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Oclaro, Inc. (NASDAQ:OCLR)

F3Q 2011 Earnings Call

April 28, 2011 4:30 PM ET

Executives

Jim Fanucchi – Summit IR Group

Jerry Turin – CFO and Principal Accounting Officer

Alain Couder – President and CEO

Analysts

Ajit Pai – Stifel Nicolaus

Alex Henderson – Miller Tabak

Kevin Dennean – Citigroup

Subu Subrahmanyan – Sanders Morris

Hamed Khorsand – BWS Financial

Mark Su – RBC Capital Market

Operator

Good afternoon and welcome to the Oclaro Third Quarter Fiscal Year 2011 Financial Results Conference Call. As a reminder, this conference call is being recorded for replay purposes through May 5th, 2011.

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

Jim Fanucchi

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

Statements of management’s future expectations, plans or prospects for Oclaro and its business including statements about future financial targets and financial guidance and Oclaro’s plans for future operations and any assumptions underlying these statements are forward-looking statements under the Private Securities Litigation Reform Act of 1995.

There are a number of important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements, including the risk factors described in Oclaro’s most recent Annual Report on Form 10-K, most recent quarterly reports on Form 10-Q and other documents we periodically file with the SEC. The forward-looking statements discussed today represent Oclaro’s views as of the date of this conference call, and subsequent events and developments may cause Oclaro’s views to change. Oclaro does not intend and is not required to update any forward-looking statements as a result of future developments.

In addition, 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 is included in our earnings release, which we have filed with the SEC. I refer investors to this release.

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

Jerry Turin

Thanks, Jim. Revenues for the quarter ended were 116.6 million down from 120.3 million in the prior quarter and in line with our April updated revenue guidance for the quarter. Revenues from greater than 10% customers included Huawei at 18% and Alcatel at 10%. Our revenues for the quarter were impacted by inventory corrections at many of our telecom customers and by a general slowing among other telecom customers possibly attributable to caution in the phase of macro events occurring in March. We believe each of these conditions will continue to impact our revenues in the June quarter and they are likely to have a more significant impact in the June quarter than the March fiscal quarter just ended.

Even as these conditions arose within the March quarter, one major customer fulfill the portion of their original quarterly demand outlook which we appreciate however our expected revenues from them in the June quarter will be lower than will be otherwise expected with the result.

We continue to make progress in our new product introductions. We hope to have product revenue traction across many of these areas in the June quarter. However we would not expect this traction to deliver either meaningful revenues within the June quarter, our margin improvement in the June quarter in the case of new products at above average margin potential.

We do hope any related traction will help us establish our foundation for the potential second half revenue growth and margin improvement we discussed in the past. The new product introduction growth opportunities include tunable FFP, our cost size released 40 gig Gb/s, state transponder, early progress in our 40-gig here in transponder, WSS products, external modulators were 40-gig, a significant ROADM line card program and various opportunities now in high powered laser, non-telecom product areas.

Our gross margins for the March quarter were 25% compared to 30% in the December quarter and lower than expectation so roughly and proportion of the level of our lower revenues compared to original guidance. Lower sales of our component level products and an adverse impact on our overhead absorption for the quarter. We expect this will continue to be a drag on gross margins from the June quarter as we expect the effectively inventory correction on related component revenues to be more pronounced in June, again in the March quarter just completed.

In addition as you know, we took a substantial portion of our annual price reductions on January 1. On our lower revenues in March with more difficult to generate cost savings to offset this price adjustments, we also do not get the advantage of scale that would come up with higher revenues. We also had approximately 1.5 million in excess in obsolete inventory reserves, higher than typical for us in the quarter so consistent with what can be expected when demand decreases.

We continue to make progress in our ramp of high powered lasers subsequent to or fab transfer however, not due to increased volumes nor the yield adjusted margins are, yet in a level to have a meaningful positive impact on overall company results. Demand in these markets continued strong however.

Our R&D expenses were 17.2 million versus 15.7 million in the December quarter. During the March quarter, we slowed our investment ramp in R&D and so the March increase largely represents growth that was already in a pipeline. We expect to be cautious in our R&D investment in the June quarter, however we do expect to see an increase in systems with material and NRE spending associated with new product introduction.

