Viavi Solutions Inc (VIAV) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your JDSU fiscal 2007 third quarter earnings conference call. My name is Rob and I will be your operator today. Throughout this conference all lines will be on listen-only. (OPERATOR INSTRUCTIONS) At this time, I would like to turn the conference over to your host for today's call, Ms. Jacquie Ross.

Thank you, Rob, and welcome to JDSU's fiscal 2007 third quarter earnings conference call. Our speakers today are Kevin Kennedy, Chief Executive Officer, and Dave Vellequette, Chief Financial Officer. As always, I would 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 managements' current expectations. We encourage you to look at the Company's most recent filings with the SEC, particularly the risk factor sections of our Form 10-Q filed for our quarter ended December 31st, 2006. The forward-looking statements, including guidance, provided during this call are valid only as of today's date, May 2nd, 2007, and JDSU undertakes no obligation to publicly update these statements as we move through the quarter.

Our comments today will include non-GAAP and adjusted measures. A detailed reconciliation of these non-GAAP and adjusted results to our GAAP results, as well as a discussion of their usefulness and limitations is included in today's news release announcing our 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. JDSU's fiscal third quarter results are characterized by; stronger revenue than anticipated, with year-over-year growth in all segments, less predictability on revenue, revenue mix, and resulting gross margin than desired. Improved balance sheet metrics, and improved cash flow, including the first positive free cash flow in more than five years.

As you know, JDSU serves the industry in providing for broadband and optical innovation across numerous geographies and insertion points in communication networks right-of-way. This portfolio structure was embraced because of the inherent regional and architectural surges and ebbs of this industry and JDSU's deliberate view to manage the inevitable volatility around an unpredictable cycle of carrier investment.

Hence our results fiscal year to date evidence the following market based observations:

First, revenue from metro optical build outs have been growing faster than DWDM long haul, which declined slightly this quarter for the first time in many quarters. Next, sales for both Optical Communications and Communications Test and Measurement were up in North America year-over-year. That said, North American growth has been vigorous among cable operators, while sales to North American telecom operators have not demonstrated the same growth. In Asia Pacific, both Comm Test and Optical Communications have delivered our strongest year-over-year growth rates, while growth in EMEA has been as strong -or stronger- than North America. And finally, sales to an increasingly highly concentrated set of Tier 1 network equipment manufacturers for Optical Communications have decreased as inventory management, lean initiatives or consolidation pauses have introduced an evolving adjustment to ordering rhythm.

Our fiscal Q3 results therefore represent a current snapshot of this dynamically evolving industry. Non-GAAP revenue of $361.8 million was stronger than our $333 million to $353 million guidance range due to strong international orders, primarily in our Communications Test and Measurement segment, as well as outperformance by our Advanced Optical Technologies team. All segments reported year-over-year revenue growth, with Comm Test up 28%, Commercial Lasers up 19%, AOT up 12%, and Optical Communications up just 1%. On a sequential basis, Comm Test declined only 3%, representing a much smaller seasonal decline than anticipated. Optical Communications revenue was also down 3% relative to last quarter, with many customers in the midst of operational adjustments or pauses related to either industry consolidations or to manufacturing and inventory initiatives. Non-GAAP gross margins declined sequentially to 37.6%. Relative to fiscal Q2, product mix associated with strong international demand, in addition to seasonal decline in North America telcos, resulted in lower gross margins for Comm Test, which impacted overall Company gross margins by nearly 3 percentage points. Lower revenue and product mix, along with lower absorption also negatively impacted our gross margin performance in Optical Communications. Non-GAAP operating expenses were within our target range at 36.7% of revenue, but were up from last quarter primarily due to expenses associated with the newly acquired Casabyte business and trade show activities. Adjusted EBITDA of $17.7 million more than doubled from a year ago and marked JDSU's sixth consecutive positive quarter. On a sequential basis, adjusted EBITDA declined to just under 5% of revenue. Moving to the bottom line, non-GAAP net income of $12.3 million or $0.06 per diluted share was down $0.07 from last quarter, but up $0.07 from the same quarter a year ago. Book-to-bill as we exited the quarter was slightly less than one for JDSU as a whole, although three of our four businesses, Comm Test, AOT, and Commercial Lasers had a book-to-bill greater than one. Finally, and reflecting an appropriate focus on improved cash flow, we are reporting our second consecutive quarter of positive cash flow from operations, which benefited from lower inventory and improved receivables. Free cash flow was positive for the first time in over five years.

