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Oclaro, Inc. (NASDAQ:OCLR)

Oclaro and Opnext Merger Conference Call

March 26, 2012 05:00 pm ET

Executives

Jim Fanucchi - Summit IR Group

Alain Couder - Chairman & CEO, Oclaro

Harry Bosco - Chairman & CEO, Opnext

Jerry Turin - CFO, Oclaro

Bob Nobile - CFO, Opnext

Analysts

Patrick Newton - Stifel Nicolaus

Ehud Gelblum - Morgan Stanley

Subu Subrahmanyan- Juda Group

Hamed Khorsand - BWS Financial

William Stein - Credit Suisse

Operator

Good afternoon and welcome to the joint conference call announcing the proposed merger of Oclaro Inc and Opnext Inc. At this time, I would like to turn the call over to Mr. Jim Fanucchi of the Summit IR Group. Please go ahead, Mr. Fanucchi.

Jim Fanucchi

Welcome everyone to the Oclaro and Opnext proposed merger conference call and webcast. Please note that the slides accompanying today’s presentation are available in the Investor Relations section of each company's websites. And as a reminder, this conference call is being recorded for replay purposes.

During the course of this conference call webcast, we will be making a number of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to statements about Oclaro and Opnext and the proposed combination that the companies jointly announced earlier today; potential synergies and cost savings of such combination and the timing thereof; future financial and operating results; quarterly synergies; the combined company's plans, objectives, expectations and intentions with respect to future operations, products and services.

Such forward-looking statements are based on the current beliefs and expectations of Oclaro’s and Opnext management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are difficult to predict and generally are beyond the control of Oclaro and Opnext. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. Further information about the risks inherent in these forward-looking statements is contained in the joint investor presentation that was filed with the SEC today and the most recent Form 10-Q and most recent Form 10-K and other periodic reports filed by Oclaro and Opnext with the SEC.

Neither Oclaro, nor Opnext assumes any obligation or intent to update any forward-looking statements, whether as a result of new information, future events or otherwise. In addition during this call we may be referring to non-GAAP financial measures. With respect to any of these non-GAAP measures directly comparable generally accepted accounting principles measures are set forth in a reconciliation of GAAP to non-GAAP measures and included in the accompanying presentation which is available in the investor section of each company's website.

We would also like to clarify now that Oclaro and Opnext will not be providing an update nor will we answer questions relating to the current quarter’s results. In connection with the proposed combination, Oclaro intends to file documents with the SEC, including a registration statement on Form S-4 containing a joint proxy statement and perspectives. Investors and security holders are urged to read carefully the joint proxy statement perspectives, when it is filed with the SEC and other documents filed by either company with the SEC relating to the proposed combination when they are filed because they will contain important information.

Our speakers today are Alain Couder, Chairman and CEO of Oclaro and Harry Bosco, Chairman and CEO of Opnext; Jerry Turin, Chief Financial Officer of Oclaro and Bob Nobile, Chief Financial Officer of Opnext will also be available during the question-and-answer session. I would now like to turn the call over to Alain.

Alain Couder

Okay, I would like just to introduce this merger. This is a very exciting day for us and I would like to turn to Harry to make all the thought processes in the production as he has many, many years of experience with the industry and can give you even more color than I could.

Harry Bosco

Okay, thank you Alain and good afternoon. From a historical revenue perspective, the merged company that we have now will be number two in the industry. But you have to really look underneath that and see the merged company in more detail. The combination, truly unique with its world-class customer, product and technology base.

Before we start talking about the combined company, let me summarize the key points about the transaction. This is a stock for stock tax-free exchange at a fixed exchange ratio of 0.42. The implied pro forma ownership is 42% for Opnext shareholders and 58% for Oclaro shareholders. Alain, the current CEO and Chairman of Oclaro will be the CEO and Chairman of the new company.