Our SG&A expenses were 16.1 million versus 15.1 million in the December with increases in information systems, professional fees, largely tax services nature and bad debt reserves. Our cost of sales R&D and SG&A line times included stock compensation are $350,000, $340,000 and 900,000 in the quarter respectively.

Our non-GAAP operating results were a loss of 2.9 million compared to income of 6.6 million in December quarter. Our adjusted EBITDA was 1.1 million compared to 10.1 million in the December quarter. Our non-GAAP net income results were a loss of 4.1 million compared to income of 5.9 million in the December quarter.

Now on to the balance sheet, our cash, cash equivalent in restricted cash were 75.7 million at the end of the quarter, compare to 78.1 million at the end of the December quarter. Accounts receivable were 96.4 million, compared to 105.7 million at the end of the December quarter.

Inventories were 87.5 million, compared to 82.8 million at the end of the December quarter, with the increase primarily associated with the changes in customer demand within the quarter, increases in our 40 day transponder business it continues to be strong and also ramping of high power laser production subsequent to our fab transfer.

Fixed assets were 64.8 million, compared to 54.1 million at the end of December. CapEx was 14.2 million compared to 11.8 million in the December quarter.

We expect CapEx to be within the similar range over the next couple of quarters largely in association with expected new product introductions. Depreciation was 4 million compared to 3.5 million in December quarter. Current liabilities were 111.6 million compared to a 107.3 million at the end of December we continue to be debt free as of the end of March. Our share count at the end of March was 48.6 million basic and diluted.

Now let me reiterate our guidance for the quarter ended July 2nd 2011 as stated in our press release today. We expect revenues in the range of 105 million to 115 million. We expect gross margins in a range of 21% to 24%, we expect adjusted EBITDA in a range of negative 6.5 million to negative 1.5 million.

Let me hand it Alain now.

Alain Couder

Thank you, Jerry. As Jerry addressed explained to you we went through an industry which has experiencing inventory correction in this type of market remain quite strong you know. We expect the question to team (ph) prosper as well and not only the mass profit. And our customer continued to sort out inventory situation. We have not experienced at this point in time any impact from the tragedy in Japan but we continue to carefully evaluate any potential impact on our first and most of (indiscernible).

This is kind of the background. When we set the initial guidance for last quarter, it was based on bullish forecast on some of our tough customer and I would like to point out that certain of our major customer were helpful in fulfilling a substantial portion of the original forecast and even as that demand were reduced during the March quarter. Therefore they may have been down some inventory beyond the immediate current quarter need and as a result, we believe our June quarter was also impacted by this customer use of that current inventory.

So without the profits of these key customers in the March quarter, we would have had a lower March quarter and we believe that we would be getting up for the June quarter. So therefore we believe this is an additional indication that the demand has hit bottom and that’s a key point as I discussed and we discussed and we talked to them, I think they have a very open discussion with that and we are clearly looking at that very carefully on a weekly basis.

So despite these inventory correction, we believe the fundamental of the silicon markets remain very strong. You know there is a demand for bandwidth, the demand for latency, the demand for new application all of those things create heavy demand on the core optical network where we are focused and I think some customer tell us that they are confident that going to resume in the second half of calendar 2011. In the meantime let me repeat that non telecom industry and consumer market remains quite strong. So the rest of the year Oclaro will start ramping several new products and that’s a key element for the second half of the year. Several of this new products to have broader range gross margin.

Mintera acquisition it clearly starting to bear fruit the 40G DPSK product that we inherited from them continues to grow in revenue and we also expect to start selling this summer the first 40G coherent transponder. We know that the coherent ventilation is a modulation of the future that is going to be introduced at (inaudible)that will be the only modulation that will be used at (inaudible)So we believe that through the 40G and the Mintera acquisition we have to establish a leadership position in the 40G space and in particular we have know-how in building 40G module that we believe is unique.

It is worth nothing that in the December of 2010 this was the first time that in DWGM (ph) long haul revenue as the size of the market strategy as which is same level as energy market. So now most market are above the same size. We expect the energy to stay flat where we expect 40G to continue to grow.

