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Finisar Corp. (NASDAQ:FNSR)

F1Q10 Earnings Call

September 10, 2009 5:00 pm ET

Executives

Jerry Rawls – Chairman, President, and Chief Executive Officer

Stephen Workman – Chief Financial Officer, Senior Vice President of Finance

Eitan Gertel – Chief Executive Officer

Analysts

Analyst for Bill Choi – Jefferies and Co.

Paul Bonenfant – Morgan Keegan & Co.

Daniel Morris – Oppenheimer & Co.

Ted Moreau – Cardinal Research

Operator

Welcome everyone to the first quarter fiscal year 2010 results conference call. (Operator Instructions) Mr. Jerry Rawls, you may begin your conference.

Jerry Rawls

Thank you operator. Good afternoon everyone. We appreciate you taking the time to listen to our conference call today. A replay of this call should appear on our website within eight hours. An audio replay will be available for two weeks by calling 800-642-1687 for domestic or 706-645-9291 for international. Enter the ID 23224474.

I need to remind you that any forward-looking statements in today’s discussion are subject to risks and uncertainties, which are discussed at length in our most recent quarterly SEC filing. Actual events and results can differ materially from those forward-looking statements.

We have a lot to discuss today so we might as well get at it. First it is important to understand that we will be discussing our financial results for the first time since we went public in November 1999 in terms of our operations without Network Tools. We sold that division to JSDU for $40.6 million on July 15th. As a result we now operate in only one business segment. The results of operations associated with Network tools last quarter as well as all prior periods have been reclassified and collapsed into one line called “discontinued operations.”

In addition, our results under GAAP reflect the adoption of APB 14-1 dealing with the accounting for convertible debt instruments that may be settled in cash upon conversion. We entered into such an agreement back in October 2006. This new accounting pronouncement became effective for fiscal years beginning after December 15, 2008 and requires a retrospective application of our historical GAAP financials so our historical GAAP financials have been changed for this item as well. Steve Workman will speak to this a little later. There is no impact on our non-GAAP financials for recording this non-cash adjustment.

Before we continue I would like to make just a couple of comments regarding the sale of Network Tools and our reasons for doing this. First, the division was a home-grown effort we started in the early 90’s to test our own transceiver products for compliance with the fiber channel standard. It was somewhat synergistic with our optics business back then as we were selling test equipment to some of the same engineers who were evaluating our optical transceivers for being included in the storage systems or in network equipment.

Since then, this division has developed a portfolio of products with a particular emphasis on analyzing protocols for those storage systems. While it excelled in this undertaking, Network Tools has a decidedly different business model from that of optics. While gross margins are high, so are the operating costs especially R&D and sales and marketing. However, we should remember the signals being tested by the equipment were really just data packets and they were being tested or analyzed for protocol compliance. There was no optical measurements or optical testing done.

With the Optium merger last year it became clear we are much more an optics company. A much larger optics company. Our Network Tools business became a much smaller percentage of the total revenue. So it made sense for us to sell this Network Tools division to someone who had a large test and measurement product portfolio to be able to capitalize on the business and the revenues we had created in the last decade.

Finally, I would like to remind some of our new listeners that we typically discuss our optics revenues by transmission systems and application with optical transceivers designed for short distance data center applications designated as LAN/SAN and longer distance applications either referred to as metro telecom or analog and cable television. You can see a summary breakdown of our revenues by going to the Investor Relations portion of our website and looking under “Financial Information.”

Turning to the results for the quarter we had previously indicated we thought our revenues for the first quarter were going to be between $120-130 million. Upon announcing the sale of the Network Tools division on July 9th, we felt order trends were strong enough that despite the loss of $3-4 million in revenue from Network Tools we could leave our top line guidance alone.

We did announce preliminary revenues for the quarter of $134 million including Network Tools on August 4th. The final revenue number was in fact $135.5 million including $6.8 million from Network Tools for a partial quarter and $128.7 million from optics. Due to the rules of accounting in these situations we are forced to recognize just the optics portion of revenues at the top line. While some companies may report their non-GAAP results with that higher revenue number, we think the focus should be on the core operating results of the company and Network Tools is obviously no longer part of that story.

