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Finisar Corporation (NASDAQ:FNSR)

Q4 2014 Earnings Conference Call

June 12, 2014 05:00 PM ET

Executives

Jerry Rawls - Executive Chairman

Kurt Adzema - EVP, Finance and CFO

Eitan Gertel - CEO

Analyst

Troy Jensen - Piper Jaffray

Patrick Newton - Stifel

Alex Henderson - Needham

Mark Sue - RBC Capital Markets

Simon Leopold - Raymond James

James Kisner - Jefferies

Kent Schofield - Goldman Sachs

Joseph Wolf - Barclays

Jorge Reyes - Craig Hallum Capital Group

Bill Choi - Janney

Michael Genovese - MKM Partners

Presentation

Operator

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

Jerry Rawls

Thank you John, and good afternoon, everyone. We appreciate your taking the time to listen to our conference call today. We appreciate you tuning in and a replay of this call should appear on our website within eight hours. An audio replay will be available for two weeks by calling (888) 203-1112(888) 203-1112 for domestic or (719) 457-0820(719) 457-0820 for international, than enter the ID number 3838782.

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. As a result, any forward looking statements are vulnerable to sudden and dramatic changes. In addition, the company undertakes no obligations to update information presented in forward looking statements. 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 view 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 fourth quarter 2014 earnings call.

I am pleased to report that fourth quarter revenues were $306 million, and annual fiscal 2014 revenues were over a $1 billion for the first time at $1.156 billion. These are both new all-time records for Finisar. We also had a record year for net income of a $159 million. Quarterly revenues increased by $12 million or 4.1% over the third fiscal quarter and $62.6 million or 25.7% over the fourth quarter of the prior fiscal year. Quarterly revenues grew for the seventh consequent quarter and annual revenues increased by $222.5 million or 23.8% over the prior fiscal year.

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

Kurt Adzema

Thank you, Jerry. Revenue for products for data communications was $223 million, an increase of 6% from Q3, primarily driven by increased sales of 10-gigabit per second or in faster Ethernet transceivers and transceivers for LTE wireless applications. Revenue for Telecom products was $83 million, a decrease of $0.7 from Q3, primarily driven by the impact of the full three months of the annual price reductions for Telecom products that typically take effect on January 1st.

In the fourth quarter, we had one 10% or greater customer. Our top 10 customers represented 60.9% of total revenues compared to 62.6% in the preceding quarter. Non-GAAP gross margin was 34.2% compared to 37.2% in the preceding quarter, primarily a result of the impact of the full three months of the annual price reductions for Telecom products as well as the impact in these two, key acquisitions whose products carry a lower gross margin on the corporate average.

Non-GAAP operating expenses were $65.9 million, an increase of $2.7 million primarily as the result of the acquisition of u2t during the quarter. Non-GAAP operating income increased to $38.9 million or 12.7% of revenues compared to $46.3 million or 15.7% in the preceding quarter. Non-GAAP income was $37 million or $0.36 per diluted share compared to $45 million or $0.44 in the preceding quarter.

Average diluted shares for non-GAAP purposes totaled $105.4 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 approximately $539,000 of interest expense and other costs associated with the 5% convertible notes to calculate diluted EPS.

For non-GAAP purposes, for our $258 million of 0.5% convertible notes due in 2033. The interest expense associated with these convertible notes was approximately $323,000 in Q4. This interest expense is the only impact of these converts on our non-GAAP diluted earnings per share. For the purposes of calculating non-GAAP diluted earnings per share, no shares were added as the result of the issuance of the 0.5% convertible notes to 2033.

Non-GAAP taxes are estimated approximately 5% for fiscal 2015. Weighted average fully diluted shares for the first fiscal quarter are expected to be approximately $106.5 million for non-GAAP purposes. Fourth quarter capital expenditures totaled $36.5 million. Capital expenditures totaled $36.5 million, capital expenditures are expected to be approximately $40 million in fiscal first quarter, primarily driven by the continued construction on the shell of the second building of our new Wuxi China production sector. We expect the shell of the building to be completed by fall 2015. We plan to immediately finish a couple of floors and to fit out additional space one floor at a time as needed to accommodate growth.

