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Opnext, Inc. (NASDAQ:OPXT)

Q4 2008 Earnings Call

May 22, 2008 9:00 am

Executives

Douglas Dean – Vice President of Investor Relations

Harry L. Bosco – President and Chief Executive Officer

Robert J. Nobile – Chief Financial Officer

Analysts

John Harmon – Needham & Company

John Lau – Jefferies & Co.

Tim Savageaux – Merriman Curhan Ford & Co.

Sam Dubinsky – Oppenheimer & Co.

Patrick Tallery - Piper Jaffray

Ehud Gelblum – J.P. Morgan

Paul Bonenfant – Morgan, Keegan & Company, Inc.

Ajit Pai – Thomas Weisel Partners

[Koff Statler - Deutsche Bank]

Operator

Good morning. My name is Lucretia, and I will be your conference operator today. At this time I would like to welcome everyone to the Opnext, Incorporated fourth quarter earnings conference call. (Operator Instructions). I would now like to turn the conference over to the host, Vice President of Investor Relations, Mr. Douglas Dean. Mr. Dean, you may begin your conference.

Douglas Dean

Good morning. Thank you for joining us today. May name is Doug Dean, and I am the Vice President of Investor Relations for Opnext. Today we will discuss our financial results for the fourth quarter ended March 31, 2008, 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 and 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 questions 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

Thank you, Doug, and good morning everyone. I would like to start by saying that we are glad to be back on our growth path, as demonstrated by achieving nearly 73 million in revenues for the March quarter. This represents a growth of nearly 10% over the December quarter and 11% over the quarter ending March 2007.

Our gross margin was 32.9% versus 32.8% last quarter. Earnings on a GAAP basis were $.01 per diluted share and $.03 per diluted share on a non-GAAP basis. The performance capped a very strong year for us in Opnext. For fiscal year 2008 the revenues totaled nearly $284 million dollars and net income was 17 million. This represents a growth of 27% in revenues for fiscal year 2007 and an improvement over $16 million in net income.

For 2008 we achieved GAAP earnings of $.26 per diluted share with profitability in every quarter. This compares favorably to a $.01 profit in fiscal year 2007. So while we sounded a cautionary note entering the March quarter, the deployment of broadband applications continues to drive demand for our products. This was confirmed in the quarter as sales of our 40G products rebounded in the quarter.

A demand for these products continues to build across our customer base. Recently we committed to expand our manufacturing capacity to support this demand. Sales for Cisco, our largest customer, remains strong, and we are well balanced across all of our product lines. We continue to increase our design wins with customers such as Huawei, Ericsson, and Nortel, and a pickup in spending from Japanese customers.

As we mature as a public company, we have made some key personnel appointments to help manage our growth. Most recently we created and filled the position of Vice President [inaudible 00:05:19] under leadership of Gilles Bouchard, our Chief Operating Officer. The focus will be to identify opportunities for strategic sourcing and procurement leverage.

In the global sales organization we have also added select account personnel to address our diversification efforts. And we have formalized the global sales support team with the focus to improve productivity and efficiency ultimately to better service our customers.

As we round out our portfolio products with several introductions planned over the course of the next couple quarters our priorities include suitable labor technology for current and next-generation 10G and 40G modules. 40G client and line side or DWDM modules focused on superior performance and cost benefits and cost reductions across the product portfolio. Longer term we are focused on a hundred gigabit lasers, detectors, and transceivers.

Looking back on the year, I am very pleased with the progress that we have made as a public company driven by our broad and expanding customer base and product portfolio in a 10G and higher speed markets. Our product development roadmap is on track to stay on the leading edge of technology. And I am excited about the opportunities that are ahead of us in the coming year. With that backdrop, I’ll now turn it over to Bob Nobile to review our fourth quarter results.

Robert J. Nobile

Thanks, Harry, and good morning everyone. For the quarter ended March 2008 we generated sales of 72.7 million, representing growth 6.3 million or about 10% as compared to the previous quarter. This growth primarily resulted from increased sales of 40G, X2, and SFP data products. Our 10G and above products grew about 11% to 60.1 million and accounted for nearly 83% of our total revenue.

