Viavi Solutions Inc (VIAV) 2007 Q2 法說會逐字稿

Good day, Ladies and Gentlemen. Welcome to the JDSU fiscal 2007 second quarter earnings call. My name is Danielle and I'll be your coordinator for today.

At this time, all participants are in a listen-only mode. We will conduct a question and answer session toward the end of the conference. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to your host for today's call, Jacquie Ross, Director of Investor Relations. Please proceed.

Thank you, Danielle, and welcome to JDSU fiscal 2007 conference call. With me are Kevin Kennedy, Chief Executive Officer and David 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 different materially from management's current expectations.

We encourage you to look at the company's most recent filings with the SEC particularly the risk factor section of our Form 10-Q filed for our quarter ended December 31, 2006. Forward-looking statements including guidance provided during this call are valid only as of today's date, January 31, 2007. JDSU undertakes no obligation to publicly update the statements as we move through the quarter.

Our comments today will include non-GAAP measures, a detailed reconciliation of these non-GAAP to our GAAP results as well as a discussion of usefulness and limitations is included in today's news release announcing results and 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. I'm very pleased to report that our second quarter results included a number of five year highs for JDSU including: revenue, gross margin and net income on both GAAP and non-GAAP basis. These results reflect the ongoing impact of the two-pronged strategy we set in motion almost two years ago. Namely, to increase revenue, through organic growth and diversification, while also executing a far reaching and ambitious program of cost reductions. Highlights of our second quarter results include;

• Non-GAAP revenue of $366.4 million, up 15% from last quarter and up 16% from the same quarter a year ago. Primarily due to seasonal strength in the Communications Test and Measurement business.

• Non-GAAP gross margin of just under 41% was up 35% last quarter and 36% from the same quarter a year ago. Segment mix was the primary driver although gross margin was up in all four businesses across the quarter.

• Importantly, we achieved the first positive non-GAAP operating margin result in six years with non-GAAP operating income of almost $20 million or about 5% of total revenue.

• Additionally, the second quarter represented our fifth consecutive quarter of positive non-GAAP EBITDA which increased more than threefold sequentially to about $34 million or 9% of revenue.

• Moving to the bottom line, JDSU delivered its second consecutive quarter of positive non-GAAP net income increasing $30 million from just under $7 million last quarter and from a loss of $4 million from the year ago quarter. On a per share basis, non-GAAP earnings of around $0.13 per diluted share compares to $0.03 last quarter and to a loss of $0.02 the same quarter a year ago.

Finally, the company book to bill was once again greater than one.

Last quarter we shared with you for the first time a business model that we were targeting for achievement during fiscal 2007. The targets included a non-GAAP gross margin in excess of 40%, a non-GAAP operating margin in the range 2%-5% and non-GAAP EBITDA in the range of 6%-9%. We met or exceeded each of these targets in the second fiscal quarter.

The early achievement of these targets was primarily the result of a very strong seasonal performance in our Communications Test and Measurement segment. Our objective for rest of the calendar 2007 will be to drive improved efficiencies across JDSU in order to achieve a targeted model on a sustainable basis.

Dave will give his regular update on the progress later in the call.

Before I address each of our businesses in turn, I'd like to share a few observations from Q2 regarding the broader environment surrounding both our Optical Communications and Communications Test and Measurement businesses.

First, we observed no change to the underlying drivers of investment in new or upgraded broadband networks, the proliferation of rich media content and increasingly aggressive competition from cable and telco service providers. Second industry and operator consolidation continues to evidence throttled spending in some franchises.

Initially, pauses are associated with timing and completion of M&A transaction, and later supply chain rationalization of new combined entities. And this said, we did observe in the Communications Test and Measurement segment that some spending recovered as two customers began to emerge from the multi-quarter transition. Regarding sales of our Communications Test and Measurement products to operators, we saw growth across all three geographic regions. Operator spending continued to support growth and sales to cable operators were particularly brisk.

With that I'll update you on each segment in turn. After four consecutive quarters of growth, Optical Communications declined 4% to about $133 million from a strong $138 million last quarter. Year-over-year second quarter revenue grew 21% and for calendar 2006 Optical Communications grew 27% from calendar 2005, highlighting the ongoing favorable environment.