So that’s an in-process element of the market because we have invested heavily in strategy module as I mentioned before but we’re also investing in many components for our 40G like iTLA, laser diode, tunable discussion compensation, 40G modulator and some of those are new product introduction that will be contributing to our growth in the second half.

So we are quite bullish about the 40G market. This being said, we believe the 10G market remain a very good market for Oclaro. We have aggressive plan to ramp our Tunable XFP product in the second half. We are keeping this product but in can of limited quantity and we are fully equipping infrastructure to start ramping up this product quite aggressively in the second half of 2011.

The market adoption of Tunable XFP is now obvious and which has a significant revenue potential. Although we expect that 10G is flat overall. We are seeing that the TXFP is going to become the predominant solution to 10G transmission in the data quality space (ph) and we are well position to take advantage of that.

Regarding the Xtellus acquisition, last quarter I was telling you that we started shipping two customers WSS, this quarter we are starting to ship, not only the WSS itself but we also starting to ship – that means the amplifier that include the WSS and we think that this is very meaningful revenue potential for us in the second half of calendar year. And this is going to give us an expanded portfolio in this area.

The challenges that on a different market, the telecom market as you know we experienced some significant challenges in moving the (inaudible)fab to our (inaudible)fab, the transfer of our product line from to Europe is now mostly behind us, and we believe we are well positioned to begin serving and increasing demand in this market for high power lasers. We did that not only the traditional market but as we discuss the (inaudible) six months ago, we also see a new market opportunity around that, now we are already to sell those market.

So, well, these inventory correction was happening and in the past few quarter, as we discussed in the past, we have heavily invested in R&D and we are heavily invested in manufacturing infrastructure, to be able to scale the company. And we have been focused on executing on new product introduction. And as a result of that we are now qualified with customer on the several new products. And we are ready ramp production for the second half of this year on those new programs. So these increase in R&D, this increase in manufacturing although obviously been impacting our profitability. Already this quarter the revenue production low we are cutting on expenses and we are imposing on scaling R&D and infrastructure.

And as we expect the inventory correction in the telecom market to end this summer as I said before its increased the market demand as broadened by now as a result of that we will be continue to manage the company in a conservatively a conservative way until we know for sure that the growth has come back.

I mentioned last time also that we had put in place a new organization. And it’s now fully operational I also mentioned that we were investing in process improvement. And we launched this program in January and it’s well underway. It will be completed in the next few quarter and we expect those efficiencies to contribute our goal of improving gross margin in the second half and beyond.

So in conclusion although the results today are disappointing we feel that we are well positioned to take advantage of the growth coming back in the second half of the year and we have plan in place to improve profitability in the second half of this calendar year.

So thank you, I think we can now open for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Ajit Pai with Stifel Nicolaus. Please go ahead.

Ajit Pai – Stifel Nicolaus

Couple of questions, the first one is just a new products that you are talking about, the ramp in the September quarter, could you give us some color as to broad quantification and sort of dollar terms what that could potentially be if you look at the combined contribution of TXSP and the RODM business as well as some of the other modules on the 40-g side that I knew that you are talking about just to get an idea of how much they could contribute?

Jerry Turin

Well I think the way to look at that is obviously we are not going to go to September of product-by-product. But if we go back to the December quarter, there Analyst Day and other context, we talked about the potential for 30 to 40% growth December-on-December.

Certainly to approach that level, this December we need to see some turnaround from the inventory correction and pickup in general demand, but as you recall a big driver in that with a very product series you are talking about and so why I can’t give you a quantification for September I think and still aiming to achieve that sort of growth potential if we execute on the new products and if there is the turnaround in the inventory correction quickly, and I think we’ve talked about it fairly even proportion across many of those products as far as the opportunity from those different areas.

Ajit Pai – Stifel Nicolaus

So right now you are not taking back your December on December growth forecast, is that fair?

