Interview with Dr. Steve Turley, Chief Commercial Officer, Bookham Technology.

See also earlier interviews with Bookham Technology and Cierra Photonics.

Was the purchase of Cierra a defensive move by Bookham and the start of another acquisition spree to make the company large enough to prevent its own takeover?

No, it was driven very much by market positioning and expanding our product breadth. The way we see it, the old Bookham had a view that PLC technology would rule the world and ASOC was the best PLC technology - sooner or later Thin Film would crumble in face of the onslaught.

But what has become clearer is that the market is not that simple and there are some products that are best addressed with Thin Film and some best addressed with ASOC PLC technology.

There is functionality that Thin Film can deliver which PLC cannot and vice versa. When people are not utilising as many wavelengths, this very much plays to the strengths of Thin Film technology. So the move was not defensive in any way - we had a gap in our portfolio, we felt it was important to fill that gap and Cierra is the best in class.

But you already had an agreement with Cierra, dating back to September 2002?

That's correct, we were taking Cierra's products to market in Europe. The problem we had with a lot of customers, including the top optical networking companies, was that, while Cierra was seen to have great technology, its survivability was in question.

Taking the company to market under the Bookham sales channel did not help as much as we thought. There was a large reluctance on the part of our customers to spend time and resources designing-in products from a company whose financial survival was as questionable as that of any startup these days.

Cierra had reached revenues of over half a million dollars per quarter and had shown good growth, which for a small company is good, but its revenues were limited by the views of the large customers on whether to risk dealing with a small startup. We see that revenue growing significantly in the future as the customer base can use Cierra's excellent technology without worrying about survivability.

Was any of that $500k per quarter due to Bookham's marketing in Europe or did Cierra achieve that on its own?

Some of it was, but to be honest we did not make as big a contribution as we had hoped, due to the problem outlined above - the question of the company's survival.

In other words your purchase has just helped Cierra out of a marketing fix?

It's certainly one of the main values that we will bring. What customers can do now is recognise the value of the technology and know that it belongs to a company that is going to stick around. Our customers are convinced that we will survive, we share enough with them in terms of our financial status, and they understand our plans, and how we will get our cashburn under control and move to profitability.

The core puzzle though has little to do with the way Bookham is run but rather with the market you are in. If you have a range of products that is being stonewalled because of a market situation that Bookham can do nothing about, having more products to address that market doesn't help you?

I don't agree with that view and I will try and explain why. There are two basic pillars to the financial model. One is that we have to take out a lot of overhead to make sure we can get our cost levels down.

The Nortel optoelectronics operation is a case in point - those financials were pretty brutal. But we had a fair amount of overlap. We already had a fab as a result of the Marconi acquisition that had had a lot of money poured into it - probably not as good as Nortel's but still very good - so we had the opportunity to achieve a lot of cost savings by that consolidation, which is currently going extremely well.

The products are getting up and running in Caswell, and we are within one or two weeks of our original time plan. But at the moment we are burning cash running two fabs, building inventory, etc, and all of this costs money. We will have finished the consolidation in the fourth quarter, and while there will be expenses associated with severance costs, our cash burn will be dramatically reduced.

We have consolidated packaging in Paignton, so all of the packaging activities from Caswell and from Milton have gone down to Paignton. We have also consolidated the sales forces, overheads etc. In addition we have announced a dramatic downsizing of the ASOC activity in Milton. All of these moves are designed to reduce our costs. Our cashburn at the moment is not showing the benefits of all these actions as we are still paying out severance costs and the process is not finished yet.

The second point is that our business plan does not assume a magical market recovery, but it does assume an increasing share within that market, so though the market is indeed ugly, we are aiming for a bigger slice of the pie within a relatively flat market.

We are being helped by the fact that competitors are moving out of the market - Nortel got out, Agere got out and handed it to Triquint (resulting in revenues from those product lines collapsing), and the way Agere handled it was beneficial to Bookham, as customers, knowing Agere was intending to quit the business, looked around to design other suppliers in as an additional source.