Cash and cash equivalents and short-term investments decreased $41.7 million to $513 million at the end of the fourth quarter, principally reflecting the acquisition of u2t Photonics, which closed during the quarter, an increase of accounts receivable of $29.6 million and capital expenditures associated with the build out of the second building of our new manufacturing site in Wuxi China. There are a number of non-cash and frequently occurring charges and benefits that were excluded from non-GAAP results. These totaled $8.6 million last quarter. If you include all of these items as required under GAAP, we generated net income of $28.4 million or $0.27 per diluted share, compared to $27.1 million or $0.26 per diluted share in the preceding quarter.

I note that the GAAP financial results for the fourth quarter in fiscal 2014 do not include the impact of amortization of acquired intangible assets in connection with the acquisition of u2t Photonics, because such impact has not yet been determined. The amount of such amortization of acquired intangibles, when determined is not expected to be material.

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

Eitan Gertel

Thanks Kurt. As we announced in our last earnings call, during Q4 we closed acquisition of Berlin based u2t Photonics and we are happy to announce that we have successfully completed the integration of their team into the Finisar Organization. The first major development program to utilize the former u2t Photonics is our CFP2 coherent module, where we are making excellent progress in our development. By utilizing our vertically integrated advanced Indium-Phosphide laser, modulator and receiver components, we believe we will have the industry leading product in terms of power consumptions and performance.

To date, the market feedbacks have been very positive and more customers are indicating that they are planning to migrate to a pluggable CFP2 coherent for 100G and 200G coherent architectures. We are continuing to ship qualification samples of our tunable SFP+ to many of have new customers and we expect multiple key qualifications to be completed by the end of the year. As a result of our next generation vertically integrated optics, we continue to believe we will have the lowest power consumption module of the industry, of about approximately 1.5 wide. We expect to be in full production of this product in the second half calendar year 2014.

Our standard and low profile twin WSS development is progressing very well and we are being qualified on multiple new line cards at our customers. Due to our long history of development innovative LCoS-based WSS product, we are offering our customers a higher level of performance than they can obtain from other solutions. Our designs are using one common platform that can address multiple markets and give our customer the flexibility of buying one product that can be deployed in many different applications and configurations.

Our wireless product CPRI business continued to grow in Q4 and we expect this market to continue to grow due to accelerated LTE deployments around the world, but especially in China. We have a very broad portfolio of short and long reach and different data rate solutions for this market and we are continuing to cost reduce this product and extend our portfolio while expanding production capacity to meet market demand.

In datacom we have production released our 100G CFP2 LR4 and we expect this product to ramp throughout the calendar year. Due to our vertical integration of lasers and receivers, our module consumed the lowest power of any other module in the market. We are currently adding capacity in order to shorten our lead times and address opportunities to extend our market share. In the 40G market we have increased our market share and we believe we have the broadest portfolio in the market for both transceivers and active optical cables in a single mode and multi-mode configurations.

In the parallel markets, we are continuing to win new customers for both our 10 gigabit and 25 gigabit per channel bode (ph) mounted optical engines, which are proprietary products for Finisar. These high density solutions are now being used for high performance computings, routers, interconnects and server applications. Currently our main development focus is on our 25 gigabit per second per channel product where we are expecting strong demand from multiple customers in the second half of 2014 calendar year.

I will turn the call back to Jerry.

Jerry Rawls

Thanks Eitan. For the fiscal first quarter we expect revenue to grow for the eighth consecutive quarter and to, again set a new Company record. We expect revenues for the first quarter to be in the range of $320 million to $335 million. We expect non-GAAP gross margins to be approximately 32% primarily as result of the less favorable product mix including the sale of additional transceivers for wireless applications. Non-GAAP operating margins are expected to be approximately 10.3% to 11.3%. Non-GAAP earnings per diluted share are expected to be in the range of $0.30 to $0.34 per share.

Finisar’s revenue is driven primarily by growth in the worldwide demand for bandwidth to handle 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, higher 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 spending will increase to provide more bandwidth capacity. 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, I’m going to turn it back over to John to open it up for questions. John?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Troy Jensen from Piper Jaffray.

Troy Jensen - Piper Jaffray

You know my question gentlemen. I guess I want to dive into the gross margins a little bit here. I think that’s going to be the focus clearly, I mean they’re a little bit below our expectations. We know about the Telco weakness, the pricing and the dilution from the acquisition, but curious to know if you've got gross margin your plans and then was there anything else in there, any inventory, any China ramp being dilutive or any help on margins would be helpful?

