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Opnext, Inc. (NASDAQ:OPXT)

Q1 2011 Earnings Call

May 16, 2011 4:30 p.m. ET

Executives

Steve Pavlovich - Vice President, Investor Relations

Harry Bosco - Chairman and Chief Executive Officer

Bob Nobile - Chief Financial Officer

Analysts

Natarajan Subrahmanyan - Sanders Morris

Alex Henderson - Miller Tabak

Ari Bensinger - Standard & Poor’s

Ajit Pai - Stifel Nicolaus

Sarkith Sorbechian - B Riley & Company

Operator

Good afternoon. My name is Misty and I will be your conference operator today. At this time I would like to welcome everyone to the Opnext fourth 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. If you would like to ask a question during this time simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question press the pound key. Thank you. Mr. Steve Pavlovich, Vice President, Investor Relations, you may begin your conference.

Steve Pavlovich

Thank you Misty. Good afternoon and thanks for joining us today. We will discuss our financial results for the fourth fiscal quarter and fiscal year ended March 31, 2011. We’ll begin with Harry Bosco, our Chairman and Chief Executive Officer, for an overview of the quarter followed by Bob Nobile, our Chief Financial Officer, who will provide additional detail on the financial results.

And then Harry will return and talk about market trends, operational plans and guidance and of course it will be followed by Q&A. As a reminder, the matters we will be discussing today include forward-looking statements and as such are subject to risks and uncertainties that may cause actual results to differ materially from those set forth in these statements.

Such risks and uncertainties are discussed in the company’s filings with the SEC including the press release filed today and our most recent annual report on Form 10-K, quarterly reports on Form 10-Q and any applicable amendments. Please refer to the Safe Harbor language contained therein.

In providing forward-looking statements the company expressly disclaims any obligation to update these statements. Also let me mention that throughout this conference call we will be referencing both GAAP and non-GAAP financial measures. A complete reconciliation of the non-GAAP financial measure to the applicable GAAP financial measure including a reconciliation of the adjusted EBITDA to EBITDA can be found in the press release we issued today, which is available on our Web site in the investor relations section. With that I’ll turn it over to Harry.

Harry Bosco

Thank you Steve and good afternoon everyone. Today we reported $95.3 million in revenues for the quarter ending March 31, 2011. This is down 2% compared to the December quarter and up 24% compared to Q4 2010. I’m pleased with this outcome given the challenges we faced this quarter resulting from the earthquake and tsunami in Japan.

We were very fortunate none of our employees was injured and we experienced minimal damage to our facility. Our production at two of our factories in Japan were temporarily disrupted and our team did an outstanding job of restoring our module assembly facility in just ten days and our chip production facility by mid-April.

I’d like to personally thank them for all their efforts during this very trying time. For the fiscal year ended in March 2011 revenues of 10G and below products increased $20.7 million or 10% to $222.2 million. 40G and 100G module revenues increased by $57 million over the past last fiscal year, which represents a growth of over 200%.

And sales of industrial and commercial products increased by $15 million or almost 95%. Our progress toward profitability continued this quarter. If not for the earthquake our gross margin percentage would have increased sequentially given the benefits from our lower cost optical subassemblies and a higher mix of 40G and above revenues.

Cash increased to $100.3 million and benefitted from a 21.4 million of net proceeds from the sale of certain technology assets. This transaction enabled us to monetize prior R&D investments without compromising our competitive position. While we prepare for the future growth we will remain focused on our cash position and returning to profitability. Now let me turn it over to Bob to discuss the financial results in more detail.

Bob Nobile

Thanks Harry and good afternoon everyone. Revenue in the quarter ending March 31, 2011 was 95.3 million, a decrease of about 1.8 million or 2% compared to the December quarter. The decrease resulted from a ten day interruption in our Japan module manufacturing following the March 11 earthquake and tsunami.

10G and below revenues decreased 20% to 48.9 million primarily due to lower 310, Zen Pack and X2 module sales. 40G and above revenues increased 37% from the December quarter to 38.2 million despite the effects from the earthquake. The growth was led by strong demand for 40G and 100G modules and an increase in sales of 40G subsystems. Revenue from industrial and commercial product sales increased 4% to 8.2 million representing the seventh consecutive quarter of I&C growth.

