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Shares: Go Go Oclaro

While the majority of CS shares head south, Oclaro's are bucking the trend and soaring

BY RICHARD STEVENSON

Some of the biggest names in the technology sector are grabbing the headlines for the wrong reasons. Apple has attracted media attention for a drop in sales, leading pundits to question whether its golden years are over, while IBM is making waves by shedding workers in the US. Given these troubles, it is of no surprise that the share price of both companies is also struggling, with Apple's having fallen by nearly a third over the last 12 months and IBM's by almost one-fifth.

This pair is by no mean alone in having a tough time on the stock exchange. The technology-rich NASDAQ has fallen by several percent during the last year, while the share prices of many firms within the compound semiconductor industry have fared far worse. Take, for example, the heavyweight quartet of Cree, Aixtron, Skyworks and Qorvo, which have all fallen in valuation by more than 20 percent in the twelve months leading up to the end of April 2015.

However, a canny "“ or lucky "“ investor in shares of companies within our industry could still have made a very tidy profit in the last year. To get their best return, they would have invested in Oclaro, which has had a share price that has rocketed by more than 160 percent. And they could still be very pleased with themselves if they had bought shares in JDSU-spin out Lumentum "“ its valuation has climbed by 30 percent since its launch in August 2015.

It is not the first time that Oclaro has topped our share price leader board. It was also the leader in 2014, when company CEO Greg Dougherty took radical steps to make the company profitable. Back then he slashed the workforce from 3000 to 1500 and streamlined operations, halving the number of sites from 20 to 10.

Fast-forward to today and it is clear that Dougherty's actions are working. In the two most recent fiscal quarters the company reported a profit of $2.5 million. And in the current quarter, ending on 2 July, it expects earnings of $7 million to $11 million on sales ranging from $115 million to $123 million.

Since Oclaro started its turn around, its share price has steadily increased, and it is now trading at its highest point since summer 2011 (although it is still far, far lower than the heady days of the dot.com boom). Driving these gains is an improved product portfolio, particularly for 100 G components with relatively high profit margins. For these products, sales for the most recent quarter were up 18 percent sequentially, and almost double those of the equivalent quarter of the previous year.

Speaking to investors on 3 May, 2016, in an earnings call following the release of third fiscal quarter results, Dougherty revealed that in addition to the success of 100G products, Oclaro's sales growth was being driven by an incredibly strong demand from China. "We are well positioned with all four of the major network equipment manufacturers in the region," claimed Dougherty, who added that Oclaro has had unanticipated demand for 10G parts.

Encouraging for the company CEO and his colleagues, demand from China shows no sign of abating. Strong growth is on the cards well into 2017 "“ demand for 100G is believed to be for a widely publicized backbone in metro networks, while shipments of 10G products are set to serve metro networks and aid access aggregation.

There are also other factors behind Oclaro's success. Revenue is increasing for lithium niobate modulators and narrow line-width lasers for coherent transmission. What's more, there is an increase in sales of the company's CFP line of transponder modules and transceivers, and its QSFP28 transceivers, which are said to benefit from the company's vertical integration model and its industry leading lasers.

To further increase sales, Oclaro is investing in the development of new products. They include what is claimed to be the industry's first 400G CFP8 PAM4 transceiver targeting primarily core routing applications, and a single-channel 400G lithium niobate modulator, which several customers are evaluating for field use.

Another highlight is the qualification of 25G DFB lasers for use in non-hermetic environments. "The significance here," said Dougherty, "is that we've demonstrated that our chips can reliably enable lower-cost packaging for data centre applications, by allowing use of cheaper materials and piece parts of optical sub assemblies." 

Oclaro's ramp in production has even led to capacity constraints, according to Dougherty: "Our growth in Q4 will not be gated by demand, but will be limited by what we are able to ship." The company is currently production-constrained on the QSFP28, and recently allocated a significant amount of capital spending to grow its capacity. For most 100G products and tuneable 10G offerings, capacity is "very tight".

Oclaro's share price has climbed steadily during the last year, and is now at its highest point since summer 2016.

Lumentum's momentum

The only other company enjoying a double-digit rise in share price during the last 12 months has been Lumentum, the JDSU spin-out that acquired the parent company's optical components and subsystems for telecommunications and data centre applications, along with its portfolio of high-power fibre lasers and its scientific laser and three-dimensional sensing technologies.

Lumentum's shares launched at $17 on 4 August, 2015, and initially headed north, to spike at just over $23. But by October they had plummeted to a low of $14, before climbing since then to now trade at around $25. 

The company did not get off to an easy start. A week after launching on the stock exchange, company CEO Alan Lowe admitted during a call to discuss first fiscal quarter 2016 projections that sales of fibre lasers had dipped "“ although they were expected to recover "“ and revealed that there had been a now-resolved component problem directly related to the industrial fibre laser. The JDSU spin-out was also suffering from weak demand in the semiconductor equipment sector, where its lasers are used for PCB drilling, and wafer scribe and dice applications.

By the time the company reported its results for its first fiscal quarter on 3 November the share price had already began its steady climb from its nadir, and encouraging results led to further gains. Sales for the three months leading up to 26 September were $212.6 million, up by $3.7 million sequentially, and net loss was down to $0.4 million from $15.4 million. 

Since then the company has increased its revenue quarter-by-quarter to hit $230.4 million for the third fiscal quarter 2016. Results for this period were discussed in a quarterly earnings call on 4 May, 2016, where Lowe described the demands for the company's products as strong and increasing. 

With revenue on the up, Lumentum's share price is heading north.