As noted in our preliminary announcement a few weeks ago, our Optical Communications segment was impacted by supply chain and inventory rationalization by certain customers during the second quarter. Bear in mind that roughly 80% of our Optical Communications revenue derives from the top 20 customers in any given quarter. During the second quarter, five of these customers were involved in consolidation activities, and an additional three customers were working with us to address their lean manufacturer initiatives or inventory management.

In general, JDSU and other suppliers will be expected to offer shorter lead times to enable customers to carry smaller inventories going forward. As a result, we believe that some Optical Communications customers ordered less during the second quarter as they work through existing inventory. Of interest, our subsystem business was impacted most by the transition to shorter lead times.

In fact, it was the only sizeable exception to quarter of growth in nearly element of Optical Communications business, with particularly strong performance in passives, high-power lasers and modulators. Based on discussions with customers, we suspect inventory and supply chain rationalization activities are likely to be multi-quarter phenomenon and will continue to hamper visibility; nonetheless we remain confident in our end markets and believe the Optical Communications segment will grow at the upper end of the previously targeted 5% to 15% range for fiscal 2007.

Within the segment metro targeted products continue to grow. Tunable lasers enjoy ongoing strong demand and with our new capacity coming online we expect to ship twice as many in the third quarter as we shipped in the second quarter. Our Agile Optical Network portfolio including tunables now represents more than 20% of Optical Communications revenue and has grown more than 50% from the same quarter a year ago.

During the second quarter we announced we had shipped more than 10,000 ROADMs, once again highlighting JDSU leadership. JDSU's ROADMs are carrying live traffic in tier one networks today and we remain the only company that offers all three of the leading ROADM technologies. Design activities for next generation products continue to be strong with all of the major equipment manufacturers. And during the quarter, we further expanded our ROADM portfolio with the introduction of a new wavelength selective switch with integrated channel monitor.

Moving to other elements of our portfolio, we experienced record shipments for our 980 pump used to power optical amplifiers. Our leadership position in the pump segment also enables JDSU to participate in the small but growing submarine opportunity. Our Lithium Niobate modulators, driven by the growing demand for 10 gig links grew 20% compared to the previous quarter. In the datacom market we continue to hold the leading position in the storage network segment, thanks to our four gig fiber channel offering. The Communications Test and Measurement segment delivered revenue of about $168 million in the second quarter.

Coming off a lower than expected Q1 this represented an increase of 44%, in large part due to strong year end spending by certain customers. Additionally improved operations and sales execution also contributed to higher revenues following changes made in the first quarter. While the quarter was represented by sequential growth across all elements of the business, our field services group performed particularly well. Adoption of our HST Triple-Play telecom test platform continues to grow with more than 20,000 units shipped to date. Several new multi-million-dollar orders closed during the second quarter. The cable version of our HST, known as our DSAM also performed well.

During the second quarter we closed our largest deal ever for this product highlighting a very strong quarter in terms of demand from cable operators. To give you an idea of the scale, this quarter two cable operators were included in the list of JDSU's largest eight customers versus none two quarters ago. Field service solution fiber optic test also performed well driven by continuing strong acceptance of TBERD 8000 and fiber to the curb test instrument.

JDSU service assurance is an area of strategic importance. The acquisition of Casabyte which closed on January 23rd extends JDSU's broadband triple play test capabilities into the quadruple play and we are excited by the opportunity to expand our portfolio to help customers address the complexities of fixed and mobile networks in an emerging multi-service rich media environment.

Following receipt of Frost & Sullivan's 2006 Growth Strategy Award our IPTV portfolio was further validated in November when JDSU was formerly selected by Alcatel as a test and measurement partner. As a leading innovator in this area we continue to extend our IPTV related products offerings to enable customers to initiate and maintain reliable services at a lower cost. For example, during the second quarter, we added IPTV transport stream monitoring for our QT-600 Ethernet and triple-play probe.

Consequently JDSU offers only the test solution on the market today that addresses quality of service from the head end to the home. Another first our 40 gig ONT optical transport platform is enjoying strong adoption by network equipment manufacturers and operator labs. It is the only portable single box solution on the market with 40 gig and advanced jitter test capabilities.