Our less than 10G product line contributed favorably with over 9% growth to 82 – to 8.2 million from industrial and commercial product sales decreased by $500,000 or 10% to 4.4 million. Compared to the quarter ending March ’07 our sales increased 7.3 million or 11% from 65.4 million. The increase is driven primarily by higher demands for our 40G, X2, and SFP data products that were partially offset by lower demands for 300 pin fixed wavelength products.

For this quarter, Cisco and Alcatel-Lucent represented 46% and 14% of total sales as compared to 38% and 20% in the previous quarter. For fiscal year 2008 sales to Cisco and Alcatel-Lucent were 40% and 20% as compared to 38% and 20% in fiscal year 2007. Geographically, revenues in the United States represented over 60% of our total sales for the March 2008 quarter while Europe represented 19%, Japan 15%, and the rest of Asia-Pacific was 6%.

First margins for the quarter ended March ’08 was 32.9% as compared to 32.8% in the previous quarter and 33.9 in the March quarter of last year. The sequential increase primarily reflects the benefits from lower warranty reserve requirements that were partially offset by increased sales of lower margin SFP and 10G multimode fiber data products and the negative effects of foreign currency exchange fluctuations while the decrease from the prior year was primarily due to currency fluctuations.

As compared to the December quarter R&D expenses increased 2.1 million to 10.7 million, an increase of a percentage of revenue to 14.8 from 13.1. The expense increase primarily reflects the anticipated higher levels of R&D material spending related to the timing of prototype builds as well as the negative effects from foreign currency exchange fluctuation.

SG&A expenses increased 2.1 million from the September quarter, the 13.8 million, an increase as a percentage of sales from 18.5 from 17%. This increase primarily resulted from the cost to amend our previously filed financial statements, the anticipated higher levels of marketing communication expenses related to the OFC trade show as well as the negative effects from foreign currency exchange fluctuations.

In addition, R&D and SG&A expenses during the quarter ended December 2007 included the benefit from the reversal of performance-based bonus accruals. Operating loss including $1 million of stock-based compensation expense was $800,000 or 1.1% of sales as compared to the operating income of 1.8 million or 2.7% of sales in the previous quarter.

The decrease in the quarter ended December 2007 primarily resulted from the increase in operating expenses including non-cash charges related to the disposal of certain obsolete fixed assets. As compared to the December quarter, foreign currency exchange fluctuations had a 270 basis point negative impact on operations as the average yen to U.S. dollar exchange rate moved from approximately 113 to 105.

This impact was offset by 120 basis point benefit from the hedge program we implemented in December. After accounting for net interest income of 1.6 million and net other income of $120,000, net income was $900 million or a penny per diluted share. GAAP and non-GAAP earnings of a penny and $.03 per share, respectively, decreased earnings of $.07 and $.09 per diluted share in the previous quarter.

The $06 per diluted share decrease includes a $.05 reduction from foreign currency exchange fluctuations, the cost to amend our previously filed financial statements, non-cash asset disposal costs, lower interest rates on short-term investments, and lower exchange gains on foreign currency denominated transactions.

Our cash position increased by 18.3 million to nearly $222 million at March 2008 as we have generated 1.8 million of cash from operations, entered into a new 20.1 million short-term yen-denominated loan, made additional investments to manufacturing capacity, and paid existing capital equipment lease obligations. I won’t belabor the year-over-year comparison, but it’s worth noting again.

Fiscal year 2008 was a very strong year for us. Annual revenue was nearly 284 million up 27% over last fiscal year. Gross margin improved to 34% and diluted earnings per share increased to $.26 from a penny in fiscal year 2007 including a $.03 negative effect from foreign currency exchange fluctuations. So with that, now let me now turn it back to Harry to discuss our outlook and guidance.

Harry L. Bosco

Thanks, Bob. Let me recap by saying that we are encouraged by the market opportunities that we have before us as we broaden our product lines to address new markets in the highest growth market segments. Our expectations for continued revenue growth and profitability are driven by a new range of 40G and 43G products to address the line side applications.

