Finisar Management Discusses Q3 2014 Results - Earnings Call Transcript

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 |  About: Finisar Corporation (FNSR)
by: SA Transcripts

Operator

Good afternoon, ladies and gentlemen, and welcome to the Finisar Corporation Third Quarter Results Conference Call. Just a quick reminder, today's call is being recorded. And now, at this time, I'll turn things over to Jerry Rawls, Executive Chairman.

Jerry S. Rawls

Thank you, Janine, and good afternoon, everyone. We appreciate your taking the time to listen to our conference call today. A replay of this call should appear on our website within 8 hours. An audio replay will be available for 2 weeks by calling (888) 203-1112 for domestic or (719) 457-0820 for international, then enter the ID number 7659562.

I need to remind all of you that any forward-looking statements in today's discussions are subject to risks and uncertainties, which are discussed at length in our annual and quarterly SEC filings. Actual events and results can differ materially from any forward-looking statements. In addition, unless otherwise indicated, all results discussed are on a non-GAAP basis. A complete reconciliation of our GAAP to non-GAAP results may be found in our earnings press release and in the Investor Relations section of our website.

We have prepared some slides for today's earnings call. You can access them by connecting to the Investor Relations page of our website at finisar.com, click on Investors, then scroll down to Webcast Archives and click. You'll see a listing for today's third quarter 2014 earnings call.

I am pleased to report our third quarter revenues were $294 million, a new all-time record for Finisar. Revenues increased by $3.3 million or 1.1% over the second quarter and by $55.7 million or 23.4% over the third quarter of the prior year.

Our revenues increased for the sixth consecutive quarter. Non-GAAP gross margins improved to 37.2% from 37.1% in the previous quarter, and earnings per diluted share improved to $0.44 a share from $0.43 a share in the previous quarter.

Now with that, I'll let Kurt review the rest of the numbers. Kurt?

Kurt Adzema

Thanks, Jerry. Revenue for products for datacom was $210.3 million, an increase of 3% from Q2, primarily driven by the increased sales of 40-gigabit Ethernet transceivers. Revenue for telecom products was $83.7 million, a decrease of $3.2 million from Q2, primarily driven by the impact of 1 month of the annual price reductions for telecom products that typically takes effect on January 1.

In the third quarter, we had 2 10% or greater customers, both large OEMs. Our top 10 customers represented 62.6% of total revenues compared to 61.4% in the preceding quarter. Non-GAAP gross margin was 37.2% compared to 37.1% in the preceding quarter, primarily as a result of favorable product mix, partially offset by the impact of 1 month of the annual price reductions for telecom products that typically take effect on January 1.

Non-GAAP operating expenses were $63.2 million, flat with the prior quarter. Non-GAAP operating income increased to $46.3 million or 15.7% of revenues compared to $44.8 million or 15.4% in the preceding quarter. Non-GAAP operating income was $45 million or $0.44 per diluted share compared to $43.8 million or $0.43 per diluted share in the preceding quarter.

Average diluted share for non-GAAP purposes totaled $104.4 million. This includes the impact of converting the $40 million of outstanding principal amount of our 5% convertible notes to equity for purposes of calculating EPS. Therefore, you need to add back $539,000 of interest expense and other costs associated with the 5% convertible notes to calculate diluted EPS.

During the quarter, we issued $258.75 million of principal amount of 0.5% convertible notes due in 2033, with net proceeds of approximately $255 million. For non-GAAP purposes, the interest expense associated with these convertible notes was approximately $135,000 in Q3. This interest expense is the only impact of the new converts on a fully diluted earnings per share on a non-GAAP basis. For purposes of calculating fully diluted earnings per share for Q3, no shares are added as the result of the issuance of the 0.5% convertible notes.

Non-GAAP taxes are estimated at approximately 3.5% for the fourth quarter. Weighted average fully diluted shares for the fourth quarter are expected to be approximately $105.5 million for non-GAAP purposes.

Third quarter capital expenditures totaled $35.4 million. Capital expenditures are expected to be approximately $33 million in the fiscal fourth quarter, primarily driven by the construction on the shell of the second building of our new Wuxi, China production site. We expect the shell of the building to be completed by fall of 2015 and now plan to immediately start to fit out several floors of the building and then fit out additional floors over time as needed.

Cash and cash equivalents and short-term investments increased $238.2 million to $554.7 million at the end of the third quarter and compared to $316.5 million at the end of the preceding quarter, principally reflecting the net proceeds of approximately $255 million from the convertible debt offering completed during the quarter.

