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Executives

Jerry S. Rawls - Chairman of the Board, President, Chief Executive Officer

Stephen K. Workman - Chief Financial Officer, Senior Vice President - Finance, Secretary

Analysts

John Harmon - Needham & Co.

Tim Savageaux - Merriman Curhan Ford & Co.

Paul A. Bonenfant - Morgan Keegan & Co.

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris Group

Cobb Sadler - Deutsche Bank

Ajit Pai - Thomas Weisel Partners

Troy Jensen - Piper Jaffray

Finisar Corporation (FNSR) F4Q08 Earnings Call June 12, 2008 5:00 PM ET

Operator

Good afternoon. My name is Jen and I will be your operator today. I would like to welcome everyone to the Finisar fourth quarter financial results conference call. Jerry Rawls, President and Chief Executive Officer for Finisar, and Steve Workman, Chief Financial Officer, will be hosting this call. (Operator Instructions) Mr. Rawls and Mr. Workman, you may begin your conference.

Jerry S. Rawls

Thank you, Jen. Good afternoon, everyone. We appreciate your taking the time to listen in on our conference call today. A replay of this call should appear on our website within two days following the filing of the transcript of this call with the SEC. An audio replay will be available thereafter for two weeks by calling 877-660-6853 for domestic, or 201-612-7415 for international. Enter 2791 for the account number and 284578 for the conference ID number.

I need to remind all of you that any forward-looking statements in today’s discussion are simply risks -- are subject to risks and uncertainties which are discussed at length in our 10-K and quarterly 10-Q SEC filings. Actual events and results can differ materially from these forward-looking statements.

As you all know, on May 16th we announced we had entered into a definitive merger agreement with Optium Corporation in a stock-for-stock tax-free exchange. We think the benefits of this combination are considerable, given our core strengths in enterprise and metro optical networks, and Optium’s core strengths in long-haul telecom and cable television. With little product overlap, we will have one of the broadest product portfolios in the industry, one that addresses the highest growth segments of the optical communications market.

The merger will also combine Finisar's vertically integrated, low-cost manufacturing capabilities with Optium’s mass customization expertise, create a formidable supplier with broad capabilities to offer to customers.

The next part of this process will be to file our 10-K with the SEC in late June, followed by an S-4. Investors and security holders are urged to read this S-4 when it is filed with the SEC because it will contain important information about the merger, as well as any other filings Finisar makes regarding the merger.

Once approved, a joint proxy statement and prospectus will be mailed to shareholders about 30 days ahead of the actual shareholder meeting.

There are obviously timing variables as to when the two companies will hold their shareholder meetings but we are still focused on closing in the third calendar quarter of 2008.

We will defer any further comments regarding the proposed combination until after the S-4 has been filed.

As a reminder for those of you who might be listening to us for the first time, we break down our revenues by distance and network application. For example, optical transceivers designed with common technologies, such as VCSEL lasers for data center applications with transmission over less than 500 meters of fiber are designated as LAN-SAN.

The rest of our optics products are for WAN, or wide area network distances. Those that are for ethernet or fiber channel applications we designate as metro. If the product is designed for SONET SDH protocols, we refer to those revenue as telecom.

Both metro and telecom products generally use common technologies to transmit and receive signals at distances of up to 120 kilometers, while new technologies acquired from [ASNA] last year promise to extend those distances even further in the near future.

You can see a summary breakdown of our revenue by product group and application by going to the investor relations portion of our website under fundamentals.

As we pre-announced a couple of weeks ago, simultaneous with the announcement of the merger with Optium, revenues for the fourth quarter were stronger than we had predicted. Total revenues of $121 million were up $8.3 million, or 7% from $112.7 million in the previous quarter.

Total optics revenues of $111.4 million were up $8.4 million, or 8% from $103 million last quarter, while revenues for network tools were mostly unchanged from the prior quarter at $9.6 million.

The breakdown of our total optics revenues by applications is as follows: revenues for LAN-SAN applications were particularly strong at $62.7 million, up $7.4 million or 13% from $55.3 million last quarter. Within this category, we include revenues for all transmission feeds including 10-gigabit per second applications. 10-gigabit LAN applications increased by about $2.2 million from last quarter, which means most of the increase in LAN-SAN revenues this quarter, about $5.2 million of it, was in fact related to 1- to 8-gigabit applications.

Revenues for these applications have now grown for six consecutive quarters and appear to be benefiting mostly from strong demand by the storage industry, due in part to the adoption of storage virtualization technology.

Virtualization creates new SANs, with optical interconnects to replace direct attach servers with copper interacts. Virtualization increases CPU utilization and storage efficiency while reducing costs, space, and energy consumption.

Metro revenues of $25.3 million were up $2.5 million, or 11% from $22.8 million last quarter. Telecom revenues of $23.4 million were down $1.5 million, or 6% from 24.9 last quarter.

