Viavi Solutions Inc (VIAV) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the JDSU fiscal 2006 third-quarter earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Ms. Jacquie Ross, Investor Relations.

Thank you, Colby, and welcome to JDSU's fiscal 2006 third-quarter conference call. Joining me on the call today are Kevin Kennedy, Chief Executive Officer, and Dave Vellequette, Chief Financial Officer. As always I'd like to remind you that this call is likely to include forward-looking statements about the future financial performance of the Company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to look at the Company's most recent filings with the SEC, particularly the risk factors section of our Form 10-Q, filed for the quarter ended December 31, 2005, and 10-K filed for the year ended June 30, 2005. The forward-looking statements, including guidance, provided during this call are valid only as of today's date, May 3, 2006, and JDSU undertakes no obligation to publicly update these statements as we move through the quarter.

Our comments today will include non-GAAP measures. A detailed reconciliation of these non-GAAP results to our GAAP results, as well as a discussion of the usefulness and limitations of these non-GAAP measures, is included in today's news release (indiscernible) results, available on our website at www.JDSU.com.

Finally, and as a reminder, this call is being recorded and will be available for replay from the investor portion of our Website, at www.JDSU.com/investors. I would now like to introduce JDSU's Chief Executive Officer, Kevin Kennedy.

Good afternoon. Thanks for joining us today. Our fiscal third-quarter results are characterized by four important accomplishments -- first, revenue in the top-half of our guidance range; second, gross margin improvement amid dramatic mix shifts; third, double-digit sequential growth in the Optical Communications segment; and fourth, a book-to-bill greater than one in all segments.

It has been one year since we first shared with you our specific plans to build a JDSU that was capable of delivering improved profitability. While our journey is not yet complete, I'd like to take a moment a recap the scope and status of the underlying initiatives.

First, we have initiated our manufacturing consolidation program targeted to reduce the number of North American Optical Communications sites from seven to two. We remain on plan to see the full benefit of these activities after the end of the calendar year.

Second, and in support of this consolidation program, we are executing an aggressive program of product transfers from North America to either our own Shenzhen facility in China, or to one of our contract manufacturing partners. To date, we have transferred 13 product lines.

Next, seven product lines have been divested or discontinued in order to support our gross margin objectives. Relative to the third quarter of fiscal 2005 ended March 31, 2005, approximately 20 million dollars per quarter of revenue was deliberately removed in pursuit of improved probability.

Next, we met the cost-saving targets that we shared with investors a year ago, achieving quarterly cost savings of at least 4 million in fiscal Q1 '06, 9 million in fiscal Q2 '06, and 17 million in fiscal Q3 '06, as compared to our fiscal Q3 '05 results. In fact, we have pulled in some savings ahead of schedule, bringing the cumulative total to more than 18 million. These savings have contributed to improved gross margins and operating margins in our Optical Communications and Commercial and Consumer business.

During the last 12 months, we launched 34 new Optical Communications products developed internally, highlighting our continued commitment to innovation and to meeting our customers' needs. As a result, Optical Communications revenue has increased more than 25% in the last year, and we believe that JDSU is gaining market share.

And finally, we welcomed approximately 2000 employees from four acquired companies, demonstrating our continued commitment to extending our opportunity in growing profitable markets. The integration of Lightwave, Photonic Power, Acterna and Agility has been completed or is being executed on or ahead of schedule. As I said, this remains a work in progress, but we believe our third-quarter results further illuminate the path for an emerging JDSU business model.

Now some detail on our fiscal Q3 '06 results. Non-GAAP revenue of $315.5 million was flat from last quarter as growth in Optical Communications and Commercial and Consumer more than offset a 20 million seasonal ebbing in our Communications Test and Measurement segment. Compared to our year-ago results, revenue was up 90% from $166.3 million. Excluding our Communications Test and Measurement business, which was not included in last year's results, and adding back instrumentation revenue which was transferred to the Communications Test and Measurement segment, revenue was up 16% from the same quarter a year ago.

Non-GAAP gross profit was $118.3 million, or 37.5% of revenue, our highest margin in five years. The bulk of this quarter's improvement reflects the impact of our cost-saving initiatives in our Optical Communications and Commercial and Consumer segments, although we also benefited from a favorable mix in our Commercial and Consumer and Communications Test and Measurement segments. While we expect our non-GAAP gross margin to fluctuate on its path to greater than 40%, we believe that our actions to date have created a floor around the 35% level.

Non-GAAP EBITDA was once again positive at $7.9 million, which was roughly flat from last quarter and compares to non-GAAP EBITDA loss of $19.8 million in the year-ago quarter. On a non-GAAP basis, pre-tax income was positive for the first time since June 2001. However, higher taxes resulted in an overall net loss of $2.8 million, a slight improvement from last quarter's loss of $3.5 million, and an improvement of $20 million from the year-ago quarter. On a per-share basis, we were once again slightly below breakeven.

