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OCP blames the market for gross margin crash

Optical Communication Products says that fewer shipments, a fall in average selling prices, and a portfolio dominated by legacy products are to blame for its negative gross margin in its recent fiscal quarter.

Optical Communication Products, which is currently negotiating with Oplink over a possible merger (see related stories), has reported a substantial reduction in its gross margin.

The California-headquartered fiber optics component manufacturer, which is in the process of switching its manufacturing to China, had a gross margin of -3.5 percent for its second fiscal quarter of 2007. That's a fall of 22 percent sequentially, and 38 percent year-on-year.

"When we launched our turnaround plan we expected market volatility and market changes," revealed OCP's chief financial officer Frederic Boyer in a conference call for the recent financial quarter. "But we did not expect such a difficult industry environment."

Boyer pointed out that these unfavorable trading conditions are not unique to OCP, and were highlighted at this year's Optical Fiber Communication (OFC) conference. At this meeting, the key issues facing this sector were identified as massive over-capacity, free-falling prices for several years to come, and increased competition.

According to Boyer, the analysts at OFC claimed that the companies most likely to succeed in this market were those with new and differentiated technology and products.

"Our Q2 results reflected all of these industry issues," said Boyer. "OCP is getting primarily hit because our product mix consists primarily of legacy products, which is driving down unit sales and average sales prices."

Boyer then admitted that the company does not currently have a broad enough product line to compete, and is particularly weak in the higher speed application market.

In addition, the company is also suffering from a "softening" of the fiber-to-the-home market in Japan, that it entered by buying Gigacomm last year (see related story).

The current poor performance is not obvious from OCP's revenue of $16.4 million for the recent quarter, which is down $0.6 million sequentially and $1.9 million year-on-year. And the company's two biggest customers, Alcatel and Lucent, are the two biggest players in that sector, so the company is winning business with the key clients.

However, operating expenses for the second fiscal quarter were $18.0 million. This included an $8.5 million "non-cash good will impairment charge" associated with a legacy product line, and a combination of a decline in sales volume and a reduction in sales price due to market conditions. Loss for the recent quarter was $17.1 million.

Guidance cuts

In the light of these results, OCP has cut its fiscal 2007 revenue goal from $80-90 million, to $65-70 million, and reset its gross margin target to 10-12%.

Amid all this doom-and-gloom, Boyer did offer some encouragement for investors: "The transfer of manufacturing to China is on track, and progressing smoothly, and the planned reduction in the workforce at Woodland Hills is still on schedule for this summer."

He added that products produced in Asia are already being re-qualified with customers, and said that manufacturing is on track to begin in the fourth fiscal quarter 2007.

In addition, the company is also starting to get into the more lucrative high-speed market. It launched its first 10 Gbit/s product late last year, and this April it has invested $5 million in Stratalight Communications, which specializes in products with speeds of 40 Gbit/s or more.

This set of measures should help OCP towards its long-term gross margin target of 30 percent.

The company's cash position, which is also suffering from the company's current performance, should also get a welcome boost, as the Woodland Hills facility will be put up for sale in a couple of weeks. This building is fully-owned by the company, and it is expected to fetch $20-25 million.

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