Compared to the fourth quarter ended in March 2010 total revenue increased 18.5 million or 24%. Sales of 10G and below revenue were essentially flat at approximately 49 million compared to the fourth quarter of last year. Increased sales of XFP Plus, XFP and X2 modules were largely offset by a decrease in Zen Pack and 310 module sales.

40G and above revenues increased 16.3 million or 74% from the quarter ended in March 2010 primarily from an increase in 40G and 100G module sales that was partially offset by lower revenues from research and development contracts and lower 40G subsystem sales. Sales of industrial and commercial products increased 2.1 million or 34% compared to the quarter ended March 31, 2010.

This quarter’s Cisco and Waway each represented 10% or more of total revenues and on a combined basis represented 33% of revenues. In the December quarter these two customers represented 30% of total revenues. For the fiscal year ended March 2011 Cisco, Waway and Alcatel-Lucent each represented 10% or more of total revenues and combined represented approximately 45%.

Geographically for the quarter ended in March 2011 revenues in the Americas represented 30% of our total revenue while Europe represented 19%, Japan 15% and the rest of Asia was 29%. Gross margin was 19.6% in the quarter ended March 2011 compared to 20% in the December quarter while non-GAAP gross margin was 21.3% compared to 21.5%.

In the March quarter non-GAAP gross margin percentage was unfavorably impacted by lower average selling prices including the effect of calendar year price adjustments. It was also affected by a 110 basis point negative effect from idle capacity and damaged inventory charges as a result of the earthquake and a 60 basis point negative effect from foreign currency exchange rate fluctuations and hedging programs.

Non-GAAP gross margin percentage was favorably impacted in the March quarter by higher mix of 40G and above revenues, lower average per unit material and outsourcing costs and an 80 basis point net benefit from the sale of previously written down inventory. For the year ended March 31, 2010 gross margin was 19.7% and non-GAAP gross margin was 21.5%.

Excluding the negative effects from foreign currency exchange rate fluctuations and the Japan earthquake we realized 37% gross margin on the incremental revenue from the prior fiscal year despite a minimal increase in 40G and above revenues. Looking forward to our first fiscal quarter ended in June 2011, we expect our gross margin percentage to modestly improve at constant exchange rates as the negative effects of the earthquake are reduced.

R&D expense was 15.6 million in the March quarter compared to 13.7 million in the December quarter while non-GAAP R&D expense increased to 15.2 million from 13.3 million. The increase was primarily due to the timing of material and outsourcing costs related to advanced development programs as well as prototype builds associated with new product introductions as we discussed last quarter.

For fiscal year 2012 we expect R&D spending to average less than $15 million per quarter as several advanced development programs transition to new product introduction efforts. SG&A expense was 14.5 million in the March quarter, down from 15.4 million in the December quarter. Non-GAAP SG&A expense was 13.1 million in the March quarter, up from 12.9 million in the December quarter.

For Q1 we expect SG&A expense to be similar to the March quarter. Operating loss for the March quarter was $12 million compared to 10 million in the prior quarter. On a non-GAAP basis the operating loss for the March quarter was 8.4 million compared to 5.3 million in the December quarter. The increase in non-GAAP operating loss primarily resulted from lower absolute gross margin, higher R&D expenses I previously mentioned and a $1 million negative effect from foreign currency.

Net income was $9 million or 10 cents per fully diluted share compared to a net loss of 10.2 million or negative 11 cents in the December quarter. Net income for the quarter ended March 31, 2011 includes a $21.4 million gain on the sale of technology assets net of costs directly associated with the transaction. Non-GAAP net loss was 8.7 million or negative 10 cents per fully diluted share compared to 5.5 million or negative 6 cents in the December quarter.

EBITDA for the quarter ended March 31, 2011 includes the 21.4 million net gain on asset sale and was positive 17.3 million compared to negative 1.8 million in the December quarter. Adjusted EBITDA was negative 2.2 million compared to positive 1.1 million in the December quarter. Cash and cash equivalents increased by 12.9 million to 100.3 million at March 31, 2011 primarily reflecting 21.4 million of net proceeds from the asset sale.

That was partially offset by 2.1 million of cash used in operations, 2.3 million of capital expenditures, 2.4 million of short-term debt payments and 2.4 million in capital lease payments. Net working capital other than cash and cash equivalents was essentially flat. For Q1 we expect working capital requirements to modestly increase while CapEx and capital lease obligations are expected to remain consistent with the March quarter.

Q1 will also benefit from about $2 million of net proceeds from the second and final phase of the asset sale. And now let me turn it back to Harry.

