Opnext CEO Discusses F3Q2011 (Qtr End 12/31/2010) Results - Earnings Call Transcript

| About: Opnext, Inc. (OPXT)
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Opnext Inc (NASDAQ:OPXT) F3Q2011 (Qtr End 12/31/2010) Earnings Call February 3, 2011 4:30 PM ET


Steve Pavlovich - VP, IR

Harry Bosco - Chairman and CEO

Bob Nobile - CFO


Dave Kang - B. Riley

Sven Eenmaa - Stifel Nicolaus


At this time, I would like to welcome everyone to the Q3 earnings conference call. (Operator Instructions) I will now turn the conference over to Mr. Steve Pavlovich, Vice President of Investor Relations.

Steve Pavlovich

Good afternoon and thank you all for joining us today. We will discuss our financial results for the third fiscal quarter ended December 31, 2010. We'll begin with Harry Bosco, our Chairman and Chief Executive Officer, for an overview of the quarter; followed by Bob Nobile, our Chief Financial Officer, who will provide additional detail on the financial results. Then Harry will talk about market trends, operational plans and guidance and of course will follow with Q&A.

As a reminder, the matters that we will be discussing today include forward-looking statements and as such are subject to the risks and uncertainties that may cause actual results to differ materially from those set forth in these statements. Such risks and uncertainties are discussed in the company's filings with the SEC, including the press release filed today and our most recent annual report on Form 10-K, quarterly reports on Form 10-Q and any applicable amendments. Please refer to the Safe Harbor language contained therein.

In providing forward-looking statements the company expressly disclaims any obligation to update these statements. Also let me mention that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures. A complete reconciliation of the non-GAAP financial measure to the applicable GAAP financial measure, including a reconciliation of adjusted EBITDA to EBITDA can be found in the press release we issued today, which is available on our website in the Investor Relations section.

So with that, I'll turn it over to Harry.

Harry Bosco

Thank you, Steve, and good afternoon, everyone. As you know in addition to my responsibility as a Chairman, I became interim CEO and President in December. I am fortunate to be surrounded by an experienced team and management team that is enabling me to the smooth transition. My focus as CEO will be returning the company the profitability, and I'll talk about more about that later on.

Today we reported improved results for third quarter ended December 31, 2010. Compared to the September quarter, revenues for the quarter ended December 31, 2010 were $97.1 million. It's 12% higher than the quarter ending September 30 and 28% higher than the quarter ended in December 2009.

Sequential growth in 10G and below products improved to 9%, while sequential growth in 40G and above products was 24% led by the growths in 40G and 100G modules. The benefits from our investments in these products continue to gain momentum.

The industrial and commercial business grew 3% sequentially, following several quarters of very high growth. Demand for 10G and below in industrial and commercial products were good. However, our overall book-to-bill was slightly below 1, for two reasons. First, customers have reduced 40G and above order rates as a result of recent supply constraints. And secondly, due to increased 40G and above capacity, we were able to ship more of our backlog.

We made progress toward profitability this quarter. We reduced our non-GAAP operating loss by 46%, and adjusted EBITDA was positive by $1.1 million. Sequentially, gross margin continued to improve on a constant currency basis, and operating expenses were down $2.8 million.

Cash used in operations decreased from the September quarter, to our reduced operating loss. As we prepare for continued growth, we will remain focused on both cash management and achieving profitability.

Now let me turn it over to Bob to discuss the financial results in more detail.

Bob Nobile

Thanks, Harry, and good afternoon everyone. We generated total revenue of $97.1 million in the quarter ended December 31, 2010, representing an increase of approximately $10.7 million compared to the September quarter. Revenue from sales of our 10G and below products increased 9% to $61.8 million, primarily as a result of increased sales of SFP+ and X2 modules.

40G and above revenues increased 24% to $27.4 million and was primarily driven by higher module sales, while subsystem sales increased modestly.