Our Communications Test and Measurement business has historically enjoyed very strong relationships with carriers, so we're very pleased with the opportunity to extend our presence with equipment manufacturers. In fact, since being acquired by JDSU, bookings for the Communications Test and Measurement business with network equipment manufacturers have more than doubled.

For the segment as a whole, year-over-year revenue growth was 15%; however adjusting for revenue associated with acquisition of Test-Um in May last year, and execution based revenue pushouts from last quarter, year-over-year revenue growth was in the middle of our 6% to 12% projected growth rate.

Following a seasonally strong December quarter, and consistent with historical trends, revenue for the business is expected to decline in Q3. While seasonality hinders easy understanding of trends in the segment action we remain very pleased with the overall trajectory of the business. We now expect fiscal year revenue growth in the range of 8% to 12% when compared to adjusted fiscal 2006 revenue of almost $520 million.

Our Advanced Optical Technology segment delivered revenue of $40 million during the second quarter, up 3% sequentially but down 2% from the same quarter a year ago. You'll recall the segment was in the midst of significant restructuring a year ago, so the achievement of a second consecutive quarter of growth is notable. We expect consolidation activity at the segment's Santa Rosa site to be complete at end of the fiscal third quarter. With that in mind we continue to incur expenses from the transition as you can see from the segment report, but benefits are being realized.

Our Commercial Laser and Photonic Power business continued to grow in the second quarter with revenue of $25 million, up 4% sequentially and 39% year-over-year, enabled by strong adoption of our solid state offering. The transition of manufacturing out of Santa Rosa was completed on schedule during the quarter contributing to an improved operating margin of 9% compared to 7% last quarter. JDSU continues to innovate in solid-state and fiber lasers, applying the company's broad telecom and optical technologies to the commercial laser market. Our newest 100 watt fiber delivered laser makes extensive use of our Optical Communications high power diodes and extends our range of direct diode laser offerings. We also announced our FCD488 at Photonics West last week, the industry's first solid-state laser based on fiber optic telecom grade components. This new product, which was developed leveraging expertise and resources across multiple business segments has already received excellent customer feedback.

We expect to continue to outpace the projected solid state market growth rate of 5%. And through the transition from gas to solid state, further strengthen the segment's profitability. Moving to corporate updates, we've been evaluating real estate and investment portfolios over the last two years as part of our broader restructuring exercise.

During the second quarter we continued to consolidate the Company's global footprint and also sold three investments realizing a gain of $28 million on our GAAP income statement. Following the conclusion of our heavy lifting phase of restructuring and the establishment of near term business model targets a few months ago, we believe it's the right time to help the investors gain a better understanding of the business.

Going forward, it will be the progress of each individual business rather than corporate level cost initiatives that will guide the Company's organic improvement. For that in mind, we'd like to invite analysts and investors to a series of educational webcasts that will offer perspective on growth drivers and expectations for each of our segment as well as understanding how each segment is structured and managed internally.

Look for a press release in the next two week announcing dates and times of four webcasts which will take place during February and March. Our decision to host the webcasts now is intended as a sign of confidence in the overall trajectory of the company and our evolving business model.

Getting back to our results, the Company achieved a new set of milestones from the second quarter in terms of just about every key financial measure. Revenue, gross margin, EBITDA, net income and cash flow from operations.

Achievement of positive non-GAAP operating income for first time since the collapse of telecom market is extremely important, and I'd like to thank JDSU's employees who have demonstrated a great deal of commitment and resilience over the years. We have more work ahead of us to translate this quarter's results into a sustainable business model, but this quarter, more than any previous quarter, has clearly signaled what can be achieved. With that I will hand the call over to our Chief Financial Officer, David Vellequette. Dave.

Before I start, please note that all numbers are non-GAAP unless I state otherwise. GAAP revenue for the second fiscal quarter 2007 was $366.3 million.

Non-GAAP revenue of $366.4 million, which includes revenue associated with acquisition accounting, was up 15% sequentially and up 16% in the same quarter a year ago. Second quarter non-GAAP gross profit of $148.9 million or 40.6% of revenue improved from $110.3 million or 34.7% of revenue last quarter.

Non-GAAP gross margin benefited primarily from the fact that 46% of total revenue was derived from our higher margin Communications Test and Measurement business. Targeted cost savings of $2 million were also achieved in the quarter and contributed to the overall gross margin improvement.