I will now address each of our three market segments, Optical Communications, Communications Test and Measurement, and Commercial and Consumer in more detail.

At $128.7 million, our Optical Communications business was up slightly year-over-year and down 3% sequentially. Metro and Agile Optical Network product sales increased while long haul DWDM sales declined. Tunable transponder revenue, for example, more than doubled during the quarter supported by the capacity ramp of our tunable lasers. Additionally, JDSU's ROADM portfolio continues to resonate with customers and we secured multiple double-digit million dollar design wins during the quarter. Of note, we achieved record growth in the Asia Pacific region associated with strong modulator, pump and passive sales.

We enjoyed a strong presence at OFC, where we demonstrated JDSU's continued commitment to innovation with previews of a new mini ROADM targeting the access market, and the new low power integrated Mach-Zehnder laser modulator. During the quarter we announced our intention to acquire Picolight, which when closed, will significantly strengthen our offering in the high growth pluggable optics market. The acquisition also supports our vertical integration strategy with the addition of Picolight's established VCSEL technology.

While our Optical Communications portfolio has supported carrier metro buildouts, order predictability has been unusually hampered by consolidation activity, reductions in previously built inventory, and lean initiatives that reduce order intervals.

With the bulk of our Optical Communications revenue deriving from fewer than ten customers, several of whom contribute more than 10% of the segment's revenue each quarter, these factors may be significant in any sequence of quarters. As we entered the fourth quarter, many of our most significant customers were executing operational adjustments of one nature or another. Two of our top eight customers, for example, were executing lean manufacturing initiatives. An additional four of our top eight customers were involved in targeted inventory management action, and separately, five of our most significant customers were involved in consolidation activities.

As a result, our Optical Communications segment exited the fiscal third quarter with a book-to-bill of considerably less than one, bringing limited visibility into the second half of the calendar year. And while demand for broadband remains strong, the pace of deployment activity varies by operator franchise, and by the share that each network equipment manufacturer achieves, resulting in uneven spending patterns that are hard to predict.

Looking back, it is now clear that some of our customers were building larger inventories during calendar 2006. The trend today however, is towards lean manufacturing and aggressive inventory management. For some of our customers, this transition entails working through existing inventory which slows purchasing activity. And for customers executing lean manufacturing initiatives, JDSU is partnering to reduce lead times where possible, and in that some cases, by more than half. These industry transitions further restrict our visibility into future quarters, and as a result, JDSU has taken steps to prepare our business to operate in this turbulent environment. We have already initiated actions, primarily within Optical Communications, to ensure that we are able to progress our profitability initiatives regardless of revenue. While fully one-third of our portfolio is already operating at or above our target gross margin of 30%, and standard margins are much improved across the segment as a whole, we can and must do more to minimize manufacturing variances so that these improvements flow to the bottom line. In support of these efforts, we have united the segment under a single leader for the first time, and re-scoped Operations so that the Optical Communications manufacturing function now has a dedicated team.

Moving to our Comm Test segment, revenue of $162.9 million was significantly stronger than anticipated. During fiscal 2005 and 2006, this segment demonstrated strong seasonality from December to March, resulting in double-digit revenue declines, so fiscal 2007 sequential decline of only 3% represented a favorable outcome. This performance was driven by strength in our fiber optic and field service segments. On a geographic basis, we saw strength in our EMEA and Asia Pacific markets, while North American telecom customers demonstrated a seasonal decline. As an indication of our strong market leadership, all three of our product groups within Comm Test achieved year-over-year growth in the third quarter. As a reminder, these three groups are Lab and Production, which supplies test equipment for development system verification and production, Field Services, which supplies both telecom and cable instruments to install and troubleshoot broadband triple play services, and Service Assurance Solutions, which ensure quality of services by providing end-to-end network test and monitoring.

Within Field Service, cable continued to be a particularly strong performer, with growth of more than 70% over the same quarter last year. Our DSAM is now the most widely deployed voice-over-IP meter in the world, with more than 30,000 units shipped. On the telecom side of Field Service, our T-BERD 8000 achieved a new record in terms of revenue for the quarter, and we believe that our market share in the core and metro field test segment is now in excess of 50%. In fact, we believe that we have an unmatched ability to meet end-to-end test requirements across core metro access and home networks for triple play service deployment.