Finally, book-to-bill was once again greater than one for each of the operating segments. This quarter our served markets were generally favorable relative to a year ago, although variability existed across customers.

Moving now to our business segments. Led by JDSU's agile optical products, our Optical Communications revenue increased from $109.6 million last quarter to $127.5 million in the third quarter, an increase of 16% from last quarter and 25% from the year-ago quarter. Growth in our Optical Communications segment was almost entirely driven by our agile optical network, or AON, products, including ROADMs, optical switches, blockers and tunables. The agile optical network components, modules and subsystems are key elements of next-generation optical networks that allow service providers to manage changing traffic demands remotely, supporting the cost-effective acceleration of new service deployment.

JDSU's agile optical portfolio was on display and well-received by customers at OFC. Customers choose JDSU's agile product portfolio because of our technical leadership in this area. Our wavelength selective switch, or WSS, for example is carrying live long-haul and metro traffic today. And in the PLC ROADM market, we believe that JDSU currently has more than 60% market share.

In terms of the optical communications industry, we continue to believe that the overall market is growing in the region of 5 to 10% per year, possibly better. JDSU's stronger performance this quarter was driven by the industry's transition to newer technologies that are enjoying higher growth rates than the industry as a whole. Modems, for example, are expected to grow more than 40% annually, according to Ovum-RHK.

At the same time, our Optical Communications revenue was still reliant on a relatively small number of large orders from a limited number of customers. This means that our Optical Communications revenue will continue to fluctuate from quarter to quarter and be heavily impacted by the timing of deployments and orders, and our ability to manufacture and ship those orders. Our operations team continues to execute solidly in an environment of ongoing transition, enabling a greater than $17 million ramp in Optical Communications revenue during this quarter.

Highlighting the positive impact of our cost reduction initiatives, Optical Communications operating contribution improved from a loss of $10 million last quarter to a segment operating income of $2.2 million in the third quarter. This represents the first time in five years that that segment has made a positive contradiction, and marks a very important milestone for this particular business.

Our Communications Test and Measurement business grew more than 10% from the year-ago quarter. As anticipated, the marked seasonality in this business was clearly visible in our results, with revenue declining from December's very strong $146 million to $126.8 million this quarter. Even without the benefit of year-end carrier budget spend, we continued to strengthen our position as the supplier of choice for broadband triple play test and measurement solutions, partnering with BT's 21st Century network, and realizing double-digit revenue growth quarter-over-quarter in our MTS-T-BERD platform designed to support the deployment of fiber-to-the-home networks.

During the quarter our Communications Test and Measurement segment introduced a number of new products and enhancements designed to enable the efficient delivery of triple play services and reliable deployment of FTTx and digital cable networks. New products in our Smart class handheld series, for example, introduced a range of high-value, high-performance instruments for dark fiber installation and troubleshooting. Additionally, our pending acquisition of Test-Um further establishes JDSU as a leader in the growing home networking test and measurement market, and gives us a unique ability to offer solutions from the core network to the customer premise.

We are also seeing momentum in our test system business. During the quarter we launched and received our first order for NetComplete broadband tools, a new software tool for broadband network management and performance monitoring. The product, developed in collaboration with AT&T, will provide DSL network capacity planning support for a major U.S. service provider. We also received our first order for our recently introduced digital video monitoring system.

Our Commercial and Consumer business contributed $61.2 million, up 3% from last quarter's $59.4 million, despite our exit from the front surface mirror business which was completed during the quarter. Reduced revenue from front surface mirror was more than offset by solid performances in our Laser and Flex groups. Year-over-year, the segment was down 5%, highlighting the impact of our series of product phaseouts. Our segment operating contribution improved slightly at $8.2 million, or 13% of revenue, which compares to an operating income of $1.3 million, or 2% a year ago.

During the quarter our Flex group launched an authorized partner program designed to extend the reason of our SecureShift technology. By partnering with Nosco and CCL, JDSU intends to broaden the reach of our anti-counterfeit products without compromising the security of the supply chain. JDSU's family of SecureShift products enables consumers to immediately verify branded merchandise as authentic. Branded owners in turn recognize that SecureShift inks and labels offer a cost-effective anti-counterfeit measure. More than 40 well-known pharmaceutical brands are protected by JDSU, for example, as well as a very well-known brand of printer consumables, and most recently, one brand of cellphone batteries.

Our Laser business continues to gain recognition for its high-power, high-performance precision lasers. The introduction of the telecom-class single emitter diode laser in January, for example, demonstrates our ongoing commitment to innovation. With in-house manufacturing now consolidated, the business is well positioned to build on its growth this quarter with a very strong portfolio of lasers that supports the industry's transition to solid state.

Our coated optics team completed the divestiture of the front surface mirror assets during the quarter and received its first $1 million order for custom optics built using a new semiconductor-class of precision coater, mentioned on previous calls.