Optics revenues of $128.7 million were up $21.2 million or 19.8% from the $107.5 million in the preceding fourth quarter and were up $13.1 million or 11.2% from the $115.8 million in the first quarter of last year. You will recall that revenues that quarter marked an all time high for Finisar and comparisons to prior year then reflect the impact of the Optium merger completed on August 29, 2008. I will ask Eitan to provide a breakdown of our revenues by product group in a moment.

On the customer front we had only one customer greater than 10% of revenues in the quarter. Our top three customers comprised 31% of total revenues as compared to 35% last quarter. Our top ten customers represented 57% of total revenues compared to 63% last quarter. In terms of profitability we saw optics gross margins of 28.7% increase from 27.2% last quarter and exceed our own expectations. Although margins were down from the 36.6% we achieved on record quarterly revenues one year ago prior to the merger.

I would point out that comparisons to prior year on a pre-merger basis are a little misleading. Due to the lower gross margin profile of Optium’s products at the time of the merger the blended margin for both companies in Q1 2009 would have been only 33.5% so our most recent quarter of 28.8% is down 4.8% from a year ago. Eitan will speak more to this but it looks as though we get back to the low 30’s in terms of gross margins in the upcoming second quarter.

At the bottom line we were profitable on a non-GAAP basis once again with over $10 million in non-GAAP EBITDA for the quarter. I will let Eitan provide a little bit more color on our optics revenues this quarter as well as our near-term outlook. Eitan?

Eitan Gertel

Thanks Jerry. First, we will continue to break out revenues for the former Optium products for at least one more quarter in order to better understand the comparisons to prior year. In that regard, the revenue contribution this quarter from those product sales totaled $28.8 million as compared to $25.1 million last quarter. Almost all of the increase over last quarter can be attributed to increased sales of our ROADM products where demand has been very robust lately.

ROADM sales were $10.9 million this quarter, up $3.8 million or 52.6% from the prior quarter and our backlog is pointing to a similar increase for the upcoming quarter. All other product sales totaled $99.9 million last quarter. That is up $17.5 million or 21.3% from the fourth quarter but down $15.9 million or 13.7% from one year ago.

The strength versus the prior quarter was due to an increase in revenue for 10G products for both LAN and metro telecom application as well as higher revenues from SAN products from both 8G and 4G along with additional optical component sales. In fact, the only softness we saw was with respect to the 40G product sales which were down from prior quarter.

The decline from one year ago is primarily related to lower revenues from transceiver sales for SAN applications along with lower component sales. While we are seeing improvement in demand from our SAN customers of late we have a way to go to match our prior year performance. More importantly, with the robust portfolio of products for LAN and SAN applications I think we are well positioned as the enterprise markets start to recover.

Jerry mentioned earlier our gross margins of 28.8% this quarter were up compared to the last quarter but were down 4.8% as compared to a year ago on a pro forma, blended basis. While some of that decrease can be certainly attributed to a decline at the top line, we also encountered lower yields and higher scrap last quarter that was related to making 10G lasers and for transferring the production of certain sub assemblies from our factory in Allen, Texas to Ipoh, Malaysia.

That issue was a drag on the gross margins in the quarter and explains most of the 4.8% decrease. At the end of the day this should be a controllable item and represent an opportunity for improvement going forward. In terms of product transfers, we have largely completed the transfer of the cable TV product line from Horsham, PA to Malaysia and ROADM line card production from Horsham, PA to our plant in Shanghai.

We are currently in the process of moving the production of 10G transfer products out of our Pennsylvania facility to Malaysia. We expect the process to be completed in the second quarter ending in October of this year. We have recently qualified our operation in Shanghai to produce a number of key sub assemblies associated with our ROADM product lines that are currently being manufactured in Australia. That transfer is also expected to be completed by the end of October.

As a result, we will see some gross margin improvement next quarter but the cost benefit of all this product transfer activity will become fully visible during the third quarter ending in January. I will let Steve talk through the rest of the P&L balance sheet. Steve?

