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Oclaro, Inc. (NASDAQ:OCLR)

Q3 2014 Earnings Conference Call

May 6, 2014 5:00 PM ET

Executives

Jim Fanucchi - Darrow Associates

Greg Dougherty - CEO

Pete Mangan - CFO

Analysts

Dave Kang - B. Riley

Patrick Newton - Stifel Nicolaus

Operator

Good afternoon and welcome to the Oclaro Third Quarter Fiscal Year 2014 Financial Results Conference Call. As a reminder, this conference call is being recorded for replay purposes through May 20, 2014.

At this time, I'd like to turn the call over to Jim Fanucchi of Darrow Associates. Please go ahead, sir.

Jim Fanucchi

Thank you, operator, and thanks to all of you for joining us. Our speakers today are Greg Dougherty and CFO Pete Mangan.

Statements about management’s future expectation, plans or prospects of Oclaro and its business, including statements about future financial targets and financial guidance, Oclaro's plans for future operations together with the 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. These forward-looking statements include, but are not limited to, statements concerning financial targets and expectations and progress toward our target business model, including financial guidance for the fiscal quarter ending June 28, 2014 regarding revenue, non-GAAP gross margin and adjusted EBITDA, status of Oclaro's restructuring plan, market interest in Oclaro's 100G products and Oclaro's future financial performance and operating prospects.

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 the risk factors described in Oclaro's most recent Annual Report on Form 10-K, most recent quarterly report on Form 10-Q, recent Form 8-Ks and other documents we periodically file with the SEC.

The forward-looking statements discussed today represent Oclaro's current views as of the date of this conference call and subsequent events and developments may cause Oclaro's views to change. Accordingly, actual results may differ materially from those indicated by these forward-looking statements. Oclaro does not intend and is not required to update any forward-looking statement as a result of future developments.

In addition, today, we will be discussing non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with GAAP and should not be considered as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A table that outlines the reconciliation between the non-GAAP financial measures to GAAP financial measures together with a discussion of their usefulness and limitation is included in today's earnings release, which we have filed with the SEC, and I refer investors to this release.

I would now like to turn the call over to CEO Greg Dougherty.

Greg Dougherty

Thank you, Jim, and thank you everyone for joining the call. First and foremost, it is clear that our fiscal year third quarter overall results did not meet our expectation. However, we made meaningful progress in our turnaround plan.

Our gross margin performance of 12% matched the substantial advances that we have made in restructuring the company as we continue to take out significant levels of fixed cost. These actions combined with the strong 100G new product momentum that we are seeing are establishing a foundation for a successful and sustainable Oclaro.

Pete will take you through the numbers for Q3, but first let me provide some high level commentary on the result and then discuss our customer and market activity.

Our revenues for the quarter at $95.4 million were at the lower end of our expectation due to several factors. First, we saw lower revenue from vendor managed inventory or VMI from two of our largest customers for some of our 10G products.

Second, we experienced a bit of a pause for our 100G product on the client side after having strong shipment of our CFP in the December quarter.

Third, while we had a strong customer demand for lithium niobate product, we did not ramp this business as we had planned. We do, however, expect shipments of our 100G coherent lithium niobate modulators to improve dramatically this quarter.

We had another record quarter for our 40G line cards as we quickly increased our capacity to meet specific customer orders during the quarter. We successfully ramped up our factory in San Jose to support firm customer orders for June. However, we were recently informed by our customers that their end customer, a major North American carrier has reduced their 40G needs for the second half of this calendar year. The new levels being projected are more consistent with the lower run rates of past year.

As previously discussed, we continue to expect this business to roll down over the course of calendar year '15.

As we also mentioned before, our overall revenue growth will be somewhat muted as our legacy product revenue comes down and our new 100G portfolio takes off. Longer-term we expect to see nice growth as we believe that we are competitively well-positioned in the 100G coherent for transmission and for the convergence datacenters (inaudible) fiber and the 100 G data rate.

Our gross margin performance of 12% was unfortunately well below our expectation and resulted from several factors. As you know, the March quarter is historically a tough quarter for gross margin due to the annual price negotiations with many of our major customers. This year was no different as we absorbed about 4% decline in pricing during Q3.

In addition to the expected price impact, we had some execution issues in our lithium niobate modulator line resulting in lower-than-expected revenues and much higher manufacturing cost. During the third quarter, we did make significant improvements to our lithium niobate processes which will enable us to increase our shipment by our 50% this quarter. The transition to new process resulted in stranded inventory. Although adversely affecting us in the March quarter, we are now better positioned to address the significant demand for our 100G modulators and we are strong order fill for this quarter and beyond.

