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Executives

Jim Fanucchi – IR, Summit IR Group

Alain Couder – President and CEO

Jerry Turin – CFO

Analysts

Ajit Pai – Thomas Weisel Partners

Paul Bonenfant – Morgan Keegan

Alex Henderson – Miller Tabak

Dave Kang – B. Riley

Mark Sue – RBC Capital Markets

Tim Savageaux – Terrapin Research & Management

Oclaro, Inc. (OCLR) F3Q10 (Qtr End 04/03/10) Earnings Call Transcript April 29, 2010 4:30 PM ET

Operator

Good afternoon, and welcome to the Oclaro third quarter fiscal year 2010 financial results conference call. As a reminder, this conference call is being recorded for replay purposes through May 6, 2010.

At this time, I would like to turn the call over to Jim Fanucchi of the Summit IR Group. Please go head, sir.

Jim Fanucchi

Thank you, operator. And thanks to all of you for joining us. Our speakers today are Alain Couder, President and CEO and Jerry Turin, Chief Financial Officer of Oclaro.

Today's statements made about management's future expectations, plans or prospects of Oclaro and its business, including statements concerning future financial targets and financial guidance, the proposed offering of common and the use of proceeds therefore, potential merger-related synergies and cost savings and Oclaro's plans, objectives, expectations and intentions with respect to future operations, financial objectives, products and growth opportunities and any assumptions underlying these statements constitute forward-looking statements for the purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

There are a number of important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements, including our ability to complete the proposed offering on the terms currently contemplated, or at all, the impact of continued uncertainty in world financial markets and the resulting reduction in demand for our products, the future performance of Oclaro following the closing of the mergers with Avanex Corporation and Xtellus Incorporated and the Spectra-Physics asset swap, the inability to realize the expected benefits and synergies as a result of the mergers with Avanex and Xtellus and the Spectra-Physics asset swap, increased costs related to downsizing and compliance with regulatory compliance in connection with such downsizing, the lack of availability of credit or opportunity for equity-based financings as well as the factors described in Oclaro's most recent Annual Report on Form 10-K, most recent quarterly reports on Form 10-Q and other documents we periodically file with the SEC.

The forward-looking statements discussed today represent Oclaro's view as of the date of this conference call. Oclaro anticipates that subsequent events and developments may cause Oclaro's views and expectations to change. However, Oclaro specifically disclaims any intention or obligation to update any forward-looking statements as a result of developments occurring after today's date. Those forward-looking statements should not be relied upon as representing Oclaro's views as of any date subsequent to the date of this call.

In addition, during this call, we will be referring to Oclaro's non-GAAP financial measures with respect to any of these non-GAAP measures directly comparable Generally Accepted Accounting Principle measures are set forth in a reconciliation of GAAP to non-GAAP measures and included in our earnings release, which is available in the Investor section of Oclaro's website.

I would now like to turn the call over to Jerry.

Jerry Turin

Thanks, Jim. Before I get into our earnings for the March quarter, which ended April 3, 2010, let me be sure everyone is aware of the public offering we also announced today expected to be 6 million shares of our common stock. In addition, the reverse stock split we announced on April 14 takes effect after market today.

Share numbers referred to in this call are after the effect of this 1-for-5 reverse split. Beginning tomorrow, our stock will trade under the symbol O-C-L-R-D in connection with the stock split for 20 trading days. Further details are available in the corresponding press release and a prospective summary expected to be filed later today.

As to this quarter, we're pleased with the results. We grew revenues and expanded our gross margins in what is typically a seasonally slow March quarter. This is evidence of the strength of the underlying demand environment of our share gains and of the gross margin leverage in our operating business model.

Revenues this quarter were $101.2 million, compared to $93.6 million in the previous quarter. We had three 10% or greater customers, Huawei at 13%, Alcatel-Lucent at 10% and CNI plus the former Nortel MEN division combined at 10%. We believe these are the three market share leaders in the telecom markets we serve.

We also have five additional customers who were each greater than 4% of our revenues this quarter. These customers include five of the next six equipment companies in terms of telecom market share. This is an impressive mix of customers that is nicely reflective of the core optical network markets we serve.

Our telecom revenues in total were $87 million this quarter, compared to $82.2 million in the December quarter. Our advanced photonics solutions revenues were $14.1 million this quarter, compared to $11.4 million in the December quarter.

Later in this call, Alain will comment on our ramping to address the demand environment, including customer feedback on our responsiveness and our progress in ramping to demand during the quarter. Our guidance for the June quarter where we expect revenues to increase to a range of $111 million to $116 million is another reflection of this progress.

Our gross margins this quarter increased to 28% from 27% in the December quarter. Earlier in the quarter, we reiterated our 30% gross margin target for the June quarter. Our guidance of 30% to 33% expected gross margins for the June quarter reinforces these expectations.

