Opnext, Inc. F3Q10 (Qtr Ending 12/31/09) Earnings Call Transcript

Feb. 4.10 | About: Opnext, Inc. (OPXT)

Opnext, Inc. (NASDAQ:OPXT)

F3Q10 (Qtr Ending 12/31/09) Earnings Call Transcript

February 4, 2009 4:30 pm ET

Executives

Steve Pavlovich – VP, IR

Gilles Bouchard – President and CEO

Bob Nobile – CFO and SVP

Analysts

Paul Bonenfant – Morgan, Keegan & Company

Ajit Pai – Thomas Weisel Partners

Ari Bensinger – Standard & Poor's

Rahul Khanwalkar – Jefferies & Company

Dave King – B. Riley & Co.

Cobb Sadler – Catamount Strategic

Operator

Good afternoon. My name is Ashley and I'll be your conference operator today. At this time, I’d like to welcome everyone to the third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator instructions) I would now like to turn today's conference over to Steve Pavlovich, Vice President of Investor Relations for Opnext. Please go ahead, sir.

Steve Pavlovich

Thanks, Ashley. Good afternoon and thank you for joining us today. We will discuss our financial results for the third fiscal quarter ended December 31, 2009. We'll begin with Gilles Bouchard, our President and Chief Executive Officer, for an overview of the quarter followed by Bob Nobile, our Chief Financial Officer, who will provide additional detail on our financial results. Then Gilles will provide some commentary on our plans and provide guidance, and then of course we'll follow with Q&A.

As always in our prepared remarks and our responses to your questions, we will rely on the Safe Harbor exemptions under the rules and regulations of the securities laws, and our Safe Harbor statements in the company's filings with the SEC. So with that, I'll turn it over to Gilles.

Gilles Bouchard

Thank you, Steve, and good afternoon everyone. This quarter we experienced solid growth in our 10G products, as well as strong growth in 40G modules and in the industrial and commercial business. Offsetting this strength was significant weakness in 40G subsystems’ revenues, which were the primary contributor to our disappointing gross margins. I'll talk more about our 40G and above business later.

Our 10G module and industrial and commercial sales continued to rebound from the lows we suffered in 2009, we're seeing very encouraging trends in these markets. We achieved 13% sequential growth in 10G sales overall, comprised of 28% growth in datacom products and 5% growth in telecom products. Our industrial and commercial business grew 35% sequentially for the second straight quarter, so we're seeing a nice rebound in this business.

During the quarter, we continued to control expenses as spending for R&D and SG&A was down about 1 million from Q2. Nevertheless, we continue to invest in new products and technologies. For example, last week we announced the world's first ultra-high speed SMT multiplexer chip for 100G applications. We'll also talk more about 100G later. Now let me turn over to Bob to review the details of our third quarter performance.

Bob Nobile

Thanks, Gilles, and good afternoon everyone. We generated total revenue of $76.1 million, representing a decrease of 4.9 million compared to the September quarter. Sales of our 10G and below products increased 10% to 55.1 million as a 13% increase in 10G sales, primarily from higher sales of SFP and 10G data products, was partially offset by reduced sales of less than 10G SFP products, as we continue to be selective in this highly competitive market.

Our 40G and above revenues decreased 11.2 million to 16.8 million as weak sales of 40G subsystems were partially offset by strong 40G module sales. And finally, industrial and commercial product sales increased about 35% to 4.2 million. Compared to the quarter ended in December 2008, our sales increased 5.6 million from $70.5 million, including $12.1 million from the acquisition of StrataLight. For the quarter ended in December, Cisco, Alcatel-Lucent and NSN each represented 10% or more of total revenues. Combined, these three customers represented 54% of total revenues compared to 56% in Q2. The decrease resulted from lower 40G subsystem sales to NSN and Cisco, partially offset by increased 10G and below sales to Cisco and Alcatel-Lucent.

Geographically, revenues in North America represented 47% of our total revenue, while Europe represented 24%, Japan, 9%, and the rest of Asia was 20%. Gross margin was 15.7% compared to 21.7% for the September quarter. The December and September quarters include 240 and 250 basis point negative effects respectively from non-cash charges and costs associated with the acquisition of StrataLight and stock based compensation expense.

