Finisar Corp's (FNSR) CEO Jerry Rawls on Q4 2017 Results - Earnings Call Transcript

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About: Finisar Corporation (FNSR)
by: SA Transcripts

Finisar Corporation (NASDAQ:FNSR) Q4 2017 Earnings Conference Call June 15, 2017 5:00 PM ET

Executives

Jerry Rawls - Chairman & CEO

Kurt Adzema - EVP & CFO

Analysts

Patrick Newton - Stifel

Troy Jensen - Piper Jaffray

James Kisner - Jefferies LLC

Simon Leopold - Raymond James

Alex Henderson - Needham

Michael Genovese - MKM Partners

Joseph Wolf - Barclays Capital

Doug Clark - Goldman Sachs

Dave Kang - B. Riley & Co.

Dmitry Netis - William Blair & Co.

Richard Shannon - Craig-Hallum Capital

Tim Savageaux - Northland Capital

Operator

Good afternoon ladies and gentlemen and welcome to the Finisar Corporation Announces Fourth Quarter Results Conference Call. Just a quick reminder today's call is being recorded.

And now at this time, I'll turn things over to Jerry Rawls, Chairman and CEO.

Jerry Rawls

Thank you, Jus, and good afternoon, everyone. We appreciate you're taking the time to listen to our 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 following the call by dialing 855-859-2056 for domestic or 404-537-3406 for international, enter the following prompt the conference ID is 61562686.

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, the company undertakes no obligations to update any forward-looking information presented. Unless otherwise indicated, all results discussed are on a non-GAAP basis.

A complete reconciliation of our GAAP to non-GAAP results may be found in our earnings press release and in the Investor Relations section of our website. We have prepared some slides for today's earnings call. You can view them by connecting to the Investor Relations page of our website at finisar.com. Click on Investors, then scroll down to Webcast Archives. Click on it, and you'll see a listing for today's fourth quarter 2017's earnings call.

I am pleased to announce that Finisar achieved all-time records for revenues and profits in fiscal year 2017. Revenues for the year were $1.45 billion, an increase in $186 million or 14.7% over fiscal 2016 and net earnings were up 111% to $231.7 million, an increase of $122.8 million over fiscal year ‘16. Demand for our QSFP28 transceivers for data centers continue to be strong in the fourth quarter. QSFP28 revenues increased more than 30% over the prior quarter, however, our overall revenues declined 6.1% to $357.5 million, a decrease of $23.1 million.

This decline was primarily the result of reduced telecom revenues from our Chinese OEM customers plus the impact of the full three months of the annual telecom price erosion. Now I'll let Kurt review the rest of the numbers.

Kurt Adzema

Thanks Jerry. And sales of datacom products decreased by $2.8 million or 1.1% compared to the third quarter. Sales of 100 gig QSFP transceivers for datacom applications increased over 30% compared to the prior quarter, however, this increase was more than offset by lower demand for other datacom products, primarily 10 gig and below shortwave transceivers. Sales of telecom products decreased by $20.2 million or 18.2% compared to the third quarter. This decrease was primarily due to lower revenues from our Chinese OEM customers and the impact of the full three months of the annual telecom price erosion.

In the fourth quarter, we had one 10% or greater customer. Our top 10 customers represented 58.9% of total revenues compared to 57.4% in the third quarter. Gross margin was 36.2% compared to 37% in the third quarter, primarily due to the impact of the full three months of the annual telecom price erosion. Operating expenses were $71 million compared to $70.5 million in the prior quarter. Operating income was $58.4 million or 16.3% of revenue compared to $70.4 million or 18.5% of revenue in the third quarter. Net income was $57.5 million or $0.50 per diluted share compared to $67.2 million or $0.59 in the third quarter.

Weighted average diluted shares totaled $115.2 million. Weighted average fully diluted shares for the first quarter of 2018 are expected to be approximately $116 million. Interest and other income was approximately $2.1 million in the fourth quarter. Taxes for the fourth quarter were approximately $3 million. Taxes for FY18 are estimated at approximately 6%. Cash, cash equivalents, and short-term investments increased $22.6 million to approximately $1.2 billion at the end of the fourth quarter.

Capital expenditures were approximately $47.8 million in the fourth quarter. We recently started construction of a third building on our Wuxi site, whose primary use will be manufacturing. We expect to complete the construction of this building in the second half of calendar 2018. Capital expenditures for the first quarter of fiscal ‘18 are estimated to be approximately $45 million. We have excluded from our non-gap results a number of charges or benefits that are either non-cash or we consider outside our core ongoing operations. These totaled $72.7 million of benefits last quarter. If we include all these items as required under GAAP, we generated net income of $130.2 million or $1.13 per share compared to net income of $46.4 million or $0.40 per diluted share in the third quarter.