Revenue from industrial and commercial product sales increased 3% to $7.9 million, representing the sixth consecutive quarter of INC growth.

Compared to the third quarter ended in December 2009, total revenue increased $21 million or 28%. Revenue from 10G and below products increased $6.7 million, or 12% compared to the third quarter ended in December 2009, primarily as a result of increased XFP, 300-pin and SFP+ sales, partially offset by decreased Xenpak and X2 revenues.

40G and above revenues increased $10.6 million or 63% from the quarter ended in December 2009, primarily as a result of an increase in module sales, partially offset by decreased revenues from sales of subsystems.

Sales in industrial and commercial products increased $3.7 million or 88% compared to the quarter ended December 31, 2009.

This quarter, Alcatel-Lucent and Cisco each represented 10% or more of total revenues. Combined, these two customers represented approximately 33% of total revenues compared to 34% in the September quarter.

Geographically, revenues in the Americas represented 42% of our total revenue, while Europe represented 20%, Japan 17%, and the rest of Asia was 21%.

Gross margin was 20% in the quarter ended December 31, 2010 compared to 20.4% in the September quarter, while non-GAAP gross margin was 21.5% compared to 22.2%.

In the September quarter, non-GAAP gross margin was unfavorably affected by lower average selling prices and a 90-basis point negative foreign currency impact, as the average Yen exchange rate decreased from 85.8 to 82.5 Yen per U.S. dollar. And gross margin was favorably impacted by higher sales volumes and a higher mix of 40G and above revenues.

Looking forward to our fourth fiscal quarter ending in March 2011, we expect our gross margin percentage to improve at constant exchange rates as we continue to benefit from improved volumes and product mix and the benefit from cost reductions in several of our internally developed components. Offsetting these benefits will be lower average selling prices, including the effects from calendar year-end price negotiations.

R&D expense was $13.7 million in the December quarter compared to $16.4 million last quarter. Non-GAAP R&D expense decreased to $13.3 million from $16 million in the September quarter, primarily due to the timing of material and outsourcing costs related to advanced development programs as well as prototype builds associated with new product introductions.

Approximately $1.5 million of the Q3 shortfall in planned R&D spending will be spent in Q4 when we expect R&D expense to be in the $16 to $17 million range. As we look toward fiscal year 2012, we expect R&D expense to average less than $15 million per quarter, as several advanced products development programs transition to new product introduction efforts.

SG&A expense was $15.4 million in the December quarter, up from $14.1 million in the September quarter. Non-GAAP SG&A expense was $12.9 million in the December quarter, up $100,000 compared to the September quarter.

Looking forward to Q4, we expect SG&A expense to be slightly higher than Q3. Operating loss for the December quarter was $10 million compared to an operating loss of $13.6 million in the prior quarter.

On a non-GAAP basis, the operating loss for the December quarter was $5.3 million compared to $9.8 million in the September quarter, a reduction of $4.5 million or 46%, primarily as a result of higher absolute gross margin and lower R&D expenses, net loss of $10.2 million or negative $0.11 per fully diluted share compared to a net loss of $14.4 million or negative $0.16 in the September quarter.

Non-GAAP net loss was $5.5 million or negative $0.6 per fully diluted share compared to $10.7 million or negative $0.12 in the September quarter.

EBITDA was negative $1.8 million compared to negative $6.4 million in the September quarter, while adjusted EBITDA was positive $1.1 million compared to negative $4.4 million in the September quarter.

Cash and cash equivalents decreased by $10.1 million to $87.4 million at December 31, reflecting $2 million used in operations, $3.4 million of short-term debt repayment, $2.9 million of capital lease payments, $1.2 million of capital expenditures and a $600,000 unfavorable impact from foreign currency exchange fluctuations.

Cash used in operations primarily related to working capital required to fund the sequential revenue growth.

Looking forward to Q4, we expect our working capital to continue to benefit from our efforts to improve our day sales outstanding and our inventory days on hand.