Revenues for 10- to 40-gigabit products for all applications totaled $31.2 million, up $2.1 million, or 7% from the $29.1 million last quarter. Most of that increase, as we mentioned earlier, was the result of increased revenues for short distance LAN applications. Those revenues totaled $12.2 million, up $2.2 million or 22% from $9.9 million last quarter.

10- to 40-gigabit product sales for metro and telecom applications totaled $19.1 million, about flat with last quarter. That is primarily due to the fact that the third quarter benefited from higher than normal 40-gig revenues that were the result of delayed shipments from an earlier quarter.

In combination with our earnings release today, we announced that we will be spinning out our NetWisdom product line into a separate entity for which we will be taking a minority ownership position. This product was designed as a monitoring system for large SANs. It is particularly useful in understanding the IO impact of deploying virtualization technologies in the data center, as well as troubleshooting various performance issues in the SAN.

Since its introduction, this product line has been difficult for us to support adequately. It requires an enterprise data center sales and marketing effort that is quite different from our OEM sales of fiber channel protocol analyzers.

We believe the new company will be better able to focus on this data center opportunity and make the required investments to make it successful. Revenues for this product line totaled approximately $3.5 million for all of fiscal 2008. However, we incurred operating expenses that exceeded any gross profit contribution from the product line. By spinning this out, we should improve our bottom line by about $500,000 per quarter.

Again this quarter we had only one 10% customer. Our top three customers this quarter accounted for 29% of total revenue compared to 38% last quarter, while our top 10 customers represented 55% of total revenues versus 63% last quarter.

If you adjust the top 10 for quarter three and quarter four so that they contain the same customers, you will end up with a top 12. Revenues for these customers in fact were down slightly in the quarter, which means that our all other customers for Q408 were in fact up almost $10 million from the prior quarter. In other words, our quarter to quarter sales increase was very broad-based.

As this marks the end of our fiscal year, I’d like to add a few comments about our performance over the year. Between supply chain issues at our customers and our own execution problems, our first half of fiscal year ’08, optics revenues were actually down from the same prior year period by 4%. We then recovered, such that optics revenues grew 15% year over year in the last half, enabling us to hit a new record of $440.2 million in total company revenues for the full fiscal year. That’s up 5% from $418.5 million last year.

While the overall growth rate was lower than we expected, there were some significant in-roads into new markets, particularly for 10- to 40-gigabit applications, which we think bodes well for next fiscal year.

Revenues from our 10- to 40-gig products last year more than doubled, growing from $40.3 million in fiscal ’07 to $96.8 million in fiscal ’08. That increase was led in particular by 10-gigabit products for LAN applications, that grew by a factor of 6X, reaching $30.4 million in the year, while 10- to 40-gigabit products for metro and telecom applications nearly doubled from $35.3 million to $66.4 million.

We obviously took a hit somewhere else in terms of our overall growth rate during the year and it was in our revenues for 1- to 8-gigabit products for LAN-SAN applications, which represent about $197 million in revenues the previous year. They were in fact down about $27 million, or 13.5%, to $170 million this year. That was due in part to a bubble of inventory at our customers in fiscal ’07, making year-over-year comparisons somewhat difficult. However, the last few months of increased demand lead us to believe that this part of our business may be on an up trend.

Turning to our guidance going forward, we are very enthusiastic about our prospects for growth next fiscal year, despite the economic clouds that continue to hang in the air. That growth will be driven by: one, a number of new product qualifications for 10- to 40-gigabit applications, the fastest growing market segment; two, the growing information pressures to upgrade communication networks to handle ever-growing bandwidth storage demands; and three, the continued adoption of virtualization technologies that will create demand for more fiber-optics in the data center.

According to the industry analyst [light counting], the market for all 10- to 40-gigabit transceivers and transponders totaled approximately $800 million in calendar 2007, and is expected to increase over 20% to $962 million in calendar 2008.

Our revenues for 10- to 40-gig products grew 140% last year and we think we can continue to grow those sales faster than the overall market. For next year, we think that growth can be about 40%. This growth will be driven by a number of new product qualifications, as well as continued growth in the demand for our XFP and SFP plus products. In addition, we will see our first revenues from our fiber-to-the-home PONs products which are also in qualification at this moment.

Assuming a more conservative single-digit growth for our LAN-SAN business at 1- to 8-gigabits, we think total optics revenues can grow on the order of 10% to 15% this next year. That same growth rate should apply to our network tools business, despite the spin-out of our NetWisdom product.

Once again, new products will help drive growth for this business, including new protocol analyzers for 3- to 6-gig SASS and SATA and PCI Express. Overall, that would mean the total fiscal 2009 revenues for the company could approach or even exceed $500 million.