There are a number of noncash or infrequently occurring charges and benefits, which we exclude from our non-GAAP results. These totaled $17.9 million last quarter. If you include all these items, as required under GAAP, we generated net income of $27.1 million or $0.26 per diluted share compared to $30 million or $0.29 per diluted share in the preceding quarter.

That concludes my comments, and I'll turn it over to Eitan.

Eitan Gertel

Thanks, Kurt. During the quarter, we will announce that we entered into an agreement, under which Finisar would acquire Berlin-based u2t Photonics. This transaction closed on January 31, 1 week into our fourth fiscal quarter. With this transaction, Finisar added u2t Indium-Phosphide-based, high-speed receivers and photodetectors, including their industry-leading 100G and 200G coherent receivers that are used by multiple system manufacturers today. In addition, this acquisition consolidates Finisar's previously announced partnership with u2t on Indium-Phosphide-based Mach-Zehnder modulators for 100-gig and 200-gig coherent applications. These receivers, photodiodes and modulator technologies and products, combined with Finisar's narrowband tunable -- narrow-line width tunable lasers, provide a full suite of vertically integrated optical components that enables Finisar to offer its customers the very high-performance modules for the 100G and 200G coherent metro and long-haul markets.

In addition to using these components for OIF discrete 100G and 200G applications, Finisar will utilize key components in our CFP2 coherent modules, as well as new form factors, such as CFP4 and QSFP28 and SFP+ for next-generation telecom and datacom applications.

During the quarter, we continued to make significant strides in new product developments for both datacom and telecom products.

In the datacom, we have production released our 100G CFP2 LR4 product. Due to our vertical integration of lasers, receivers and optical subassemblies, our modules consumed the lowest amount of power of any solution in the market today. Our 100G CFP4 and our QSFP28 module developments are progressing very well. We continue to be designed into new applications with our parallel optical engine product that operates up to 28 gigabits per channel.

In telecom, we are now shipping our beta samples of our tunable SFP+ modules that are utilizing -- that utilizes our internal low-power tunable lasers and optical subassemblies, which allow a total power consumption of approximately 1.5 watts. We're scheduled to make several important product announcements and demonstrations at the Optical Fiber Conference trade show in San Francisco next week, so please stop by our booth.

And now, I'll turn the call back to Jerry for some final comments.

Jerry S. Rawls

Thanks, Eitan. For the fiscal fourth quarter, we expect revenue to grow for the 7th consecutive quarter and to, again, set new company records. Without taking into account the impact of the acquisition at u2t, we expect revenues for our fourth quarter will be in the range of $290 million to $305 million. We expect non-GAAP gross margins to be approximately 36% as a result of the impact of the full 3 weeks of the annual telecom price reductions that typically take place on January 1.

Non-GAAP operating margins are expected to be approximately 13.8% to 14.8%. Non-GAAP earnings per diluted share are expected to be in the range of $0.38 to $0.42 per share. After taking into account the impact of the acquisition of u2t, we expect revenues will be in the range of $296 million to $311 million. Non-GAAP gross margins will be approximately 35.5%. Non-GAAP operating margins will be roughly 12.8% to 13.8%, and non-GAAP earnings per diluted share will be in the range of $0.36 to $0.40 a share.

We expect the acquisition of u2t to be accretive to non-GAAP earnings per diluted share in approximately 1 year, as we realize costs and other synergies. As Eitan mentioned, we view the acquisition of u2t as strategically important in allowing Finisar to provide a differentiated vertical-integrated solution to address the 100-gig coherent transceiver market. This market is forecasted by LightCounting to be over $500 million in calendar year 2017.

Finisar's revenue is driven primarily by the growth in the worldwide demand for bandwidth with the ever-increasing distribution and use of video, images and digital information. Another important trend that is benefiting us is the growth in cloud services with larger data centers and an increasing number of longer, high-speed connections. This increase in the optical content and data centers creates more opportunities for Finisar products. Over time, we believe both enterprise and carrier capital spending will increase to provide more bandwidth capacity, and we believe Finisar is uniquely positioned with our broad product line, extensive customer engagements, profitable vertically integrated business model and strong balance sheet to capitalize on these market opportunities.

And now, with that, I'm going to turn it back over to Janine and open it up for questions. Janine?

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Alex Henderson with Needham.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Well, the obvious question to start with is, can you talk a little bit about the seasonality of the datacom business relevant to the Web 2.0 and infrastructure-as-a-service players? How does that build and how does their demand transition across the December period? And specifically, obviously, there's a lot of news out about one of your larger customers having a very rough October quarter and then following it up with some pretty soft guidance. Can you talk a little bit about to the degree to that is playing into the datacom business?