I will join the board of Oclaro along with three other Board Directors from Opnext. The size of the board will be ten and the closing is expected in three to six months depending on the regulatory and shareholder approvals.

Now Alain and I want to share with you why we are so excited about this merger and unique opportunities the new company has the service customers while generating value for the shareholders and opportunities for our employees. Starting out the number one; our products and customers overlap is very minimal and the two companies will lend itself to a smooth, efficient integration once the closing occurs.

The broad portfolio of components and modules will allow us to take advantage of more vertical integration needed to differentiate our products, reduce our costs and offer more comprehensive solutions to our customers. The extensive customer base includes a leading global optical equipment providers in both the telecom and datacom space. Although Oclaro and Opnext share some of the same large customers, the products sold to them are quite different. In the future there is a real opportunity to be a preferred supplier to our customers that has a full complement of products, which includes most of the critical building blocks for an end-to-end optical network.

For the higher speed networks, this is going to be important because we can help our customers make the trade-offs for the most cost-effective solutions. As a strategic partner, both companies are strategic partners to the large piece of the customer base, but think of us together. The extensive optical technology base of the combined company will enhance our ability to be a strategic partner with our customers. And by that I mean we can jointly define what products are needed in the future based on their needs and look at the technology evolutions that are needed to realize that.

We have found us in the past to be very, very valuable and we start to bring our tools together and start to talking to our customers, it's a very differentiating way to deal with your customers. So we think there are very few competitors that can do what we are going to do. We also will do some customization for some customers as well as do the more standard multi-sourced modules.

From a global presence standpoint, having R&D in Japan, Europe, China and US allows us to better support our global customers and let us attract the very best talented people. We have the flexibility to develop products where we have the right resources available. In the case of manufacturing, Oclaro’s supply chain management, product support and R&D resources in China will help us accelerate the transition of our module manufacturing from Japan to lower cost contract manufacturers.

Due to the economics of scale and diversity of our products, the merged company should realize cost savings as well as experience less volatility in revenues quarter over quarter. We expect to realize $35 million to $45 million in annualized cost synergies by the end of 18 months post closure.

Now let's take a look at the market. The market for optical components and modules is estimated to be $6.4 billion in 2012 with a CAGR of 13% over the next four years. Because of the breadth of our product portfolio the combined company can address the majority of these segments. The fastest growing segment of the market is the 40G and 100G components and modules which is expected to grow at a 42% CAGR over the next four years. The combined company will be well-positioned to take advantage of this opportunity.

Now, I will take a look at our technology based and differentiation. The combined technology base for innovation is extensive from the chip level to the subsystems. The intellectual property and patent portfolio is a result of 30 years of technology heritage from the previous optical compound divisions of Hitachi, Nortel, Alcatel, Marconi and Corning. As well as we've added to the innovations from Opnext, Bookham and Avanex over the past 10 years. The new company will be unique and we have the best class wafer fabs with very broad and deep technologies that allow us to innovate at a chip level or system performance and cost or impacts. By having vertical integration capabilities on the basic devices through subsystems, continuous innovation we will be able to maintain through product differentiations.

Now we are creating a unique company here. There's a broad set of talented engineers, core technologies and fundamental IT. These unique core competencies enable us to offer solutions from basic components such as lasers, detectors, modulators and passives to integrated photonics to modules add value custom subsystems. Going forward we plan to further our strength in the areas of material science and devices that are critical to enable future size, power and cost productions for the 10G, 4G and 100G.

For the market place, if you take a look at our product line right now 40G and 100G we have it at the component level all the way up through the subsystems. So we have the actual devices that are going to be used in the 100G and 40G solutions that come right out of our fabs and we will be doing optical sub-assemblies that we could feed into our products. So it gives us a tremendous advantage. We have a full family of client-side modules. These are ones that are the shorter-reach modules in 40G and 100g and then we also have hope expanding of those and then you go onto line side with Oclaro and Opnext coming together, we have a fully family of all the different formats. DPSK. DPQSK and coherent solutions for both the 40G and 100G. So we really bring to the table a broad portfolio of products and we also package those models in the line cards and subsystems. So we are a full supplier to our customers.