In the more immediate term, we are guiding to $120 million to $125 million in revenues for the first quarter of fiscal year ’09, of which 10- to 40-gigabit product revenues should range from $30 million to $35 million.

We expect revenues from network tools to exceed $10 million in the quarter, even without the NetWisdom product.

I would like to add that more than half of our optics revenues come from vendor managed inventory, or VMI, just-in-time [hub poles] by our customers. This limits our visibility since the lead time on just-in-time usage is essentially zero.

Our forecasts, therefore, are derived from customer production schedules overlaid with our own judgments as to the expected levels of customer demand.

Now I’ll let Steve walk you through the rest of the P&L statement and the balance sheet. Steve.

Stephen K. Workman

Thank you, Jerry. Let me first talk to the charges that are not included in our non-GAAP results, which are summarized in our reconciliation of GAAP and non-GAAP items. These include a non-cash charge of $3.1 million for slow-moving and excess inventory; a non-cash charge of $3 million for stock compensation expense; a non-cash charge of $1.6 million related to the amortization of acquired developed technology and intangibles from previous acquisitions; a charge of $721,000 related to an incentive payment, which was agreed to as part of the acquisition of [ASNA] last year; a non-cash charge of $1.2 million tied to the discount on the issuance of a convertible note in 2001; a non-cash charge of $588,000 related to tax differences; and a $1.3 million non-cash charge associated with the value of minority investments in our balance sheet.

The duplicate facility costs you see in the GAAP and non-GAAP reconciliation reflect the duplicate facility costs in Shanghai, China as we look to move into a new, larger facility in August or September of this year. In addition, as part of our year-end review of intangible assets, we took a non-cash charge of $4.9 million related to the cost of patent filings, which we have determined are impaired and which we will no longer pursue in order to reduce the ongoing costs of maintaining those patents.

All of these charges totaled approximately $16.6 million, of which only about less than $2 million of these are cash related in the quarter.

Excluding these non-cash or non-recurring items, non-GAAP gross margins were down slightly to 37.4% from 38.2% last quarter. And this decrease reflects an unfavorable product mix as most of the increase in revenues from last quarter was comprised of lower margin LAN-SAN products at 1- to 8-gigabits per second, combined with the impact of the network tools business that represented a smaller proportion of overall revenues.

Non-GAAP operating expenses of $35.6 million were up $1 million from $34.6 million last quarter, primarily due to R&D expenses of $18.5 million, which were up $1 million from $17.6 million the previous quarter. That was due primarily to increase personnel and project costs.

An increase of sales and marketing, due in part to higher revenues and trade show activity was offset by lower G&A expenses, primarily related to lower patent litigation expenses during the quarter. That litigation expense still totaled $1.2 million in this quarter, although down from $1.8 million last quarter.

Non-GAAP operating profit totaled $9.6 million in the quarter, or 8% of revenue. That’s up from $8.5 million, or 7.5% of revenue last quarter. And with $1.6 million in net interest and other expenses, pretax income was about $8.1 million, net income $7.9 million, or $0.03 per share for the fourth quarter, as compared to $6.7 million or $0.02 per share last quarter, and $2.3 million or $0.01 per share one year ago.

Shares outstanding totaled 309 million on a basic basis. Diluted was not much different at 310 million.

Total depreciation and amortization of $6.8 million in the fourth quarter means our non-GAAP EBITDA was almost $17 million, while CapEx was a little higher than usual at $9.5 million. Included in this CapEx number was about $1 million related to our facility expansion in Shanghai.

Our cash balance at the end of April, represented by cash and short-term investments, as well as certain long-term debt securities, which can be readily converted into cash, totaled $116.5 million, down $6 million from $122.4 million last quarter. However, it is important to point out that we undertook open market purchases to retire $8.2 million of our convertible notes due in October, and we used $6 million to pay down a portion of the convertible note issued with the acquisition of [ASNA].

On top of that, we made minority investments totaling $2.5 million, of which $2 million was in the ROADM supplier Nistica, and we made a final non-recurring payment related to employee retention in a previous acquisition. These unusual uses of cash totaled approximately $17 million, so if we add these back, in fact, we would find that our cash balance would have increased to $133 million, up 11 from the prior quarter. And just in terms of the quality of our cash, I would point out that we do not own any auction rate securities. We only own the highest grade of mortgage-backed securities, of which there is a very small balance at the end of April, and we do not see any indications of impairment with respect to our money market investments.

Also as a reminder, on March 17th we entered into an agreement with Silicon Valley Bank to increase our available line of credit to $70.5 million. We have previously maintained a revolving line of credit of $35 million since October of 2004, consisting of a $20 million non-recourse receivables purchase agreement and a $15 million letter of credit reimbursement agreement to cover the issuance of standby letters of credit.