Harry Bosco

Thanks Bob. Let me first start by again acknowledging the extraordinary effort of our team in Japan. To give you an idea of the magnitude of their accomplishments, we started out with 35 identified supply constraints, which now have been reduced to two with a plan to resolve those as well.

The team has also arranged for and is now in the process of installing back up power systems to mitigate any future power interruptions similar to those we experienced in March and April. So all of Opnext extends its thanks to our colleagues in Japan. Now let me turn to my primary ongoing focus, which is to return Opnext to profitability and positive cash generation.

While we experienced a setback as a result of the earthquake, the fundamentals of our plan are intact. We continue to make focused investments in future products as we execute the various actions I spoke to you about last quarter. First, we are working to improve our overall gross margin. Here we have two primary areas of focus - improving our product cost structure and improving our product mix by continued focus on the faster growing, higher speed segments of the optical component market.

The latest industry analyst reports continue to indicate strong growth prospects for the markets Opnext is focused on. While the 10G market is expected to grow at a 10% kegger through calendar year 2014, the 40G and above market is projected to grow in excess of 50%. Our 40G and above products have sequential growth in excess of 25% for the last three quarters and increased to 40% of our total revenues in the March 2011 quarter.

The 40G and above market growth continues to be driven by major carrier deployments and upgrades across all regions of the world. The transition to higher speed products is accelerating as all optical infrastructures are being deployed to accommodate the bandwidth demand. Also, more of our equipment customers are transitioning their products from custom, in-house solutions to module based systems.

Our 40G modules are now qualified in 73 slots across 28 customers. Our 100G CFE modules are being qualified in 16 slots with 11 customers. Last quarter I mentioned that we created a dedicated team to work with our suppliers to improve the supply situation primarily affecting our 40G and above products. I’m pleased to report that the team has made significant progress to minimize these constraints.

To improve our product cost structure we are better utilizing our contract manufacturers’ capabilities and working with our suppliers to design lower cost parts. We are also focused on improving gross margins by increasingly using more in-house optical components and lower cost subassemblies. The more cost effective products are driving 10G design wins and as a result we added 14 new slots during the March quarter.

Our effort to better utilize our contract manufacturers has the added benefit of also reducing our yen-based costs, which is the second element of our plan to return to profitability. While we continue to drive yen-based costs and expenses lower, we are focused on resources in Japan on high value added activities.

As we said last quarter, we have created a model where we can be profitable and cash flow positive with an exchange rate of 80 yen per US dollar. The third part of our plan is to return to profitability consists of a reduction in operating expenses. As you know, we have made significant investments in advanced product development programs over the past two years and those programs are now transitioning to new product introduction efforts.

Accordingly, we expect R&D spending to average less than $15 million in fiscal year ’12 and we expect to be able to favorably leverage our SG&A infrastructure as we grow this business. In summary, we believe our growth prospects remain solid. We have great products with more on the way so we’re expecting to grow at least as fast as the market. In addition, we have a solid plan in place to improve gross margins and leverage our infrastructure.

My objective continues to be to achieve profitability as fast as possible. Before moving to our guidance I’d like to say a few words about our I&C business, industrial and commercial products, and our 100G coherent development program. Our industrial and commercial products continue to perform well. We have seen consistent revenue growth for almost two years.

During the March quarter we announced two new products that have been well received, a violet laser diode used for medical illumination systems and direct imaging on PCB manufacturing surfaces as well as a blue laser for many projector applications. Our 100G coherent program continues to be well received as we actively engage DWM system providers on our 100G module approach.

We believe based on these engagements and progress in our labs our investments today will allow us the opportunity to address about half the market with moderate additional investment. And so we continue to see this as an exciting future revenue stream for the company. In addition, we will continue to look to other ways to monetize our R&D investments. Now let’s move to Q1 guidance.

Taking into consideration the earthquake related supply constraints that continue to affect our 40G and above and our 10G products and a loss of production at our Japan factories, we expect revenues to be between $93-97 million for our first fiscal quarter ending June 30, 2011. So with that I’ll turn it back over to Steve for the Q&A portion of the call.

Steve Pavlovich

Okay. Thanks Harry. So that completes our prepared remarks and now we’ll take questions. Missy, why don’t you go ahead and provide instructions?

Question and Answer Session

Operator

At this time if you would like to ask a question please press star then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Sabu Subrahmanyan with Sanders Morris. Sabu, your line is open.