If you go to the 10G, Opnext has been in the 10g business for quite some time. We started way back in 2000 working with customers like Cisco, devolving modules. We have a full complement of modules for the datacom area as well as the telecom area. And again, Oclaro brings together, their strength in the telecom area. They also have a full family of tunables. The tunable technology, which is going to be very critical in the future network solutions. So combining this together allows us to continue our 10G family of product into the tunable range and address those needs of the customer. So we’re well-positioned to make sure we capitalize on that market.

We also with Oclaro bring a supplier of ROADMs and amplifier solutions. And this is very important again looking at the end-to-end network solution. The amplification that is in the core of the product is very critical as well as the endpoints in the networks and the transmission gear. So Oclaro brings leading market position in EDFA amplifiers and really the ROADM type portfolio of products. So again all optical networks we’re going to be a supplier of that and we can address most of the needs.

To summarize, we also have another key area, which I don’t want to pass up. It’s in the industrial and consumer business. We both have had businesses in that area. We have the lasers used in different kinds of applications, quite different than the optical stuff in communication. Oclaro has basically they’ve been into high pump lasers as well as VCSELS. And we’re looking now at areas like, just to give you some idea, measurement devices, we do high speed printers with multiple lasers. We have night vision, we do welding and drilling. We look at different things like, I think, Alain tells me about the navigation on some these devices like a Blackberries, there is a ball on it with the VCSELS in it. So, and then we also are looking at mini projectors. So just think about the consumer and industrial is another piece of our business that could be very substantial going forward. Of course different than the communications.

So to summarize, this combination will create a company with a comprehensive product line that no one else in the industry has. In telecom, we will be leading component vendor in the core optical network. Both Oclaro and Opnext have strong roots in this space. Together we will even be stronger. We’re also strengthening our presence in Datacom with an expanding product portfolio for enterprise and datacenter applications. The examples 40G QSFP package is a good example of addressing the data center needs.

We also have a combined portfolio in the industrial commercial space and will be a leading supplier of laser diodes in that market. This merge is a great opportunity for all stakeholders in both Oclaro and Opnext. I am very excited about the future of the new company. And with that I will turn it over to Alain.

Alain Couder

Hi thank you Harry and good afternoon. Again it is a very exciting day Oclaro and Opnext, have announced that they’ve agreed to merge. So Harry has discussed the overall value of the transaction and also the market and technology dimension. I will focus more on the customer I mentioned and the value created for our shareholders. So if you have the slide in front of you can turn to slide number 16. We shall demonstrate that our customer base are quite complementary. In fact in several customers where Opnext is very strong Juniper for instance. We are not very strong and the other way around. Some time we are strong together, For instance we are both as strong as Cisco. So that means that to those customer now we could offer a much broader product line and therefore get a deeper penetration and therefore a growth that go beyond the industry.

As you can see from the same slide we don’t only have a core optical network data center and enterprise customer but we also have industrial and consumer. These business will be now in the range of $100 million per year for the merged company. So we are going to have critical mass to address it and sell those customer better and continue the penetration of those new markets that we have selected.

The other thing here is that the products from Oclaro and Opnext are totally complementary. There is no overlap whatsoever. So again, we will be able to offer a broader product line. As the example that how they were giving on the cell phone or a mini projector, and also the single navigation is a good example where we can offer now two technologies instead of one to one customer. So that’s the exciting portion of our customer.

We are also proud to strengthen our global presence and this is what you get on slide number 17. Clearly, from a footprint viewpoint of Opnext is very strong in Japan and in North America. We are strong in Europe, in North America as well and in China. So together we sell in those four parts of the world very well.