Our next gross margin target is 35%. Prior to today, we have not yet been specific as to timelines for that threshold preferring to wait to validate the 30% target first. Today, we are ready to say that as of now we expect to achieve this 35% gross margin target by the end of our 2011 fiscal year ended next June. If the strong demand environment continues, this 35% target could conceivably be achieved as early the upcoming December quarter.

At 35% gross margin levels, we expect our non-GAAP operating income targets to be in the range of 10% to 12% with the parameters of that range largely a function of the level of our investment in research and development. We are currently investing in R&D at about 11% of our revenues.

Given the pace of our recent revenue growth, this percentage is translated into substantial increases in the dollar amounts of our R&D spend. Since about one-third of our engineers are in China and another third are in certain regions of Europe less expensive than Silicon Valley, we believe we get excellent leverage from these dollars.

At the same time, our business model allows for an increase in that investment from 11% towards 13%, if necessary, to find any expansions of our product roadmap. Later in this call, Alain will discuss these opportunities in more depth, including how these sorts of investment decisions kind of sum up the rationale for the stock operating we announced today.

But getting back to this quarter, R&D was $11.3 million, compared to $9.7 million last quarter. This increase is consistent with the ability to invest that I just discussed. This quarter's R&D includes $330,000 of stock compensation.

SG&A was $14.5 million this quarter, compared to $14.6 million last quarter. This quarter's SG&A includes $660,000 of stock compensation. Our non-GAAP operating income as a percentage of revenue was 3.2% this quarter, compared to 1.5% last quarter. The leverage of our operating model is beginning to translate to the bottom line.

Our adjusted EBITDA was $5.8 million this quarter, compared to $4.3 million last quarter. We are guiding to an adjusted EBITDA range of $8.5 million to $12.5 million in the June quarter. This is further validation of how we expect our operating model to continue translating top-line growth into bottom-line profitability.

Now, on to the balance sheet. Our cash, cash equivalents and restricted cash were $55.8 million as of April 3, 2010, compared to $56 million at the end of the prior quarter. This includes a $2.5 million draw we took on our line of credit to de-risk the timing of customer collections that were scheduled later on around the last day of our quarter end.

We've held our cash in this sort of range, $50 million to $56 million for a couple of quarters, while paying for restructuring and fueling the strong growth environment. This is a good thing. Over the next couple of quarters, we expect a similar dynamic on generating sufficient cash from operations to fund the growth of these operations, so we should stay in a similar range of cash balances absent a proposed offering. If our operating results continue to scale and if the strong demand environment continues, we could reach an inflection point later this year.

Our accounts receivable increased to $77.7 million at the end of this quarter from $70.6 million at the end of last quarter, relatively consistent with our revenue growth. Our inventory balances were $60 million at the end of the quarter, relatively consistent with $61.1 million at the end of last quarter. Even as we're growing our top line, we're keeping our inventories relatively steady. Of course, this is largely to be expected given the strong demand pull on our production and output.

Our net fixed assets went up to $34.7 million from $34 million last quarter. This includes $3.6 million of CapEx this quarter. Over the next couple of quarters, we expect this to increase to somewhere in the range of $5 million to $6 million a quarter, mostly related to adding incremental test equipment to meet increasing product demand and associated with the ramp of new product introductions earlier.

As mentioned earlier, we expect to finance this CapEx, as well as any growth in working capital, with cash otherwise generated from operations and within the parameters I discussed earlier.

The liability side of our balance sheet includes the $2.5 million drawn under our line of credit. We continue to have no other outstanding debt. As mentioned earlier, on April 14, 2010, we announced the 1-for-5 of our stock split and as of tomorrow our share count will be reflected in 1-for-5 post-reverse split numbers.

Our weighted average shares outstanding for the quarter ended April 3, 2010 on a split-adjusted basis, were 41.1 million basic and 43.8 million fully diluted and we expect our share count at the end of the upcoming June quarter increase by the weighted average number of shares ultimately issued in connection with our public offering.

Now, before I hand off to Alain, let me summarize our June guidance once again. For the quarter ended July 3, 2010, we expect revenues to be in a range $111 million to $116 million, non-GAAP gross margin to be 30% to 33% and adjusted EBITDA to be $8.5 million to $12.5 million. Alain?

Alain Couder

Thank you, Jerry. So, two days ago, we celebrated the first anniversary of Oclaro and we are quite pleased with our progress. In the past, we stressed that we were moving to a successful integration of the acquisition and we delivered to the acquisition plan. But meanwhile, we said supporting our customers as being the measure of focus, because as I said, many times in this call customer satisfaction and ease of doing business is most important to us.

So, we are beginning to get over the hump, but we still expect to be trailing full demand as long as we continue to see this very strong demand. The first half of the quarter pressure from customer at the CEO/COO level to meet needs was very high. I got many escalations. In the second half, I received some thank you letters over the progress we made during the quarter. That's nice, again a relationship that we want to have with our customers.

So, we are overachieving because our people have continued to improve our production machine while we were doing what I just discussed. And I would like to give you a few examples of the kind of progress we made to make our production machine run smoothly and to accelerate.

