From GS on recent quarter:
VTSS delivered results towards lower end of guidance and outlook is for wide
rev range of $38M to $45M, which is a downtick from expectations. Given
continued challenging business environment and its high op structure, VTSS
announced restructuring with reduction in headcount and closure of Camarillo
GaAs fab, which helps improve longer term viability. Adjusting estimates: F’02
from $174M to $163M, LPS unchanged ($0.42); F’03 from $244M and LPS
($0.21) to $195M and ($0.13). Given continued weak telecom market and
newsflow, we expect trading to remain rangebound near-term and lowering
rating from MO to MP. The stock trades at 3x C’03 sales but has net -$0.07 in
cash/share.
MASSIVE RESTRUCTURING, BREAKEVEN STILL A WAYS OUT
Given the stall in revenue momentum and high operating cost structure, VTSS
announced a massive restructuring, including the reduction of 220
employees, which will result in total headcount of approximately 950 when
actions are completed by the end of September. VTSS is also
restructuring its manufacturing base (including writing off $83.2 million in
PP&E and closing the Camarillo GaAs manufacturing fab) given current
utilization rate of only 10-20%; this is expected to result in deprecation of
$11 million per quarter going forward versus $18 million last quarter.
Additionally, VTSS is combining 8 business units to 4 organized into
Transport, Storage, Networking and Ethernet and discontinuing investment
in next-generation products such as 10Gb network processors and OC-768
products. As a result of the restructuring, VTSS expects to reduce
breakeven from $75 million to $60 million by the December quarter.
However, given the continued challenging business environment, we do
not expect breakeven to be achieved until the end of 2003.
BUSINESS REMAINS CHALLENGING, LOWERING TO MP
VTSS reported inline June quarter results with strength in storage, networking,
and switching, offset by continued weakness of telecom PHYs and
push-out of $2M related to optical transponder modules. Overall, telecom
continued its sequential decline with sales of $16.7M, down from $17.9M in
FQ2. Additionally, while the company recorded book-to-bill greater than
1.0 for a second quarter in a row, outlook is for a wide revenue range from
down 12% to up 5% given the high amount of turns necessary and the
possibility of continued push-outs of transponders; this is clearly a downtick
from expectation, which assumed continued growth in overall revenues.
Vitesse remains well positioned in the comm IC universe but still has a
very high operating expense structure despite the cuts. Further, given our
views that the road to recovery in telecom remains long and with a more
limited net cash position to fall back on, we are adjusting our rating from
MO to MP. In the absence of end market growth, we believe rallies will
continue to be short lived and more dependent on the broader tech tape than company specific newsflow. We
still believe, however, that the company is well positioned once the markets recover and will look to revisit our
rating at either that time or when valuation becomes compelling. Vitesse currently trades at a discount to its peers
at 3x C’03 but we are modeling for breakeven at the end of 2003.
Details on the quarter:
Vitesse reported inline FQ3 (Jun) results with revenues of $43.0 million,
up 2.2% sequentially, down 28.5% year-over-year, slightly lower than our
projection of $45 million, and towards the lower end of the company’s
guidance for revenues of between $42 and $46 million. Pro forma net loss
was $20.6 million, resulting in LPS of ($0.10), which is up from the
previous quarter’s net loss of $21.5 million and LPS of ($0.11); we were
projecting for net loss of $19.5 million and LPS of ($0.10).
As a result of the announced restructuring, the company now has 4 business
units as opposed to the previous eight. The new business units are
Storage, Ethernet, Transport and Networking. Storage includes PHYs for
Ethernet, fiber channel and other datacom applications. Ethernet includes
the upper layers for LAN and the network edge, such as Ethernet switches,
MACs and network processors, including last year’s Exbit acquisition.
Transport consists of PHYs for telecom, including products form the former
advanced transmission division, optical analog division, InP, and optical
subassemblies. Networking includes the upper layer products for long haul
and metro, including pointer processors, packet switches, and traffic
management. Of these segments, Transport continued to be weak, while
Networking inched up slightly, Storage exhibited good growth and Ethernet
grew significantly but off a low base.
