Oclaro's CEO Discusses F4Q11 Results - Earnings Call Transcript

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Includes: OCLR
by: SA Transcripts

Oclaro, Inc (NASDAQ:OCLR)

F4Q11 Earnings Call

July 28, 2011 4:30 p.m. ET

Executives

Jim Fanucchi – Summit IR Group

Jerry Turin – CFO and Principal Accounting Officer

Alain Couder – President and CEO

Analysts

Ehud Gelblum - Morgan Stanley

Ajith Pai - Stifel Nicolaus & Company

Kevin Dennean – Citigroup

Alex Henderson – Miller Tabak

Dave Kang – Business. Riley & Company, Inc

Natarajan Subrahmanyan – TheJudaGroup

Nathan Johnsen – Pacific Crest Securities

Chris Glancy – Avondale Partners

Operator

Good afternoon and welcome to the Oclaro Fourth Quarter and Fiscal Year 2011 financial results conference call. As a reminder this conference is being recorded for replay purposes through August 5th of 2011. At this time, I’d now like to turn the call over to Jim Fanucchi at the Summit IR Group. Please go ahead sir.

Jim Fanucchi – Summit IR Group

Thank you operator and thanks to all of you for joining us. Our speakers today are Alain Couder, Chairman 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 10K. 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 does not require to update any forwarding looking statements as a result of future development.

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 measure is included in our 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 Jerry.

Jerry Turin

Thanks Jim. Revenues in the fiscal quarter ended July 2, 2011, were a $109.2 million compared to a $115.7 million in the prior quarter ended April 2, 2011. The decrease was consistent with our last earnings calls discussion on market dynamics and the related inventory correction. Revenues in our 2011 fiscal year which ended July 2, 2011, with $467 million compared to $392 million up 19% which represent a significant year-on-year growth even though that growth has taken a time out in much of this year due to corresponding slowness in the telecom optical sector.

Major customer revenue is greater than 10% for the quarter. For Fujitsu it's 17% and Huawei at 10%. Both Alcatel-Lucent and Ciena were just under 10% this quarter.

Fujitsu has risen into the major customer category on the strength of 40-gig transponder sales as well as strengthened the customer amplifier product. During the June quarter, we recorded early revenues on a series of new products including our Tunable XFP Transceivers, 40-gig coherent transponders, 40-gig external modulators, and an integrated ROADM line card. In aggregate, these revenues were below $1 million. However, even these modest revenue levels establish important traction on the related revenue guidance.

While we do not expect dramatic ramps of these products in September, which would have been the expectation coming into this calendar year for some of the products, as of now we believe the potential aggregate revenues in the December quarter from all of our 40-gig transponders our tunable XFP, our 40-gig and 100-gig modulators and our WSS ROADM related products, could be in total groups of products in the $25 million to $30 million range. While we are beginning to see some progress on these new products, the overall markets for our telecom optical product has continued to be soft. Alain will elaborate on our current visibility including the mixed signals we are seeing on this front and broader market condition later in the call.

Outside of the telecom market revenues from our high power laser business were up $1 million was approximately 10% quarter-on-quarter. Demand for these products remain strong. We expect similar revenue increases in this business in each of the remaining calendar quarters of 2011 and expect related gross margins to continue moving towards pre-fab transfer levels.

Total revenues from our non-telecom product including these high powered lasers, our filters, and our high volume VCSEL products for consumer applications were $15.1 million in the quarter compared to $13.7 million in the prior quarter. Our overall gross margins for the June quarter were 23% compared to 25% in the prior quarter. The gross margin in the June quarter includes over $3 million for excess and obsolete inventory reserves and related charges.

Our gross margins in June have also been impacted by lower wafer fab overhead absorption caused by a decline in revenues from our photonic components products that tend to be at the package chip level during this current period of market softness and inventory correction.

Currency exchange also add close to one point adverse impact on our June quarter gross margin. The impact was primarily associated with European currencies, in particular the Swiss Franc. At this time, we don’t expect to see meaningful gross margin improvement in the September quarter for the following reasons. We did not yet see a meaningful recovery of the component level product revenues, which I just referred to in the September quarter.

With our inventories up and our revenues relatively flat, it is taking longer for us to realize the benefit of cost improvements in our product. This means we have to sell the (inaudible) cost products already in our inventory first prior to realizing the benefit of any recent improvements in the cost of making these same products.

In some cases, we also see related delays in getting our own Oclaro components into vertically integrated products. At the same time, customer price decreases continue right on schedule with a top competitive environment among our customers reinforcing pricing pressure. The disconnect between timing of our cost improvement and timing of price reduction is not helpful for gross margin to say the least. And finally, we don’t expect a significant enough ramp of higher margin new products within September to move the needle on overall company gross margin.

Moving on, R&D spent was $18.9 million compared to $17.2 million in the March quarter. We continue to invest in R&D through the initial slowness in our telecom market. However, as the sluggish market is persistent we have fall back on our R&D ramp. This June quarter we did continue to have heads come onboard from requisition filled earlier in calendar 2011 and we also saw increased spend on materials directly associated with new product introduction. We also saw approximately 300,000 of ad (inaudible) back on currency exchange. Otherwise, our R&D was relatively flat and we plan on holding R&D flat in the September quarter. Ultimately as revenue growth returns, we expect our R&D to move back towards our 13% of revenue target.

SG&A was $16.7 million in the quarter compared to $16.1 million in the prior quarter. Currency exchange impacted SG&A expense in the quarter by approximately $250,000. Our stock compensation break ups for the quarter was $370,000 in cost of sales, $360,000 in R&D, and 940,000 in SG&A. Our non-GAAP operating loss for the June quarter was $9.4 million compared to $3.3 million in the March quarter.