For instance, in the past year we about doubled the number of wafer coming out of our fab, but we did not increase the overhead to do it. The visual lead of our modulator, compact Mach Zehnder, coming out of our indium phosphide fab went from 60% to 90%. Now, all our tunable products are in the 95% range. Our cycle time for our Gallium arsenide fab in Zurich from wafer to bar improved by 30%. So that's a significant improvement in efficiency.

In our lithium niobate fab in San Donato in Italy, we were able to reduce our cycle time down to 10 days for our customers. So that meant we were able to respond to a new design from customers there very quickly and so we are much faster than in the past.

Our filter coating division in Santa Rosa, yield has improved by 50% that's also a significant improvement in efficiency and in use of our capital equipment. So, our assembly and test inventory turn, that means what we have in Asia in terms of backend and assembly and test, the inventory turn went from 4 to 6 over the past 12 months. So if you – in the meantime, we increased our revenue after this – by about 40%, so you can see the amount of cash that we were able to avoid spending because we could improve our inventory turn. So it is another prime example of efficiency.

In terms of customers, the dates requested by the customers and shipping when the request is important and Fabrinet our contract manufacturer improved by 50%. When we are doing that, both Fabrinet and our Shenzhen factory continue to deliver on-time to their commitment at around 95% of the time. So that's a key element of customer satisfaction improvement.

Our supply chain has also been playing a role. While we were combining the two supply chains of Avanex and Oclaro, we were also able to reduce part costs by 10%, which is a significant element of our cost reduction. Obviously, it was complemented by the design changes that we made and the improvement in manufacturing technology. That's why, as Jerry mentioned, we were able to improve our gross margin in the last quarter even with the price adjustment that exists every December.

VCSEL is another success story. VCSEL has been ramping very, very quickly. We were able multiply it by 10 the number of VCSELs that we shipped out of our fab and we are now shipping 14 million VCSELs a quarter out of Europe.

So, this is kind of an example of our production machine and how it has been improving and accelerating and being smoother and being able to deliver a best value to customers. But we do not stop here. In January, we launched a process improvement program across the company. We call it "Everest" so we climb the Everest to improve things.

We are addressing 18 processes and each one is driven by the owner with a target to improve efficiency of the company over the next 12 months. And this includes new product introductions, quality, supply chain efficiency, forecasting, capacity planning and obviously customer interface. So, we expect to be able to demonstrate another significant progress in the next 12 months.

So, let me now switch to what we call the innovation engine. Now, the production machine is smoother and pretty small. The innovation engine we have been spending time tuning it and this is really the engine of a race car. You know, if you want to run the race and distance competition, we need to innovate faster than our competition.

There, also, we have several important points. Jerry mentioned to you the increased investment we have done in dollars and that has turned into very good hiring. But proof point of the improved innovation of the innovation engine, for example, we came out with modulator, lithium niobate for 40G and then 100G soon. We are now very close to shipping this quarter the second generation of our 40G DQPSK transponder.

We are preparing a tunable XFP based on an integrated photonic chip that will be easier to replace the fixed wave length XFP for 80 kilometer for fixed wavelength transmission. But our performance as such we also believe that we should be able to match 300 pin existing transponder performance and therefore, supply to our customer the ability to put four transponder in a card and therefore to reduce the number of line cards by a factor of two that would turn out in a very significant system cost improvement. We plan to sample this summer and ship before the end of the year.

Another example is what we call TCMZ, which is a combination of our iTLA and our modulator that we put in the same chip and we deliver this in partnership with one of our top customers. And this chip allows to reduce the real estate for the same function on the printed circuit board by a factor of three, but it's also significantly reduces power dissipation which is so important in telecom systems.

An example of make-or-buy that I will mention when we talk about the offering again, will require MEM technology to do VOA with some kind of amplifier in the optical world. And right away, we got great customer traction. I know this was a very small company and customers were worried about buying from them and right away to us.

The same way as I mentioned to you in the last call, Xtellus acquisition in December, we have many customers now ordering and qualifying and our problem is to ramp our WSS production as quickly as possible. So that and as we do that, the Xtellus is already on the next generation in utilization.

Another very innovative product where we think we have more than 50% market share and growing very, very fast is tunable dispersion compensation. That means the ability to compensate the destruction of the fiber but to be tunable in such a way that you can adjust dynamically. This one is also a great innovative product.

Now, if we look at the photonic solution business, we clearly have some of the best diodes in the industry. I visited the Tucson team and which we acquired as part of the Newport deal. And now we have closed the fab over there and there's an engineering team and they are very excited because the diodes they get out of Zurich are even better performance than the Tucson one. And therefore, their current design will be able to upgrade the performance. So it's another example of innovation and leadership at the fab level.

We obviously continued to be successful with in the new markets in our advanced photonics solution business. I mentioned the aesthetics with hair removal devices and wrinkle reduction for the home. And one of the proof points of innovation and capability is that Light Peak has been discussed a lot, as the optical USB cable. But Intel found us, we’ve been talk to Intel, they found us as the best fab to be able to get the ramp-ups that we discussed, although the current ramp-up that I discussed in VCSEL is not linked yet to Light Peak. It is linked to other products. So you can believe that when this comes there will be another significant ramp-up.