Non-GAAP operating expenses of $129.4 million were above last quarter's $117.3 million. The increase in expenses resulted from increased Communications Test and Measurement selling costs, increased R&D investment in Optical Communications business and an increase in our reserves. As a percentage of revenue, non-GAAP operating expenses of 35.3% declined from 36.9% last quarter, in line with our 35% to 38% range.

Second quarter, non-GAAP net income of $30 million or $0.13 per diluted share improved from $6.8 million or $0.03 per diluted share last quarter and compares to a net loss $3.5 million or a net loss of $0.02 per share a year ago quarter. A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release.

Our non-GAAP results include amortization of acquired technology and intangibles of $16.9 million, $8.7 million charge related to stock-based compensation, a $5.5 million charge for restructuring, primarily associated with Ottawa manufacturing transition in our Santa Rosa site consolidation and a $28.2 million gain in sale of investments. Including these items GAAP net income of $23.2 million or $0.10 per diluted share improved from last quarter's net loss of $17.4 million or net loss $0.08 per share. And from a net loss of $42.1 million or a net loss of $0.20 per share from the same quarter a year ago.

Moving to the quarterly results for business segments. Optical Communications revenue declined 4% sequentially to $132.7 million. On a year-over-year basis growth remains strong with revenue up 21% from the same quarter a year ago.

Operating margin declined from just under 2% last quarter to break even as higher gross margin were offset by increased R&D investment. The higher gross margins reflected our execution against our cost saving initiatives which were partially offset by the impact of lower revenues and continued sequential ASP declines which were at the higher end of our 2% to 4% range.

Moving to our Communications Test and Measurement Segment. Revenue of $168.2 million was up 44% from the first quarter and up 15% from the year ago quarter. However, you will recall that first quarter performance in the segment was negatively impacted by our Oracle implementation and sales force realignment. Combined with the acquisition of Test-Um, we believe that these factors accounted for about $9 million of revenue in the second quarter. Excluding these items year-over-year revenue growth was closer to 9%. In addition to higher revenues, the segment also benefited from a favorable product mix which resulted in the operating margin of 21.3%, the strongest performance since we acquired the segment in the summer of 2005.

Advanced Optical Technologies which includes our Flex and Custom Optics businesses delivered revenue of $40.4 million, this was up 3% over last quarter or down 2% from the year ago quarter when this business was still in the midst of restructuring activity. The segment's operating margin continued to improve, highlighted -- highlighting continued progress in our cost reduction and consolidation initiatives at the Santa Rosa site. Operating income was 31.4% of revenue which compares to 28% in the previous quarter.

Our Commercial Lasers business grew 4% this quarter and 39% year-over-year to $25.1 million. Operating income improved for the fourth consecutive quarter to $2.2 million or 9% of revenue reflecting ongoing operational. improvements in addition to the growing mix of higher margin, solid state products.

On a geographic basis, Americas contributed 57% of revenue, EMEA 27% of revenue and Asia Pacific 16% of revenue. On a dollar basis, revenue grew in all three regions, with particular strength in Europe which was up 23% sequentially and 34% year-over-year.

Moving to the balance sheet. Total cash, cash equivalent, short-term investment and restricted cash was $1,227.7 million at the end of the second quarter, up $11.7 million. Also we are cash flow positive from operations for the quarter. Net accounts receivable of $274 million increased $43 million from last quarter highlighting volume of quarter-end book and ship orders in the Communications Test and Measurement. DSO was up two days to 68 days.

Inventory turns decline slightly to 3.9 and finally headcount as of December 31, 2006, was 6,851, up from 6,736 last quarter.

Next, I'd like to update you on our ongoing cost reduction initiatives. As noted earlier, we achieved the $2 million of targeted cost savings in the second quarter, spread between our Optical Communications, AOT and Commercial Laser businesses. Specifically, we completed the manufacturing transition out of Ottawa during the second quarter.

For the third quarter we are targeting an incremental $3 million of savings bringing our cumulative quarterly savings to $7 million. We expect third quarter savings to come primarily from the transfer of our Santa Barbara manufacturing which was completed at the end of the second quarter and the consolidation of our Santa Rosa site from 13 buildings to 6 by the end of the fiscal third quarter.

