Filed by Bookham, Inc.
Pursuant to Rule 425 Under the Securities Act of 1933
And Deemed Filed pursuant to Rule 14a-12
Under the Securities Exchange Ace of 1934
Subject Company: Avanex Corporation
Commission File: 000-29175
Event Name:
Bookham, Inc. and Avanex to Hold Joint Presentation at Thomas Weisel Partners
Technology & Telecom Conference
February 11, 2009
CORPORATE PARTICIPANTS
Alain Couder; Bookham, Inc.; President and CEO
Giovanni Barbarossa; Avanex Corporation; President and CEO
Jerry Turin; Bookham Inc.; CFO
CONFERENCE PARTICIPANTS
Ajit Pai; Thomas Weisel Partners; Analyst
Seth Spalding; Passport Capital
Ajit Pai:
Welcome to the presentation at the Thomas Weisel Partners Technology and Telecom
Conference 2009. It gives me great pleasure to have with us today Alain Couder, the Chief Executive
Officer of Bookham and also Giovanni Barbarossa, the President and Chief Executive Officer of
Avanex Corporation.
For those that dont know me, Im Ajit Pai, the Applied Technologies Analyst at Thomas Weisel and
to begin with, I think were going to have Alain walk us through a few slides talking about the
potential combination of the two companies, which has not yet been consummated. And then after
that, well open it up for questions. And if the audience doesnt have any, I have several.
So, over to Alain.
Alain Couder
: Okay. Good morning and its clear that we have not closed yet, so we are still two
independent companies, but we thought it was clearly more effective to do the presentation
together, otherwise you will have to ask the questions twice and we are not sure you will get the
same answer twice. So, this time we are much more consistent.
The slides that Im going to show you were already in the announcement package, but we are going to
give you the different flavor because since we announced, we have been going to the world and
talking to customers and partners and suppliers and investors as well and therefore, I thought
sharing with you the kind of feedback we got and why we think that the rationale for putting the
two companies together is the right one. So, Giovanni is with me and will share the questions and
he will intervene if I forget something in my speech.
So this, you can read and this you can read as well. I think this is the first slide which I
covered in the announcement, so I dont want to repeat it here. I think the most important one, and
that was in the announcement, is this one that means the two companies together in the telecom long-haul and metro markets have a very strong position from a product standpoint.
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And this is the feedback we got from major customers like Alcatel, Cisco and others, that basically
we are now in a position to be a true alternative to JDS in the long-haul and metro
telecommunications markets. Before, in order to be an alternative to JDS, you had to call on
several point companies as the slide demonstrates. Right now, basically in the long-haul and metro
telecommunications markets, between Bookham, Avanex and JDS, there are two suppliers, which is
exactly what they want.
This is good news for us because first, its recognition of the complementarities of our product.
And second, we are clearly becoming a strategic supplier. And some customers have already discussed
longer term potential projects that could be done with us as a result of that. And also, they see
that the combined company has a financial stability and financial strength that neither of the two
companies had before. So, I think this is quite a strong point.
Do you want to add something on technology and products?
Giovanni Barbarossa:
Yes. I just want to add a comment that we need to kind of remember that our
customers dont have the same buying pattern. So that our customers, theyre really pretty much
still buying components. And a good example is Huawei versus other customers that buy primarily
modules. Another good example is Alcatel-Lucent.
So, having a very complementary product portfolio, like the two companies combined, obviously will
give us the ability to penetrate the market and gain a market share that we have not been able to
kind of gain as separate companies. So, thats very important.
In terms of the product complementarity from a technology standpoint, it obviously gives us, the
combined company, the ability to extract costs from the modules and the subsystems solutions, which
we were not able to extract as separate companies. So, thats also very important in a market where
our customers and our customers customers are really looking at the lowest possible cost of
ownership of the network and so, we are putting together the two product portfolios, well be able
to provide those cost synergies at [part] a level that we have not been able to provide separately.
And again, from a market standpoint, there is really only one other company that has a similar
product portfolio. Actually, they lack the special compensation for the portfolio, which we have,
thats really an issue. So from that perspective, we have a little bit broader portfolio actually
than JDS Uniphase. Thank you.
Alain Couder:
So, this is a good foundation for customers. In terms of customers in the telecom
area, we basically have all the big names, but most of the time, when one company was strong, the
other one was not as strong. For instance, at Alcatel-Lucent, Avanex has been very strong for many
years. We were just starting to penetrate Alcatel-Lucent. As you get Nortel, its kind of the other
way around. At Cisco, some of that as
well, and so the and Fujitsu, Avanex has a stronger position than we had. Our position
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in Japan
was not very strong, while Avanexs position in Japan is much stronger. So, the complementarity of
the two is a big asset.
But now, we are coming with one sales force, a much broader product line and we sell to those
customers. But because we already have the relationship, then we can expect a much more rapid
penetration than either of the companies would have been able to do on their own. And thats the
potential for growth in terms of taking market share, even if the economy was not going to pick up
quickly and that the market will stay flat, we think that we have real opportunities through that
to be able to take market share in the long-haul metro portion of the telecommunications market.
So, we see that as a good opportunity that we will tackle. But, also its an opportunity to
increase sales productivity because even if you have a large penetration at a customer, you still
use one account manager. Those people are great, but they are expensive. So, we have another
opportunity of being leaner and more profitable. So, this is the first point. That means the
customer feedback and why we think we are quite well positioned to grow even in a flat market.
The second point is about the synergy. I think Giovanni already described to you the
complementarity of our product lines. One important feedback from customers is that usually when
there is a merger of two companies of similar size, you have two of each, such as two of every
product. Therefore, you have to make a selection and the customer for whom a product line gets
stopped might get upset because they have to re-qualify with the other party. We have none of that.
In fact, out of all our products, there is one product where we have the same product to one
customer.