On this slide, you can see that in North America we have in particular the system architecture expertise, the advanced module design, micro-optics and high power packaging and pluggable. In Europe and Israel, we have tunable laser; photonic integration receiver modulator; optical mechanical design and packaging, the WSS and the high-power laser and the VCSEL. And the VCSEL has been mostly a consumer product for us, but we do know that VCSEL has the capability to be excellent in datacom as well and therefore that’s going to be an excellent entry into the Opnext product and therefore give a better price performance for our customers.

In Asia, we have advanced transceiver design, advanced active devices in R&D. We have software and value engineering R&D in China. We have liquid crystal in Korea and we have a manufacturing as we have now a long experience of low cost region in manufacturing. And as you know recently we have expanded the strategy and Harry already mentioned that we have the mean to accelerate the transfer of Opnext manufacturing from Japan and from California into Opnext region, which obviously will be an important element of the synergy. So in summary, R&D product, tech support, in Europe, Japan, US, china would be closer to the customer.

Let me now move to the value created for our shareholders. So first of all, if you look at slide number 18, we have very significant operating leverage and we expect to be able to achieve them within about 18 months. One is vertical in-feed of components parts into module subsystems as we already mentioned, whether they show our tunable laser into datacom or some electronic component like QIA adopted Opnext has and that we can within our new model. The leverage of the global supply chain, being a company much larger, we have more leverage with out our supplier and also we have more leverage with our contract manufacturer, is going to be untold element of this synergy as well.

We are going to focus on their resources, but we also will be able in this area to put a larger critical mass which is essential to be ahead of the game in terms of innovation. So the other thing is that we will be aligning SG&A and obviously getting from two public companies to one public company, so their significant costs associated with that that we will be able to trim.

So those operating leverage are expected to create a financial leverage. We do expect a non-GAAP operating income positive in first full fiscal quarter post-close. In order to achieve that, we will achieve the first part of synergy that’s only going to be a three to six month effort. After that, within 18 months we can get, we expect to be to driving an annualized cost synergy of $35 million to $45 million. In order to achieve that, we expect our restructuring cost and system integration cost to be in the range of $20 million to $30 million in total.

As we do integration planning in the next couple of months, we will refine that, but clearly doing the work that we have done in the past several months, discussing between Opnext and Oclaro, we both got more excited week after week about the opportunity we have. But this is about the cost leverage, the ability to take cost out of the company. There is another element is that we believe that the steady foundation of technology we have is also an ability to grow faster than the market.

As Harry mentioned, we have a very strong intellectual property with more than 2,000 patents. We have the world-class fab with incremental capacity. We don’t need to invest much more capital equipment to do more with our fabs already describe to you is the value of that to various markets that we serve. We have a scalable assembly and test strategy that we also call the backend. We are going to become a highly strategic supplier to major customers; you probably remember that when we merged Bookham and Avanex, we became a Tier 1 supplier to customers which was a big difference for us.

Now I think it’s even more, because we are going to have all the core technology needed to create the future of optical technology. So we’re even more highly strategic supplier to major customers. And strategic synergies create extended market opportunity. I mentioned some in the industrial and customer that we also can expand in the datacom business beyond the datacenter and enterprise that will be another protégé that we could be looking at. So this is an opportunity furthermore. So that’s why we believe that this combination is going to create significant value for our shareholders.

So let me now conclude by showing again the same slide, and telling you again, that we are going to just speak about this opportunity. As the four quadrants of this slide are complementary of product and customer, the niche market leadership in technology and innovation, the global presence of customer and proximity to customer and this is creating a financial leverage with operational efficiency and scale.

So we not only expect the integration to create significant value to our shareholders, we also expect the integration to create a very strong strategic partner to our customer. And that's what we are doing today, we will be working on detailed integration planning in the next few months and we will close probably in the 3 to 4 months timeframe and now I will like to open it for questions.