Our CapEx and capital lease obligations are expected to remain consistent with the December quarter, and we plan to pay down an additional $2.5 million of short-term-debt.

Last quarter, we adjusted our planning exchange rate to 80 Yen per US Dollar and established our target of achieving breakeven adjusted EBITDA when revenues reach $97 million for quarter. Although we achieved $1.1 million of positive adjusted EBITDA or $97.1 million of revenue this quarter, we did so with the benefit of lower than expected R&D spending and an average Yen exchange rate of JPY82.5 per $1.

Now, let me turn it back to Harry. He will have more to say about financial objectives.

Harry Bosco

Thanks Bob. I'll start with the market. Industry analyst reports continue to indicate strong growth prospects for our markets. The total optical component market is expected to grow at 16% CAGR over the next three years. And our addressable market is estimated to grow at 22% CAGR. While the 10G markets continues to grow at about of 12% rate, the 40G and above market is now projected to grow in excess of 50%.

Our 40G an above business has had sequential growth in excess of 20% for the last two quarters. Going back to Q3 of last fiscal year our total 40G and above revenues was about $17 million. This quarter it was $27.4 million, which represents a 63% increase in one year.

Excluding subsystem sales 40G and above revenues grew 177%over the past year. While component supplies has improved, we are still dealing with constraints as we ramp productions. Based on the actions we have taken including creating a dedicated team to work with critical suppliers, we expect the supply situation to continue to improve in Q4 and into the new fiscal year.

With supply chain issues easing, we were able to bring down our backlog from the high levels that we had in the past few quarters. We mention last quarter that we believe the 40G subsystem business had bottomed out and that we could start to see some growth in second half. That actually happened in Q3 as the subsystems business delivered modest growth, the first time since Q4 last year. We are not expecting the business to recover to leveled experience during initial network deployment in 2009. But we believe we'll see modest growth going forward.

So let's take a deeper look at the modules. The 10G and below business, which was essentially flat last quarter was up 9% and on a fiscal year-to-date basis our 10G and below business has grown 14%, which is generally consistent with the market. The growth agents for the 10G market continue to be SFP+ and the SFP product families.

We are introducing new products using in-house uncooled-laser technology and lower cost optical subassemblies to improve our cost and provide modules, which consume less power. These products favorably impacted our revenues and margins this quarter and we expect their contribution to increase in the future.

These new products also contribute an increased 10G and below design wins as we added 31 slots during the December quarter. Revenue growth in 40G and 100G module was strong again this quarter. Much of the growth we're seeing has been driven by major carrier deployments and upgraded across all regions of the world.

The transition to higher speed products is a self accelerating as all optical infrastructures are being deployed. Access capacity as well as the core backbone capacity has to expand to accommodate the bandwidth demand from both the consumer and commercial customers.

Also more of our equipment customers are transitioning their products from custom solutions to module base systems. New products have been driving designs wins here as well, 40G modules are now qualified in 69 slots across 28 customers; 100G CFP modules are being qualified in 13 slots with eight customers. Our 100G coherent program continues to progress and we continue to actively engage DWDM system providers on our 100G module approach.

We believe based on these engagements our investments today will allow us the opportunity to address about half the market with moderate additional investment. And so we continue to see this as an exciting opportunity for our company.

Our traditional industrial and commercial markets are healthy and new opportunities continue to emerge. Last week we announced two new products at the Plutonics West Show in San Francisco. Our Violet Laser Diode used for medical illumination systems as well as for direct imaging on PCB manufacturing services and a Blue Laser Diode for mini projector applications. We believe these products will help this business to continue to grow and improve its profitability.

So all-in-all, Q3 represents progress toward our goals. However, we are still not profitable and we continue to use cash. As I mentioned earlier, my top priorities are returning this company to profitability and generating positive cash. While we continue to make focused investments in future products here are some of the actions we are going to take.