During the quarter, we also addressed some contract manufacturing management issues relating mostly to start up cost and variations as we ramped up our transferred line with Venture. We have taken steps to improve our management and discipline going forward. We did see marked improvement in production coming from Venture as they came up the learning. In fact, by the end of the quarter their execution was on our with her manufacturing partners in our internal sites. We are pleased with the result.

During the quarter, we also continued to focus on the rationalization of our product portfolio emphasizing differentiation, market leadership and improved margin. As we've said, we do not intend to chase markets or product areas and catch up unless we are really confident that we can quickly become a market leader.

As I mentioned before, historically Oclaro has not done a very good job of integrating its numerous acquisition or making hard decisions on product line. One move that we made this quarter as part of our restructuring was to integrate into Japan all of our client site pluggable optics products which were previously designed and supported in San Jose. The move provides stronger management and focus for these products. This restructuring resulted in excess and obsolete inventory impacting our gross margin.

As you can see, over the past several months, we have taken and will continue to take aggressive steps to integrate the company and improve our business processes. While some of these moves have resulted negative adjustments impacting gross margin they are strengthening our foundation for further improvement in our financial performance. All told, these events impacted our gross margin by about 400 basis points.

Despite these hits to gross margin, we have improved our gross margin by about 6 basis points compared to the March quarter of last year and lower revenue. We have also reduced our operating expenses by $8 million leading to a year-over-year reduction in our operating loss of over $12 million. The reason for the significant year-over-year improvement is that our restructuring actions continue to be ahead of schedule. As an update, we have reduced our headcount from the 3,000 people that we had last June to approximately 2,000 people in early January and as of early April, we are down to a level of just under 1400 employees.

During the quarter, we transferred 500 people from our pump product line to II-VI as planned. As you recall, our original plan calls for us to be at 1500 people by July 1. Our current plan will take us to about 1350 employees by then. This figure includes planned new hires for 100G product development in our pilot production line.

Our site consolidation continues. During the quarter, we sold our WSS assets in Korea for a net of $1.4 million. The sale, while bringing in some cash, also eliminated our need to take on any building restoration, equipment disposal and cleanup that would have consumed additional cash. We are now down to 11 sites and we will be at 10 as planned by July 1. In addition to eliminating complete sites, we also reduced our floor space in Shenzhen as we are able to transfer one and half floors of our Shenzhen site to II-VI when the transferred the pump production line and employees.

We continue to best invest in R&D as part of our core strategy to be a technology and product leader. Today, our R&D investment is 50% of revenue focused primarily on 100G solutions for both the client and line side. Compared to the March quarter a year ago, we have doubled 100G sales year-over-year. Validating the customer demand for these highly differentiated products which addressed rapidly growing market, we expect to expand our successes in this area.

Another investment that we have made in setting up a pilot production line in Caswell, our primary wafer fab site on the line-site. This allows us to co-locate early production with our chip and package designers as opposed to doing this remotely. It'll allows us to ramp new, highly complex products more quickly which results in better time to market and increase customer satisfaction.

I am happy to say that the line has been completed and has shown the expected benefits in making our Tunable Laser Assembly for our new Tunable SFP+.

We will also begin pilot production of our recently announced coherent CFP2 product on the pilot line during the second half of calendar year '14.

On the product side, we continue to see large demand for 10G SFP product, which support large LTE build out, primarily in China. We were sold out last quarter and likely will be again in the June quarter.

Turning to the client side or datacom side of the business. As I mentioned, earlier, revenue was down this quarter driven by the less than expected VMI pools and reduction in 100G CFP sales. The CFP reduction came after a very strong December quarter, during which our customers pushed us to deliver a large volume of 100G CFP for Chinese telecom, which we did. As expected, this reduced the demand for CFP in Q3 as our customers deployed their systems. We've seen a slight uptick in Q4.

We're also seeing the conversion from CFP to CFP2. This again placed our strength as we believe that we were first to market delivering unmatched performance for CFP2.

Our customers are ramping quickly to convert their interfaces slot from CFP, CFP2, and we began volume production in Q3 to support that. We expect to see increasing demand for these products to continue throughout this calendar year.

We are also developing new products such as CFP4 and QSFP28 to continue to maintain our product leadership for a 100G application and support the emerging needs for datacenters.