So beyond the proof points of the last 12 months that I've just discussed with you, two weeks ago I went to Caswell in the U.K. By the way, I got stuck for five days because of the ashes but that's a different story. But I spent a great week with the best technical team of the company who flew there as well and we just reflected on what kind of investment we need to do to distance competition.

And the number of ideas in photonic integration and how to combine the capability of optical competence with software and high speed electronic are very, very exciting. And the CTO office that we established a year ago is starting to really make a difference and foster innovation as well for the company. So that's quite exciting, because that's really the future growth and the future value to customers that is behind this kind of innovation.

So that's really what we are with a production machine and the innovation engine to win the race in the optical component. But as Jerry mentioned, we believe for our company of our size. We don't have a balance sheet strong enough to have the flexibility to make some of the choices. We believe that our production machine and our innovation machine can get us to 35% gross margin and even as soon as, Jerry, described we should be able to get there within 12 months and as the growth continues, maybe even sooner than that. But we won't stop there. We think this production machine and this innovation machine can get us even beyond that to the 40% reach.

So achieving those returns can feed into a virtuous circle where a portion of this return, the capital generated by those results gets recycled back into further innovation, serving further improvement of our fab and further efficiency of our manufacturing. And we will be able to generate more and more cash on our own.

So we expect to reinforce and extend the differentiation that we deliver with those returns. This offering should allow us to right from now distance our competition in several technologies. To distance for competition we only have one proof point and tunable is the first example of this. We are really taking significant market share both at the component level and at the module level.

So our long-term business model, we discussed in the past is 13% of R&D and right now we are running 11%. But with the offering we will have the bandwidth to invest in new opportunities, not only through organic R&D, but also with the ability to do a make-or-buy decision. We need a given technology it is available from small startup. Should we buy this technology or should we take 18 months or two years to develop it ourselves? We will have the flexibility to do it.

And this is the kind of judgment that we will be doing. The same way sometimes there is a partner that is already to scale, already has the infrastructure and can deliver faster than we do. And therefore, it will be cheaper to put some NRE in place that will get into the 13% R&D to get that fed to some kind of technology.

And as a result of that, we expect to be able to accelerate time to market and therefore to be able to accelerate our growth. As you know, the core optical network for the non-captive portion is expected to grow at 16% in the next three years. We are taking market share I think we are already growing faster than that with those tuck in acquisitions. With the make-or-buy decision, I think we can further accelerate the growth.

But even more as we develop modules faster, we also expect to be able to address some of the current captive market with some of our largest customers are developing their own module. We also with this offering will have the ability to upgrade our fab. We don't plan to spend a lot of money, but we want to make sure that we are able to scale capacity with volume, make sure we have no single point of failure. And that we will be able to have a better wafer and better yield and distance our competition. That's another thing that's important to do.

So I think this offering is really the means to accelerate the company. We wanted the first year to complete it to make sure that all our processes were in place that the production machine was running smoothly and that the innovation engine was being turned to accelerate. We are ready for that and we are ready for the next step.

So let me conclude in thanking all the employees of Oclaro for their effort and the success of the past 12 months. Thank you also to our customers who have been working closely with us and give us a lot of business. And sometimes our patience in having us delivers what they need. And we celebrated our first anniversary the day before yesterday and next year we will celebrate the second anniversary and we expect to also have good news at that point. So, let's now open for question.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Ajit Pai with Thomas Weisel Partners. Please go ahead.

Ajit Pai – Thomas Weisel Partners

Yeah. Good afternoon and congratulations on your first anniversary.

Jerry Turin

Thanks, Ajit.

Ajit Pai – Thomas Weisel Partners

A couple of quick questions. The first is about fab utilization. You talked about enhancements that you need to make to your fab. So could you give us some idea of what the rough utilization is right now? And as are going to volume continues to ramp, what – where you could see it over the next couple of quarters?

Alain Couder

Yes. We started recently the second shift in our fab in Europe. And right now we are in the 30 to 40% range of reposition with the current equipment in Caswell. We're about in the 60% range in Zurich and in the 30 to 40% in San Donato. So that means we have very little additional capital equipment we still have sitting in place.

Ajit Pai – Thomas Weisel Partners

Got it. And then the second is pricing trends. You know, you've talked about in the past that pricing was declining about 15% annually?

Alain Couder

Yeah.

Ajit Pai – Thomas Weisel Partners

And you expected those trends to improve. Can you give us some color as to what you're seeing right now over there and also over the next six to nine months?

Alain Couder

It's difficult to predict what the pricing will be. But right now, we are not seeing any price pressure from last December. The name of the game since last December has been the ability to focus and deliver everything we can to our customers. The relationship with the customer has been around that.

So but we still assuming that price reduction will happen and that's why we continue to have major cost reduction in place. And if price reduction slows down, our margins will go up faster. If we – it continues as it is, we will be able to keep up.