So, this is very good news in terms of customer satisfaction. It is also very good news in terms of
the combined revenues. We should not see any revenue decline due to some customers trying to move
to the competition because theres already two products from Avanex and Bookham. So, I think this
is one important element of the synergy between the two companies. Its complementary to our
product lines and therefore, to the ability to keep customer satisfaction high.
Now in terms of executing on synergies, the number one thing that we told the team is that the
number one criteria is to maintain customer satisfaction and customer continuity. But at the same
time, cut, from day one, anything that is not absolutely necessary for customer satisfaction.
We now have an integration planning team in place, led by a team of two people, one from Bookham,
one from Avanex. And we are going to make sure that even if the deal closes in three months, which
could happen if we dont have a necessary review, then we will be fully ready to trigger on day
one, all the synergies.
So, the question I got from several of you on the phone in the past few weeks, what about
synergies? Can you tell me why they are real and why is that going to happen? So in
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terms of
synergies, basically theres $7 million in synergies that we will be able to realize during the
first full quarter after the deal closes. And in order to do that, we are going to spend $7
million. But another number you might be interested is that this $7 million is going to generate
$20 million of synergies in the first year. So, if you turn to return on investments, we are
expecting a nice return on investments for this type of merger.
So, how does this $7 million per quarter that we will have beyond the fourth quarter play? The 35%
on gross margin and 65% on SG&A, while we will be keeping R&D at 12% to 13%, so we will if we
have some synergy in R&D, we will reinvest to make sure we keep innovation up and that we drive
from technology leadership. So in terms of the gross margin, there are several items. One is the
supply chain. We do not need two supply chains. We will have one supply chain.
The second one is the ability to pick the best place to manufacture at the best cost. So, we have
Fiber Net, now [Tooka] went Shenzhen, which is insourcing. And clearly, well tell Fiber Net, if
you cannot manufacture at the same price as Shenzhen, we will remove the product. And well make
sure that Shenzhen is as competitive and as lean as whatever Fiber Net can do. So, we have an
ongoing benchmarking. But there are short term elements of capability. If you look way down at the
chip component level, like ship-on carrier or submarine pump and things like that, there is a lot
of IP at this level. So, I think its inside, its quite important to protect the IP.
When you move out of the food chain and go on to assembly and test, then outsourcing is a
possibility. There, clearly on the manufacturing strategy, we do not intend to grow all outsourcing
or all insourcing. When Shenzhen will be full, we will not do another Shenzhen, we will outsource.
But the answer I think is all, that if theres some things that are better inside for time to
market and the possibility short term, all the things kind of very standard assembly test and
they are better done by contract manufacturers. So, we play on that as another source of synergy at
the gross margin level.
The third one is in-feed. That means we will be able to use our lasers, our receivers, our filters
into the Avanex products and we could use some of the modulators from Avanex in some of our
products as well if when they can give better performance. So, this in-feed can be pretty
significant. Just one example on the pumps, that Avanex is using, is in the amplifier. Right now,
we are supplying no more than 25% of those pumps to Avanex, so well be able to expand that over
time to 100%.
So, those are the three measures associate of synergies. Did I forget something, Jerry?
Jerry Turin:
I think you hit them.
Alain Couder:
Okay. Thanks. The second point is about the 65% of SG&A. In SG&A, we noted two public
companies and D&O insurance, external auditors, or two Boards and all that. Its something pretty
expensive. Its probably $3 million to $4 million per year to run a public company. So, we will get
down to one and that we can do right away.
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We dont need two finance organizations. We dont need two HR organizations. We need only one
sales force. On the sales force, we cannot divide the sales force by two, but we probably can put
the two sales forces together and downsize by about 30% the results of the two. So, this a sum of
all of those elements in SG&A that are going to cause the others the 65% of $7 million.
So, thats how we are going to make that happen. The good news about SG&A is that a lot of it can
be done in the first 90 days, while the gross margin will take a little more time because it means
the re-testing of the products and a choice of manufacturing if you have to move manufacturing from
one site to another and things like that. It will take more time.
As a result of that, we believe that about half of the $7 million can be done in the first full
quarter after we close. So, thats basically where we are on synergies. There are other things that
we already discussed that will play on the top line. That means expansion in the customer base that
can happen faster. And the more positive feed as we grow further. So, theres quite a few things in
terms of in-feed and technology in terms of synergy.
And I think that the combination is quite compelling from a financial standpoint. We put the two
companies together, we clearly I give you one data point is that when we will be back at $110
million, per quarter, we will be at 7% operating margins, thats what I said in the
announcement. So, the question Im getting all the time, but what if the market is flat? What are
we going to do?
In terms view that is the market effect, we will take further action and that we will lower the
$110 million. And right now with the current structure, we think we can be proactive around $90
million. But even if necessary, we would do more. Because if you remember, the production machine
of Bookham was able to break even at $70 million. So, if it was really a very bad market, we could
take some restructuring actions to make sure that we lower the break even point in such a way that
we get to the profitability fast and that we preserve cash.
And so in conclusion, I think the two companies is a much more powerful company. We create the new
company for now. We have clearly a best-in-class product at the terminal level, at the chip level,
at the amplifier level, some very interesting 40G technology, both using lithium Niobate from
Avanex and Indium Phosphide from Bookham.
In terms of operational strength, I think Avanex has a very lean operational capability, everything
being outsourced except the fab in Milan where Bookham has a very effective
production machine. I think we demonstrated that in the December quarter where before we learned
about the Nortel bankruptcy, on an $11 million reduction of revenue, we were still able to increase
the gross margin to 27%.
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So, clearly this is a deal that is with the first full quarter, will start to be accretive. And
this is a repeat, at the bottom of the slide, of what I already said. But one last point is that
the company has no debt and neither Avanex nor Bookham have debt and thats an important element in
these down markets.