Moving to Lab and Production, we continue to expand our business with network equipment manufacturers and saw strong bookings growth in this quarter in all regions of the world. We continue to focus on building our portfolio of innovative Lab and Production solutions, and believe that a stronger presence in this market gives us visibility into emerging test requirements in the Field Service and Service Assurance segments.

Our Service Assurance Solutions business was awarded a major operations support system, or OSS, contract by one of the world's largest network operators, the biggest test software contract in the history of our T&M business. The three-year contract has a potential value of more than $20 million. It calls for JDSU to deliver services assurance tools, specifically our NetAnalyst, which is a test management application software component of our NetComplete Service Assurance portfolio. This solution supports centralized and automated testing of circuit switch and broadband IP services. JDSU's NetAnalyst will be used as the single OSS supporting the consolidation of wireless and wireline business services under a single testing platform for the operator's customer care center.

As noted previously, non-GAAP gross margin declined for this segment as a whole, due to both product and geographic mix. Offsetting the seasonal decline in North America telecom sales, revenue growth was strong in the Asia Pacific region, but tended towards lower margin product configurations. In the near term, we expect margins to return to the typical 55% to 59% range, although we are targeting a 57% to 61% range for the longer term, as we improve our mix towards higher margin products.

Gross margin aside, we rounded out a very strong Comm Test quarter by being named as Frost and Sullivan's 2007 Global Communications Test and Measurement Company, highlighting our industry leadership in terms of innovation and market share.

Moving to the Commercial and Consumer market, AOT's results benefited from higher Optically Variable Pigment sales associated with currency protection. Revenue of $45.6 million was up 13% sequentially and 12% year-over-year. Operating contribution also improved as this is a higher margin business, although it's worth noting that it can be lumpy in nature, depending on the timing of currency launches and reprints.

Finally, with revenue of $24.6 million, our Commercial Laser business was down marginally from last quarter, although it continued to demonstrate year-over-year growth of 19%. This business serves a relatively small number of customers, and so quarterly performance is significantly impacted by spending cycles. In fact, our Q Series laser reported record revenue in the quarter and our FCD488, the industry's first solid state laser based on telecom grade components, is ramping faster than anticipated. However, operating margin declined disproportionately due to a $500,000 series of one-time impacts associated with business's restructuring activities.

At a corporate level, we have been increasingly focused on cash generation. As noted earlier, we achieved positive free cash flow for the first time since September 2001, and we are intensely focusing on reducing our working capital requirements to support improved cash flow from operations. During the quarter, we repurchased about $19 million of our 2003 convertible notes, demonstrating that we will be opportunistic in terms of retiring this debt, which is callable from November 2008. As a reminder, we also expect to continue to be acquisitive across the portfolio as opportunities arise. During the third quarter, we closed the acquisition of wireless service assurance company, Casabyte, and announced our intention to acquire datacom focused Picolight. More generally, you should expect occasional acquisitions of growing, profitable businesses which fit the evolution of JDSU's portfolio.

Finally, I'd like to remind you that we are now mid-way through our virtual series of analyst day presentations. For those of you who missed the Comm Test and Commercial Laser presentations, they have been archived on our website. The next presentation will be on our Advanced Optical Technology segment on Friday, May 11th. And in order to allow our new Optical Communications leader and team to focused 100% on immersion and execution, we are delaying the Optical Communications call until later this year.

In conclusion, our third quarter was characterized by stronger revenue than anticipated, reflected in year-over-year growth in all of our segments, but with particular strength in Communications Test and Measurement. Improving our predictability, both in terms of revenue and gross margin, clearly remains an area of focus going forward. With many Optical Communications customers in the midst of operational adjustments however, we expect top line visibility to continue to be challenged in the coming quarters. As a result, our primary focus will be on margin expansion and predictability. Dave will share detail of new cost reduction activity that we expect to positively impact our results starting in the fourth quarter. We believe that the structural changes underway in our Optical Communications segment will also support these efforts, and we look forward to updating you on our progress in the coming quarters. And with that, I will hand the call over to Dave Vellequette.