Excluding these effects, as well as a negative 40-basis point impact from restructuring costs, non-GAAP gross margin was 18.5%, a decrease of 5.7 percentage points from 24.2% in the September quarter. While we indicated last quarter that we expected gross margin to decline by several percentage points from the 24.2% we reported in Q2, the actual decline was greater than we expected, because of weaker than anticipated sales of higher – higher margin 40G subsystems, unfavorable product mix within 10G, and continuing negative currency impacts.

Research and development expenses decreased $1.2 million from $18.7 million in the September quarter. While non-GAAP research and development expenses were 16 million compared to 16.5 million in the prior quarter, primarily as a result of the timing of prototype builds.

Selling, general and administrative expenses decreased approximately 300,000 from $13.5 million in the September quarter, while non-GAAP SG&A was essentially flat at $11.2 million. Operating loss for the December quarter was $19 million compared to an operating loss of $17 million for the September quarter, while non-GAAP operating loss was $13.1 million compared to $8.2 million in the September quarter. The increase in non-GAAP operating loss primarily resulted from the decline in gross margin and approximate $1 million negative effect from foreign currency exchange fluctuations that were partially offset by lower operating expenses.

Net loss was $18.6 million, or negative $0.21 per fully diluted share compared to a net loss of $17.9 million, or negative $0.20 per fully diluted share for the September quarter. Non-GAAP net loss for the December quarter, which excludes non-cash charges and costs associated with the acquisition of StrataLight, stock-based compensation expense and restructuring charges was $12.7 million, or negative $0.14 per fully diluted share compared to $9.2 million or negative $0.10 in the prior quarter.

EBITDA was negative $11.4 million compared to negative $8 million in the September quarter. Adjusted EBITDA in the December quarter was negative $7.3 million compared to negative $3 million in September.

Cash and cash equivalents decreased by about $8.7 million to $146.3 million at December 31, 2009, reflecting $2.4 million of capital expenditures, $2.6 million capital lease payments and $3.8 million of cash used in operations during the December quarter.

Excluding $6.5 million of payments in connection with the StrataLight employee liquidity bonus plan, we generated $2.7 million in cash from operations in the December quarter, primarily due to lower DSOs and inventory levels, as we improved our cash conversion cycle.

And now let me turn it back to Gilles to discuss our operational plans and guidance.

Gilles Bouchard

Thanks, Bob. As I mentioned earlier, our 10G and below business was quite strong. Throughout the downturn, datacom products were hit particularly hard so there was a lot of room for growth. The decline in telecom products was not as severe.

In our Q4 plan, we’ll see a modest sequential growth for both, taking into consideration annual price reductions, which generally take effect in January. 4G modules posted better than 50% sequential growth.

Unfortunately, more than offsetting this performance was the outcome in 4G subsystems, where revenue was down almost 65%. This customer base remains highly concentrated and slower the common [ph] rates and high inventory levels that’s created reduced demand and resulted in poor visibility.

To address this issue, we have been very focused on diversifying our 40G customer base in both subsystems and modules. We are now qualified in 45 slots across 22 customers. We also have more than 50 additional opportunities in the pipeline. While we believe Q3 we’ll represent the bottom for our 40G subsystem sales. We remain cautious in our ongoing assumptions.

Overall, we are looking for moderate to sequential growth in the 40G and above business in Q4, driven by growth in 40G modules, the new 40G subsystem deployments, and the emergence of 100G.

Finally, we expect our industrial and commercial business to continue to recover. Growth has been strong in the past couple of quarters and we are ramping new products with printing and display applications. Based on these factors, we expect revenues to fall in a range of $78 million to $83 million for the fourth fiscal quarter ending in March.

Now, before turning back to Steve for Q&A, I would like to discuss the plans we have under way to optimize our operations and recent 100G developments. First, on the operational side, we are finalizing our plans intended to optimize activities in Japan. The goal is to focus our Japan activities on their core competencies and comparative strength.

Optical design, optical device design and manufacturing, the defense module development and new product introductions. We also intend to leverage these across the whole company. Activities such as main stream module and assembly, manufacturing, will be further outsourced and moved offshore. We intend to finalize our plans in the beginning of our next fiscal year and we expect that our actions will result in significant cost savings and reduced in next quarter.

Finally, I would like to talk about some recent exciting developments in our 100G program. As I mentioned earlier, last week we announced the development of the world's first Ultra-High Speed SMT Multiplexer chip for 100G applications.

Since then, we have also demonstrated in our lab single wave length 100G DWDM transmission with real time processing on the 1500 kilometer fiber testbed. And we are now working to take this platform from the lab to the broad optical networks. We are also happy to report that we have signed development contracts with two more customers.