Question-and-Answer Session

Operator

thank you sir. Ladies and gentlemen will now begin the question and answer session. (Operator Instructions). Our first question is from the line of Patrick Newton with Stifel Nicolaus. Please go ahead.

Patrick Newton - Stifel Nicolaus

I guess a question for Alain and also for Harry. You know you detailed the $35 million to $40 million in the cost synergies, could you help us bucket where those synergies are coming from, are we looking at any major facility or headcount reductions and I assume that the majority is coming on the OpEx line.

Alain Couder

I'm going to ask Jerry to answer this question. He has been leading all the modeling, so we can give you a quite fair precise answer and Bob Nobile can help him also on that.

Jerry Turin

So Patrick we are still going to be operating as two separate public companies over the intervening time. As Alain said continuing to refine integration plans and while the categories on the operating leverage side clearly identify significant savings areas in both gross margins and operating expenses. As far as providing the granularity in those savings, we will wait until we are combined as one company and give more granularity at the close.

Patrick Newton - Stifel Nicolaus

I guess on that, the same lines, if you look at some of the challenges that both Opnext and Oclaro were having as individual entities, it was a high cost basis with Oclaro having a significant amount of cost in Europe and Opnext is facing some challenges from having some high expenses in Japan. You know something, Alain that you walked through was that vertical integration and your five fabs are a major competitive advantage, but is it fair to say that we should see some kind of restructuring associated with some kind of facility consolidation or do you think that right now that the combined entities have the footprint that you want and is necessary?

Alain Couder

No, we already know that we probably will be able to reduce the number of sites, but the fab is a core competence and we plan at this point that to keep our five fabs with R&D very close because we expect that the major element of cost reduction or performance improvement will account for the chip level. So that's clearly an asset for the future company and as we discuss about the Oclaro manufacturing strategy, we have decided to, all our backend outsourced to contract manufacturers. So we are doing it with Europe as we speak and we are moving the backend we have in Zurich to Asia and as Harry mentioned, this organization that we have in China in place will allow to accelerate the move of manufacturing from Japan and from California to Asia as well.

Harry Bosco

You know we can also move out the cost reduction that follows on after the product developments go, you put them into manufacturing. We are going to put that closer and closer to the contract manufacturers. So basically you move more and more of your core development activities for the next generation of products, leave that in place and move the cost reductions and product support piece away from the high-priced places like Japan.

Jerry Turin

And Patrick as we have discussed this, moving our Japan backend to lower cost environment, you know this enables us not to have to recreate that additional site somewhere else in the low-cost region.

Operator

Our next question is from the line of Ehud Gelblum with Morgan Stanley. Please go ahead.

Ehud Gelblum - Morgan Stanley

A couple of questions that I'm still trying to understand a little bit. Each company did have its challenges and even before the flood. I know size is certainly an issue, but you know they were both decently sized companies and had very good product I think, that was really never the issue, the engineering or the quality of the product or the breadth of the product. Given that as you have so rightly said, it looks like the overlap is incredibly minimal in terms of the product portfolio. I'm having a hard time just understanding where the synergy is on the revenue side and why the combined company would do any better than each company did individually?

Harry Bosco

I can tell you this. If you take a look at the modules and subsystems, the end feed of the components into that is going to put tremendous margin back into our products. Now because today we buy a lot of the piece parts in that from other suppliers, where Oclaro has a lot of the stuff that can match into that, so we will pull that into our products.

And also you know we are both going down in an endeavor of 40G, a 100G coherent. It turns out right now, we are complementary in that area, but before we invest any more in that and start overlapping, it's a perfect opportunity to take advantage of that.

Ehud Gelblum - Morgan Stanley

Is there any way of quantifying what those savings would be and that’s not the $35 million-$40 million you are talking about right now, right?