Moving to corporate developments, and consistent with our objective to recruit additional talent to support and guide the management team, we welcomed Openwave CFO Hal Covert and former Sun executive Masood Jabbar to our Board of Directors during the fiscal third quarter. [40]% of JDSU's board members have joined us within the last 14 months, allowing us to benefit from a wealth of sales, finance and operations experience in the turnaround context.

Finally, and just a reminder that stockholder authorization for reverse stock splits remains in effect until December 1, 2006. The exercise of this authorization remains a matter of ongoing review by our Board of Directors.

Before I hand the call over to Dave, I will just share with you some of our areas of focus going forward.

First, we will continue to execute our program of cost reduction and gross margin improvement initiatives to realize previously identified cost savings. Second, we must decrease our operating expenses as a percent of revenue. Third, we will continue to be focused on improving our manufacturing supply chain yield and capacity metrics to ensure that we are able to meet the demand and customer quality and performance expectations. Fourth, we continue to strengthen our finance team and streamline processes. We have made 28 new hires in the finance department in the last nine months, including eight CPAs. And finally, we will continue to invest organically and inorganically to enable optical and broadband innovation.

I'd now like to invite our CFO, Dave Vellequette, to discuss the financials in greater detail.

Thank you, Kevin. GAAP revenue for the third fiscal quarter of 2006 is $314.9 million. Non-GAAP revenue of $315.5 million includes $600,000 of revenue associated with acquisition accounting, in addition to the first full quarter of revenue from our acquisition of Agility Communications, which closed at the end of November. When comparing our revenue to the year-ago quarter, you should recall that our topline has been impacted by four acquisitions, as well as the sale or exit of seven product lines over the last 12 months.

Non-GAAP gross margin improved from 36.3% last quarter to 37.5%, as the incremental savings from our cost reduction initiative more than offset downward pressure on gross margin caused by the seasonal ebbing in our Test and Measurement business. In terms of our cost reduction programs, we were able to pull in some of our scheduled cost savings, and therefore exceed our targeted $8 million of cost savings for this quarter. This brings the cumulative cost savings total to over $18 million when compared to our third-quarter results of fiscal 2005. Our target for incremental cost savings in the fourth quarter is therefore approximately $4 million, which would bring the cumulative total to $22 million, or $88 million on an annualized basis.

As a percentage of revenue, non-GAAP operating expenses of 39.7% increased from 38.1% last quarter, reflecting our first full quarter of Agility-related operating expenses, as well as higher SG&A expenses associated with selling, integration and finance support. The majority of these SG&A increases were associated with our Communications Test and Measurement segment.

Operating expenses as a percentage of revenue will be impacted by the seasonality of the Communications Test and Measurement segment. Overall, we continue to target 35 to 38% of revenue as a desirable range, which we expect to achieve during the next fiscal year, which, as you know, starts in July.

Non-GAAP net loss narrowed to $2.8 million from a net loss of $3.5 million last quarter, and compared to a net loss of $23.5 million a year ago. Non-GAAP earnings per share for the third quarter was slightly below breakeven, flat from last quarter and compared to a net loss of $0.02 on a per-share basis a year ago.

A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. In addition to the deferred revenue adjustment noted above, our non-GAAP results exclude a $37.7 million gain on sale of investments reflecting the sale of our remaining investment in ADVA, amortization of intangibles of $16.3 million, an $8.8 million charge for restructuring and nonrecurring expenses relating to exiting our former headquarters location and to the sale of our Ottawa manufacturing facility, and a $4 million charge related to stock-based compensation.

Including these items, GAAP net income of $3.7 million improved from last quarter's loss of $42.1 million. This net income was due to the sizable gain on the sale of investments noted previously.

GAAP gross profit of $115.5 million, or 36.7% of revenue, improved from 33.3% of revenue last quarter. GAAP operating expenses of $154.7 million, or 49.1% of revenue, were down slightly from last quarter.

Moving to the quarterly results for the business segments, Optical Communications revenue of $127.5 million was up 16% from $109.6 million last quarter, and up 25% from 101.7 million a year ago. These results include the first full quarter of revenue from our Agility acquisition.

For the fifth consecutive quarter, the segment book-to-bill was greater than one. Higher revenue, in addition to our cost reduction program, resulted in improved operating results for the segment, with the operating contribution improving by more than $12 million, from a loss of $9.9 million last quarter to an operating income of $2.2 million in the third quarter.

Our Optical Communications segment remains a work in progress, with product transitions from our former Ottawa site ongoing through the end of this calendar year. As with previous transitions, there are incremental costs associated with the move to a lower-cost location. As a result, we will not realize the full benefit of this action until calendar 2007.

As we expected, Communications Test and Measurement revenue declined in line with seasonal trends from $146 million to $126.8 million. The resulting decline in gross profit, along with higher SG&A expenses, reduced the segment's operating contribution from $26.5 million last quarter to $15.3 million this quarter.