Jerry S. Rawls

Well, as we pointed out in our comments, the data -- our datacom business was up in the quarter. And like always, we have various customers that are up and various customers that are down. But I -- with respect to seasonality, I don't think we have any information that would indicate seasonality in any part of the datacom business, honestly. I don't -- I'd think more of the telecom sector having some seasonality attached to it just because we go through this annual price negotiation thing. But...

Alexander B. Henderson - Needham & Company, LLC, Research Division

So you don't think that there's any slowdown in data center builds around Christmas time frame or any -- or into the first quarter?

Jerry S. Rawls

Well, I don't have enough experience that goes back enough years to be able to indicate that, that happens every year or doesn't happen every year. I think back, it used to -- in the telecom business, we used to think about it was very seasonal because when it was winter, you couldn't do construction, so CapEx went down. But that's really not the case anymore because most of the additions are really just changing out equipment or adding equipment in central offices, which doesn't really get affected by weather.

Alexander B. Henderson - Needham & Company, LLC, Research Division

And then off of that same question, can you give us any sense of what portion of your business or what portion of the datacom growth was coming from the Web 2.0 and infrastructure-as-a-service end markets?

And then I'll cede the floor.

Jerry S. Rawls

We don't really break it out that way, and I don't know that we can -- we'd have to do some guessing to try to get to that number, so I'd rather not nail it down.

Operator

And we'll take our next question from Subu Subrahmanyan with The Juda Group.

Natarajan Subrahmanyan - The Juda Group, Research Division

Jerry, I just wanted to follow up on the datacom question. Obviously, last year, you saw several call it [ph] quarters of very robust quarter-over-quarter growth, and this quarter was a little bit more moderate. And I'd like to first understand, going into next quarter, if, on an organic basis, the revenues down slightly, how do you expect datacom, telecom to play out? And then how you see the trajectory, on a quarter-over-quarter basis through the year, do you think it's a temporary slowdown and reacceleration or you were in an extraordinary period and it's more moderate growth?

Jerry S. Rawls

Well, let's see. First of all, we expect next quarter that our datacom business will be up again, and we expect that our telecom business will be down a little bit. We've got full 3 quarters of ASP declines for telecom, and I think that we're not going to have unit growth that will offset that. So let's see. Trajectory of our datacom business, well, I looked at it the other day and our datacom business has grown 22% a year for the last 4 years, maybe it's a little more than that, maybe it's 24%. Anyway, it's in that range. And it -- and in every quarter, it hasn't been up. We've had quarters in that where it was flat or down slightly. But it was up big the next quarter and -- but the line, if you go through it for 4 years, it's almost a straight line. And so I don't have any expectation that trajectory of growth in our datacom business is going to slow down, and I don't know that, that -- the slope of that line is going to be any different than it has been for the last 4 years.

Kurt Adzema

And Subu, I just want to clarify, the midpoint of our guidance, excluding u2t for a little bit of growth, I think you had said -- you thought it was down.

Natarajan Subrahmanyan - The Juda Group, Research Division

But -- you're right. Sorry, it is up a little bit. And then in terms of the second 10% customer, any color you can provide whether it's driven by telecom or datacom or domestic/international? Any color you can provide on the second 10% customer?

Kurt Adzema

Well, I think what we said, it was a large OEM customer. I don't think we're going to say anything beyond that.

Natarajan Subrahmanyan - The Juda Group, Research Division

Okay. And final question, in terms of customer-specific impacts, there's been concerns of, obviously, like your large customer, those issues now are a few months away and I just -- I'm just wondering if there are any other kind of issues from that large customer or uncertainty in -- from an environment perspective versus the last few quarters or visibility of how you think about that right now?

Jerry S. Rawls

No, I don't think about it much different. I mean, I -- for every customer that has -- is having a good quarter, there's another customer that's having a bad quarter. I mean, it's always a mix. And we always hope that all of our customers are successful and they all are up every quarter, but that's a dream. So I -- right now, we're -- our outlook is still very positive and we think that 2014 is going to be a good year for us. So...

Operator

And we'll take our next question from Troy Jensen with Piper Jaffray.

Troy D. Jensen - Piper Jaffray Companies, Research Division

Yes, but -- so quick, Jerry or Eitan, I'd just kind of love to get your confidence regarding the telco cycle starting and maybe kind of pull in some thoughts on China demand, if we're seeing that pick up.