Stephen Workman

Thanks Eitan. I think we have already beaten on the gross margin topic but for those who like accounting obfuscation and would prefer to hang onto the prior way of looking at our results with Network Tools, our non-GAAP gross margin last quarter was 31.1% and that was up from 30.8% on a comparable basis in the fourth quarter and it was right down the middle of our guidance which was originally set at 31% plus or minus a half point. Now that I have told you that I want you to immediately erase it from your memory because we are going to be talking today about our results in terms of continuing operations throughout the rest of the call.

So if we continue our journey down the P&L on a non-GAAP basis for continuing operations, OpEx for continuing operations totaled $33.8 million in the first quarter up $2.9 million from the preceding quarter of which $1.3 million is R&D, $800,000 is higher sales and marketing on higher revenues and about $800,000 is from additional G&A expense. Most of the increase in G&A is related to what we think are one-time items including an allowance for bad debt that ultimately may be collected.

I would also point out that litigation expense in our results which has been fairly high in previous quarters this quarter amounted to order of magnitude of about $500,000 from continuing operations.

That leaves us with operating income of $3.3 million from continuing operations. That is an improvement of $4.9 million from a loss of $1.6 million in the prior quarter but is down $8.2 million from operating income of $11 million in the prior year. Net interest expense of $1.3 million in the first quarter resulted in net income of $1.8 million in the quarter compared to a loss of $3.4 million last quarter. Again that is all for continuing operations and income of $9 million one year ago.

With depreciation and amortization expense totaling $7.3 million, EBITDA was back over the $10 million this past quarter. Basic shares outstanding for the purpose of calculating EPS was approximately 481 million in the first quarter. We had 486 million shares outstanding at the end of the quarter and of course with that many shares outstanding EPS is usually going to round to somewhere close to zero. Income from discontinued operations was $733,000 for the quarter.

We exclude certain non-cash or non-recurring items from our non-GAAP results and the largest of course this past quarter was a gain of $36.1 million from the sale of Network Tools. We also excluded a gain of $1.2 million from cash received from securities that were issued in conjunction with the sale of a product line one year ago and for which we had assigned no value until that cash was received last quarter. We excluded another small gain of $375,000 associated with the sale of a minority investment.

Charges excluded from our non-GAAP results include $5.2 million for slow moving and obsolete inventory, $4.8 million in non-cash stock comp expense, $2.1 million for amortization of intangible assets related to prior acquisitions and $1.2 million for non-cash charge associated with the amortization of that discount. There is a smattering of other small items which are highlighted in our press release.

Including these items under GAAP we saw a net loss of $11.1 million from continuing operations and a gain of $37.1 million from discontinued operations. A complete reconciliation between GAAP and non-GAAP is included in our earnings release and is also available on the Investor Relations portion of our website.

Turning to the balance sheet, our cash balance at the end of the first quarter represented by cash, short-term investments and certain long-term debt securities which can be readily converted into cash totaled $60.4 million. That is up from $37.2 million last quarter. I would also highlight there were no borrowings outstanding as of the first quarter under the secured credit line with Silicon Valley Bank and there were no sales of trade receivables.

To understand our net cash change in the quarter from operations, if you subtracted $40.6 million in cash for the sale of Network Tools this quarter you would get $19.8 million and if you subtracted $15.7 million from the cash balance last quarter associated with the sale of AR you get $21.5 million. In other words, cash decreased slightly in the quarter by $1.7 million due primarily to an increase in working capital.

DSO for the quarter came in about 68 days. That looks like a deterioration when you look at last quarter but if you add back the $15.7 million of AR that we sold last quarter you would see DSO in the order of 76 days. So the most recent quarter at 68 is in fact an improvement.

We still had $142 million in outstanding convertible notes at the end of the quarter but of course we launched a tender offer in August and in fact retired $47.5 million in principle value of those notes at less than par and we used about $25 million in cash and issued 28.3 million shares in doing so. Following the completion of the tender we recently retired another 15 million in principle value of the notes in cash at less than par. So as we stand here today our outstanding convertible note balance is now $79.3 million. In terms of our cash balance post quarter end one way to think about it is to assume our $60 million at the end of last quarter, subtract $25 million used in the tender and perhaps another $15 million used for the additional purchases. Remember that we have an additional $41 million available under the credit facility at Silicon Valley Bank and the ability to generate a substantial amount of EBITDA going forward.