Lastly, our Commercial and Consumer revenue increased $1.8 million, from last quarter's $59.4 million to $61.2 million. Growth in our Laser and Flex groups more than offset the anticipated decline in our custom optics business.

As planned, we completed our phaseout from the front surface mirror business during the quarter end, and as a result, expect fourth-quarter revenues to be negatively impacted by several million dollars. Operating contribution from the segment was $8.2 million, or 13% of revenue, up slightly from last quarter.

Taking the Company as a whole, our Optical Communications segment contributed 40% of total revenue. Communications Test and Measurement also contributed 40% of total revenue, while the Commercial and Consumer segment contributed 20%. On a geographic basis, The Americas reported revenue of $190.6 million, or 60% of non-GAAP revenue. Europe contributed $76 million, or 24% of revenue, and Asia-Pacific contributed $48.9 million, or 16% of revenue.

Moving to the balance sheet, total cash increased by approximately $6.9 million to $847.3 million as of the end of the quarter. Net accounts receivable declined to $216 million, reflecting improved collections. Our DSO improved to 62 days. Net inventory increased to $189.1 million, primarily due to the Agility acquisition, as well as strategic purchasing activity. Inventory turns were 4.2.

As of March 31, 2006, headcount was 7005, down just over 200 headcount from last quarter. We continue to add headcount at our Shenzhen, China facility to support our manufacturing transitions, but this was more than offset by headcount reductions by virtue of the sale of our Ottawa manufacturing facility.

Moving to an update on our ongoing cost reduction initiatives, for the third consecutive quarter, we met or exceeded our cost reduction targets. Compared to the third quarter of fiscal 2005, we have reduced costs by more than $18 million per quarter, and we remain on track to reach our goal of $22 million in cost savings in the fourth quarter of fiscal 2006. We expect to realize approximately $4 million of additional cost savings, primarily in cost of goods sold, in the fourth quarter.

On the last call, we told you that we would quantify the cost savings anticipated from an additional set of actions announced in November. These actions related to our Rochester, Ottawa and Santa Rosa sites. The Rochester closure is expected to be complete by the end of June 2006. The Santa Rosa activity is targeted for completion by the end of the calendar year. And although we have transitioned our Ottawa site to Fabrinet, we will not see the financial benefits until the products have been transferred to lower-cost locations, which we expect to be complete by the end of the calendar year. The expected quarterly cost savings from these actions are $2 million in Q1 '07, growing to $3 million in Q2 '07 and $5 million in Q3 '07.

Now to our guidance. For the fiscal 2006 fourth quarter, we expect revenue to range between $302 million and $322 million. While the Optical Communications environment continues to be favorable, we have widened our guidance range to accommodate several potential impacts.

First, our program of North American assembly manufacturing transitions is entering its final phase, and, as always, includes an element of execution risk.

Second, you should recall that the June quarter has historically been the seasonally weakest for our Communications Test and Measurement business.

Third, our Commercial and Consumer segment revenue will be negatively impacted by low single-digit millions associated with our exit from the front surface mirror business.

Fourth, you should be aware that we are approaching an important deadline for our customers who serve European markets. We have been working with our customers to meet the RoHS requirements. RoHS refers to the EU's restriction of certain hazardous materials in products shipped after July 1, 2006. We cannot preclude the possibility that this effort will exert a limited downward pressure on the performance of our Optical Communications segment this quarter.

Finally, our Optical Communications business continues to depend on a relatively small number of very large customers. It remains to be seen what impact, if any, the current consolidation activity will have on our business.

From a bottom-line perspective, if one or more of these items impacts our topline, there could be an associated downward pressure on our gross margin and other profitability metrics. RoHS and factory transitions, for example, could result in lower revenue and/or inventory write-offs that could impact our results. In addition, product mix within the Communications Test and Measurement segment, which we noted was favorable in Q3, could be less favorable in Q4.

Finally, the integration costs associated with each acquisition exerts an upward pressure on our operating expenses. The scope of these factors taken together may introduce variability on the order of zero to mid single-digit millions. That said, as we look forward to fiscal year 2007, we are very focused on controlling costs and on improving our overall business model. We believe that the investments we are making now in IT and finance support, for example, are critical elements of our strategy to deliver an integrated business model that is capable of sustainable profitability.

With that, I'd like to invite the operator to begin the Q&A.

(OPERATOR INSTRUCTIONS). John Harmon, Needham & Company.

I was wondering what you were saying about your optical business, that most of the growth came from new products. Is there any way to think about how big the market for ROADMs and wavelength blockers might be, and how big it's growing?