Our non-GAAP operating income for the 2011 fiscal year was $1.6 million compared to $15.7 million in fiscal 2010. Year-on-year changes in our operating results were largely a function of our continuing to increase our investment in R&D, which was up $24 million for the year. In addition, depreciation, a reflection of capital investment to support new products in our scalability as a company was up $4.5 million in 2011.

This is also the time of the year when we perform our annual review of intangible asset evaluation. This process led to a good rule impairment charge of $20 million in the June quarter associated with our December 2009 acquisition of Xtellus. The corresponding analysis leading to the charge was largely based on the companies market cap and therefore recent declines in our stock price had a material impact on the magnitude of this charge.

Now on to the balance sheet. Cash and restricted cash at the end of the quarter was $63.4 million compared to $75.7 million at the end of the prior quarter. Our accounts receivable was $92.9 million compared to $96.4 million at the end of the prior report. In the last six months, our DFOs have improved from 80 in December to 59 for this June quarter.

On the other hand, our inventories increased to a $100.2 million from $87.5 million at the end of the prior reporter. Our returns are now under four, which we do not consider to be acceptable. Inventory reduction is one of our key internal objectives in the second half of the calendar year.

Our fixed assets were $69.4 million compared to $64.8 million at the end of the prior quarter. Our CapEx for the quarter was $9 million down from $14 million in the March quarter. We expect our CapEx to trend around $9 million a quarter for the remainder of the calendar year. We continue to have no debt on the balance sheet. On July 26, we signed an extension of our line of credit facility through August 2014. We also increased the amount of the line to $45 million from $25 million. No amounts were drawn against the line as of the end of the June quarter. Our share count for the quarter was $48.8 million and is expected to be at a similar level at the end of the September quarter.

Now before handing over to Alain, let me reiterate my press release, our guidance for the upcoming quarter ended October 1, 2011. We expect revenues to be in the range of a $103 million to a $113 million. We expect non-GAAP gross margin to be in the range of 18% to 24%. We expect adjusted EBITDA be in a range of negative $8.5 million to negative $2.5 million. Alain?

Alain Couder

Okay. Thank you Jerry. So, the first quarter for 2011 has no surprises. The quarter came as expected and within (inaudible). But the revenue were down on the quarter and gross margin was constrained due mostly to continued inventory correction in the optical market and I will come back on this point later on. As you recall, we are focused on two markets, the core optical network for telecom where we sell component module and subsystem and the high power laser market, which we often refer to as non-telecom.

So, this high powered laser market is quite strong right now. The laser show in Munich recently indicated a lot of energy. The material processing portion of this market is really concentrating on fiber laser and with our BMU25 that’s 25 watts with three laser is kind of a unique product right now and with very good traction. We also have a very good traction in the cosmetics field both in hair removal and wrinkle reduction in the doctor office, in the spas, and they use a combination of fiber laser and (inaudible). And in producing those product, the education continue to improve and the problems that we had with transfer of the fab seem to be now mostly behind that. So with that all of the high power laser is stable, growing, very nice business to have with good margin.

The other part is the telecom market and the core optical market. There the situation is not as stable as you know and the signals from customer are mixed. I felt a very short term visibility. Most of our customer don’t have more than one or two month of visibility and we get all that late in the cycle with a two to four week delivery. The good news is that recently I got a couple of escalation for more product of a given type, which didn’t happen in the past six months, where it was always cancellation or moving (inaudible) later in the year. At the same time, we see that some customer who have reduced our forecast from months ago in a significant fashion.

So I think this volatility that there is in our customer base is due to certainly because of uncertainty of the debt sitting both in Europe and in the U.S. and also a soft test result in the carrier, CapEx as a result of that and you probably arrived as a lead. The recent announcement by Dell Labs, Alcatel-Lucent and Juniper, which certainly didn’t have excellent news around that. So we have to operate in this environment with a lot of necessity to be able to be very reactive and serve our customer as flexibly as possible.

On the other hand, what we believe is that this market driver for this market are there now, very strong you know. As you remember, the gross there is on video services and NetPix continue to download more and more as an example. The adoption of cloud computing continue to expand that mean having your service in the cloud is more economical and more effective way to run information systems and to have your own services inside the company. So that continue to grow, and the deployment of network by major service provider continue as well. They are building their own network and there are new sets of customer for us as well, and clearly they create more bandwidth and low latency as a result of that.

The order flow is reasonable that means that telecom book to bill last quarter was 0.96 of telecom to 1, and if we have the backlog that we had in our 40G coherent product, we have about a 1-1 order backlog, which is in line with the guidance that Jerry just announced.

If you look at the various aspect of the core optical network, first of all let me tell you that the 10G market is far from being dead, in fact it is being reactivated mostly for metro application. Recently, we got more request for more 10G modulator, more request for transponders, more compactor, and obviously the tunable XFP demand continue to be strong. And there we started to come to market with this product as already said, but we are also coming with better version of that so-called zero shock (ph) market that will have the same performance as the small form factor transponder and that we should be quite well positioned compared to competition.

If we look about 40G, 40G all the modulation technique are now out with the so-called DPSK DQPSK and more recently the coherent. We started to ship a few transponder to the first two customer last quarter and we should start ramping this quarter. At the same time 40G is the market where our customers are fighting for market share. We see a lot of pricing battle between our customers on 40G. We have even seen in China some coherent solution being able to beat on price some older DQPSK solution. So it's extremely competitive market. At the same time we expect the combination of old modulation technique and coherent to continue 50-50 for the next couple of years. So the components that we sell in both spaces will be a good business to us in addition to our module business.