An expanded 10G portfolio, including a full lineup of SFP plus transceivers, and DWDM enhancements for SFP and X2 and a focus on pinnable products for both 10G and 40G applications using our own tunable laser module. Additionally, we have focused on 100G developments to keep up us at the forefront of technology innovation and ensure long-term growth and profitability.

At the OFC trade show in February we demonstrated this capability. In summary, we believe the 10G and above market segment should continue to grow faster than the overall market. However there continues to be limited visibility in short-term customer demand lumping us in customer spending patterns and uncertainty related to the broader economic downturn.

For these reasons we believe it is prudent to remain cautiously optimistic for the June quarter just as we were in the March quarter. For our fiscal quarter ending June 30, 2008, we expect sequential revenue growth with revenues to be in the 74 to $77 million range. For fiscal year 2009 we are well positioned to continue our growth in the 10G and 40G markets while expanding our 40G portfolio to address broader network applications.

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

Douglas Dean

Thanks, Harry. This completes our prepared remarks. And I will be glad to take your questions. Again, so that we may get to as many of you as possible, please limit your questions to no more than two at a time. The operator will now provide instructions on how to submit your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Mr. John Harmon of Needham & Company.

John Harmon - Needham & Company

Hi. Good morning.

Douglas Dean

Good morning, John.

Harry L. Bosco

Good morning, John.

John Harmon - Needham & Company

I think it said two questions. So the first question is the obvious question. Given the recent news, you know, what are your thoughts on industry consolidation and how it pertains to Opnext? And second, could you give us some kind of outlook on gross margins, and what you are doing to bring them up, and the rough timeline. Thank you.

Harry L. Bosco

Hi, John. This is Harry. Let me take the first one. Clearly both Optium and Finisar are competitors on their own to us in marketplace with certain products. And certainly they are going to be a competitor as they are combined. We really don’t have any insight into what their next moves are as a combined company. And we won’t know until they finally get merged.

But consolidation has always been a positive if you have complementary products, then you can gain some market of scale. So that is one that we always look at. But again, from Opnext’s perspective, we are keeping on course with our product lines right now and expanding it going forward. And obviously, we always look for candidates to combine with to join forces.

Robert J. Nobile

And John, for your second question regarding gross margin and our outlook at this point, you know, the things we have discussed in the past, the most significant things affecting our gross margin and are primarily consistent that the product mix of our portfolio, the extent and timing of our cross-production program, and obviously the impact of the yen to the U.S. dollar.

So based on the current mix of our products coming into the first quarter of fiscal 2009, we see our margins staying relative consistent with the margins we just achieved in this fourth quarter. And that’s assuming that the yen were to stay at the average 105 rate that we have experienced in the fourth quarter. And then we have got cost-reduction actions taking place as we proceed throughout the rest of the year.

So we would expect modest improvements in those margins throughout the rest of the year.

John Harmon - Needham & Company

Great. Thank you very much.

Operator

Your next call – your next question comes from John Lau of Jefferies & Co.

John Lau - Jefferies & Co.

Great. Thank you. Harry, I wanted to ask you with regards to your current business at Cisco, it seems like it’s getting a little bit better, especially – and a little bit more on who is the strongest adopter of 40G. And then finally circle back and ask you a little bit about Huawei and how that China market is doing also. Thank you.

Harry L. Bosco

Okay. John, one good thing about Cisco, not only is it large volumes and revenues for us, but it is across all of our products, which we are very pleased with. It goes across our 10 gigabit products as well as the tunables and the 40G. So we see, again, it always goes up and down depending on quarter-over-quarter. But the business continues to increase as they grow their business.

So we are very positive about that. And the other parts about it is we saw growth in X2. We saw [inaudible 00:19:18] as staying solid. We saw growth in [break in audio 00:19:22-00:19:30]. We are pretty well established there. And again, we have to earn our keep each day with them. On our Huawei’s perspective, Huawei has been making some big inroads. And we continue to get some demand increases coming out of them as they start to penetrate things like India, and Europe, and that.

