Opnext, Inc. F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

Mar. 4.08 | About: Opnext, Inc. (OPXT)

Opnext, Inc. (NASDAQ:OPXT)

F3Q08 Earnings Call

February 25, 2008 4:30 pm ET

Executives

Douglas Dean - Vice President of Investor Relations

Harry L. Bosco - President and Chief Executive Officer

Robert J. Nobile - Chief Financial Officer and Senior Vice President

Analysts

Patrick Callery - Piper Jaffray

Analyst for John Lau- Jefferies & Co.

Paul Bonenfant - Morgan Keegan

Ajit Pai - Thomas Weisel Partners

Ehud Gelblum - JP Morgan

Operator

At this time, I’d like to welcome everyone to the Opnext Inc. third quarter earnings conference call. (Operator Instructions) I’d now like to turn the conference over to our host, Vice President of Investor Relations, Mr. Douglas Dean.

Douglas Dean

Good afternoon. And thank you for joining us today. My name is Doug Dean. I’m the Vice President of Investor Relations for Opnext. Today we will discuss our financial results for the third quarter, ended December 31, 2007 and provide some commentary regarding our market conditions and business outlook. We will begin with remarks from Harry Bosco, President and Chief Executive Officer of Opnext, along with our Chief Financial Officer, Bob Nobile. We will then take your questions.

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 under the Securities Act in our Safe Harbor statements in the company’s filings with the SEC. Following our prepared remarks, we will address questions from the audience. At that time, please limit your question to no more than two at a time so that we can get to as many of you as possible in this session. And now, let me introduce Harry Bosco.

Harry L. Bosco

Good afternoon everyone, on February 13 we announced the need to restate our prior year financials for the fiscal years ended March 31, 2007 and March 31, 2006 and for certain of the quarterly periods within each of those fiscal years.

And as we announce this morning in the course of correcting the identified errors and preparing the necessary restatements we have also determined the financial statements for the quarter ending June 30, 2007, needed to be restated as well.

As of this afternoon I am pleased to advice you that all have filed all the necessary restatements with the SEC. This has been a very tedious and time-consuming process and we are thankful to have it behind us. Bob Nobile will discuss this restatements a bit later. So let’s turn for the summary of our financial results for the most recent quarter.

For the December quarter we achieved revenues of $66.4 million, earnings up $0.07 per diluted share and we generated $2.5 million of cash from operations. Our gross margin was 32.8% primarily reflecting the lower than expected revenues and the increase in product warranty expense associated with the quality issues related to the 40 gigabit Digital Integrated Circuit that we purchased from an external supplier.

In addition, our revenues from the lower margin 10-gigabit products addressing multimode fiber applications have increased and the planned cost structures to improve the margins for these products will be phased in throughout fiscal year ‘09 as the volumes increase.

In the revenue update provided on January 11, we summarized the primary reasons that contributed the lower than expected revenues. Supply issues caused a significant part of the shortfall. A 40-gigabit Digital Mux/Demux integrated circuits purchased from external supplier required a change to alleviate quality issues and as a result we discontinued the use of that IC.

Although the transition to the new IC began during the quarter, our production output was affected because of the limited availability of new integrated circuit from the supplier. By the end of the quarter, the supply issue was resolved and we were back to production volumes.

The payroll transition for the new device, reliability test was done on the older device to characterize the severity of the reliability issues. Based on results of the testing, we have decided to increase our warranty reserves to cover any rework that we expect to occur in future. Now withstanding this temporary setback, we expect our 40-gigabit production capacity to be sufficient to handle increasing market demand as well as any rework required in the March quarter. The shortage of parts also limited our XenPak production in quarter.

How do we resolve these supply issues? We have stepped up our efforts to qualify and secure additional sources of critical parts and increase the buffer stock of long lead-time parts to accommodate the fluctuations in demand in the future.

Another significant factor was inventory that did not get pulled by customers as expected, from vender managed inventory program. We don’t view this as an issue of demand but more of a timing issue when the inventory gets pulled for production. In this particular case, almost half of the inventory that we anticipated to be pulled in the latter part of December was pulled on the few days of January.