The 100G is certainly being deployed as the line card level by some of our customer like Ciena or Alcatel, but the module level and the volume deployment doesn’t seems to be able to happen before 2013. Some chips that are out right now but the consumer has lot of power. To give you an example, a 40G chipset is in the 25 to 30 watt chip. At 100G there are certain things that right now are in the 60 to 80 watts so that’s a lot of power to dissipate. So we still have a lot of technical problem to resolve to be able to put that into a module. So that’s why we do not anticipate volume deployment before 2013. So there is about two years of life for the 40G ahead of us, and we are quite well positioned in this market.

In addition to those transponder component you have all the amplification and switching that is in line with that. you know, the so called coherent magician that simplify transmission and cohesion of impairment on the fiber. So there is more of that that is being deployed.

There is new amplifier being invented to satisfy that market while more tradition market continue to deploy. We also see differences by region. For instance in Europe you have a lot of old fiber in the ground. So coherent is an important modulation technique to make a difference. While in Asia most of the fiber is fairly recent and can have little distortion and therefore can use the older modulation technique. So this is clearly being deployed all across the world.

So, in summary, whether we say - there is erratic session in volume and mixed customer by customer product and segments, we see a major variation of volume of other from one – from the same customer from quarter to quarter and we also see a lot of mixed evolution because as I mentioned before their visibility is very short, in weeks if not in months. As a result of this quite competitive environment specifically 40G that I mentioned before, we see increased price pressure. Obviously, there are two things that felt our customer (inaudible) 40G, but in addition to that because volumes are down more of us in the optical component industry want to get the volume. So our customers take advantage of that and come to us and say why don’t you give us a better price and we would give you a better allocation. That’s the game that is being played and as expected in this kind of environment.

So as a result of that we expect the September quarter to have a financial result relatively flat sequentially and with uncertainty that I mentioned for the core optical market, but we should see a nice growth as Jerry said for the high power laser market that we sell.

So if we go back in history for Oclaro in 2009 fiscal year it was mostly about strategic acquisition, expanding our product portfolio, strengthening our system expertise. In fiscal of 2010 it was about the integration, innovation, and scaling. We had very nice growth at that time, but in 2011 we have really been focusing at the structuring and energy norms of company to be able to innovate faster that means faster time to market with more R&D and better processes having also the capital equipment in place to provide affectivity to our customer and also the processes that are necessary to scale a company from $500 million up to $1 billion and more. So those investments have been made in capital and in people and in processes.

I think we have now the R&D in place. As Jerry mentioned we increased R&D by 50%. As R&D people come on board, it takes some time for them to be productive. Now they have been on board for on the average six to nine months so they are fully productive. So in fiscal year ’12 we should be able to leverage that and have a very good new product introduction momentum, which is one of the pressing demand from our customer, be on time with your new product introduction.

We are also focusing this R&D where we have differentiation from our peers. I mentioned the BMU25 for the power laser market, which is a fiber laser delivering 25 watts and we are also working on the more powerful version of that. Obviously, we have a 40G offering and coherent module in particular where we are very well positioned. We have some interesting differentiation and innovation coming in our phone (ph) business and we are also probably going to be among the first to market with WSS (inaudible). For instance we’re about to sample this quarter a 1/23 WSS to a customer.

So that means that our new product introduction pipeline is in good shape and it's starting to bring in new and differentiated solution to the market. We are also well structured to grow and increase profits as the telecom market recover and we certainly do that on a continuous basis on the high power laser market.

So we made the significant investment in capital equipment. You saw that in our CapEx number even if we are down to $9 million from the 14 before, $9 million in quarter is still a significant number. And I mentioned last time that we hire the PRCM dual path (ph) put in place in the company as the best practices. Most of those best practices are now in place. Most of this program will complete by the end of August and we will have only a few thing to finish later on in the year and that’s where we position us very well for this fiscal year.

We have other critical skills that we are missing to our leadership team. You have seen that with the new executive team. With Gray William in operation and Bob in as a CIO joining us in January, as well as Terry taking expended function. Terry was CEO of Mantra before. So that is a very strong executive team. More recently we decided to go leaner with executive team. So, I decided to regroup sales and marketing and Eve Lamento (ph) was strategy and business development, but Eve used to be our sales VP in the Bookham timeframe. And he will be focusing on the increasing strategic partnership with our major customer, but also continue to impose the ease of doing business which I believe is absolutely crucial for a long term relationship and stable relationship with customer.

We also made some changes in our board. We are very pleased that we had McKesson (ph) join us. She is next Sun self executive in charge of operation services and customer advocacy. And she is a great addition to our board. She will help us in every aspect where she has experience. We also appointed George Mittal (ph), the lead director in our board. Joel is a very seasoned board member. In fact he has been associated with Avanex and Oclaro for more than 10 years and he and I work very together. So I am very pleased to have involved – that he is helping us management team drive the company to success. So all of that is for strengthening the company.

So in conclusion, I think we have structured the company to scale and to accelerate innovation. We have the organization, the people, the processes, the technology, and the product format in place and the one short term the telecom market condition certainly uncertain we believe the market driver are strong, I mentioned that before. At the same time our high power laser business remain quite strong. We have structured to innovative scale and Oclaro is expected to grow in high power laser business this quarter and the following quarter and we are well positioned to grow as the telecom markets recover. I think with the team and the processes in place with the company, I am much more confident than a year ago that we can execute and deliver and get Oclaro to a very successful future. Thank you very much.

Jim Fanucchi

Operator lets go ahead and open up the call for questions.

Question-and-Answer Session

Operator

Thank you sir. Ladies gentleman at this we will now begin the question and the answer session. (Operator Instructions). Our first question comes from Ehud Gelblum with Morgan Stanley please go ahead.