So we are benefiting from that as well as getting more of our products qualified in Huawei.

John Lau - Jefferies & Co.

If you were to take a look out over the course of the next year or so, can you see the Asian markets? You know, they were coming in at 6% of the revenues. Can you see them, in terms of their growth rate, coming up towards 10% over the next year?

Harry L. Bosco

Ten percent may be a little aggressive because the North American market is still growing pretty significantly, you know, with the impact of guys like Verizon, AT&T, and [inaudible 00:20:16]. But we also see – we have seen an uplift in Japan right now. They are starting to deploy now more of their broadband infrastructure.

John Lau - Jefferies & Co.

Okay. So there is no major difference. I mean all of the areas are growing for you. There is no one area that is overshadowing any other one. So they are all growing?

Harry L. Bosco

They are all growing right now. Europe was a little soft. It looks like it’s coming back now.

John Lau - Jefferies & Co.

Great. Thank you.

Harry L. Bosco

You are welcome.

Operator

Your next question comes from Tim Savageaux with New York Merriman.

Tim Savageaux - Merriman Curhan Ford & Co.

Hi. Good morning, a couple of questions. First with regard to operating expense, you seem to indicate there is possibly some one-time nature to relieve some of the SG&A costs from financial restatements and the OFC. And also, you argued there was obviously bounced around pretty violently based on prototyping. I wonder if you could talk a little bit about your expectations for the direction of operating expenses, at least in the relatively near term. And then I’ll follow up.

Robert J. Nobile

If you were to exclude the one-time nature thing, the restatement costs, the asset disposal, non-cash asset disposal cost, you would see – and also factor in the seasonality of the R&D spending and the marketing communication cost. We left the fourth quarter at about a $22 million OpEx run rate assuming the yen about 105, which would be average for that quarter. We see that rate increasing to about $24 million per quarter going into this fiscal year ’09, alright.

And that increase is really going to support a couple of things; increase investment in our R&D programs, the normal variable costs of selling our products as well as normal salary increases and our bonus program.

Tim Savageaux – Merriman Curhan Ford & Co.

Do you see that 24 million run rate kind of building throughout the year? Or moving kind of directive to that in June?

Harry L. Bosco

It will move fairly close to that in June and then again we will have some timing throughout the year given the prototype and marketing communications study.

Tim Savageaux – Merriman Curhan Ford & Co.

Okay, and then I hear you mentioned some focus on customer diversification and you mentioned Europe has been bouncing around, looks like Europe was actually up a little bit from last the quarter though Alcatel-Lucent has been down for you guys. You called out a few names of some other major OEMs where you talked about design wins but if you could kind of address the base of customers beyond Cisco and beyond your 10% guides and talk to us about where some of your opportunities lie and who you think could be significant for you through the course fiscal ’09 other than kind of your current big guy.

Harry L. Bosco

Tim, we have the three major ones of course we don’t want to exclude anybody else that we’re trying to get penetration in or moving in to Huawei certainly has a lot more opportunity for us. Ericsson has more opportunity for us and we’ve got more of our products qualified in there and design wins; and then Nortel. So those are kind of the three major ones that we’re really trying to get penetration into. We also have penetration into Fujitsu and NEC and of course they address the worldwide market too.

We have about, just a tidbit of information, which we look at. Out of our top 10 customers we have increased the design wins by about 60% from 2006 to 2008. We have about, approximately, 460 design wins. What that means is we have sockets where we were qualified in across our customer base that once they start to sell their products then they will start drawing our product. So those are engines. Kind of like the sales tunnel analogy. So we watch that very carefully and make sure that keeps growing and then make sure it keeps growing in those diversified customers.

Tim Savageaux – Merriman Curhan Ford & Co.

Okay, thanks. I will pass it along.

Operator

Your next question comes from the Koff Statler [ph 00:24:40] of Deutsche Bank.

[Koff Statler - Deutsche Bank]

Thanks a lot and I got on the call late. My question was on X2. I don’t know if you break that out or not but could you talk about how it did and could you give me again the Cisco percentage of revenue. Thanks a lot.