I think that completes my comments. I will turn it back to Jerry.

Jerry Rawls

Thanks Steve. Turning to guidance for next quarter our order trends have consistently stayed ahead of revenue levels since early March and many of our customers have grown more optimistic regarding their prospects for the remainder of this calendar year. With that background we believe our revenues for next quarter will increase from $128.7 million this quarter to a range of $132-142 million primarily on the strength of our ROADM sales and the sale of 10 gigabit products for both LAN and metro telecom applications.

We do not expect the same growth we saw last quarter in our less than 10 gigabit LAN/SAN business and we think 40 gig sales will continue to languish. At least that is our read for now. At those revenue levels we will still be short of the $147.7 million in revenue we saw last year in the second quarter, the first quarter following the Optium merger but not by much. More importantly our profitability in terms of the amount of operating income and margins is expected to be on par with last year on lower levels of revenue.

To better explain I will ask Eitan to give us some additional insights to that part of our story. Eitan?

Eitan Gertel

First I think we should remember that Q2 2009 has not yet seen the benefit of substantial synergies from the merger. Gross margin in the year-ago quarter of $147.7 million were 32.7%. Despite the lower gross margin last quarter we believe that the combination of higher revenue, reach and product mix and the improvement in manufacturing costs including yield in scrap should result in similar gross margins in the low 30’s but on the lower level of the revenue.

Operating expenses which totaled $33.8 million last quarter and $37.4 million last year are expected to be in a range of $35 million in the next quarter due to higher levels of revenue. If we marry the spending with gross margin of 32% plus or minus a half a point we should see an operating margin in the 6-7% range as compared to $3.3 million or 2.5% last quarter and $11 million or 7.5% last year.

At revenue levels of $130-140 million net income should be in the order of $67 million or almost 5% of revenue compared to $2.5 million last quarter and $10.4 million a year ago. EBITDA which totaled $10.4 million in the last quarter is expected to rise to the $15 million level next quarter.

Again, assuming we see sequential growth in Q3 gross margins and profitability should continue to improve going forward especially as we complete the transfer of production of many of our products to lower cost, off-shore locations at the end of next quarter.

Moving forward you can expect us to continue to aggressively develop new products and technologies which should contribute to our revenue growth and market expansion. New products such as 40 gig Ethernet CFT module, 40 gig QSFP active cable products, CXP 100G active cable, SSP plus 40 kilometer and [narrow] tunable XSP, those of which are based on our CML technologies and new ROADM platforms from [edge] applications and a number of low cost cable digital transmission products. Some of those products have already started shipping to our customers this fall.

Jerry?

Jerry Rawls

Thanks Eitan. While we shudder at the thought of giving any guidance beyond next quarter even though we have seen improving orders rebound nicely from earlier in the year. However, we are big believers in the insatiable demand for bandwidth which ultimately drives our business. While that demand might sputter once in awhile as it did last fall, market estimates from industry analysts like [Blake County and Ovum] give further support to growth rates expected to hit 15-20% in the 2011 and 2012 timeframe. That coupled with our entry into two new markets should expand our adjustable market by up to $300 million and will allow us to grow a little faster and gives us some confidence our revenues will continue to grow for several quarters to come.

Assuming that is the case and in conjunction with the sale of Network Tools it is probably appropriate that we share some of our thoughts on the operating model that should be achievable by the middle of next fiscal year. That model assumes revenue levels of $150-160 million a quarter and at those levels gross margins could range from 33-35% which should drive an operating margin of 10% assuming expenses of 23-24%. 10% operating margins will drive EBITDA levels in excess of $20 million per quarter. Achieving this model will not only enhance our bottom line prospects but will assist in generating the cash flow we need to maintain a healthy balance sheet and keep our debt levels manageable for the coming years.