There are other people that are estimating these things. I would say that traditionally, we have felt that the optical market was growing at 5 to 10% per year. I'd say based, upon what we've seen recently, it's at the high-end of that range, if not better. So, it is a favorable market. We think things like ROADMs and wavelength switches are probably growing at the 40 or 50% per year growth rates, and those are numbers that people other than myself, analysts, developed. And so, I think we have a piece of our portfolio that is in the lower end of the growth range, this 5 to 15%. We've got these high-end products that are probably in the 40% per year growth rates. Then we have products like tunables that are sub-$100 million markets -- and that of course is true of ROADMs -- but over the next two years they will become $100 million markets, and they are probably growing at 40 to 50% per year as well. So, I think a lot of beacons for growth out there, and we know what those are, the high-end products as well as the tunables. The traditional stuff is growing a bit slower. I should say that both metro and long-haul for us grew at double-digit growth rates quarter-over-quarter. So, there was good activity in both of those as well. I hope that helps.

Dayle Hogg, JMP Securities.

With the RoHS, is there an inventory -- do you see some excess inventory in the channel already, or do you see that as building in the next quarter?

I don't know that I see excess inventory in the channel. As you know, much of what we make for the top-tier customers are built to order. So, they're not the kinds of things that people would buy with the purpose of having inventory in general. But our big concern is that people could decide to flip a switch at some point and require everything from some point forward to be RoHS-compliant. And that would mean us accelerating the future and possibly having things left over in the past. So, I don't know how to call that until we get further into it. We are fairly intimate with each of our customers and trying to manage that process one customer at a time.

Can you sort of quantify what percentage of your current shipments are RoHS-compliant versus ones that you still have to do some work on?

I think the vast majority of what we have is either shipping or will be shipping by July 1. It's very high percentages. But I don't have a specific number that is quotable at this point.

Paras Bhargava, BMO Nesbitt Burns.

Just a basic question on your revenue growth, Kevin. There's a lot of moving parts in terms of stuff you're adding with new acquisitions, stuff you're taking off, especially in the optical components and the com business. The com business -- the commercial business looks like it's down year over year, but my sense is that's mostly due to divestitures. And the com business looks like it's up massively, but I think some of that is due to acquisitions. I wonder if you could tell us what it is on an organic basis from both of those two. And secondly, for you Dave, the corporate overhead seems to keep on going up. Is that all due to Agility, or is that due to other items? And will it come down any from here?

Let me take your first question, and -- on the optical coms, I don't know the numbers and can't do them in my head, but I can give you the primitives to work with. If you go back a year ago, we divested a cable TV asset and we exited a number of businesses in coms less than 10 million a quarter, more than four or five. So, the way to think about it is we took a -- maybe a 5 to $10 million run rate business away from our optical coms. And the only thing that we basically added through acquisition in optical coms was Agility, and that's very low single-digit millions of dollars. So, we probably divested more than, or exited more than we've added back organically. And so, the organic growth rate is actually higher than what was stated, if you will, because of what we've kept. Does that make sense to you?

Absolutely. I forgot about the divestitures.

As far as the corporate overhead, Agility did contribute to the increase in the corporate overhead. At the same time our com test group was at the end of their traditional fiscal year, and we had not adjusted their sales plans, because we did not want to -- when we completed the acquisition we wanted to leave them on their sales plan. So, they had their typical end-of-year spike in earnings, having to do with over-tier accomplishments. Also, as we noted, we've hired a number of (technical difficulty) which has added to expense, and the integration cost with all our acquisitions has also added to our expense structure.

What should the corporate overhead be going forward? Will it be closer to 25, or closer to where it is now?

The corporate overhead right now is -- longer-term will be going down in that direction. But right now, that's what we stated about. That will be more of a fiscal '07 action as we bring it down during that period. It's more in a percentage of revenue range as opposed to an absolute dollar.

So, we should budget at 33, 34 for now? Or will it go higher than this? Because Oracle might chew up some more, right?

We're at pretty much full speed on our Oracle integration activities. So, I'm not expecting any big swings in that expense at this point.

Let me take your question and generalize it and give you a way that at least I'm thinking about it. And I'll simply take the category of OpEx as a percent of revenue. I actually think today we are nominally running at the high end of our stated range. Now, although we ended up with reported 39%, remember there's a high degree of seasonality. So, if you walk away from either the nadir or the peak of Com Test, and you pick -- add 12 million back of revenue, at that rate we are at around 37.5% of OpEx as a percent of revenue. That being said, realize T&M has the highest ratio and does not scale with seasonality. But of course, it will naturally improve as the seasonal cycle is good in the second half of the calendar year.

The second piece is that the integration brings higher near-term transition costs, but longer-term reduction in geographically-dispersed finance and other resources. And as I've said publicly with folks, you do need the Oracle integration to be complete, which Dave has said he will get done by the end of this calendar year, in order to be able to release those resources.

The next piece is acquisitions like Agility will add near-term departures from any particular model. And we were overt about the fact that Agility was not accretive; it will be dilutive in the near-term, and that's what you're seeing here.

And I would say the last piece is we do have a program of ongoing reductions of buildings and factory consolidations that will continue to drive improvement at a lower level. So, that cacophony of items will accumulate into moving us -- what I think nominally we're at the 37 to 38% range -- again, not accounting for the peaks of seasonality. And as we exploit all of those four items, we will get down to the 35% or better. Does that help?