Jerry Turin

Well I think would caution that as always it’s a factor of general market conditions as well as our new product execution and certainly we have to get beyond some of the softness we see in the market right now and as Alain said while weak indication that we think it bottomed and that there should be upside from here certainly that needs to manifest so you need to have both of those work.

Ajit Pai – Stifel Nicolaus

Okay. And the second question and then I’ll get back in queue, just in terms of pricing you did talk about sort of taking a hit in January which is normal every year but given the inventory situation and given supply exceeding demand across many-many products, have you seen any change in the demands and pricing from your customers?

Jerry Turin

No other than the contractual start of quarter pricings that we’ve talked about before in fact when we were doing our January call we didn’t see anything – incremental during that quarter and we didn’t see any changes in those conditions with the result of the inventory correction.

Ajit Pai – Stifel Nicolaus

Got it. Thank you.

Operator

Thank you. Our next question from the line Alex Henderson with Miller Tabak, please go ahead.

Alex Henderson – Miller Tabak

So $1.5 million reserve in the quarter is obviously higher than normal for the write-off in inventory, are you assuming a similar kind of hit to the gross margins in the upcoming quarter or should we assume that that’s one time in nature in the current quarter?

Alain Couder

I would think it’d be largely one time. Your demand takes a step backward and now it impacts your determination of ENO. If you are flat it is slightly down in June as we described that doesn’t really represent subsequent to lot of defining market conditions. So on a one-off basis we could always have some exposure one way or the other. I would think that the 1.5 is largely isolated. It was a number of small items but I don’t think I would expect that in June at this point.

Alex Henderson – Miller Tabak

And second question you had talked about getting up to 35% margins if you were at the December level result that you had prior indicated that was your target. Is that still what you would expect to occur if the conditions rebound and you were in table to hit those targets?

Jerry Turin

So I think we’ve always described them as targets and we got back to those revenue levels with strong market and with the new products. We certainly continue trying to target towards that. But to be frank as you go through quarter and then into another quarter with this off market, the steepness of ramping into that becomes more of a challenge so I think we are internally going to continue driving towards that. Certainly there is some variability in the opportunities to get to that level.

Alex Henderson – Miller Tabak

I take that as a probably not even if you were to get back to those original targeted revenues for the fourth quarter that the margins would still be under some further pressure then where they would have been otherwise, is that the right way to think about it?

Alain Couder

It’s just too difficult to cut it that fine, right, I don’t think, I have opportunity out the window, but certainly it was always the challenge to get there, and it continues to be a challenge and certainly no less of a challenge.

Alex Henderson – Miller Tabak

Okay. One last question and then I’ll the leave the floor. We’ve heard positive comments from least a half a dozen contacts in the industry about comments about Huawei about reaccelerating orders does this seem the sharp reacceleration of demand from China Mobile, China Telecom and China Unicom, can you talk about a little bit how you see this play of the pressure in the June quarter, is it a function of the Chinese inventory correction which was described at 65 to 70% of the weakness in the market back in March or was the weakness broader by geography, how do I think about Huawei is indicating they are coming back, you’re indicating this software sequentially and to what should be your seasonally stronger June quarter?

Alain Couder

The first of all in the last quarter, the inventory correction was broader than China. There were other customers, operating in North America and in Europe but as some inventory correction; there is not only China, but probably the biggest one, that it is not the only one.

Alex Henderson – Miller Tabak

Mostly 65%, is some other venders that they suggested?

Alain Couder

Yes, I think the 60% that is correct.

Alex Henderson – Miller Tabak

So in the June quarter, would it be a similar play, or is it a different supply than that?

Alain Couder

Right now we are seeing – when we interact with customer and in China in particular we are seeing little less uncertainty of the forecast at this point in time that also is still low like I said we’re seeing that we hit the bottom.

Alex Henderson – Miller Tabak

I’m sorry what?

Alain Couder

We hit the bottom of this market demand decline I mean now the market demands to go up.

Alex Henderson – Miller Tabak

Yeah let me repeat the question is the supply of weakness in the June quarter the same as it was in the March quarter or is it you’ve experiencing something different in terms of the mix, in terms of geography of demand?

Alain Couder

Not really there is nothing significant difference.

Alex Henderson – Miller Tabak

Thank you.