Jerry Rawls

So for Q4, the reason I think margins were a little bit lower than we had expected was a less favorable product mix. Again, we sold a fair amount to these wireless applications and they have a gross margin below our corporate average.

Troy Jensen - Piper Jaffray

So how about that quickly datacom gross margin, specifically on 10G? Has there been any erosion on that side and maybe size up this LTE business for you. I guess I'd be curious to know how big it is as a percentage of the Telco business.

Jerry Rawls

We don’t comment on the gross margins for any particular product line. So I can’t help you there. But obviously this wireless opportunity is large for us and it’s growing and we expect it to grow even more in Q1 which is why consequently we’re guiding gross margins down in Q1.

Troy Jensen - Piper Jaffray

And can you just tell us where you 40G went in the quarter, obviously the competitor was weak and with that I’ll cede the floor.

Kurt Adzema

40G for us on the datacom side grew in the fourth quarter.

Operator

Thank you. Our next question comes from Patrick Newton of Stifel.

Patrick Newton - Stifel

I still -- given your explanation to Troy, still struggle on the gross margin side. You beat the top line in April quarter by roughly $2.5 million and the gross profit even with mix on wireless. It’s just -- I’ve struggled to I guess mathematically get there. So can you talk a little bit about u2t? Was the revenue there a little bit higher than the $6 million that you had guided too? And can you talk about if wireless was up, what gross margin accretive product line underperformed to offset at?

Kurt Adzema

Well, I’d say u2t was approximately in line with where we expected it to be as maybe a little bit more dilutive to gross margin, but not the major cause there. Again, I’d say the delta between our expectations and where we ended up coming out for Q4 is again primarily based on mix and again I’d say the place where the mix was much higher was we sold to lot more wireless, transceivers for wireless applications than we thought.

Patrick Newton - Stifel

And then I guess just going onto the guidance side if you could, talk a little bit about datacom versus telecom, how we should think about the sequential growth rates of both of those? I assume that both are going to be up sequentially. And on a product basis, could you talk a little bit about I guess just speed size Jerry on 10G versus 40G on the datacom side, should -- are both expected to grow sequentially? And then I guess Eitan, if you could touch on telecom for u2t, should that once again be growing sequentially, which is I guess embedded into this gross margin softness?

Jerry Rawls

Well, 10G and 40G grew in the fourth quarter and we expect 10G and 40G to grow again in the first quarter.

Eitan Gertel

To u2t side, we expect that to continue to grow, but as we said in beginning, it’s going to take us a number of quarters as we move our production from Berlin based production to our China until we make it a lot more accretive to our numbers. But we still expect growth quarter-over-quarter in revenue.

Patrick Newton - Stifel

And then I guess just last one just as we look out beyond the July quarter, Kurt on gross margin, if we think about wireless and how you guys view wireless; what’s the new norm for gross margin? Is this is a bottom in the July quarter? Is there another way you downside -- clearly mix dependent but help us kind of think through fiscal year ’15 and what we’re looking at from a gross margin perspective?

Kurt Adzema

Well, again I think the two big drivers obviously for gross margin are the pace of revenue growth and the mix. And I think in the near term we do --we see this wireless opportunity as a good opportunity even though it has lower than average gross margins and we expect it to last beyond this quarter. So that will affect near term gross margins but certainly over time we think as other products grow that we have the opportunity to improve gross margins over time. But I think in the near term the mix is going to be relatively similar to what we’re seeing in this quarter.

Operator

Our next question comes from Alex Henderson from Needham.

Alex Henderson - Needham

Hi Kurt. I was hoping you could give us a little bit more understanding here about the role of capacity additions in this equation. I understand the mix issue. But even if I address the mix issue, it looks like you’ve had a lot of startup costs relative to number of different products kicking in and where -- could you talk a little bit about the timing of the production line coming on stream in China, when that impact things in terms of your cost of goods sold, if there's any startup costs and when do those kick through?

Kurt Adzema

Sure. So obviously we’re spending a lot of money on capital expenditures. We’re going to at record levels and that’s driven both by the building -- the second building in China but as well as adding capacity for products including products for wireless application. So you are correct in that we’re spending a lot more CapEx. Our depreciation is doing up approximately $2 million a quarter and so obviously that has some impact on gross margins. In terms of the move to China, again we expect to be fully occupied in the first building by within the next I’d say quarter or so by the end of Q2. And then in terms of the new building, again that will be finished in the fall and will be occupied hopefully by the end of our fiscal year. So there are some costs associated with bringing those facilities up in terms of CapEx and then some costs associated with filing those factories. So you’re right, there is kind of a time period where there is some inefficiency and I’d say hopefully coming out of -- getting everything in both buildings by the end of the fiscal year and we should start to see some efficiencies from China.