Thank you, Kevin, and good afternoon, everyone. Before I start, please note that all numbers are non-GAAP unless I state otherwise. GAAP revenue for the third fiscal quarter of 2007 was $361.7 million. Non-GAAP revenue of $361.8 million, which includes revenue associated with acquisition accounting, was down 1% sequentially, and up 15% from the same quarter a year ago.

Third quarter non-GAAP gross profit of $136.2 million, or 37.6% of revenue, was down from last quarter's very strong gross margin of 40.6%, and up from $118.3 million, or 37.5% of revenue, in the same quarter a year ago. Growth in the Comm Test international markets, which typically order products that are not highly configured, and the seasonal decline in North American telco, resulted in Comm Test gross margins that were below the near term target range of 55% to 59%. This shift in product mix impacted overall corporate gross margin by nearly 3 percentage points when compared to last quarter.

Non-GAAP operating expenses of $132.9 million included operating expenses from the Casabyte acquisition, higher corporate marketing costs associated with trade shows, most notably OFC, and costs associated with the commencement of our annual Sarbanes-Oxley testing procedures. As a percent of total revenue, third quarter non-GAAP operating expenses were 36.7%, within our target -- within our near term target range of 35% to 38%, and down from 39.7% in the year ago quarter.

Third quarter non-GAAP net income of $12.3 million, or $0.06 per share, was down when compared to last quarter's $30 million and $0.13 per share, and was up when compared to the year ago net loss of $2.8 million, or $0.01 loss per share.

A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. Our non-GAAP results exclude, among other items; amortization of acquired technology and intangibles of $16.4 million, and a $7.5 million charge related to stock-based compensation.

Including these items, GAAP net loss of $14.2 million, or $0.07 loss per share, compared to last quarter's net income of $23.2 million, or $0.10 per share, and to net income of $3.7 million, or $0.02 per share, in the year ago quarter.

Moving to the quarterly results for the business segments. Optical Communications revenue declined 3% sequentially to $128.7 million. Year-over-year, revenue was up 1%. Operating loss for the segment of $1.3 million represented a decline from roughly breakeven last quarter, and was associated with unfavorable mix and lower overhead absorption. With many of our customers in the midst of numerous operational adjustments, our visibility into their product requirements is reduced. As a result, we are taking steps to reduce our manufacturing and operating expenses by $4 million in the current quarter.

Moving to our Communications Test and Measurement segment, revenue of $162.9 million was unseasonally strong, up 28% from the year ago quarter, and down just 3% from the December quarter. Casabyte, acquired in January, contributed very low single-digit millions of dollars of revenue during the quarter. As already noted, the segment's gross margin was impacted by product mix and the resulting operating margin for the segment was 15.3%, down from 21% last quarter, but up from 12% in the year ago quarter.

Advanced Optical Technologies, which includes our Flex and Custom Optics businesses, delivered revenue of $45.6 million, representing 13% growth sequentially and 12% year-over-year. Revenue strength was due to strong orders in our Flex business, with large currency pigment orders associated with new bank note introductions, and a record performance from our Brand Authentication product. Benefiting from Flex's strong performance, operating contribution increased from 31.4% last quarter, to 34.6%.

Our Commercial Lasers business was down slightly this quarter at $24.6 million, and operating margin declined to 2% of revenue from 9% last quarter.

On a geographic basis, Americas contributed 54% of revenue, EMEA 27% of revenue, and Asia Pacific 19% of revenue. You will recall that Europe enjoyed very strong growth from Q1 to Q2, and our third quarter results show the region sustained this strength and was roughly flat on a sequential basis from Q2 to Q3. Asia Pacific revenue for Q3 grew 45% year-over-year and 19% sequentially due to higher revenues from Comm Test and Optical Communications products.

Moving to the balance sheet, total cash was $1,223.8 million at the end of the second quarter, down about $4 million. Uses of cash during the quarter included our acquisition of Casabyte, and also the repurchase of $19 million of our 2003 convertible notes. Also, DSOs improved by four days to 64 days, and inventory turns improved to 4.3. Highlighting our focus on cash generation initiatives, we are once again cash flow positive this quarter, with cash flow from operations in excess of $20 million. Additionally we are free cash flow positive for the first time in more than five years. And finally, headcount as of March 31st, 2007, was 6,834, down slightly from 6,856 last quarter.