That concludes my comments and I'll turn it back to Jerry.

Jerry Rawls

Thanks Kurt. We expect revenues for our first fiscal quarter of 2018 to be in the range of $330 million to $350 million. We expect telecom to account for most of this decline, primarily due to lower revenue at our Chinese OEM customers. We expect datacom will be relatively flat as revenue growth for 100 gig QSFP28 transceivers is offset by lower sales of 10 Gigabit and 100 gigabit CFP2 ethernet transceivers. We expect first quarter gross margins to decline to approximately 35% primarily due to our lower revenue levels. We expect operating expenses to be relatively flat at approximately $71 million.

Non-GAAP operating margins are expected to be approximately 14%, earnings per diluted share is expected to be in the range of $0.03 per share. Despite a challenging outlook in the near-term with lower demand for our Chinese OEM customers, we are optimistic about the outlook for Finisar's fiscal 2018. We expect revenue growth to resume in our second fiscal quarter, primarily driven by the sales growth of 100 gigabit QSFP28 transceivers for the big hyperscale data centers and sales of VCSEL arrays for 3D sensing. We have made really good progress with our high-powered VCSEL array program.

We have received production purchase orders and expect to soon receive customer approval to ship meaningful volumes at our second fiscal quarter. In addition in the second quarter, we expect our 100 gigabit, 200 gigabit coherent CFP2 ACO transceiver and our ROADM line card to be fully qualified by a key OEM customer who supplies to the Verizon Metro upgrade.

We are currently qualified at multiple other customers for our CFP2 ACO and are in the qualification process with a number of additional new customers. And with that, I'm going to turn it back over to Jess to open it up for questions. Jess?

Question-and-Answer Session

Operator

Your first question comes from Patrick Newton with Stifel. You line is open.

Patrick Newton

Good after Jerry and Kurt. Thank you for taking my questions. I guess first, Jerry you commented that you expect to see growth - sequential growth in fiscal second quarter driven by hyperscale. I'm curious how you anticipate China will layer in, in your October quarter as always?

Jerry Rawls

It's hard to tell. We have heard for a long time 2017 was going to be a strong year in China. Well to tell you so far, it has not been a strong year in China. I've heard from a number of Chinese OEMs that said the second half of this year will be a strong year. Well we haven't seen much of that yet. So I think it's a little, our crystal ball is a little cloudy with respect to China.

Now, there has been some bright spots, there has been some announcements and some new upgrades. There has been announcements of new deployments of ROADMs, but most of the things that I have seen have been relatively limited, I would almost call them field trial scale deployments in the US.

Patrick Newton

Okay. So, and then, I guess on the 3D sensing, good to hear that you have orders and expect I guess meaningful production going into the second fiscal quarter. I'm curious if we look out into -- later into the fiscal year 18, do you anticipate that your 4-inch wafer capacity is scalable or do you believe that you're going to need 6-inch capacity, and if so would that be done via foundry partners, internal, or some combination of both?

Jerry Rawls

Well, we're going to ramp that 4-inch fab and we're going to produce record volumes for us by a lot. As we move forward, my guess is that we are -- to ramp capacity further, we're going to have to shift to six inch. And the question is exactly how we do that is unclear, maybe by the organic growth in an internal facility, it could be through outsourcing, there's lots of options at this point, but we are aggressively pursuing all.

Patrick Newton

And just one clarification for you Jerry, you talked about meaningful production volumes in fiscal second quarter. Can you help us quantify that, what does that mean?

Jerry Rawls

That means that we're going to make and we're going to ship millions of devices.

Patrick Newton

And any revenues you could wrap around that?

Jerry Rawls

It's not. Second quarter is not going to be a big revenue quarter. We're going to ship a lot of stuff but it will be nothing compared to quarters after that.

Patrick Newton

Great. Thank you for taking my questions. Good luck.

Operator

Your next question comes from Troy Jensen of Piper. Your line is open.

Troy Jensen

Hi. Thanks for taking my question gentlemen. Just to follow-up here on Patrick, with respect to China. I was wondering if you could just kind of let us know what is baked in your assumptions, and maybe if you could tell us what peak China revenues have been, I mean if you don't want to give peak maybe like average recent quarterly China revenues and then how much are you implying in your July guidance?

Kurt Adzema

Well, I'm not going to get into the exact revenues. I think we've talked about historically how the Chinese OEMs have been about 20% of revenue and I think at this point we were significantly less than I would say we're in the low teens. So depending on when that demand snaps back, obviously there is a lot of opportunity there.

But in terms of our guide for Q1, obviously we're expecting it to continue to be challenging.