Alex Henderson - Needham

So is it reasonable to think over two or three quarter of absorption for manufacturing coming on and some of the yield issues associated with getting these new products up that once those two factors are behind us that we get back to the 37% plus type gross margins that we were enjoying not two quarters ago. This is pretty steep reduction in margin expectations.

Kurt Adzema

Well I think, our goal is to have gross margins in the mid-30s and that is going to vary over time and it’s going to be very mix dependent. As we’ve seeing now, we’re at the lower end of that range right now based on mix. But in the future certainly we hope mix will shift differently and so that we can expand gross margin. So it’s going to depend on mix. It’s going to depend on the pace of revenue growth but certainly our goal is to get our gross margins more in the mid-30s or as now we’re kind of on the lower end of that range.

Alex Henderson - Needham

And one another question -- on the datacom side, can you talk about Web 2.0 infrastructure as a service demand growth? What factor that’s playing in terms of your expected ramp of revenues and conversely what the impact you see that in terms of the margin percentage impact?

Kurt Adzema

Web 2.0 is an exciting market and it’s -- we expect that it’s going to continue to grow. The demand coming from Web 2.0 is going to grow for years to come and it depends on the scale of each one of the Web 2.0 operators aspires too but they are -- they have plans and dreams for networks that crisscross this country. So it’s pretty amazing in terms of optics.

And we think -- in terms of margins, the nice thing about Web 2.0 is that we think that long term their demand is mostly for the highest end products that we make. So and usually our higher end products and higher performance products carry higher margins than the older products did. We expect that would be positive.

Operator

Thank you. Our next question comes from Mark Sue of RBC Capital Markets.

Mark Sue - RBC Capital Markets

I understand the gross margin is mix dependent but can’t you control the mix? Why go after lower margin businesses? Is this more of a footprint or for a particular customer?

Kurt Adzema

I think, obviously we look at all sorts of opportunities and decide to go after them or not, but ultimately here it adds to the bottom line and so we would prefer to take that revenue, take the contribution product from that revenue and grow earnings and I think ultimately for us, our number one goal is to grow earnings for shareholders and so that’s what we’re most focused on.

Mark Sue - RBC Capital Markets

Okay, and the question we’re getting was, was this actually unprofitable but you would not do unprofitable deals?

Kurt Adzema

No. It’s profitable business. It just happens to have margins lower than our corporate average.

Mark Sue - RBC Capital Markets

Understood, and gentlemen how should we think about just the split of the business over the next quarter, as we look at datacom, telecom, as you look at some of the big deals over in China. You should see telecom kind of ramping. Any qualitative comments would be helpful as you engage your business.

Kurt Adzema

Well just to make it clear, I think most of the growth was going to be in what we call datacom but how we classify datacom, and a lot of this stuff that’s going into wireless applications actually falls into our datacom bucket under our definition. So as that business grows, that’s going to be reflected in growth in datacom. So from our strict definitions of telecom and datacom, I think most of the growth will come from datacom. I think telecom has the potential to grow, especially the WSS business and tuneable XFP but I'd say its primary growth engine is going to be what we would call datacom and that includes this wireless business.

Jerry Rawls

Remember that our -- the way we define products between whether they are datacom or telecom is by each individual part number, each deal, and we -- if it’s for Ethernet or fiber channel, by our definition it’s datacom and if it’s for Sonnet or wavelength division multiplexing, it’s for telecom and in the wireless space there’s a lot of -- the products we’re selling generally are things that we might also sell to an equipment company for Ethernet or fiber channel application. Simply rates tend to fall in the 10 gigabit and below range. So that’s how we end up in the classification.

Operator

Thank you, our next question is from Simon Leopold from Raymond James.

Simon Leopold - Raymond James

Just a couple of quick clarification questions here. In terms of the pricing environment, in the past we’ve talked about a normal range, if there is normal, declines of 10% to 15% year over year and lately it sounds like we’ve been running closer to the 15% end. In this current quarter you did highlight the price reduction as the main factor on gross margin. Where are we on the range of normal price reductions?

