent, or at best, require an additional infusion of high-cost capital. The company ended up burning $2.8M in Q4, including $4.9M paid for gumshoe accounting. Looks like next quarter will be a little worse, but nowhere near the $50M burned in the previous six months.

The breakup value of Vitesse Semiconductor (VTSS) is $2.50/share, net $170M debt and $20M cash this yields a valuation of $1.75/share. This is based on valuation of each of the three Vitesse business units.