Alain Couder

But as Jerry said you know let us go through the detailed integration planning and we will give you more breakdown of that, but the two elements that Harry mentioned combines with the fact that the, what I call the backend in the assembly and test, which is still done in Switzerland and California and Japan, two contract manufacturer. Those two are significant and if you add to that the fact that you grow from one company, two public companies to one public company, you get to a large portion of those numbers. But we will give you the breakdown after we have done all the detailed work, but we really expect to be able to be operating income positive in the first full fiscal quarter post the close.

Ehud Gelblum - Morgan Stanley

Can you just take Opnext in and of itself and it wasn't operating income positive, so what are you getting from Oclaro specifically to bring you over that hump?

Jerry Turin

Well to speak for Harry and Bob as to Opnext. As Harry said, the significant margin improvement from component end feeds which also has a top line dynamic because that can improve competitiveness and there maybe some examples where there can be a differentiated technology that's difficult to get on the open market and again single public company, aligned infrastructure costs and so forth.

Harry Bosco

We were pretty close actually until the flood as Opnext by itself. We had -- Bob you had an EBITDA, adjusted EBITDA…

Bob Nobile

I mean Ehud, it’s been a while since we've talked about the Opnext business but our model when you exclude the impacts of the flood was that at $85 million of revenue per quarter we were EBITDA breakeven and at about $100 million we were OI breakeven. So as both of our businesses kind of come out of this flood next quarter and we get into the post-close scenario we will be in good shape to get us to the point.

Jerry Turin

And then similarly from Oclaro we have talked publicly about, if we get back to pre-flood levels in June, we’ve compared our profitability to June of the prior year and should also be EBITDA positive, again, subject to getting back to pre-flood revenues. So you need to think of that as maybe a foundation point for the two companies.

Ehud Gelblum - Morgan Stanley

Right, now the issue of the $35 million to $45 million cost savings over 18 months is that versus what Oclaro is doing today or post the outsourcing debenture?

Jerry Turin

That was a good question Ehud. First of all each of the companies has costs improvements and cost reduction plans in place standalone. So that's incremental to the standalone improvement plans of either company. So the 35 plus, 35 to 45 is all incremental. From the backend manufacturing point of view for Oclaro our objective is to drive that margin neutrality as we execute that.

So we don’t see margin upside in the short-term from that but we will be striving to maintain our existing trajectory s Oclaro. So the venture doesn’t play into it. The existing cost improvement of these standalone companies doesn’t play into it and there is an incremental 35 to 45 million we think is out there for us.

Bob Nobile

And Ehud, a piece of the 35 to 45 million, will be the added benefit of taking the Opnext plan, which already assumed some move into lower cost jurisdictions but then getting the added benefit of using the existing Oclaro infrastructure.

Ehud Gelblum - Morgan Stanley

Which is being sold anyway?

Jerry Turin

No, Ehud. Not infrastructure in terms of brick and mortar. But in terms of the first [LN] processes, expertise and relationships.

Ehud Gelblum - Morgan Stanley

Got it. Now that’s actually worth a lot then. Last thing, so you get the benefit of the in-feeds that means that Opnext has to re-design or both companies have to re-design some products to use…

Alain Couder

I think I can give you a good example when we acquired Mintera. We exactly made the same thing that Mintera was buying all its components. Now most of these Mintera product use laser, modulator, receiver and so on from Oclaro and that’s made the big difference.

We see exactly the same thing happening with the module that Opnext is doing. But the inverse is true. For instance we buy some medical and component lasers, TIA and Opnext has some TIA. So we have the in-feed both ways this time and these are very significant in term of margin improvement. These are not cost savings per se in term of cost synergies. They are more, margin improvement because they come directly from our fabs.

Jim Fanucchi

Operator, lets move on to the next participant please.

Operator

Thank you. And our next question is from the line of Subu Subrahmanyan with Juda Group. Please go ahead.

Subu Subrahmanyan- Juda Group

Thank you. First question is on the operating breakeven in the first full quarter. I just want to make sure first full quarter would be the September quarter if the deal closes as per as expectation. Are any of that 35 million to 45 million in savings in that quarter? I am just trying to understand between the revenue levels where Oclaro was last June, it was not operating breakeven and neither was it for Opnext. Are you already starting to see some of that 35 to 45 in the first quarter?