So, while we get frequent, even daily feeds for demand from the customers or the contract manufacturers, the exact timing of the pull is difficult to estimate which adds an element of uncertainty in predicting quarterly revenues. This will, no doubt, continue to introduce more uncertainty in predicting our quarterly revenues as the quarterly revenues attribute to customers with VMI programs approaches about one-third of our total business.

The last factor was lower than expect 300 pin fixed wavelength demand. While the product has exhibited volatility over the last 12 months, we believe that the demand softness is partially associated with the industry transition to accept fee. So while we expect that the demand for 300 pin fixed wavelength will continue to fluctuate from quarter-to-quarter, the transition is inevitable as our customers’ next generation systems using XFP are introduced.

Our growth in XFP business continues to be strong and we continue to be qualified by new customers. We also noted that in 300-pin product category, the tunable market continues to grow and we’ve been recently qualified into another large telecommunication networks equipment customer.

And with this recap I will now turn it over to Bob to review in greater detail the December quarter results.

Robert J. Nobile

Good afternoon everyone let me begin my discussion by first addressing the restatements of our financial statements. We announced on February 13 that while we were preparing our December 2007 financials, we determined that errors occurred in the valuation of inventory consigned to one of our contract manufacturers and as a result our financial statements for the March 31, 2006 and 2007 fiscal years had to be restated.

The final impact of the errors was to reduce net income by $1 million in 2006 and $1.7 million in 2007. We also announced today that while we were completing our review of the 2006 and 2007 errors and preparing the related restated financials, we determined that a restatement of the quarter ended June 30, 2007 was required to reduce net income by $700,000. The nature of the June restatement was also the result of errors in the valuation of inventory consigned to the same contract manufacturer.

This morning we filed amendments to our previously filed form 10-K for the year ended March 31, 2007 and to our form 10-Qs for the quarters ended June 30 and September 30, 2007, which restated all of the financial statements, effected by the inventory valuation errors. We also filed our form 10-Q for the quarter ended December 31, 2007.

We and our audit committee have determined that the restatements are indicative of the material weakness in our internal controls over financial reporting because our controls did not identify the errors on a timely basis.

Accordingly we performed additional account verification and reconciliation procedures and review and analysis procedures to ensure our consolidated, unaudited financial statements for the three and nine-month periods ended December 31, 2007 were prepared in accordance with U.S. Generally Accepted Accounting Principles.

We are in the process of designing and evaluating the effectiveness of additional and enhanced account verification and reconciliation procedures, as well as review and analysis procedures with respect to the valuation of inventory consigned to the contract manufacturer.

We believe these additional enhanced procedures when fully implemented will provide additional enhanced internal controls over financial reporting and improve our ability to identify any potential errors prior to and during the company’s future consolidated financial statement close processes.

Let me now move on to my discussion about our current operating results.

For the quarter ended December 31, 2007, we generated sales of $66.4 million, representing growth of $4.7 million, or nearly 8% as compared to the same quarter last year. This growth was balanced across all the company’s major product lines.

Our 10G and above products grew slightly more than 5%, to $53.9 million and accounted for 81% of our total revenue. This increase primarily resulted from increased demand for our 40G XFP, X2 and 300 pin tunable products, that was partially offset by declining demand for our 300 pin fixed wavelength, and XenPak products as Harry described earlier.

Our less than 10G product line contributed favorably, with nearly 22% growth, to $7.5 million, as demands for our SFP products was partially offset, by declining sales of 2.5G custom modules. We also experienced 13% growth in our industrial and commercial product line that resulted primarily from strong sales of infrared laser diodes, as well as our family of high-powered laser diodes.

Sequentially, our sales decreased to $10.2 million or about 13%. The decrease is driven by decreased demand for our 300 pin fixed wavelength products, vendor quality and production delays, which limited our ability to ship 40G products, and lower X2 and SFP product revenues. These decreases were explained by Harry earlier, and were partially offset by continued increasing demand for our XFP products.