Against this backdrop we also announced a reverse stock split today to go effective on September 25th this year. While there is always some hand wringing over this issue, we think the time is right for undertaking a reverse split for a couple of reasons. First, remember that we undertook a 3 for 1 stock split in 2000 following our initial public offering. Secondly, we have issued 230 million in additional shares for numerous acquisitions over the last 10 years of which 195 million were issued in just two transactions; the Optium merger and the Infineon acquisition. It is very difficult for investors to see our progress in earnings per share due to the large number of shares outstanding.

With that I will turn the call back over to the operator and we will open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Analyst for Bill Choi – Jefferies and Co.

Analyst for Bill Choi – Jefferies and Co.

My first question is about your forecast for improving market conditions. Is there any region in particular that you see where one region is better than the other in improving demand conditions?

Jerry Rawls

We saw telecom sector fall off first last winter but we saw the telecom sector come back earlier this year so it remains strong and it has remained strong not only in Europe but also in Asia, Japan and the U.S. Sales have been good in telecom. We saw a lot of strength in the last quarter in Ethernet sales. Ethernet 10 gigabit was really the high spot in that market. So all of a sudden that has to be data center applications, enterprise applications, installing 10 gigabit trunks as opposed to multiple 1 gigabit links. That is focused mostly in North America.

Analyst for Bill Choi – Jefferies and Co.

With respect to your increased ROADM sales can you explain if this is a one-time or other temporary issue where certain of your customers are ordering in bulk right now based on their own purchase requirements or does this signify some kind of structural change in the market where ROADM type of products are increasingly in greater demand and will continue to be so for a few quarters or even one or two years? How do we interpret this increased selling in ROADM?

Eitan Gertel

If you look at the ROADM market today you see that all the systems being deployed are utilizing ROADM. Historically the use of ROADM in the 100 gig space was the majority of those ROADMs. As the markets are coming back, as Jerry was saying telecom was coming back first, we saw that business pick up. In addition we are shifting today to a lot of customers who are 50 gig 1 x 9 ROADM. We see a lot of the new systems are using the 50 gig ROADM rather than the 100 gig ROADM and we see a major ramp up in demand for those products.

As we look forward and talk to our customers and look at our order pattern we believe as far as we can see right now this is more long-term pattern rather than a temporary thing. We are still watching how it develops but it looks like it is sustainable and customers are buying products [inaudible] products and our biggest problem right now is raising capacity as fast as we can.

Analyst for Bill Choi – Jefferies and Co.

So you do expect double digit growth sequentially for ROADM to continue at least for a few quarters?

Eitan Gertel

Basically what we said was last quarter Q1 over Q4 we saw growth of about 50%. We expect our growth in the current quarter in Q2 to continue the same rate. Our bookings show that is what we need to do and more. As far as we look forward to still sustain the growth whether it is going to be 40, 50 or 60% is yet to be seen but it looks very healthy from our side.

Analyst for Bill Choi – Jefferies and Co.

What was your cash flow from operations for this quarter?

Stephen Workman

With respect to EBITDA from continuing operations that was I believe $10.4 million. We had capital expenditures of 3.1. Barring movements in working capital that is the kind of cash we should be able to generate going forward. Now you have other movements in your balance sheet so if you look at the net change in cash was down about $1.7 million because of increases in working capital.

Operator

The next question comes from the line of Paul Bonenfant – Morgan Keegan & Co.

Paul Bonenfant – Morgan Keegan & Co.

My first question is a couple of housekeeping questions actually. You mentioned your 40 gig revenues were soft and maybe down sequentially. Can you tell us what that was seeing as you gave it to us last quarter? Where did 40G sales come in?

Stephen Workman

That was around the $5 million level.

Paul Bonenfant – Morgan Keegan & Co.

That compares to $7 million last quarter?

Stephen Workman

It compares to a little bit less than $7 million.

Paul Bonenfant – Morgan Keegan & Co.

You talked about ROADM being strong on the transition from 50 GHz to 100 GHz. Does all of the increase reflect increasing demand or do you think there might be some share gains in there as well?

Eitan Gertel

We believe it is a combination of both. I don’t want you to think it is only due to the 50 gig. We also had an increased demand in the 100 gig at the same time our 50 gig demand is high. As far as the demand we are getting, some of it is from share increase and additional customers who are shipping currently and some of it is from historical customers just at higher take rates.

