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Finisar Corporation (NASDAQ:FNSR)

F1Q 2013 Earnings Call

September 4, 2012 05:00 pm ET

Executives

Jerry Rawls – Executive Chairman

Eitan Gertel – Chief Executive Officer

Kurt Adzema – Executive Vice President & Chief Financial Officer

Analysts

Troy Jensen – Piper Jaffray

James Kisner – Jefferies & Co.

Paul Silverstein – Credit Suisse

Kent Schofield – Goldman Sachs

Alex Henderson – Needham and Company

Michael Genovese – MKM Partners

Subu Subrahmanyan – The Juda Group

Dave Kang – B. Riley & Company

Patrick Newton – Stifel Nicolaus

Ehud Gelblum – Morgan Stanley

Analyst – Raymond James

Operator

Good afternoon, ladies and gentlemen, and welcome to the Finisar Corporation F1Q 2013 Earnings Conference Call. Today’s call is being recorded. And now I’ll turn things over to our host today, Mr. Jerry Rawls, Executive Chairman. Please go ahead, sir.

Jerry Rawls

Thank you, Melissa, and good afternoon everyone. We appreciate your taking the time to listen to this conference call today. A replay of this call should appear on our website within eight hours. An audio replay will be available for two weeks by calling (888) 203-1112 for domestic; or (719) 457-7820 for international – then enter the ID #2107143.

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

I would like to point out that we have prepared some slides for today’s earnings call, which you can access by connecting to the Investor Relations page of our website at www.finisar.com. Click on “Investors” then scroll down to “Webcast Archives” and click on it, and then you’ll see a listing for today’s F1Q 2013 Earnings Call.

As expected, our F1Q 2013 was challenging. Our revenues were $220.5 million, consistent with our prior guidance. The decline from the prior quarter’s revenues of $239.9 million was primarily the result of sluggish macroeconomic conditions, especially in Europe, as well as the slowing of economic growth in China. Generally, telecom spending throughout the world has been soft. In addition, we had two fewer shipping days in F1Q than in the previous quarter.

Non-GAAP gross margin of 30.3% was also consistent with our prior guidance. We held operating expenses for the quarter relatively flat, resulting in earnings per diluted share of $0.12. And now with that I’ll let Kurt review the rest of the numbers. Kurt?

Kurt Adzema

Thanks, Jerry. For F1Q our revenue was of $220.5 million, a decrease of $19.4 million or 8.1% from $239.9 million in the preceding quarter. Revenue for products from data communications was $139.5 million, a decrease of $6.5 million or 4.5% from the prior quarter, primarily as the result of the impact of two fewer shipping days in F1Q than in the previous quarter. Revenue for telecommunication products was $81 million, a decrease of $12.8 million or 13.6% from the prior quarter, primarily as a result of soft telecom spending throughout the world.

In F1Q we had one 10% or greater customer. Our top ten customers represented 62.1% compared to 58.5% in the preceding quarter. Non-GAAP gross margin was 30.3% compared to 31.4% in the preceding quarter primarily due to lower revenue levels. Non-GAAP operating expenses for F1Q were relatively flat at $54.7 million compared to $54.6 million in the preceding quarter. F1Q non-GAAP operating income decreased $8.9 million to $12 million or 5.4% of revenues compared to $20.9 million or 8.7% of revenues in the preceding quarter due primarily to lower revenue levels.

For F1Q net interest expense was approximately $389,000; other expenses were approximately $102,000. The adjustment for net income or loss of a non-controlling interest was a negative $12,000, and non-GAAP taxes were approximately $650,000. Non-GAAP income was $10.9 million or $0.12 per diluted share compared to $20.2 million or $0.21 in the preceding quarter.

Average diluted shares for F1Q for non-GAAP purposes totaled $94.2 million. Please note, unlike prior quarters, given the level of earnings this diluted share number does not include the impact of converting the principal amount of our expanded convertible notes debt for the purposes of calculating EPS as the convertible notes are anti-dilutive to EPS at the current earnings levels; and therefore you do not need to add back the interest expense and other costs associated with the aforementioned convertible notes in calculating diluted EPS for the quarter.

The sum of net interest expense, other expenses and the adjustment for net income or loss of a non-controlling entity is expected to be a deduction of approximately $750,000 to income in F2Q 2013 compared to $500,000 in F1Q 2013. Non-GAAP taxes are estimated at approximately 5.5% of non-GAAP pre-tax income for the remaining quarters of F2013. In F2Q weighted average fully diluted shares are expected to be approximately 98.5 million for non-GAAP purposes as we expect the convertible notes will again be dilutive given our higher earning expectations for F2Q.