Troy Jensen

Okay. So two more questions for me on the 3D sensing, the capacity expansion that you are doing right now, is that 100% for high power, and to get into low power, would that be through a partnership?

Jerry Rawls

Everything we're doing today is high-powered VCSEL array. Let me make a comment here. While I answered Patrick's question, I got in my mind that off by a quarter. We don't -- in our first quarter, we're not going to have big revenues. In our second quarter, we expect big revenues.

Troy Jensen

The October quarter you expect big revenues.

Kurt Adzema

Yes.

Troy Jensen

Right. Second quarter shipping or second fiscal quarter Jerry?

Jerry Rawls

Second fiscal quarter.

Troy Jensen

Okay, perfect. And then Jerry just one last question for you, and then I'll cede the floor. I know you've talked a lot this year about supply demand imbalance with this datacom stuff. I'm sure the demand hasn't changed, but just curious if you're seeing more supply come on for QSFP28. Given we're seeing China slowdown, some of your competitors are now focusing more on QSFP28 than they were other flavors.

So just thoughts on supply demand balance for the datacom stuff?

Jerry Rawls

Well, so far there is still a shortage. And I hear people talk every now and then saying it's all well, we're coming close to being supply equals demand, but that's not the behavior we see from the big customers. But it will have, it's inevitable at some point. Supply is going to catch up with demand. Our belief is it will happen in calendar year 2018 sometime.

Troy Jensen

Yes. Right, understood guys. Good luck and congrats on the VCSEL win.

Jerry Rawls

Thanks.

Operator

Your next question comes from James Kisner of Jefferies LLC. Your line is open.

James Kisner

Thank you. I guess just for 3D sensing first here , so can we assume this is basically really, primarily one customer, one application or are there multiple customers and applications that you are expecting here to ramp in the October quarter?

Jerry Rawls

We're engaged with a number of customers, but short-term revenue is going to be predominantly from one.

James Kisner

Okay. That helps. All right, so in QFSP28, maybe you could update us here on the split of LR versus CWDM4. My math, usually I am getting something like $75 million in revenue here for QFSP28 I kind of want to verify that. And I guess relatively what are you kind of anticipating in the coming quarter and how much capacity are you adding and could we see a similar ramp in Q3 2018 revenue in the July quarter?

Kurt Adzema

Well, I still think we're seeing a pretty strong presence of LR4 relative to CWDM4, and while we are adding capacity for both in Q1, I think the next large chunk of capacity for QSFP28 really comes online in Q2. So I think we will see an increase in QSFP28 Q1 over Q4, but we will see a larger capacity add in Q2 over Q1.

James Kisner

I mean before you guys said I think you have more units of CWDM4 and then but still more revenue or Forex it sounded like it was maybe little more than half can you help us out little bit more and like is it 80%? How much of this Q2 2018 revenue really is our -- also just curious what do you think is really driving that demand?

Kurt Adzema

Well, again I think what we can say is that exactly what you said which is I think there is higher revenue for LR4 than CWDM4 but there's more units of CWDM4 but we're not going to get into the exact splits of all that.

James Kisner

Is the - driven by aggregation is it on - what's the LR4 demands into it as the forecast for are generally pretty small members and just its interesting it's for demand. Can you elaborate on that a little bit?

Jerry Rawls

LR4 is a 2 kilometer product and for lots of people 2 kilometers is a distance they need to large buildings or connection between buildings. So I think I can't - we have all projected that CWDM4 is ultimately the largest as it is the short distance interconnect within the data center. But the longer distances there are some streams in this hyperscale data centers where CWDM4 may not reach from one corner to another.

James Kisner

Okay. Last one I'll pass. Just how big - you mentioned weakness in 10 gig and below maybe you can kind of parse there. I assume of that is you are talking about 10 gig datacom and not the wireless slippery stuff. But how big is 10 gig within datacom overall and maybe how because wireless and what are you expecting sequentially is that still declining or what thanks?

Kurt Adzema

Yes. I think 10 gig is about 20% or so of datacom and we expect that to continue to decline over time. So it's more about kind of 10 gig SFP plus and some of the slippery stuff that you alluded to.

James Kisner

Okay. Thanks very much.

Operator

Your next question comes from Simon Leopold with Raymond James. Your line is open.

Simon Leopold

Great. Thanks for taking my question. Couple quick clarifications if I may. On the QSFP28 business, you talked about the 30% sequential growth, I think that gets us to about $75 million, I just want to make sure I'm not compounding errors and then I'm in the ballpark.

Kurt Adzema

You are in the ballpark.

Simon Leopold

Great. And when you think of that business can you talk at all about what kind of customer concentration you have in that is it significantly oriented towards one customer or well diversified?

