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IQE

15 May 2014

Oclaro's quarterly revenue falls 7% as drop in 10G and pause in 100G outweighs 40G growth

For its fiscal third-quarter 2014 (ended 29 March), Oclaro Inc of San Jose, CA, USA (which provides components, modules and subsystems for optical communications) has reported revenue of $95.4m, down 7.3% on $102.9m last quarter and 6% on $101.5m a year ago (and at the lower end of the expected $93-103m).

By application, revenue was 50% Telecoms and 42% Datacoms (together comprising 46% 40G-and-above products and 46% 10G-and-lower products) plus 8% Industrial & Consumer (I&C).

The drop in total revenue was driven by declines of 12% in 10G-and-lower transmission products and 11% in Datacom products, partially offset by growth in 40G-and-above telecom products. “First, we saw lower revenue from vendor-managed inventory (VMI) from two of our largest customers for some of our 10G products,” notes CEO Greg Dougherty. “Second, we experienced a bit of a pause for our 100G product on the client side after having strong shipment of our CFP in the December quarter [during which customers pushed Oclaro to deliver a large volume of 100G CFP for China Telecom]. Third, while we had strong customer demand for lithium niobate products, we did not ramp this business as we had planned. We do, however, expect shipments of our 100G coherent lithium niobate modulators to improve dramatically this quarter,” he adds. “We had another record quarter for our 40G line-cards as we quickly increased our capacity to meet specific customer orders during the quarter.”

The top 10 customers contributed 78% of revenue (up from 75% last quarter), with three greater than 10%. Coriant (formally the Optical Networks business of Nokia Siemens Networks) was again largest with 21% (up from 18% last quarter, including 3% from the merged Tellabs, due to growth in 40G telecom sales). Cisco contributed 12% and Huawei 11% of total revenue (up slightly from 13% and 10%, respectively, last quarter).

Of total revenue, customers in Europe contributed 34% (up from 32% last quarter), China 28% (up from 25%), Southeast Asia 15% (down from 16%), Americas 15% (down from 18%) and Japan 8% (down from 9%), indicating a further shift away from the Americas and Japan to Europe and China.

“While the March quarter results did not meet our expectations, we continued to make good progress on our turnaround plan,” says Dougherty.

On a non-GAAP basis, gross margin was 12.3%, up on 6.9% a year ago but down from 17.1% last quarter (and well below the expected 13-17%).

“The March quarter is historically a tough quarter for gross margin due to the annual price negotiations with many of our major customers. This year was no different as we absorbed about 4% decline in pricing,” says Dougherty. “In addition to the expected price impact, gross margin was negatively impacted by certain product rationalization and production ramp decisions made during the quarter and issues related to management of our contract manufacturers,” he adds.

“We had some execution issues in our lithium niobate modulator line, resulting in lower-than-expected revenues and much higher manufacturing cost,” Dougherty says. “During the third quarter, we did make significant improvements to our lithium niobate processes, which will enable us to increase our shipment by 50% this quarter. The transition to a new process resulted in stranded inventory. Although adversely affecting us in the March quarter, we are now better positioned to address the significant demand for our 100G modulators,” he continues.

“We also addressed some contract manufacturing management issues relating mostly to start-up cost and variations as we ramped up our transferred line with Venture,” says Dougherty. “We have taken steps to improve our management and discipline going forward. We did see marked improvement in production coming from Venture as they came up the learning curve. In fact, by the end of the quarter their execution was on par with our manufacturing partners in our internal sites,” he adds.

“We also continued to focus on the rationalization of our product portfolio, emphasizing differentiation, market leadership and improved margin. We do not intend to chase markets or product areas and catch up unless we are really confident that we can quickly become a market leader,” says Dougherty. “Historically, Oclaro has not done a very good job of integrating its numerous acquisitions or making hard decisions on product line,” he comments. “One move that we made this quarter as part of our restructuring was to integrate into Japan all of our client-side pluggable optics products, which were previously designed and supported in San Jose. The move provides stronger management and focus for these products. This restructuring resulted in excess and obsolete inventory.”

All these items impacted gross margin by about 400 basis points in total compared with last quarter. Despite this, plus the lower revenue, gross margin has still improved on a year ago. “These actions masked the progress that we made in executing our restructuring plan, in particular our continued reduction of operating and manufacturing overhead costs,” Dougherty says. Operating expenses have been cut by $8m year-on-year, as restructuring actions continue to be ahead of schedule.