So, Giovanni, do you want to add something?
Giovanni Barbarossa:
No, I just wanted to add one comment about what the growth engines of the
combined company are going to be. The complementarity of the product portfolio is also with respect
to the next generation products that the network is already looking for.
And so in fact, if we divide applications between the regeneration, transmission and waveling
management, at the regeneration, we are really with the combined company, well be able to
tackle the tunable dispersion, compensation applications that our customers are really looking for
as well as all of the automated regenerators, all of the automated amplifiers where we can really
put more intelligence into the regenerating mode.
The transmission, from the transmission standpoint, the two companies basically have the complete
set of component technologies that are required to address short, long, medium and long reach
applications. Whether we talk about [inter-nile baiter], advanced modulators for what we call
spectrally efficient transmission formats, like new to PSK, PSK, both 40G and 100G. And then, also
all of the tunable lasers, and also the high speed receivers.
So, we have as a combined company, we have the full set of technologies at component level to
differentiate the modules products. And then, in the waveling management world, we also, as a
combined company, we have the filter technology that is required to have the lowest cost possible
for multiplex, the multiplex interweavers and so forth that are still a very important part of the
network as well as all of the more kind of fastest growing segment of the waveling management
applications such as modems, especially in the waveling selectors reach applications.
So, we have not just a combined a very complementary portfolio from an operating standpoint, but
very complementary also in terms of what are the fastest growing segments of our of the market
that we serve.
Alain Couder:
So, let me add just one point in conclusion, is that the question I get asked, merger
or recall are very difficult to succeed. The statistics are terrible, 20%
succeed and those kinds of things. We are very confident we can make it grow for a couple of
reasons. The first one is the feedback from our customers that I mentioned.
The second one is the employee feedback. Theres two teams, not only at the management team, but on
the employee level are very pleased with this merger. And one
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very difficult thing when you do a
merger of companies of similar size is that one team doesnt like it because they cannot they
have been sold to the other or they have been sold by the other.
I think we are really playing it as the merger and taking the best people and we are creating a
sense that the two teams can win together. And we are looking at the possibility of having a new
name to rally all the employees behind that. Because in the end, it is the people and the
employees, working with the customers that makes the merger successful. And what you have seen so
far is very, very encouraging.
So thats all, I think, in the general comments. And Im sure you have questions.
Q and A
Ajit Pai:
Well, do we have any questions from the audience?
Okay. So, let me begin with some of my questions. When youre looking at the sort of overall
structure of the optical component industry, one of the big issues has been that there have been
too many players and too much capital moved into an industry in the late 90s and the early 2000s.
And for a long time now, the industry has not been profitable. The industry returned to
profitability, I think, in the fourth quarter of 2007. And it was a very brief period of
profitability. It didnt last very long, so maybe about four quarters of profitability for the
industry.
Now, when you see the combination of Bookham and Avanex, its still, I would say, a number four
player in terms of scale. But it hasnt really changed the total number of players or top 20
players that materially. How do you see the structure of the industry changing because of your
merger right now? Do you think that pricing, which I think has been the biggest issue for the
industry, theres been more than an order of magnitude drop in pricing in the past five to seven
years? Whats going to get pricing to stay out there to give you folks some help?
Alain Couder:
Okay, I can start again. The first point is that Bookham and Avanex, on the long-haul
metro markets, are going to be clearly probably the number one or at least the number two player.
So, I think you need to look at that particular industry by certain markets and not as the global
thing. Thats the first one.
Ajit Pai:
And can you quantify that for us? Like what percentage of that market do you think you
have?
Alain Couder:
I dont know. I havent sized it precisely, but you will help me with that, Im sure
on that. But let me give you one example where the consolidation of the industry already existed,
which is at the chip level and the pump level, for instance, the 90 pump.
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We are down to basically
three suppliers and there the margins are pretty nice. So, when the market gets down to two or
three suppliers for a given product, then the prices are reasonable, because nobody is desperate to
sell their products.
So, I think we get there in the metro long-haul between JDS and Bookham-Avanex, which will be the
two strategic suppliers. Well have a few point competitors, the transporter [RF], thats the new
one, which is very crowded there, and he amplifier area, which is very crowded. But we will have
the strength of being a strategic supplier and over time, I think it will pay off.
I dont know if you wanted to add something?
Giovanni Barbarossa:
No, I think consolidation is definitely really going to be very important
to improve the overall outlook of the industry. If you plot the market share by all players for the
past 10 years, theres one entity, which grew substantially. Its called others.
So, there has been consolidation over the past 10 years, but the fact is the newcomers have grown
faster than the other companies have been able to consolidate. Avanex and Bookham is a good
example, separately, of consolidation through the Nortel, Marconi, Alcatel and [Cogney]. And no
doubt acquisitions were made, but the fact is that we havent really been consolidating faster than
the other companies have been able to put to come up on the market and so forth.
So, the fragmentation of the technology, the fragmentation of the market, has really led to this
fundamental problem with profitability where we need to as independent companies, we need to spend
a lot of energy in so many technologies and there really is no synergies. And only combining, we
can extract those synergies that will be able to make us more competitive.
Ajit Pai:
Got it. So, when Im looking at you know what I heard from both of you right now, I
think the synergies, while theyre tremendous, I think you talked about sales and marketing, you
talked about all of that. You also mentioned that the product overlap is only one product and one
customer where you have a complete overlap. So, given that youre not concentrating any one
particular market, because its a complementary portfolio of products, so you dont think that
youd be helping in terms of the pricing side of things so much in this particular merger in the
industry?
Alain Couder:
I think we are because there is no overlap. But for instance, in amplifiers, Bookham
had a couple of customers and Avanex has a lot of customers, so we bring the two customers to the
Avanex product line, in the so-called terminal of products, Avanex is bringing their transponder
business. And it is a product that they are selling to customers that Bookham didnt have.