This demand stems from upgrades and expansions by network and data centre operators in response to the need to increase capacity, connectivity and efficiency to accommodate the rapid growth in cloud computing, video streaming, mobile and other high-bandwidth applications.

According to Lowe, the only way to meet these demands is to deploy advanced optical communication technologies, such as 100G products. "Lumentum is a leader in these enabling technologies," claimed Lowe, "and our investments in new products position us well for these trends. Increasingly, network and data centre operators around the world are critically dependent upon our products."

Like Oclaro, Lumentum is benefiting from strong and growing demand from China. But there is also significant opportunity in North America, where metro deployments are poised to ramp as Lumentum's customers start to transition from field trials to fullscale deployment. "Hyperscale data centre operators continue to plan major 100G upgrades," enthused Lowe, "and we expect roll out to begin in the second half of the calendar year."

Lowe admitted that the company is struggling to fulfil some of its orders: "Despite investing in additional manufacturing capacity, we continue to have challenges in meeting some of our customers' increasing demand." To address this, Lumentum is increasing investments in capital equipment in order to expand capacity and meet the rapidly growing demand from customers, particularly for 100G and ROADM products. In the fourth quarter, the company plans to spend $25 million to $30 million on capital equipment.

For JDSU spin-out Lumentum, quarterly datacom sales increased by 30 percent sequentially.

The lion's share of Lumentum's sales comes from the telecom sector. It was worth just over $150 million in the most recent fiscal quarter, an increase of 2 percent sequentially. However, datacom revenue is growing far faster, with a quarter-over-quarter growth of 30 percent propelling sales to $45.5 million. Within this, revenue for 100 G products shot up by 140 percent in the latest quarter, to now contribute 40 percent of all revenue for Lumentum's datacom business. Total sales are tipped to increase, with Lumentum offering revenue guidance of $232 million to $242 million for the fourth fiscal quarter 2016. Operating margin should be between 8.5 percent and 10 percent, leading to earnings of $18.6 million to $22.1 million.

Third on the leader board is substrate maker AXT. It has had a significant jump in valuation in the last few days, so is already well positioned for a top spot next year. On 2 May it reported first fiscal quarter 2016 results. Sales and income exceeded guidance, with the company making a tiny profit on revenue of $18.7 million.

Commenting on the results, CEO Morris Young remarked that AXT's InP revenue was the highest it had been for several years. "Our manufacturing team continues to work on efficiency and yield improvement, and these efforts, along with our product mix, helped improve our gross margin in the quarter."Plunging the depths

Footing the table for the second year in succession is sapphire producer Rubicon. Over that time frame its share price has sunk from just over $7 to around 60 cents. Rubicon's struggles result from a weak sapphire market with excess capacity. And recently, according to company CEO, Bill Weissman, these issues have been exacerbated by fluctuations in inventory levels, which have created additional downward pricing pressure.

Rubicon's share price has tumbled, due to lack of demand in the LED substrate market.

Although it might appear that the Illinois sapphire-maker is in dire straits "“ sales are still heading south, with the most recently reported quarterly revenue of $2.5 million down $2.9 million sequentially "“ the company is by no means dead and buried. It has products that promise to make a big impact in tomorrow's LED market, and it is pursuing opportunities for sapphire in other sectors.

The company is hopeful that its patterned sapphire substrates (PSS) can revitalise its business. "For PSS, we believe we have a competitive advantage in being able to produce PSS wafers in a vertically integrated process starting from powder aluminium oxide, particularly in larger diameters," said Weissman to investors in late February, during an earnings conference call to discuss results for the fourth fiscal quarter of 2015. He believes that many of his rivals don't have this capability, making them more vulnerable to disruptions. "[Vertical integration] was a significant factor in our qualification at an important six-inch PSS customer and we believe it will become increasingly important to other LED chip manufacturers over time."

Qualifying customers for PSS can take a long time, but this can be beneficial, as it fosters an intimate, loyal relationship. However, even with this benefit, pricing for 6-inch PSS is weak, due to the low demand for 6-inch wafers. So, to make the best of a bad situation, Rubicon is striving to cut costs by introducing new consumables and refining its processes.

The weak pricing in the sapphire market stems from the unfulfilled promise of using this as a replacement for cover glass in mobile phones. It is unclear if this situation will change, but interest in this area has helped to spur development of sapphire for other applications where tough, transparent materials could prove very useful.

Rubicon's optical business is pursing these opportunities, and developing sapphire with dimensions of up to more than 500 mm for aerospace, semiconductor, defence and industrial markets. By the end of this year it aims to be producing 16-inch Kyropoulos boules for semiconductor and defence applications. Other companies can grow crystals of comparable size but Weissman believes that most of these rivals cannot meet the quality of the requirements.

Rubicon's share price has tumbled, due to lack of demand in the LED substrate market.Rubicon's share price has tumbled, due to lack of demand in the LED substrate market.

Rubicon is also working on a government-funded project to produce windows of sapphire up to 2 inches thick, and as large as 18 inches by 36 inches. Weissman claims that there is significant customer interest in these massive windows, and argues that this US programme will position Rubicon to be the dominant supplier of large-area sapphire optical products within the next one-to-two years.

The sapphire maker clearly has a long way to go to turn around its fortunes. But as all investors know, when a company is struggling, significant gains in share price can result from reporting a relative modest, but better, balance sheet. Rubicon should also take heart from the fortunes of Oclaro, which footed the share price leader board in 2012 and 2013, but has topped it in 2014 and this year, by not doing anything spectacular, but simply heading in the right direction.

Rubicon is increasing the size of its sapphire products to try and tap into opportunities in the aerospace, semiconductor, defence and industrial markets






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