Ajit Pai – Thomas Weisel Partners

Got it. Thank you.

Operator

Thank you. And our next question comes from the line of Paul Bonenfant with Morgan Keegan. Please go ahead.

Paul Bonenfant – Morgan Keegan

Hi, good afternoon. I wanted to start with a housekeeping question, I guess. You had guided to Xtellus ROADM revenue in the quarter I think in the range of $2 to $3 million and I may have missed it. Did you give us that number earlier in the call?

Jerry Turin

No. But it was right around the top end of that range, Paul. And now that they're baked into our trends we probably won't break that out going forward. But that's where they came in as far as that range. So they had a good solid contribution to the quarter.

Paul Bonenfant – Morgan Keegan

So call it about $3 million?

Jerry Turin

Yeah.

Paul Bonenfant – Morgan Keegan

And just as a point of clarification on that previous question, you talked about pricing being more of an issue than even in a typical March quarter, I think on the last call. Have you seen some relief now that we're out of the March quarter?

Jerry Turin

I think the clarification, Paul that as far as the pricing that took effect in the March quarter, wasn't so much the magnitude of the change. It was the number of customers doing it on an annual basis, so more of it was in effect at that point in time. I don't know if Alain has an elaboration on your question?

Alain Couder

It is the same. I think – I don't think the price adjustments that happened in December was more than in the previous year. And I think the proof point is that we have been able to increase our gross margin with those new prices. And therefore, we have been forecasting for that.

Paul Bonenfant – Morgan Keegan

Okay. Fair enough. And relative to your discussion of hitting the 35% gross margin target, you had talked about certainly by the fiscal year end, June of '11 or maybe as early as the December quarter. Can you talk about what kind of a revenue level you have in mind to hit that number?

Jerry Turin

No, Paul. I don't think – I think just the trouble with that is, that would get into guiding the 12-month or 15-month revenues. While, we want to give people a sense of parameters around our margin progress and our business model progress. I think we want to be careful about guiding towards revenues over that period of time.

Paul Bonenfant – Morgan Keegan

Okay. Fair enough. And a question on how should we think about OpEx sequentially on a dollar basis? It sounds like your ratcheting up the CapEx and I'm wondering if there's a commensurate increase in OpEx coming in the June quarter?

Jerry Turin

Well, not – so it's kind of two different kinds of questions from ratcheting up the CapEx. The implications on depreciation aren't that significant. Our depreciation trends between about $3.5 million a quarter. We've recently had some quarters where our CapEx was down around $1 million, $1.5 million. If you have a couple of quarters where it's up around five to six that balances out over a period of time, so it doesn't really create a spike in your depreciation trends that are kind of on a five year rolling basis.

As far as OpEx, you look at it category-by-category. I think sales and marketing and G&A over a 12-month period. I look at that in terms of what sort of annual growth rate is needed to add a little bit of personnel and depth here and there and support the growth. But really it's more of an inflation plus some key talent areas; they are a little bit of scale. For the most part we have the infrastructure to support much higher revenues than we are at. R&D, Alain talked a great deal about from an investment point of view. So that's kind of the two different answers to your question.

Paul Bonenfant – Morgan Keegan

Okay. And last question if I may. And I'll get back into the queue. The $7 million performance guarantee that was part of the Xtellus acquisition, given the stock price and the Xtellus revenue ramp would you say chances have diminished that this is triggered in calendar year 2011?

Jerry Turin

Yeah. There wasn't a precise share price number, because it was subject to a formula. But in general, the price is somewhere between $1.75 and $1.85. If we're above that, then it becomes a moot point. So certainly, today we had a pretty good day and we closed $2.80 or above, I can't recall the exact number. But we're certainly and again this is all on pre-split numbers. But certainly, we've got a lot of head room above that number. So it pretty much becomes a moot point going forward.

Paul Bonenfant – Morgan Keegan

Okay. Thank you for taking my questions.

Jerry Turin

Thanks, Paul.

Operator

Thank you. And our next question comes from the line of Alex Henderson with Miller Tabak. Please go ahead.

Alex Henderson – Miller Tabak

Hey, guys.

Jerry Turin

Hi.

Alex Henderson – Miller Tabak

So I just want to revisit the pricing commentary a little bit. So you talked about the pricing being heavily weighted towards the March quarter as a result to the price declines that happened at the end December taken in the very early days of January. Just so I understand, if you were to look at the full year price declines, what percentage of it do you think occurred in the first quarter?

Jerry Turin

Yeah. Well, looking at historical trends, we think that probably over half the pricing was set at the start of June. So even if the remainder of the year kind of trends historically we certainly have positioned us well going forward. So by taking a significant portion of the pricing reduction on January 1, by increasing your margins in March – through March, are you well-positioned for the rest of year because a substantial portion of the price reductions were already in place.