Sales of 10G and above products decreased by $9.6 million or 15%, while sales of less than 10G products decreased $700,000 or 8% and industrial and commercial product sales modestly grew by $100,000 or about 2%.

For this quarter Cisco and Alcatel-Lucent represented 38% and 20% of our sales respectively as compared to 41% and 23% in the September ‘07 quarter. Geographically revenues in the U.S. represented over 56% of our total sales while Europe represented 23%, Japan approximated 14% and the rest of Asia Pacific with 7%.

Gross margin for the quarter ended December, was 32.8% as compared to 35.2% in the previous quarter and 33.4% in the December quarter of last year. Gross margin for the current quarter includes the negative effects of approximately 150 basis points attributable to the $1 million product warranty reserve that we recorded to cover our anticipated future costs associated with the replacement of defective 40G Mux/Demux ICs.

This quarter also includes an approximate 50 basis points negative impact related to hardware excess and obsolete inventory reserve requirements and an approximate 90 basis points impact from fluctuations in foreign currency exchange rate as compared to both the September ‘07 and December ‘06 quarters.

Looking forward to the quarter ending March 2008, we expect the competitive pricing environment and fluctuations in foreign currency exchange rates to continue to put pressure on our gross margins. As compared to the September quarter, R&D expenses decreased $1.7 million to $8.7 million and decreased as a percentage of revenue, to 13.1% from 13.5%.

The expense decrease primarily reflects the timing of R&D material spending. As we have discussed in the past, our R&D material spending can vary by approximately $1 to $1.5 million per quarter, based on the timing of prototype builds. R&D expense during the current quarter also benefited from the reversal of performance based bonus accruals that were recorded earlier in the year.

SG&A expenses, decreased $1 million from the September quarter to $11.3 million, but increased as a percentage of sales to 17% from 16.1%. This decrease primarily resulted from the reversal of additional performance based bonus accruals.

Operating income was $1.8 million, or 2.7% of sales as compared to $4.3 million, or 5.6% in the previous quarter. The decrease from the prior quarter ended September 30, 2007, primarily resulted from lower sales volumes, the negative effects attributable to higher warranty and inventory reserve requirements, and fluctuations in foreign currency exchange rates, and higher stock based compensation expenses partially offset by the reversal of performance based bonus accruals, recorded earlier in the year, as well as lower R&D spending.

Currency fluctuations had an approximate 160 basis points impact, on the current quarter, as compared to both the quarters ended September ‘07 and December ‘06.

After accounting for net interest income of $2.1 million and net other income of approximately $400,000, net income was $4.3 million, or $0.07 per diluted share.

As compared to the prior quarter earnings of $0.09 per diluted share, the $0.02 per diluted share decrease primarily consists of a $0.04 reduction from operations including higher stock based compensation expenses. and lower interest rates on short-term investments that were partially offset by a $0.02 increase in other income net which was primarily as a result of shortened foreign currency transaction settlement periods.

During the December quarter, we also entered into a series of forward contracts to hedge approximately 50% of our Japanese Yen currency exposure for the quarter ending March 2008.

Our cash position increased to $220 million and as we’ve generated approximately $2.5 million of cash from operations, and we continue to invest in new equipment for our factories. On a year-to-date basis, cash from operations has improved by approximately $20 million from the same period a year ago.

So, with that let me now turn it back to Harry to discuss our outlook and guidance.

Harry L. Bosco

Let me start by saying that we expect to resume our path of sequential quarterly revenue growth. But there will continue to be uncertainty in a given quarter to a limited near-term visibility in customer demand. However, we believe that the growth in broadband applications will continue to drive the long-term demand fundamentals of our business.

We continue to benefit from large Telco deployments, including 40-gigabit products and our data customers are stepping up their efforts to meet the needs of the service providers who are deploying wide area IP infrastructures to support new applications and services.

In support of our customers we are continuing to broadening our portfolio of high speed transceiver and transponder products to include 8 gigabit fiber channel, an entire line of SFP Plus product, DWDM enhancement for XFP and X2 form factor products, and various next generation devices and sub assemblies including coaxial 10 gigabit avalanche photo detectors, wide temperatures 10G EA-DFB lasers, and our own tunable laser module.