Ehud Gelblum - Morgan Stanley

A couple of quick questions. First of all, on the gross margin guidance, seeing as it'll be down fairly significantly quarter over quarter on relatively – at the midpoint, call it, relatively flat revenue. Can you go through a gross margin walk, Jerry, that kind of helps us get to what are the issues bringing the gross margin down, is it lower volumes, is it pricing pressure, how do we understand that gross margin on the flat volumes.

Jerry Turin

We were pretty specific in the call. So I’ll kind of reiterate the points. A lot of our margins leverage is at the component level product and those don’t recover in September. Probably the primary quarter to quarter issue is where we mentioned that with our inventories high and revenues at relatively low levels it’s taking longer to translate cost improvement to the product level and the cost improvement for the gross margin level because you’ve got a longer time to cycle those through in the actual shipment and P&L. At the same time your pricing doesn’t take your time out and Alain mentioned that we probably see a little bit more pricing pressure than typical is well based on some of the market conditions that our customers are facing. And then at the same time we don’t expect that off that with high margin products ramping in September. The new product ramp in September will be at the modest and so therefore you put those three factors together and you have flat to down margin and there is also (inaudible).

Ehud Gelblum - Morgan Stanley

I got all those pieces. But, the new high margin products aren't hitting yet, and it's taking longer to actually get the cost savings in, so is the main factor that we're left with, I mean on an apples to apples basis from one quarter to the next, mainly the pricing declines, because that seems to be the one thing. The others aren't happening, but I'm just looking on an apples to apples basis.

Jerry Turin

Right. The price declines combined with the ways and delivery and recognition of cost improvement, typically you try and execute cost improvement to offset your pricing. If your cost improvements are being delivered more slowly that the negative and if the pricing is may be a little higher then it hits you both ways and you are right, but that factor in sum is the main point, correct.

Ehud Gelblum - Morgan Stanley

Okay, but it does seem that the other ones are just things that are not offsets. They're not necessarily in and of themselves pushing the pressure down on the margin. So, it is the pricing.

Jerry Turin

Right.

Ehud Gelblum - Morgan Stanley

Okay, that makes sense. Did I hear right when you said Huawei, I think, was 10% of revenues.

Jerry Turin

Correct.

Ehud Gelblum - Morgan Stanley

In the beginning. I believe it may have been 18% last quarter, so on a sequential basis it looks like Huawei was down $10 million. Given that the total revenue was not down that much, other things, obviously, went up. Was it one customer in particular that went up or should we look at the entire rest of the business was actually doing pretty well if we were to take Huawei out?

Jerry Turin

Well, certainly just on a miracle basis you’ll also see that Fujitsu popped into the 17% range underneath that there is a lot of volatility within individual customers and individual product. But certainly from the customer point of view Fujitsu took a big step up.

Ehud Gelblum - Morgan Stanley

I think these two example of customers that we published because they are both 10%. That gives you a good reading of the kind of volatility that we have to deal with. Basically our top end customer we have similar volatility up and down quarter to quarter, and we have to deal with that, and we also do have to deal with the necessary (inaudible) not only is the total number changes, but also the product mix change quite a lot from beginning of the quarter to the end of the quarter. The good news is that with the capital investment that we made in the past year we have a quite a lot of activity in our values, the product line and I won’t juggle with that.

Ehud Gelblum - Morgan Stanley

Ok. Yeah. Fujitsu was a huge uptick on that. And then finally the $25 to $30 million you are talking about for your four growth areas in December. Is that the same number that you were looking up before or has that changed?

Jerry Turin

Well, certainly there has been no specific guidance ever given in that (inaudible). If we back to December of last year we gave some very broad ranges for a series of those product that gave some potential. I think when we came out with the March quarter we were describing the market condition as making it difficult necessarily to hit on all of those fronts and we gave a bit of risk analysis through the year on which products were more likely – and to make that, which ones have probably more risk, and I think those numbers we are talking about for December are probably consistent with that sort of risk analysis we have been describing.

Ehud Gelblum - Morgan Stanley

Okay. So since then pretty much of what you had in mind and you just…

Alain Couder

Maybe one another comment is that when we made those comment in December and in April in fact that was the March quarter. The forecast that we were receiving from our customers for December were much higher. And so I think in a relative basis those numbers are the same, but in that sort of number they are down, because basically we have seen the forecast for the December quarter in the last six months go down by about 30%.

Jerry Turin

I would also just for clarity, during the call we mentioned that we probably won’t see a dramatic ramp in those products in September. If I had gone back to the very start of the year I think September is when we would have expected to see a significant ramp in those products. So that’s all for the data point for understanding how things have evolved from December of last year through the market softness through execution and where we are looking at December right now.

Ehud Gelblum - Morgan Stanley

Right, but it sounds like it's safe to assume over the last few months that $25 to $30 million is kind of what you have been thinking?

Jerry Turin

Yeah. If you are speaking of in a couple of few months timeframe that’s probably reasonable.

Ehud Gelblum - Morgan Stanley

Okay. I appreciate it. Thank you.

Operator

Thank you and our next question comes from line of Ajith Pai ,Stifel Nicolaus and company. Please go ahead.

Ajith Pai - Stifel Nicolaus & Company

Couple of questions. I think the first one when you are talking about these new product ramping especially on the ROADM side that you said you shift from WSS samples in this particular quarter. So could you get us some color as to the number of customers you are seriously engaged with and particularly on the TFXP side as well on the WSS side. What we can expect the ramp to look like in terms of number of customers? If you don’t want to share revenue numbers through the end of the year?

Alain Couder

Basically right now we are working with five customers. Some customer buy WSS directly. Some customer buy a line card that includes WSS. Right now what we are shipping in production is 1/2 and 1/9, and as I mention before we are working on high cost count which is the future new architecture that will be a different carrier. We are working with one of our customer on the 1/23 that we should sample this quarter that means the September quarter, and where we think we have kind of relief. So that’s basically where we are really coming with new generation of technology for (inaudible).