And then a second part to that, which is something we don't have a crystal ball on and which Alain eluded to, which is if the demand is very strong does the historical pattern continue through the rest of the year or is there some change as a result of the demand dynamic. Ana again, that's hard to pull out the crystal ball and understand how that comes into play through the rest of the year.

Alex Henderson – Miller Tabak

Let me just try it one more time. So if we assume the normal rate of price decline which you've talked about a number of times on the call. And we're looking at the full year calendar 2010, you're saying we took approximately something over 50% of that decline in the first quarter?

Jerry Turin

Yeah. So just kind of applying some math modeling, if we applied over 50% in one quarter and if you were to take the other 50 or 40% or whatever the remainder is and spread that over three quarters, you can see that the quarterly impact in March was much more than we would expect in the subsequent quarters, which means we should be better positioned that going through the rest of the year.

Alex Henderson – Miller Tabak

I just want to make some clarification on that point as well. So the second round of price adjustments tends to be, as I understand it in July. So for that six month window for the people who are on six month contracts? So is it fairly flat sequentially into this quarter, should we then be a little bit more cautious on the sequential improvement that you might think will occur in the September quarter gross margins as a result of that timing, historical pattern?

Jerry Turin

Well, historically we've never seen that going from June to September and if in fact, we've pulled more of the pricing from six months into annual, I would expect less of an impact. So I wouldn't see that there is any extra step-up that we have to overcome in the September quarter versus June. I don't know, if Alain has any other visibility probably not I wouldn't think.

Alain Couder

Okay. Our strategy has been to plan in such a way that the price erosion is the same as in the previous year (inaudible) and make sure our gross margin improves as we say. And that's what I said before, I think if it doesn't reduce as much as in the previous year this is gravy. It will be easier to get to our target model.

Alex Henderson – Miller Tabak

Okay. Second in the line of questioning, can you give us a little more granularity on what you're thinking is on the OpEx sequentially into the June quarter? You generally do talk to the sort of sequential OpEx line?

Jerry Turin

Well, we speak to the EBITDA guidance and we've typically talked in terms of the moving pieces with restructuring and so forth. I think at this point in time when you look at the OpEx lines I think we have a reasonable baseline for moving forward.

And therefore, I would look at it more on an annualized basis and a steady growth rate, maybe 8% to 10% a year with a few percentage points quarter-on-quarter. There's no step function reductions remaining and we don't need to grow it significantly to support higher revenues. So, think in terms of inflation, a little bit of added resource here and there, a very little commission that would vary a little bit with revenues but a fairly steady, consistent quarter-on-quarter movement from here.

Alex Henderson – Miller Tabak

The Tucson plant closing, does that impact anything other than the cogs line?

Jerry Turin

A little bit below the line, but probably not enough to have any impact on trends. Most of it would be above the line.

Alex Henderson – Miller Tabak

Okay. Technical question on the tunable dispersion compensation technologies. It seems pretty clear as the focus has gone from tunable lasers to tunable receivers and dispersion compensation that that changes the architectural design of the equipment. Can you talk a little bit about how long it takes for that change in the architectural design to play out for the OEMs?

What's the testing cycle on this product line and can you talk a little bit about how you expect the adoption to look on it? It seems pretty clear that that's a major event as we go to what Ciena is calling colorless laser.

Alain Couder

The tunable dispersion compensation becomes a key technology when you go above 10 Gigabits. So as more 40G and later on 100G, is deployed there will be more and more of that because then you need to be able to compensate for the destruction of the fiber. So, that's the way we look at the market. And a typical several month cycle of new products is in the 18-month range but we have already several customers shipping 40G very actively. And that's why, in fact, our problem is to ramp as quickly as customers want.

Alex Henderson – Miller Tabak

So you don't see any delays or any testing cycle issues in terms of the ramp-up scheduled for that product?

Alain Couder

No. We are ramping as fast as we can. There are many people shipping 40G today and they all use tunable dispersion compensation of some kind.

Alex Henderson – Miller Tabak

One more question on technology, any indications at this juncture of the ramp of the Light Peak program and things along that line that could absorb a lot more than $14 million VCSELs per quarter?

Alain Couder

I think we need to talk to Intel about that.

Alex Henderson – Miller Tabak

I was just interested if you'd seen any real progress in that program?

Alain Couder

Yes. We have good progress in optical cable and VCSELs in general, but we cannot give you any detail on the specific question you're asking.

Alex Henderson – Miller Tabak

Okay. Thanks.

Alain Couder

Thank you.

Operator

(Operator Instructions). Thank you. And our next question comes from the line of Dave Kang with B. Riley. Please go ahead.

Dave Kang – B. Riley

Yes. Thank you. Good afternoon. I was juggling a couple of calls, but did you say you've made another small acquisition? If so, could you talk about the financial details, like the price and revenues and all that kind of stuff? What kind of products they do?

Jerry Turin

Dave. It was a very small technology acquisition. It was under the radar screen, but a great example of having a little bit of financial flexibility to bring in a technology that you can leverage with other products. So it's not something we announced or it's not something material.

Dave Kang – B. Riley

Okay. But I thought Alain talked about VOAs, is that what they're doing?