Operator

Thank you. Our next question comes from Kevin Dennean with Citigroup. Please go ahead.

Kevin Dennean – Citigroup

(Inaudible) plus the back half of the year and hearing Alain’s comments loud and clear about thinking that you’ve hit the bottom on market I guess other than customers taking product that they don’t necessarily need. What tangible data points or thoughts can you offer us to give us comfort and the outlook for the back half of the year seeing a significant pickup.

Jerry Turin

So as far as we are concerned when we get a month of the second half in new product introduction. But at the same time when we wrap with procurement organization of our customer line by line is about two weeks you know. We see that they have done their homework in terms of inventory they have on hand today. And much better visibility of what’s in it, so we do expect that not on every product, but on most of the product, demand is going to come back into second half.

Kevin Dennean – Citigroup

Okay. So can you give us a sense for where your lead times are in aggregate now versus where they were, say three months or six months ago?

Alain Couder

Right now with the – all the investments we have done in capital equipment and in infrastructure cost as that Jerry described before. We clearly have the ability to ship much more than we were able to ship last year and as a result of that our delivery time is much better and we can take advantage of any fixed BTs or days of the market.

Kevin Dennean – Citigroup

Well Alain, can you quantify it or we are at six week lead times versus maybe 18, if you go back two quarters, are we somewhere just – ?

Alain Couder

I think lead times are at bottom levels. I think we give people more confidence.

Jerry Turin

We will get it differently. That means in some product launch last year, we were just capacity limited and in lead time issue we just didn’t have the test equipment in place to produce more. So we are too much – the lead time issue is the capacity issue. I think right now we do have the capacity to produce, thanks to this significant investment that we made in the first – several quarters. And in term of lead time we are back to what I could call normal lead time which varies from two to eight weeks depending on the product lines.

Kevin Dennean – Citigroup

Okay. Just one quick follow-up Alain and then I’ll drop back in the queue. You mentioned I think that customers have really done their homework and scrub through inventory, where would you tag inventory levels for your customers, however you want to step, is it in terms of coverage versus their forward looking business are we month of inventory on hand or weeks of inventory on hand?

Jerry Turin

No, with most customer we are talking about something that will be recovering in the second half, that means that we started during in the second half.

Kevin Dennean – Citigroup

Okay. Thanks very much.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Subu Subrahmanyan with Sanders Morris. Please go ahead.

Subu Subrahmanyan – Sanders Morris

Thank you. I had a couple of questions, can you talk about you had some commentary when you preannounced about order uptake ended the quarter some (inaudible)that maybe it will be more flattish, how the first part of the quarter has inspired, and you talked about some customers taking in revenue that they promised and I would have moved the numbers around how much lower mark would have been, that – kind of percentage to June that had not happened?

Alain Couder

Well, on the orders, at the end of last quarter we saw few weeks rather than a pickup in orders, I think we’ve seen little bit soft orders in the early part of the quarters, so far, but at the same time that’s not unusual to have valuable orders in the first couple of weeks, so I think, that premise that your flattish quarter on quarter was maybe a little bit of downside in June relative to March is the result of the timing of some of the customers maintaining some of the inventory commitments Alain talked about. I think you end up with kind of a balanced demand wise so a one-to-one book to bill is kind of consistent with that.

As far as specifically quantifying amount I don’t think we can get into that and it’s difficult to call anyway because then you’d be making a 100% sort of assurance that, that those specific numbers would have been realized in the next question. And I think we have to be somewhat – somewhat general in pointing out that dynamic but I think it’s very difficult to be little precise.

Subu Subrahmanyan – Sanders Morris

Understood. And then has been referencing couple of times why we use (inaudible)I got the number right but 18% of revenues did I catch the right Jerry?

Jerry Turin

That’s correct –

Subu Subrahmanyan – Sanders Morris

That’s about flat sequential versus last quarter when it was – it was in the December quarter where it was 17% of revenues. I’m just trying to understand the concerns and while it sounded like on the dollar amount basis they were flat versus your volumes being down. And how we should think about that?