Absolutely. Kevin (indiscernible). Have you got a planned date for the reverse split, or have you actually committed to it? Or is it just something that you are free to do until the end of December?

We're free to -- the Board is free to exercise it until December 1 of this year. The first -- the discussion that you would hope that a board has is what criteria are required to exercise the authorization that shareholders have given the board. The first criteria was that the Board wanted to make sure that we were EBITDA -- non-GAAP EBITDA positive. At the time the shareholders authorized it, we had not hit that threshold. And we passed that threshold in February. I would say the next thing that you might think a board would discuss is is it sustainable, so this is the second quarter in a row that we've been able to do it. And I'm sure the next time the Board meets it will take a look and say, how's the EPS number? Is it positive or negative, and what's the trajectory? So those are the kinds of thoughtful discussions that occur at a board level. Hope that helps.

(OPERATOR INSTRUCTIONS). Brantley Thompson, Goldman Sachs.

First on the gross margin front, you obviously had a pretty big swing in terms of your operating income and your communications components business. Could you talk a little bit about how that gross margin fared through that transition? It seems like it would have been a big contributor; the incremental operating margin of that business was phenomenal in the quarter. Could you just give us an update on what you're seeing there? And second, on your operating expense trends into the June quarter, how should we think about them on an absolute level?

The gross margin for op com, you're correct that the majority of the savings that we realized in the quarter was in the Optical Communications segment. And you can see from the segment report that that's reflected in the numbers from the $12 million improvement. That $12 million improvement reflects not only the savings, but also the higher revenue levels that we achieved during the period. So, the AON products helped, obviously, in the execution against our cost reduction programs.

As far as the operating expenses go, as Kevin stated, we have a number of expenses that we are incurring right now. We're at a level that's at the upper end of the range that we want to be in. The ebb and flow of the revenues will impact it as a percentage of revenue, but we're not really forecasting expense levels. But we're not seeing significant decline from the expense levels in the next quarter, and over time we'll be looking at reducing them as we are able to execute against the programs that Kevin just highlighted.

Arnab Chanda, Lehman Brothers.

I was taking a look at your -- where you discuss different businesses in terms of the operating contribution, and there was another item that's all other. Is that exited businesses, or is that something that you can't allocate? And then I have a follow-up, please.

Those of the expenses that if you look at the historical we have not allocated, and we were just talking about those briefly with Paras that relates to the basically finance, IT, legal, HR, those departments. When we look at the segments, we don't load those segments up traditionally, other than the com test, since that's basically a stand-alone segment at this point. So, those expenses we have kept separate, because as we measure the GMs, we don't include those in their results.

Thanks, Dave. Maybe a question for Kevin. It sounds like we have kind of a little bit come full circle from 2000, where your Optical Communications again is your fastest growth business, and some of the other businesses inside of the divestitures probably not. If you just look at the Commercial and Consumer versus Optical Communications, what do you think is the strategy there? Do you think it makes sense to keep both businesses? Are there enough synergies? If you could shed some light on that.

Clearly, you're right in asserting that we believe that coms has the greatest growth potential in revenue and is where we focus on profit improvement. Our test business, because of the leadership position we have, it is demonstrating that it, too, can grow in double-digit year-over-year growth, as we've seen here for a number of quarters. And on the CCP side, I think we have tried to represent that as a business that has products that, we believe, service markets that will allow it to grow someplace between 5 and 10% per year. It's the slower growth, but on the other hand, I believe that the three elements in it are capable of very good profit. So, let me now answer your question of how do those elements relate to anything else we have in the Company.

It turns out that the technology that serves this very profitable pigments business, the anti-counterfeiting business, is really a set of coating machines and the ability to, with high precision and low defect, lay down two micron level particles. And if you think about that capability, that is also the capability that we use in our coated optics business to serve nightvision goggles and things that are very high-precision boutique optics.

Now, the next piece is the laser business. And we've specifically chosen the laser business, the solid-state laser business because it requires two or three things that come from the rest of the Company. If you think of a commercial laser, it's basically a set of electrons in, there's a bar that -- laser diode that creates the stimulation, there's two mirrors and there's packaging. The packaging in a solid-state laser is the same kind of packaging we use for telco optics. The mirrors that are set on either side of the laser diode are actually -- the reliability is improved by coatings, just like we get out of the boutique coating optics business, and the laser diode actually comes out of our telecom laser business. So, think about the commercial lasers as simply a commercial use of the technologies that we have developed in telco. Think of the coatings as serving three things. One is this pigments business, one is a boutique set of coated optics, and the third is the laser business. And in fact, we use coatings for our telco business as well. So, that's the relatedness from a technology perspective. As you'll note, we actually have a very low R&D in the pigments and the coated optics that serves a resource to the rest of the Company. I hope that helps.