Customers are now sampling our 8-gigabit fiber channel products for applications which are a new market for us.

In the 40G and 43-gigabit area, we continue to enhance our core capabilities and have expanded our target market with a range of products for the line-side applications. On the line-side, many of our customers are looking for 43 gigabit modules in standard form factors rather than relying on discrete solutions. We have begun sampling our 43 gigabit tunable line-side product using binary coding for metro and regional applications.

We are expanding this family on a 43-gigabit line-side, modular price to include DPSK coding and are investigating the DQPSK coding for the longer solutions over different kinds of fiber.

We are also working with our customers on defining 40-gigabit Ethernet requirements to position us for the expansion of the wide area IP infrastructures into network.

And finally, we have been working with our customers on a 100-gigabit prototype development, which goes hand-in-hand with our active participation in the 100-gigabit standard form.

So we continue to broaden our product line to address new markets in the highest growth market segment, all with an eye toward the continued growth and profitability of our business. We are showcasing many of those new developments here at the OFC tradeshow in San Diego this week.

Initiatives have been accelerated such as additional sourcing of critical parts and increased levels of buffer stock should serve to make us more resilient to the type of issues that plagued us in December. In addition, our demand forecast and procedures supported by our automated systems continue to be refined for shorter intervals to ensure that manufacturing is better aligned with our customer needs.

While we believe the 10 gigabit and above market segment should continue to grow faster in the overall optical market, lack of short-term visibility of customers demand, coupled with broader economic uncertainties has caused us take a cautiously optimistic view of guidance for next quarter. While our fourth quarter ending March 31, 2008, we expect sequential revenue growth with revenues to be in the range of $67 to $70 million.

And with that I’ll turn it back Doug to begin the Q&A portion of our call.

Douglas Dean

This completes our prepared remarks and now we’ll be glad to take the questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Patrick Callery - Piper Jaffray.

Patrick Callery - Piper Jaffray

I wonder if you could comment a little bit on the sequential declines on the Cisco and Alcatel accounts, particularly given that I think the rest of other customer revenue looked about roughly flat.

Harry L. Bosco

If you take a look at the Cisco account, again 40 gigabits was one of the places that hurt us there in the last quarter. And because Cisco in particular, wanted to only have products with the new chip in it, and they wanted to have additional testing done. We take a look in the X2 area; we basically ended pulling in January as opposed to the latter part of December.

In the case of XenPak, we had about $1 million that was affected because of parts, where we had the demand; we could not deliver the product. And SFP, and in particular the gigabit Ethernet part, there was a hold on that for a short period of time. But it has been released and again the demand is backed up on that. From tuneables perspective, that still has stayed strong, and so has XFP.

In the case of Alcatel-Lucent, the 300 pin was really where it hurt us there because there is a definite softening across the market of 300 pin fixed wavelength. And actually we see a continuing softness of that in the fourth quarter. We do expect again if you look at our history in Cisco revenues, it’s been up and down from quarter-to-quarter. You see some quarters where you peak in certain products and ones where you are down.

In the case of Alcatel-Lucent, the same thing happens there. We still have a strong business with Alcatel-Lucent in the tuneable areas and XFP area.

But again, it’s highly dependent on when they get the order. And again with the VMI programs, now we get closer to the customers when their demands come in, then we have to be responsive. But we won’t see the orders until they get the orders. But most of them, have all predicted that they see their business is growing. But again the instantaneous, when you get the forecast gets realized into an order.

Patrick Callery - Piper Jaffray

Could you split out your 40G revenue for the quarter and also for Alcatel? Any comments on, if you have any price reductions moving into this March quarter of revenue effect, what you get from them in this current quarter?

Harry L. Bosco

In the case Alcatel-Lucent, we do our negotiations, so, you’ll see lower SPs taking account at the beginning of the year. But again, you’re cranking your cost reductions as they come in.

The 40G business basically ends up the quarter at $6.8 million where we have a $10 million capacity as we said last time. So if you remember back in Q2, we were around $9 million, we expected to have that recover back now.