Our product leverage are outstanding laser technology both in directly modulated and externally modulated lasers. We are continuing to invest in next-generation high speed lasers, receivers, and advanced packaging, to address the market needs of smaller size and lower power.

At OFC, we introduced our next-generation tunable SFP+ module that's also a customer's critical issues of smaller size, plus ability to operate at higher temperatures, while consuming less than 1.5 watts of power. The tunable SFP+ leverages our new indium phosphide material from Caswell and advanced packaging technology from Japan. We are sampling the new tunable SFP+ modules today and plan to do volume production starting in the third quarter of this calendar year.

On the transmission side, we are seeing many design wins for our 100G coherent Micro-iTLA and lithium niobate modulator product. We are struggling to keep up with the demand and to ramp both of these products rapidly enough. As a result, we are not increasing our revenue as quickly as we had hoped. I do expect the revenue for these two products to grow by over $3 million this quarter compared to last. We anticipate that these two product lines will continue to grow over this calendar year and beyond.

Also, at OFC, we not only announced but demonstrated the industry's first CPF2 module, the 100G coherent transmission. We will be shipping our first prototype module this month. We have many very strong customer engagements for the CFP2.

By leveraging our indium phosphide, laser integration and advanced packaging capabilities, our customers can now use pluggable coherent modules for metro and long-haul application. The modules compact form factor that delivers new levels of performance and flexibility for optical network operating in a 100G and beyond. Major carriers are planning to use the 100G coherent in the metro network, providing us with significant long-term additional growth opportunities. This further emphasizes that our R&D investment and priorities have positioned Oclaro to be a leader in this large fast growing market.

In order to strengthen our new product introduction and our execution ability for integrated products or line-site business, we welcome Dr. Richard Craig to the Oclaro Executive Team as President of the Integrated Photonics Division. Rich was formally the CEO of Sanford, the initial market leader for tunable lasers. He brings to Oclaro a wealth of telecom experience and a strong track record of executing on new product introduction. In his role he will be responsible for R&D, marketing, product line management, new product introduction, and business management for the Integrated Photonics Business.

We have consolidated line-site under operation under Jim Haynes, our Chief Operating Officer, who will also mange Oclaro's manufacturing strategy.

With that, I would like to turn the call over to Pete who will summarize the financial results. Pete?

Pete Mangan

Thanks, Greg. As Greg noted earlier, the financial performance for the March quarter was disappointing with our results coming in at the low-end of guidance. I will now provide a few key points about the third quarter and then close with our outlook for the June quarter.

For Q3 net revenues of $95.4 million, declined by 7.3% compared to $102.9 million in the prior quarter. This decline as shown on the revenue tables, we have posted today on our website was driven by 12% drop in our 10G and lower transmission product, and 11% reduction in datacom product. This was partially offset by the growth in our 40-gig and above telecom product.

In total, our 40G and above products contributed 46%, 10G and lower comprised 46%, and industrial and consumer accounted for the balance of 8%. Also, our telecom represented 50% of our revenue, datacom 42% and again I&C 8%.

Last quarter, we had three customers, each contributing greater than 10% of revenues. Coriant remained our largest customer with 21% of total revenues and grew 10% in the quarter on 40G telecom sales. This growth contributed 12% and Huawei represented 11% of total revenues. Additionally, our top customers contributed 78% of our revenues. And regional sales showed Europe at 34%, China 28%, Southeast Asia 15%, America 15%, and Japan 8%.

Our non-GAAP gross margins declined to 12.3% in Q3 compared to 17.1% in the prior quarter. The vast majority of the decline was split between product rationalization and production ramp decisions made in the quarter and additional contract manufacturing cost. The product decisions include process improvements in our lithium niobate line and a product rationalization inventory reserve. The contract manufacturing costs reflected startup yields and price variances reported in the third quarter for fiscal year 2014. These items impacted gross margins approximately 400 basis points in the aggregate.

On the other hand, as planned, we significantly reduced our non-GAAP operating expenses in the March quarter to $29.2 million, down 15% or $5.2 million, which helped mitigate the shortfall on gross margin. The spending reduction was driven primarily by restructuring and cost saving actions begun in November 2013. It represents the achievement of 80% of our expense reduction plan and has significantly reduced our breakeven point going forward.

In summary, lower gross margins were somewhat offset by reduced operating expenses and our non-GAAP operating loss of $17.5 million, grew slightly by 4% over the prior quarter.