As Kevin noted, this quarter marked the achievement of our near-term business model targets, specifically a non-GAAP gross margin in excess of 40% and non-GAAP operating margin in the 2% to 5% range. When we discussed target business model with you last quarter, we based it specifically on a 40-40-20 split between the three markets. That is 40% of revenue from Optical Communications 40% from the Communications Test and Measurement and 20% from the combined AOT and Commercial Laser groups.

It is clear that we outperformed the near-term targets in the second quarter due to a segment mix heavily in favor of our Communications Test and Measurement business. If our revenue mix had been 40-40-20, then our non-GAAP gross margin would have been approximately 39%, and operating profit would have been in our near-term operating margin range.

Other points to bear in mind as you think about the financial performance over the coming quarters: first, our Communications Test and Measurement business has traditionally benefited from strong calendar-end customer purchases. This seasonality can result in fluctuating growth rates and we believe that it makes sense to assess the business in terms of year-over-year quarterly growth. We expect year-over-year growth to range between 6% and 12%.

Due to Q2 seasonality in Communications Test and Measurement, we have historically seen sequential revenue decline in the segment. For fiscal 2005 and 2006, Q3 revenue declined 17% and 13% respectively. Next, for JDSU as a whole we continue to target non-GAAP operating expenses in the range of 35% to 38% of revenue. Also, operating expenses for Q3 will include low single digit millions of dollars related to the acquisition of Casabyte. And below the line, our income tax expense is expected to range between $3 million to $5 million per quarter.

Now, to our financial guidance for the third quarter. Risks to the revenue guidance include among other things: first, ongoing pauses among the network equipment manufacturer and carrier customers associated with industry consolidation, albeit in a generally favorable environment for optical and broadband equipment.

Second, continued execution of inventory and supply rationalization of network customers in the optical communications business.

Third, the Communications Test and Measurement segment tends to have a high level of book and ship activity based on customers' historical order flow these orders tend to be weighted toward the third month of the March quarter.

Although the team has a strong track record of turning in-quarter business, manufacturing constraints may impact our ability to fulfill some orders in the quarter. With these factors in mind, we expect third quarter revenue to be in the range of $333 million to $353 million. Operator, we are ready to begin the Q&A.

Thank you, sir. [OPERATOR INSTRUCTIONS] Your first question from the line of Michael Genovese with Citigroup. Please proceed.

Thanks a lot. And, congratulations, guys, on a nice, solid quarter. I've been wondering -- I want to ask about seasonality in both businesses.

First in Test and Measurement, if you could help me understand, now you've had the business under your wings for a while, why do you think -- what is the seasonality a factor of the strong 4Q seasonality? Is it budget flush, is it carriers emphasis on signing up subscribers at the end of the year? I can't imagine it's the weather. I'd like to get your views there.

And secondly, in the optical business sounds like there's some supply chain movements impacting your term growth. What's the view on seasonality in opticals. Is that basically going away? Is traffic growing the same amount? Or roughly the same pattern every quarter or do you expect to see seasonality throughout the year in the optical business? Thanks.

Mike, we've been -- thanks for the question. We've been pretty consistent in relative to the Communications Test and Measurement business. In fact, the December quarter is a budget flush phenomenon. And we think we saw that, again.

So, I don't think there's any -- much more to say. That it was consistent. We were pleased with the performance of our team. It became aggressive in all theaters. But the seasonality is -- is clearly at a piece of budget question.

So I say the magnitude of what we experienced at a piece of just good performance and execution, but the general phenomenon is a budget flush phenomenon. Relative to the optical coms I would say we don't see a huge amount of seasonality in general, although the -- this particular quarter tends to be the most uncertain or have some of the least visibility. I'll let Dave comment on that.

Yes. I think in the optical com, if you look at a year ago saw the benefit Q2 to Q3 from tunables and this year we're seeing more of an impact from the rationalization of the inventory levels from our customer as they go to the lean programs. So, not a seasonality issue as much as our customers getting their arms around their inventory levels and reducing their inventory. Those inventory investments..

Your next question will come from the line of Subu Subrahmanyan from Sanders Morris, please proceed.

