MRV Communications' (MRVC) CEO Dave Stehlin on Q2 2014 Results - Earnings Call Transcript

| About: MRV Communications, (MRVC)
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MRV Communications, Inc. (NASDAQ:MRVC) Q2 2014 Earnings Conference Call August 26, 2014 5:00 PM ET


Kirsten Chapman – IR, Lippert/Heilshorn & Associates

Dave Stehlin – Director and CEO

Mark Bonney – Director, EVP and CFO


Orin Hirschman – AIGH Investment Partners


Good day, ladies and gentlemen, and welcome to the MRV Communications Second Quarter 2014 Results Conference Call.

[Operator Instructions] As a reminder, today's conference is being recorded.

I would now like to turn the call over to Kirsten Chapman.

Kirsten Chapman

Thank you, Jamie [ph]. Good afternoon. Thank you for joining us today for the MRV Communications conference call and webcast for the second quarter 2014 results.

I would like to remind everyone that certain statements made during this call regarding the matters that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Because such statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the statements. To learn more about such risks and uncertainties, you should read the risk factors set forth in the MRV Communications' most recent annual and quarterly filings with the SEC.

All forward-looking statements made during this call speak only as of the time they are made. MRV Communications undertakes no obligation to update such statements to reflect events that occur or circumstances that exist after they are made.

The information provided on this call was also contained in the financial press release in Form 8-K which were posted in the Investor Relations section of MRV Communications' website at, and filed with the SEC.

Joining us today are CEO, Dave Stehlin, and CFO, Mark Bonney. It's my pleasure to turn the call to Dave. Please go ahead, sir.

Dave Stehlin

Thanks, Kirsten, and thank you all for joining us today.

Before commenting on the quarter, I do want to introduce and welcome Mark Bonney. Mark's been a Director at MRV since April of 2013, and I'm thrilled that he's joined me and my executive team as our Executive Vice President and CFO. He has significant experience and success as the CFO of multiple public companies, and will be a great addition as we continue to build this business. Welcome, Mark.

As you are all aware, this conference call is being held much later than it should be, and I apologize for that. Mark will explain the events that caused the delay, but rest assured we're not happy about it, and we're confident that we'll be on track next quarter.

The transformation of MRV that we started about a year and a half ago continues. We believe we are now in a much better position to capitalize on the significant growth opportunities in packet and optical networking. While MRV continues to navigate through some short-term challenges, we believe that we have great opportunity to grow and drive increasing shareholder value.

I'll first review our second quarter highlights. Total revenue grew 13% year over year to $43.1 million, reflecting a strong performance by the network integration business. Network equipment revenue grew 3%. The relatively stable performance was impacted by the timing of certain deliveries that remained in transit in the last two weeks of the quarter. While this is true at every period close, this quarter's sales in transit were more pronounced.

Regionally, sales increased in Europe and in Asia Pacific, primarily from a combination of a broader set of customers and increases from certain key customers. However, sales were roughly flat in North America as we retooled the customer-facing team. Over the past few months we've restructured our U.S. sales team to better align the organization with our strategic objectives of selling more sophisticated packet optical solutions to larger communication providers. We've brought in new sales leadership and added to the team to better serve our key customers. We're already starting to see positive results. The major changes to the sales organization are now complete.

Our focus for the past six-plus quarters has been on building a very competitive product portfolio targeting the optical edge of a network. We're now in the stage where some of the products have been released and we're starting to see some good activity. The momentum we're seeing includes strong results with OptiDriver, our next-generation optical transport platform, that was introduced in late 2013, and we had initial sales in Q1. And in Q2 we booked orders from 10 customers, including five who are completely new to MRV.

Additionally, these customers are located in our target geographies including North America, Europe and parts of Asia Pacific. And OptiDriver is being used in key growth applications such as datacenter connectivity and metro optical transport. These are positive indicators that our strategy is -- of creating a valuable packet optical product portfolio and articulating our value proposition of empowering the optical edge is starting to work. I'll talk more about OptiDriver and another key new product OptiPacket in just a minute.

Our network integration business experienced a strong quarter, increasing revenue 25%. Sales to our largest customers have grown as a result of our solid relationships built on years of performance and our customers believe in our ability to support them better than our competition in a difficult macro economy. Some of our network integration competitors are not weathering the storm as well as we are, and our strong balance sheet has enhanced our ability to win business in a flat economy. We're pleased with the network integration's performance and continued contribution to cash flow.

This quarter we also made significant investments in our new packet and optical products, including complex solutions, which will open new market segments for us. Our increased expense in product development was offset substantially by ongoing cost control and effectively scaling the business. As you know, MRV is committed to serving the metro edge, that is, as I mentioned earlier, what we call empowering the optical edge.