Non-GAAP EBITDA decreased $9.3 million to $24.9 million or 11.3% of revenues compared to $34.2 million or 14.2% of revenues in the preceding quarter. F1Q capital expenditures totaled $15 million which is lower than our prior guidance of approximately $23 million. This was the result of a slight delay in the timing of some major expenditures related to the new manufacturing facility we are building in [Wousho], China. We still expect the building to be completed in the second half of calendar 2013. Capital expenditures are expected to be approximately $22 million in F2Q 2013.

Cash and cash equivalents totaled $220.4 million at the end of F1Q compared to $234.5 million at the end of the preceding quarter. During F1Q Finisar completed the acquisition of RED-C Optical Networks for a total of $23.7 million in initial cash consideration. During F1Q Finisar repaid the remaining outstanding debt balance of $3.2 million at our Ignis subsidiary. At the end of the quarter Finisar had approximately $40 million in principal amount of convertible notes outstanding with a conversion price of $10.675 per share.

There are a number of non-cash earned frequently occurring charges which were excluded from non-GAAP results. These totaled $17.1 million last quarter. If you had included all these items as required under GAAP we generated a net loss for F1Q of $6.2 million or $0.07 per diluted share compared to net income of $18 million or $0.19 per diluted share in the preceding quarter. That concludes my comments and I’ll turn it over to Eitan.

Eitan Gertel

Thanks, Kurt. Despite the challenging macroeconomic environment we have continued our significant investments in research and development, expanding our product portfolio with innovative new products that will position us for growth in the future as enterprise and service providers’ spending increases. In telcom we continue to invest in new product development for our wavelength selective switches, optical tel monitors, and 1040 Gb/sec and 100 Gb/sec transceivers and transponders.

During the last quarter we acquired RED-C Optical Networks to broaden our telecom product lines by adding [T amplification] technologies. These technologies are considered critical for ROADs and line cards and are increasingly important in cost effectively extending the reach of transceivers and transponders, especially for coherent 100 Gb and 40 Gb submissions in low latency networks. We expect that the integration of RED-C technology into Finisar products will enable us to offer our customers a much higher level of product integration with increased cost effectiveness. This combination should accelerate our market share growth.

We have continued to win customers for our low port count WSS [flat plane] for 1x2 and 1x4 applications. We have also been very successful in winning new customers for our high port count WSS [flex plane] platform. This product includes our 1x9, 1x20, and (inaudible) WSS. Finisar is the only company currently delivering a full portfolio of (inaudible). In addition to new customer wins from our WSS modules, we have also continued to win new next generation line cards with multiple customers based on our LCoS technology and Flexgrid capabilities. We expect to see the revenue from these wins in the second half of calendar 2012. We believe we will continue to increase our market share as more of the industry incorporates Flexgrid technology [in their modem] system.

For our tunable access P transceiver business we have completed numerous additional qualifications and are not starting to see the benefits in market share gain. Our [LineSight] transponder business is increasing as we have won some significant new contracts for our 40 G [ZPSK modules]. And lastly, on the telecom side of the business, we are continuing to win new business for next generation wireless LTE deployments as more carriers worldwide begin to deploy the technology. We believe we have a superior product and are winning significant market share as a result.

In the datacom business we are investing in a variety of multi-source agreements and proprietary form factors for both short- and long-range transceiver applications. These include the SSP Plus, XSP, QSFP, CXB and CFB. Our 16 GB/sec fiber channel transceivers continue to be very well received in the market and we continue to qualify those products with multiple new customers.

We are continuing to invest in our QSFP portfolio and are developing new short- and long-range products while expanding the capacity of our existing QSFP product lines. Many of our customers are migrating to QSFP due to the increased broad panel density we offer over SSP Plus, and the versatility of the [form factor] in servicing many different applications and regions. The demand for our 100 G SR10 and LR4 CFP transceivers continues to grow. We are also investing heavily in our next generation CFP and CFP2 form factors that will result in lower power consumption and higher density solutions for our customers.

In our power product line we’ve continued to see significant traction with several key OEM customers for our proprietary optical engines that will be used in next generation storage, switches, routers, servers and super computers. We expect this product line to grow very rapidly over the next few years as many of our customers move to using optical engines for high-density solutions for low power and very high bandwidth. In addition, we have some exciting new product announcements scheduled for the ECOC Show in Amsterdam which will be taking place September 17th through the 19th.

We believe that our strong portfolio of products and new designs and design wins have set a strong foundation for future market share growth and revenue growth for our company. Now I’ll turn the call back to Jerry for some final comments.