And with that, I'll turn it over to Steve to begin the Q&A portion of the call.

Bob Nobile

Thanks, Gilles. That completes our prepared remarks and now we'll take your questions. Ashley, would you please provide instructions on how to submit questions

Question-and-Answer Session

Operator

(Operator instructions) We have a question from the line of Paul Bonenfant with Morgan Keegan.

Paul Bonenfant – Morgan, Keegan & Company

Hi, good afternoon. Thank you. I wanted to start with a question of clarification. I think I missed something that you said late in our prepared remarks, with regard to the 40Gig business, I think you said that modules was up over 50% sequentially and subsystems was down. What was that percentage?

Bob Nobile

Almost 65%.

Paul Bonenfant – Morgan, Keegan & Company

65%, okay. Just pulling that out a little bit, the subsystems business seems like it, looks like it's the lowest revenue since about June of '07, as far back as I can tell, which was about 14 million. And I'm wondering what gives you confidence that this market is coming back? And related to recent commentary from some of your competitors who have reported this week also offering 40Gig solutions, that 10Gig pricing, thanks to recent innovations like tuneable, pluggable, SFPs has made 40Gig more difficult to prove then. What gives you a sense that 40Gig is coming back or even that 100Gig is around the corner, given this sort of tight competition that you have from 10G?

Gilles Bouchard

I think as we've discussed before, Paul, you've reentered the segment of the market in terms of this question. We do feel, we still hear from customers and carriers that for long haul DWDM networks, our 40G still offers a pretty compelling value as an upgrade to 10G. It's clearly more challenging in the more mature and original networks at this point.

So from my point of view, our historical or legacy subsystems business is very highly concentrated, and we expect this business to continue, as I've said, in our prepared remarks, we made very conservative assumption in that area. We're also seeing some good activities and design wins in new subsystem deployments that between developing economies where again 40G provides a very nice and easy upgrade pack to the subsystem from 10G. So, again, we do have conservative assumption I think most of our assumption is focused on till long haul and core network markets in the foreseeable future.

Paul Bonenfant – Morgan, Keegan & Company

Okay, thanks. That's helpful. Now, on the flipside, it looks like the organic growth was very good in the quarter. You talked about 13% sequential growth in 10G, 28% in datacom, 5% in telecom. Should we expect those trends to continue, and do you see maybe a more significant rebound in the telecom business coming?

Gilles Bouchard

Yes, several comments. As you know, the fourth quarter first kind of quarter is a bit of challenging quarter because of the annual price reductions. So, I think the overall trend in the market on the long-term perspective we see as being quite good. But, again, we build very modest growth assumptions quarter-over-quarter just because of this annual seasonality. Now, one of the main reasons also just basically datacom is back, as you recall, we saw a bigger dip in datacom in 2009 than we did in telecom. Telecom obviously dipped as well, but came back, especially on the 10G [ph] SFP products. I tend to feel two segments not to be on par and will probably grow at similar rates looking forward.

Paul Bonenfant – Morgan, Keegan & Company

Okay, and last question, if I can just squeeze one last one in, since you brought up the pricing, some others have recently suggested that they are absorbing a greater percentage of the annual contractual pricing declines than normal, than they would normally see in the March quarter. Are you seeing a similar dynamic?

Gilles Bouchard

I would say that we're not seeing anything different from prior years. As you know, some customers renew contracts, some on our six months and three months. That's clearly the bulk of the annual contracts is in this quarter. So it does make this quarter more challenging, but I'm not sure I would point to any definite change of trends from last year's.

Paul Bonenfant – Morgan, Keegan & Company

Okay. Thank you for taking my question.

Steve Pavlovich

Thank you. Next question?

Operator

Our next question comes from the line of Ajit Pai with Thomas Weisel. Please go ahead with your question.

Ajit Pai – Thomas Weisel Partners

Couple of quick questions. I think the first one, you talked about the 40G and 45 slots [ph] across 22 customers, Is I get that number right, and then could you give us your view, I mean getting the design wins is great, but your view of whether carriers are going to mass deploy or have to see broad based adoption of 40G. This year and, or is it going to be more likely to be the ramp next year, and then also whether introducing 100G right now is increasing uncertainty of carriers to do going for 40G and just leapfrog, so if you could give us some color as to how that fade-off, how are you looking at that fade-off?