Jerry Rawls

There's a lot of customers for it, but those -- no there is a lot more than one customers. In terms of the web to -- guys and the enterprise OEM, so it's not hundreds or not even was split between 100, but it's even about half a dozen big customers.

Simon Leopold

And back at the OFC tradeshow you talked a little bit about some issue one of your competitors had that created an interoperability problem that was not your issue but your product didn't work with their product that was creating a disincentive for at least one OEM, smaller OEM to not buy your products. Has that issue been resolved yet?

Jerry Rawls

The particular issue of that one OEM has not been resolved. We expect it to resolve shortly. But it's not an issue anywhere else that I know.

Simon Leopold

And then at the beginning you did have an issue with your CFP products with Huawei. You talked openly about that and you gave us an indication that it would take some time to resolve can we get an update on the conformance or acceptability of that product with Huawei?

Jerry Rawls

That product is now shipping.

Simon Leopold

Great. And then just last one wrapping up on ROADMs. ROADMs and WSF combined it sounds like you're optimistic about getting that certification for the Verizon initiative that we talked a lot about opportunities coming out of China. My impression is that that's not an area where China had a lot of inventory. So if you could speak to the trends you're seeing in your ROADM WSF products of this quarter as well as your outlook?

Kurt Adzema

Our outlook is really bullish on the WSF and a lot of this is all based on China and our expectations of China demand. There is a couple of ROADM deployments that have been announced and relatively kind of small province upgrade or provincial upgrades but we still, still think it's going to be sale of -- and selective switches and China is a big opportunity. There is the OEMs there also export a lot of their systems. So a lot of our, selective switches and virtually all of them historically except for couple of trials during the last year has ended up --.

Simon Leopold

So is this an area where you are expanding production capacity and where are you in terms of utilization or capacity today on WSF?

Jerry Rawls

We have expanded capacity and will not know -- we have right now, I would say we have a bit of capacity of what we are shipping.

Simon Leopold

Great. Thank you for taking my question.

Operator

You next question comes from Alex Henderson with Needham. Your line is open.

Alex Henderson

Thanks. If I can just follow-up on that last question. Can you just give us an indication of the direction of ROADMs and WSF sales in the quarter whether flat, up, down if you could give us some sense of the split between volumes and price would be helpful if you are willing to?

Kurt Adzema

So in WSF was down, and I think we talked a little bit about that was expected. We had an extremely strong quarter especially with one of key Chinese OEM in Q3. So it was down because that order was not repeated. What were the additional questions Alex?

Alex Henderson

So it's down on volume as well as on pricing?

Kurt Adzema

It is. I mean it's down on volume and on pricing, yes.

Alex Henderson

And would you expect to be able to see sequential growth each quarter as we go out over the course of the year. And that takes longer?

Kurt Adzema

I think as what Jerry has talked about I think the primary driver that we see for that business in the quarters is around domestic deployments in China. So we're still hopeful that that's going to happen, but we still don't have the exact clarity on the timing of that. We'd say we were optimistic for growth in that business. But in the near-term we're not seeing growth.

Alex Henderson

One other area that doesn't get talked about a lot but it is not trivial the San business. Can you just give us some directionally what that product area did in the quarter and what you are thinking?

Kurt Adzema

Yes, I think it was - the San business was down some as expected in Q4 and I think we talked a little bit about that when we were given guidance. I think we do see that kind of being relatively flat in Q1.

Alex Henderson

Okay, great. And just to avoid being obtuse the millions of devices comment that was for which quarter? You kind of made that comment before you went into the race set to the quarter of timing I wasn't sure which quarter you meant. Is that the October quarter or the July quarter?

Jerry Rawls

Our second fiscal quarter.

Alex Henderson

Second and so you would describe millions of device units as being a large number?

Jerry Rawls

Well it will be a lot more than that in the sequential quarter. But it's a big number.

Alex Henderson

Yes, I'm just trying to understand the mechanics of what you said. You said millions of units and then you also said it's becoming a very large number. A big number the wording we use. So is that you kind of the run rate that you think is near-term peak and then it rolls back off into the, what's normally seasonally softer back end of the year?

Jerry Rawls

We're relatively new to the consumer business. There is seasonality to it and there is product introduction Christmas season and a bunch of other stuff that goes into it. That does effect supplier shipments. So we do predict some seasonality, but right now we are making everything we can make.

Alex Henderson

Is it reasonable to think that you over the course of the next 18 months will get to a period where you are doing tens of millions of units in the quarter?

Jerry Rawls

No question.