Jerry Turin

So, Subu, for that purpose, I direct people to the slide package. That presumes a July close. So as far as the first full quarter together, think of that as a datapoint. Certainly some of the cost savings will be in place, but relatively limited and to the extent they are in place, they may not be in place for the full quarter. So there is upside from savings. There is both companies has a starting point in that June-July timeframe. Hopefully getting back to pre-flood revenues and having the starting point that Bob and I referred to from a bottom-line point of view.

Think in terms of normal market growth from there and normal, we have some slides talking about market growth rates and you all have your own views of market growth but think about market growth through the second half of the year and then the first part of some of the synergies starting to catch.

Subu Subrahmanyan- Juda Group

Understood. And from a timing perspective and a market perspective, can you talk about why now; a consolidation in this industry has been talked about for some time. What are the kind of levers that made you do this deal now and what were are the other kind of considerations?

Alain Couder

Really we have been looking at consolidating the industry in the past two years. We have been looking at all kind of combination. I think in this industry everybody has been talking to everybody in the first two years. It is very clear to us that the combination of Opnext and Oclaro is the most accretive combination that we could find. And we are doing it now because we have been discussing in depth we have been convincing ourselves that it can be, the integration is doable.

Because in fact what is most important in a merger of this kind is to absolutely convince our self that we have the management, the energy, the bandwidth, the resources to make the integration work. We did successfully in the Bookham and Avanex. It is an integration of the same kind and I think the industry is in a situation where its now where such a merger can be the very important step to other simpler industry.

Harry Bosco

I think the other thing is, if you look at the market it is changing. You can just see we started out in a customization world about 12 years ago, 15 years ago and then went through a standardized module world and now it is going back into customization plus modules. So you are going to be selling compounds as well as modules to customer bases, depending on type of products. You will also see announcements coming out of our customer base about buying technology companies. And they are going to be looking for companies to partner with these technology companies to take their products forward, their customized products and we want to be that company that can address that.

Jim Fanucchi

Operator lets move on to the next participant please.

Operator

Thank you. And our next question is from the line of Hamed Khorsand with BWS Financial. Please go ahead.

Hamed Khorsand - BWS Financial

First question I had was what’s the sort of as far as Oclaro’s decision into going into datacom because it seems as though you guys were just staying out for a long time of the datacom customer base?

Alain Couder

Yeah, in fact this is a strategy question that we have been working on for two years; because we have the laser, we have digital, we have tunable laser and we have the photonic integration. But we concluded that without a merger or an acquisition, we could not enter this market where there were already some strong players.

So we have been slowing down in getting into that market for that reason. This merge give us the entry into these markets by strengthening the current position of Opnext and I think this is going to be an extremely strong combination as Harry was mentioning through the leverage of the technology on the fab from both Europe and Japan.

Hamed Khorsand - BWS Financial

And my other question was related to I know Opnext has had a history with the yen, how is the cost structure and how is the foreign exchange exposure work as far as merged company goes?

Alain Couder

Why don’t you go through that?

Harry Bosco

Yeah, from an Opnext perspective, there is about a $30 million per quarter net yen exposure and on an individual basis what that meant was basically every three yen plus or minus impacted us about 1% at the gross margin level.

From a historical perspective, the ends have been trading at its low point for about the last six months or so. We have actually seeing some strengthening of the US dollar. I don’t have any crystal ball in terms of where it’s going, but the comments I made earlier about the Opnext breakeven point assume a yen exchange rate of about 80 and we are comfortable, at that level, the business can, on a standalone basis was able to -- was ready to meets its target.

Hamed Khorsand - BWS Financial

And as a combined company, do guys would you still that same kind of $30 million a quarter?