Harry Bosco

Are you there Sabu?

Natarajan Subrahmanyan

Can you guys hear me?

Harry Bosco

Yes. Now we can.

Natarajan Subrahmanyan

Okay. Sorry about that. So I wanted to start talking about the demand environment. Most of your peers have talked about inventory correction and issues across the board more specifically in some of the (laser) components you’re less involved in. But can you talk about the demand environment?

Have you seen any kind of impact from correction because that’s something that all of your peers have talked about, a slower demand environment in which you have actually not spoken about? And can you also talk about book to bill and what the actual demand was and production constraints and largely not being able to ship against that but book to bill and actual level of demand that you saw in March and what you would expect it to be in June.

Harry Bosco

Yes. Let me just start with the demand side of the house Sabu. We’re fortunate enough that we are across many customers with our 40G and 100G products so we do see fluctuations on a customer basis in and out on a monthly basis but again, we’re fortunate enough to be spread across them that we don’t see any really drastic change in demand from our customer base. As far as book to bill, our book to bill now is just recently over one.

Bob Nobile

Sabu, it was below one for the quarter ending March. Quarter to date it is above one.

Natarajan Subrahmanyan

So it was below one for the quarter ending March but quarter to date about one? And if you look at - if you ex out the impact of what you could not ship, I mean what do you think the real level of demand was if book to bill was below one? Were there some products in which you were still constrained because of the production issues?

Bob Nobile

I mean I think the way we look at it is absent the earthquake we feel very comfortable with our guidance this past quarter.

Harry Bosco

Yes. Our impact mainly was in the 100G, 40G and some of the pinnable areas.

Natarajan Subrahmanyan

Understood. And for this quarter again, can you quantify the impact of half a month of not having the laser tab and continuing component issues, how you would quantify that in terms of your guidance?

Harry Bosco

We have first of all again, we’re down to two really constraints we have in components now and one is in PCB area. And it’s basically the epoxy that they use in it is limited. So we already have achieved and received and alternate supplier of that but we have to go get it requalified back in the customer base. But again, it’s gone through that performance.

And the second one is external lasers that we buy and we have two problems there. One is accelerating working with them to accelerate their productions and second is using our own internal source. So we have both those going. And we talked about it - it’s basically we’re through basically the module line impacting us as far as manufacturing capacity.

It’s really down to the critical components, getting enough of those in and by the end of this quarter we should be pretty well through this.

Bob Nobile

Afterwards Sabu we then expect to sort of grow with the market.

Natarajan Subrahmanyan

I was just going to say given the capacity constraints now turning into inventory issues that some others have faced, first of all, have you - what inventory issues do you see issues at some customers or any of your products? And how do you think about market growth given overall market does seem to be going toward a little bit of a downturn once your component issues are sorted out? How do you view market growth going out of the June quarter?

Bob Nobile

I’ll talk about the inventory situation and then I’ll let Harry tell you about the market. But as Harry said, we saw some pockets of ups and downs in the demand this quarter and actually some of our BMI inventories went up as well. But again, nothing of any one unique thing and any specific geographic area or customer was that individually significant.

Harry Bosco

Yes. In the case of demand 10G has always gone up and down and where we had some down side the past quarter was really in the 300 pin area. And that fluctuates. That’s continually fluctuating up and down. In the 40G area we still feel pretty strong growth there again across multiple customer bases. And you will have these pockets, I’m sure you will, of inventory issues.

But it’s really again by supplying to so many customers we’ve kind of alleviated that. And 100G we’re pretty close to the only person delivering a lot of short-reach 100Gs right now.

Natarajan Subrahmanyan

So you view the market as growing past the June quarter for the subset of products that you’re involved in?

Harry Bosco

Yes.

Bob Nobile

Sabu, when you look at the book to bill for this quarter, again 40G and above was above one. The 10G and below business was down below one.

Natarajan Subrahmanyan

All right. Thank you very much.

Steve Pavlovich

So Sabu, one last clarification. The guidance that we have given takes into consideration all of the contingencies that Bob and Harry have talked about with respect to the earthquake situation.

Natarajan Subrahmanyan

Understood. Thank you.

Operator

Your next question comes from the line of Alex Henderson with Miller Tabak.

Harry Bosco

Hey Alex.