This segment is becoming a new focal point for the network for a variety of important reasons. Traffic growth is being driven by massive increases in IP video and cloud or datacenter usage. Network operating costs are under the microscope as traffic types and patterns as well as capacity growth requires rethinking from network architectures. And studies show that metro traffic is growing at twice the rate of traffic to the core. Within a few years, 75% of all metro traffic will never leave the metro, as the applications driving the bandwidth and the need for lowering costs are forcing change. All these factors point to the need for packet optical solutions that are capable of handling significant capacity on day one and can scale to much higher levels with very low operational costs, all with more hardware flexibility and software intelligence. And this is precisely where MRV is headed.

MRV has been developing differentiating platforms optimized for this optical edge. First, OptiDriver, our new optical transport platform, as previously described, is performing well. We initially introduced the platform in late 2013 and have since added key features such as intelligent Rotims [ph], a variety of 100-gig transport applications for very high capacity needs, and multiple new chassis [ph] sizes for various deployment applications. The same system that can offer the high 10-gig per second efficiency in the community that we compete in, with more than 80 wavelengths and only 10 rack space [ph] also offers the lowest power consumption per bit.

As with our other products, OptiDriver is fully integrated into MRV's advanced provision, service provisioning and management platform which operates seamlessly with a mixed network of MRV optical and carrier Ethernet systems. OptiDriver is succeeding not only because of its flexibility and low power consumption but also because of a variety of standalone applications including metro access, regional transport and datacenter connectivity.

Next, OptiPacket, which we also called the OPX. It's our groundbreaking metro service edge platform, and we announced it in June. While this will be a net new market segment for us, it is both a logical extension to our current packet and optical technology expertise and aligns very well with what is strategically important to our customers. OptiPacket builds on our broader strategy to empower the optical edge by accelerating packet optical convergence with innovative hardware and intelligent software.

By optimizing the OPX platform to packet optical and converge packet optical networks, MRV is enabling customers to seamlessly deliver multi-layer services over the same metro edge. This along with our industry-leading bandwidth capacity, port density and power efficiency make it easier for service providers to manage unpredictable bandwidth demands and service flow control. The intelligence and flexibility we architected into the OPX enables a strong foundation and bridges to success for software-defined networking and network functions virtualization, and other future software-driven services.

OPX enables MRV to address the metro service edge segment of the network and it is a multibillion dollar new market opportunity for us. This segment is adjacent to our current market segment and is a natural extension of our technology capabilities and our customer relationships. Our customers will include communication service providers, data centers, content delivery networks and Web 2.0 customers as well as larger enterprise and governments. Many of these will be the same customers we currently call on. We'll win based on features, flexibility and lifecycle cost.

Initial feedback from the dozens of customers we're engaged with has been very positive as they recognize that our key differentiators, and that this platform is well-positioned for the next-generation network needs. OPX is complex and strategic to many of our targeted customers, so the sales cycle may be longer than what we have previously experienced, and we don't expect it to be a significant revenue contributor this year 2014.

Additionally, we'll continue to add important functionality over time as the platform can support wide range of applications. Strategically, our products work well together as a well-integrated optical edge solution set. Our OptiSwitch packet demarcation and aggregation products, OptiDriver, optical transport, and now our OptiPacket optical metro service edge platform, all managed by a provision management system, form a compelling and leading solution set to layer one, layer two and layer three services, network convergence, adding intelligence into the metro, and addressing the needs of its rapidly-changing optical edge.

I'm now going to turn the call over to Mark to review our quarterly financial results. Mark?

Mark Bonney

Thanks, Dave. Thanks for the welcome, and it's great to be here. I'd also like to add my thanks to each of you on the call today for your interest in MRV, and I look forward to the opportunity to meet you in the future.

Before I review the second quarter results, I want to spend a moment describing why our 10-Q was filed later than normal. As management worked through the quarter closing process, it was determined that Tecnonet, our Italian network integration business, have recorded revenue on transactions but customers had asked them to bill them but to hold the inventory. This practice is allowable under both Italian GAAP and U.S. GAAP, and common to Tecnonet's business. The SEC is very clear about what is required to allow these transactions to be recorded as bill-and-hold under U.S. GAAP.

The finance team, under the direction of the Audit Committee of the Board, supported by internal audit and independent accountants in Italy, fully researched the issue going back three years, and determined that these types of transactions did not meet all the SEC requirements and therefore were incorrectly accounted for.

After analysis, it was determined that they would have been immaterial to our consolidated results in all prior and current periods. We corrected the financial statements at June 30, 2014 for the balances in bill-and-hold inventory. The effects of the corrections on the profit-and-loss statement were approximately a $2 million reduction in revenue and a reduction in gross profit of $200,000. We also increased inventory by $1.8 million as a result of the corrections.