Robert J. Nobile

Our X2 business for the quarter represented between 10 and 15% of our total business. And Cisco’s revenue percentage for the quarter was 45.7.

[Koff Statler - Deutsche Bank]

Okay, I guess one of your competitors did not have particularly good X2 quarter. I am just wondering what is going on there. I realize the market shifts back and forth quarter to quarter but are you taking – obviously you are taking share, I guess the question is probably why?

Harry L. Bosco

I think, basically, you have to take a look at the particular X2 product. We have the ones that are addressed in the multimode [inaudible 00:25:35] the LX4, the LRM. We have the stuff that is the short reach, the long reach, the extended reach, the EDR, we have ZRs and then we have DWDM. So it has kind of crossed those lines and each one peaks up on quarter to quarter basis.

[Koff Statler - Deutsche Bank]

Okay so I guess the short reach is probably the weaker one of the three. SFP plus, do you – are you shipping material volume there yet or is that still kind of a work in progress to get them [inaudible 00:26:04] or that segment [inaudible 00:26:05]?

Harry L. Bosco

Yes, we have two products completed now and in mass production. One is the short reach and the 8 gigabit. Both SW and LW, and they are all in qualification stages in customers.

[Koff Statler - Deutsche Bank]

Okay. And could you talk about the six wavelengths laser businesses. Is that still weak and I guess your tuner was selling there pretty strongly, where are you on your track for tunable development?

Harry L. Bosco

Our tunable is coming in the second half of this year. Our own tunable module and then of course you go through the qualification period. One thing that is happening on fixed 300 pin is all of a sudden we have seen uplift in demand. As some of these projects are being won in other countries, it is coming back up but it could be a one-time deal so we are very cautious about that.

[Koff Statler - Deutsche Bank]

Okay and then on the currency how much of that hit EPS or is that the last question? Thanks a lot.

Harry L. Bosco

Currency for the fourth quarter, net of the hedge benefit was about $1.1 million.

[Koff Statler - Deutsche Bank]

Okay. Thanks a lot.

Operator

Your next question comes from Sam Dubinsky with Oppenheimer.

Sam Dubinsky – Oppenheimer & Co.

—revenue this quarter?

Harry L. Bosco

Excuse me?

Sam Dubinsky – Oppenheimer & Co.

What was the 40 gigabit revenue this quarter?

Harry L. Bosco

About $10 million.

Sam Dubinsky – Oppenheimer & Co.

Okay, that means you guys were basically shipping near capacity. What are the capacity expansions for this business throughout next year?

Harry L. Bosco

We expanded from Q1 to Q2 about 20% of our capacity increase and we are going to increase another 30% beyond Q2 to Q3.

Sam Dubinsky – Oppenheimer & Co.

Okay and then are you guys going into 8 gig fiber channels networks yet and if so is that in the below 10 gig business or, I know they use this 10 gig laser, where is that classified?

Harry L. Bosco

That is in below 10 gigabit range.

Sam Dubinsky – Oppenheimer & Co.

Okay, are you in that bit market now?

Harry L. Bosco

Just starting, we are in a lot of qualifications of multiple customers now.

Sam Dubinsky – Oppenheimer & Co.

Okay and then on the OPEX side. You said it could be north of – what was the number you gave next quarter 23 or 24 million?

Robert J. Nobile

24, right.

Sam Dubinsky – Oppenheimer & Co.

Is that GAAP or that pro forma? Does that include options or exclude them?

Robert J. Nobile

That is non-GAAP.

Sam Dubinsky – Oppenheimer & Co

Non-GAAP, okay, thank you.

Operator

Your next question comes from Patrick Callery of Piper Jaffray.

Patrick Callery - Piper Jaffray

Morning guys, nice job on the great quarter there. Quick question about the yen exposure, is that fundamentally are you guys reaching a place where you are expecting more or less a drag on OPEX moving forward? How are we planning for that?

Robert J. Nobile

Well, the impact to the end as I said earlier on OPEX, Pat, was assuming that that is at 105 you have heard where we see OPEX coming out. As we sit here today the ends in 103, 104 range, it started out the quarter just about at 100. So it looks like, not knowing where it is going end up by the end of June, it looks like the impact – we could have a small impact going forward for this quarter.