Alain Couder

Well I think in Alain’s early part of Alain’s commentary he talked about number of customers very bullish on the March quarter. You know hence why they are now initially had any inventory correction we had guidance up in March which is historically the weak quarter as you know. So certainly there was a retraction of that bullishness not just across one customer but our costs across in P&L more than one customer as Alain mentioned.

Subu Subrahmanyan – Sanders Morris

Understood I was just trying to understand how (inaudible)flat when we talk about kind of the yours consensus – lower expectation was in sound like you always expected much more, I was just trying to have some color on how (inaudible)was flat in terms of the non-quarter and without those?

Alain Couder

Like I mentioned, some major customer have been very helpful in fulfilling a substantial portion of the original forecast and we are always one of them.

Subu Subrahmanyan – Sanders Morris

Understood and last question, Jerry did you (inaudible)book-to-bill and learn can you just broadly talk about visibility and trajectory of improvement in second half, in September seasonally now from quarter from quarter, so what kind of trajectory of improvement should we think of for second half?

Alain Couder

Well I’ll go back to what I mentioned to one of the other guys was – the factors right are – if the correction starts picking up at the end of the June quarter, what sort of market growth rate expectation will that imply and then you are familiar with each of the product areas that we’ve talked about from an NPI point of view and you are familiar with the sort of targeting parameters, the profitability’s we’ve sent out for December.

So other that kind of putting those out of the tool and everyone is kind of free to figure out what they think the growth rate coming off and inventory correction is and exactly what point in time they want to start that trajectory. I don’t think I can be specific as far as exactly what that angle looks like, but between the opportunity for the inventory correction to pick up in the second half, plus the various new product opportunities that’s how in some we’re comfortable that at least this point in time that we expect a second half pick up, but again to apply a trajectories to that would be pretty mature.

Subu Subrahmanyan – Sanders Morris

yes, I think as it was in our pre-analysis it was one to one in telecom and it was higher than that in non-telecom and I actually don’t remember on a blended average basis to uplift a number, but those are the two relevant data point, Telecom one to one which were revise relatively flattish which is barely consistent with what we’ve talked about today and non-Telecom higher than that but we’re still improving the yield and getting things on the right trajectory upwards from the fab transfer, so you’re limited to the ability, you’re going to be able to deliver that demand robustness, but we feel good about the progress, we’re making there, we’re not all the way back there, but we’re making the progress on the high power lasers.

Subu Subrahmanyan – Sanders Morris

Thank you.

Operator

Thank you. Our next question comes from Hamed Khorsand with BWS Financial. Please go ahead.

Hamed Khorsand – BWS Financial

Hi, if you could quickly go back to inventory and talk about what steps you’re taking to reduce down in inventory?

Alain Couder

Sorry. Our inventory specifically are you talking about working with them.

Hamed Khorsand – BWS Financial

On the inventory. Your inventory specifically.

Alain Couder

Right now, we don’t happen in the second half, we are going to need the inventory, so we each will need the stakes for us, to reduce inventory right now that we used inventory and make sure that is the right inventory we are clearly walking on an usual business on day to daily basis, but we are very expecting growth in the second half and that we are having to need this kind of level of inventory.

Jerry Turin

And in fact Neil let me add a little bit of color. It is important to breakdown the inventory. Some of the inventory growth is been in 40 gig modulator, modules certainly the transponder products that are ramping nicely and the demand has continued to be strong on that. So as you ramp the business of Mintera that have been quite low levels before we acquired them in the September quarter last year. Certainly you are seeing inventory growth associated with that brand new product line that’s ramping at a pretty significant level. And also with the fab transfer where we shut down the Tucson fab last year.

And we’re bringing that production up within our Zurich fab well we are replenishing the inventories and the work in progress. So those two things are really substantial portion of our inventory increase. And then to the extend we have been building inventory early in the quarter anticipating higher revenues well you all have told (ph) in a bit of that as well. And therefore you manage yourself as tightly as you can over the next quarter or so as the customers turn the orders back on in our work through their inventory and get back into those things. So other than managing conservatively and focusing on the products where you expect strong second half demand I think we’re in fairly reasonably control of our inventory levels.

