11 November 2013

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

For its fiscal first-quarter 2014 (ended 28 September 2013), Oclaro Inc of San Jose, CA, USA (which provides lasers and optical components, modules and subsystems for optical communications) has reported revenue of $138.9m, down on $148.8m a year ago but up on $136.1m last quarter (and above the guidance of $134-138m). Adjusted EBITDA was negative $15.5m, an improvement from negative $21.1m last quarter and $20.3m a year ago (and better than the guidance of negative $24-19m).

However, although this includes $28.3m from a full quarter of revenue for the Amplifier & Micro-Optics business (sold on 1 November to II-VI Inc), it includes only $13.9m from about 11 weeks of revenue for the Zurich, Switzerland-based laser business (sold to II-VI Inc on 12 September).

“While we believe that we have a very solid and exciting strategy for winning market share and seeing growth, our cost structure is far too high and our cash burn rate is unsustainable,” says CEO Greg Dougherty. “We have now completed the first phase of our turnaround plan by closing our previously announced sales of our Zurich and Amplifier businesses.”

Excluding $42.2m from the discontinued Zurich and Amplifier & Micro-Optics operations (which include subsystems, ROADM line-cards and thin film filters, high-power laser and VCSEL products), revenue was $96.6m, up on $95.4m on last quarter and $95.6m a year ago. Of total revenue, customers in Europe contributed 27%, China 24%, the Americas 23%, Southeast Asia 14%, and Japan 13%. The two greater-than-10% customers were Cisco at 15% and Coriant (formally Nokia Siemens) at 11%, with previous 10% customer Huawei at 9% (impacted by delays in China Telecom’s 100G roll-out).

By market, revenue was 50% Telecom (up from 48% last quarter), 43% Datacom (down from 45%), and 7% Industrial & Consumer. In particular, 40G and 100G transmission products (transponders and transceivers) grew strongly by 23% from last quarter (to 40% of total revenue), while Industrial & Consumer products grew by 15%. However, this was offset by an 11% drop in 10G and lower-bit-rate transmission products (to 52% of total revenue) due to both market share loss and supply constraints (from delays in transferring manufacturing of some products from Oclaro’s plant in Shenzhen, China to the firm’s contract manufacturers).

On a non-GAAP basis, gross margin was 12.6%, almost doubling from 7.3% last quarter and 6.5% a year ago. Hence, net loss has been cut further, from $36.2m ($0.45 per diluted share) a year ago and $29.5m ($0.32 per diluted share last quarter to $27.5m ($0.30 per diluted share). Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was negative $19.7m, cut from negative $22.4m last quarter and $25.6m a year ago.

During the quarter, Oclaro recorded a $62.8m gain on sale of the Zurich business (net proceeds of $100.3m - including $8m of holdbacks - offset by net assets sold of $32.5m and deal-related fees of $4.9m). During the quarter, cash, cash equivalents, restricted cash and short-term investments have risen from $87.6m to $94.7m, driven by net cash received from the Zurich sale of $95.6m offset principally by debt repayment of $66.3m and negative cash from operations of $17.6m. Oclaro also paid off its working capital line of $40m as well as its bridge loan of $25m.

“The sale of our Amplifier & Micro-Optics businesses to II-VI brought in an additional $79.6m in cash and gives us the means to take strong actions to restructure the company,” says Dougherty. “In recent months, we have generated in the order of $185m from our product line sales, including some of the holdbacks expected to be released to us in the future,” says outgoing chief financial officer Jerry Turin. “Some of these proceeds have gone to repay our debt, and Oclaro can now apply the remainder of these resources to restructure the company, complete its manufacturing transfers, and fund its operating losses to breakeven,” he adds.

Restructuring to halve number of plants and staffing

“In late October, we began the process of implementing global headcount reductions,” says Dougherty. “We began with notifications in the USA, Europe and Korea. Within the next two months, we intend to finalize our plans for the rest of Asia,” he explains. The plan is to reduce total headcount from about 3000 on 1 July 2013 to about 2200 on 1 January 2014 and likely down to less than 1500 by 1 July 2014. In addition, the executive team and board of directors will reduce its pay by about 15%.

“We have also taken action to simplify our global footprint and organization,” says Dougherty. “Through the previously announced divestitures, we have already reduced the number of our global sites by four. In October, we announced we will be closing our Korea fab for our WSS [wavelength-selectable switch] products and we will complete our last-time buy obligations for WSS and completely exit that business by the end of our fiscal year,” he adds. “We also announced we will be consolidating our high-bit-rate module design team into our San Jose location, allowing us to close our Acton, Massachusetts site as well.” Oclaro expects its restructuring actions to cut its number of sites from about 20 in June 2013 to 10 by the end of June 2014. “We do not expect to see the majority of the benefit of our downsizing until fiscal first-quarter 2015,” cautions Dougherty. “We have aggressively looked to reduce our cost and manufacturing overhead and operating expenses.” The anticipated result of planned actions will be a $10-12m reduction in quarterly spending.