Patrick Callery - Piper Jaffray

In terms of EFP there has been a kind of fundamental shift down. We hate to speculate on where currencies move, but is there more or less a fundamental change in terms of the operating expenses structure long-term here?

Harry L. Bosco

I think we have to go back to working, Patrick. Like anything else about half of our OPEX is in that currency, right and we have engineers so we are not going to change that. But we will have to manage our expenses.

Robert J. Nobile

It is a, in terms of the number of people we have in Japan and how we spend our R&D and SG&A dollars in Japan, that is going to stay relatively consistent Pat. The opportunity that we have to improve our organic exposure position in our cost of goods with the amount of materials that we spend today in yen; we have begun programs to move some of that into dollars but it takes some time to one, not only negotiate with the vendors to move that change but then you may also be talking about product changes that may require some qualification.

Harry L. Bosco

The other thing is that is why we have these operational initiatives underway right now, by the way. We talked about is because we want to make the organization as efficient as possible because we want to increase the margins and be more efficient in the way we use our people.

Patrick Callery - Piper Jaffray

Great and then if I could ask a couple quick questions on product side. With respect to SFP plus and that opportunity coming in later this year, how do you guys feel about where you stand competitively in the some of the shorter reach stuff which, I think is expected to be on a higher volume basis given how you stack up with the cost structure of some of the competition.

Harry L. Bosco

I think we are in pretty good shape on the SR. We have had it out for quite some time. We have multiple customers that we are getting qualified into. Clearly cost is everything so we keep addressing that all the time. So I do not see a big issue with that right now.

Patrick Callery - Piper Jaffray

Okay and ball park on when you expect to be rolling in the internal developed tunable laser and what that is going to help with – if that is going to be helping on the margin side as well?

Harry L. Bosco

It went up on the margin side and it is going to come in, in the latter part of this year. It will be both in our 10G products and our 40G products. So it will help on both the cost and by the way, performance.

Patrick Callery - Piper Jaffray

Thanks very much guys.

Operator

Your next question comes from Ehud Gelblum with J.P. Morgan.

Ehud Gelblum – J.P. Morgan

Thank you very much, good morning. Couple of questions if I could, first of all on the gross margin side, Bob you said that the gross margin year over year decline was hit a little bit by the increase in SFP, I assume that the expense of XFP. Can you give us a sense as to the gross margin profile between your SFP products, your XFP product, your 40Gs and your X2s as 40G even more did that increase the gross margin? And why is SFP doing better than XFP? That is my first question right now.

The second was I just need a clarification about the 22 million you said coming off of Q4 you just reported. I assume there was some one-time in addition to what you mentioned, were there some one-time in there to increase the 40G capacity and can you give us a sense of how much of that was one-time and as we get to the end of the year after you have had your two upgrades in capacity should not those expenses start actually coming down once you have gotten into some sort of steady run rate of 40G capacity?

And then for clarification, can you tell us what the other OPEX number was [inaudible 00:33:26] 543 this quarter, a little bit higher and as well as how much the warranty reserve changed US margin? Thank you.

Robert J. Nobile

I’m not sure which one we want to start with.

Ehud Gelblum – J.P. Morgan

The gross margin profile across the products the SFP versus XFP.

Robert J. Nobile

And in our border scheme our SFP products right now are less than 10G portfolio whereas the XFP are in our 10G and above portfolio. As we have discussed in the past, there is about a 10 to 15 point differential in the margins between those two product lines. And that stays fairly relatively consistent across most of the products in the 10G and above as well as those below 10G.

Ehud Gelblum – J.P. Morgan

But your greater than 10G way outstripped growth in your less than 10G yet you still call that SFP being a cause of gross margin decline.

Robert J. Nobile

Well, for this quarter, alright again, whenever we are looking at specific one quarter over one quarter impacts you are going to see that. Okay, so any one product makes could have an impact.