Under the new credit arrangement with Silicon Valley Bank, Finisar will have access to as much as $70.5 million, consisting of a $50 million secured line of credit, in addition to $10 million under a non-recourse receivables purchase agreement and $10.5 million under a letter of credit reimbursement agreement. And the new credit arrangement may be used for general [corporate] purposes, including a reduction in the outstanding convertible notes. As of the end of April, the company had utilized about $7 million under the non-recourse receivables purchase agreement and had letters of credit totaling approximately $9.4 million under the letter of credit reimbursement agreement. We have not drawn under the new secured line of credit.

Inventory declined slightly in the quarter with inventory turns improving to 3.7 on a non-GAAP basis. DSOs improved to 37 days from 44 days last quarter, and while we typically sell some receivables every quarter on a non-recourse basis, most of the improvement in DSOs this quarter in fact came from improved collections experience and a very linear quarter in terms of shipments.

Turning to guidance at the bottom line, with $120 million to $125 million in revenues for the upcoming quarter and a similar product mix as the fourth, gross margins should be in a similar range of 37% to 38%. OpEx should decline a bit to $35 million, as a result of eliminating costs for a portion of the quarter associated with the NetWisdom product line, along with slightly lower OpEx R&D and sales and marketing, and that will likely mean an improvement in operating margins from 8% in Q4 to between 8% and 9% in Q1, which would translate to $0.03 per share.

With respect to our cash balance, we should see that increase to the $120 million to $125 million range, barring further purchases of our convertible notes.

Looking ahead to fiscal 2009, 10% to 15% revenue growth would mean revenues of $485 million on the low-end, with $500 million a reachable target. We’re not going to lay out the year by quarter just yet but starting with $120 million to $125 million for the first quarter, we’re likely to exit the year somewhere in the range of 135 to 140. Assuming a richer product mix of 10- and 40-gigabit per second products, gross margins should slightly improve on a year-over-year basis, also taking into consideration lower ASPs throughout the year.

And with operating expenses of $36 million or below throughout the year, we should see operating margins move into double-digit territory in the last half of the year. Obviously this guidance is going to need to be revised with an Optium overlay once approved by shareholders and we anticipate providing that guidance for the combined company once the merger has been approved.

At this point, I’ll turn the call back to Jerry.

Jerry S. Rawls

Thank you, Steve. To wrap things up, I just want to emphasize that it is the talented and dedicated employees of Finisar who work tirelessly to make this company successful. I am continuously impressed with the zeal with which they attack opportunities in front of us day in and day out. Their enthusiasm for making our customers successful and improving our processes clearly had a big impact over the last year.

Thanks to them, we are well-positioned for continued profitable growth as we enter our new fiscal year. It will be challenging like most years but overall there will be no shortage of new opportunities for optical communications. We will stay focused on doing what we do best -- getting new products introduced and qualified, therefore to increase our revenues to new record levels. And with that, I would like to turn the call back over to Jen for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of John Harmon with Needham & Co.

John Harmon - Needham & Co.

Good afternoon. A couple questions, please. This is not a merger question but I just want to run by something that your merger partner said. During their call, Optium said that on 10-gigabit products, price declines had gotten to a certain point where certain vendors, not yourselves, had gotten to a point where they are either unable or unwilling to match them and didn’t ship, which looks like it might form a basis for price stability. Is that something that you saw as well, or can you elaborate on that?

Jerry S. Rawls

Well, most of the Optium shipments are -- at 10-gigabit are for long-haul, line-side applications at, you know, in 300-pin transponder form. And we sell nothing there. And so it’s -- it’s really -- and it’s a totally different competitive environment in terms of that versus the pluggables that we make at 10-gigabits out of XFPs, particularly in telecommunications.

I don’t -- you know, I’m always hopeful when somebody thinks that there’s a -- that there is an end in sight to price declines but I’m -- maybe. I mean, maybe, but I don’t think that I -- in terms of the XFP market necessarily has the same characteristics. Prices continue to decline, though I -- though on any sort of a relative basis, I don’t think that there are at any abnormal rate of decline right now.

John Harmon - Needham & Co.

Okay, thank you. Just a couple more, please; what changed in terms of customer diversification? It seems like the ratios as a percentage of sales of your major customers has really hit an inflection point in the quarter.

Jerry S. Rawls

Well, we shipped a lot more stuff into Asia, was a strong point for us. And when you ship more products into the networking world, the LAN-SAN space, there’s just a lot more customers there than there are in telecom. The telecom equipment space, there’s dozens of customers as opposed to literally hundreds of customers that are in the networking space.

John Harmon - Needham & Co.

Okay, thank you. And just finally, at one point you thought that virtualization by using storage assets more efficiently was reducing demand for optical modules, but today you are saying that it’s a growth driver. What changed in your thinking there?