Thank you. Question on margins. Just if you will look at the near term margin gross that you have achieved. Can you look out over the next few quarters and talk about what longer term margins goal are going to be? Also, in the near term, I understand mix is clearly a big variable, but it is in the past we talked about getting the classic JDSU business margins to first over 30% and then the longer term goal of over 40%. Can you give us a sense where you are in that process?

Sure. I'd say if I were to take two book-ended goals, the nearest term goal is to get the 40% gross margin to be a sustainable, and what I would call mix. Benign to mix, if you will. It wouldn't matter what the mix of Comtest versus Optical Com per se in a reasonable range to get that 40%. So, we'll be spending the better part of calendar '07 to do that.

I still believe that for the nature of the portfolio that we have, the relative mix of Comtest and where I think the other businesses will grow, it is -- the potential for this Company as a portfolio company to achieve mid 40% gross margin is still something that I intend to drive to drive the Company to. I'd say the last pieces is we still have a lot of margin improvement, I think, in a number of our segments. Clearly, optical coms has room to grow.

Comtest ended up operating with the particular mix it had this quarter at the high end of our -- I don't know what it is? 55% to 59% range there? So, good margin performance. Lasers as we get a more of a solid state base we have a significant number of margin points to grow there and I think we still have restructuring to deliver margin improvement to the AOT piece.

So that's really why I say that the story here becomes the ongoing improvement of the leverage in each of the businesses that we have and we are -- we're not near -- certainly in the JDSU classic businesses, we are not at where the potential of those businesses is, steady state. Okay?

Your next question will come from the line of John Anthony with Cowen and Company. Please proceed.

Good evening, guys. I apologize if you already went over this, but did you give detail on the breakdown of the ROADM shipments? Have you started shipping any of the WSS with the channel monitor?

We have some in the market. The one that we just announced we have not begun to ship. We've just announced it this quarter. And the only we haven't given a breakdown between the different technologies. We just said that in aggregate across the liquid crystal, MEMS and waveguide technologies we've shipped over 10,000.

Could you give us a little more detail about whether the 10,000 units bias is one technology versus another?

We haven't broken it out and I would not, I certainly would not know that detail as sitting before you.

Oh.

It's really dependant on which customers are shipping into what franchises, to be honest with you.

Your next question will come from the line of Ehud Gelblum from JPMorgan. Please proceed.

Alright. Thank you. How are you? Couple of questions. Couple things, Dave, you said that I thought were kind of interesting. One, you said that ASP had declined in higher end of the 2% to 4% range, and Kevin, you had mentioned that optical components you thought were going to be growing in '07 in the higher end of your 5% to 15% range.

Sort of not opposing comments, but ASP is a little bit more aggressive from the decline than you'd thought, but revenue up at the higher end implying that volumes are very strong. If you could talk about, kind of, that dichotomy and is the decline in ASP kind of causing the extra little bit of volume? Or is there pricing pressure that's causing that? Or why is the ASP down if the demand seems to be so strong?

The other thing I was interested in, your Europe was incredibly strong. Correct me if I'm wrong Communications Test and Measurement does sell to Europe but not a lot. So the strength, I'm guessing, in Europe, was not Communications Test and Measurement and does that mean that Optical components was incredibly strong in Europe? But where was that European strength coming from? The converse to that, if in fact it was Optical components strong in Europe does it mean weak in the U.S.? Kind of help us understand the dynamic?

Yes. Well, I'll try to do it in reverse order. Turns out that Communications Test and Measurement typically is pretty strong in Europe.

If you remember, the genesis of that company included the world headquarters of Wandel & Goltermann, WWG and so we had strong base in Europe and we had good growth during the quarter. Relative to what you could potentially be posing as are they congruent or incongruent observations about the growth rate of optical components and ASPs? I think we have simply said that over the last several years we've seen the 2% to 4% per quarter erosion, and so this was no different other than we saw it on the high end of it.

Certainly customer concentration would tend to a bias toward the high end and so I think the last call we mentioned that as Lucent, Alcatel, Nokia, Siemens, Marconi, Ericsson and so forth are getting together and they will try to apply a greater level of buying power, because they have larger volumes and that kind of interaction is certainly occurring. The good news is that broadband deployments are continuing to be driven out and, therefore, our revenues are continuing to be in this double digit range.