Gilles Bouchard

Yes, let me build from my remarks to answer Paul's question. In the 40G space, obviously we've been hit very hard with the subsystem decrease in sales. And, again, as we've indicated in the past this is a highly concentrated on a couple of carriers and deployments and US long haul. Now, aside from this, we're actually seeing a lot of activities in various backbone networks. And as I indicated earlier, in particular in developing economies with subsystem and kind of across the board with modules. Hence forth, I would say the fairly large number of qualifications and opportunities.

So I think we feel pretty bullish about the recovery of 40G over the next year. But again, as I mentioned, visibility remains a little unclear at this point, especially we are early into the CapEx cycle for carriers. Clearly, the level of interest, the level of complication is there, and we worked with a lot of customers, transform those into actual orders.

Ajit Pai – Thomas Weisel Partners

Got it. And then could you – uses of cash right now for the company?

Bob Nobile

Sure. And this past quarter we used $8.7 million. And of that 6.5 million of it was specific to the employee liquidity bonus plans related to the StrataLight acquisition. We used 2.4 million for CapEx and another 2.6 for capital leases. So our cash from operations was actually positive this quarter by 2.7 million, primarily on the strength of our improving DSOs and lower inventory levels.

Ajit Pai – Thomas Weisel Partners

Got it. And then when is your expectation that on the growth phases that you've turned cash flow positive – free cash flow positive?

Bob Nobile

Well, it all depends upon how the P&L develops. Last quarter we talked about a non-GAAP EBITDA breakeven point at $95 million of revenue and assuming a 90 in exchange rates. And there's been no change in – given the results of this quarter, there's still no change in those expectations. We would expect our CapEx spending and our requirements of capital leases to be fairly consistent next quarter with what we spend this quarter. We have $2 million remaining under the employee liquidity bonus plan and we'll pay that out before the end of our March quarter coming up, and then the rest is all dependent upon how the P&L develops.

Ajit Pai – Thomas Weisel Partners

Got it, and then the last question is, just looking at consolidation within the space, do you think that further consolidation is necessary for the pricing environment for you folks to improve? And also, do you see yourself being a consolidator in the space?

Gilles Bouchard

I mean at a micro level, I think we all feel that more consolidation is possible. We are not necessarily counting on it, and we are developing our own strategies and our own plans based on who we are today. But clearly the industry has gone through a lot of changes and consolidation and more is definitely possible.

Ajit Pai – Thomas Weisel Partners

Okay. Thank you.

Steve Pavlovich

Okay. Next question, please?

Operator

Our next question comes from the line of Ari Bensinger with S&P. Please go ahead with your question.

Ari Bensinger – Standard & Poor's

Just on the business model, if you could give us some sense in terms of gross margin because given your continued investment in R&D, and even if you have some leverage of, that was cost cuts and SG&A, it seems like 30% gross margin and what you'll need to sustain to have consistent profitability. Is that something that's possible in the near term?

Bob Nobile

Well, let's first talk about the short-term, and this past quarter, all of the things, the major items that impacts gross margin went negative on us. We had lower volumes result – the lower volume effect not only on our fixed cost base but from the lower revenues. We had unfavorable mix in our – between our 40G and above and our 10G and below categories. And we also had unfavorable mix within the 10G category, and the yen hurt us as well this quarter.

As we look towards next quarter, each of those will be turning around. Based on the items that Gilles discussed, we had improved volumes. Our mix of 40 10G will improve as well as the mix within 10G. And we've also hedged about 50% of our yen exposure for this quarter at rates in excess of 90. So, the net exposure going forward should – may actually help us. The other thing, – and now when we look further beyond next quarter, we really have to look to our product portfolio. And, you know, next quarter and especially next year, many of our 10G products will be going through next generation renewal. And we also have these – a good number of laser technologies coming out that will help the competitiveness of our portfolio. So with that and the statement I made earlier about being able to achieve our non-GAAP EBITDA breakeven at $95 million of revenue, we feel comfortable about the future profitability of the business.

Ari Bensinger – Standard & Poor's

Thank you. Very helpful.

Bob Nobile

Okay. Go ahead.

Operator

Our next question comes from the line of Bill Choy with Jefferies & Company. Please go ahead with your question.