Ajith Pai - Stifel Nicolaus and company

And how do you expect that 1/23 to ramp - I mean the 21 customer is (inaudible).

Alain Couder

Its next calendar year.

Ajith Pai - Stifel Nicolaus and company

Next calendar year is the big ramps. And what about on the tunable XFP side?

Alain Couder

The tunable XFP we started to ship in production in the June quarter. So we are going to stop and to continue to run this quarter and big volume will really be in the December quarter.

Ajith Pai - Stifel Nicolaus and company

And then, the next question is just looking at the pricing. Usually, the vast majority of the pricing decisions are made very late in the year and begin I think with the calendar year is the way most industry participants have described it. So, right now what we are seeing with the customers coming back a year, I think you mentioned specifically for 40 gig that they're coming to you and wanting greater discounts and changes in prices. Is that typical to happen at this point in the year, and are you seeing on other products, also, an increase of pricing negotiations or are you not seeing that?

Alain Couder

No. It’s not really a novel pricing negotiation like the one we have at end of the year. I think as old component supplier are begging the silicon customer for more volume our customer take advantage of that and say, yes, I can give you more if you give me a better price. I think this is right now a buyer market and not a supplier market and this is what’s happening. So it's kind of a one-off from selected product where they need more at the last minute and also they take advantage of that. And we have the ability to say yes or no, but clearly these dynamic in the market which is unusual for this time of the year.

Ajit Pai - Stifel, Nicolaus & Company

And then, the last question, just looking at your termination of the contract that you had with Fabrinet, could you give us some color as to what are the options you're considering longer term from a manufacturing perspective, internal versus external, and what kind of progress you would expect to make over there over the next 12 to 18 months?

Alain Couder

Yeah. We as I said we have been working in the past few months that making sure that we talk to the company to be able to scale, and we think that to be able to scale we need to have a tool contract manufacturer of significant size and not one. So, so far we have Fabrinet only. So what we decided is to put out an RFQ which is going to return result early next month and we bid for 12 different products to compare in fact we issued it to four contract manufacturers and as a result of that we are going to make a decision on which contract manufacturer can give us the better service in term of ongoing cost reduction, in terms of an MCI capability in terms of all of that. What is for sure is that with Fabrinet we already have a significant portion of our business with them. We don’t plan to take the business away from them for the business they currently have, but obviously for future business it will depend on the response. And right now the reason why we have to issue the net K to announce that is because we have the contract with them that the request that we give them a six months notice to be able to negotiate a new contract, and in the new contract with contract manufacturer we are in a bidding contest between several contender. So we wanted to make sure that we have the same negotiation leverage with Fabrinet that we with new one as well. So that’s basically the background of what you saw.

Ajit Pai - Stifel, Nicolaus & Company

Got it. Thank you so much.

Operator

Thank you. and the next question comes from Kevin Dennean with Citi. Please go ahead.

Kevin Dennean – Citigroup

Great. Thanks very much. Just wondering if you could talk a little bit about some of the hurdles you have to clear to reach this $25 million to $30 million revenue goal for the new products in the December quarter?

Jerry Turin

Well, I think the starting point of the committee addressing that is to refer back to what we’ve talked about in the last six months as far as the different product areas and where the traction is harder and may be less risk versus areas where maybe the market is more competitive with more risk. So I think we talked about 40-gig is an area where, first of all, Mintera had ramped significant revenues in the past and tunable revenue products are one of our strength and we kind of go in as an incumbent. So we have had a stronger position there and then maybe you think about tunable XFP where again a tunable product where we have some differentiation in summaries, but a very strong market demand across the board out there. And I think from a WSS point of view we’ve talked in two ways. One is that, as far as the WSS component, we are entering a very competitive market in existing (inaudible) and so that’s a challenge in coming as a second source into incumbent areas and that’s where we focused a lot of our resource and areas of differentiation like the 1/23 Alain talked about that maybe a second phase of ramp coming next year and then secondarily at the integrated ROADM line card level, where we think we have differentiation incoming as more of an incumbent in this space.

So if you think in the terms of those challenges and you think in terms of those ranges, I think product by product you can kind of draw a picture of the different sorts of hurdles in each of those areas to get there.

Kevin Dennean – Citigroup

Okay And Jerry, do you think that by the December quarter – it's great if we see you hit these revenue goals, but do you think by the December quarter, the base business, the traditional Oclaro business, do you think that will have stabilized by then in telecom?

Alain Couder

This is a crystal ball you know. I think you ask me the question every quarter and I always tell you that life is going to be good six months from now. I made the mistake I think four quarter in a row, but at this time I am not going to make the same mistake. I don’t think anybody know at this point in time.

Kevin Dennean – Citigroup

Well, I don't think I've asked you the question every quarter, but – so, let me try it a different way.

Alain Couder

Not you, not you personally. I am sorry.

Kevin Dennean – Citigroup

Okay, so let me try it a different way, then. When – I'm sure, given everything that's been going on in the industry and kind of the controversy around the stocks, I'm sure that senior management in Oclaro and sales, you're out talking to your customers and you're doing a lot of scrubbing as far as what sort of inventory levels are at your customers. We're starting to see some systems companies guide, and a few companies have reported and guided up sequentially. And so, you must have some sense, I mean your – you have to have your own plans for what you see happening in terms of consumption, what are you seeing out there, I mean do you see egregious amount of inventory still on your customer books?