While our third quarter results were challenged by product mix, we remain committed to the achievement of our business model targets. As a reminder, by the end of calendar 2007, we are targeting a non-GAAP gross margin in excess of 40% of revenue, and non-GAAP operating expenses in the 35% to 38% range. The near term objective is to deliver a sustainable non-GAAP operating margin in the 2% to 5% range. As Kevin mentioned, we will continue to critically assess our profitability performance and take additional actions in order to achieve our business model targets. In our Optical Communications business, we need to reduce our cost structure.

With that in mind, we have initiated actions to reduce headcount by approximately 400 through a combination of attrition and targeted action. The headcount reductions will primarily impact our Optical Communications manufacturing function, based in China and North America. During April, we reduced headcount by more than 100. These actions will be ongoing from now until the end of the calendar year. As a result, and when combined with the $1 million of cost savings already targeted for the fourth fiscal quarter, we expect to achieve cost savings of approximately $4 million, split between cost of goods sold and operating expenses. These cost savings will ramp through the second quarter of fiscal 2008, and we expect to exit the calendar year with cost savings of $8 million on a quarterly run rate, when compared to our most recent results.

Some other points to consider as you think about our financial performance over the coming quarters. First, revenue associated with the pending acquisition of Picolight is not included in today's guidance, although we do expect the acquisition to close during our fiscal Q4. Second, we will continue to target operating expenses in the 35% to 38% range, although recent acquisition activity could result in OpEx slightly above this range for the next several quarters. Finally, we expect our net interest income and expense to range between $11 million and $13 million, and our tax expense is expected to range between $3 million and $5 million.

Now to our financial guidance for the fourth quarter. You should also note that many of our Optical Communications customers are in the midst of operational adjustments, or purchasing pauses related either to industry consolidations or to manufacturing and inventory initiatives. As a result, we exited the quarter with a book-to-bill of less than one in Optical Communications, and our visibility is even more limited than it has been historically. With the Optical Communications environment firmly in mind, we expect fourth quarter revenue to be in the range of $325 million to $345 million. Operator, we are ready to begin the Q&A.

(OPERATOR INSTRUCTIONS) John Harmon, Needham & Company.

And congratulations on being free cash flow positive. So two questions. One, on your last webcast, you outlined your margin targets. And I think you said it will take you about four quarters to get there. What are the steps that you have to take between now and then to get there? And my second question is any guess how long your customers will be doing this lean manufacturing and inventory reduction?

Two separate pieces. I will try to take both, and if Dave has any comments, we will let him follow-up. The message on the gross margin improvement is largely that the structural changes in the Company that are required to improve gross margins are largely behind us. However, the improvement will come from specific actions in each segment. Each segment probably does have some level of gross margin improvement. I'll give you an example of some of the things that have transpired thus far.

In the case of our Communications Test, we felt that we could move from a target range from 55% to 59%, to 57% to 61%, largely by reducing the mix of what we call complementary products, as well as some mix of higher value-add software products that we have. In the case of lasers, it's stabilizing and minimizing the variances now that we've moved the manufacturing, there's a little bit of growth and there's also a little bit of mix in terms of the mix of solid-state versus gas. So I won't go through all of the segments, but the whole purpose of those reviews was to outline probably not more than three or four steps in each of those business segments that would expand the margin. I think Dave and I are goaling the Company to achieve this sustainable 40% gross margin by the end of the calendar year. And then we will try to raise it another 5 points by the end of the following year. So that's the kind of rhythm we are trying to mobilize the Company on.

Your second question, John, was I believe how long do we think our customer --- the concentrated customer base of the network equipment manufacturers will be going through either lean, inventory purge or consolidation -- supply chain management reconciliation. First of all, I think the inventory purge piece is peculiar, I think to only several of those customers. So we try to break that out. The lean piece, I think is in mid course. And I think the consolidation -- the people who will be the driving supply chains are in place. So I think the last conference call we said that we thought it was a more than one, and probably not more than a four quarter phenomena. We are probably one or two quarters into it right now. I still think that's sort of the nature of things, so I think we are in the midst of it. I would say our customers tend to communicate to us that they think towards the end of the calendar year, things will be continuing to improve. But right now, I think it's less than four and certainly more than two quarters.