Hamed Khorsand – BWS Financial

Okay so the levels of inventory still go hand in hand with the conservative manufacturing management?

Alain Couder

Yeah they just go for instance let’s take an example of 40G for instance the initial 40G DPSK that we narrated from Mintera was (inaudible)so they are carrying the inventory. The new (inaudible)that we suffered shipping this quarter is building in our own factory, so try all the inventory on our book, so we have some of this going out as well.

But just to clarify what I think your question may have been, about – at least 60% of our backend is internal and then we control all of our fabs. We have three wafer fabs, so the substantial portion of the inventory is manufacturing work in progress finished goods and to the extend there is raw materials, those operations, so it’s not like a – an entire subcontract manufacturing relationship where that – inventories fitting in the warehouse.

Hamed Khorsand – BWS Financial

Okay. Is there a revenue point where you can say that the new manufacturing structure is going to breakeven? Or do you not go off revenue with that?

Alain Couder

The new manufacturing structure – I didn’t get your question.

Hamed Khorsand – BWS Financial

What the way you are saying – the wafer fabs and the 60% backend and the work in progress, the built-up in inventory being work in progress parts and materials, is there a revenue point where you think this is the number you have to sale to breakeven with this structure?

Alain Couder

Probably, it’s a breakeven probably in the low 120s.

Hamed Khorsand – BWS Financial

Okay.

Alain Couder

That’s not a substantial ramp to get back to the profitability. We had some margins set back this quarter, but specifically in November and December we did 120 and we made about 6% of our operating income. So we’re going to have to have a dramatic increase in scale to show improvements in the margin point of view based on leveraging those fixed cost.

Hamed Khorsand – BWS Financial

Okay. And my final question is, you could give us some color, if you think of the market it will possibly go to 100G more quickly now than before?

Alain Couder

No, we don’t think so, there is some nine calculation by Ciena, Alcatel first situation like that, but right now if you want to get the module level this – that’s are available at 40G and this we paid quite a lot of power, and also there is some chips that we can be available at 100G we still don’t see any volume deployment of 100G, because the late 2012, 2013, so there is plenty of time for more 40G deployment.

Hamed Khorsand – BWS Financial

Okay. Thank you.

Operator

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

Mark Su – RBC Capital Market

Thank you, gentlemen, I was just wondering, is there any chance of inventory lessens if we do see an inventory correction processed for more than one more quarter or are we had a point where, there is enough demand and there is enough diversification so that’s high demand likely?

Alain Couder

I don’t think it’s very highly likely Mark, as Alain said, we think the demand has hit the bottom point, whether it continues flat or whether it stop, we should be okay shape from the inventory point of view and to the extent even in this quarter, where we took reserves it was accessed over a certain period of time demand as appose to lessons, we don’t have a very, we have an even within our 10-gig products and our non 40-gig products we have a fairly contemporary sort of product set. So we’re not seeing in a lot of product areas that are very all poised to go off to reach a base on technology changes or so forth.

Mark Su – RBC Capital Market

Okay. That’s helpful. And as we see this return from the customers which were weak in the prior quarter are you seeing a blank order in terms of the return or is it kind of broad based return from Huawei and the others or is it more regional. Any granularity on just kind of the return of this, this would be helpful.

Alain Couder

No I don’t think we – the clear visibility on which front is going to return first, we take that by customer and not geography. And right now we are seeing some corrections on most of our major customer at this point in time. We have a few customer who are clearly increasing revenue because they have been successful in wining new network requirement. But that’s not a way for us in telecom it’s based on the winning network determent. Then by geographies you know.

Mark Su – RBC Capital Market

I see okay. Thank you gentlemen and good luck.

Alain Couder

Thanks Mike.

Operator

Thank you. And I am showing no further audio questions at this time. I’ll turn the call back to Mr. Mr. Fanucchi for any closing remarks.

Jim Fanucchi

Thank you operator. And we look forward to speaking with all of you again when we report our June quarter results. Thank you.

Operator

Thank you ladies and gentlemen that this does conclude our conference for today. We thank you for your participation. And you may now disconnect.

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