Jeff Evenson, Sanford Bernstein.

What's been the trend in gross margins in the test and measurement business since the acquisition of Acterna?

I don't know that there's a trend to be stated. I think they have stayed between the 55 and 59%, which is representative of the high-end of what has been recent history for the Com Test team. There is a significant change in the aggregate gross margin depending upon what's selling in that particular quarter, so the mix. Some portion, some business units have a significantly better mix than others. But I wouldn't suggest that there is a macro trend at this point.

You talked about share gains in optical components. Do you think that's applying outside the agile optical area, or it's pretty much due to that?

No, I think our -- we are successful in general in the new areas that we chose to invest when others couldn't. So, I think the tunable transponders, the ROADMs are all areas where we were able to invest and others didn't, and that's where the share gain will come from. So, I think it's more in the future products, yes.

Subu Subrahmanyan, Sanders Morris.

My first question is on the agile optical components and modules. Can you talk about what percentage of revenue they contribute? And given the gross margin uptick and the operating margin uptick, were circuit packs a smaller percentage of optical component revenues? My second question is just a bigger picture question on orders versus guidance. Kevin, we've seen strong orders in all groups. And I understand there are a bunch of variables for this quarter, including RoHS and exiting FSM. But looking out, are you going to start seeing this translate into revenue growth in the second half of the year? We've had a couple of flat quarters in terms of revenue.

Let me try to take them one at a time. We haven't provided any insight into a specific mix between AON sales and the rest of our portfolio. What I can tell you is that the aggregate of our AON products in any of the last two quarters would account for more than $10 million of revenue and less than 50. So, they are less than 50% of our total in any quarter right now, and we'll try to update that in the future. But that's about the most insight that we have provided to date.

In terms of circuit pack revenues, I don't know the answer to that specifically. Sometimes when we sell ROADMs, we sell them at a circuit pack level, and sometimes we just sell them at a device level. And I just am honest with you on the call here; I don't have any delineation of what that mix is.

In terms of the environment, while our topline revenue for the Company was flat, and certainly the significant growth in Optical Communications was anything but flat, the $17 million growth of one quarter, that manufacturing scaling was bigger than many of our competitors in their entirety. So, I think that speaks to that the market is favorable. I'd say the market right now is somewhat constrained by leadtimes and the ability to ramp capacity. Half of the industry is transferring products from one side of the ocean to the other. We've been blessed in being able to do what we did this quarter. So, I think the good book-to-bill means that the optical communications part of the business is strong. The fact that we had year-over-year growth in test and measurement that was double-digit means that that's a strong business; it's just seasonal, which is something that we've been trying to communicate to people.

And I think what you're seeing on the other part of our business is that we either hit this quarter or we will next quarter hit the nadir of the CCP business. So, my suspicion is that optical coms will lead us through this from a revenue perspective for the next quarter, and then in the second half of the calendar year I think we're going to have most of -- all three segments having growth.

Just a quick follow-up. Was there any capacity this quarter for you guys in any of the areas that restrict your ability to ship and record revenues?

I'd say every quarter for the last two or three we have had either supply constraint problems, or if we had executed better we could have shipped more. So, we were constrained by our ability to get things out the door. That would be a true statement.

Ajit Pai, Thomas Weisel Partners.

The first one is on the test and measurement group. Even though you have excluded from the expense allocations that would be onetimes, there’s still quite a sharp decline sequentially in the operating margins for that business. Could you give us some color as to how much of that was volume related, and then some color on the pricing environment and competition within -- you're facing within that business? And the second one would be looking at the communications products business, not surprising that you are facing in terms of components or any kind of constraints over there. But from a competitive perspective, have you seen any pricing pressure, or that's being alleviated over the past couple of quarters and is actually looking -- you're able to pass on higher prices to customers right now?

Let me break it up into two pieces. I'm going to try to give you a sense of the -- try to respond to the market conditions and pricing strategies of the two segments that you asked about, and then I will defer to Dave in terms of the specificity on the com test operating margin.

I'd say in com test, this is a market that first and foremost is consolidating. We saw EXFO make a purchase, Spirent make a purchase. And while some people might think that that might improve the stability of pricing, I would say that we don't think anything has changed significantly in the pricing structure. So, I wouldn't call it a particularly painful environment, but I don't think it's necessarily improved either. It's just much the same as it's been for several quarters.

On the optical communications side, this is a market that has many suppliers that are boutique and niche, so while there may be four or five prominent names, there are many more startups. And so I would say that pricing continues to be something that you watch very carefully. In the past I've given a sense that we try to bucketize pricing into three classes of products. There's the switching products, the transmission products, and then I would call the transport products. The switching, which are the high-end, the ROADMs and such, is where the least competition exists and the least pricing pressure exists. The transmission products tends to be where the largest amount of pricing pressure exists. And the transport tends to be in the middle. And so, if you were to take -- the high-end of that might be 10 to 13% year-over-year change, the low-end is zero to 5, and the middle is 4 to 6 or 4 to 8; that's sort of how I would parse that. So, hopefully that helps on the market side. And Dave, maybe you could take a stab at the com test question.