Now we will be doing a rework in addition to meeting the new customer demand. But we feel like we have plenty of capacity to handle that.

We’ve done some other things, Patrick, instead of just adding group forced capacity with machines and that, our manufacturing team has come up with a better ways to get more throughput through the factories. So we’ve actually increased our capacity without adding capital.

Patrick Callery - Piper Jaffray

If you say capacity now is probably better than $9 million moving forward, and also considering that there will be some recognizing were taken up by your expected rework.

Harry L. Bosco

I think we can do $10 million a quarter, in addition handle the rework.

Operator

Your next question comes from the line of John Lau with Jefferies and Company.

Analyst for John Lau - Jefferies

It is Rahul Kanvarker calling for John Lau. I would actually like to know much more on your quality issues affecting revenues in this quarter. So was that a design issue from your part? Or was that really a manufacturing issue on the part of your suppliers?

Harry L. Bosco

Let me explain it. Basically we buy a Mux/Demux integrated circuit from a supplier. We put it in our product and that’s part of the 40G transceiver. We have not seen any failures in the field. But it was identified, by another customer, another person’s product that used that chip, but they saw a reliability issue with it.

It took a lot of acceleration on the reliability testing to actually get the part to fail. And so, we had nothing to do with us, and actually changing the way of packaging process actually fixed the problem.

So it’s again nothing to do with our quality, in fact our products did not fail, it’s just they would fail eventually in the future. That’s what the testing shows.

Analyst for John Lau - Jefferies

And my second question actually is on the impact of foreign exchange fluctuations on your gross margin. I would imagine your costs are in dollar terms and dollar has been falling. So actually it should be beneficial to your gross margin. So am I missing anything there?

Robert J. Nobile

Yes. We have a substantial portion of our costs are denominated in Yen. As the exchange rates have fluctuated between the Yen and the Dollar, this past quarter-over-quarter we had an approximate 90 basis point impact on our gross margin.

Analyst for John Lau - Jefferies

So it is entirely Yen-related issue, not any other functional currency.

Robert J. Nobile

That’s correct.

Operator

Your next question comes from the line of Paul Bonenfant - Morgan Keegan.

Paul Bonenfant - Morgan Keegan

I think you mentioned that relative to pricing and currency you would continue to see pressure on gross margins. And I’m wondering if you are calling for flattish sequentially or an increase sequentially, if you could give us a little more color there?

Harry L. Bosco

It will all depend on the ultimate product mix that we’ll see for this quarter. As well as where the Yen winds up by March 31. So we would see it to be flat to slightly down.

Paul Bonenfant - Morgan Keegan

And relative to the changes in the mix and the demand that you’re seeing from our customers, within your 10G and above revenue, I’m wondering if you could tell us what percentage of revenue was 300 pin versus pluggables. And then fixed versus tuneable in terms of the wavelength?

Harry L. Bosco

The fixed was about $4.5 million, and tuneables twice that. Now that fluctuates.

Paul Bonenfant - Morgan Keegan

But it seems like we are seeing a secular trend here with the demand for the fixed is decreasing and will continue to do so.

Harry L. Bosco

Paul, the other part about it is though, as the 300 pin goes down, XFP is going up.

Paul Bonenfant - Morgan Keegan

In the past, you’ve given us gross margin ranges for your 10G and above products, I think being 40% plus below 10G, 25% and below, and I don’t know if you could give us an update there, and perhaps give us some guidance as to where your industrial and commercial margins are relative to the corporate average?

Robert J. Nobile

The INC business is, tends to be in the 25% plus range as well. But in terms of all of them going forward, I mean, they are all going to take a slight decrease as the Yen has moved over the past six months and plus.

Paul Bonenfant - Morgan Keegan

Can you give us a reminder or a refresher on your long-term operating model targets and whether those have changed?

Harry L. Bosco

No, our operating targets have not changed. We want to be in the 10% to 15% range.