Jerry Rawls

Thanks, Eitan. I am happy to report that we expect revenue growth to resume in F2Q, primarily driven by improved traction for some of our newer products and increased market penetration. We expect that our product sales to both the datacom and telecom markets will increase from F1Q. We believe revenues for F2Q 2013 ending October 28 will be in the range of $225 million to $240 million.

Non-GAAP gross margins are expected to improve to approximately 30.6%. We expect the F2Q operating expenses of approximately $56 million with the increase primarily driven by the inclusion of a full quarter of results from our recent acquisition of RED-C. We expect non-GAAP operating margin to be in the range of 5.7% to 7.2% and non-GAAP earnings per diluted share to be in the range of $0.12 to $0.16 per share.

We should remember that Finisar is a company that is driven primarily by growth in the demand for bandwidth by the pervasive distribution and use of videos, photos, and digital information. Over time as enterprise and carrier spending ultimately increases, Finisar is uniquely positioned with our broad product line, extensive customer engagements, profitable, vertically-integrated business model and strong balance sheet to capitalize on these market opportunities. We will continue to gain share and advance our position as a market leader.

And now with that I’m going to turn it back over to Melissa and open it up for questions. Melissa?

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) And our first question will come from Troy Jensen with Piper Jaffray.

Troy Jensen – Piper Jaffray

Hey, I’ve got a quick one for Kurt. The RED-C contribution, I guess I’d just be curious to know what, for your guidance since you’re up sequentially, how much of it is inorganic versus organic. So if you can help us with RED-C’s revenues that would be helpful.

Kurt Adzema

Sure. So the increase in F2Q over what we recognized in F1Q is about an additional $3 million of revenue.

Troy Jensen – Piper Jaffray

Okay, and can you give us the number you recognized in the current quarter?

Kurt Adzema

Yes, in the current quarter revenue was a little bit under $1 million.

Troy Jensen – Piper Jaffray

Alright, gotcha. Perfect. And then for Jerry or Eitan, just can you get into pluggables? Your biggest competitor had a great quarter in pluggables here and your datacom business was maybe flatish if you factor in days. But just I’d be curious to know what you guys think is going on there for [market share].

Jerry Rawls

I think we’re doing pretty well in the market. We’re number one in market share and I don’t think that’s changed. I think in any one quarter there are people who will have stronger results and weaker results but overall I’m very pleased with our pluggable sales into the datacom world.

Kurt Adzema

And I would just mention if you look at F4Q we had an unusually strong F4Q, up 9.2% in datacom. So when you start comparing F4Q to F1Q you need to take that into account.

Troy Jensen – Piper Jaffray

Okay, gotcha. And how about this, Eitan, too – the last one. Discuss on second half rounds, you guys have typically four- to eight-week lead times. So if there’s going to be a pickup in the second half it’s going to happen pretty soon. So are there any signs at all that business trends could be better?

Eitan Gertel

I’m sorry, Troy, I didn’t get your question – can you repeat it?

Troy Jensen – Piper Jaffray

Yeah, just on the second half round for (inaudible) spend – you guys typically have four- to eight-week lead times for a lot of products, so if there was going to be a ramp in the second half it seems like you’d have to see it sometime soon. Are there any datapoints you see [to indicate] a pickup in trends?

Eitan Gertel

So we see some improvement in the number of products. I would say the majority of improvement on the telecom side came from tunable XSP and from WSS. I can’t sit here and tell you that the whole telecom market has started to take product in a much higher level but we see improvements on those products and a number of other products, and we’re waiting for the market to take off.

Troy Jensen – Piper Jaffray

Thanks. Good luck in the second half, guys.

Operator

And our next question will come from James Kisner from Jefferies & Co.

James Kisner – Jefferies & Co.

Hi guys, thanks for taking my question. Just first on telecom, I mean this was down quite a bit sequentially, I think 14%. If we back out even the days it’s down over 10% sequentially. Is it possible that your exposure to [Sonidos DH]-linked products could be causing worse results than you peers here?

Kurt Adzema

James, I don’t think it was any product in particular. I think telecom was broadly down across the board last quarter as we had expected. So I don’t think it was any particular product.

James Kisner – Jefferies & Co.

Can you tell us how WSS modules, I mean I know you don’t break this out normally but just to help us out – WSS modules and [two luxe] FP – how they did sequentially?

Kurt Adzema

Again, I think telecom overall broadly was down, so I would include WSS in that.

James Kisner – Jefferies & Co.

Okay, and on, just switching gears to datacom briefly and I’ll pass it: so to what degree, can you talk about 100 GB demand trends and to what degree capacity had any impact on the quarter? Did you turn away any business as a result of capacity constraints in this quarter? And I also want to clarify: you said you’re going to be online with the new facility in China in the second half of this year – do you expect to be shipping product out of that facility this year?