As far as the segment report goes and the operating income, as you noted, the revenue alone was down $19 million quarter-to-quarter. And as Kevin mentioned, the margins from their revenue ranges between 55% to 59%. So, just from the revenue decline is the majority of the decline in the operating income.

Ehud Gelblum, JP Morgan.

First of all, Kevin, you mentioned that if you did not have the supply constraints that you ended up having you would have been able to ship more. Can you quantify how much revenue you forgave this quarter due to supply constraints, and how compared that last quarter?

You may be testing my age as to whether I can remember. But I would say it's roughly the same. And I don't remember any quarter where it was double-digit millions; probably low singles.

That's helpful. Do you think that situation of supply constraints will probably remain going forward?

You know, I think there's enough growth that we will end up -- and I say this as an industry, not as JDSU -- that people will fix some things, and then there will be a new problem of the quarter. Optics is a place where in order to have competitive advantage most companies have sole sources, and aligning your needs with the ability of your source is often the thing that takes a while to get right. So, I think the industry, given where I see the favorable climate right now, is that almost any company could end up having a supply-constrained environment for a period of time.

Thank you. If I move to Acterna for a minute and talk a little bit about the seasonality there, just to understand. Clearly, it was down 19 million this quarter. In the past you have said that the June quarter is the seasonally weakest, following the March being the second weakest, and then it comes back again in the back half of the calendar year. Can you give us a little insight as to how to quantify the sequential movement from March to June, vis-a-vis December to March? And then, now going forward to the back half of the year, are we going to be off of the old Acterna seasonality? And so, how should we view the (indiscernible) as we get through back into December again?

I'll take a stab at it. I think you should view the -- your second question is easier to answer than the first, I think. I think it's reasonable to assume that overall the business is going to continue to grow at this 8 to 12% year-over-year. And I think it's reasonable to assume that as you look forward from the June quarter to the December quarter, that basic kind of dynamic that we have articulated in the past will likely occur again. We haven't changed anything to make that different. And so the guidance that we have given people, or the modeling that we have suggested to people that we have observed from the past was that the ratio of the peak to the nadir -- therefore, December to June -- could be anywhere from 1.1 to as high as 1.25 or 1.3. But there's quite a bit of variability. And I think we're learning as we go again, but I wouldn't change that. That observation from the past is going to continue. Now, the only other guidance that we give is what we've given to you in terms of the range of -- for this particular quarter. And so, we have not given any guidance on a per-segment basis. I think --

Do you have something implicit in there?

Yes. It's all calculated implicitly in the guidance that we've given you, and Dave have sort of walked you through -- if we are challenged in the way that we thought about our guidance, the factors that are our risks relative to our consistent thinking, he sort of enumerated for you. So, like RoHS and those kind things are the ones that we have less of a model for, I guess, is what I'm trying to tell you.

Okay. Thank you. If I could squeeze one last in. Dave, you mentioned that the move from 35% gross margins to 40% gross margins was not going to be a straight shot. Is that due to the variability of this high-gross margin Acterna business as it goes up and down, or are there other factors that will play into the gross margin not necessarily being up or down, up [linearly]?

There will be other factors as we do the manufacturing reductions. But generally, it is -- the seasonality of the T&M business has the most significant effect.

John Anthony, Cowen & Co.

First, can you at least tell us whether the test and measurement business was within your internal plans? Did it hit your internal targets, or was that below or above expectations?

Obviously, since we met guidance, and the numbers for the quarter ended up within the range of the model of peak to nadir that we just articulated and have in the past, it was in the range of everything that we thought could happen.

So the sequential decline there did not surprise you?

That's correct.

If you could also comment on -- with respect to -- kind of categorize or rank the drivers of the optical coms business, ROTEMs versus tunables versus other things; that would be tremendously helpful.

I think the number one thing that has happened in the industry has been the expansion of WDM into the metro core and access, and the minimization of future SONET buildouts. So, about 18 months ago metro eclipsed long-haul, largely for that reason. And we continue, as I stated here even in this last quarter, saw double-digit quarter-on-quarter growth in metro. Now, every now and then we see stronger growth in long-haul, so we are continuing to see that. This quarter we saw strong growth in long-haul.

The second thing is tunables. And so, I think that's on a much smaller denominator, but it's in every RFP, and that is the wave of the future. And I think the third is pluggable. So, if I were to talk about three dynamics at a device level, those are the three. And of course, at larger than a components level, all of the broadband buildouts -- anything that drives bandwidth, whether it's the backhauls for 3G, whether it's fiber-to-the-home -- all of those things ultimately require more metro optic content. So that's been good for us. I hope that helps.

This now concludes our Q&A session. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.