Alex Henderson

You guys did a fabulous job given what happened in Japan. I’m very impressed. Not an easy task to deal with that kind of trauma. I’ve got a couple of questions for you on some of the older products. Are you seeing any impact on your 300 pin business from the rollout of tunable XFPs at this point?

Harry Bosco

No. It’s really - this is Harry. It’s really a different market that’s being developed there. The 300 pins are already well deployed in the field right now so it’s more growth on those systems. You really have to go out with different systems when you start using the XFP tunables.

Alex Henderson

So it’ll be a redesign of the board and redesign of the system before that starts impacting?

Harry Bosco

It’ll be replacing the fixed wavelength XFPs.

Alex Henderson

I’ve heard that 90% plus of what JDF ships so far is replacing fixed XFP but 24 million a quarter, that’s pretty much the scale of the market. I was concerned that there might be some impact starting to develop or in anticipation of some impact on that if they get out into some of these board designs.

Harry Bosco

I think as the cost comes down on the XFP tunable we’ll see more and more impact on the fixed wavelength XFPs.

Alex Henderson

There can’t be that much more to go. I mean it’s already $100 million run rate. I’m sure the market’s not that large.

Harry Bosco

No. It’s probably going to be that they’re using them as spares and stuff in some of these systems.

Alex Henderson

The other question along the same lines, do you think that the products, the tunable XFPs that you’ve seen out there can replace 300 pin or do you think that you’re protected for a little while longer on the technology side?

Harry Bosco

I think it eventually as the systems get redesigned we’ll start to take the 300 pin business down. Again, what’s going to be critical on this thing is the cost.

Alex Henderson

Don’t you need zero chip on those, though? And I’m not under the impression that those are zero chirp.

Harry Bosco

Yes. We have three different ones coming out from us I know and the last one will have zero chirp.

Alex Henderson

Okay. The Chinese market obviously is a point of significant debate and contention. Do you have any sense of what the Chinese service providers are doing? Have you got any read through to the end customer whether they are reaccelerating orders? And if you don’t, it’s not a problem. I just was hoping to look through it a little bit.

Harry Bosco

I know what the one of our customers Fiber Home and that is still forecasting pretty aggressive growth.

Alex Henderson

All right. That’s a customer to the service providers though. What I was asking is…

Harry Bosco

They provide the China telecom net.

Alex Henderson

Right. The other thing that I had heard is that Waway is in the process of pushing pretty hard on rolling out BMI and consolidating some venders. Obviously you had good numbers there. Are you seeing any impact from them pushing out or trying to draw down inventory in anticipation of rolling BMI?

Bob Nobile

We have already been involved with their BMI program for quite some time already.

Alex Henderson

So no impact on you from that issue. Do you think that that’s a factor in some of the other people who are having difficulties?

Bob Nobile

I think it’s hard to tell.

Alex Henderson

Okay. Great. And then finally on the 40 gig side, obviously very robust. Can you give me some sense of how much was coherent versus noncoherent in the mix?

Harry Bosco

Yes. 40G is we have no coherent offering right now. We have the short reach, we have DPSK and DQPSK.

Alex Henderson

Okay. When do you expect to get that out again? Can you remind us?

Harry Bosco

On the coherent, our strategy is the coherent is going to hit the 100G first.

Alex Henderson

Okay. So you’re skipping by that one? Okay. Great. Got it. Just couldn’t remember the detail on it. I appreciate it. Thank you very much.

Harry Bosco

Okay Alex, thanks a lot. Next question please.

Operator

Your next question comes from the line of Ari Bensinger with Standard & Poor’s.

Ari Bensinger

Yes thanks. Question on the operating model - you guys held steady quarter to quarter and absent the charges related to the earthquake and FX it looks like gross margins are starting to widen and you definitely had a large 40G mix.

Looking ahead, can you give some guidance and outlook given that that’s one of the primary drivers towards profitability?

Bob Nobile

Yes. I mean this past quarter when you take away kind of the one-off items our margins probably widened by about 70 basis points even while revenues were down a bit. You know the way you should look at our business is as our revenues grow there is about 40% gross margin on the incremental revenues.

Ari Bensinger

That’s helpful. Thank you. And then just you gave some guidance on R&D. Looking at SG&A, is there any long-term target there? It’s running roughly 13 million a quarter for the last two quarters and you said flat for this quarter. Is that a level that can be narrowed going forward on an absolute basis?