Kurt Adzema

I think we said in prior earnings calls that for the telecom price reductions that affect approximately January 1, that we were at the higher end of that 10% to 15% range.

Simon Leopold - Raymond James

Okay, we’re still in that range. That’s a key point. We didn’t break out of the range.

Kurt Adzema

I think in general, we’re definitely still on that range.

Simon Leopold - Raymond James

And then in terms of the, you mentioned single 10% customer; was that 10% customer related to the LTE builds or is more of the traditional 10% customer you’ve had in the past.

Jerry Rawls

Not related to LTE builds.

Simon Leopold - Raymond James

Could you repeat that?

Jerry Rawls

I said, not related to LTE builds.

Simon Leopold - Raymond James

Thank you, I wanted to make sure I heard the not. Okay. And so in terms of what’s going on in the pricing environment, it does sound like the LTE builds are, would you characterize that as the biggest factor and therefore within your segments the gross margin for datacom has fallen more, than telecom because the LTE is in the datacom side?

Jerry Rawls

I think that’s right.

Kurt Adzema

But at the same time I still say that overall datacom margins are still higher than our telecom margins but yes, -- because that’s a lower gross margin business and it's growing and it’s included in datacom and obviously that brings our overall datacom gross margins down.

Operator

Thank you, our next question comes from James Kisner from Jefferies.

James Kisner - Jefferies

I was hoping to beat a dead horse a little bit here, could you help us understand like how of much of this datacom business today is wireless? Is it over 20% now? I think it was kind of running 10% of the total market. I feel like I’ve seen some data that’s around 10, something can be more than that and even anything on the magnitude, is there a 10 point difference in these wireless transceivers, just again trying to understand the 30%.

Kurt Adzema

I would say that, again we’ve had in these wireless -- this business is I'd just say more than doubled over the last couple of quarters and it’s continued to expected to grow in terms of margins. Again, we don’t talk about margins on product line but it is -- obviously it’s a very meaningful gross margin difference between our corporate average and average for this products. But again, it adds to the profitability at the bottom line and so that’s part of the reason why candidly I think our guidance is for growth, significant growth this quarter of midpoint approximately 7% whereas some of other people flat to not to down.

James Kisner - Jefferies

Got it, okay. And you mentioned cost reductions. Like when, do you have sort of a timeline for those efforts, when we might see a little bit of impact from this cost reduction efforts on this product line?

Kurt Adzema

Well, I think in the term our number one priority is adding capacity so that we can sell more and I think that’s going to happen in Q1 and Q2. I think beyond that and obviously once we all do that, we should start to see some efficiencies and improve off the cost. So I'd say you probably, are just a quarter away from meaningfully improving those margins, but I -- I still think even with margin improvement they’re going to be loss in our corporate gross margin average.

James Kisner - Jefferies

Okay. That’s helpful. And drilling in back on datacom, could you talk about a 100 gig? Is that kind of flat, is it down? What’s the trend? I'm really curious. Like you said CFP2 has now been full production release. I assume you’re still vast majority CFP -- the original CFP form factor and not CFP2. Would you give us any color there?

Kurt Adzema

100 gig datacom is pretty flat for us right now. There are number of competitors that have appeared in the market and where we used to have a very dominant market share there. Today our revenues are, like I said flat quarter-to-quarter but I - we’re still the number one market share position.

James Kisner - Jefferies

CFP2 are pretty small or is it getting material in there?

Eitan Gertel

Say that again?

James Kisner - Jefferies

CFP2 contribution; is it significant now, still very small? Could you dimensionalise CFP2 contribution versus CFP?

Eitan Gertel

CFP is still the biggest contributor for our revenue and products. And CFP2 is quite a bit small.

Operator

Thank you. Our next question comes from Kent Schofield from Goldman Sachs.

Kent Schofield - Goldman Sachs

Great. Thank you. Jumping over to telecom side of things, can you just talk a little bit about the demand environment heading into the next quarter? And you’ve talked a little bit about maybe things not getting a lot better until CY15 in the past. Is that still the thought process?