JDS is probably still number one in the telecom sector, number two would probably have been Agere, and that has fizzled away. Number three was Nortel, which has been folded into Bookham now, and then we are talking about Corning and Alcatel, now wrapped into Avanex.

We were also lucky with our Nortel acquisition, as a lot of it is UK based, so that made the integration easier. We attacked that process aggressively and methodically and as a result the integration was pretty much complete two or three months ago. The challenge that Avanex/Alcatel/Corning have got is that the entity now has a very diverse geographic base. They clearly have the major integration challenge in front of them whereas we have it pretty much behind us.

Is Bookham at all worried that Avanex has turned itself into an acquiring wolf, from being a relatively small post-IPO company? Could it acquire Bookham?

Clearly Avanex is a much stronger competitor now than it was before the Corning + Alcatel deal. But we are absolutely not worried about that company having the ability to swallow Bookham. To be honest, it has more than enough to keep itself busy for quite a while, due to the scale of the integration.

The question remains, while Avanex has a lot of cash at the moment, how much will it burn to get through the integration process - this is a very cash-intensive process? Then the question remains as to how well the integration will be conducted, and what will be Avanex's cashburn as it comes through the other side. Bookham now has a clear plan of how we get our cashburn under control, post acquisition.

How much is the Cierra acquisition costing Bookham?

Approximately 3 million Bookham shares - around £2.2 million ($3.7 million).

Why did the company sell out at that price?

The problem smaller companies have got is how to get continued funding. It is not easy to get cash in the opto space at the moment. If you need more investment, you have to have people who understand what you are bringing to the table.

Will the team be kept intact?

Absolutely, no question about it. There will be a small downsizing exercise going on, but we regard the engineering and manufacturing skills as extremely good, and we have a very high opinion of the people there. They are an extremely innovative team and are probably the best in class on Thin Film.

They are innovative, have excellent design skills, and they have the process control, in which the company has invested very heavily. It is highly automated also - Cierra can load the substrate in, hit the 'go' button and it does it pretty much by itself. It is constantly monitoring the film that is being put down, correcting it as it goes. The robots pick up the chip, test it and the system drops it in whichever wafer tray is appropriate. So the combination of an excellent design team, excellent process control and the degree of automation all add up to make Cierra and its products both cost effective and disruptive.

When I looked at our product portfolio, I recognised that we were lacking in a Thin Film capability. I had known Cierra from my own Nortel days, and I knew how good it was. Initially I had felt that if I could offer Cierra a route to market in Europe, that would be beneficial from both of our perspectives, but in the end we realised there was an opportunity to move into an acquisition, which is precisely what we have now done.

Are there any other gaps in your portfolio?

Obviously there are some. We get a lot of companies talking to us, and we judge any opportunity on product synergy, what the revenue prospects would be if those products were within the Bookham portfolio, and what is the cashburn. There are a number of great technologies out there that are interesting, but the revenue is so far out and the cashburn so high in the short term that they often just don't make financial sense.

Could the Cierra product line have been developed in-house by Bookham?

It would have cost too much and taken us too long to get there. In the current market conditions, Cierra was a more natural route for us. It already had the capability and had made the investment; it has demonstrated shipments for revenue, and our customers already tell us it is great product.

Cierra received $40 million investment in its Series B round alone, so one can assume that total funding to date must be of the order of $50-60 million. It seems puzzling as to why the investors would sell out at such a low level? Does this indicate that the investors did not believe there were any realistic market prospects for the foreseeable future?

It is not only the size of the market, rather the question is how much of the market it would be possible for the company to take. Cierra investors may well have thought that it was better to put in with Bookham and take some Bookham stock with an upside, because on its own Cierra probably could not crack the market. This is absolutely no reflection on Cierra personnel or the quality of the product. It is just the way customers regard startups at this time.

What is the market worth for these products at the moment?