Harry L. Bosco

The SFP business this past quarter, as we said in the previous quarter, we were a little under on that one. It came in almost over $2 million growth. I know it has probably flattened out now we anticipated. And then the 40G and the rest of high protein products will start to increase.

Ehud Gelblum – J.P. Morgan

Well, that is what I would have thought would have helped your gross margin this quarter because of the 40G going up.

Harry L. Bosco

And again we had the SFP come in at $2 million growth.

Ehud Gelblum – J.P. Morgan

Okay, so we should view this quarter as gross gross margin as the baseline and as 40G goes up from here, hopefully the capacity numbers that you mentioned we should see gross margin go up, correct? Or are there other offsetting things?

Harry L. Bosco

That is exactly right.

Robert J. Nobile

We also had growth in the 10G multimode data products this quarter too. And those are the ones that is virtually the one product line in the 10G and above that is lower than the average.

Harry L. Bosco

But we have cost reduction plans on that one to kick in and we think that has probably leveled out also.

Ehud Gelblum – J.P. Morgan

What was the other OPEX?

Robert J. Nobile

The other OPEX was we had about a $0.5 million worth of fixed asset disposal costs. Every year we continuously look at our assets and our factories and to the extent we find something obsolete, at this point and time we have got to get rid of it. So it is a non-cash charge.

Ehud Gelblum – J.P. Morgan

And finally why did you take out that 20 million yen denominated loan with all the cash that you have on your balance sheet?

Robert J. Nobile

It helps us with the working capital of our Japanese subsidiary and thereby helps minimize any of our foreign currency exchange fluctuations or from a transactional basis as we move product from Japan to the US and then Japan to Europe.

Ehud Gelblum – J.P. Morgan

Okay and finally, I am sorry –

Robert J. Nobile

Also, the interest rate on yen denominated loans is very favorable at this point and time. And also the yen being where it is, it was a good time to make that, take the loan off.

Ehud Gelblum – J.P. Morgan

Thanks and finally the warranty expense? How did that benefit you this quarter? The warranty accrual change.

Robert J. Nobile

The warranty accrual had about a 1.14%, 140 basis point benefit this quarter.

Ehud Gelblum – J.P. Morgan

And you – should we see that then gross margin falls back 140 basis points next quarter or are you –

Robert J. Nobile

No, no it is the – now it is gone. That should not be a variation going forward.

Harry L. Bosco

Bonus reversal and our warranty accrual were in third quarter. Alright so the warranty, $1 million SMI issue, was in third quarter, it was not in fourth quarter. The bonus reversal benefit was in third quarter not fourth quarter.

Operator

Your next question comes from Paul Bonenfant with Morgan, Keegan.

Paul Bonenfant – Morgan, Keegan & Company, Inc.

Thank you. I just wanted to circle back on what you said earlier about 40G. I believe you said you did about 10 million in the quarter and I am wondering if that was about at capacity. And if not, what revenues would be if you were at capacity today given that you have increased and plan to increase it further?

Harry L. Bosco

Paul, what the implication is really the mix. We take 43 gigabits versus 40 gigabit. It takes longer to test the 43 than 40 so you have to look at the mix. Yes we are running at capacity for Q1 because remember with the SMI H2 we are rolling back some repairs back through the same lines. Next quarter we will increase that again by 20% and we hope to make that at maximum capacity and then we will do another 30% the following quarter.

Paul Bonenfant – Morgan, Keegan & Company, Inc.

Okay, that is helpful, thank you. And just to come back to unexposure question. I am just wondering given that you had some hedging in place last quarter and I think you have done some more incremental this quarter, are we still talking about 80% COGS and 60% OPEX exposure to the end?

Robert J. Nobile

Yes.

Paul Bonenfant – Morgan, Keegan & Company, Inc.

Okay, that was an easy one. And last the question if you could just comment on the stock buyback. It does not look like you bought back stock in the quarter and I am wondering what your plans are relative to that program and stock price where it is today.

Harry L. Bosco

Yes, we are not going to do any right now. We have not decided but the Board and I are discussing it right now. There are a lot of factors in this.