Telecom continued its sequential decline with sales of $16.7 million, down
from $17.9 million in FQ2 and $18.5 million in FQ1. This decline was
primarily due to a $2 million push-out by Cisco of the optical transponder
module. The push-out was attributed to Cisco undergoing interoperability
tests with its vendors. Vitesse is hoping to ship that product in the
current quarter but was uncertain of the timing. Recall that the optical
transponder module, which is a family of OC-192 long-reach modules for
metro applications, was acquired through last year’s purchase of Versatile,
a private company. Today roughly 20% of its bill of materials is
manufactured internally by Vitesse; the company expects that number to
reach 40% by next year. Currently the margins on the product are in the
low-50s, with the expectations of 60% ultimate margins. The primary
customer for this product is Cisco, with less than $1 million in sales
coming from other customers, although Vitesse did say that it is currently
sampling it with several additional customers. This product has exhibited
good growth, with $1 million in sales in FQ1 and $3 million in FQ2. Once
Cisco ramps up, Vitesse expects quarterly shipments of $7-8 million to
Cisco alone. Overall, Vitesse assessed the long haul market as very weak,
with 7 quarters of sequential declines and September likely to be a down
quarter as well. Vitesse is not seeing a lot of new activity, which is
further aggravated by inventory of finished line cards that are still
outstanding in the channel and will not likely be depleted for another
quarter.
Ethernet and Storage both exhibited good growth this quarter with strength
seen for 3 consecutive quarters and across almost all customers. Ethernet
sales (which include upper layer products-switches, MACs and network
processors) were up 44% to reach $2.6 million versus $1.8 million in FQ2
and $1 million in FQ1. While coming off a low base, the company is seeing
increased strength in this segment, with strong interest in 16-port
Ethernet switches, 10/100/1000MHz MACs and 2Gb network processors for the
network edge. Storage sales (including PHYs for Ethernet, fiber channel
and other datacom applications) were $15 million, up from $13.7 million in
FQ2 and $11.5 million in FQ1. The company is seeing a general recovery in
storage especially in 2 Gbit/sec fiber channels and 2x Gigabit Ethernet.
Storage customers include EMC, HP, Sun and McData, with EMC now
contributing 8% to sales.
The Networking segment showed slight sequential growth, inching up to $8.7
million from $8.6 million in FQ2 and $8.1 million in FQ1. This segment
includes the upper layer ICs for long haul and metro, including pointer
processors, packet switches and traffic management. While growth in the
segment was modest, the company is seeing strong design activity, with many
products that have already passed design qualification and about to ramp
production. However, this will not necessarily translate to predictable
sequential growth due to the particularly high percentage of new products
in this segment: as customers make changes and qualify products with
customers, it is not unlikely that Vitesse may face delays and push-outs.
On a product-type basis, PHYs were up to $19.5 million from $18 million,
while upper layer devices were up to $23.5 million from $23 million. CMOSbased
products accounted for approximately 77% of sales, up from 75% in the
previous quarter, with the remainder almost entirely GaAs and some InP.
The company expects CMOS to continue to rise as a percentage of the total
as it uses CMOS for almost all new product introductions.
InP development
is still ongoing for OC-192 products but has been discontinued for OC-768
due to lack of demand and the need to refocus R&D efforts on the highest
return projects.
The only 10% customer this quarter was Cisco. Lucent accounted for 7% of
sales, down from 10% last quarter due to weakness in optical transport.
EMC accounted for 8% of sales due to strength in storage.
New products
sales accounted for 40% of total sales in the quarter. Geographically, 75%
of sales were in North America and the rest were international. China
exhibited particular strength, with Huawei contributing 5% to revenues.