Alain Couder

No. From an inventory viewpoint I think inventory seems to be mostly gone at this point in time. Whether the carrier are going to pull for a lot new product is where the uncertainty is and I mentioned the debt sitting as the uncertainty that there is right now. So right now we are hopeful that in December we will see more traction. But I was maybe I shouldn’t have joked with the answer, but I tell you I have been so confident in the past that the things are going to recover and the September quarter, which was supposedly even two months ago to be significantly up from the June quarter is a flat quarter for us. That’s why I am becoming quite cautious in the comment I am making.

Kevin Dennean – Citigroup

Understanding that, Alain, just to be perfectly clear, so you don't think that your customers are holding aggressive inventory levels. You think at this point your demand is dependent on carriers moving forward with deployment plans. It's no longer – it's not so much of an inventory on customers that's the problem. It's more – you think it's uncertain end market demand?

Alain Couder

Yeah. That’s very fair summary. This is a difference between one year ago and now. I think it is really now a much more a carrier investing and deploying quickly to satisfy the bandwidth demand and the latency demand I have than an inventory production. We think most of the inventory production is over.

Kevin Dennean – Citigroup

Okay. Great. Thank you very much.

Operator

Thank you and the next question comes from the line of Alex Henderson with Miller Tabak Robert Securities LLC

Alex Henderson – Miller Tabak

Well, got a LLC in there even, wow. I've got a couple of clarifications. I just wanted to make sure I had the data right. You said in the presentation, I believe, that wave selective switches, tunable XFPs, and then you said 40-gig coherent was a small number of millions of revenues. Is that correct?

Jerry Turin

In total was less than one million in June. So there was.

Alex Henderson – Miller Tabak

But it is coherent that you mentioned there.

Jerry Turin

Yes, yes.

Alex Henderson – Miller Tabak

So your overall 40-gig product line is a lot more than a million dollars I would assume.

Jerry Turin

Oh yeah. Okay.

Alex Henderson – Miller Tabak

So, when you gave the $25 million to $30 million number, are you talking about wave selective switches, tunable XFP and 40-gig coherent, which is what you had prefaced it with, or are you talking about all 40 gig?

Jerry Turin

No. we very clearly said all 40-gig and 40-gig modulators as well.

Alain Couder

Let me be very precise. Right now in 40G we are shipping a product called 4000, which is old technology coming from Mintera. We are shipping a huge DQPSK, which is XO Cloud (ph) technology and we started shipping the first few transponder in coherent in the June quarter. In the new product that we mentioned in the December timeframe the major portion of this new product is so-called 7000, which is a replacement for the 4000, which is a smaller, compact, and cheaper and the other one is a coherent, which we call as 5000 that would be in volumes. So there is really two products that’s our new product in the December quarter compared to what we currently have.

Alex Henderson – Miller Tabak

Great. Thank you. That’s a very helpful clarification. The second thing is before we get out with a bunch of people writing notes tomorrow saying – oh my God, the pricing in the market's going to hell in a hand basket – which is what you've kind of implied, can you give us a little bit of a sense of the magnitude in the variance in the pricing is from quarter to quarter from what you would normally expect a June to September quarter price decline to look like? So, historically, you've had price cuts in January and a price cut, effectively, you know, these semi-annual stuff in July those are normal. I assume you're seeing a quarter-to-quarter price decline, what's the variance relative to that normal decline?

Alain Couder

Yeah thank you for the question because it's obvious that was not clear. We are not seeing a novel price negotiation at this time. We are seeing a product by product request that means there is a certain product you know.

Alex Henderson – Miller Tabak

I understand. If you aggregate it, though.

Alain Couder

It is good inventory. In our competition (inaudible) good inventory. The customer find a way to find that out and they will come and say, if you want us to take more of this then why don’t you give me a better price?

Alex Henderson – Miller Tabak

Alain, if I could, I think you've said that twice already on the call. What I'm trying to get is what is the sense of the variance in the price decline relative to what you would normally get as a result of the scrambling for price adjustments to get more volume? So, what's the magnitude of that impact that you just described? Is it a percentage point, is it two, is it three, how much of an impact are we getting quarter to quarter from that?

Jerry Turin

The way I would address that Alex, if you look at our gross margin guidance and if you look at our revenues and yeah, midpoint of revenue is not too different, midpoint of margin is down, as Ehud asked earlier what’s the driver, combination of two things, cost productions coming slower, price reduction still there and in fact up a bit more than typical. I think if you split it the margin delta between those two categories you probably got a good sense.

Alex Henderson – Miller Tabak

Is it a percentage point or two of swing in the pricing.

Jerry Turin

Well, it's probably up a percentage point or two. I think if you do the math on the margin I think that’s (inaudible).

Alex Henderson – Miller Tabak

Okay, that's fine. Simple answer, then. Okay, then, second question. So, obviously, on this gross margin discussion, a big part of the issue is you're significantly reducing your inventory back to normalized levels. They ballooned in the quarter, you got to bring them back in. You can't cost fix them as a result. How much of a decline in inventory should we anticipate is built into the guidance on these gross margins of the older, higher-cost product that's impacting the numbers? Is it – I mean, is it the amount that it increased last quarter that you're going to rationalize in the quarter causing that overhead variance and the like?

Jerry Turin

No, no. So there is no gross margin impact from trying to work down inventory. It is just a question of the inventory that we are selling the next quarter, is inventory that we built a quarter or two ago, and if we created cost improvements this quarter they won’t come true for another quarter. So there is no overhead dumping or any mixed implications like that. As far as how quickly can we bring down inventory which is largely a cash (inaudible) right because you invest an inventory and if you can bring it down to a lower level with quicker turns you are more efficient from a cash point of view. We’ll probably have limited upside in September from that balance sheet point of view and driving harder to having more impact in the December quarter.

Alain Couder

One thing we can tell also is that the significant portion of inventory increase has been in a recreating wafer stock as a buffer between our fab and our backend. And this one would not be generating cash even if we reduce it. so that’s…

Alex Henderson – Miller Tabak

So, the 16%, 17% quarter-to-quarter increase in inventory is going to stay at these levels or is it going to decline?