Overall, our fiscal Q3 adjusted EBITDA was a negative $12.3 million, an increase of $1.6 million from the prior quarter.

Our net loss on a non-GAAP base was $17.9 million or $0.17 per share and our GAAP net loss was $22.9 million or $0.22 per share. This compares with a non-GAAP net loss of $27 million or $0.29 per share and a GAAP net income of $31.5 million or a positive $0.34 in the December quarter.

The improvement of $9 million in the non-GAAP net loss in the March quarter resulted from the December quarter having an $8.3 million interest charge from the exercise of our convertible note. The GAAP net loss delta of $54.4 million resulted primarily from the December quarter having included a gain on our amplifier business of $69.7 million offset by the convertible note interest, lower restructuring cost in the March quarter of $3.7 million and a final settlement of $1.7 million in the March quarter.

Now turning to the balance sheet, cash including restricted cash was $122 million representing a decrease of $22 million in the quarter. The decline resulted primarily from a cash usage related to working capital of $13 million, an adjusted EBITDA loss of $12.3 million and a GAAP P&O charges of $4.5 million mostly from restructuring and was offset by other cash receipts from the quarter of $6.7 million. The other cash including $3.9 million paid on divestiture hold back and true up of $1.7 million of flood related income and $1.1 million from the sale of our Korean factory which occurred at the end of the quarter. Overall, our cash position remains strong.

Other significant balance sheet items included accounts receivable of $75.5 million or 72 days of sale was down slightly in the quarter. Inventory of $81.7 million or 89 days improved slightly as additional inventory was transferred to our CM Venture.

Accounts payable and accrued expenses decreased by 14% in the quarter to $136.4 million.

In summary, the third quarter was a mixed bag. Gross margins were disappointing masking both the significant improvement we made in reducing our operating expenses and the progress towards lowering our breakeven.

This concludes the financial review of the third quarter of fiscal 2014. Let me now comment on our outlook as well other cash and breakeven plan. Today, we announced the following guidance for the fourth quarter ending June 28, 2014.

Revenues are expected to be in the range of $90 million to $100 million. Non-GAAP gross margins are expected to be between 12% and 16% and adjusted EBITDA is expected to be between negative $13 million and negative $9 million.

Regarding cash requirements for this calendar year, there is a progress update on the four areas noted on the last conference call. One, regarding restructuring, in the past two quarters we've incurred $10 million of our $20 million to $25 million plan and expect the balance of $10 million to $15 million to occur over the calendar year. Two, related normalizing working capital post divestiture about half of the $25 million to $30 million adjustment was made in the March quarter and we expect most of the balance or approximately $12 million to $17 million to the reflected in the June quarter.

Three, our CapEx and capital lease needs remain at $4 million to $5 million per quarter and, four, we will need to continue to fund our adjusted EBITDA losses until we achieve breakeven.

Lastly related to cash, in early April, we establish a $40 million working capital line of credit with Silicon Valley Bank. We do not expect to utilize the facility this year.

Regarding our breakeven objective, we continue to be on track to achieve our adjusted EBITDA model, which continue to the revenues of approximately $110 million per quarter, non-GAAP gross margins of 20% and operating expenses of 25%. Beyond this one model there are multiple tasks reaching breakeven. This could include further adjustment to our revenue, gross margin and/or operating expense level which we will continuously refine over the remainder of the year. That said we remain committed to our adjusted EBITDA breakeven objective at $110 million revenue by the December quarter.

That concludes my comments on our financial outlook. I'll turn the call back to Greg for his closing remarks.

Greg Dougherty

Thank you, Pete. While our Q3 results overall were disappointing for me we made considerable progress on our restructuring and I'm very proud of what the team has accomplished in such a short time. The execution of the restructuring plan combined with a considerable new product momentum gives us good reason to believe that our turnaround remains on track. While we are moving quickly to get breakeven I want to be very clear that our path will not be through a quick fix or a overnight success story. We're taking a deliberate one step at a time approach emphasizing continuous improvement and we are focusing on long-term sustainable success. We remain very optimistic about the opportunities ahead as we continue to strengthen the company across all vectors.

With that, I will turn it back to the operator to begin the Q&A session. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions).

Our first question comes first question comes from the line of Dave Kang with B. Riley.