Kurt Adzema

Again, on China, what we said is the second half of calendar 2013, so not F2013 to be clear on that.

James Kisner – Jefferies & Co.

Okay.

Kurt Adzema

And what was your first question, I’m sorry?

James Kisner – Jefferies & Co.

To what degree was capacity, or I guess trends at 100 GB and to what degree capacity had an impact on 100 GB?

Kurt Adzema

I’d say 100 GB grew last quarter as expected, but I would say capacity is starting to catch up with demand.

James Kisner – Jefferies & Co.

Okay, thanks guys. I’ll pass it.

Operator

And now we’ll go to Paul Silverstein with Credit Suisse.

Paul Silverstein – Credit Suisse

Guys, I know you no longer break out the revenue this way but I’m hoping you can give us some quantification on when we look… There was a lot of positive commentary about the growth products, increasing traction, etc. I’m hoping you can give us some quantification of where those products stand today in terms of contribution to revenue and what type of growth you’re looking at. And obviously you bring up the datacom/telecom but I’m looking for more than that in terms of where you’re seeing demand. Again, if you’d give us quantification that would be appreciated.

Jerry Rawls

I don’t know how much quantification we’re going to give you but I will just tell you that the demand for our products generally in this last quarter and what we expect for the next quarter come in sort of the newest products, the highest performance, the highest speeds – 10 GB, 40 GB, 100 GB. That’s where we expect all the strength to be and in this last quarter we didn’t see a lot of strength obviously because revenues were down in the last quarter. But in this coming quarter that’s where we expect strength.

Paul Silverstein – Credit Suisse

-Jerry, in terms of trying to understand the business model and how that strength translates into growth, and not just in terms of this quarter but for a longer term, don’t you think it’s important to give us some perspective on what the base is?

Jerry Rawls

I’m not sure I understand the question.

Paul Silverstein – Credit Suisse

I’ll take it offline, that’s fine.

Operator

And now we’ll go to Kent Schofield with Goldman Sachs.

Kent Schofield – Goldman Sachs

Great, thank you. Looking at the guidance for the OPEX in the next quarter and then looking longer term, is it purely a function of improved gross margins to get back to levels higher than what you’re guiding to in operating margins for the October quarter? I’m just really trying to get a sense of how we can go above and beyond the next quarter’s guidance.

Kurt Adzema

Well again, the increase in operating expenses is primarily just driven by the fact that you’ve got a full quarter of RED-C in there. So of the $1.3 million increase that’s the vast majority of it, and I think ultimately in order to improve operating margins we need to improve gross margins and so I think to the extent that we can get more volume driven through the factory that’s going to be ultimately what drives higher gross margins as well as selling some of these newer products that have better margins.

Kent Schofield – Goldman Sachs

Can you remind us a little bit on the mix side when we think about datacom versus telecom in terms of how that plays into it as well on the gross margins side of things?

Kurt Adzema

Well right now, as we’ve said, a lot of our telecom products – because telecom has been down over the past multiple quarters – the gross margins are actually lower in telecom than in datacom just because of underutilization. But if you look at contribution margin for incremental revenue for telecom versus datacom I’d say they’re relatively comparable.

Kent Schofield – Goldman Sachs

Okay, great. Thank you for that.

Operator

Our next question will now come from Alex Henderson with Needham and Company.

Alex Henderson – Needham and Company

Hey guys. Just to clarify: you said you didn’t think there was any other competitor selling a wave-selected switch at this point based on LCoS – is that correct?

Eitan Gertel

What I said is that we have a full line of LCoS modem with (inaudible) and I think what you said is correct also.

Alex Henderson – Needham and Company

So as far as you know nobody else is out actually moving a product in the field at this point.

Eitan Gertel

As far as I know nobody’s in production.

Alex Henderson – Needham and Company

Okay. And then given the July launch of the line cards, can you give us an update of how you see that starting to ramp? Is it going to be a slow ramp initially as you get the kinks out of the line and then kick in in the January quarter? Or would that be something that would be more of a 1H 2013 calendar year?

Eitan Gertel

It’s a slow ramp. We have started already to ship [for] our scheduled customers in low quantities, so it depends on the process of qualification but it’s going on our schedule. And we see it’s more meaningful on the quarter ending January, or the beginning of the first part of 2013. So you can see it’s gradual but I don’t think it’s going to be (inaudible); the more meaningful part is going to be the beginning of 2013 calendar.

Alex Henderson – Needham and Company

And last question: can you give us some sense of what you’re seeing in terms of pricing conditions as we go into the year-end price negotiation? And do you have any thoughts on what happens if the productivity gains you need in order to offset those pricing can’t be delivered through product demand leverage as we get through the year? Is there any offset to that that we can anticipate that might help you hold your margins in if the price hits come through in the April timeframe?