Eitan Gertel

I think when we’re talking about CY15, we were talking about the coherent side of our business and the metro impact, if you expect the metro demand to grow in the 250 and so the metro impact to help demand or raising demand for WSS and coherent transmission. Now if you look at our performance of our telecom product, even though without the effect of metro, we expect growth in WSS and we expect growth in tunable XFP. And it’s coming from market share growth and coming for some market demand in different pockets around the market. But overall, and also on u2t, we expect to be slightly up this quarter. But overall we say it’s not a significant growth for quarter-over-quarter but improvement.

Kent Schofield - Goldman Sachs

Got it. And then on u2t, you talked about going from Berlin to China in terms of the production. Can you remind us again just kind of how that helps out the gross margin, the timing there?

Kurt Adzema

Yes. I think it’s going to -- again it’s going to take about a year overall and so I'd say we’re a couple of months into that process. So we should see that happen I’d say Q4, roughly Q4 of fiscal ‘15 for us. And in terms of margin, I think that will, should improve the margin on those products, I’d say pretty significantly at that point. So obviously it's something we’re working very hard to do and moving as fast as we can.

Operator

Thank you. Our next question comes from Joseph Wolf from Barclays.

Joseph Wolf - Barclays

Okay. Just I guess a question on the wireless. Do those sales lead to lead to other component sales further on with those customers in the wire -- in the -- I guess in the different parts of the network as they build it out or is it just the original build. And do we have multiple wireless work that you guys are growing specifically into?

Jerry Rawls

Multiple wireless builds. We’re selling to a number of customers. But most of the volume ends up in China. And the biggest application -- almost all of it actually -- it ends up where you’re connecting the radio to the base station. And that’s -- and so it’s not -- some of the products, they are the same kinds of products or exactly the same SKUs that we might sell into a datacenter for a fiber channel or Ethernet application. Some of them are short wavelength and some of them are long wavelength where they want to put the base station some number of miles from the antenna.

Joseph Wolf - Barclays

Okay, and does this help with the customers in terms of moving into your new integrated modules with (indiscernible) modulators or there's no relationship at all.

Jerry Rawls

Joseph, you're breaking up, and we're having trouble hearing you.

Joseph Wolf - Barclays

Yes. I’m sorry about that. I am sitting in the airport, apologies. I am wondering if that helps with those customers in terms of other optical sales as you think about the overall contribution of filling those (indiscernible).

Jerry Rawls

I think so. The thing is that if you're engaged through the customer on applications, engineering, procurement; more opportunities become available to you. You will become knowledgeable of more opportunities and you also have opportunities that demonstrate your capabilities as a large volume producer and that generates confidence on the part of the customers. So I think, net it’s positive. The business as Kurt's described it is its competitive world, it’s very low margin, but it is positive and it does generate incremental net profits for us. So we’re going to expand capacity to be able to handle more of this business.

Operator

Thank you, our next question comes from Jorge Reyes from Craig Hallum Capital Group.

Jorge Reyes - Craig Hallum Capital Group

I have a question about your traditional large customer, Dallas having a number of issues a few quarters in the recent past but they had a decent April report, and it appears they’re bouncing back a bit, and I’m wondering if your outlook for the next fiscal year has baked in any type of recovery from this customer based on where it seems to be an inflection point in routing and switching cells for them.

Kurt Adzema

Well, the exact outlook for any particular customer is something that we really can’t discuss. For many customers, we have access to their forecast or production schedules that go out anywhere from a quarter to a year, but that’s their proprietary information and we’re really not in a position where we can share that.

Jorge Reyes - Craig Hallum Capital Group

Fair enough; and then a through leads to these LTE build outs in China, I know you only guide one quarter ahead but I’m wondering what kind of visibility you have on demand. Do you think this type of demand could extend through 2015?

Kurt Adzema

Yes.

Operator

Thank you, our next question comes from Bill Choi from Janney

Bill Choi - Janney

Going back to margin, I apologize for that. But given just the magnitude of what this implies, it’s indicating that the wireless application is going to be somewhere at or above 10% of revenue. I just -- it seems that such a big magnitude to impact it this much. I want to kind of understand how uniquely this application is versus any other type of datacom products and apps; meaning what are the dynamic that drove gross margin so much lower on 10 gig or LTE and is somewhat driven by competition and supply demand dynamics that is related to major Chinese build out. Why wouldn’t this competition expand to some of the other components that are also enjoying high growth? I.e. why wouldn’t it bleed out into more of the datacom WSS business?