First, we're working to improve our gross margins by better utilization of our contract manufacturer's capabilities and working with our suppliers to design lower cost parts. In some of the more mature products, we will use an ODM model with our contract manufacturers, which utilized their design capabilities as well as manufacturing.

In order to accomplish this and ensure a sense of urgency, I appointed a Head of Global Operations, earlier this week to centralize procurement and module manufacturing across the company.

Second we are streamlining our business to further reduce our operating expenses. We have made significant investments in new product development over the past two years. And those products are now coming to the market. Actual R&D expenditures should continue to decrease over the next few quarters.

As we move forward investment in future products and technologies will re-bounce with achieving profitability. Third, we are going to continue drive Yen-base cost and expenses out of the company, while we focus on our Yen-based resources on high valued activities. Our exposure to the Japanese Yen has had a significant impact in the recent past. We can't control the exchange rate, so we're creating a model where we can be profitable and cash flow positive with exchange rate of Y80 per U.S. dollar.

In summer, we've have talked about the market and the growth opportunities before us, we have great products with more on the way, so there's no reason we should not grow at least as fast as the market. However, we will not rely solely on growth as a way to become profitable.

Based on the action I just outlined my objective is to improve our profitably targets by the middle of the fiscal year '12 so that we achieve breakeven adjusted EBITDA at a lower level revenue than the $97 million per quarter that Bob previously discussed.

Now I like to move to the Q4 guidance, we expect revenues from sales, our 40G and above models to continue to grow for most of our product portfolio will be affected by calendar year in price adjustments, therefore, we expect revenues to be between $97million and $102 million for our fourth fiscal quarter and in March 31, 2011.

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

Steve Pavlovich

So that's completes our prepared remarks. And now I'll take questions. The operator will provide instructions on how to submit your questions.

Question-and-Answer Session


(Operator Instructions) And we do have a question from Dave Kang with B. Riley.

Dave Kang - B. Riley

I guess the first question is on, can you just provide more color with this supply issues with 40Gs? Is this your initial live problem? Or any color on that please?

Bob Nobile

Thanks for the question. I think it really primarily relates to some on the IC's that we are purchasing from some other vendors. And yes, there are many others that are using those IC's as well. So they'll be experiencing that also.

Harry Bosco

Also, there are different IC's for 40G and 100G products we have. And then some of them are just really leading edge chips, and so therefore our customers or our suppliers are ramping up their volumes.

Dave Kang - B. Riley

So it sounds like you could have done more. I mean, can you estimate how much was left on the table?

Bob Nobile

There is probably a couple of million dollars, but I mean the thing to look at is our book-to-bill this quarter as we said was a bit under 1, but when you look at our 40G and above businesses, it was still above 1.

Dave Kang - B. Riley

And then regarding your customers, what drove Huawei to drop off as a 10% customer, and where is Nokia at this point?

Harry Bosco

Huawei is still in our top five customers list. And you're going to see things over time where that's going to fluctuate. They're still a significant customer to us, and we would expect to at very times in the future and frankly you'll see them there again. Nokia, Siemens is still also a very good customer of ours'. As you know, they were primary purchasers of our 40G subsystems and actually those subsystems to them and a few of our other customers did grow slightly this past quarter.

Dave Kang - B. Riley

So would Nokia still be top five or at least top ten at this point?

Harry Bosco

What I can talk specifically in what range of customer is at any point in time as we've talked in past generally our top fifteen customers make up about 85% of our revenue, and they fall into that category.

Dave Kang - B. Riley

I guess there is some kind of rumbling going on there Nokia may have lost AT&T or may be sharing AT&Ts 40G with CNI and may be that's why Nokia's numbers aren't that strong. Is that a fair assessment?

Harry Bosco

I would think that first of all, we can't comment about Nokia, Siemens about what their presence is in AT&T. We do know that the AT&T that's deployed right now is still growing.

Dave Kang - B. Riley

Just couple of more, like, can you provide more color, you talked about customers, 40G customers transitioning to modules from custom products. Any more anecdotal evidence on that situation?