Operator

Your next question comes from the line of Ajit Pai - Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Related to the pricing environment, I think you addressed some of your recent price renegotiations with Alcatel-Lucent. But from a broader basis, when you’re looking at across your customer base, can you classify what kind of pricing declines you are seeing right now on a year-over-year basis, broadly as a blended average? And whether it’s deteriorating or improving right now?

Robert J. Nobile

Going into the New Year, quarter-over-quarter pricing are in the 5% to 6% range. And as it’s compared to the past, the price decrease is a bit higher now than it was in the past.

Ajit Pai - Thomas Weisel Partners

When you are looking at, the price decreasing slightly greater than the past, you’re looking at some of your expenses being slightly higher in the past, are you maintaining higher inventory balance and stocking some of the inventory. And then also looking at what the Yen has been doing against the dollar, while your target for operating margin might not have changed, what kind of timeframe would you be able to provide for reaching, on a sustainable basis, your target range?

Robert J. Nobile

In the past, we have not put a specific timeframe on that and obviously given where the Yen is, and the current pressures that timeframe has pushed out a bit.

Ajit Pai - Thomas Weisel Partners

But would you say by 12 months or by 18 months, or is it further out than that?

Robert J. Nobile

Given the volatility that we see, a lot of the things which Harry discussed earlier, it’s actually difficult to put a precise time on it.

Ajit Pai - Thomas Weisel Partners

With your strategy to actually get up to that operating margin range right now would be to both increase volumes by broadening your product portfolio, which means continued investment on the expense line where you do need the sales leverage, and just cutting costs, streamlining costs, getting the efficiency to scale up. Are those the two or is there anything that I’m missing out on?

Harry L. Bosco

Well, first of all, we want to really go after the high-end products also, right, in the 40-gigabyte area. They have a pretty good margin in them.

We’ve also started four different initiatives right now in the manufacturing area and procurement areas, to increase our margins to be it that way, be more efficient. And then also we’re going to do some product prioritization on the lower margin products, take those out and put more investment into the higher margin.

Operator

Your next question comes from the line of Ehud Gelblum - JP Morgan.

Ehud Gelblum - JP Morgan

If I could dig a little bit deeper into the long-term auto question and the gross margins, it looks as though you are now taking a little more for warranty expense, some more reserves for that, as well as possibly some more inventory charges for obsolescence.

You used to talk about gross margin getting in the 35% to 40% range, and you are already there, but going up to 40%, do you still think you can get there? And how do you get there if you are carrying around the baggage of higher inventory and warranty expenses that would implicitly, I would think bog down your gross margin a little bit.

Robert J. Nobile

Well, both of those would have accounted for about 200 basis points this quarter. The warranty expense, which was 150 of those basis points, we believe, is going to be a one-time event here. We have normal warranty expense, which has been built into our margins for as long as you’ve been looking at our numbers.

This $1 million reserve is unique to the 40G business. It at this point should have captured virtually all of the expense we should see associated with replacing those Mux/Demux chips. We don’t expect that to reoccur. Also this quarter, because of the shortfall in the revenues, we did see higher inventory growth, and we are working on plans to bring those inventory levels down.

Ehud Gelblum - JP Morgan

Harry, you’d mentioned that of the inventory that was not sold in the December quarter about half of that was taken down in January?

Harry L. Bosco

What I mean was half of the shortfall, which is about $4 million, was taken up the first couple of days in January.

Ehud Gelblum - JP Morgan

And do you think that was just due to budgetary concerns that they wanted to purchase them and pay the cash in 2008 versus 2007?

Harry L. Bosco

There is no way I can tell that. That’s the issue, right? Because, you just don’t know what happened there, I think, it was going to be pulled. We looked at the historical data, and we thought it was going to be pulled. It just pushed out.

Ehud Gelblum - JP Morgan

And when you build the inventory, you don’t build its orders, I can see build it to your own forecast, the matter continues to outperform, is that how?

Harry L. Bosco

In the case of VMI program, we build to their orders. They gave us an order and say put this in the inventory. And they are committed to pulling it within 90 days. If it’s a customized product, its like-for-like and other people can use it, then you have to use it other places.