Eitan Gertel

So we said the telco is going to be slightly softer this coming quarter and a lot of it driven by the 3 months of price reduction versus 1 month in the current quarter. And -- but going forward, I mean, we have a lot of new products coming in. And the big thing we're talking about, which is going to be the coherent products and the network upgrade, which will drive WSS of new product from a -- on the 100G, that's towards, we believe, the '15 -- 2015 year. So it's towards the end of the year start sampling customers, and the rest of the products in telecoms still continue to perform as we expect and continue to perform well. On the international side, we see that the wireless continue to grow but nothing changed, I think, from the way we were thinking about it before.

Troy D. Jensen - Piper Jaffray Companies, Research Division

All right, perfect. And how about -- just to follow up on it, on the data center stuff, given the sustained strength we see in that category, any concerns about double ordering? That's an issue we've had with strong product categories in the past.

Jerry S. Rawls

We don't think so. Now to be fair, we don't always have insight into our customers' inventories, and so we can ask them. But in general, how -- are we -- some of our 40-gig products, we're at capacity. So no question, there's -- we've got people who are ordering more of those than we can deliver right now. But I don't -- we don't see any evidence of anybody hoarding product or double ordering or any of that. So...

Kurt Adzema

And again, on the datacom side of the business, most of that stuff is coming through just in time to see them high [ph] inventory hubs.

Operator

We'll take our next question from Patrick Newton with Stifel.

Patrick M. Newton - Stifel, Nicolaus & Company, Incorporated, Research Division

Kurt, Eitan and Jerry, I guess, to dovetail off of Subu's earlier question on your 10% customer, is it fair to say that the two 10% customers match the list that you've had going back to 2011, or is one of those customers, perhaps, would be a new name to that list?

Kurt Adzema

It's not a new name.

Patrick M. Newton - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay, great. That's very helpful. And then I guess, during your prepared remarks on Wuxi, you talked about immediately fitting out several of the floors of the building. Could you discuss if that's a material change from your prior expectation? Or could that be a particular product line that's driving that and if there's anything that's driving you to accelerate the ramp of that second Wuxi facility?

Kurt Adzema

Well, I'd say there's probably 2 things driving it. Number one, we did the acquisition and so there's additional need for space as the result of that. And I think the second thing as we've talked about is there's some strength in the 40-gig datacom market, and so I'd say that's the other big driver.

Patrick M. Newton - Stifel, Nicolaus & Company, Incorporated, Research Division

What were your lead times on that 40G product?

Jerry S. Rawls

Oh, well, right now, we're at capacity. So I -- what's our lead time? 16 weeks. You got to order them a quarter in advance to get them.

Patrick M. Newton - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay. And then, I guess, just last one for, I guess, either Eitan or Kurt, is you talked about u2t deal taking about a year to reach accretion. If I couple that, Eitan, with your prior commentary that kind of the metro and business is going to be a 2015 event, is that fair to say that, that's why it's going to take a year to reach accretion? Is that -- do we have roughly that time before your 100G coherent portfolio starts to accelerate?

Kurt Adzema

Well, I think it's 2 things. I think, first of all, again, for us to integrate that business and leverage our manufacturing infrastructure, it typically takes us about a year to do things and if we need any requalifications as a result of that. So I think that's the first thing. And then -- and obviously, the second thing, as Eitan talked about the module market, that's going to develop over time and starting in 2015, so I'd say it's a combination of those 2 things.

Eitan Gertel

Yes. And then some of the things we're looking at is, how do we move the production from Germany into our location in China. That takes a while, and that's an existing business. And what we talked about the coherent business is going to come on top of that. So I think, in a way, they are related. But the majority of the impact we're talking about for that accretion is coming from moving manufacturing to the new locations and start to -- you start benefiting from our manufacturing strengths into those products.

Jerry S. Rawls

I want to go back on your question about our Wuxi facility; I've been sitting here thinking about that. It is a -- you asked about, was that a change? And it is a change because if we go back a quarter, we were planning, we were going to build this building, we were going to build it and leave all 4 floors. Each floor is 75,000 square feet, and we were going to leave the 4 floors in a unfinished state and to be built out with clean rooms and assembly areas and all that at a later date. During the quarter, it became apparent to us that we need more capacity and we're -- now our plan is that we're going to fit out or finish 2 floors of that building and maybe part of the third floor. So we'll still have a fourth floor and maybe part of that third floor that we will finish at a future date. But it's a -- we're going to be installing clean rooms in that new building. So...

Patrick M. Newton - Stifel, Nicolaus & Company, Incorporated, Research Division

And Jerry, could you just comment on what is driving -- is it fair to assume that it's datacom side? And also, obviously, the 40-gig giving you the lead time. Is that the key driver that drove the, I guess, the acceleration?