Eitan Gertel

Our view on price reductions is to talk about telecom – those are negotiated towards the end of this year, probably starting in the October-November timeframe and being implemented January 1st for the vast majority of customers. So the question on the pricing for telecom parts, I’m not sure how applicable it is to telecom at this point. And I don’t think we have seen anything that’s diverged from the norm on the rest of our products, so we’ll see how this price negotiation season starts.

But as far as how we implement that and how we negate the price, obviously the cost reductions we always plug into our products and our gross margin always depends on a mix of new products which tend to have a higher gross margin versus older products. So the mix of all those in our history have helped us eliminate or reduce the risk of price reductions. Now, it all depends on the level of revenue, and as long as telecom and demand is robust and also for datacom, so we expect that to also help us from a utilization on our gross margins. All together that has been and it is still our plan.

Alex Henderson – Needham and Company

Am I wrong in saying that you need volume growth in order to offset the price pressures, though? I mean it seems pretty clear to me that without that you can’t drive the productivity gains.

Kurt Adzema

Alex, yeah – we always need the volume growth. We need, as Eitan points out, selling more of the next generation products that have higher ASPs and better gross margins; and then we’re always looking for ways to save money, either through reduced prices at our suppliers or moving more production from US-based to Asian-based manufacturing.

Alex Henderson – Needham and Company

Okay, I’ll cede the floor. Thanks.

Operator

Michael Genovese with MKM Partners has our next question.

Michael Genovese – MKM Partners

Thanks a lot. Three questions, I’ll ask them all at once: so you’re guiding for solid sequential growth for F2Q. Can you tell us, and I feel like this question’s been asked a number of times but maybe not this specifically – are you looking for greater sequential growth in F2Q from telecom or datacom, which would you expect to see? Secondly, in Eitan’s part he talked a lot about market share gains, and I’m just wondering what data are you guys looking at? I imagine it’s the deals that you’re winning, the slots that you’re winning, but you know, as revenues can change from quarter to quarter and company to company, what is really giving you guys the confidence that you’re gaining market share? And then finally as some of your smaller competitors like [Oclero] get bigger and more scale, do you expect to see any disruptions to the market? Thank you.

Jerry Rawls

Well, in F2Q we actually expect our telecom sales to grow a little faster than our datacom sales. And our market share gains – well, we track several places. A lot of the industry analysts, some of them are RHK-Ovum, infiNET EX, and Lightcounting are the three that we track most often, looking at the markets that we participate in.

Kurt Adzema

I think the third question had to do with the disruption from other smaller competitors out there. I think in general when an industry goes through tough times, I think the strong get stronger and the weak get weaker. So I think that we feel pretty good about our relative market position and our ability to continue to invest to bring out new products so that when spending does come back we’re in good shape to continue to increase our market share.

Operator

And now we’ll go to our next question. It comes from Subu Subrahmanyan from The Juda Group.

Subu Subrahmanyan – The Juda Group

Thank you. I have two questions. First, Jerry, can you talk about order trends through the quarter; did they get stronger towards the end of the quarter? Can you give us [an update going into the next quarter]? And how do you think in general of trends for the second half? Some of your peers have pointed to a more flattish second half while others are pointing to growth, so how do you think it’ll work for the second half of the calendar year?

The second question is on share, specifically in telecom. I know you’ve talked about general weakness in telecom but the last couple of quarters you’ve had two successive quarters of 14% sequential decline which is sharper than some of your peers; and I’m trying to figure out if it was in specific products or related to specific customers of yours who are spending less versus some of your peers.

Jerry Rawls

Well in terms of order trends we obviously see orders a little bit stronger because we’re guiding to revenue growth in F2Q. Now, was there anything unusual about order trends in the quarter? I guess not; I don’t recall anything that was particularly unusual about it. As orders came in late in the quarter that we couldn’t supply in the quarter, that lead times drove into F2Q then we built backlog for F2Q.

The second half of the year, a lot of customers have publicly discussed and privately discussed that they expect strength in the second half. On the other hand, I’ve sure heard a lot of them say their crystal ball is sure clouded. So I want to be optimistic and say the second half of the calendar year is going to be strong from the telecom sector in particular but I really don’t know. We’re not close enough to all of the big telephone companies around the world to be able to predict their purchasing behavior through the equipment companies.

And with respect to our telecom revenues being down a pretty big number – 14.0%, 13.6% - in the last two quarters, most of that is related to big customers who had difficult times in the markets that they serve. And a lot of those products went into Europe, some into Asia but I would say Europe was the biggest impact.