Paul Bonenfant – Morgan Keegan & Co.

Another housekeeping category, you talked about the target operating model being $150-160 million run rate, gross margin 33-35, operating margin of 10%. I thought I heard you say in the middle of the next fiscal year. Given where your revenue is now I would think that would be in the middle of this fiscal year wouldn’t it?

Jerry Rawls

We sure hope so.

Paul Bonenfant – Morgan Keegan & Co.

I just want to clarify. Did I hear that correctly?

Jerry Rawls

You heard the words correctly and I think that was an effort to be conservative. There is no question if the continued strength in incoming orders stays where it is we will hit those levels a lot sooner than the middle of next fiscal year.

Eitan Gertel

Also I think we said during the call that some of the synergies will take us to the end of next quarter to clean up which contributes to that number too.

Paul Bonenfant – Morgan Keegan & Co.

Which would suggest again I think it is this fiscal year versus next. Rather than picking this, I will go on. The next question, I am wondering if there is a potential or a plan to reverse some of the cost saving measures you had implemented earlier in the year. From an OpEx perspective the 10% salary cuts, the suspension of the 401K match, etc.?

Stephen Workman

We are. We plan on unwinding those in the second half of our fiscal year. Basically November 1. As you think about going into the third quarter, I should say, November 1 would be the start of that increase so you will see our costs jump up a little bit in that next quarter.

Paul Bonenfant – Morgan Keegan & Co.

Can you ballpark that? What type…?

Stephen Workman

It is somewhere around $1.3 million sort of level.

Jerry Rawls

On the November 1 date we are reversing the 10% salary decreases but the resumption of the 401K match is going to come in a subsequent quarter. We haven’t picked a date yet.

Operator

The next question comes from the line of Daniel Morris – Oppenheimer & Co.

Daniel Morris – Oppenheimer & Co.

I wanted to start off with a housekeeping question as well. I’m not sure if I missed this. Could you give us the breakout between the LAN/SAN revenues, metro telecom and cable TV?

Stephen Workman

Sure. That chart I believe is also on our website but I can give you those numbers. LAN/SAN revenue was about 50. Metro telecom revenues of, that doesn’t include ROADM, about $40 million. ROADM was $10.9 million and I didn’t pick up all of metro’s telecom. Metro telecom actually was a total of $63.6 million. ROADM was $10.9 million. Cable TV was $3.7 million.

So I will give it to you again. $50.5 million for LAN/SAN, $63.6 million for metro telecom, $10.9 million for ROADM and $3.7 million for cable TV.

Daniel Morris – Oppenheimer & Co.

Looking at the gross margin improvement of 160 basis points there, could you provide a bit more color on what drove that? Was it primarily the top line or was it some other components as well?

Stephen Workman

I think product mix with respect to increases in the metro telecom and the ROADM space certainly helps with respect to gross margins. It is also we are beginning to realize a few synergies with respect to product transfers. That is kind of an ongoing process. They become fully visible in the third quarter in January. It is a mixture of those two.

Daniel Morris – Oppenheimer & Co.

Is it similar for the same puts and takes for the gross margin guidance you gave for the upcoming quarter?

Stephen Workman

I think we pick up some efficiencies with respect to additional revenues as well. That product mix shift continues to work in our favor going forward over the next couple of quarters.

Daniel Morris – Oppenheimer & Co.

You mentioned in the prepared remarks something about some 10G laser issues. I just wanted to find out what is the there. Has it been resolved? Is that going to take a little bit more time?

Jerry Rawls

We have the ramp up in 10 gigabit optic sales put some stress on our internal supply chain. We are working very hard to stay up with the demand. I am very hopeful and my expectations are we will be able to maintain production rates of 10 gig dye and 10 gig transmitted optical assemblies will match our output. I think we are going to be okay.

Daniel Morris – Oppenheimer & Co.

You mentioned about the parallel optics starting to ship. Can you just help us with expectations there as far as what that ramp might look like?

Jerry Rawls

It is a key to our expectation so far. It was a totally new product and all of a sudden we have a number of new customers who have placed orders and have put a fair amount of stress on our Shanghai factory where we are producing this product. They all go into high performance computing centers, especially in finiBand quad data rate connections. These are four by ten gigabits or 40 gigabit links.