So, I don't think there's anything incongruent that the dynamics driving ASPs in industry consolidation and the dynamics driving swift absorption of optics is really broadband buildouts and clearly biased toward Metro and clearly biased toward these agile optical products. Does that help?

And your next question comes from the line of Jim Powell with GMP Securities. Please proceed.

Thank you very much. Quick one on the lean programs that you've mentioned in your statements. Does that mean going forward that we're going to have higher inventory you're going to be carrying as we've seen it since some of the EMS guys? Quick one, I think I missed it on that gain on sale of investment? Is that real estate or something else?

The first question on the -- let me handle the investments. We had investments in a company called IPG that went public during the quarter and we sold that investment. That's the single biggest contributor to that investment profit we had there.

As far as the lean initiatives go, the lean initiatives, our customer would like to us carry more inventory with those initiatives. It is a balance we're trying to work out because we need to improve our turns in the inventory area.

So we're working with our customers to meet their needs from a lean initiatives and we have to balance that with the inventory levels. Our goal is to get the turns above the four turns range and right now we're at about 3.9. So we need to improve the turns. It's a balancing act, quite frankly.

Yes, I'd say the biggest impact the lean initiatives will bring is, one, the level of integration between the supply chains will have to increase. We'll look more like an extended factory. I think the second piece is we will have less visibility because we will be pressed to improve our lead times. As we focus on improving lead times we'll probably have lower backlogs at time coming into the quarter.

So, you know, visibility will go down. I don't think our intent right now to allow inventories to move into a negative direction, based upon lean initiatives per se.

Thank you.

Your next question comes from the line of Paras Bhargava with BMO Capital Markets, please proceed.

Good afternoon, guys. Question on, Kevin, you made a comment, I think I heard you right, saying that you'd like to get the Company to 45% gross margin. I figure that means 10% operating margins, given your OpEx range. I'm wondering if you have a timeframe for that?

And then secondly, I'm picking up some of the newer players in the market, Optium and Opnext, some Chinese guys are injecting a lot of pricing pressure into the market. Is that primarily the reason you're seeing pricing increase or is there some other dynamic?

Sure. I -- right now I don't plan on giving you a specific timeline for the 45%. I think as I mentioned on the calls before, I believe the asset is capable of it.

The first thing we have to do is get the asset delivering against a sustainable 40% and that's this year's work. Relative to the pricing pressure that most significant piece is in fact that you've got a level of industry consolidation occurring.

Pick an area like ROADMs, today there's like 12 to 14 suppliers of ROADMs and there's probably only 10 people that could be customers of them. So, any industry where you have a one to one relationship between customer and supplier you'll probably operate a lower gross margin structurally than where you have thousands of people per supplier. I'd say the customer concentration is the number one issue, you're right. More competition.

Optics is a place where we've always had a lot of competition in general. And then -- so I think that's the story is customer consolidation. Hope that helps.

Your next question will come from the line of Jeff Evanson with Sanford Bernstein. Please proceed.

You think the growth rates year-over-year optical test and measurement business, what are you expecting for the underlying fiber to the home deployment demand and how that impacts your field sales?

Jeff, I don't think we have a point of view on what kind of PON or other growth rate is required to achieve our numbers. Right now, a lot of our numbers are coming from -- you probably think more in terms of Capex sales and sort of build-outs of cable operators, how many head-ins, how many head-ins are being tested and so forth. So, I don't know of any calculus that we use to simply look at homes past for fiber.

We've probably are simply looking at spending and how much is going into the next generation networks and so forth. So, that's the way we sort of gauge it.

Your next question comes from the line of Ajit Pai with Thomas Weisel Partners. Please proceed.

Yes. Good evening and congratulations on a very solid quarter.

Thanks, Ajit.

You couple of quick questions. I mean, the most significant one is about the communications products business.

When you're just looking at the optical components business and seeing the sort of current profitability and assuming there isn't further consolidation within the components business, no change in industry structure, what kind of margins do you think just with the kind of demand growth you're seeing, current driving trends and with the current set of level of concentration of your customer base, do you think it could get to, you know, 18 months to 20 months out on an operating margin basis?

Well, you know about a year ago we told people that we thought that this industry could achieve between 30% and 40% gross margin. I think some of people that are new players and unburdened from moving factories to China have already demonstrated they can operate within the 38% gross margin range.