Jerry Turin

Yes.

Alain Couder

Yes. We are doing a VOA with the MEM technology; absolutely yes. And we are shipping to our large customer in particular as we speak.

Dave Kang – B. Riley

Got it. Can you just talk about how much business was left on the table because of the supply chain issues?

Jerry Turin

Well, what was it, Alain, about?

Alain Couder

It was about I would say $5 million to $6 million in the last quarter.

Dave Kang – B. Riley

It sounds like it's getting worse. I mean, a couple of quarters ago it was like a couple million and now it's $5 million to $6 million.

Alain Couder

This is the way we have invested more in CapEx in the March quarter. And we then even more in CapEx in the June quarter and in such a way that we need that. But right now, clearly our capacity has been going up. We see the metal shortages as well that we are working on with customers. But this is something which is pretty good news, because we are taking market share as a result of that. It's not like we were as a result of that going with the market. We are clearly taking market share with everything we can ship.

Jerry Turin

And I'll just elaborate on that, Dave, too. I think one of the stories in March was our responsiveness to the demand. So, if you look at the December to March growth rate versus the March to June growth rate in our guidance, you can see we've gone a long way to addressing the step-up in demand. And so that was a key focus in the quarter and we think we're positioned to deliver in June as a result.

Dave Kang – B. Riley

Got it. Can you just give us an update on – you talked about line cards integrating ROADMS and amplifiers? Can you just give us an update and some customer activities on all that?

Jerry Turin

Well, the main update there, Dave, is more again of a reiteration that on the WSS side from Xtellus, we see 2010 as the year we help them execute their WSS ramp. And really, 2011 is when traction from the different business units working together to integrate functionality and introduce ROADM price to our customers is probably more of a 2011 event. Alain can elaborate a little more on the parameters.

Alain Couder

As we speak, we are responding to RSU or we have been responding thus far to RSU of several large customers. Qualification time for those types of products is typically in the six-month range. So, this is probably not any measure of revenue for this calendar year but it can be quite attractive next calendar year. Fiscally, it's the way it is.

The great news is that before we had only 1 by 2 reasonably complex. Now, we have a full line of products with WSS. Not only we are able to engage at 1 by 2, but Xtellus has 50 GHz and 100 GHz products. So we compete most with Finisar who's the leader at 50 and JDS who is the leader at 100. As you know, we have a combination of MEM and LCDs that give us an optimum design. And we are basically shipping right now 1 by 2, 1 by 4, 1 by 9, 1 by 10. And we are working with some customers on 1 by 23.

Dave Kang – B. Riley

Thanks. Got it. And then can you just talk about the combination with Ciena/Nortel, what is the net effect? I saw you said it would be positive, just a little bit more dynamics as to why you think it'll be positive for you.

Alain Couder

At first it is positive because Nortel is ramping again. That's always nice. The second thing we have a good relationship with both and the result of the combination there was no new product that they dropped on us. They didn't terminate a product line that terminated supply from us. So that's the other positive we have. But it is clearer that now they have much more aggressive plans than before and we are part of them. We have the long history with both companies and we are actively innovating with them and working on the next generation of technology.

Dave Kang – B. Riley

Got it. And the last question is on the ROADM expectations. You thought you could do $17 million to $23 million. Are you sticking with that number or care to increase that window a little bit?

Alain Couder

I think Jerry answered the question. We are at the high end of our March number, so we go one quarter to one quarter to hit our target.

Dave Kang – B. Riley

Okay. Fair enough. Thank you.

Operator

Thank you. Our next question comes from the line of Mark Sue with RBC Capital Markets. Please go ahead.

Mark Sue – RBC Capital Markets

Thank you. Alain, just a question on pricing. Couldn't you just stagger the price negotiation by customer quarter-to-quarter or even depending on the fiscal year-end of your customer?

Alain Couder

This is an industry where our customers are much bigger than we are and I wish we could do something about that, but they have their processes and we have to go by their processes. And that's the way the industry is. I am expecting with industry consolidation and all of that that there will be a few less companies, less in this space, so we'll have more leverage.

But right now that's the way we have to work. But it's a matter of planning. We know it's like that, so we plan accordingly. We put our cost reduction plan in place accordingly and so on, so it works.

Mark Sue – RBC Capital Markets

And then, looking at consolidating the industry and also perhaps your make-or-buy decisions. Will you only consider accretive deals that go to kind of nudge your gross margins of 35% higher on longer term? What kind of parameter should we consider as we look at your M&A activities?

Alain Couder

We are not going to do any accretive deal which is going to crash our gross margin, if this is your question. And we will certainly be looking at that very carefully. Then it must depend on the size of the deal. If you do a very small deal which is less than $1 million when we get it, the gross margin is lousy but we know we can fix it within a few months, then we can do it.

If we are doing a more significant acquisition in terms of revenue, we will have to be much more careful. I think there is not one answer to that. It's a matter of access to technology. We are not doing that just to increase the top line overnight. We are much more doing that to make sure that we extend our technology portfolio and we can accelerate our growth as a result of that.