Rahul Khanwalkar – Jefferies & Company

This is Rahul Khanwalkar calling in for Bill Choy. In your prepared remarks, you mentioned 45 slots for designing with 22 customers for 40G. I was wondering if you could give us some more clarity on geographical breakup of your 40G revenue, and where this design win activity is going on. You mentioned some of them is in the emerging markets as well as in backbone of the carrier networks. But is there any exposure to alternative operators like cable, cable guys or even in the datacom for 40G?

Gilles Bouchard

I don’t have a detailed breakdown in front of me. And again, when we talk about customers we talk about system vendors and not carriers directly, right. But pretty much from what I see, the opportunities are across the globe. Obviously, as I mentioned, there are some good, good and strong opportunities in emerging economies in China. And we are well positioned in North America historically and also looking at new developments in that area; Japan as well. So it’s pretty broad across the spectrum. I don’t think I would quote on any particular trend, frankly.

Rahul Khanwalkar – Jefferies & Company

Okay, and going back to your guidance for March quarter, it looks like there is – there are pretty strong headwinds going into the quarter. There are ASP pressures on the 10G side and you will be dealing with annual price reductions and also March quarter is seasonally weak in western markets and maybe not in Japan, but western markets. So why would you expect sequential increase in revenue?

Bob Nobile

As I indicated before, we’re going to get the benefit of volume increase, not only at the top line, but also the impact on our fixed cost base and our mix is improving. We’ll have a higher ratio of 40G and above to 10, and some of the portfolio renewals and laser technologies that I talked about before will also start to help.

Gilles Bouchard

With reference to gross margin –

Rahul Khanwalkar – Jefferies & Company

Yes, I was talking more in terms of revenue growth?

Gilles Bouchard

Yes, on the revenue side, clearly there are some headwinds, but as we indicated first on the 40G side, we feel that some of the segments we hit bottom and thanks to all those new activities and new design wins, I think we should see some benefit on tailwinds based on that. On the 10G side, yes, the seasonality is low, but we’re also still in a recovery mode of the market and, again, as Bob mentioned, we are in our renewal phase of our portfolios. So we are in a good position as well competitively. I think those effects will now shut it in slightly positive for us.

Rahul Khanwalkar – Jefferies & Company

Okay, and finally, looking at your now outsourcing opportunities that you are exploring, could you give us the detail as to what kind of operating margin we would be looking for, or what kind of operating margin you would be targeting ideally, over the long-term?

Bob Nobile

From our long-term model, again, we're looking at break-even non-GAAP EBITDA at $95 million of revenue. You know, at that level, our operating expenses that being R&D and SG&A expenses will stay relatively consistent with where we are today.

Rahul Khanwalkar – Jefferies & Company

Okay, so these outsourcing opportunities that you talked about. Do you expect them to affect your growth margin more than OpEx maybe?

Gilles Bouchard

I would say yes, in dollar terms, although there will be an impact on both. But again, I'm not really prepared to get module details on this and it give us far other plans but obviously the idea is to improve cost and also gross margin expenses.

Rahul Khanwalkar – Jefferies & Company

Okay. And finally, did you see any change in competitive dynamic maybe increasing competition from low cost Asian vendors or anything like that in the quarter?

Gilles Bouchard

I don't know if I saw anything different this quarter, but there's been a, I think a rising level of competition from Asian vendors, especially in below 10G segments which in some areas particularly in China has become quite competitive. But as Bob indicated, this is a segment that is not very large for us and where we decide to be selective when we play. We're also seeing the emergence as well of some 10G level competition. I mean, it's a bit early to assess it at this point.

Rahul Khanwalkar – Jefferies & Company

Okay. So is it okay to think that maybe the barriers to entry will be higher for 40G and eventually 100G market basis, 1G or 10G or even – 1G or 10G or even 10G markets?

Gilles Bouchard

That might be higher and slightly different. Again, even if you look at 10G today or 1G, the compare as you mentioned usually don't control optical device technology. So, we believe long-term this will remain a core advantage for companies like Opnext and that's why we invest things what we're doing in Japan and going for transformation we're going through.

Similar in 40G, I think 100G is a different animal because of the whole move to quadrant [ph] protection, where so much of the value add in investment are in affix [ph] as opposed to just optical devices. So, we believe 100G will bring a whole new layer I think of various treasury.

Rahul Khanwalkar – Jefferies & Company

Okay. It sounds good. Thanks a lot.

Bob Nobile

Okay. Next question?

Operator

Our next question comes from the line of Dave King with B. Riley. Please go ahead with your question.