Bob Nobile

On an absolute basis it’ll probably stay relatively consistent with where it is. But obviously as the business grows it will require more costs to fund the variable elements of the marketing and sales functions, which we should be able to compensate with on the fixed side.

Ari Bensinger

Okay. Thank you. Good quarter.

Harry Bosco

Thanks Ari. Next question please.

Operator

Your next question comes from Ajit Pai with Stifel Nicolaus.

Ajit Pai

Good afternoon. A couple of questions - one on just looking at the gross margins. In addition to what you just told, the variable margins on the 40G and higher products should be quite significant just given the higher software content. And as you bring the costs down and the driving volumes, how soon do you think that you can get back to sort of 25-30% kind of gross margin for the overall company?

Bob Nobile

I think as the business approaches let’s say $110-115 million per quarter of revenue, I think that’s when you get to around that 25% level.

Ajit Pai

Got it. And then from a CapEx perspective is there any sort of requirement outside of restructuring costs, etcetera? Is there any other requirement for CapEx to accelerate with the rising volumes? What kind of utilization do you have right now?

Bob Nobile

We’re in good shape. This past year between CapEx that we funded along with new capital leases, we put into service about $19 million of new capital, which was about almost a $10 million increase over the prior year. So we did a lot of the heavy lifting this year. We would expect in fiscal year ’12 to be less than the 19 we spent this year and obviously that will depend on how fast the market grows and how quickly our capacity gets utilized.

Harry Bosco

The other thing is we put a lot of our capital goes into test sets. It’s not really going into like SMT machines and stuff like that and manufacturing.

Ajit Pai

Got it. But with your current manufacturing across the board including test sets, would you say that you can grow your revenues another 30-40% without requiring additional CapEx? Or do you think you need additional CapEx beyond 20%?

Bob Nobile

We’ll spend $12-13 million or so over the next year on the expectation that the business is going to grow with the market, right? And as Harry talked before, 10G has got a carrier of 10% while the 40G and above is at over 50. So it’s kind of that level to support that level of revenue growth.

Ajit Pai

Right. And then one other trend that you have talked about in the last cycle ten years ago, you had a lot of the comm equipment vendors sort of spinning out their component divisions. But going into 40 and 100G especially on the 100G coherent side, you’ve seen a lot of the system venders with their own solutions.

Harry just talked a little bit about expecting the market for 40G and higher to get to grow 50% a year and you also said that you expect to grow faster than the market. When you are talking about faster than the market, do you still think especially with all the captive sort of technology utilization by some of the large OEMs that the merchant market for audio and subsystems 40G and higher that you can still grow faster than 50% for a two to three year period?

Harry Bosco

Here is what I think is happening right now. In fact, when you talk with people who have their own internal solutions, they are going on to the next generation. So they did it basically to get out of the marketplace fast and get out there first. But they’re all going to go into module type structures and take modules from multiple venders as they move on to the next generation.

Ajit Pai

So that’s becoming clear to you as you’re looking at the way they’re operating? They get it out first and then after that, the economics don’t work for them, it makes much more sense to go to the merchant venders rather than keep that captive capability? Is that fair?

Harry Bosco

Yes because the cost comes down and they just don’t want to invest in that any more because they want to go on to the next thing.

Ajit Pai

And you’ve seen that with most of the leading venders?

Harry Bosco

Yes. When I talk to them they talk about okay, so we don’t have 100G. They won’t be taking 100G modules for the next two years. But they’ll be transitioning into module-based systems.

Ajit Pai

At some point. So from a group perspective then you’re still comfortable with growing faster than that 50% growth for the market that folks expect?

Harry Bosco

Yes. I think we’re in pretty good shape on that.

Ajit Pai

Okay.

Harry Bosco

On the 40G and above side. That’s where the growth is going to be, right?

Ajit Pai

Right. And now on the 40G and above side just until you get to price parity with 10G, you typically see slower adoption and pricing declines coming in faster. From this point onwards as adoption is accelerating and you’re pretty close to parity, do you think that the pricing declines will be far more moderate than you have seen in the past?

Harry Bosco

I hope they slow down. I mean they’ve basically come down from the initial introductions but again, in parallel with that is the components are coming down. As the volume goes up the critical components we use inside of our systems are going to go down in price. There are more competitors coming into those.

Ajit Pai

Right. So it’s fair to say that the price of the components is falling faster than the price of the modules?