Jerry S. Rawls

Well, the fastest-growing product that we do over there is our whole series of parallel products and that includes 40-gig. But one of the things that we -- that we're trying to do is with the acquisitions that we've got, particularly with u2t now is in Germany, we have the RED-C acquisition in Israel, is it -- we're still manufacturing in those locations. And we would like to be in a more efficient place for manufacturing. So it's both through organic growth in our product lines but also through the acquisitions of trying to realign or restructure their manufacturing operation.

Operator

We'll take our next questions from James Kisner with Jefferies.

James M. Kisner - Jefferies LLC, Research Division

So I was wondering if you could tell us how revenues are trending with your largest customer in datacom, just sequentially or -- would be helpful.

Jerry S. Rawls

Well, the problem, we can't, really, be specific about any one customer. That would, in some cases -- their expectations for confidentiality, all our customers' expectations for confidentiality, would preclude our discussing their -- anybody's demand or results.

James M. Kisner - Jefferies LLC, Research Division

Okay, it was worth a shot. I guess, I'm wondering, you had a competitor talked about a adjustment -- inventory adjustment at a major OEM and I'm just wondering if you saw anything like that.

Jerry S. Rawls

No.

James M. Kisner - Jefferies LLC, Research Division

Okay. And then what about, you said the 40-gigs are the most that grow sequentially in datacom, can you talk about just 10-gig and 100-gig, how those did sequentially? And also, just on 40-gig, is it 40-gig LR that's driving it or is it the mix? Any detail around that would be helpful.

Jerry S. Rawls

Well, it's a mix. And with respect to 100-gig, 100-gig was relatively flat for the quarter but 10-gig was up a little bit.

James M. Kisner - Jefferies LLC, Research Division

Okay. And then 100-gig is -- I mean, what's the mix now of CFP versus CFP2? Is CFP2 ramping? It sounded like you said it was ramping. But I was just wondering, is it still a pretty small proportion of it? And I assume you'll see some ASP erosion. I mean, it's the whole point of this new version, just -- can you talk about the ASPs in 100-gig at this point?

Jerry S. Rawls

CFP2 is shipping to a number of customers, but it is still a very small revenue generator relative to CFP. And the prices of CFP2, it's smaller, doesn't weigh as much, it's lighter, fewer components. It's going to be lower priced. I don't want to discuss exactly what that price is, but it's -- but it will save our customers some money.

James M. Kisner - Jefferies LLC, Research Division

Okay. Just last question, just on 40-gig. What are you thinking of now? What's your latest thoughts on the BIDI optics? I mean, do you feel like you're missing a fair amount of opportunity here? Are you still seeing a ton of growth with folks who still want a 40-gig solution that's not just BIDI optics. Or what are your plans for launching something that's compatible? Sort of any thoughts -- updated thoughts on BIDI and I'll pass.

Jerry S. Rawls

Well, BIDI Optics are interesting for people who want to save money on fibers. If they have an installed fiber plan, BIDI optics don't buy them anything. It's probably increased cost for transceivers. And you don't -- if you don't save anything on fiber, it doesn't pay off. So the response is -- has been mixed, honestly. There's the people that talk about BIDI optics and I would -- I suspect that we will have products that are bi-directional and try to be more efficient in the use of fibers over the next -- probably, over the next year.

Operator

And we'll take our next question from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

From a high level, if we think about -- how should we think about the sequence of events as -- when it comes to this -- the whole year, telecom and datacom? For example, in telecom, the big projects this year should be Vodafone and also China LTE. Perhaps you could give us some thoughts on your positioning for the flow-through opportunities for Finisar as it relates to some of your customers and then, subsequently, to you. And then maybe -- and kind of parse that also in datacom, how we should think about datacom now. Is it more of a steady year with upgrades at key OEMs? Just kind of at a high level will be helpful.

Eitan Gertel

I don't know if we can break it down to the granularity you're looking for. But I would say that on the telecoms side, right now, we are expanding our share on a number of products. We have extended our share even year-over-year. And the -- there's many projects of long-haul that are ongoing, and a lot of people are talking about the metro coming in towards the end of the year. So we're looking forward to both of those things affecting -- impacted by our new products in variety for our customers. But I can't give you the sequence of events, exactly how they're breaking down per customer. And the same on datacom, we were addressing all our customers in datacom, data centers are continuing to grow. As Jerry mentioned before, we're expecting the average growth to continue for the rest of the year and our mix of products to actually benefit us. So looking forward to this year, we -- overall, we're expecting the trends to continue as they were.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. That's helpful. Any thoughts on just kind of the 2 major projects this year? We -- should we kind of think about some opportunities of pull through for you? Or is it still mostly, since it's wireless, it's to be determined?