Kurt Adzema

Subu, the other comment I would make is when you compare our decline in telecom revenue over the last couple quarters versus some of our competitors’ you need to remember that those competitors are coming off of being impacted by the Thailand floods. And so when you look at their declines or changes in revenue, they’re coming off of a much slower base because they were impacted in the last couple quarters for the Thailand floods. So I don’t think it’s an apples-to-apples comparison.

Subu Subrahmanyan – The Juda Group

Fair enough, but I think it’s fair to say that if you look at a year-over-year basis, Kurt, they’re getting back to more or less June, September last year levels while you guys are still significantly lower off of those levels if you do a year-over-year comparison which exes out the flood impact.

Kurt Adzema

Well, I can’t comment on that but I think in general we feel pretty good about our position in the marketplace.

Subu Subrahmanyan – The Juda Group

Understood. And so just to follow up, Jerry, in the past in this industry we’ve seen these kind of cyclical trends where we have a few quarters of decline, several quarters uptick, quarters of decline. Now we’ve gone through a few quarters of decline last year and some more this year – do you think this sets up for a few continuing sequential quarters of improvement or you don’t expect that kind of a cyclical trend given the current environment? I would just like to hear kind of how you think about the trends in the market, not in any given quarter but a multi-quarter trend.

Jerry Rawls

Well, I sure hope you’re right. If you go back to the global financial crisis in ’08, ’09, we went through a nine- or ten-month period when there was no capital spending by datacom or telecom. And but the demand for bandwidth continued to grow. People continued to log onto the internet and download videos, etc. So when money became available spending took off like crazy, and for six sequential quarters double-digit sequential growth and revenues.

Now, we’ve seen now about six quarters where revenues have been down and then flat. My view is that they built lots of capacity during that year-and-a-half period and they’ve got plenty of capacity, but as demand continues to grow the phone companies of the world are getting close to the policy levels at which they have to start adding capacity. And I think we’ll see sustained spending for some period of time. So I’m not clairvoyant to tell you exactly how many quarters it might go but I think that’s generally what we’ve seen in the telecom sector for years and years – it’s always been this sort of cyclical spending pattern.

Subu Subrahmanyan – The Juda Group

Got it, thank you.

Operator

Our next question will come from Dave Kang with B. Riley.

Dave Kang – B. Riley & Company

Thank you; good afternoon. The first question is you talked about, regarding the telecom business you talked about your new products providing incremental growth going forward. But what about your legacy products, your core business? Have they stabilized in the last couple of quarters? And of $81 million in telecom revenues, how much of that is considered to be legacy?

Eitan Gertel

Well, if you look at those products we think they’ve stabilized and how much is legacy… I don’t know the exact number but I would say the majority of it is existing product. And as you see right now, we said that the growth is going to come from the tunable XSP and WSS and products like that, so we see the contribution of those products. You can say the tunable XSP is probably a new product so we’ll have it for a number of quarters, and our ramp in tunable XSP depends on [and is] effected by the demand from overall telecom companies.

And in our WSS business, the acceptance and the ramp of the real system deployment into markets for Flexgrid is actually affecting our business and also some of our biggest customers, as Jerry was mentioning before, were affected by the demand in telecom. So all those things combined are affecting our telecom business and where we are today.

Dave Kang – B. Riley & Company

And I know you’re not breaking out WSS revenues but are they down what, about 50% from the peak or any kind of color there as far as where you guys are running now?

Kurt Adzema

Yeah, we’re not breaking out those numbers, Dave.

Dave Kang – B. Riley & Company

Okay, fine. I think that was it. Thank you.

Operator

And now we’ll go to Patrick Newton with Stifel Nicolaus.

Patrick Newton – Stifel Nicolaus

Yeah, thank you for taking my questions. I guess Eitan, thank you for the details on the ROADs and line cards and some of the ramps on the Flexgrid side. I guess could you give us a little bit of detail of have you seen any delays or push-outs I guess from your original expectations for volume shipments of design wins? It just seems like you have a pretty material customer that was talking about some push-outs on their end of the business.

Eitan Gertel

Not from deployment of Flexgrid; it’s more related to historical product that their demand was relatively slow. So a number of customers got affected by telecom demand, so the slowness we have seen from the non-Flexgrid WSS, the Flexgrid contributions revenue – the significance of that – is starting to ramp right now.

Patrick Newton – Stifel Nicolaus

I guess maybe to ask you a different way, I’m not necessarily talking about this quarter; I’m not talking about the October quarter guidance. I guess I’m thinking about the January timeframe and into the April timeframe – has that bogie been pushing out at all for Flexgrid?