Jerry Turin

Let me add a few things to that, too, Mark. So, if you look over the last 12 months, I think we demonstrated quite a bit of discipline in how we've executed the restructuring and the combination of companies and technologies. And we certainly would expect to exercise the same sort of discipline going forward. I think to the extent that there would be the opportunity to make an investment that in the short-term would be viewed more as a technology investment.

I think that comes back to that 11% to 13% revenue metric we were talking about, as far as R&D spend and the sort of make-buy analysis, Alain was talking about. So, if we're spending at 11% and there's an opportunity to make a small acquisition that maybe needs a little bit more R&D into the expense but you fund out within those parameters, then you're letting your business model still drive that investment decision. So those are the sorts of ways we look at this.

Mark Sue – RBC Capital Markets

Okay. That's helpful. Lastly, lead times in aggregate, where are they at the moment? Just roughly.

Alain Couder

The expectation of some customers in the telecom field is that we can deliver in two weeks.

Mark Sue – RBC Capital Markets

Okay. That's helpful. Thank you and good luck gentlemen.

Jerry Turin

Thank you.

Operator

Thank you. And our next question comes from the line of Tim Savageaux with Terrapin Research & Management. Please go ahead.

Tim Savageaux – Terrapin Research & Management

Hi. Good afternoon and congrats on the numbers and the outlook. I have a couple of questions. First, I note that has joined the 10% customer list. I think that's the first time that's happened in a while. I don't think they were there last quarter. So if you could comment to some degree about what you're seeing out of sort of Ciena and Nortel.

I wonder if you have any commentary on what's driving Alcatel-Lucent in general, as you look towards your very strong guide, double-digit sequential growth. If you can give any product or customer or regional-type commentary around what's driving that guidance?

Jerry Turin

Sure. Let me just refer historically. Alcatel was not a 10% customer last quarter but that was almost in the rounding. It was very close, so it wasn't this quarter and last quarter were not dramatically different. I believe the quarter before they were 10% or 10.5%. So it's been fairly consistent within our customer base. Alain can probably elaborate on your more specific question.

Alain Couder

Basically, we are looking at all the telecom customers and clearly Huawei, Ciena and Alcatel are the top three and they control 50% of the optical core networks. And we are working in such a way that we get our fair share of those customers. In the end, we have a little less than 50% of our business out of those top three, because all those customers tend to do their modules themselves and they buy components. And therefore, there is more captive business as a top customer. But I think otherwise we are very much in line with the market share they have in the core optical network.

As Bookham we made a conscious decision two and a half years ago that we were very small with Alcatel and to make an investment. And with the merger with Avanex gets us the entrance into that. Avanex has a big foot into the transponder but they had lost their share when we acquired them, but as they had already all the contact and all that.

Pretty rapidly, we were able to get the ex-Bookham transponder qualified with Alcatel and we are now qualified on two product line and soon on the third product line. And therefore, this is a very successful product for us from directly at Alcatel.

Tim Savageaux – Terrapin Research & Management

In terms of the outlook, can you describe this kind of broad based across customers, products, geographies or any particular elements of the business driving that?

Alain Couder

We see strength everywhere. The question mark on Europe, because of those country problems in terms of debt, etc, whether they are going to continue to invest because of that. But besides that, we see strength in all regions of the world right now. It's a pretty strong market and the outlook as of today is pretty good and we have not seen any significant buildup of inventory that at this point in time.

Tim Savageaux – Terrapin Research & Management

The second question on operating expenses, I think the original expectation was for those to continue to tick down in the quarter. It looks like they ticked up in the quarter instead. I wonder if you could talk about whether that's accurate and what's driving that?

And maybe I think I got your expectations for OpEx going forward, which is maybe a moderate increase with business levels and barring anything large or one-time on the R&D side. But more to talk about the directionality in March and what changed relative to your expectations?

Jerry Turin

Well, you have to break it in two again. R&D, we expected to increase and we expect to increase, because as revenues go up we're going to invest at least to that 11% level. Breaking out SG&A separately, SG&A was down this quarter.

Alain Couder

In terms of R&D, I gave the direction inside to staff R&D as quickly as possible with quality people. The top number is 13% but with the top line growth it's impossible to get quality people fast enough to go faster. So right now we are at the 11%. We may do a little more if we can get some very good people, but that's the way it is. You will see R&D in dollars continue to increase significantly over the rest of the year as we grow the top line.

Tim Savageaux – Terrapin Research & Management

Okay. Thank you.

Operator

Thank you. This concludes our conference call for today. I'd like to turn the call back over to Jim Fanucchi.

Jim Fanucchi

Thank you, everyone, for participating today and we look forward to speaking with you again when we report our fourth quarter and fiscal year 2010 financial results.

Operator

Thank you, ladies and gentlemen. This concludes the Oclaro third quarter fiscal year 2010 financial results conference call. Thank you for your participation and you may now disconnect.

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