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So, in fact the there is no overlap from a customer viewpoint, but in total, we have
complementary strengths. So, I think this is going to play to the fact that our market share by
product line is going to increase and therefore from an R&D viewpoint, I discussed that several
points, the vertical integration strategy of Bookham, the limitation was is that resulting in our
scale and revenue, we would have been spreading R&D too thin over the products from chips to
subsystems.
I think with the combined company, by keeping R&D at 12% to 13%, now we have the critical mass. And
the only alternative is JDS. I think well be spending as much or more R&D on their product line as
in any of our competitors. And thats really the recipe to work, reasoning in the long term and to
also win in terms of pricing.
Because one thing I didnt mention about pricing, everybody complained about price pressure, price
pressure, but if you look at the history of semiconductors, as there are more of those supplies,
everybody hopes every year, two years that the modules are going to slow down, to look back at
history, it just applies. Because if youre not the quickest, somebody else will be the quickest.
And then, what Im saying, our engineering team is at there is no choice. You need to innovate
in such a way that the gross margin improves. And then, yes, the price will decline, but that
doesnt mean that the margin will decline. I think this is the other way around, investing for
gross margin is the top priority of R&D.
Giovanni Barbarossa:
Right. And I wanted to add one question here. We were talked about vertical
integration. I just wanted to make one point. The ability to vertically integrate and therefore,
using your own components for your motors and your subsystems, its obviously an advantage because
of the margins and so forth. But the fundamental advantage, which is not that obvious, is the fact
that you can extract costs by eliminating redundancies at the subsystem level.
When you put together a good example is a Roadham line card. So, you have an amplifier, you have
a waveling safety switch, you have an optical performance monitoring and if a third-party would
have to buy all of those modules independently, theyll buy with the modules three CPUs.
With our approach, because we will be able to control every single part of those of the card,
well be able to control all of these modules with a single CPU and therefore reducing the costs by
eliminating redundancies. So, its not just about the integration at
the card level or the various modules. Its really extracting costs by vertical integration, by
reengineering the modules and leveraging the components that both companies would have.
A Roadham line card is a very basic example its the best example because we have the pumps for
the amplifiers, we have the being flattened filters for them to amplify, we have
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the [thin film]
filters for the [mask-to-mask] portion of the Rodham card, we have all of the module technologies
that go into that kind of an application.
No wonder why one of the largest slots, design wins opportunities that were out there on the market
was only won by Fujitsu and us. Even if I could say that on the wavelength selectors, which 10
point, Avanex is not as strong as other competitors, but the combination makes the valuable
position much stronger. And so, the customer ultimately went with the company that has the largest
ability, the greatest ability, to extract costs from the subsystem solution.
Ajit Pai:
So, looking at what you just said, I think theres the R&D question that well address
again in a few minutes, but the interesting thing that you talked about is having multiple
components sharing the same CPU, having some synergies over there. So, theres been a trend, I
think, over the past eight to nine years, which is that the com equipment vendors have been
outsourcing more and more of the capabilities of the box to the component vendors.
So, you move from making everything all the way down integrated to the component level, so just
having Nortel offer their electronics, Alcatel offer electronics, all these other things getting
shipped out, being independent companies. You then had the back plane and overall systems being
shipped then. Then, you had even Nortel sort of planning to become a software-driven company with
everything else being done outside.
Now, given that trend that you have seen right now, how comfortable are they going to be with
having all those capabilities on a single module that youre talking about, all in one CPU, rather
than having the flexibility to use other people. What while its possible what youre saying,
are the com equipment vendors, your customers, are they open to having that level of integration?
And then in addition to that, if they do get that level of integration, where do you see your
content in that box stopping?
Alain Couder:
Want to start?
Giovanni Barbarossa:
Please.
Alain Couder:
So, its very clear that different customers have different views on that. Some
customers are clearly willing to go to the subsystem level now, other ones to be able to master the
confidence level and do it themselves. But I think over time, that something will happen that will
happen in the computer industry, as we are more and
more efficient at doing the subsystems for the reasons Giovanni was discussing, then they will come
to the realization that it is not efficient for them to do their own assemblies. But thats
probably a three to five year horizon, some companies have very strong know-how in terms of optical
capabilities and they will continue to try to leverage that. So, its not one or the other.
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On the other end, if you look at some younger companies, they are clearly willing to go to the
subsystem level, but to answer your question about being dependent, basically each subsystem is
derivative of a common platform, but its kind of unique. And
Avanexs software, it is unique. We
one thing that Avanex brings to Bookham is the software capability. Bookhams software
capability was not as good as it should be, I would say. And I think Avanex has some better much
better software capability. Electronic integration is very important and we have some, but we also
partner with some electronic capability to do a very dense, very fast electronics to complement
this.
So I think the two companies scaled together are going to increase the ability to do very cost
competitive and high-performance subsystems.
Giovanni Barbarossa:
And I wanted to add that our customers, I dont believe they have a particular
religion whether they should buy components or modules or systems. Its all about cost. As long as
they believe that they can have a lower cost solution internally, Huawei is a good example, they
make it internally. And in their case, well supply components. However, it is also true that the
reason why they think they can do this internally at lower cost is because there isnt, probably, a
low enough cost supply out there.
So, they are and at Avanex, we have been able to, even without the merger with Bookham, would be
even a stronger valuable position with Bookham, weve been able to take some of the amplified
captive business from two customers in Europe and in Asia. And because we have been able to propose
them a solution, which ultimately was lower cost than the one they have now. So, as soon as they
saw they realized the cost advantages, they changed their strategy. So, there isnt really
anything kind of magic about their thinking in terms of what is the best solution for their own
systems.