Eitan Gertel

I don’t think so. If anything people try to accelerate us into actually ramping our Flexgrid production for them. What we have seen across the board – we expect maybe one product to have it, maybe a 1x9, and now we’ve seen across all our products that people are asking us to introduce the Flexgrid. What we have to remember is that when Flexgrid is introduced there’s a totally new management system that goes with it from the integration companies, from the systems companies so there’s a delay not only in us introducing the part to them; they have to finish their qualification, the introduction of a new management system and introduction to the end customer. So the delay time is pretty substantial, but in a direct answer to your question we have actually seen an acceleration in people asking us to deliver it faster.

Patrick Newton – Stifel Nicolaus

Okay, that’s helpful, thank you. And I guess, Kurt, a clarification for you: I think an earlier questioner asked about telecom weakness in the quarter and you’d gone through and said it was pretty uniform across, and you specifically brought up WSS. You did not allude to tunable XFPs so was that in line with the broader decline? And I guess what I’m trying to get a sense of is for you to gain share relative to your largest competitor, your largest competitor saw a sequential decline in their June quarter of 25% so it’s a pretty wide range and I’m just trying to get a gauge of that product line.

Kurt Adzema

Yeah, I think tunable XFP was relatively flat last quarter and we expect it to grow this quarter.

Patrick Newton – Stifel Nicolaus

Okay, that’s very helpful. And then I guess the last one on RED-C: can you help us understand, obviously is the ROAD and line card play and can you help us understand any other components that you’re missing inside of the ROAD and line card as far as vertical integration? I believe it’s pretty much just the pump laser and then other than that you have all the components in-house. And then can you also talk about the opportunity for RED-C outside of internal use and just selling it in a broader merchant market?

Eitan Gertel

So RED-C historically was selling amplifiers to the broader markets and we haven’t stopped doing that so we continue to do that business. But the reason we have acquired them is the combination of them to our line card, it helps us in introduction of new line cards and new capacity. If you look at the line cards but [within production] of the amplifier technology, as broad as it is in RED-C we basically have everything in-house. No, we don’t have the 980 but we have everything else in-house currently. And I don’t think at this point you can look at it and say that we are missing any parts to grow that business.

Patrick Newton – Stifel Nicolaus

Perfect. Thank you for taking my questions.

Operator

And next we’ll go to Ehud Gelblum with Morgan Stanley.

Ehud Gelblum – Morgan Stanley

Hey guys, thanks. I appreciate it. A couple of clarifications just to make sure I understood. I got a good sense on the tunable XFP that that was going to be flat last quarter but it’s going to grow now. [ROAD-Ms], did [ROAD-Ms]… Jerry, at one point it sounded like [ROAD-Ms] had gone up this quarter and another time it sounded like [ROAD-Ms] were down. Can you clarify what [ROAD-Ms] did last quarter and WSSes and a similar comment on 100 GB modules? Did it sound like they were up? I just wanted to get a sense if it’s true that they’re slowing now. You made a comment about the past (inaudible) catching up so do we have a backlog that we’re finished on in the 100 GB modules?

Jerry Rawls

In the 100 GB modules, the growth rate has been very healthy over the last several quarters, but as we’ve been increasing capacity and building capacity in Asia, we’re seeing now that that capacity is catching up with demand and now we’re seeing that percentage growth rate slow down a little bit. Wavelength selective switches last quarter were in fact soft. I think as Kurt alluded to earlier, our weakness in telecom was across a broad range of products and there were almost none that were exempt.

Ehud Gelblum – Morgan Stanley

And did those go back up again with telecom this quarter?

Jerry Rawls

Yes.

Ehud Gelblum – Morgan Stanley

Okay, so we’re seeing growth in WSSes and tunable XFPs. We’re getting $3 million from RED-C next quarter and those are the main three parts that drive telecom.

Kurt Adzema

Yes.

Ehud Gelblum – Morgan Stanley

Okay. Can you give us a sense as to how large WSSes are now and how large 100 GB modules are?

Kurt Adzema

No, we don’t break that out.

Ehud Gelblum – Morgan Stanley

Okay. Can you give us a sense on a relative basis versus last quarter or two quarters ago?

Kurt Adzema

Well again, I think WSSes… We’ve said telecom’s been down for the last two quarters and we said WSS was down for the last two quarters but we expect it to start coming back this quarter.

Ehud Gelblum – Morgan Stanley

Okay. Another question that’s been sort of asked and I want to try to rephrase it in a different way: if you look at your results versus your competitors’ results in the last couple quarters on the telecom side they haven’t been as strong. Could there be some explanation based on the customer base? I know someone asked earlier about that as well. Could some of your customers not be seeing the same product cycle trends that other component guys have seen with their customers?