Harry Bosco

Yes. The whole system is dropping of course to keep up with the price reductions but the modules - there are certain critical components that are coming down at different timeframes. They depend on the complexity of them. We have also done another thing, Ajit. We are replacing out some of the internal components we buy with our own. We’re looking for those high value niches that we can take our third parties out of.

Ajit Pai

Got it. And then is it still fair to assume looking at the operating margin that you expect to be at 25% gross margins at 110-115 million in revenue that you’d expect a positive operating income at that point of time?

Bob Nobile

Yes. It’d be about break even at that time.

Ajit Pai

Got it. Okay. And do you have an update on like the long-term model? Can we expect like a 30% about a year beyond that? Would you expect something with a high single digit, low double digit operating margin and 30% gross margin? Is there any kind of internal model looking out a year out?

Bob Nobile

At this point we’re not updating anything longer. We’ve still got to get through the rest of the Japan earthquake situation and the things that Harry talked about.

Ajit Pai

Got it. Okay. Thank you so much.

Operator

Again if you would like to ask a question please press star then the number 1 on your telephone keypad. Your next question comes from the line of Sarkith Sorbechian with B Riley & Company.

Sarkith Sorbechian

Hi. Good afternoon. Thanks for taking my questions. Nice to see that you averted some of that disaster nicely and restored your operations. And that’s pretty solid guidance there also. So just off of the top of my memory for break even EBITDA run rate, is it still 97 million in revenues?

Bob Nobile

That’s correct with less than R&D, less than $15 million a quarter in R&D, SG&A expense is about comparable to where we’re at today.

Sarkith Sorbechian

Okay. And given that we still have maybe a little bit of overhang it looks like from the Japan situation, do you anticipate on that taking maybe a quarter or two to shake out?

Harry Bosco

I think right now our plan is we should be out of this constraint view by early second quarter.

Sarkith Sorbechian

Okay. Early second quarter - and so the two constraints that you did mention, one was the epoxy and the other one was the external lasers that you’re procuring? Is that correct?

Harry Bosco

Yes.

Sarkith Sorbechian

Okay. So the laser situation, now that’s not really something that’s new right? That’s been ongoing.

Harry Bosco

No. That occurred during the earthquake because they basically had to reprocess wafers, right? They’re living off of inventory right now and processing those.

Sarkith Sorbechian

Okay.

Bob Nobile

This is a different laser supplier than what we were talking about a quarter and two quarters ago. This is one specifically affected by the earthquake.

Sarkith Sorbechian

Okay.

Harry Bosco

Right. We’re in pretty good shape on those other suppliers that you’re referring to.

Sarkith Sorbechian

Okay. And now how do you feel about your inventory levels? Have you established some type of a buffer there just in case? Or can you maybe give some color around that?

Bob Nobile

Buffer in terms of what sort of product?

Sarkith Sorbechian

Just with respect to your book to bill was over one. So I don’t know if you have some type of level that you’re comfortable with in inventory. I just wanted to get some more color around that.

Bob Nobile

You know, our overall inventory - we would look to improve our days on hand as the business improves over the next several quarters. As it comes to the specific items that are constrained, obviously we’re trying to get those as fast as we can and to eliminate those constraints. But until we get through this quarter and see how these venders or suppliers react to the situation, it’s hard to say at this point. We’ll have a lot more to say next quarter.

Sarkith Sorbechian

Okay. Sounds fair. And can you give some more color maybe on some of the recent announcements around the tunable XFP product?

Harry Bosco

Well, we have an XFP tunable that has been under development, which we’re going to introduce under some customer bases the second half of this year.

Sarkith Sorbechian

Okay. So that’s still on target I think was it around the June quarter you wanted to get some samples out?

Harry Bosco

We’re going to have samples out there. Obviously we had a little bit of impact from the earthquake but that’s still being assessed. But yes, we’re going to be in customer base getting some qualifications going.

Sarkith Sorbechian

Great. And do you think mass production is still achievable during fall?

Harry Bosco

I think it’s probably going to be the latter part of the year, yes.

Sarkith Sorbechian

Sounds good. My other questions have been answered. Thank you very much.

Operator

At this time there are no further questions.

Harry Bosco

Okay. All right. That will conclude our call then and we thank you all for participating and we’ll talk to you real soon. Bye for now.

Operator

This concludes the Opnext fourth quarter earnings conference call. You may now disconnect.

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Source: Opnext's CEO Discusses F4Q 2010 (ending March 31, 2011) Results - Earnings Call Transcript
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