Alex Henderson

Okay. That's very helpful. Thank you. Wanted to ask one more question on the CFP CFP2 segment, there's a lot of talk about another round of price reduction here as we go into the midyear timeframe. So as we're looking at some of those legacy products should we also be looking at both volume decline as well as a price decline on a semiannual basis here?

Jerry Rawls

There are a few in the world of OEMs; there are a few who negotiate prices on a six month basis not on a yearly basis. And I'll just tell you prices never go up.

Alex Henderson

Right. But that's my understanding that the Chinese tend to be more on a six-month process and it seems like the price pressure in China is that a reasonable thing for us to be assuming for that segment of the market?

Jerry Rawls

I think that's reasonable.

Alex Henderson

Right. I'll see on the floor. Thank you.

Operator

Your next question comes from Michael Genovese with MKM Partners. Your line is open.

Michael Genovese

Great thanks. Can you guys characterize the annual price declines on the telecom side what you saw in those negotiations?

Kurt Adzema

I think what we said back in March is that we were at the lower end of the 10% to 15% typical range.

Michael Genovese

And then on QSFP28 would you describe that -- would you still describe them as sold-out conditions and if so is the pricing there behaving like a typical sold-out condition and is the pricing holding up on QSFP28 or is there any unusual pricing activity there given demand?

Jerry Rawls

We are still sold out and the prices have been stronger than we had predicted a year ago.

Michael Genovese

Okay. That sounds good. And then Verizon for the ROADM and the CFP2 ACO, is it correct to try to say that the work has been done and you've done everything and it's just a matter of getting on the approved vendor list in July but all the heavy lifting is done and they just have to cross the -- in July is that a fair way to think about it?

Jerry Rawls

I sure hope so. Everything we've done, we think all the reports have been done all the testing has been done and it is now there is some bureaucratic procedures that go through to get you on aVL and into the Verizon system. But we think all the heavy lifting has been done.

Michael Genovese

Okay. Then last for me is I think in China on transmission up until now you've primarily just been on the client-side and what's your prognosis for getting into line side in China in the future and then also on the client side do you think you did there's going to be a transition the QSFP28 in China at some point and when would that be?

Jerry Rawls

You are correct most of our business in China has been client-side except for our - switches. In the future -- what's in the future I think that you will see a client-side shift toward QSFP28's, I think happening around the world.

Michael Genovese

Just are you going to get, do you think the CFP2 ACO would you have an opportunity in China.

Jerry Rawls

The answer is we're going to sell CFP2 ACO all over the world. We're selling anywhere we can. The question is going to be how much ACO product is bought in China and there will be some at least here to -- has been more persons other than that they don't line -- so for DCO was the principal device that could get. In the future we hope to have much more sales besides -- selective switch and the line side of the transport systems.

Michael Genovese

All right. Well, thanks for taking the questions and good luck with improving the fiscal 18 outlook.

Jerry Rawls

Thanks.

Operator

Your next question comes from Joseph Wolf with Barclays Capital.

Joseph Wolf

Thank you. Question about the data centers. If you look at the progression on the sales per hundred gig have - architecture. It seems like you are used to be more of a standard architecture that was being deployed and a lot more merchant devices being used at least maybe on the electronics one and the optics. Are you seeing any of the more custom designed activity that you think it'll be different across the different the hyperscale guys?

And do you see activity across the second tier of the smaller public web datacenters?

Jerry Rawls

There are some important differences between large web - and cloud provider, cloud services companies. They are particular architectures that they have chosen and the particular hardware the way they deploy it. Yes, it leads to some customers use only one type product and other use different ones and different mixes. So they are uniform at all.

On the second tier they tend to be pretty much to QSFP28, CWM4 and LR4 and you see a lot less non-standard of products or different sort of offerings or different architectures.

Joseph Wolf

Is everybody moving at the same trajectory right now in terms of growth or are you seeing a - is most of the 100 gig activity still the larger customers the six that you mentioned.

Jerry Rawls

Most of the 100-gig is still the big customers.

Joseph Wolf

And then I guess for Kurt, with the gross margin, there was I guess the way that I understood was that more of the revenue side than the mix side for this quarter. If we look forward for the rest of the fiscal year, how does the - how much - how would you weigh this to a component in terms of, if you get a better mix, do you still need to hit over 350 or 360 in revenue to get back to the higher margins that you put up a couple of quarters ago?

Kurt Adzema

Well, I think mix is going to be very important, especially as it relates to the VSCEL array opportunity. So, I think that will be a big driver depending on the volume of that and the associated deals and margins with that. So, I think that will have a big impact, but volume is important. We're vertically integrated manufacturer, so I think it's important that we start as we grow again, we'll start to get some leverage in manufacturing. It's very challenging, the last two quarters as volume has gone down. You've got to spread those cost over less units. So, the hope with revenue starting to increase in Q2 will start to get some leverage again out of the fabs and the factories.