Jerry S. Rawls

Well John, I think we’ve talked about this maybe even last quarter -- one of the things that happens in virtualization, one of the reasons that VMWare was such an attractive investment for ENC was that the effect of virtualization is to create more SANs. It is to take direct attach servers, consolidate them into a storage array, and attach many fewer servers, I mean, like 10% of the total servers with big fat pipes to that storage array and have virtualized servers. But all those big fat pipes are now optic, so all -- this takes many copper connections of typically 1-gigabit ethernet and converts them into mostly 4- or 8-gigabit fiber channel connections. So virtualization really does increase by a large number the number of optical connections in a data center.

John Harmon - Needham & Co.

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Tim Savageaux with Merriman.

Tim Savageaux - Merriman Curhan Ford & Co.

Good afternoon, guys and nice quarter. A couple of questions, and I may have heard this; Jerry, I thought you gave some guidance with regard to 10- and 40-gig next quarter moving up to $35 million or so. Maybe I heard that wrong because I wouldn’t -- I would expect the mix to change and maybe a more positive near-term impact on gross margins as a result, so correct me if I’m wrong there.

And secondly, did you give a U.S. versus international sales breakout? If not, I wonder if I could get that.

Jerry S. Rawls

We did not give a breakdown between U.S. and Asia, and the issue with 10- and 40-gig products are growing. I think we said it was between $31 million and $35 million for next quarter but I think that’s -- you know, generally 10-gigabit stuff is positive for gross margins for us but overall sort of -- I don’t know, given our projection right now, and we are trying to be some conservative about it as to where, you know, we project each one of the product lines and we project the average selling price for each one of them. We think that margins are going to be roughly flat.

We think there’s a pick-up in the second half of the year in terms of that 10-gig and 40-gig product. It’s mostly in the 10-gig ethernet space, where if you remember we have qualified our X2 product for sale and we’ve now got multiple customers that are buying it but in the second half, we will be shipping our Xenpak product.

Tim Savageaux - Merriman Curhan Ford & Co.

Okay. Just to follow up on OpEx, Steve you mentioned it will come down a little bit but only partially as a result of NetWisdom.

Stephen K. Workman

We don’t -- you don’t have the impact for full quarter.

Tim Savageaux - Merriman Curhan Ford & Co.

Right, but overall you’d expect $35 million to be kind of a trough level of OpEx for the year as other stuff moves up despite some continued reductions as a result of NetWisdom, fair to say?

Stephen K. Workman

Yeah, I think overall -- I mean, there’s a few moving pieces there. Trying to judge the litigation expense is always a challenge, but I think you could even go a little bit lower than $35 million in the first quarter, but I think it’s best to think about kind of 35 as a run-rate, if you will, and then trending probably up a bit toward the end of the fiscal year.

Tim Savageaux - Merriman Curhan Ford & Co.

And another quick one and I’ll pass it on -- what are you spending these days on a quarterly basis on litigation?

Stephen K. Workman

It was $1.2 million in the most recent quarter and $1.8 million the quarter before. Hopefully the air clears a little bit with respect to where all that’s headed and certainly in the next couple of months, but that’s what is in the most recent quarter.

Tim Savageaux - Merriman Curhan Ford & Co.

Okay, thanks. I’ll see if I can follow-up.

Operator

Thank you. Our next question comes from the line of Paul Bonenfant with Morgan Keegan.

Paul A. Bonenfant - Morgan Keegan & Co.

Thank you. I had a couple of questions of clarification. The first one was with regard to your guidance on the impact of NetWisdom. I thought I heard you say that there would be a positive impact of about $500,000 per quarter. Is that bottom line impact a positive impact of about 500K on net income?

Stephen K. Workman

Yes, that’s right.

Paul A. Bonenfant - Morgan Keegan & Co.

Okay, so that sounds like that was a relatively high gross margin business, yet as a percentage of revenue the OpEx associated --

Stephen K. Workman

Yeah, high margin, high OpEx.

Paul A. Bonenfant - Morgan Keegan & Co.

-- was proportionately higher than the rest of your business. Okay.

Stephen K. Workman

Right.

Paul A. Bonenfant - Morgan Keegan & Co.

Okay, great. And you had made a comment about pursuing the patent litigation. I thought I heard you say you would no longer pursue it but based on the answer to the last question, it sounds like you will continue to pursue that.

Jerry S. Rawls

Well, absolutely. We are engaged and we are engaged fully in that and until we -- you know, the result from the federal circuit court was not encouraging for us, in that they took of the seven claims that the federal district court had ruled that DIRECTV had infringed, the federal circuit ruled that one of those claims was in their mind invalid, and they sent the case back to the federal district to go recalculate damages or to reconsider the other claims in light of infringement. So I think the date for that federal district court hearing is in September, has been set in September.