Ajit Pai:
Yes, I think that thats an interesting point. When you look at the overall sort of
landscape of com equipment vendors, you have the new emerging vendors, the VTs, the Huaweis that
are coming out of China. But I think they think the same way that you think. When you look at the
more established vendors, when you look at the Ciscos, you look at the Alcatel-Lucents, you look at
all the traditional incumbents, they always like things dual sourced at a minimum.
Alain Couder:
Yes.
Ajit Pai:
So, when youre looking at that, having these kind of capabilities, unless they have a
second source that can provide the same kind of capabilities, is that something that they jump to
until they get to that stage?
Alain Couder:
No, they will manage to have two sources. And this is where you need to be the first
one. Because you do the design with the customer and the second one has to complete the same design
and be compatible. And thats not as easy to make money doing that. So, being leading edge and
being first designed in is very important. But you
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also, you are right. And I think over time,
everybody will want two sources. Thats the way the market works.
Ajit Pai:
Yes, absolutely.
Alain Couder:
So time to market, the performance to market. Cost, cost to market is not a place we
want to be. We want to be first and with a better product. Coming in as the second supplier is
always a challenge.
Ajit Pai:
Got it.
Alain Couder:
So, we have been pushing for innovation in Bookham for the past two years. And I
think we have demonstrated some results with our number of products and things of that kind.
Theres no replacement for innovation, if you want to be first to be designed in.
Ajit Pai:
So on that note, lets shift over to start looking at innovation and looking at R&D and
how R&D is positioned in the world right now. So one of the interesting things, I think, you
pointed to, I think one of the most significant things you brought up on your conference call when
you announced the merger was the fact that finally, you have a joint R&D budget that is becoming
material again, which can become a source of competitive advantage for the combined company.
Alain Couder:
Yes.
Ajit Pai:
So, youve learned the math and while you dont really have very good visibility into the
OpEx satellite numbers, et cetera, it appears that out of the sort of the Western world, that the
Bookham and Avanex R&D budget is now number four, in terms of total dollar spending. But it also
still ignores, and you still dont have very good visibility into whats happening in Japan. So,
can you give us an indication as to where do you actually see the R&D investment still being
cutting edge? How many competitors do you have that have the same capability of investing?
And more importantly, as governments around the world are seeing the big economic slowdown, while
your revenue might fall, governments are trying to harbor innovation in France, in the US, in many
parts of the world, the governments giving these R&D grants.
What possibility is there for this combined entity to get a material percentage of its R&D
government subsidized?
Alain Couder:
You asked several questions there. The first one, on the R&D budget, yes, we are
number four in terms of the optical industry.
Ajit Pai:
Excluding the Japanese.
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Alain Couder:
Excluding the Japanese. But in terms of the long-haul metro market, I think we are
number one.
Ajit Pai:
Yes.
Alain Couder:
So, that is a very important point. Because in the end whats important is the amount
of money you put their product line. As far as the grants are concerned, we already both
companies have already grants in the countries in which we are working. We have grants in the UK
and in the US, and I think we have grants in France and Italy. So, we will continue to pursue that
because, you are absolutely right, this is a real opportunity. And the optical world is known by
governments as being one of the key technologies of the future.
Ajit Pai:
So, when you look at the combined R&D of, lets say that the target is how much? Youre
looking at about $50 million?
Alain
Couder:
Its 12 to 15% of revenues. So, if youre talking about a $400 million company, which
is particularly where we are with the downturn, that gives you the number, about 15%, $60 million.
Ajit Pai:
Right. So and then of that, how much do you think youd be able to get as I mean,
thats excluding the grants or including the grants? How are you thinking about it? What percentage
?
Alain Couder:
It includes its excluding the grant. The grant becomes we will be a 12% to 13%
net R&D.
Ajit Pai:
Got it. So we do expect and are you seeing signs that the grants could potentially
increase materially or ?
Alain Couder:
Yes, it is in the discussion with the government. The problem is that the process to
give grants is a long process, typically it takes a year. So, we will see the results of that only
a year from now.
Ajit Pai:
Okay. If anyone in the audience has questions, please raise your hand. Ill look
periodically.
Unidentified Audience Member:
One comment, maybe Giovanni can elaborate on our East-West split of
R&D resources that should give some leverage on a dollar basis. How much resource we have in China
between the two companies?
Giovanni Barbarossa:
Yes, thats a very good point. Both companies have adopted the most efficient
way of developing new products, which is having the innovative teams in the Western world between
North America and Europe and then having what we call the derivative engineering or value-added
engineering in Asia in the low cost regions. And
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that way, you get the best of both worlds because,
well, not just for the cost reasons, but also from a time to market, the engineers are able to work
24 hours a day because of the time zones and so forth.
So, products do get developed also faster and software testing is a very good example where the
people in the engineers in the Western world do the coding and the people in the Eastern world,
they do these regression tests and all of the debugging and so forth. So overnight, you get what
you basically have engineering forces working two shifts, which hasnt really happened that often.
And so, thats a very good way to split costs and also be more efficient from a development
standpoint.
Weve been able to I have to say that probably Europe is a little bit more aggressive in funding
these Photonics 21 initiatives, sponsored by the European community where both basically both
companies have been able to get grants for advanced development. We havent really been able to get
any funding in Asia. I dont know if there is any. And in this country, hopefully, with the new
administration, well see a little bit more funding towards the telecommunication world.
Ajit Pai:
Okay. Then shifting over to just looking at the integration
Alain Couder:
What is your question?
Ajit Pai:
Oh, theres a question from the audience?
Alain Couder:
Yes.
Unidentified Audience Member:
I just had a very broad question about the end market. And it looks
like a lot of the end customers were in trouble before the downturn and were just starting to see
the CapEx come out of the carrier. Can you just what do you think is happening here whats
the big picture for (inaudible microphone inaccessible) markets are down. I dont know.