Joseph Wolf

And then just finally on China, I mean Jerry, you were very clear about not expecting us to be a recovery in the bigger parts of the country, but do you - are you close at all to thinking that you are kind of at the bottom in China, and I guess, as you look at that going forward, I guess how - what kind of indicators you are looking for there, expect the size as obviously sales?

Jerry Rawls

One of the things that is often deceiving is forecast from the Chinese OEM base, because the forecast aren't always, they don't always reflect reality as reality then comes along. So, what we look at mostly is sort of backlog incoming order rate, what are the commitments that customers are making for product shipments. And I would say they went down in the fourth quarter. I mean we saw the incoming order rate drop, but that is flattened out and I think our first quarter will be, it will be you know it's stabilized right now. Now will it start increasing? Well, we think it will, but tune in next quarter and we'll talk about it.

Joseph Wolf

Thank you. That was helpful.

Operator

Your next question comes from Doug Clark with Goldman Sachs. Your line is open.

Doug Clark

Hey great. Thanks for taking my questions. First is a follow-up Jerry to a comment that you had made earlier about big capacity coming online, it may have incurred on the QSFP28 in the fiscal second quarter. Can you give us a sense for what the magnitude of that incremental capacity is versus what you have today?

Jerry Rawls

You know I think we've talked in the past about trying to, you know $15 million or so for a quarter capacity I think, just given some lumpiness, I think we're seeing less of that and less of that in Q1, but I think we'll see more than that will play in Q2.

Doug Clark

Got it. That's helpful. And then another clarification in the question on the China WSS opportunity, I know the orders that have been placed recently were quite small. I was just curious if you are explicitly participating in those are waiting for larger orders to come?

Jerry Rawls

Our WSS' will be used in some of these early deployments, our smaller deployments that we wrote about. So, and we optimistic anytime they used ROADMs in domestic Chinese networks, because they are developing experienced, they are learning how to manage these networks. Their network operating systems, their looking after bugs and that but eventually the deployments will be huge.

Doug Clark

Got it. Okay. That makes sense. And then Kurt, a question for you, just inventories on the balance sheet kind of took another step up higher this past quarter. Can you talk a little bit about inventory management and what's causing that increase?

Kurt Adzema

Well, I mean obviously going into the quarter, we thought that it was going to be a stronger quarter, and so now there is various lead times for inventory that we had placed, and so we had to take delivery of that even though we didn't have the revenues to match that. But it's all, and we think it's all good inventory and we think we'll use it and that's just a matter of kind of burn through some of the stuff. So, I don't think it's especially worrisome to us, but inventory is cash, so we try to minimize that as much as possible.

Doug Clark

And actually that brings me to my final question, which is just on the cash balance continues to grow. You mentioned in a few different context, perhaps the VCSEL using cash in certain ways. Can you talk about some of the opportunities that that cash might afford for you guys?

Kurt Adzema

Well, again I think, when we did the capital raise back last December, I think we ultimately we wanted to provide flexibility and that could mean investing in more organic growth as well as looking at acquisitions as well. So, I think, we'll continue to aggressively look at that and try to find the right opportunities, but at the same time it's always hard to get few parties to agree. So, I would say you know we'll continue to be active about that, but we'll only do deals of the mix, makes sense for us and best sense for our shareholders.

Doug Clark

Got it. That was it from me. Thanks for taking my questions.

Operator

Your next question comes from Dave Kang with B. Riley. Your line is open.

Dave Kang

Thank you. Good afternoon. First, a clarification, do you say for Verizon, qualification of ROADMs in ACO's by July quarter? Did I hear that…

Jerry Rawls

Second quarter.

Kurt Adzema

We said second quarter in Jerry's remarks.

Dave Kang

So, in the previous call, you said first quarter, so what has - I mean what gives you confidence that will happen in the second quarter?

Jerry Rawls

Well, the customer moved it out, and it wasn't a technical issue. It's not a product problem. It has to do with a transition with Verizon and they are in charge of the inflection points in these transition. So, we are - we take orders.

Dave Kang

Got it. And speaking of orders that you received for VCSELs for 3D sensing, is that VCSEL dies? And if so, then should we expect gross margin to be naturally over 50%.

Jerry Rawls

Well the gross margins are going to - we think will be attractive above our cooperate average we hope, but the real issue is going to be yields. If our yields are good, our margins will be good. If our yields are exceptional, you got - you understand, but we're optimistic that our yields will be better than our cooperate average.

Dave Kang

But the question was that the orders that you received was if for dies or not?