Paul A. Bonenfant - Morgan Keegan & Co.

Okay, fair enough. Last one, did you mention whether you had any appreciable ROADM revenue in the quarter and if not, or if so, I guess, which segment would we expect that to appear in?

Jerry S. Rawls

We had no appreciable ROADM revenue in the quarter and in terms of segment, ROADM sales occur in the telecom space. And exactly, I assume we would report that in a bucket we call telecom. I don’t know. Steve, what do you think? Do you think we’d create a separate reporting bucket for ROADM?

Stephen K. Workman

I think we would probably carve that out, just as we carve out 10- and 40-gigabits, so you can get a little better feel for what’s happening with various product lines. We’ll probably do that at the time where it becomes a little more significant. And ROADMs also can be used in both metro ethernet and telecom applications, so we’ll -- it could go in either bucket, I suppose, ultimately, but I think most of it probably goes it the telecom.

Paul A. Bonenfant - Morgan Keegan & Co.

Okay, and last question and I will cede the floor; I hate to use a cliché but with regard to data center virtualization, I think it’s well-established now that that will have a positive impact on the business, or be a positive catalyst. What inning would you say that we are in -- do you think we are in the early stages of a multi-year process, in your view?

Stephen K. Workman

Yes.

Jerry S. Rawls

I would have to defer to some guys at Gartner or someplace else that have a better view of the total world in that one, but information that I get back is that virtualization is implemented in, I don’t know, 20% or so of the larger data centers and is under consideration by virtually every data center. And that transition is likely to take place over a few years.

Paul A. Bonenfant - Morgan Keegan & Co.

Okay. Thank you for taking my questions.

Operator

Thank you. Our next question comes from the line of Subu Subrahmanyan with Sanders Morris.

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris Group

Thank you. Steve, could you tell us again kind of what progression you are expecting from a gross margin and operating margin perspective going through the year? And I want to tie that to your expectations of more telecom revenues from the new products. A mix perspective, I would imagine that would help, so just what you would expect exiting the year for gross margin.

And then, on the 300 pin side, given that you’ve embarked into a merger agreement with Optium, how does that affect your standalone investment in kind of a 300 pin module? Does that take down OpEx in any way?

Stephen K. Workman

Well, just setting the merger comments to the side for the time being, I think when we look at profitability, you know, we’re not laying out every quarter but I think as we -- I think the second half of the year probably looms as one that is going to be somewhat more profitable, and as you look at the -- I think Jerry mentioned we have some 10-gig revenues. The growth there is likely also to kick in more in the second half, with some additional product qualifications that are currently in process.

And I think between maybe slightly improved gross margins then in the second half in terms of operating margins, I certainly think we can break into double-digit territory in the second half, so if that answers your question.

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris Group

Yeah, and specific to the 300 pin investment, is that something you are not addressing at this point?

Jerry S. Rawls

Well, 300 pin is -- with the combination with Optium, they have a lot of talented engineers who work on 300 pin projects and what we have -- what we are planning to do is rationalize our 300 pin projects with theirs, and it’s probably fair to say that the center of excellence for 300 pin transponders will probably be focused on Horsham, Pennsylvania, and exactly how the rest of the company helps support that effort is yet to be determined.

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris Group

Understood. And a final question on telecom side revenues -- you had some, a decline this quarter. Jerry, you mentioned 10-gig Xenpak side -- [inaudible] those are all on the LAN side. I’m wondering on the telecom, 10-gig telecom side and also the 40-gig telecom side, which seems to be taking off, is there a client side opportunity? How do you see the opportunity over the next few quarters?

Jerry S. Rawls

Well, if I look at our metro sales for the quarter, they were -- which really is the combination of metro and telecom as we describe it. It just has to do with the protocol or the application. Our sales were up a little bit for the quarter from 47.7 in the third quarter to 48.7 in the fourth quarter, though as we described it, all those sales were -- the up, or the growth was really in the -- was within the metro ethernet space, whereas the telecom SONET sales were down slightly.

Generally the sales in the metro space for us are lumpy. They have always been lumpy and part of the reason is that there are identifiable projects by all of our customers that are creating these metropolitan networks, either in cities, in campuses. They could be enterprise networks from multiple sites around cities, but it’s not like you have 10,000 data centers that are buying ethernet optics. It’s -- and so as a result, some quarters are up and down based on project success.

So overall though, we expect that this portion of our business is going to continue to grow because we think spending on metro networks is -- and metro bandwidth is related a lot to all of the information that appears at the edge of the network. It’s all about phones, photos, videos, Internet access, et cetera over -- and mobile devices.