Dave King – B. Riley & Co.

Yes, thank you. Good afternoon. Just first question is on, can you just talk about the supply chain issues, some of your competitors are saying that our company assures is especially on ICs, how much revenues did it cost you last quarter, and regarding your fourth quarter guidance, how much are you kind of taking into your guidance as far as company shortages are concern?

Gilles Bouchard

Yeah, Dave, there are definitely some supply chain constraints, especially in the ACEX [ph] and components, but also sometimes into the very basic components. I don't really like to put numbers frankly because we build those into our plans and its part of what doing business is about. So I'm not going to quantify how much it was, but I would say those numbers have gone into our guidance.

Also remember that there's always a downside effect but there’s also potential upside because the – whoever can provide and supply has opportunities that might open up. So it’s a bit of a two-way street as well as we’ve optimized supply chains.

Dave King – B. Riley & Co.

Right. Just so actually some of those (inaudible) they said their lead time had stretched quite a bit, so does that mean your products are as far as lead times are concerned are stretched too, or...?

Gilles Bouchard

Well, again, there's some areas of tension and, yes some lead times have stretched, but again, those issues have been build into our plans so far.

Dave King – B. Riley & Co.

Got it. And can you talk about capacity, what your utilization was and how you see that going forward?

Gilles Bouchard

Well, capacity utilization on the module level is quite high right now, because obviously the ASPs are defined and the revenues have come back, so you can imagine at the unit level the numbers have gone up. So we have been investing in capacity and we'll continue to do so through the growth of the margin.

Dave King – B. Riley & Co.

When you say quite high, I'm assuming you talk about 10G and below 40G?

Gilles Bouchard

40G, it depends which products, right? Remember our 40G problem I would say is limited to one product category but in modules and other areas, demand is quite strong.

Dave King – B. Riley & Co.

Okay. And then just then talk about the price difference between 10G and 40G, I think last quarter the number was like 50% premium, At what point because I just – or can you just talk about advantage of having the 40G, I guess there’s some operational advantages of having a 40G versus 10G like spectrum efficiency and all that, so at what point would customers say, hey this is closing now, we are going to 40G rather than buying for 10G? Could you just talk about that?

Gilles Bouchard

Yes, it's a very broad topic, but to try to oversimplify, long haul core network, even with the price differential between 10G core and 40G core when you look at the whole link all the and between and upgrade content to 10 to 40 can be compelling financially versus new 10G rail for example. That's very clear. When you get to metro networks where the price pressures are higher, where the fiber quality required potentially different 4G technology which might be more expensive we're not quite there yet, so these are just kind of emerging markets.

Dave King – B. Riley & Co.

Okay. Just one more on maybe a case study, since last week, AT&T said they will be increasing their CapEx, but what they said is the wireless investment will be priority number one. So I am assuming wireless will get most of the investment attention because I am assuming their reduction [ph] we have to take care of their backbone part as well. So what do you think the timing is as far as, from wireless to backbone, what do you think the lag will be or will they work simultaneously?

Gilles Bouchard

Well, I will not speculate on this. As I have indicated before we feel like the visibility in terms of business is not very good at this point and made conservative assumptions. Obviously we will be more – more than welcome any change or assumptions but right now we've been quite conservative there.

Dave King – B. Riley & Co.

Just one more question then. Can you guys talk about what's going on in the R&D? You caught us in the pipeline, especially in your datacom. What about – how are you positioned in cable optics and how are you positioned in the products for wireless back haul?

Gilles Bouchard

We're not present in cable optics as of today.

Dave King – B. Riley & Co.

Is that something that will be addressed later on or –?

Gilles Bouchard

I'm not prepared to discuss it today.

Dave King – B. Riley & Co.

Okay. What about back haul?

Gilles Bouchard

In back haul, yes, we see some interesting opportunities. It plays mostly in the below 10G market, which again, is more an opportunistic market for us, but such opportunities belong to that. And as you know, on a broader sense, as Bob indicated, we are starting a very important refresh cycle with our 10G portfolio, both at the module and device level, which will continue through the year, which is very important for us, and in parallel with more new products in the 40G and all these spaces that I discussed.

Dave King – B. Riley & Co.

Got it, thank you.

Steve Pavlovich

Next question?

Operator

Our next question comes from the line of Cobb Sadler with Catamount Strategic. Please go ahead with your question.