Harry Bosco

What we are seeing is, we're selling PPSK modules, DQPSK modules where before a lot of the customers were trying to do their own custom designs. And so changes in the modules allows them to do the transition at different protocols for different (inaudible) across those lines. Same thing's going to happen in the 100G eventually. Custom designs made transition. We saw the exact same thing happen in 10G. It's generally a matter of when it's the right cost points.

Dave Kang - B. Riley

And is volumes significantly more towards DPSK versus DQPSK at this point?

Harry Bosco

It depends on the customers, certainly in Japan is DQPSK. And it depends on the quality of the fiber that they're going to go across and what the constraints are.

Dave Kang - B. Riley

Are there any kind of the margin differential between those two? I assume DQPSK is more expensive?

Harry Bosco

DQPSK is definitely more expensive, but it has better performance for long distances over course fiber.


(Operator Instructions) And we do have a question from Sven Eenmaa with Stifel Nicolaus.

Sven Eenmaa - Stifel Nicolaus

I wanted to ask about the pricing discussions as far in this year, how do they compare with the last year? And how should we think about the impact of those discussions in 40G products versus 10G products?

Bob Nobile

We've talked about again in the past that generally below we see around 15% year-over-year price reduction. And now for the last year or two, we've seen that a couple of points higher than that, primarily in the lower distance short-reach 10G products, because that's where most of the competition is today.

I think as we've looked at what just transpired with the year end price adjustments, it's fairly consistent, especially when you pull out the impact of 40G sampling. And generally, the 40G product decreases will be less.

However, as the products ramp up, you're going from pricing, established for sampling purposes, to pricing established for mass production and that decrease can be higher. But when you look at it kind of on a mass production to mass production level, it's fairly consistent with the historical levels.

Sven Eenmaa - Stifel Nicolaus

And in terms of then, if I just reviewed it under the puts and takes you gave on the margin outlook for the March quarter, it sounds like you will be constrained on the 40G side in the March quarter. How should we think about the gross margin before missing that quarter? Is that going to be sequentially lower or do you expected to be flat?

Harry Bosco

I think we're committed right now to get continuous improvement of margins going forward. So quarter-over-quarter we should see a better increase in margin. And we're not constrained right now with the 40G for next quarter that this quarter we're in right now. So we do have some constraints looking out, because of the volumes required. But I think we'll keep our most of the demand this quarter.


The next question will come from (Shao Wang) with Lotus Capital.

Unidentified Analyst

A couple of things, one, I think in the last quarter, you mentioned there were some supply constraints. Were those related to same IC issues that you said here on this call?

Bob Nobile

They were and it was boarded than that. It also was affecting our various ICs and other components for the 10G business.

Unidentified Analyst

So in aggregate it's moving in the right direction if you will?

Bob Nobile

And if you recall, we had said that some of that supply constraint was affecting our data business, which was down last quarter. And that actually our 10G data then kind of return this quarter.

Unidentified Analyst

Totally separate, I think, Harry, you had mentioned sort of $97 million per quarters as of breakeven by mid 12, was that calendar or fiscal?

Harry Bosco

That's fiscal.

Unidentified Analyst

And then related to that, I'm assuming you're going to sort of a budgeting plan for fiscal '12 at this point. Do you have a sense to what you think headcount might be at the end of fiscal '12?

Harry Bosco

It's really in our business the lot of cost has to do with the services, we have contractors. So our internal headcount will go down somewhat, but it's going to be pretty flat.

Unidentified Analyst

Could you tell me what the headcount number was in the December quarter?

Bob Nobile

It's between 600 and 700 people.

Harry Bosco

Again, you can expect that headcount to fluctuate in manufacture.


(Operator Instructions) And at this time I am showing no further questions.

Steve Pavlovich

Thank you. So we have no more questions. That will conclude our call for today. Thanks again for joining us this afternoon. And we'll look forward to talking with you soon. Bye for now.


Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.

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