Ajit Pai
: Could you repeat the question as well then?
Alain Couder
: I think the question is a lot of questions for the end-customer, which are who are
the carriers? And the downturn the slowdown for those customers started before the actual
downturn and the financial crisis. So, you keep talking about flat markets. Could it be a down
market? Thats your question, I think.
And so, I think this is there is some markets where clearly we could see a slowdown and a down
market. But there is others in this country where we still see growth. And in fact, we still see
some of European and Asian customers who are still looking for growth year-over-year and this
quarter. And because we are serving China, India, South Africa kind of markets. So, I think the
balance of the two, as we see it right now, is about flat.
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For the customers who are mostly focused
on the North American market, yes, the downward pressure is significant.
At the same time, there is not enough bandwidth in the network. So, the question is CapEx is down,
where is the CapEx going to be down? Is it going to be on the access network with fiber-to-the-home
and cable distribution and all of that? Or is going to be in the core network, where we are
focused? Where you need more bandwidth and therefore, you need to add more line count?
One comment I heard two weeks ago from one customer is that some carriers are revisiting the
tradeoff of tunable versus fixed because the fixed wavelength line cards are less expensive than
the tunable line cards. Even if long term its not the good solution, short term, it may be a way
to do it. But we sell both, so thats okay for us.
Did you want to add to that?
Giovanni Barbarossa:
No, just a comment. There is no doubt that the CapEx spending has been
declining and so forth. On the other hand, I think we need to differentiate between the telecom
bubble and this market that were seeing today.
The there is really no overcapacity in the network. The CapEx spending is declining not because
there is an overcapacity. The demand is still there. As you know, the telecom bubble was driven by
an inflation, an overinflated capacity driven by CLECs, which are not around anymore. At least in
North America. And also the other issue with the telecom bubble was there was really no application
that was really driving bandwidth demand.
Now 10 years later, or so, it the situation is very different. You can just look around
yourself, of all of the different applications that come up, which are really demanding a lot of
bandwidth, and then you understand why the fundamentals of the telecom industries are still very
healthy.
And even if there are, in some cases, the cell phone is a very good example where they are not
still broadband enough to drive a lot of bandwidth demand. On the other hand, there is a much
larger number than there used to be, nine years ago, 10 years ago, so the
aggregate bandwidth demand is actually growing very rapidly, driven by users that today dont use a
lot of bandwidth, but in an aggregate, they do request a new investment from a network standpoint.
So, I think that there is quite a difference with respect to the past telecom market decline and
this time, so we believe all of the applications that we see, video broadband, video on demand,
Internet video and all of the aggregate demand by applications, which are not necessarily bandwidth
intensive, they will still drive a major need for new CapEx spending from the network operators.
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Ajit Pai:
But to the same question, which is the same direction I was heading, back to the margin
side, while weve seen this tremendous bandwidth growth for the past, I think, five to seven years,
even after the downturn, I mean youve seen the carriers return to health in 2005, 2006, good
margins, good performing stocks with market gas. Your customers, the equipment vendors and to this
point, have they are selling more stuff.
The problem is theyre not getting any pricing power. And then, if they dont get any pricing
power, how will you get any pricing power? And to this point, when things were still okay, and
CapEx was still growing maybe 2%, maybe 5%, if Alcatel-Lucent, Nortel and everyone else, CNL, are
already having problems, then with a slowdown, how ugly do you think things are going to get for
your industry, regardless of the consolidation?
Alain Couder
: I at this point in time, we have not yet seen more price pressure than we had a
year ago. This is not happening, the negotiations we had in the first two months were no worse than
last year. So
Ajit Pai:
Well, lets in a slightly different way, (inaudible) which is that if youre looking
at someone like Nortel for example.
Alain Couder:
Yes.
Ajit Pai:
And they decided to ask for protection from that.
Alain Couder
: Yes.
Ajit Pai
: They still have cash on the balance sheet.
Alain Couder
: Yes.
Ajit Pai
: Now, are you seeing a change in their buying patterns? Their business levels for you are
of an account, they require the line cards because the demand is growing at their customer level,
but is it impacting demand? Not so much for the pricing factor right now, but your customers are
not getting pricing power, thats why their margins are bad. Is it impacting their ability to
purchase from you even at the pricing youve agreed?
Alain Couder:
We dont see the fact that it is is they have a problem purchasing. Where they are
much more cautious than they were last year is to make sure theres no inventory build up. So, the
difference in buying pattern that we are seeing is smaller orders and shorter term deliveries.
Thats really what the change is, which is a challenge for us because at the same time, we need to
keep the inventory as low as possible, so theres a tradeoff there. And I think that the tradeoff
is much more in terms of the flexibility we have in terms of being able to deliver the product very
quickly because of the change of buying pattern than the actual price, so.
Ajit Pai:
So, then just did that address your question?
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Unidentified Audience Member:
Yes. But I had sort of a follow-up question if I may. You talked
about the rise of the others in terms of market share, I guess in the end-markets, others fell
dominant, so (inaudible microphone inaccessible). Could you just assess from an objective point
of view if you can what the ability of these others that survive. Are you seeing a lot of companies
are kind of on the edge here (inaudible microphone inaccessible)? Whats the status of others?
Alain Couder:
I dont know all the status of the others. What I can tell you is that the number of
phone calls and visits I have from private companies since we announced is incredible. And we see
it is starting to be a reasonable people as well. Thats a thats new news and good news for the
industry. They are not looking at getting all their money back and more anymore. So, I think that
means that a lot of the smaller companies are really struggling. But thats the only factual
indication I have at this point in time.