Jerry Rawls

Most of the volume in the wireless business is at 3 gb/sec or 6 gb/sec. Now there is a little bit of 10 gb/sec; but it is a very small portion of it.

Bill Choi - Janney

So you are saying that the lower margins on this LTE application is because of sub 10 gig.

Jerry Rawls

Correct.

Bill Choi - Janney

Okay. And is this lower margin, this product uniquely created because it's very much China specific which is clearly lot of people who want to play that high volume game, or does this dynamic bleed out into other regions, other product categories, why or why not?

Jerry Rawls

Well, first of all, we didn’t create this product specifically for wireless. We have products on our portfolio that we’ve been selling for some time. They tend to be older products that we have but they are suited for the application here for the CPRI, the Common Public Radio Interface data rates. And so we didn’t have to do a lot of R&D to create these products. They were on our shelf, but because they are the slower data rates, we do have more competition and we do have in particular in these cases more competition from Chinese suppliers. So I don’t think that’s -- maybe that shouldn’t be surprising.

And how does that affect the rest of our business, well I would tell you that our older products generally have lower margins than our newer products. So the nice thing is, I think you mentioned -- earlier in your question you said, well, something about lower margins on 10 gig. Our margins aren’t lower on 10 gig. Margins on 10 gig are usually are -- because 10 gig and above are what we would consider to be high-performance products which generally carry higher margins.

Bill Choi - Janney

And these lower 3 gig, 6 gig, is that just LTE for China or will other regions, LTE deployments and backhaul also be at these lower rates?

Jerry Rawls

Other regions as well. We sell these same products all over the world and -- but I'm just telling that the largest applications are ending up in China. You've read all about the fourth generation wireless expansion in China and it’s hundreds of thousands of tower -- new LTE towers. And I think we all read a forecast here, most of us did not long ago, which said there was an opportunity for something like 2 million more of these towers to be built, just in China.

Operator

Thank you. Our next question comes from Michael Genovese from MKM Partners.

Michael Genovese - MKM Partners

Just one question from me. I want to ask directly, the higher margin datacom products that you sell, has there been any change in the pricing environment recently, that you’ve seen?

Jerry Rawls

No prices have been pretty stable there.

Operator

Our next question comes from Alex Henderson from Needham.

Alex Henderson - Needham

Just so I understand here, if I take the wireless piece, the CPRI type of modules out, am I still producing strong double-digit growth in my datacom business?

Jerry Rawls

I don’t know if it's was strong. I don’t know if it was double-digit last quarter or not. It’s sure double-digit year-on-year. It’s not double-digit quarter-to-quarter. I don’t think so.

Alex Henderson - Needham

Nobody was forecasting a double-digit quarter-to-quarter. So double-digit year-over-year is still robust strong growth in that piece. Are you seeing the impact there of any change in dynamics for that portion of your business that would cause your margins in that piece of your business to be falling off. Keeping in mind that you’ve got production capacity coming on-stream, would that production capacity coming on-stream lower the margins in that piece?

Jerry Rawls

It shouldn’t.

Alex Henderson - Needham

Okay. So you’re telling me that we’ve gone up from $266 million in July of last year to $320 million some odd in July of ‘14 and had flat EPS all because of CPRI? That seems a very large hike guys. This is very difficult for the street to grasp on to; how you could have flat EPS year-over-year based off of grasping the nettle of selling to China.

Kurt Adzema

Again I think it’s a combination of things. Again it’s the wireless which we have talked extensively here about. Obviously it’s the impact of u2t. We didn’t have u2t a year ago. And again I think there have been other -- we’ve talked about over in the last year and all of our earnings calls how a 100 gig used to be huge growth driver for us and it’s been more flattish recently. So I think the combination of those three things are affecting it.

Eitan Gertel

And telecom price reduction.

Kurt Adzema

Yes, I am sorry and obviously the telecom price reductions. You can’t -- you always have those every year. If you do the math high end of 10% - 15% range is a lot of money.

Operator

Ladies and gentlemen that is all the time we have for questions. There are no more questions in the queue.

Jerry Rawls

Well everybody, I thank you very much for tuning in today. And I look forward to hearing or seeing all of you at this same station three months from now. Have a good day.

Operator

Ladies and gentlemen that does conclude today’s call. We do appreciate your participation and please have a great day.

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Source: Finisar's (FNSR) CEO Eitan Gertel on Q4 2014 Results - Earnings Call Transcript
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