Eitan Gertel

Well, the more wireless it is, it's benefiting our business. Because a lot of the backhaul for wireless is optical. Majority of the wireless cover are coming off our optical, and they're using our 10-gig transceivers in those application, whether it's CPRI or others. So that's benefiting us, and that will continue to benefit us going forward. And what was the other question?

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay, that was it. And then maybe just separately, it's -- we're still seeing a lot of that 10-gig and a big -- a lot of strength in 40-gig as well. Maybe your thoughts on the parallel of 40-gig, and considering specific applications of the 100-gig out there, just kind of how we should think about the longevity of 40-gig?

Jerry S. Rawls

Well, I would say -- now there's -- it's very different -- 2 different markets. And in the telecom market, 100-gig is now the range, right? 100-gig coherent transmission is all anybody wants to install. If you back up only a couple of years ago, it was 40-gig, and there was -- everything was going in. It was a 40-gig upgrade. In the datacom space and data centers, most of the upgrades we see or most of the newest, high-performance data centers are using 40-gig interconnections, not 100-gig. Now that's not to say we won't see 100-gig in the future and that we haven't seen any 100-gig. We have, but still I think the majority of the really high-speed lengths are 40-gig. The workhorse of data centers today is 10-gig, and I think that's going to continue for a long time.

Operator

We'll hear next from Simon Leopold with Raymond James.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

A couple of just, I think, straightforward questions. You talked about the transitions in terms of where your manufacturing regionally as well as capacity you're turning up. So I'm wondering if you could help us think about how gross margin should progress over several quarters. And I'm not looking for a quarter-by-quarter rundown, although that would certainly be wonderful. But just kind of an idea of the trajectory of gross margin and the milestones through the course of the year, how to think about that?

Kurt Adzema

Well, I still think the biggest drivers for gross margin improvement is growth in revenue and product mix. So it's hard to -- obviously, it's hard to predict that stuff beyond the quarter that we're giving guidance in. But as Jerry and Eitan pointed out, we are optimistic about the business overall. In terms of some of these manufacturing transitions, again, that's probably going to take another year to kind of get those synergies out. So I still think that we're going to have to wait a little bit of time to get the uptick from that.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

And then looking at the acquisition of u2t, it does seem like -- and certainly, it's a low-scale business, taking a pretty big hit on the gross margin, given its small size. Could you help us understand what aspects of that are organic versus sort of the accounting issues?

Kurt Adzema

I'm not sure I understand what you mean by organic versus the accounting issues. I think, candidly, there's no date, they have a small business that's doing all the manufacturing in Germany. And I think as we leverage our manufacturing infrastructure and our supply chain, that we'll be able to improve those gross margins.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

So help me out with this, it's basically rough math, telling us that their gross margin currently is somewhere in the teens and operating margins would be pretty steep loss. Is that in the right ballpark of where they're starting?

Kurt Adzema

That's the math, yes.

Operator

We'll take our next question from Kent Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

To follow on the earlier CFP question, when should we think about CFP2 being a good chunk of the revenue? Half? How should -- whatever you think is helpful from that perspective. And then a quick one on the inventories, spiked up last quarter, just want to get a sense for your inventories on the balance sheet there. What drove that?

Jerry S. Rawls

CFP2, at least in the datacom business, and remember, there is also a CFP2 form factor that's coming in the telecom business, which will house our 100-gig coherent offering for metro. But in the datacom business, we expect it to be meaningful in revenue late this year, early next year; this is calendar year.

Kurt Adzema

On the inventory question, I think the increase in inventory, again, as we transfer from our current manufacturing site in Shanghai to the new building in Wuxi, we have to build up buffer inventories over time and so the increase is primarily driven by that. And again, as we complete the -- that transition, those inventory levels should start to come down. But that's, again, going to be several quarters away.

Operator

We'll hear next from Joseph Wolf with Barclays.

Joseph Wolf - Barclays Capital, Research Division

There's some talk about some, in the cable market, an upgrade cycle going on. Are you guys seeing that and -- is there opportunity there?

Jerry S. Rawls

We're having trouble hearing you. So...

Joseph Wolf - Barclays Capital, Research Division

On the cable market, there's talk of an upgrade cycle. Is that business picking up as you guys see it? And is it large enough to drive incremental revenue growth for you guys in the telecoms part of the business?

Eitan Gertel

Are you talking about the optical cable markets?

Joseph Wolf - Barclays Capital, Research Division

The cable TV market, the infrastructure.