Ajit Pai:
So let me ask, you talked about BMI which is basically about, I think two years ago,
you had BMI initiatives at a number of your customers. You had a drop in demand to do it, inventory
being used up and a smaller pool of inventory in the entire supply chain. Now, when youre putting
together Bookham and Avanex, youre talking about cost synergies, all of that, but could you give
us some idea as to the integration, not from like the 65%, 35% that you talked about in terms of
marketing, but more from a systems side.
Both companies are sort of roll-ups in their own right, they have combined other companies. What do
the systems look like? What kind of investments are required? The ERP programs that have just
recently been updated, what systems are those?
Alain Couder:
So, those companies are on SAP. So, on the surface, its very easy. We are looking
right now at how SAP is being used to understand how we can convert it to the system quickly. So,
this is being analyzed right now. But the good news is that at least in terms of system origin and
ERPs, the two companies are out there.
In terms of engineering systems, we are using Agile; Avanex is not using Agile anymore. They use
SAP. But they used to use Agile, so most of the engineers are already trained on Agile. So we have
to decide whether we get Agile, which is a more proficient system for engineering, or whether we
take the cheaper module of SAP. So thats a decision that is going on.
In terms of CRM, Bookham doesnt have any share and Avanex had been using Salesforce.com and I have
been pushing for a CRM system because I hate to be totally dependent on the sales people when I
visit the customer and I like to go into the CRM and try to understand what happens. So, I think we
have an opportunity there to do that because we are already at CRM working into Avanex. So, its
not a complex system integration from what we know at this point. There are some choices to be
done. But its not we are a total different approach and totally different system.
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Ajit Pai:
But throughout the two companies, there wasnt any I mean, the upgrade for SAP had
been recent enough that its fully integrated across Avanex and across Bookham, so there isnt
anything thats required to be sort of redone or anything so far?
Alain Couder:
No, theres only in I think in Avanex you are fully integrated. In Bookham, we had
one site, which was not in SAP yet.
Ajit Pai:
Okay, so thats fine. And then, looking going back to the sort of inventory and the
channel issue, if they ended the cycle, just the velocity that there was in the month, the
write-offs were tremendous. Billions of dollars of component write-offs.
Alain Couder
: Yes.
Ajit Pai:
Now this cycle, we already saw a fall in demand well before end markets fell because of
the BMI, all of that. So but youre still taking charges and still seeing Bookham and Avanex
taking obsolescence charges in the financials.
So, can you give us an idea as to whether the current level of obsolescent charges that youre
taking every quarter, every other quarter, whether that is actually the long term sort of
obsolescence that youre going to see on components? Because of the normal business? Or should we
still look at it remove it to think about it on a pro forma basis that that could stop happening
at some point and still be in excess of the last cycle? Not excess of the last cycle, in that
sense, but its a transition period.
Alain Couder:
Well, I think we have been taking less, at least for Bookham, we have been taking
less recently. Jerry can give you more detail on that. So .
Jerry Turin
: Yes. So Bookhams not been experiencing any significant change in its E&O. I think
its partly because of the vertically integrated model that were able to respond a little bit
more. I think Avanex has taken charges, I think there may be products
as well as the market conditions. And I dont know if Giovanni wants to elaborate or not, but I
dont think we see a long-term trend like the bubble where there may have been a complete fallout
of demand and enormous write-offs that continued. I dont see a long-term continuing trend.
Ajit Pai:
So, the current level of write-offs should be considered at a normal level of business,
the write-offs will continue for the next three, five, six years?
Jerry Turin:
I would think so for Bookham.
Ajit Pai:
Right.
Jerry Turin:
From a Bookham point of view. And again, I think there may be a few specific spikes
that Avanex has experienced.
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Giovanni Barbarossa:
Yes, that wont be the case for Avanex. We definitely experienced higher than
normal E&Os over the past couple of quarters.
Ajit Pai
: So, itll start falling to a lower level.
Giovanni Barbarossa:
Level.
Ajit Pai:
So, we should look at that more on a pro forma basis? The pro forma would be lower? On an
ongoing basis, what you expect.
Giovanni Barbarossa:
Correct.
Ajit Pai
: Excellent. And then any other questions from the audience?
So looking at the expense, you talked about the $7 million in restructuring expense and youve
to get the $7 million quarterly benefits. And I think the first year, you said you would get about
$20 million in benefits for that $7 million investment. Over and beyond the $7 million in
restructuring, are there any other expenses that you are seeing that have cropped over since you
announced the combination of the companies?
Alain Couder:
Not at this point in time since we launched the integration plan. I think were
and we are still within the $7 million of expenses and this is for a to do the restructuring.
Ajit Pai:
And when youre looking at the customer reactions from the largest customers of both
companies, what has been the way that the customers have communicated to you that they want to be
working with the company, both in the intermediate period, the next three months and then after
that as well? Has there been some kind of communication on a or change in behavior?
Alain Couder:
So, the number one is that we are now considered the tier one supplier by them. And
both Avanex and Bookham are confident that we are tier two suppliers. That means they would buy it
from Bookham and Avanex, that we have superior technology before, but not as a tier one supplier.
That means that JDS has been considered tier one for the big suppliers by all of the larger OEMs.
And now, weve got the feedback, I personally got the feedback from two large companies that we are
now clearly tier one. And well be considered as sustainable as JDS. And that should be a big plus
for us.
Ajit Pai:
Right. And when youre looking at the balance sheets of the two companies, and the last
two or three times that the stocks have gone up in the optical space, youve been fairly
opportunistic and shored up your balance sheet a couple of times, at least. And right now, if you
look at the two companies, what the market expects, not necessarily the sales side analysts, but
both the companies have a negative enterprise value, which is the market expects you to burn cash
at a pretty rapid rate.
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Alain Couder:
Yes.
Ajit Pai:
As a combined company, do you actually expect greater financial flexibility at an earlier
date? What is the sort of relationship right now with the banks in terms of lines of credit, et
cetera? And do you expect any improvement in your ability to be getting better terms as a combined
company?