The issue is now behind us, except that it led to a material weakness over financial reporting, which we began to remediate as soon as it was discovered. All this effort took considerable time and occurred after the end of the quarter, which led to our filing a notice of late filing on August 11 and filing our Form 10-Q within the allowable extension on August 18.

Now on to our financials. Consolidated revenue was $43.1 million, up 13% compared to the second quarter of 2013. Network equipment grew 3%. Revenues for carrier Ethernet networking, optical transport and infrastructure management products all grew, which was partially offset by lower service revenue. Additionally, revenue was impacted by a higher level of products in transit at quarter-end, and therefore not recognizable for revenue purposes until Q3. Network integration had a strong quarter, with revenue increasing 25%, primarily due to increased product revenue. The team continues to deliver competitive product offerings and take market share, despite the difficult economy in Italy.

Our consolidated gross margin was 34.3%, as compared to 35% in the prior-year quarter. The reduction was essentially the result of a significant revenue increase in network integration at substantially lower gross margins than network equipment sector, which led to network integration revenue increasing to 49% of total revenue, as compared to 45% of total revenue in Q2 2013.

In network equipment, gross margin was 51.2%, compared to 53% in the second quarter of 2013, primarily due to a shift in geographic mix as sales in areas outside the U.S. increased as a percentage of total sales and margins are lower there due to distribution channel costs.

In network integration, gross margin was 16.8%, increasing from 12.8% in Q2 2013. Certain sales with higher-than-typical margins were recorded tied to specific projects in the quarter and are not expected to continue.

Total operating expenses for the second quarter of 2014 were $15.9 million or 36.9% of revenue, compared to $13.9 million or 36% in the year-ago period. As you know, we've been systematically investing in product development for 18-plus months. Our recently introduced OptiPacket is a sophisticated higher-end product that has required and will continue to require significant development investment.

We also continue to introduce product line extensions for our OptiDriver platform, to provide flexibility and penetrate new applications. Our continued cost control is in place and corporate legal consulting fees are all down comparatively. This is consistent with our plan to minimize G&A expenses while investing in product development and customer-facing activities.

However, total corporate operating expenses increased year over year as the second quarter of 2013 benefited from the recognition of a $1 million insurance recovery for legal fees incurred during the derivative litigation. In other words, had we not received the insurance proceeds in the second quarter of 2013, our OpEx would have been $14.9 million that quarter, and the year-over-year variance to this quarter would have been $1 million or 6.7%.

Our operating loss was $1.1 million, compared to a loss of $535,000 in the prior-year period, which included the $1 million insurance rebate that I previously mentioned.

During the second quarter of 2014, we resolved an outstanding tax audit issue in Italy. The result increased other expense by $200,000 and income tax expense by $300,000. More details on this can be found in our 10-Q filing.

Our net loss from continuing operations was $2.3 million or $0.31 per diluted share, compared to a loss of $993,000 in the second quarter of 2013 or $0.13 per diluted share. That period again including the aforementioned $1 million insurance rebate.

For the six months ended June 30, 2014, consolidated revenue was $85.4 million, up 11% when compared to the prior year's six-month period. Consolidated gross margin was 38.6%, a decline of 150 basis points when compared to the same prior-year period. This reflects the greater revenue contribution from the lower-margin network integration business and a slight decline in network equipment gross margins. The net loss from continuing operations was $6.5 million or $0.89 per diluted share, compared to a loss of $5.4 million or $0.72 per diluted share for the six months ended June 30, 2013, which again included the $1 million insurance rebate.

Now onto a review of our balance sheet. On June 30, 2014, cash and cash equivalents were $22.3 million, compared to $27.6 million at December 31, 2013. The decrease is primarily due to the operating loss year to date. We believe that the company has sufficient cash and we project it to continue to have sufficient cash to operate effectively in the future.

Accounts receivable totaled $49.1 million and days sales outstanding were 104 days at June 30, 2014. Accounts receivable decreased $900,000 while days sales outstanding increased to the 104 days from 90 days in the comparative prior-year period; and that was driven exclusively by network integration's increased sales at normal terms with their customers in Italy.

Inventory totaled $28.5 million, compared to $23 million at December 31, 2013. The increase in inventory was principally in network integration, with the bill-and-hold inventory correction mentioned earlier, along with greater product inventory due to rising order rates.

As we noted last quarter, as the business scales, we expect the timing of revenue investments and implementation of cost controls to continue to cause our profitability to fluctuate in the near future.

With that, I'll turn the call back over to Dave.

Dave Stehlin

Thanks, Mark. Not bad for your second day on the job.

