CEOs describe strategies for profitability

by Stephen Hardy

Much of the talk among executives and observers at OFC/NFOEC in San Diego centered on the economy; would recession in the U.S. trigger another downturn in the optical communications industry? Optical components and subsystems suppliers, battling against an overabundance of competition and an underabundance of profitability, appear particularly vulnerable to bending in the face of any ill wind.

The timing of the recession couldn't have been worse for companies such as Finisar (www.finisar.com) and Bookham (www.bookham.com). The former preannounced record revenues for the quarter that ended January 27, offering hope that Finisar would once again inch into the black. (Its official earnings statement fulfilled the promise of the preannouncement; a record $112.7 million in revenues led to non-GAAP net income of $7 million, or $0.02 per share.) Bookham, meanwhile, after being on many analysts' deathwatch lists, achieved positive adjusted EBITDA in the second quarter of fiscal 2008, which closed December 31, 2007.

Finisar and Bookham are two of several component and subsystem suppliers who used last year's upturn to improve their balance sheets, to the point where true GAAP-based profitability appeared within reach given continued growth in 2008. Despite the darkening economic picture, the heads of Finisar and Bookham expressed readiness in San Diego to take steps this year to ensure that the impact of their recent achievements lasts longer than a quarter.

Jerry S. Rawls, chairman, president, and CEO at Finisar, says his company needs to build on the foundation it has laid in making transceivers and other optical components and modules for the enterprise/IT market. "I think our broad product line is one thing that serves us well. I think the other aspect of it is execution," he explains. "Because we make more than a million optical transceivers a month, we have had to learn how to run a factory that can produce that many with very, very strong quality metrics, on-time delivery metrics."

But while the company's offerings may be broad within the datacom arena, Rawls says customers would like it to grow further. "We would like to expand on the line side of the telecom WDM systems," Rawls reveals. "In these next-generation networks the next place you move is ROADMs, and then the combination of ROADMs with channel monitors and other WDM products that enable these really capable networks."

To this end, Finisar announced at OFC/NFOEC a partnership with Nistica (www.nistica.com), a young company that makes ROADM products for the metro arena. The partnership will see Finisar market Nistica's technology to select Tier 1 accounts across most of the globe (Nistica already has a partnership with Fujikura for the Japanese market). Finisar has invested an undisclosed amount of cash in Nistica as well.

Rawls also has his sights on additional product expansion. "One of the things that we'd like to be able to do over the next couple of years is be able to supply tunable products," he says. "I think it's fair [to assume] it will require a partnership or at least a supplier and OEM relationship. Today, we make a number of lasers, but we don't make any tunable lasers internally."

Meanwhile, Alain Couder, who became Bookham's president and CEO last July, assigns most of the credit for the company's turnaround to COO Jim Haynes and interim CEO Peter Bodui, who assumed control of the company when former president and CEO Giorgio Anania stepped down in February 2007. Couder says the two put in place a cost-reduction plan that he agreed would get the Bookham back on track. Thus, when he first joined, his immediate priorities included ensuring the company successfully executed the plan and improving Bookham's cash position. A secondary public offering, which netted approximately $41 million when it closed in the fourth quarter of last year, met the latter goal.

"Now I meet customers and they know we are in business," Couder proclaims. "We have done EBITDA positive and $65 million [in total cash reserves]. We are stable financially for the years to come, and that's a very different dialog. We are ready to talk strategy and the future."

That strategy includes finding better ways to incorporate Bookham's technology into marketable products. Couder has reorganized the company into three business units, headed by executives with profit and loss responsibilities, to help achieve this goal. "We have to become a market maker," he says. "Technology is important, but it is more important to bring to the market the innovations that can really make a difference."

Organizational efficiency will prove essential, Couder believes. Saying that "I view Bookham as a semiconductor company," Couder measures the optical components market with metrics from the IC space. "I personally believe that Moore's Law is going to apply to optical components the same way it applies to semiconductors. And therefore it is up to us to find the means to decrease costs and increase performance fast enough in such a way that we improve our costs faster than we have to reduce price. And that's what we're already doing in pumps and in tunables -- and we plan to do that across the board. And I don't see any reason why this industry can't be profitable and growing as a result of that," he offers. "I don't think we have to complain about price pressures. It happens in all industries."

Couder sees room for new product development from internal R&D -- "We have many innovations that we are not even able to bring to market because of lack of resources," he says -- as well as from outside sources. "We have some technologies that we could grab, so we may do some technology acquisition...or partnership, because one thing I'm finding out is that we don't have many partnerships in this industry. And I think there's room for strategic partnerships."

However, Couder says that mergers and acquisitions aren't at the top of his to-do list. "We have to deliver," he explains in answer to a question about changing the financial community's opinion of the company. "What I tell my team is that Bookham, because of history, people are finding out that we have some good potential, but we are on probation. I think we need to get off of probation; I think we'll see the value of the stock go up [then]."

One could suggest that the entire optical components space is on probation in the eyes of the financial markets, with a reduction in the number of companies competing for market share a requirement for release from this condition. Rawls and Couder agree that consolidation, via mergers and acquisitions (M&A) or outright attrition, would benefit the industry. But neither expressed optimism that we'll see wholesale consolidation this year.

"One of the difficulties in the past has been trying to find ways that companies could combine that would be favorable to all the shareholders. You can find ways to combine that would be favorable for shareholders on one side or the other. But I don't know that we've found too many ways to be favorable for everybody," says Rawls in citing barriers to consolidation. "And the Japanese, who are such an important part of the optical components business, have historically not combined with anybody."

Along these lines, the willingness -- or lack of it -- of companies to play the M&A game also has played a large role in dampening consolidation. Rawls points to his company's relationship with Nistica as an example. Finisar originally wanted to buy the company, but it turned out not to be for sale; Nistica management preferred to improve the company's value rather than sell at its current valuation.

Couder would appear to understand Nistica's position. "I don't see any urgency for consolidation, at least as far as Bookham is concerned," he explains. "I think we can become a profitable, growing company. And once we are there, maybe we could look at some consolidation with companies in adjacent markets."

The "adjacent market" characteristic is important to Couder. "My experience in merging two companies with similar product lines in the same market is catastrophic," he asserts. "Usually you take 1+1=1.5, and your share of the return is not very good because the customer wants to have dual sourcing, etc., and therefore you end up with a problem."

Thus, if Bookham were to look at a major merger, it would likely be with a datacom supplier or some other company not already operating in telecom, Couder predicts. But regardless, now is not the time for a large deal. "I think we need to finish our homework first, and then probably next year we might be thinking about that. Although a year from now is a long time in this industry."

"It's not something you can really force," Rawls concludes. 'If you try to force the consolidation, the thing that you'll end up doing is paying way too much money for any company that you would acquire, and all of a sudden it would not be favorable for our shareholders."

Stephen Hardy is the editorial director and associate publisher of Lightwave.

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