Jerry Turin

It is going to decline hopefully in September, but relatively gradually in September and hopefully more in December.

Alex Henderson – Miller Tabak

Okay. One last clarification, and then I'll cede the floor. I thought I heard Alain make a comment about sequential guidance into the fourth quarter are essentially flat, excluding the ramp of APS-oriented type products. Is that what I heard?

Jerry Turin

No. We didn’t. We did in no way guided for the fourth quarter.

Alex Henderson – Miller Tabak

When he said flat he was talking about flat into the third quarter calendar.

Jerry Turin

Right.

Alex Henderson – Miller Tabak

Okay, I just wanted to make sure I was clarified on that one.

Alain Couder

We are not giving guidance for the fourth quarter. The only thing I said is that right now the market as it is doesn’t – on the telecom side, doesn’t show any significant increase at the end of the year. On that basis we are not giving guidance for Oclaro around that.

Alex Henderson – Miller Tabak

Okay. I’ll see you at the floor.

Operator

Thank you and our next question comes from line of Dave Kang with B. Riley. Please go ahead.

Dave Kang – Business. Riley & Company, Inc

Thank you. Good afternoon. So, for apples to apples that – you talked about $25 million to $30 million for December quarter. What was that in the June quarter, around $12 million, $13 million, perhaps?

Jerry Turin

It was between $10 million and $15 million probably towards lower end of that. Pardon me. Hang on Dave. Let me correct that because I was including the legacy Mintera product that’s rolling into the cost reduced version. So it is probably $2 million to $3 million apples to apples.

Dave Kang - B. Riley & Company, Inc

What was it again, $2 million to $3 million?

Jerry Turin

$2 million to $3 million, make that $3 million to $4 million. I was forgetting one product to include now, so $3 million to $4 million.

Dave Kang - B. Riley & Company, Inc

So, $3 million to $4 million, going to $25 million to $30 million. Is that right?

Jerry Turin

Yeah.

Dave Kang - B. Riley & Company, Inc

Okay. And then, on Fujitsu, can you tell us which platform you're involved with? Is that a new program or – and which product are you supplying to Fujitsu for that platform

Alain Couder

There is two parts to Fujitsu. We have Fujitsu Japan with whom we are mostly working on 40G transponders, and we have Fujitsu US, where we are mostly working on the custom designing on (inaudible).

Dave Kang - B. Riley & Company, Inc

Okay. And, so, was that just like a one or two quarter blip or should we expect Fujitsu to be a 10% customer for many, many quarters going forward?

Alain Couder

We do not give guidance by customers. They give us the forecast. This is confidential information.

Dave Kang - B. Riley & Company, Inc

Got it. That's fair enough. And then, just lastly, on CapEx. What was CapEx for the quarter and what is your budget for this fiscal year?

Jerry Turin

It was $14 million in the March quarter. It was $9 million in the June quarter and we expect it to be in the $9 million range for each of the remaining quarters of the calendar year.

Dave Kang - B. Riley & Company, Inc

Got it. All right. Thank you very much.

Jerry Turin

Thanks Dave.

Operator

Thank you and the next question comes from line of Subrahmanyan. Please go ahead.

Natarajan Subrahmanyan – TheJudaGroup

Thank you. I hate to go back to this new product question, but I just want to understand, there were a few numbers that it would turn out to. The $25 million to $30 million that you were going to get is going to include the 7000, which is the cost-reduced 4000, but it will be essentially replacing the 4000, correct? So the $25 million to $30 million will be replacing currently what level of revenue I guess is the question. Because you'll be selling the 7000 instead of the 4000, I would imagine.

Jerry Turin

There will be some of that Subu, but in general the existing product is still going to be deployed in slots by some customers. So there will be a transition. So there is probably going to be some erosion by the December quarter, but it is not a direct flow.

Natarajan Subrahmanyan – TheJudaGroup

Got it And upfront, you mentioned from new products about $1 million in revenues in September, and now you gave a $3 million to $4 million. So, I was just wondering.

Jerry Turin

No, no, Subu. What we gave was three very specific products. That wasn’t the sum of all of our new products. That wasn’t the sum of the (inaudible) products that we are talking about in December. It was specific product where we are having our very first production revenues in the quarter in June. It wasn’t the September number it was a June number for specific products where we had our first step production revenues in 40-gig coherent, in tunable XFP, and in the ROADM line card.

Natarajan Subrahmanyan – TheJudaGroup

Just to clarify, the $25 million to $30 million has to do with broader set of all new products. Is that right?

Jerry Turin

It is a broader set of product.

Natarajan Subrahmanyan – TheJudaGroup

I guess the reason I ask that is to try to understand how much of that $25 million to $30 million is incremental to the base business between what's already in there and the 4000, which was hard to taper down, so how much of that's incremental because we could make some assumptions on the market. I just wanted to understand that?

Jerry Turin

You know Subu we were not guiding product by product by product for December. We are giving a – what we are really doing is the same as last December for key growth potential areas of new product to give some potential ranges and that’s obviously evolved over the last six months and what we are giving is a sense of what those range is could be in the December quarter based on where we are at today. So I think in terms of added color to what we have talked about in the analyst day last year and gave out those potential frames of reference for December, I don’t think that it is a specific revenue guidance for subjective product lines.

Natarajan Subrahmanyan – TheJudaGroup

Understood. And then, 40 gig, can you just tell us what the revenue is this quarter for modules and components?