That helps. Thank you very much.

Ehud Gelblum, JPMorgan.

A couple of things. If I can -- one quick question, actually on just clarification. The guidance for next quarter, does that include Test and Measurement -- what seasonality in Test and Measurement does that include, so we can get a sense as to what the concept is in the guidance for Test and Measurement versus Components? And then, as you -- I see what the kind of things you are doing in Optical Components, and how you intend to bring the gross margin back up again. But as you look competitively, is it completely you think a market issue that is hurting -- in North America that's hurting the gross margin and hurting your ability to raise margins there and to drive revenue growth? Or do you think there's some competition that's entering into the game that's hurting both the ability to bring revenues up there, and the gross margins?

Let me take a shot at it, Ehud, and I think you actually asked three separate questions. So let me break them down.

Feel free to parse at will.

In terms of guidance, we have tried to comprehend all of the positives and all of the potential down sides of each segment, integrated those into a most likely outcome range, and that's what we've given you. So you are correct, that sometimes our Comm Test business has seen further seasonal decline as it's gone from the first calendar quarter to the second calendar quarter. And if that was to be a possibility, we would have comprehended that potential in this, as well. The next two questions relate to two specific topics, one is revenue trajectories in -- .

Kevin, I'm sorry, I may have missed it. But in the guidance, is it assumed that Acterna comes back down again next quarter, and by how much?

We have assumed -- we have assumed the likelihood of either it staying flat, going up or coming down. So I'm not trying to give you a specific emphasis, but I do think it's fairly clear that where we are -- where we feel that we are going to be softest will be on the Optical Comm side.

But that accounts for all $40 million of the decline? Because it sounds like -- ?

I didn't give a number, I just said that that's certainly the piece that we are most watchful of.

Right.

Relative to the revenue and the gross margin, in terms of the gross margins, I'd say we have not seen any change in ASP trajectories that are different than the normal rhythm over the last four quarters. And so there is certainly always a lot of competition, but the general gross margin, or the ASP drivers of gross margin have stayed roughly the same. I think Dave has usually used the words of 1% to 4% in any quarter, or 2% to 4%, and we probably would have been right in the middle of that this quarter. In terms of revenue, we are highly concentrated in our customer base in Tier Ones. And three customers going through lean, which could -- our order intervals are sometimes on the high-end 16 to 20 weeks. If people were to cut that out, you could almost be blacked out for a quarter. So if you think of the order of magnitude of that, most of the order changes are related to a very small subset of customers, and we are just not getting enough growth from the other ones to overcome that.

How -- ?

So there is always potential competitive things. I wouldn't rule out anything. But can I look back and do a bridge and say, do I know exactly where the order changes have come from? I do.

Can you tell the difference between share loss and lean inventory?

I said you can never 100% know that. All I can tell you is I know what order run rates were from three customers. I know what they are today. And I know that that accounts for the changes.

Okay. Thank you very, very much.

John Anthony, Cowen and Company.

A couple questions. Could you separate your end demand commentary, even as it relates to the lean initiatives, towards 10-gig and above product with relation to communications and anything below 10-gig? I'm curious, obviously, if this is impacting the 10-gig products, or whether it's specific to storage, 2.5-gig and below. And then secondly, could you also just give us a sense for what kind of ROADM volumes we are talking about? I apologize if you already gave the statistic, but I think in the past you've kind of quantified how much of your revenues were Agile. And if you did that, could you just repeat that and tell us how you see that faring rest of the -- compared to the rest of the Comms business?

Yes, let me do the best I can with both of them, although I may not know the specific statistics. I don't think of the changes in our order flow around 10-gig versus below 10-gig. What I can tell you is, at a device level, we tend to be stronger. Where we have seen the greatest weaknesses are with the highest levels of integration that are associated with sub-systems and specific customers where we've made those sub-systems for. So we tend to have gone down less where there are specific devices. We tended to have been impacting those most at the highest levels of integration. In terms of ROADM volumes, I don't have those off the top of my head. We did make the comment that both metro and Agile Optical Networks continue to grow, while long haul DWDM did decline for the first time. So you should think that there was continued growth there. Tunables, as an example, doubled this quarter.