Unidentified Company Representative

Well, Hamed I think we need to move forward as a standalone company and get to the close and understand the full integrations plans in combined growth scenarios. So certainly it will be similar, but to comment anything more than a broad statement really, we’re really not in a position to do that today.

Harry Bosco

It’s much smaller portion of the entirety of the business; than Opnext experience on a standalone basis.

Operator

Our next question is form the line of William Stein with Credit Suisse. Please go ahead.

William Stein - Credit Suisse

I am wondering if you can clarify how the combination of the two companies will impact the new relationship Oclaro has with Venture? What’s going to happen with that facility; are you going to load it with more work coming out of Opnext, any update there would be helpful?

Alain Couder

This is clearly a part of the strategy. As we are negotiating with Venture; they already knew that we were also discussing with Opnext. So we have structured the agreement with Venture in such a way that we can do more and we are going to be looking at the at the detail integration plan and to see where it’s most effective to move some of the California and Japan manufacturing in the future. We don’t have a prepared answer, but we clearly negotiated the Venture deal with this in mind.

William Stein - Credit Suisse

So you would be moving some production out of Japan into that facility?

Alain Couder

That’s the possibility; but we’re going to look at least in detail product-by-product. No decision has been made at this point in time; that’s part of the integration planning that will happen in the next couple of months.

Unidentified Company Representative

We have made a decision with the module manufacturing out of Japan. So it’s where it goes.

William Stein - Credit Suisse

One other if I can; wondering if you can comment on for those of us who aren’t as familiar with your businesses, ASP erosion in the most recent round of negotiations and how you expect that might trend as a combined company with the capacity being taken out?

Alain Couder

Go ahead Bob.

Harry Bosco

Opnext historically experiences about a 15%, 16% or so annual price deterioration across it’s portfolio of products. You wind up having a larger quarterly percentage impact of that in the quarter that ends in March, because you have most of the European and some of the Asian customers on annual price adjustments rather than quarterly and to half year. But we’ve seen that this past round of negotiations was consistent with the last several years.

Unidentified Company Representative

So two points, one you know, we tend to see 13% to 15%. So we saw a very typical year. But I think there is a broader point that we speak in Oclaro which is to be an innovator and a technology company, we expect to experience price erosion indefinitely. So you know that realize some great strategic upside and some great technology leverage, but you if you don’t keep up with improving your customers price to performance base then you are not a technology company.

Alain Couder

I always want to tell the R&D engineer is that the Moore’s Law is going to apply to the optical world. And if we do not innovate, somebody else will innovate and the price reduction is the way of leaving in the future, because price reduction we continue because other people will innovate if we don’t; it is very important as a matter of fact.

Unidentified Company Representative

You need to have the vertical integration around these things; you need all the piece and parts because then you can integrate them together and get a new solution to drive more cost down.

William Stein - Credit Suisse

I guess the upside is as a combined company having reduced capacity both for your self and for the industry we shouldn’t expect any change to the typical ASP erosion pattern that you have seen.

Alain Couder

No, I don’t expect -- we expect to be able to have a better margin as a company as I talked about it. Our assumption is that the despite price erosion will continue.

Operator

Thank you. And there are no further questions. At this time, I would now like turn the call back over to Mr. Alain Couder, please go ahead sir.

Alain Couder

Okay, so I would like to thank you for participating in a very short notice. I think Harry and I are very expressive. We have been working on this agreement for a few months and we think it’s ready as the two executive teams are eager to make it work, as the two Boards are eager to support our teams doing that. And we look forward to make it happen right after the close. Thank you very much. You want to add something Harry?

Harry Bosco

Thank you very much. Again, we are very excited about this at Opnext, of combining in with Oclaro. I think it really is going to be very positive to our customers. We are going to be able to do a lot more for them right now.

Alain Couder

Thank you.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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Source: Oclaro's CEO Discusses Oclaro and Opnext Merger Conference Call (Transcript)
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