Jerry Turin

We don’t have that number Subu, and I don’t think we would be disclosing that number in the future. We will think about whether there are ways to give color to the business from areas of the network or a data rate point of view but it’s quite complicated for us given we are on line side where you have product that get deployed in 40G that aren’t necessarily 40G transmission products. Now, but certainly it’s an increasing percentage as we move forward.

Natarajan Subrahmanyan – TheJudaGroup

And finally, book to bill, can you tell us what the number was?

Jerry Turin

It was 0.96 to 1 in telecom. And then as Alain said we have some backlog in the 40 gig (inaudible) products that would in a sense be on top of that.

Natarajan Subrahmanyan – TheJudaGroup

Got it thank you.

Operator

Thank you. And our next question comes from the line of Nathan Johnsen with Pacific Crest Securities please go ahead.

Nathan Johnsen – Pacific Crest Securities

Hi, thanks for taking my question. If you could provide some color on what the potential gross margin impact would be, kind of the $25 million to $30 million of new products? I mean, clearly, you've got some cost-reduced product in there. You've got some higher margin products. But, at the same time, you guys are kind of working through some of your inventory, and then dealing with some abnormal pricing pressure. Do you think as you layer those in, you guys have the potential to kind of get back into the mid to high 20s gross margins levels or do you think some of the pricing pressure keeps you down in the low 20s?

And then, secondly, just on the inventory, clearly with it building, I just wanted to see what your confidence was that you'd be able to work through all of the inventory that's currently on the balance sheet versus having to write off any of it? And then, last question, just on cash level. I just wanted to see kind of what your comfort level is for level of cash required for having to draw on any debt. Thank you

Jerry Turin

Sure. So, as far as the margin we are certainly not going to give any target margins or expectations. You know we are in a soft part of the market right now and we are guiding slightly down at the midpoint in September. So I think this is a good time to kind of execute and establish the traction and move forward from there. Now with that said, as revenues come back particularly in components you have upside from our contribution margins and from more absorption of fab overhead.

Certainly within that group of new products there are strong margins drivers within and over the next six to nine months we have many opportunities to add the Oclaro component content into our product. So, there is margin upside there but for us at this point in time going through a couple of slow quarters in the middle of this market softness to get predictive really wouldn’t be the right thing I don’t think .

Nathan Johnsen – Pacific Crest Securities

So, do you think it's more correct to think of it as kind of a gradual margin recovery, assuming it doesn't come down.

Jerry Turin

It become such a factor of the market because I don’t think I can understate the significant of the component level products that if that was to come back quickly you could have relatively significant impact, depending which product ramp you have a different impact. So I think at this point we get our top line tractions that – and then we can maybe get some more visibility to where we think the margins go. But other than identifying the drivers I (inaudible) specific rate now.

Alain Couder

What I can say that from the structure of the company we have aligned the structure to be able to improve our margin and we have a new head of global sourcing with a lot of experience and to negotiate results to prior we have added 60% of our R&D in such a way that just some of our R&D can work on the – just things across our current products we have reinforced our new product introduction team in manufacturing in such a way that from a yield testability, manufacture ability, we do improve. So we are rocking up all fronts of improving the margin but as Jerry said we don’t give any number more than a quarter ahead of time.

Jerry Turin

So your second question Nathan was on inventory, and we see that as more of a cash generation issue. So certainly we have absorbed cash and inventory as you increased that investment level and if we improve the terms and mapping out the cash efficiency point. As far as exposure for any reserves and so forth, market changes in the future and then the demand went down then, also like any company could have exposure on a specific product area. But we think of it more in terms of being much more efficient from a working capital and a cash deployment point of view.

Your third question was on cash level. And so, we are at $63 million we’ve reduced our capital spending and we signed a line of credit extension and increased it to 45. So we think we’ve got quite a bit of capitalization. I think I’d like to keep my cash in high 50s and I think that, that is sort of a reasonable data point for us to be thinking about in terms of using the line as we finance our return to grow.

Nathan Johnsen – Pacific Crest Securities

Thanks for the color.

Jerry Turin

Thanks.

Operator

Thank you. and our next question comes from line of Chris Glancy with Avondale Partners

Please go ahead.

Chris Glancy – Avondale Partners

Hi guys thanks for taking my question. Most of my questions have been answered, but I was just going to try and circle around the non-telecom business real fast, because there hadn't been too many questions on that. But, since the telecom book-to-bill was 0.96 and you're guiding down, is that to mean that the non-telecom business is expected to be up in the September quarter? And another question kind of dovetailing off of that is I think I heard you say that the fab transfer issues are behind you. Do I – should we take that to mean that the yields are where you want them or meaningful improvement in yields have already taken place or just any color on that would be great. Thanks.

Jerry Turin

So on the revenues we guide to a revenue range. So it is sometimes helpful to look at mid points to see that the midpoint is slightly down. But in terms of what a specific book-to-bill translates into, we are talking about a range within that and book-to-bill is merely an indicator of where you seem to be positioned going into the quarter.

On the fab transfer, a lot of the fab transfer efforts and issues they are behind but the yields are not to where they would have been prior to the fab transfers. So we still have more improvement there to be sure.

Chris Glancy – Avondale Partners

So, does that mean that you kind of have a good backlog or are you selling everything you can make into that non-telecom market?

Jerry Turin

No we have got a strong backlog and there continues to be a backlog that we can – I need to catch up on.

Chris Glancy – Avondale Partners

Okay , that helps thank you guys.

Jerry Turin

Thanks.

Operator

Thank you and that concludes today’s question and answer session. At this time I would like to turn the call back over to Mr. Fanucchi please go ahead sir.

Jim Fanucchi

Thank you thank you every one for participating today we look forward to speaking with you again when we report our financial results for the September quarter.

Operator

Thank you ladies and gentlemen and that concludes today’s Oclaro conference call. Thank you for your participation you may now disconnect.

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