“Over the past months, we have also been focused on creating a post-restructuring strategy and business model,” notes Dougherty. “Our goal is to leverage our core competencies and our strong customer relationships to effectively and profitably compete in high-growth markets. With the sales of our Zurich and Amplifier businesses, we are now well-positioned to execute on our new and refined strategy,” he adds.

“We plan to leverage our technology leadership in indium phosphide (InP) and lithium niobate materials, devices and photonic integration to offer highly differentiated products at both the component and module level for high-speed transmission in both client- and line-side applications,” says Dougherty. “We will focus our R&D on the transition to 100G and beyond in the core optical network, enterprise and data-center interconnects,” he adds.

“To simplify the company, establish a more intensive market focus and to increase accountability, we have reorganized into two business divisions: one for the client-side (‘Optical Connectivity’) and one for the line-side (‘Integrated Photonics’). Each division will have responsibility for its own fabs, operations, marketing, product development and will each contribute about half of the firm’s revenue,” says Dougherty.

In the Integrated Photonics business, Oclaro will target two major growth markets for line-side components and transceivers: next-generation 100G WDM transmission with coherent detection; and 10G medium- to long-reach regional transmission feeding the core and metro optical network. “In that business, we will be highly differentiated through our end-to-end vertical integration, our tunable laser platform, and integrated functionality at the chip level for long-haul performance,” Dougherty says.

In the Optical Connectivity business, Oclaro is also targeting two major growth areas: the 40G and 100G local connectivity between high-end packet optical systems; and applying the firm’s technology and expertise to next-generation interconnects for enterprise, data-centers and storage. “In these applications, our differentiation again lies in our vertically integrated capabilities, including optoelectronics chip and packaging innovation, superior performance and reliability at a competitive cost,” he adds.

To support the two businesses, Oclaro will continue to use its two major contract manufacturers, Fabrinet and Venture. “We have also refined our in-house back-end manufacturing strategy by deciding to remain in China for component-level manufacturing and development at our Shenzhen site,” says Dougherty. “This is prompted by our wish to speed up introduction of complex integrated products by leveraging the skills and many years of expertise of our Shenzhen team. Some of the transfers from Shenzhen to our contract manufacturers have taken longer than originally planned, which has impacted our customers. And it has constrained our revenue output,” he notes. “By maintaining our Shenzhen component-level activities, while continuing the planned transfers to our contract manufactures, we expect to improve our customer deliveries and to mitigate risks in our manufacturing transitions.”

Another change is to simplify and streamline the introduction process for new InP component products coming from the UK. Oclaro plans to establish a new component pilot line in Caswell, co-located with its chip development, to improve time to market for the complex components. “This should better position us to introduce the products that we are developing for 100G coherent applications,” reckons Dougherty.

Adjusted EBITDA breakeven targeted within a year

“In parallel to our restructuring efforts, organizational simplification, and refinements of our business strategy, we have also continued to execute on our shorter-term priorities,” says Dougherty.

“In Q1 and early Q2, we have seen robust demand in both the telecom and datacom market segments, despite some uncertainty about the exact timing of large-scale 100G deployments in China,” he notes. “We have enjoyed strong demand for 100 gigabit CFP product lines, our 10 gigabit tunable products as well as transceivers used in wireless backhaul applications. We have also seen a very large spike in demand for our 40 Gigabit line-side product lines, which are used in deployments in North America,” Dougherty adds. “We have completed our qualification of our dual-rate CFP2 product line and it is now released for mass production.”

For fiscal second-quarter 2014 (ending 28 December), excluding about $7m from the Amplifier & Micro-Optics business (sold on 1 November), Oclaro expects revenue of $92-102m, impacted by ‘price compression’ from annual pricing negotiations. Gross margin should be 10-14%, and adjusted EBITDA should be negative $20-15m, as operating expenses are expected to fall by about $3m.

“While I am pleased with our product traction, our ability to capture the opportunity has been hampered by the transfer delays,” says Dougherty. “As a result, we will be capacity-limited this quarter,” he adds. “But, with the changes we are making, I am confident we should see some improvements soon.”

Oclaro expects to spend $20-25m to restructure the firm and lower its cash burn rate, spread fairly evenly over the next three quarters. With the completion of the restructuring, the firm aims to achieve (within a year) adjusted EBITDA breakeven on revenue of about $110m per quarter, non-GAAP gross margins of 20% and operating expenses of 25% of sales. This will be followed by a goal to break even on a non-GAAP operating base, which is expected to require further improvement in gross margin.

• Oclaro has appointed Mike Fernicola as principal accounting officer (effective 8 November), reporting directly to chief financial officer Pete Mangan. Fernicola has more than 15 years of public accounting and corporate finance experience, most recently as corporate controller of Aptina Imaging Inc from 2010 to 2013.

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