Ehud Gelblum - JP Morgan

And this was which case?

Harry L. Bosco

Well, these are all customized products in this case.

Ehud Gelblum - JP Morgan

So they have to pull it within 90 days, right?

Harry L. Bosco

Have to pull within 90 days, right.

Ehud Gelblum - JP Morgan

So you are getting the revenue from that regardless?

Harry L. Bosco

We get the revenues, it is just timing.

Ehud Gelblum - JP Morgan

So all that revenue shortfall will actually come through in this quarter.

Harry L. Bosco

You’ll see some that come through, right.

Ehud Gelblum - JP Morgan

Or we should see all of this.

Harry L. Bosco

What can happen is you don’t know what that boundary is going to be for the next quarter.

Ehud Gelblum - JP Morgan

So they can continue pushing out some other things.

Harry L. Bosco

Yes, that’s moving in. And it could pull stuff in like it did in Q2.

Ehud Gelblum - JP Morgan

I find it interesting that Cisco was one of the obviously a large decliner in terms of, sequentially in terms of revenue given the guidance they gave in the last conference call for themselves.

Do you see any correlation between how Cisco’s top line is doing for themselves and how they are talking about the business going forward at least for the next two quarters and what they’re ordering from you? So has this quarter been a little bit softer than you otherwise would have expected it as well, that piece from December notwithstanding?

Harry L. Bosco

If you look at history of the data, it says that Cisco has gone from $25 to $30 million, back down to $25. And its really depends on the products they buy, the orders they get in and we see nothing softening there, there is no trend of going down. But you see fluctuations. I don’t want to mislead you on that.

Ehud Gelblum - JP Morgan

Both OpEx lines declined on an absolute value basis, and it sounds like there’s some timing involved there. Should we expect those to naturally ramp up a little bit more next quarter and the quarter after as the timing those kind of ramp in the next two quarters? Or is it going to be staying at the new levels, if you kind of maybe cap a little spending?

Robert J. Nobile

You are going to see at a minimum the impact of the bonus reversals will not repeat itself. And that was a bit over $1 million. In terms of the R&D savings, that gets to the point I discussed earlier about the timing of the prototype builds. That will continue to roll somewhere about $1 million, $1.5 million per quarters is going to kind of fluctuate depending on the timing of those prototypes.

Ehud Gelblum - JP Morgan

So when they do hit, the R&D budget will go up and we’ll see that come through for the higher OpEx than we expected?

Robert J. Nobile

That’s correct.

Ehud Gelblum - JP Morgan

Bob, interestingly you said the 5% to 6% price declines per quarter were higher than they were in the past?

Robert J. Nobile

From last quarter to this quarter.

Ehud Gelblum - JP Morgan

Can you give us an historical perspective what they did from either June to September or even from last year’s September to December?

Robert J. Nobile

Over the past year, the annual decline was somewhere in the 12%, 15% range depending upon which products you’re looking at and so on and so forth. So going from the December quarter to March, we are seeing greater price pressure.

Ehud Gelblum - JP Morgan

That’s the way you expect the 5% to 6%. That was not from September to December, it was December to March?

Robert J. Nobile

Correct.

Ehud Gelblum - JP Morgan

Can you attribute that to anything, what the customers are doing?

Robert J. Nobile

The January timeframe has the greatest number of contract price changes. So we tend to see higher price declines in, going into the March ending quarter than other times during the year.

Ehud Gelblum - JP Morgan

So can you compare this to last year’s December to March transition?

Robert J. Nobile

Yes, it’s slightly higher.

Operator

There are no further audio questions at this time, sir.

Douglas Dean

That concludes our investor call for today and thank you all for joining us. Operator, could you please provide the replay instructions?

Operator

Thank you for participating in today’s Third Quarter Earnings Conference Call. This call will be available for replay beginning at 6:30 PM Eastern Time today, through 11:59 PM Eastern Time on March 3, 2008. The conference ID number for the replay is 29822737; again the conference ID number for the replay is 29822737. Thank you for your participation and the number to dial for the replay is 1-800-642-1687, or 706-645-9291.

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