Allowing for fairly large margins of error, and depending whose figures you actually believe, probably somewhere between $60-150 million. As always, there is the problem of definition in these things.

Cierra has Add/Drop, Mux/Demux, Skip filters, EDFA infeeds such as GFF and OSC filters and can also make interleavers, though that is not in the product line at the moment - there are a lot of different applications for these products.

And that is just looking at it from a component and module level. Many of our customers are saying they want to buy subsystems from us, where we can put the whole thing together with all the electronics, firmware, and software. In fact more and more our customers want a rackmounted solution, which can be slotted straight into our customers' systems.

Who are the major competitors to Cierra?

JDS Uniphase is far and away the lion in this market but there are a number of other players as well.

So Cierra is getting (very roughly) one percent of the market currently. How much do you think Bookham can increase that by?

It does have a small share at present but we should be able to get up to 20% market share in a couple of years or so. You must remember that most of what Cierra is doing at present is selling chips into groups who then package the products and sell them on.

Bookham will continue to support the chip business but also continue the strategy of selling packaged components, as well as increasing the breadth of our subsystem offering. Essentially an amplifier is a subsystem, and you can see a natural migration for that moving into a node - you can have the Add/Drop and amplification functionality in one product.

In any case, if one talks about $100 million, for the sake of argument, that is just the component and module market. The subsystem market is significantly bigger, and what we see is that customers don't want to dedicate engineering resources to buying components and putting them together.

So Cierra is enabling us to enter a much broader market than just components. This is part of the rationale for us. The subsystem market could be worth around $250 million - again with wide error bars around that figure. Our objective is to become a creditable challenger to JDS and certainly at least number two in this market, in all its guises.

The enlarged Avanex is certainly a player within this market, although it doesn't make everything itself.

Is this market likely to shadow any upturn in the general equipment market overall or are there restraints on its growth?

I believe it should shadow the equipment market reasonably well. A doubling of the DWDM market would lead to more or less a doubling of ours.

Which leads to the conclusion that the purchase of a company whose products you believe can lead you to a number two position, if not a gift, was still remarkably cheap?

Well, we certainly believe it is a good investment.

Who are the major investors in Cierra?

Mayfield, Worldview Technology, JP Morgan and RWI Group. We negotiated with representatives of all of the investors as well as Cierra. And what they get is two things - not only the Bookham shares, which they can sell now or keep, but also an earn-out clause. So if Bookham does very well, their return is increased, but of course this is a win-win for everybody, because if we do exceptionally well, we would be happy to pay the earn-out.

Do you see this acquisition as the start of a Bookham acquisition strategy or is it a plug for a specific product line gap that you had?

For the last 18 months we have had an acquisition strategy, and it is hard to say whether or not this will be the last for a while.

What happens if the market remains at or about its current level for the next year - would you still see the Cierra acquisition as having been worthwhile?

Absolutely, we are not building our business case assuming the market is going to grow dramatically. We expect our customers will move from modules to subsystems, so the same amount of optical channels can actually sell for more.

This is happening for amplifiers where we already provide racks instead of just gain blocks, for transmit/receive we get orders for boards rather than just the components that go on it, and all this increases Bookham's available revenue even in a flat market.

Also, because we believe the competition is reducing, the players that are left have a larger market share. The other recent benefit to us has been that we can sell much more of the products formerly owned by Nortel than they could, which has been an immediate boost to our available market. System houses, who would never buy anything with a Nortel logo on it before, due to competition worries, are perfectly happy to buy exactly the same product with our logo on it.

There are accounts that we are opening up and in which we are getting design wins that Nortel was just frozen out of. So we have essentially broadened our available customer base with what were already excellent products, by simply allowing Bookham rather than Nortel to become the supplier.

These factors drive up our revenues - going up the value chain and entering markets that are open to us because we are independent. It will take time for this to filter through in terms of revenue growth, but it will certainly get there. At the same time we are lowering our cost base, and this combination is what will drive Bookham into a profitable future.