Brant Thompson, Goldman Sachs.

This is [Katie Fogarty] for Brant Thompson. Just circling back to your long haul comment. Are you talking about as an industry, that the long haul component side has declined? Or that you specifically have seen weakness in long haul? Thank you.

We commented only that we specifically had a first decline in many quarters in DWDM long haul.

So is it fair to say that it's maybe share loss?

I think you'll find that there are analysts out there that have identified a decline in DWDM largely because of the inventory build up from last half of 2006. And -- but I'll leave it to you to find those reports.

Okay. Thank you so much.

Michael Genovese, Citigroup.

A couple of questions here. First, I just want to clarify on your near term margin guidance. I seem to remember that the 40% gross margin, the 2% to 5% operating margins, was a fiscal '07 target previously, and now it sounds like that's shifted out to calendar '07. Is that right?

It's -- the calendar '07 is about exiting with a sustainable 40% margin, and that we are still targeting to keep our operating margins in the 2% to 5% range. But talking about the sustainability is the 40%. So there's no change from what we've communicated before.

So would you still expect in June to be at or near that range?

We will be -- it will be -- again, we will be at or near 40%. We expect to operate within a range of 40%, plus or minus a couple of percentage points. This quarter you saw we dipped below that 38 side of it because of the mix. So we are within the range that we expect to operate within. The goal again, is to get to the 40% sustainable by the end of the calendar year.

And just to revisit this Optical issue, there's been a big change here. It used to be that Optical was the business with the book-to-bill plus one, and good visibility. Test and Measurement was the turns business that we couldn't really predict. And it seems like there's been a big visibility change there. I understand what you are saying, Kevin, about taking out 16 to 18 weeks of inventory at the OEMs. But it was also a short while ago we were looking -- talking about 15% revenue growth in Optical that looked fairly sustainable. So are you saying that the inventory is at the carriers? Or simply the inventory is being brought down at the OEMs, when you talk about this inventory build? And do you think that there's been a change in end market demand, in terms of traffic growth and demand from end users of communications equipment, if you can see through to that? Thanks.

Yes. I don't personally believe that there's been a significant change in end market demand. Let me put that one to rest. There are in cases, shifts or deferrals of deployments for some systems in some of the large networks because of various reasons. But I don't fundamentally believe that there's an end market demand change. What we did say is that among a small number of network equipment manufacturers, and especially those that might have used contract manufacturers, they found that they had built inventories in those CMs, and that inventory had to purge at some point. Secondly, when you move to a lean environment, things that you might order with a 16 or 20 week order interval, might actually be reduced to a four or an eight week order interval. So you could essentially reduce your visibility from the order interval side for as many as 12 weeks or a quarter, and you may have had a capacitance of one quarter or more of inventory that needed to be purged. So bottom line is, the shorter order interval is less visibility built in general. The confluence of that, plus potential inventories that existed in the contract manufacturer because people anticipated faster roll-outs, basically added to a slow down. Again, very specific to -- or a significant emphasis around DWDM, long haul and the higher up in the layers of the system integration.

If I can just sneak in one other question about Test and Measurement. You gave us a lot of segmentation and product, how you are doing in different geographies and different markets there. But what about in these -- in the access, North American fiber to the home and IPTV/carrier video market? You didn't really speak about that one. Could you tell us how you stack up competitively against the main other players there?

I think we actually mentioned in the script that we feel like we have one of the best IPT -- or VoIP meters in the business. We probably are certainly number one, if not -- at worst, number two. But probably number one in field test. So -- and obviously, with a 28% year-over-year growth, we feel the team -- this was -- you had asked me once before whether you thought we had a great momentum. I think it was about three quarters ago. I hope you realize that with 28% year-over-year growth on the size of the denominator that is, we have pretty good momentum.

Thank you.

Ajit Pai, Thomas Weisel Partners.

A couple of quick questions. The first one would be just about your Advanced Optical Technologies. Those margins that you've had have been improving for some time now. Could you tell us how sustainable you think that the current margins are?