Eitan Gertel

Oh, cable TV markets. The cable TV market, we haven't seen a substantial change in the market. They're a very small part of our revenue. We have new products in there. We have expectations for it in the future but currently, it's a relatively small market.

Joseph Wolf - Barclays Capital, Research Division

Okay, great. And then I guess as a follow-up, since the datacom business is so strong, you're hearing even smaller companies focus on it, could you talk a little bit about any progress or any change in the competitive environment there?

Jerry S. Rawls

Well, I -- we've always got competitors. And we have a spectrum of them, some larger, some smaller. And I -- I mean, have we seen -- there's probably more competitors now participating in the datacom business than there were 2 years ago, for sure. But it's not like we doubled the number of competitors. There's a few smaller companies that are trying -- that are offering niche products. But I think our advantage is that we have scale. We make millions of transceivers every quarter. And if you were a big company that is buying a lot of optics, you need somebody with a big factory, a big source of supply. So I think we have an advantage there, and we have an advantage of scale in terms of just the components we're going to use and the buying power that we have.

Operator

We'll take our next question from Richard Shannon with Craig-Hallum.

Richard C. Shannon - Craig-Hallum Capital Group LLC, Research Division

A couple of questions from me, one, to follow up on the topic of building capacity with the -- with your 40-gig transceivers. Is there any limiting factor there in building up your capacity faster there in terms of acquiring equipment or cycle times or anything like that?

Kurt Adzema

Yes. Well, I think, in general, again, we have to bring in additional equipment. And there's lead times associated with that equipment that typically takes a quarter or so to bring on additional capacity.

Richard C. Shannon - Craig-Hallum Capital Group LLC, Research Division

Okay. And are those lead times any longer than usual than they've been in the past?

Kurt Adzema

For the product or for the equipment?

Richard C. Shannon - Craig-Hallum Capital Group LLC, Research Division

For the equipment.

Kurt Adzema

I don't think so. No.

Richard C. Shannon - Craig-Hallum Capital Group LLC, Research Division

Okay, great. Second question for me on -- following up from the previous discussion on gross margins and kind of looking at it throughout this year, I think some people have asked me over the last few months, looking at your performance historically and what you comment, and more recent, I think, last year, you were talking about hoping to get to 35%. You've obviously been there and above that for a few quarters now. But if you look in your past, you're able to get as high as 40%, albeit in a very strong router market, I think, back in 2010 or '11. As you spec [ph] out between the 3 levels there, how do you think your gross margin can transition? You talked about the Wuxi factory fill-out there. How can we think about your gross margins going, relative to those 3 levels?

Kurt Adzema

Well, I guess, the first comment is I don't think our gross margins got to 40% back in 2011, although I appreciate your optimism. I would say, in terms of -- again, a similar answer that I offered before, I don't think, in the near term, that the transition from Shanghai to Wuxi and moving these products is going to impact us positively. If anything, there's some additional costs associated with all these moves. But we certainly hope, a year from now or so, to really get the benefits of that. Again, we don't finish the second building until the fall, and we probably don't start moving stuff into that building for production until January of 2015. So again, I'd say the drivers for gross margins in the near term or in the next year are really going to all be about how fast we grow revenue and what the mix is. And again, that's hard to predict and part of the reason why we don't give more than one quarter of forecast. But obviously, we're, again, optimistic overall about the business.

Operator

We'll hear next from Michael Genovese with MKM Partners.

Michael Genovese - MKM Partners LLC, Research Division

I want to, first of all, just clarify on the u2t. Should we put all that incremental revenue in the telecom segment or should we put some in the datacom as well? And then, I just want to revisit the China question, and there's been some talk about China wireless project. But I guess I'm more interested in the core optical build that the China Mobile is talking about, I think, with a very high number of 100G channel card. And one of your 3 competitors went ahead and kind of quantified what they thought that would for them over the next year when they last reported. But you seem to sort of be pulling down the expectation a little bit, and I'm wondering could you be specific as to [ph] China -- I mean, which is going to be a calendar '14 ramp related to this optical build-out?

Eitan Gertel

So if you look at the China comm and China is affecting us, obviously, on the wireless build-out but also, right now, that we have u2t immediately affecting the coherent market because we sell components into China. And so it's not only the wireless that's affecting us. We sell probably every part we make into some Chinese customers in varying degrees of -- or quantities. But yes, we are participating currently in the China coherent market through our components. And what was the other thing?

Kurt Adzema

The second question is the u2t revenue will be classified as telecom revenue.

Michael Genovese - MKM Partners LLC, Research Division

Right. But just revisiting, I guess, the question about China. Is this one where we think that the revenues from China will be higher in the second half of the calendar -- of calendar '14 than they were in the first half of calendar '14?