Dave Kang - B. Riley

First, regarding your guidance for fiscal fourth quarter why flat guidance when fiscal fourth quarter tends to be a seasonally strong than fiscal third quarter? And what's baked into that guidance? If you can provide additional color as far telecom, I think you went over couple of items but telecom, datacom, [technical difficulty]?

Pete Mangan

Essentially the flat guidance on revenues is around the transition between our legacy products being offset by new product ramps. As Greg indicated, the VMI order in March is soft. So there is focus on that but as well in the remainder of the 10G ramp as we move from CFP the CFP2.

Dave Kang - B. Riley

And then just a couple of moments before I ask other questions, but can I have the depreciation in relation?

Pete Mangan

Yes, depreciation for the quarter was $5.1 million.

Dave Kang - B. Riley

And then did you give out CapEx? I know you talked about CapEx going forward but what the actual CapEx for the quarter?

Pete Mangan

The actual CapEx for the quarter was $2.4 million and so -- and the capital lease repayment was $1.2 million. So roughly $3.6 million for Q3 and the combination of those two items for the year is about $12 million. So basically on a $4 million per quarter rate.

Dave Kang - B. Riley

And then Coriant was 21% but I'm assuming that's including the percentages of Tellabs? How much is the Tellabs is about 4%, 5% and the rest is NSN?

Pete Mangan

I'll just compare it to what we said in December. The old Coriant was 15%, Tellabs was 3%. So, the new Coriant represented 18% in the December quarter.

Dave Kang - B. Riley

Right and grew to 21%. So I'm assuming 40G went up so I guess NSN went up and Tellabs like stayed place there, is that kind of fair assessment?

Pete Mangan

I would just say, at this point, we've hit the transition point and they're all one customer to us.

Dave Kang - B. Riley

And then Huawei looks like U.S. percentage went up but then dollar-wise I guess it was sort of flattish. So we are hearing certainly a lot of good things coming out of China. Just can you give us more color about Huawei, and how much was China total, I think was 25% last quarter, so how did they do and what's your expectation for the next few quarters?

Pete Mangan

Good, Dave. Actually China I think represented about 28% of sales for the quarter and we were up $1 million. So I believe Q-on-Q the combination China/Hong Kong. So Huawei we had a bit of -- as we mentioned, we had a bit of pause on the 100G CFP product as we stood quite a bit for the end of December to support the -- some of the built outs. We did see other strong demand from other Chinese customers coming in the back end of last quarter. And we continue to see strong a demand for our 100G product both client and line-site.

Operator

Thank you. (Operator Instructions).

The next question comes from the line of Patrick Newton with Stifel Nicolaus.

Patrick Newton - Stifel Nicolaus

Yes, good afternoon Greg and Pete thanks for taking my questions. I guess first a housekeeping question. If you could tell us your datacom, telecom absolute dollar mix in the year ago quarter, the information is not in your presentation?

Pete Mangan

Patrick, I don't think we have that number handy.

Patrick Newton - Stifel Nicolaus

Okay. And then, I guess on the adjusted EBITDA breakeven, you reiterated $110 million of revenues, gross margin 20%, OpEx 25% and that you will structurally achieve that level by the end of the calendar year. I guess the big curve ball we got was that that the Street was expecting that you would be well over that target, the $110 million target revenue on a -- by the December quarter. So you would structurally be there and that you would be there also on a revenue basis. Given where we are on the revenue guide, assuming what is that midpoint of $95 million, it seems like it would be mathematically pretty challenging to get there. I'd say that $110 million revenue target by the December quarter. So I guess my question is, do you have the product mix and do you spent that fundamentally? The industry will have enough growth that you could achieve that breakeven not just structurally but actually in this third quarter.

Pete Mangan

Patrick, I guess I will comment on a couple things. We are still on track to our original model that we announced six months ago. I have also added in the comments this time that there are various past breakeven that may include adjustments, revenue, gross margins, operating expenses. We continue to evaluate those as we move into the second half of the year. We're not guiding to the December quarter but have still focused on our original model of the $110 million in sales albeit evaluating various facts.

Greg Dougherty

Okay. And Patrick, I guess, I would further add to that that we actually feel pretty good that if we were able to achieve $110 million in December we would be breakeven.

Patrick Newton - Stifel Nicolaus

Okay. And then, I guess just trying to get a -- as investors try to get a gauge of a clear fundamental on a go-forward basis, you discussed legacy revenue kind of impacting the guide today with your earlier question. Can you help us understand, what is your direct absolute legacy revenue number that you just put up in your March quarter? And how much of that is in guide, so that we can cease that out and actually look at -- fundamentally what's happening on a structural basis?