“Over the past several months, we have taken and will continue to take aggressive steps to integrate the company and improve our business processes,” says Dougherty. Headcount has been cut from about 3000 in June 2013 to 2000 in early January and just under 1400 by early April as 500 were transferred during the quarter from the pump product line to II-VI Inc of Saxonburg, PA, USA (which acquired the business last September), as planned. The original plan targeted a headcount of 1500 by July, but the current plan now targets 1350 by then (including planned new hires for 100G product development in the pilot-production line). Regarding ongoing site consolidation, during the quarter Oclaro sold its wavelength-selective switch (WSS) assets in Korea for $1.4m (eliminating the need for necessary building restoration, equipment disposal and cleanup). Oclaro is now down to 11 sites and will be at 10 by July, as planned. In addition, floor space in the plant in Shenzhen, China was reduced after transferring one and half floors (the pump production line and staff) to II-VI Inc.

“While some of these moves have resulted in negative adjustments impacting gross margin, they are strengthening our foundation for further improvement in our financial performance,” says Dougherty.
Loss from continuing operations was $17.9m, cut from $27m last quarter (which had an $8.3m interest charge from the exercise of the firm’s convertible note) and $31.6m a year ago. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was negative $12.3m, up from negative $10.7m last quarter but cut from negative $23.7m a year ago.

Capital expenditure (CapEx) was $2.4m and the capital lease repayment was $1.2m (i.e. $3.6m together). During the quarter, cash, cash equivalents, restricted cash and short-term investments have fallen from $144m to $122m.

For fiscal fourth-quarter 2014 (ending 28 June), Oclaro expects revenue of $90-100m. Gross margin should rise to 12-16%. Adjusted EBITDA should be negative $13-9m. “Revenue growth will be somewhat muted as our legacy product revenue comes down and our new 100G portfolio takes off,” notes Dougherty.

Oclaro continues to see large demand for 10G SFP products, supporting the large LTE build-out, primarily in China. “We were sold out last quarter, and likely will be again in the June quarter,” notes Dougherty.

“We successfully ramped up our factory in San Jose to support firm customer orders [for 40G line-cards] for June,” continues Dougherty. “However, we were recently informed by our customers that their end-customer - a major North American carrier - has reduced their 40G needs for the second half of this calendar year,” he adds. “The new levels being projected are more consistent with the lower run rates of the past year. We continue to expect this business to roll down over the course of calendar year 2015.”

On the datacom (client-side) of the business, Oclaro has seen a slight uptick in CFP. “We are also seeing the conversion from CFP to CFP2,” says Dougherty. “Customers are ramping quickly to convert their interface slots from CFP to CFP2, and we began volume production in Q3 to support that. We expect to see increasing demand for these products to continue throughout this calendar year,” he adds. “We are also developing new products such as CFP4 and QSFP28 to continue to maintain our product leadership for a 100G application and support the emerging needs for data-centers.” R&D investment is 50% of revenue, focused primarily on 100G solutions for both the client side and line side, as 100G sales have doubled year-on-year.

Oclaro has also established a pilot production line in Caswell, UK (the firm’s primary wafer fab on the line-side), allowing it to co-locate early production with chip and package designers. “It allows us to ramp new, highly complex products more quickly, which results in better time to market and increased customer satisfaction,” says Dougherty. The line has shown the expected benefits in making the tunable laser assembly for Oclaro’s new tunable SFP+ module. The line will also begin pilot production of the firm’s coherent CFP2 product (launched in March) during second-half 2014.

Regarding restructuring costs, in the past two quarters Oclaro has incurred $10m of its $20-25m plan and expects the remaining $10-15m to occur over the calendar year. Regarding normalizing working capital post-divestiture, about half of the $25-30m adjustment was made in the March quarter, and most of the balance ($12-17m) should be reflected in the June quarter. CapEx and capital lease needs remain at $4-5m per quarter. “We will need to continue to fund our adjusted EBITDA losses until we achieve breakeven,” says chief financial officer Pete Mangan. In early April, Oclaro established a $40m working capital line of credit with Silicon Valley Bank. “We do not expect to utilize the facility this year,” he notes.

Oclaro remains on track to achieve its adjusted EBITDA breakeven objective (based on a model of quarterly revenue of $110m, gross margin of 20%, and operating expenses of 25%) by the December quarter, reckons Mangan.

“The execution of the restructuring plan, combined with a considerable new product momentum, gives us good reason to believe that our turnaround remains on track,” concludes Dougherty.

See related items:

Oclaro’s 40 and 100G transmission product revenue grew 20% for second quarter

Oclaro announces exchange of all convertible debt

Oclaro closes sale of Amplifier and Micro-Optics business to II-VI Inc

Oclaro sells Zurich GaAs laser diode business to II-VI for $115m

Oclaro’s strong growth from 40G and 100G transmission products constrained by delays in transferring to contract manufacturers

Oclaro’s revenue falls 4% quarter-on-quarter

Oclaro’s quarterly revenue falls 11%

Tags: Oclaro

Visit: www.oclaro.com

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