So, I think the current industry structure has born out the hypothesis of what the range will be. I think it's incumbent upon us to continue to move our margins into the 30% to 40% range. So. The data is right there, I think, for the industry.

[OPERATOR INSTRUCTIONS] Your next question will come from the line of Jeff Osbourne with CIBC. Please proceed.

Great. Good afternoon. You mentioned that the submarine market appeared to be heating up for you. I was wondering if you could expand on that? And then secondly, was the budget flush that you saw on the test side, notably stronger in the cable business products? Or versus Telco? Any thoughts there?

Yes. So, I'd say, I think you used words "heating up." I'd say a year ago in a particular quarter, submarine sales would be measured in hundreds of thousands of dollars or certainly less than $1 million. Today, they're millions. Still relatively small compared to $300 million a quarter. But have grown significantly year-over-year.

Relative to are there differences in spending or budget flush, if you will, between cable operators and telecom operators? I think it is hard to know the specific motivations. What I would say is that we have the benefit of having some new platforms that fall in confluence with the fact that the cable operators while big telecom are emerging continue to build out and bring services up.

So I think it was brisk spending for a number of reasons. Some portion of that cable operator as budget flush; I think some opportunistic to build out while the telecom operators are dealing with integrations. And so it was good business for us. And we did have the benefit of a new platform this quarter.

And your next question will come from the line of Brant Thompson with Goldman Sachs. Please proceed.

Hi, I was wondering if you could -- it seems like there's a number of factors influencing the top line trend over this year. Lean manufacturing, consolidation of customers, consolidations of other players in the industry. When do you think that we are through some of these?

If you could, maybe, handicap the impact from the lean manufacturing shifts are, that is, '07 issue, likely not '08. Could you kind of handicap what time period you think you're most affected by this and when does that sort of lift? Thanks.

Sure, Brant, we mentioned in the script that on the CommTest side, we saw two operators that had actually been engaged in consolidation back last spring. They began to begin spending again. So, the observation from at least two anecdotal situations was that it was measured in quarters, not years, so let's call it three quarters plus or minus one. And so based only empirically on the evidence that we have, we would say that these kinds of consolidation of things on the operator side will should largely expire through the end of the second half of calendar '07.

On the network equipment manufacturers were and supply chain rationalizations. I think the people are moving very, very aggressively. I think we saw the effects of that this quarter and we'll see a little bit more next quarter. I doubt that it will last into the fourth calendar quarter of the year and, in fact, it will probably begin to get lighter for sure in the second half. So, I think the real message, we had over three-quarters of optical components product lines grow, healthfully.

We saw the Metro grow with great health. And so, therefore, I still think that the climate is favorable, but, you know, one big customer that purges inventory can be a challenge in any quarter. That's the fits and starts that's typical of this market. Hope those are helpful concepts.

[OPERATOR INSTRUCTIONS] Your next question will come from the line of Todd Koffman with Raymond James. Please proceed.

Just a follow-up clarification in the Optical Communications market. In your opening remarks, you had said that the inventory worked down was a multi-quarter phenomenon and then you went on to say that I think you said that that segment could grow at the upper end of the 5% to 15% range. When you were referring to the multi-quarter phenomenon were you talking about multiple quarters from this starting point going forward? Or did that already include the December quarter work down that it sounded like you experienced as well?

The reference was a year-over-year comparison of numbers. So we think that fiscal year over fiscal year there will be the growth rates that we had established. That includes what happened in fiscal Q2, our sense of what we'll see in fiscal Q3 and a best outlook, if you will, for fiscal Q4.

Your next question comes from the line of Michael Genovese with Citigroup. Please proceed.

I'm sorry. Can you hear me?

Yes.

Okay. Great. I -- so -- a couple questions ago I think you made reference to this, but I'm looking for clarification on the comment you made about two carriers that came out of consolidation and that you already seen recovery in spending. Now, did that refer to seeing a recovery in spending in the quarter just reported? Or that you're starting to see a recovery in spending from the carriers in the current quarter that we're in right now?

In the quarter we just reported.

Okay. Great. Thanks.

And, ladies and gentlemen, there are no more questions in the queue. At this time I'd like to thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect, and have a great day.