The restructuring:
Vitesse announced a massive restructuring intended to reduce expenses and
refocus development efforts on the highest return areas. As part of the
restructuring, the company is laying off 220 employees in a process that
started in July and will be finished by the end of September, when
headcount will have been reduced to 950. Half of the headcount reduction
is in product development engineers, with the rest in infrastructure
functions. Furthermore, as mentioned above, the 8 business units will be
combined to 4 business units organized by Transport, Storage, Networking
and Ethernet. Vitesse has critically reexamined its product development
efforts and decided to continue investment only in those areas that are
likely to generate a sufficient return on investment, which the company
defined as generating 10-20 times return on the cost to develop a product
over the first 3 years of production. Vitesse will continue to support
already announced products but will discontinue investment in nextgeneration
products such as 10Gb network processors and OC-768 products
where it is not seeing sufficient end customer demand to result in a
suitable return on investment. The hardest hit areas, we believe, were
SiTera (10G nPs) and Orologic (10G TMs). In addition, the company is
reducing its manufacturing base to account for a utilization rate of only
10-20%. It is writing off $83.2 million in PP&E and is closing the GaAs
manufacturing process in the Camarillo fab, as anticipated. This will also
result in a reduced deprecation of $11 million per quarter going forward
versus $18 million last quarter. As a result of the restructuring, the
company stated that it will reduce its P&L breakeven from $75 million last
quarter to $60 million by the December quarter, including $22 million in
COGS, $25 million in R&D and $13 million in SG&A. On a cash basis, the
company’s breakeven will be $55 million, with $4 million in quarterly
savings as a result of the headcount reduction and another $4 million as a
result of the other restructuring initiatives. In addition, Vitesse said
it would continue to ’squeeze out’ $1-2 million of non-headcount related
expenses throughout 2003.
The balance sheet:
Cash and equivalents totaled $472.2 million, down from $509.4 million in
the previous quarter. Accounts receivable were down slightly at $47.2
million from $49.5 million, partly due to a $3 million increase in
allowance for doubtful accounts. DSO’s dipped to 99 days from 106 due to
the higher revenue coverage and reduced accounts receivable. Inventory
decreased significantly quarter-over-quarter as the company wrote off $18.5
million of excess and obsolete inventories. Inventory decreased to $26.9
million from $42.5 million, or on a days basis to 59 from 171.
The financial model:
Pro forma gross margin (excluding the impact of written-down inventory)
improved modestly by 30 basis points to 46.5%, up from 46.2% in the March
quarter, driven by slightly higher revenue coverage. Pro forma R&D of
$34.7 million was down from $35.4 million, and SG&A of $16.6 million was
down from $17.0 million as Vitesse continues to reduce costs. Total
operating costs (including cost of good sold) totaled $74.4 million, down
from $75.1 million; the company’s goal is to reduce this number to $60
million by the December quarter. This is a significantly lower breakpoint
level than previous goals of reaching $70-72 million by the December
quarter. Pro forma net loss was $20.6 million, resulting in LPS of
($0.10).
Outlook:
Of the $43 million in revenues, Vitesse shipped $27 million from backlog
and $16 million from turns business. At the end of June the company had
built up $36 million in backlog, of which $26 million is to be shipped in
the current quarter. Accordingly, it must rely heavily on turns business
to reach its revenue guidance of $38-45 million. Bookings in the quarter
of $44 million resulted in a book-to-bill ratio of 1.05, same as last
quarter and greater than one for the second quarter in a row. Prior to
last quarter, the book-to-bill ratio had been below one for over a year.
For the September quarter, Vitesse has guided to a very wide revenue range
of between $38 million and $45 million and LPS of ($0.08) to ($0.09). Of
that, the company expects to ship $26 million of its existing backlog, and
would have to rely on turns business for the remainder. Part of the reason
for the wide range is the possibility of additional customer push-outs as
customers make changes to their projects and qualify products with their
end customers. Optical transport is expected to decline again by about 5%,
while Ethernet, Storage and Networking will likely post sequential growth
again, subject to customer delays.
We are adjusting our model to reflect the company’s lowered guidance and
changed operating cost structure. We are lowering FQ4 (Sep) revenues to
$39 million (down 9% sequentially) from $47.7 million (up 6% off a higher
base) and full year F’02 to $163.3 million from $174.0 million. Our EPS
estimates for FQ4 and F’02 remain unchanged at ($0.09) and ($0.42). F’03
numbers come down on the top line to $195.4 million from $244.4 to reflect
the continued tough end market environment, but are up to ($0.13) from
($0.21) in LPS as a result of the lowered operating cost structure. As a
result of a cash burn of an additional $25-$30 million in the September
quarter and $15-$20 million in the December quarter, the company is likely
to remain in net negative cash territory. The company currently has
$472.2M in cash and $485.9M in debt. |