Stephen K. Workman

I think also Q3 actually benefited from having slightly elevated 40-gig sales. If you’ll remember, we had some problems in the second quarter and couldn’t ship some 40-gig products, so Q3 actually benefited from that, so it makes it a little difficult to compare Q4 to Q3. While it looks like it was down, Q3 was actually probably a little bit higher than normal.

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris Group

Thank you.

Operator

Thank you. Our next question comes from the line of Cobb Sadler with Deutsche Bank.

Cobb Sadler - Deutsche Bank

Thanks a lot. I had a question on the second half operating margin. I guess you -- it sounds like your 8-gig, 4- and 8-gig fiber business is going to grow and then could you talk about what your plans are for the fiber-to-the-premise components? My guess is both of those are lower gross margin products and I'm wondering, you know, I guess the 10 and 40 is going to more than offset any damage to the gross margin from those two products.

Jerry S. Rawls

Yeah, I think that’s a reasonable assessment. We don’t -- we expect that our PON product margins will be at or maybe likely a bit below our average margins for optics, and we know that the LAN-SAN products that we sell from 1- to 8-gigabits in general are the lowest margin products we sell of all the optical transceivers.

Cobb Sadler - Deutsche Bank

Okay. And then could you talk roughly about SFP Plus in the quarter? Can you give us a number for that or are you not going to break it out?

Jerry S. Rawls

I don’t think we’re going to break out just SFP Plus. I think we did talk about 10-gigabit sales in the LAN-SAN applications as being particularly strong in the quarter, but that -- but sales of 10-gigabit LAN-SAN comprises not only SFP Plus but also includes X2 products.

Cobb Sadler - Deutsche Bank

Okay, got it, and my next question, on the X2 short reach, was that -- because I guess most of your strength it looks like it was in the 4- and 8-gig space, so was X2 -- can you tell us if the X2 short reach was up or down to maybe give us an idea of how your other 10-gig products had done? Or do you not want to break it out?

Jerry S. Rawls

I don’t think we have broken that out specifically, so no.

Cobb Sadler - Deutsche Bank

All right. Thanks very much.

Stephen K. Workman

Well, as a high level comment, 10-gig short wave was up quarter to quarter.

Cobb Sadler - Deutsche Bank

And then -- okay, got it. But none of the moving parts, you’re not willing to talk about?

Stephen K. Workman

Yeah, right.

Cobb Sadler - Deutsche Bank

Thanks a lot.

Operator

Thank you. Our next question comes from the line of Ajit Pai from Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Good afternoon. A quick question on the health of the telecom market, and I think you are talking about growth out there coming from new design wins and qualifications, but just the health of the market, and excluding sort of new wins. Could you give us some color as to what you are seeing out there right now?

Jerry S. Rawls

In the telecom market?

Ajit Pai - Thomas Weisel Partners

Yeah.

Jerry S. Rawls

Well, there continues to be a fair amount of demand. We have seen -- and it’s pretty broad-based. We have a number of customers in Europe that are quite healthy, a number in Asia and Japan that are quite healthy, and a number in the U.S. A lot of project-based spending. We hear a lot of projects in international countries where they are building metro networks, but overall I think the story is that the service providers that are providing most of the funding are still in a strong competition with the cable television providers to supply triple-play at the end of the network, in the PON space. And in the metropolitan areas, they are all trying to build out enough bandwidth to handle all the YouTube traffic.

So overall, it -- you know, spending there seems pretty good, and it’s very broad-based.

Ajit Pai - Thomas Weisel Partners

Got it. And then just looking at the pricing, I think you talked about your margins being impacted largely by product mix and not so much by any change in the pricing dynamics, but across the board when you are looking at a lot of the component vendors, they talked about the first quarter being sharper pricing declines than is normal and they expected things to -- you know, the first calendar quarter, things to improve over the rest of the calendar year. Could you give us some color as to whether you are seeing the same trend? I think you specifically said on this call that you are seeing no change in pricing trends. But are you seeing an improvement as to the first calendar quarter? And how would you expect things to progress, especially if demand starts rebounding and accelerating?

Jerry S. Rawls

Well, I don’t know that we expect that -- at least built into our model right now is not any particular improvement in the pricing environment. We model at a gradual decline in prices quarter to quarter to quarter and as a component supplier, it continues to go like that.

I would love to see an environment in which we have strong enough demand all of a sudden that prices could absolutely stabilize or actually go back the other way, like they did back in the late 90s. But I am not in a position to be able to predict that right now.

Ajit Pai - Thomas Weisel Partners

Okay. And then, are you seeing any inflationary pressures right now building up in -- either in your overseas operations or anything in terms of wages, et cetera, across the board for your company?