Eitan Gertel

Absolutely. I mean if you look at certain customers who had a different set of customers for their products, that affected their revenue different than ours. The customers we have had have had more softness than others and that’s why our revenue in the telecom went with them. So it’s customer-specific, but as you look at what we talk about our market share expansion you can see us getting market from those customers and we’ll have a broader access to the growth in the business – which will help us eliminate those variations.

Ehud Gelblum – Morgan Stanley

So taking it one step further: is your optimism on F2Q and I guess going forward as well based on getting into those customers that you’re not exposed to right now? Or is it that your customer base, namely the large one in Europe, is going to come back and take share?

Eitan Gertel

I think it’s a combination of both. Some of it is coming from product shipping to customers to which we haven’t shipped before, which is new market share, and some of it’s from big customers actually growing.

Ehud Gelblum – Morgan Stanley

So should we expect for instance the [ROAD-M] line card to become a larger part of the revenue base next quarter and is that a large part of the story?

Eitan Gertel

Yes, but what we said is we expect it to be a relatively smaller growth between now and the end of 2012 and that more impact will be beginning in 2013. So from now until that point he majority of the growth will come from the WSS components.

Ehud Gelblum – Morgan Stanley

Okay. Finally, Jerry had mentioned weakness not only in Europe but in China as well. Again, can you clarify – is that with Chinese vendor customers or is that in the Chinese end markets with Chinese carriers? What can you tell with respect to how that rebounds next quarter or will that remain weak as well?

Jerry Rawls

Well, we have heard from our Chinese customers that they expect second half telecom strength in their business. Now, most of our big Chinese customers actually export most of their, or in some cases a large percentage of their output so they’re dependent upon the worldwide telecom market – not just the Chinese market. But I think they’re all expecting some increased spending in the second half on the part of the Chinese carriers.

Ehud Gelblum – Morgan Stanley

Okay, good luck. I appreciate it.

Operator

And our next question will come from Simon Leopold from Raymond James.

Analyst – Raymond James

Hello, this is (Inaudible) in for Simon Leopold. A couple of things: first of all just a follow up to Ehud’s question about China. Looking at your latest filing it seems that the China revenue has been the lowest in two years. So now you mentioned that you expect some growth going forward, especially for Q3 but how should we think about more of a [micro trend]. Do you think that the China revenue has bottomed?

Kurt Adzema

Well again, I think we expect telecom to increase. Within telecom we expect tunable XFP and WSS to increase, and certainly some of our key customers for those products are in China. So I’d say in general it’s just a broader-based recovery and a little bit of strength in telecom and China’s part of it, but I wouldn’t say China’s the story.

Jerry Rawls

When our sales into China were huge, and it’s back quite a few quarters ago, a year and a half ago – a lot of those sales actually went into Europe but they were just being exported from China. Sure, there were some domestic expenditures on the 40 GB [long haul] network and that’s benefited us, but an awful lot of it was sales to Europe. And they pretty much evaporated.

Analyst – Raymond James

So [that assumes] that your government in China experienced some weakness, but overall, if you look at the sales so far, Chinese vendors seem quite happy. So I’m just wondering if perhaps there’s some [projects] that [have slipped through].

Jerry Rawls

Well, I don’t know. If you look at annual reports of some of the big Chinese equipment companies, their carrier sales have not been particularly strong and they weren’t particularly strong in 2011. But they are expecting increased spending and they are expecting increased revenue in the second half of this year and into 2013 in particular.

Eitan Gertel

When you look at China demand, a lot of other vendors are talking about selling [tong] components into China and [tong] is not a big component of our revenue at all.

Analyst – Raymond James

Okay, fair enough. Can you talk about [any orders] in the quarter? When did you realize the orders were coming in shorter than expected?

Jerry Rawls

I don’t think orders came in softer than expected. I would say we predicted that our quarterly revenues were going to be down.

Analyst – Raymond James

But it came in lower than expected.

Jerry Rawls

Well, we’re lower than we’ve been, lower than the midpoint. I couldn’t point to a particular point in the quarter; I would just say as we saw orders strengthen the problem was it was too close to the end of the quarter and that meant that we’re now building backlog for F2Q, not taking orders that we could ship in F1Q.

Analyst – Raymond James

Alright, guys, thank you.

Operator

At this time I’d like to turn the call over to Mr. Rawls for any additional or closing remarks.

Jerry Rawls

Thank you, Melissa, and thank you to everyone. We appreciate you tuning into our F1Q conference call today and we hope you’ll be able to join us again three months from now. Have a good day.

Operator

That does conclude our conference at this time. Thank you for your participation. You may now disconnect.

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