Alain Couder:
In fact, we are already Bookham has already a line of credit, as you know. And we
are really discussing this line of credit as we speak. And, Jerry, maybe you can talk in more
detail, but we are getting very positive feedback. Because the ability to be cash flow positive for
the combined company is much more rapid than for either company stand alone.
Jerry Turin:
Yes. I mean, so first off, were not debt reliant or reliant on raising debt. So as
far as what terms are available, were really looking at our existing line of credit, extending it
and then long term possibly increasing it based on the added receivable space that it would be
based on. They a favorable reaction from that point of view.
From a cash flow point of view, we should be EBITDA break even in the first quarter together and
somewhere in the middle of the six month range to be cash flow break even. So I think thats a
metric that would be relevant for your to your question. I think that would imply more
flexibility and more terms, but again weve not explored exactly what that would mean.
Ajit Pai:
And the banks on the line of credit side that youre speaking with, will any kind of
decision only be made after the acquisition is closed? The combination is closed?
Jerry Turin:
No, so weve got an existing line of credit, Bookham stand alone, that were
expires at the end of this year. Were looking to extend that. And its on a stand alone basis and
were moving forward and having discussions and term sheets going back and forth and its very much
a business as usual.
The question is, after the deal is consummated, if we wanted to increase the level of that line,
based on being a larger company with a larger asset base, we could go back and revisit that at that
point. But were looking to stabilize what we have in place now, stand alone, and then we think
thats probably sufficient combined, too.
Alain Couder:
I think with Bookham a stand alone loan, we have the ability to get the new line of
credit. And for the two companies together, we have the ability to get a larger line of credit with
Alcatel. I think the financial stability is going to be significantly improved.
Ajit Pai:
Right. And based on what you see right now, the market seems to be saying that the cash
burn of the two companies even combined is going to continue for some time.
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But from what I gather
right now, what I just heard, is that you expect in six months, after the closing of the
acquisition, within six months, for the company to be cash flow positive, combined.
Jerry Turin:
Yes. Excluding any restructuring that were paying at that point in time. And Id put
the caveat that if we were started growing rapidly, if there was a big hockey stick, which we
dont see at this point in time in the market, but you may burn some cash and increase your
receivables in inventory. But that would be a positive situation.
Ajit Pai:
And six months would mean like the end of ?
Jerry Turin:
From the end of I was kind of purposefully vague and around six months. So, it
depends on exactly the day you closed and is it six months from the close date? Is it six months
from today? Its somewhere in the middle of the 12-month period.
Ajit Pai:
So, the second, third quarter
Jerry Turin:
So, the second or third quarter. So Id say part way through the second quarter, wed
probably be running at that sort of run rate, but wouldnt necessarily experience that for the
whole second quarter. And then the third quarter, it would be a full quarter where youre actually
demonstrating that from day one through the end of the quarter.
Ajit Pai:
And that is assuming the $110 million run rate or the current run rate?
Jerry Turin:
No.
Alain Couder
: This is assuming the run rates a little higher than the this quarter. But not the
$110 million.
Ajit Pai:
By this quarter, you mean the March quarter?
Alain Couder
: Yes.
Ajit Pai
: Okay. Excellent.
Jerry Turin
: Yes, somewhere in between. Somewhere in between.
Alain Couder:
We expect the June quarter right now to be higher than the March quarter.
Ajit Pai:
Got it. So, that would mean that the company itself, right now, doesnt see the
combined company doesnt see any reasons to raise any additional capital in the near term, barring
any other potential very, very attractive acquisitions?
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Alain Couder:
For organic growth, no.
Jerry Turin:
No.
Alain Couder:
For external growth, possibly. Theres a couple of technology where we might have a
need to get them quickly. For instance, we in the Roadham WSS, we dont have the one-by-nine, we
have only the one-by-two. So, there may be some opportunity there. And we mentioned that as Bookham
stand alone before. With the merger, we are getting the one-by-two, but we are not getting the
one-by-nine. So
Ajit Pai:
But you also get additional cash because its a stock-for-stock transaction, towards the
balance sheet.
Alain Couder:
That is correct.
Ajit Pai
: Right. And the how large is the line of credit?
Jerry Turin
: Its a $25 million line of credit.
Alain Couder
: Today.
Jerry Turin:
Today. With nothing drawn against it.
Ajit Pai:
And nothing drawn against it. Its undrawn. Excellent. So and when youre looking
right now at the competitive reaction. Youve talked about how your customers
have started interfacing a little bit with you and youre moving up into the tier one and they have
you havent made your tier one yet, but have they indicated they intend to make you a tier one
so that youre on the same level as JDS and Finisar? On a competitive reaction, what have you seen
thats happened after you announced this? How have your I know its very recent, but how have
the competitors responded?
Alain Couder:
I havent seen much response. Did you?
Giovanni Barbarossa:
No. I mean
Alain Couder:
No?
Ajit Pai:
In the marketplace, you havent got any .
Alain Couder:
Youve probably got more than I did, they probably talk to you.
Ajit Pai:
Well, I get the investor response and the but the
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Alain Couder
: But Im sure youre talking to our competitors as well. So, they probably tell you
something about that. So
Ajit Pai:
Right.
Alain Couder:
you may want to comment on that sort of thing.
Ajit Pai:
Okay. Well, are there any other questions from the audience? I think most of the
questions I have sort of been addressed.
Alain Couder
: Thank you.
Ajit Pai:
And congratulations on announcing something that is helping the industry and both
companies quite a bit. And its a pleasure to have both of you with us and thank you, everyone, for
joining us today.
Alain Couder:
Thank you very much.
Giovanni Barbarossa:
Thank you.
# # #
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TWP Conference Transcript
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Page 23
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Summit IR Group Inc.
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February 11, 2009
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