Now, can that reach $20 million next year? Can we get $10 million a quarter out of it? At this point I couldn’t guess. All I can say is at this point we are sure ahead of the game from where we expected to be and customer response has been really enthusiastic.

Stephen Workman

I might add that the parallel optics market at least according to light counting has a total in the neighborhood of $70 million in this calendar year. A little bit over $70 million and then finally hits the $100 million mark in the 2011 timeframe.

Operator

The next question comes from the line of Ted Moreau – Cardinal Research.

Ted Moreau – Cardinal Research

On the guidance, did I understand that the gross margin guidance you were providing was at the lower range of your revenue guidance and implying there might be some upside in the gross margin here if you come in at the higher end of your revenue range? I just wonder what kind of leverage there is.

Stephen Workman

Again, 33-35% I think is reasonable in terms of expectations. I think we targeted 32.5% for the next quarter and there could be upside. I think we shouldn’t let things get away from ourselves here. I don’t think we certainly want to think in terms of anything above 35% yet. One step at a time. We just saw 28% here this past quarter.

Ted Moreau – Cardinal Research

The 32.5% was the guidance for the next quarter on a revenue range that was what?

Stephen Workman

We said $132-142 million.

Ted Moreau – Cardinal Research

So it is coming in at $142, you are sort of implying you might do better on gross margin side? I guess I don’t want to put words in your mouth but I guess where I am going with this is it sounds like there might be some upside on the margin side both on gross and probably on the operating margin.

Jerry Rawls

I think that is right. Generally if we get more volume because we have a lot of fixed costs, we own a big factory in Malaysia. We own a big factory in China. We own laser fabs, one in California and one in Texas. Volume helps us amortize those costs over a larger number of units and it helps margins.

Ted Moreau – Cardinal Research

Is there some assumption on product mix? Is it pretty much the same mix trends you are seeing right now in the different product lines that is part of the guidance for the next quarter?

Jerry Rawls

We are expecting continued strength in the ROADM market and continued strength in the 10 gigabit market both for Ethernet and the telecom applications. The nice thing is our products in those areas carry margins that are better than the average for the company. I think that part of the product mix helps us.

Ted Moreau – Cardinal Research

So if you do come in at a higher end of the revenue range with that kind of mix that might help gross margins?

Jerry Rawls

Yes.

Ted Moreau – Cardinal Research

On the telecom markets you are selling into what particular applications are you seeing strength? Are you seeing wireless infrastructure and the movement to LTE at this point or is it just strictly in the wire line and optical markets? Where in the telecom markets are these applications where you are seeing the strength?

Eitan Gertel

We are seeing a majority of it coming from cellular back haul systems and some other wire line systems. I don’t think we have seen LTE yet.

Ted Moreau – Cardinal Research

In the back haul, the back haul can be across a variety of transmission mediums either copper or optics or microwave. Is it principally the optical connection which I know Verizon and AT&T are starting to upgrade significantly, is that where you are seeing a lot of the strength or is it…?

Eitan Gertel

The optical is the only one affecting us. We don’t participate in the microwave. Also all the video integration whether you see it from Verizon or AT&T it integrates whether it is [inaudible]. So that affects us too.

Ted Moreau – Cardinal Research

From my understanding of optics the optical connection in the wireless back haul is still only 10-15% or maybe 20% at the most of cell site connections. So I guess that would be a pretty robust and growth market for you I would think with the traffic that you are seeing between the cell sites.

Eitan Gertel

We hope so and we think so. The way we look at it is the more video and the more content you have on the new phones the more balance they will need which probably would affect us.

Operator

At this time there are no further questions.

Jerry Rawls

Operator, thanks for your help. For everybody who tuned in we thank you for your time, your attention and your interest in our company. We look forward to seeing you again or joining with you on a conference call again this time next quarter. Have a good day.

Operator

This concludes the conference call. You may disconnect.

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Source: Finisar Corp. F1Q10 (Qtr End 08/02/09) Earnings Call Transcript
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