Jerry Rawls

Right. The major program that we're working on today, we are only a supplier of die.

Dave Kang

Got it. And the just lastly on China, so I guess that China Telecom has started the deployment maybe small and I guess China Mobile is, that can have - first of all is that true an second question is have you been qualified into both operators?

Jerry Rawls

Well, it's not the operator that qualifies, it's the system provider that qualifies. They qualify their ROADM rack into China Mobile or China Telecom and yes we are qualified.

Dave Kang

For both?

Jerry Rawls

For both.

Dave Kang

And Kurt, last question, how much was the depreciation and amortization?

Kurt Adzema

I think it was around $24 million or so.

Dave Kang

Got it. And just one more. Just you gave us a CapEx estimate for first quarter, but what about further rest of the year, I assume, that may trend down a little bit?

Kurt Adzema

I think so we said about $45 million for this quarter. I would say Q2 will probably be in the same range and then it will start to trend down maybe by $5 million a quarter after that?

Operator

Your next question comes from Dmitry Netis with William Blair & Co. Your line is open.

Dmitry Netis

Thank you very much and thanks for taking my question. Jerry, I want to go back to the comments on the ROADM opportunity in China. You seem to indicate some kind of deal trials that are going on right now, but we have all read about this China Telecom ROADM tender. So do you mind, maybe talking a little bit about how big this could be, is that a trial really that's going on, or is that a real deal type opportunity that's been unfolding right now as we speak? And if so, when will that become, I mean a driver for you, since you have mentioned you are qualified at it?

Jerry Rawls

Well, we'll get business out of it, but it's not going to be a huge driver and I don't know the exact number. I just know that our guys that are on the ground in China say that these are provincial deployments and not very large. And so does that mean we'll get likely hundreds, and if we got thousands wavelength selective switches out of it, we might think it was a very good deal. Here before they've had other regional deployments or provincial deployments, and we've gotten hundreds if not thousands of wavelengths selected switches into each one.

Dmitry Netis

And just to clarify it is WSS, it's not a ROADM line card that you…

Jerry Rawls

Correct. We don't supply any ROADM line cards. All the OEMs in China build their own line cards. So, they buy wavelength selective switches and then they even build or buy their own or even fiber amplifiers et cetera. They package it themselves.

Dmitry Netis

That's helpful. And then similarly on the China Mobile packet transfer network opportunity, are you exposed to that at all or is that something that doesn't concern you?

Jerry Rawls

Well, we hope we will end up supplying client side devices that go into one of the OEMs. But we don't have much exposure on the line side that.

Dmitry Netis

And on the client side you mean CFP modules, the CP2 modules?

Jerry Rawls

Correct.

Dmitry Netis

Okay helpful. And then if I may, and then I have -- I'll ask you one Jerry and then one last one for Kurt on the margin side, but as you look out into 400 gig market potentially, I don't know you tell me how long that will take. But we all know it's coming right? One of the major module sort of competing for that market is this 400 gig our short reach effort which appears to be a coherent technology. And so that potential could start into the QSFP28 LR4 optics. How are you thinking about it? How are you positioned to capture this 400 gig GR opportunity?

Jerry Rawls

Well 400 gig is a big deal for everybody right now. I mean all the customers are talking about it. They all - there is still a little bit of a controversy in the industry between the QSFP DD form factor and the OSFP form factor and there is not - it's not unanimous. And so there is going to be a fair volume of both of those. Our expectation is we're going to be an important player in both and I don't - whether the two things are DR and LR. DR and what's the other one - anyway. Suffice to say, we expect to be an important supplier in 400 gig.

Dmitry Netis

Which would imply you will need to partner with somebody or purchase kind of - or go through kind of sort of an acquisition we're hearing on technology, right, but still consider that technology?

Jerry Rawls

Well, I wouldn't say that. I mean we do make - we make coherent laser today. We make a coherent receiver, we make - all the optics, we make all the coherent optics for our CFP2 ACO. They run at 200 gig, 16 QAM, so we feel pretty good. I mean but to do the 56 gig PAM4 is, you know it's not many lasers around it that can handle that today. So there is a few. We've built some demonstrations and we've had some of our customers written paper at OFC and presented papers that used our lasers at those speeds. So, the existence proof is there but we're not in volume of production or anything like that.

Dmitry Netis

Okay. Jerry, that's very helpful. Kurt, just one last one real quick on the margin front, is the kind of high-30s kind of exit rate this year, is that still a target? Can you still get there given kind of the low volume here in the first quarter and eventually a snapback as you go through the year, well starting in October?