Paul Bonenfant – Morgan, Keegan & Company, Inc.

Okay, thanks for taking my question.

Operator

Your next question comes from the Ajit Pai with Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

Thank you this is [inaudible 00:39:27] calling in for Ajit. Couple of quick questions if I may. First one, I wanted to ask about the timing of I guess supply chain streamlining and then procurement initiatives. When do you guys expect to see the full impact of those on your gross margin?

Harry L. Bosco

We think it is going to happen throughout the year. It is more complicated than ever going back right now. Obviously we have a team put together already going across the company and they are out working with the suppliers now. So we will see that continuously through the year.

Ajit Pai – Thomas Weisel Partners

And the second question is in terms of; I guess it is somewhat symbolic to talk about the Lucent. What are the expectations towards that line and how should we think about when we model our revenues in the coming quarter?

Harry L. Bosco

I think we have seen continuously Alcatel-Lucent just as continuous as Cisco up and down in their demands. Okay and we see some positive signs coming out now from Alcatel-Lucent. It looks like we will start to see some growth back in.

Ajit Pai – Thomas Weisel Partners

And the final question just wanted to ask in terms of the OPEX compensation, what was the breakdown between R&D and SG&A in the quarter?

Harry L. Bosco

Operator we will have time for one more question after this.

Operator

Okay sir. You have a follow-up from Tim Savageaux with Merriman.

Tim Savageaux – Merriman Curhan Ford & Co.

Sort of a higher level question here, did you guys look at what you are talking about for the June quarter very sequential up revenue guide but I want to focus on the year over year comparison and ask a follow-up question about business model and plans and expectations. You made references to managing expenses throughout the call that is not really imminently clear how that is happening near term. So you are talking about a double digit revenue increase, a 300 basis point or so year on year decline in gross margins which I gather is principally end driven and a 20% increase in operating expenses or so if you are up around 24 million.

After stripping the increase in revenue and so pretty modest operating margin in that regard, you have talked about plans to try and achieve double digit operating margins over time, obviously the ends put that back but you do have some control over its direction near term with OPEX. I wonder if you could explain to us your thinking about sacrificing your term profitability for investment especially in light of some semi-cautious comments about the overall environment. Should we expect a little more conservative approach toward operating spending or is your relative aggressive approach indicative of opportunities and a little more bullishness than you might be letting on? Thanks.

Robert J. Nobile

Tim, as I said earlier, the majority of the increase that we are talking about from our current position is investments in our R&D program. And we believe it is necessary for us to continue this growth rate especially the programs we have got in place with 40G and eventually with 100G. The other elements of this are just what you would consider to be normal, in terms of salary increases for existing personnel, commission logistics and the other variable costs of selling to our customers. And we are reinstating and implementing back the bonus program.

Tim Savageaux – Merriman Curhan Ford & Co.

Understood but is there a point, at which, you hope to start to deliver operating leverage into the model again. Just as you mentioned in the March quarter and plus the percentages to revenue on the expense side went up. I think that is going to be the case in the year on year basis to at least, in the June quarter, so I guess what is your current thinking as to when we start to see some leverage in the model from the OPEX standpoint.

Robert J. Nobile

Well, you will see it as we progress through year. Remember that in our OPEX this year, as you are looking back towards last year, we had over $4 million worth of public company costs, things that we did not have before we started operating this way. That is in our base plan and that level growth obviously will not continue going forward.

Just to get back to Ajit’s question on stock base compensation. The impact for – in the fourth quarter was about $900,000 on total OPEX of which about a $100,000 was for R&D; the rest being SG&A.

Harry L. Bosco

Okay with no more questions that concludes our investor call for today. We thank you all for joining us. Operator, could you please provide the replay instructions.

Operator

The encore replay will be available from today, May 22nd, 2008 at 12 noon until Thursday, May 29th, 2008 at midnight. You may exit this replay by dialing 800-642-1687 or if you are outside of the US 706-645-9291. You will be prompted to enter the conference id. You may now disconnect.

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Source: Opnext, Inc., Q4 2008 Earnings Call Transcript
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