Pete Mangan

So we don't really break it out that way Patrick. There is a couple of factors that continue to be in and out here for us and fortunately we're getting many of them behind us. So WSS product line, which you know we exited. We did have shipments in the March quarter. We have a little bit this quarter and then nothing beyond this quarter. We exited one of the old man Oclaro product lines, the MI4000 that has gone down. I think we have a little bit of revenue last quarter and may be had this quarter that goes away.

One of the big ones is the 40G line card business that we talked about. We have had -- we had a very strong quarter in March. We will have a good quarter in June based on demand, but we do expect that and we've been saying this for a while that will roll down. There is some uncertainty in terms of timing and steepness of that curve. I think last quarter one month we thought it was rolling down faster, the next month it was rolling down slower. We're now back down to the rolling down faster but there's a lot of uncertainty. And it's a classic problem of we have one customer and they have one customer. And so the sneeze creates a cold and then ripples down to us with pneumonia. So we watch that one carefully. We also have a lot of -- or some of the 10-gig VMI business is more legacy product. And so there are the areas where we have some uncertainty. And we are trying to just make sure that we are fairly conservative on what could happen over the course of this quarter.

Greg Dougherty

Yes. And Patrick, I would also add, just as a proxy the 10G business would fit into a large portion of the legacy as well. So if you took that in the Coriant could be a proxy. Also, as follow-up to your earlier question on datacom, on a like period back to the March 13, absolute dollars were basically flat at $40 million, though transition lot more under G from the lower data rates.

Patrick Newton - Stifel Nicolaus

Okay. So, maybe asked a different way; in your guidance, that's kind of flat sequentially, it sounds like if we were to strip out some of these legacy headwinds that you would be guiding more towards a seasonal type of sequential increase in June.

Pete Mangan

Yes.

Patrick Newton - Stifel Nicolaus

Okay. In your prepared remarks I think you said 100G sales doubled year over year. Could you help us understand what percentage contribution 100G represents for your portfolio currently?

Pete Mangan

At the moment, we still just leave it is 40G and above. Last time I think we had the same question, December and indicated that the 40G and a 100 were somewhat 50:50, probably closure to --

Greg Dougherty

40:60.

Pete Mangan

Exactly. There is a little bit more 40 than a 100, is the way to look at it. But we don't separate them out.

Greg Dougherty

And we see that shifting over the next couple of quarters. We continue to see a lot of growth in 100-gig for us, as we lookout.

Patrick Newton - Stifel Nicolaus

Okay. Very helpful. And then just a last one for me or I guess a multi-part on gross margin. Pete, you walked through the mix relative to expectations was due to pricing decline, contract manufacturer issues, product rationalization, site consolidation. And that, all else equal, I believe that gross margin would have been about 400 basis points higher. Is that the right interpretation? And then, could you kind of give us a walk on how each of those individual line items impacted gross margin?

Pete Mangan

Okay. So let me start. Yes, it was about 400 basis points. It was not due to the price changes, those were affected. But Greg had indicated as well that the amount that it hit the quarter was 4%, but that was not part of the explanation.

Really the two categories of the 400 basis points, we separate into the product rationalization and the production ramp, had a lot to do with the lithium niobate comments that Greg had made, as well as we rationalized our product and transferred a business unit, product line from here to Japan, those are the two elements. And again, that was in broad based terms about half of -- little over half of the 400 basis points. And then, the other half a little less than half, was related to contract manufacturing startup and price variances that we received in the quarter for the fiscal year of 2014. These are adjustments that we've made. And again, in aggregate is the 400 basis points.

Patrick Newton - Stifel Nicolaus

Okay. So, if we think about revenue being flat at midpoint of guidance, yet non-GAAP gross margin going up about 200 basis points, in essence that's you recapturing the contract manufacturing challenges.

Pete Mangan

Yes.

Operator

And at this time we have no additional questions. Please continue with any closing remarks.

Jim Fanucchi

Thank you, Operator. We want to thank everyone for their participation. Oclaro is tentatively scheduled to present at the B. Riley Conference on May the 20 and we look forward to seeing some of you there. And we look forward to speaking with you again when we report our fourth quarter fiscal year 2014 financial results. Thank you.

Operator

Ladies and gentlemen, this concludes our conference for today. Thanks for your participation. You may now disconnect.

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