Jerry S. Rawls

Well, we see a little bit of that. We have -- if I think about in major places where we operate overseas are Malaysia; you know in the past year, the Malaysian Ringgit has appreciated 5% versus the U.S. dollar, so that has a little bit of an effect on us. We don’t see any strong inflation pressures there, though. In Shanghai, we see wages going up a little faster than they do in the U.S., but that’s sort of -- throughout Asia, I think that’s the -- I think that’s the trend. But it’s not a lot faster.

And I guess the only thing that I -- you know, in the back of my mind that is -- you worry a little bit about the price of commodities and the effective price of commodities on your cost of doing business, and that’s one of the things that has not had a big impact on our business yet, and I sure hope it doesn’t.

Ajit Pai - Thomas Weisel Partners

Got it. Thank you.

Operator

Thank you. Our next question comes from Troy Jensen with Piper Jaffray.

Troy Jensen - Piper Jaffray

Jerry, just generically speaking, can you tell us how long it would take to certify new telecom equipment like ROADMs into some of your larger equipment providers?

Jerry S. Rawls

Well, it’s hard to -- the testing of some of those things can range anywhere from a couple of months to six months, but the real issue is once there’s a -- you know, either a requirement for a new ROADM line card or circuit pack is defined, and then the time it takes to design that and then get it into qualification could be anywhere from -- oh, I don’t know, I’ll say it’s probably six months is optimistic and 12 months is pessimistic. But you know, this whole process could take you a year. I mean, it’s a -- none of it’s fast.

Troy Jensen - Piper Jaffray

Got it. And then one quick one for Steve -- could you just update us on NOL status currently? And I guess what I’m trying to figure out is I know you won’t have to pay taxes for a while, but when should we start thinking about modeling them?

Stephen K. Workman

Well, it’s a ways out there, probably, given that we have $400 million plus of NOL, so I look forward to the day when we write a check for our -- a full tax rate, I guess. But I do believe it’s going to be a period of time before we chew into that.

Troy Jensen - Piper Jaffray

Even reporting them though, do you think it’s still a period of time, if we’re looking at fiscal ‘010 models?

Stephen K. Workman

Yeah, I think so. And I think we are going to have an effective non-GAAP rate of 3% or so, just based on the fact there’s limitations from an [AMT] standpoint, but I think it’s going to be that way for a while.

Troy Jensen - Piper Jaffray

Got it. All right, guys, thanks.

Operator

Thank you. Our next question is a follow-up question from the line of Tim Savageaux from Merriman.

Tim Savageaux - Merriman Curhan Ford & Co.

I wanted to follow-up on the notion, or your potential plan for a reverse stock split and how that might figure into the upcoming transaction, or what impact that might have. I’m looking at your earnings and my outlook and having to go out to four digits to get it meaningful, right? It’s all $0.03, whether it’s 2.7 or 3.2. So I wonder if you could give us your thoughts on that, given the share count and the difficulty of really seeing kind of what’s improving from an operating standpoint. And again, what impact if any the upcoming merger may have on any plans in that regard?

Jerry S. Rawls

Well, we had our shareholders approve the plan that allows the board at their discretion to exercise or to put in place a reverse split, and so it’s possible for us to do that and it’s just a matter of choosing a time when you think that it’s prudent to do so, and I will tell you that it’s always a topic with which people are lined up on both sides, so I can absolutely appreciate what you’re talking about.

Tim Savageaux - Merriman Curhan Ford & Co.

What’s the other side, Jerry?

Jerry S. Rawls

Well, the other side is that there are a lot of investors who have -- what’s the right word -- I will say a lot of passion, almost, for this topic and our phones, if you believe it or not, rang off the hook over this one issue at our last shareholder meeting more than any other, and it was mostly people who were opposed to it. And their principal opposition I think was that they have had bad like experiences with companies who have done reverse splits that most of the time, companies do reverse splits because they are distressed companies and they are in danger of de-listing. And somehow the reverse split may temporarily raise their share price but in the end, the shares or the stock is shorted, so that the price comes zooming back down and what really happens is erosion of market [gap].

You know, there clearly is the other side of it though that, as you point out, that says for us to go increase our earnings per share from $0.03 a share to $0.04 a share, we have to increase our earnings by 33% and that’s a big hurdle.

So I appreciate your comments and we do debate this topic, or talk about it anyway, at board meetings and we would welcome your input.

Tim Savageaux - Merriman Curhan Ford & Co.

Thank you.

Operator

Thank you. Ladies and gentlemen, at this time I would like to turn the conference over to management for any closing comments.

Jerry S. Rawls

Well, I appreciate everybody tuning in today. It’s great for you to be hear and I hope you are going to be back with us next quarter and it’s been exciting for us through the second half of this year where we’ve had two record revenue quarters back to back and we’re now predicting that our first quarter of next year will be a third in a row. So it’s a good time at Finisar, so thanks again and good day.

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Finisar Corporation F4Q08 (Qtr End 4/30/08) Earnings Call Transcript
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