Cobb Sadler – Catamount Strategic

Thanks a lot, guys. I had a question on how much revenue came from VMIs or hubs. Do you guys still have a breakout roughly?

Bob Nobile

Yes, when you look at VMI revenues, you really have to differentiate between the 40G subsystems revenues and the rest of the portfolio and the rest of the portfolio VMI pull is probably about 50%.

Cobb Sadler – Catamount Strategic

Okay. And what should we keep hearing your supply is tight and demand maybe a little ahead of supply with a lot of the OEMs. So what's up with the pricing environment? I would think the pricing environment would be more benign than it has been in the past, because we haven't seen a situation in a long time where demand actually is outstripping supply?

Bob Nobile

I mean Gilles, touched on this earlier. Generally, when we're looking at pricing year-over-year, it's fairly comparable. When you look at it in comparison to where it was two or three years ago, it's a little bit higher. We've always talked about 15% year-over-year pricing. Last year we saw that increase probably a couple of points and I would say at least through this point we're seeing that staying relatively consistent.

Cobb Sadler – Catamount Strategic

Okay. And on the breakeven cost structure, and I guess first of all, you don't know when you hit 95 million, but I guess would you consider taking the cost structure down somewhat for a lower breakeven, or are you set on 95 and how do you get there at some point?

Bob Nobile

As of right now, that's our point. Obviously, we continue to monitor this very closely every month, every quarter. And as Gilles indicated, we're going through a process of a valuating, had best optimize our Japan organization and that should help our overall cost structure.

Gilles Bouchard

And to build on Bob's comment, I think we've been pretty explicit of the fact that we are heavily investing right now in our 100G program, which makes our R&D as a percent of revenue very high compared to industry standards, or maybe even historical standards, or even potential future standards for us. But we feel strongly it's the right time to this investment. As I indicated, it really trying to show some good results for good momentum and that's our plan and strategy looking forward.

Cobb Sadler – Catamount Strategic

On the 100G side, can you talk a little bit about the competitive environment there, is it – the plus [ph] competitive new players actually have products today than in the sub-10 for sure in 10Gig?

Gilles Bouchard

Yes, it’s totally different. On the client side, what’s called the CFP, we’re going to find two or three competitors. Again, none of those products are fully qualified, you know they’re stamping [ph] so it will be early to know exactly what the landscape is going to be, but it’s a much more restricted space. On the 100G line side, I mean all the things I talked about were kind of rolls first, so the company of landscaping is very restricted there.

Cobb Sadler – Catamount Strategic

Got it. And last question, on 100Gig, I mean when – another crystal ball question, when do you think that hits a material level, like well say 5% of revenue?

Gilles Bouchard

I've always said that 100G was mostly a 2011 story, and we expected to ramp as it is farther to 2009 then.

Cobb Sadler – Catamount Strategic

Okay.

Bob Nobile

2011.

Gilles Bouchard

Calendar.

Cobb Sadler – Catamount Strategic

Calendar.

Gilles Bouchard

Calendar yeah.

Cobb Sadler – Catamount Strategic

Okay, got it. Okay great. Thanks very much.

Operator

(Operator instructions) We do have a question from the line of Dave King with Riley.

Dave King – B. Riley & Co.

Yes, just one question on your R&D. I mean, I think you said you’re investing heavily on the 100G. What do you think the mix is between 100G investment versus 40G and 10G and below?

Gilles Bouchard

In rough numbers, I would say 40 and 100 is well north of 60% our investment.

Dave King – B. Riley & Co.

Okay, okay, got it. All right. And what about given your strong cash position, any kind of acquisition strategies going forward?

Gilles Bouchard

Well, as we said before, we always look for the right opportunities at the right time. That's about as much as we can say, right.

Dave King – B. Riley & Co.

Okay. In terms of like technology, I mean, the technology that you might be interested in?

Gilles Bouchard

Yes. There are things we are looking at, and I would rather discuss it –

Dave King – B. Riley & Co.

Got it. Understood. Thank you.

Operator

And we have no further questions in queue at this time.

Bob Nobile

Okay. Well, with no more questions, that will conclude our call for today. Thanks for joining us this afternoon, and we look forward to talking to you soon. Bye for now. Operator, do you want to provide the replay instructions?

Operator

If you would like to access today’s conference replay, your replay number is 7066459291 or 800-642-1687. A replay will be available two hours after the call concludes and will be ending on February 12, 2010 at midnight. Thank you. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!