The markets we serve are healthy and growing and we're well-positioned to build on that position and become more strategic to our customers. We certainly have work ahead of us, and we believe our investments in product development, sales and marketing are spot on, and will help drive MRV to new levels of success.

In the second half of 2014, our goal is continue to be grow the top line by improving performance in network equipment, expand our addressable market through an increased contribution from our new products, and focused on tightly managing expenses in both G&A, and improving efficiencies while wisely investing in new product development.

Before I open the call for questions, I would also like to welcome Jeannie Diefenderfer who joined our Board in July. She has great network engineering, operations and procurement executive experience, and we look forward to her insight as we continue to execute on our strategies for building shareholder value.

Operator, I'd now like to open the call to questions.

Question-and-Answer Session


[Operator Instructions]

I'm showing no questions. I'll remind everyone one more time. [Operator Instructions]

Dave Stehlin

Okay. Let me --


I'm sorry. We did just get a question from Orin Hirschman from [I Investment Partners].

Orin Hirschman – AIGH Investment Partners

Hi, how are you? It's Orin Hirschman from AIGH. How are you?

Dave Stehlin

Hi, Orin. How are you?

Orin Hirschman – AIGH Investment Partners

Okay, good. You know, you mentioned the equipment [ph] in transit. Can you kind of give some kind of idea what the magnitude of that amount was? I assume it's going to be booked, this quarter has been booked already really. And just, you know, is it something that's a one-time affair or is it, as the deals get larger, this is going to become more of a recurring issue?

Dave Stehlin

It's probably a one-time thing. It wasn't a massive change, but it was something that shipped at the end of the quarter but we weren't able to recognize. And we don't give the specifics on how much that is.

Orin Hirschman – AIGH Investment Partners

Okay. Just in terms of the competitive landscape, how is it going to change a little bit for you?

Dave Stehlin

Yeah. So a few things. First of all, as you know, some of our products were really long in the tooth and were under-featured. And the first product that we've introduced this year, OptiDriver, is starting to do really well. We've been able to bring new customers into the fold that we, I think, we would not have been able to bring in if we did not have OptiDriver. So that's a really positive sign.

It's gotten up a lot of exposure around the globe, in all the areas we're targeting, and we expect it's going to significantly increase our business over time. We're very committed to the optical transport part of the business. And frankly, it's good to have a platform that is fully capable and not one that could only address niches in the marketplace.

Orin Hirschman – AIGH Investment Partners

If I look at the pipeline of business in terms of companies that have [played] with it, you know, how would that pipeline look, compared to let's say three months ago, six months ago?

Dave Stehlin

Yeah. It's much larger. And I think we're going to start seeing a ramping-up of the results here in the second half of the year.

Orin Hirschman – AIGH Investment Partners

In terms of network equipment that you would consider to be "legacy," is it going to be ramping down at the same time? Is it more a matter of it ramping down slowly or was that having new products pick up a big ramp-down [ph]? How do you view that?

Dave Stehlin

No, I don't think the existing products are going to ramp down, if you will, significantly. It will obviously over time, and especially as we force some changes on some customers. You know, we, at the end of the day, we would like to get customers to move to the new product whenever possible. But we're not going to force that change on people and -- because at the end of the day the customer is king, right? And if they want to stick with an older product and we can continue to support it, we'll do that. But we will encourage them in a variety of ways to move to new products.

But we're most excited about how OptiDriver enables us to go after new business, new customers and perhaps new applications that we were not able to address with the older products.

Orin Hirschman – AIGH Investment Partners

You mentioned I believe on last -- two calls ago, I believe it was Telstra in Australia.

Dave Stehlin


Orin Hirschman – AIGH Investment Partners

Have they commenced their rollout of products? And when do they kind of get into, you know, like a full bloom so to speak?

Dave Stehlin

Yeah. I think it's blooming now. We certainly are shipping to those guys. It's been a piece of the business that's becoming more significant. And they're a critical part of our growth going forward.

Orin Hirschman – AIGH Investment Partners

Okay. And meaning [indiscernible] but second half stronger?

Dave Stehlin

I think the business will over time, you know, you can't really guarantee every single quarter, especially with new customers that don't have a long track record, but when looked at over a period of time, it will continue to scale.

Orin Hirschman – AIGH Investment Partners

Okay. Thanks very much.


[Operator Instructions]

And I am showing no further questions. I would now like to turn the call back over to David Stehlin.

Dave Stehlin

Great. Thank you. And thanks for listening today to our second quarter results.

We've built a strong foundation for growth, anchored on our new products, the OPX, the OptiSwitch and OptiDriver. And we're excited as we move forward to the next phase of our growth.

Have a good day. Thank you.


Ladies and gentlemen, that does conclude the conference for today. Again thank you for your participation. You may all disconnect. Have a good day.

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