Eitan Gertel

Well, we're only guiding 1 quarter at a time but we -- if everything holds up in China, we see a positive momentum there. But it's 1 quarter at a time for us.

Operator

We'll hear next from Dmitry Netis with William Blair.

Dmitry Netis - William Blair & Company L.L.C., Research Division

I have one high-level question. Despite the growth in the datacom, which is pretty impressive. Given your guidance, I think it will shake up in the mid-30s, high 30s there as far as the growth this year. But if I look at your datacom business, and a lot of questions have been asked on that front, but if I look at it, given the guidance, you're going to be down again this year in telecom and that's third consecutive year that you're down. So I just want to ask maybe, Jerry, you're very good at rehashing things and giving history lessons to us, maybe you can give us a sense of what really is going on in that business? And I mean, can we see in the first quarter of fiscal '15 the turnaround there, maybe given the low base and in the Q4 time frame kind of what you're guiding into?

Jerry S. Rawls

Well, we provided -- excuse me. We provided guidance for 1 quarter and we said, in this quarter, because we're going to have 3 months of ASP declines, that we expect that telecom -- our telecom revenues are going to be down a bit. But I'm still optimistic that, for the year, our telecom revenues are going to be up. I think, for the rest of the year, I -- there is a seasonality that goes with telecom and we're experiencing it. We think we're going to experience it in the second quarter but I believe that we're going to have increased revenues for our tunable XFP product. We're going to have increased revenues for our wavelength selective switch products. We have -- we think we're going to have increased revenues for our line cards. So there's a number of important telecom products that we think we're going to grow in our revenues during our fiscal year '14. So I don't think we have to wait for fiscal year '15 to see growth. But I think we will see -- throughout this whole calendar year, we're going to see growth. And I -- let me -- I just misspoke, our fiscal year '14 ends in April. And so we're not -- we're -- for fiscal year '14, we're not -- we don't expect this next quarter to see growth in telecom. But for the rest of the calendar year, we do expect to see increases in revenue for telecom.

Operator

We'll take our next question from Dave Kang with B. Riley.

Dave Kang - B. Riley Caris, Research Division

Just wanted to clarify first, did you say 100G was flat and 10G was up slightly? Did I hear that right?

Jerry S. Rawls

Yes.

Dave Kang - B. Riley Caris, Research Division

Okay. And then I was wondering if you can provide any color as far as you spoke with -- spoke about ROADM and tunable XFP. How were they during the quarter that you reported?

Kurt Adzema

Tunable XFP was relatively flat, and I think ROADM WSS combined were a little bit up.

Dave Kang - B. Riley Caris, Research Division

Okay. All right. And then on u2t, it looks like you're budgeting about $6 million for the current quarter. How should we expect u2t to trend beyond fiscal fourth quarter?

Kurt Adzema

Well, we certainly hope that, that business can continue to grow and we hope that it will benefit as the result of being part of Finisar. But again, I think those synergies will take time to develop.

Dave Kang - B. Riley Caris, Research Division

So right now, I guess you're selling or they're selling mostly receivers. But when do they start to sell modulators? When do we see modulator revenues for you guys?

Eitan Gertel

So I'm not sure -- we have -- it's a decision for us to make whether we -- where we sell modulators or whether we use modulators with our devices. Currently, their business has been and continues to be selling coherent receiver and regular receiver for multiple applications. One of the biggest ones is coherent 100G. But the modulator is a new product. It's going into our CFP2 product. And whether we sell it or not, that's a decision we have yet to make.

Dave Kang - B. Riley Caris, Research Division

I see. I see. Okay. And who are some of their top customers?

Eitan Gertel

Every top consumer of coherent devices, I would say. People who build their own transceivers or people who build transceivers for sale in -- the majority of them use those devices.

Dave Kang - B. Riley Caris, Research Division

Got it, and lastly, just can you talk about any color as far as price reductions, how they went?

Eitan Gertel

I think we mentioned last quarter that price reduction will be similar to the prior year, which is, in the range of 10% to 15% is on the high side.

Dave Kang - B. Riley Caris, Research Division

High side. Got it.

Operator

And it appears there are no further questions at this time. I'd like to turn the call back over to our speakers for any additional or closing remarks.

Jerry S. Rawls

Thank you, Janine, and thank you, everyone, who dialed in today. We appreciate your joining our third quarter conference call, and we hope you'll be able to join us again 3 months from now. Have a good day.

Operator

And again, this does conclude today's Finisar Corporation Third Quarter Results Conference Call. We thank you, again, for your participation.

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