Kurt Adzema

Well, you know again, we don't provide margin guidance beyond the next quarter which we've provided. Certainly if we get the increase in volume and you know our successful with some of those 3-D sensing that Jerry has talked about, that should be helpful towards margin, but we're not going to give guide to margin beyond the quarter that we're in.

Operator

Your next question comes from Richard Shannon with Craig-Hallum Capital. Your line is open.

Richard Shannon

Hi guys. Thank you for taking my question as well. Maybe I'll follow-up on a much earlier question regarding pricing in the datacom space. Jerry, I think you were asked a question about CWDM4 pricing. I didn't recall there was referring to the 2-kilometer, 10-kilometer device, but maybe I'll ask one specifically on 2-kilometer. How does the pricing coming there both in current status as well as how difficult is the pricing getting on a forward basis looking out at least two quarters?

Jerry Rawls

Well, as I pointed out in an earlier question, the pricing has been better for us than we predicted a year ago. So it's held up and that's a reflection of the fact that there is a shortage in the industry and demand exceeds supply. We expect that's going to continue to be the case and until we have a balance and the supply catches up with demand. I think that's likely to happen sometime in 2018, we project that when that happens prices are going to come down, it's your guess as to how much of an imbalance there might be on the other side and how those prices will hold up or not.

Richard Shannon

Okay. As you see the pricing in the two kilometer area, do you expect that to still remain a favorable gross margin product area for you, at least corporate average?

Jerry Rawls

It's uncertain.

Richard Shannon

Okay. I think that's helpful. I just wanted to get a sense of what's going on there. Maybe switching over to 3D sensing, Jerry do you have any sense of what -- at least with your initial customer or early customers here, what kind of share you're getting?

Jerry Rawls

No, I don't actually know that. There is a lot of secrecy that surrounds this traffic.

Richard Shannon

Yes, I've been hearing that as well, it's not surprising. And a follow-up on that topic Jerry, when do you get a sense of when your next customers will fall in line here; is it -- assuming it to be on the October quarter, can you give us a sense of when we start to see mature contribution outside your lead customer?

Jerry Rawls

I wish I could answer that. We have engagements with a number of customers now and we're supplying devices. But we don't yet have any firm commitments, so I'm --- that's on a wait and see for us. I mean we're aggressively trying to make sure we can build high power pixel arrays in the configuration and each customer has its own configuration, there is no common approach to this thing and we're trying to make sure that we enable them to be able to do their testing and their system development etcetera; and I probably at this point, it's really hard for me to pick a quarter in which this is likely to -- where customer number two is likely to take-off and start buying millions of units from us. I do expect it will happen in the next year to 18 months.

Richard Shannon

Okay, perfect. That's all the questions for me guys. Thank you.

Operator

Your next question comes from Tim Savageaux with Northland Capital. Your line is open.

Tim Savageaux

Hi, good afternoon. Just wanted to go back on kind of the 3D sensing comments and see if I understood them properly. Jerry what I heard you saying before you -- kind of major correction was maybe a few million units in the July quarter in fiscal Q1 moving to tens of millions or a much bigger number in fiscal Q2, quick. Okay, that's correct, great. Then I wanted to follow-up with that about -- you know, basically connecting the dots between unit volumes and revenues; I think our -- at least my operating assumptions here has been around kind of a low single digit ASP here but I wonder if you'd like to provide any commentary on this ballpark, what our expectation should be there?

Jerry Rawls

I don't think I should talk much about pricing on this forum but I -- you know, our expectation is going to be a good product. We hope that our yields are really good, we have early indications and all the runs that we've made so far, I mean we have now shipped -- we sure already shipped tens of thousands of units, maybe or probably more than a 100,000 units actually. And we're making progress, the yields are respectable but not as good as we projected and all that has a lot to do with where our margins are going to end up.

Tim Savageaux

Okay. Well, let me follow-up on that margin topic; you know, you do have competitors talking about gross margin in excess of 50% and given that you're vertically integrated and versus an outsourced model, one might think you would have that potential as well although potentially offset by a cost dynamic at four inch versus six inch, that is where the yields come in. But am I kind of thinking about that the right way and when you say our yields are good, can you reach that 50% level or is that maybe a bit of a stretch?

Jerry Rawls

I'd rather not go there. Our margins will be respectable. We don't necessarily expect it to be heroic but we sure expect them to be respectable. So I'm now going to leave it at that.

Tim Savageaux

Okay, fair enough. Thanks very much.

Operator

That's all the time that we have for today's question session. With that I will turn it over to Jerry for closing remarks.

Jerry Rawls

Thank you, Jess and thank you to everyone who tuned in today. We appreciate you taking the time to spend with us and we hopefully get to talk to you again one quarter from now. Good day.

Operator

This concludes today's conference call. You may now disconnect.