Yes, sure, Ajit. There is two pieces and, of course, I should point that we do have an upcoming analyst conversation with the leader of that group shortly. And they will discuss more about margin components. But let me generally break that into two pieces and give you a sense for how that works. One is the currency-related pigments and the pharmaceutical labels that use those pigments for brand protection. And I would say that both of those have been having favorable margin expansion largely because of volume improvements. And so, do I expect those to significantly change? Not a lot. Can they have a jitter of plus or minus a point or two? They could. But they are sort of in a good mode, and will probably only improve maybe a point. There's another piece of it which is a coated optics piece that -- think of it as coatings that go on night vision goggles or specialty boutique things, and that is an area that is below our target margin range. It is improving, and it will continue to improve for awhile yet. So as long as we keep improving that one, there is some margin expansion available to that AOT group as that one piece gets better. Roy will give you more insight than that. But the way you should think about it, currency is pretty good, the labels have gotten better, and we have a little bit of improvement, and the coatings, which is a significant piece of the business, not the biggest, has a lot more improvement in it yet.

Okay. And then the second question would be about your Optical Communications group. So there's sort of two parts to that question. The first one would be very broadly, if you look at your business mix today relative to your products introduced over the past two years, and then about six months ago, could you give us a rough mix within that, that you think that -- give us some color as to how that mix has changed recently as a percent of revenues? And then the second part of the question would be what percentage of your products right now in Optical Communications are being manufactured outside of the United States? And how does that compare to what the mix was about a year ago?

Yes, let me see if I can do that in reverse order. I think -- and Dave can correct me if I'm wrong. But I think in terms of products that are manufactured outside the U.S., be they in our own Shenzhen facility or contract manufacturer, it would be in excess of 75%. And primarily, Ajit, what we make here in the U.S. tend to be products that are integrated photonics or fab-based -- semi-conductor-based products. So that's that piece. What was the second piece of the question?

And what was it in the same quarter about a year ago, the mix?

Maybe 60-ish or something.

Okay.

Most of the products are moved at this point. There's a very slight amount that still has to transition. And now it's really taking the redundancy of the cost structures from each side of the ocean out and tuning it.

Got it. And then the other question was about your products, the mix of products currently in this current quarter in Optical Communications that were introduced within the past eight quarters, within the past two years.

If you were to go back two years ago, we were dominated by long haul, and with an emerging set of products in sub-systems. So where we were taking some of our long haul products, like our wave blockers, our Dynamic Gain Equalizer, and integrating them on circuit packs for various people, and putting them in for long haul systems. And we had made bets on products like ROADMs or tunables. But the volumes were still pretty low, and we used to talk about that as the metro being less than 20% or so forth. Metro is a very, very strong piece of it. The device pieces of metro, whether they're ROADMs, whether they're tunables that go in, transceivers are up in terms of volume. Long haul as a percentage, has declined from what was close to 50%, something smaller, really on the backs of metro expanding. And I'd say the biggest change in this pause is that the volumes from long haul sub-systems, which went through an uptick in the second half of last calendar year, has -- was probably the first to slow down for right now. But at a device level, the volume was pretty good, especially in the metro.

Subu Subrahmanyan, SMH Capital.

I had a couple questions. First on the Acterna side, I know their fiscal year end used to be March into last year. Did that get changed this year? Are they on a June fiscal year end? I'm trying to figure out if there was any year end accelerators which changed the seasonality from being strong March? The other question I had was on the Optical Comm side. Kevin, obviously the visibility in the space has changed fairly quickly. I'm just looking, and I know this question's been asked, but trying to get at it from a different point of view. If you look at the end market demand, you look at the carrier spending fundamentals and so on, do you see that change at all? And do you think if the pick up in the second half, which has been expected for some time happens, the lead times could change again? Or is there fairly clear visibly that your customers have a lot of inventory and it will take a couple of quarters to work through that?

Yes, Subu, I will take them one at a time. We did change the end of the Comm Test fiscal year end to coincide with JDSU's fiscal year end, which is June. So it would be incorrect to assume that there was any accelerator that resulted in the March results -- or great March results that we had this year. I think that's your first question. The second question is the optical market and end market visibility. As I said earlier, I believe that in general, broadband deployments are continuing to roll-out. I don't see any fundamental change in it. There are cases where carriers are slowing down for one to three quarters because of architecture choices or because of equipment working. But at the end of the day, I think they want to spend the money. And I think that environment hasn't changed significantly. The majority of the lack of visibility is really due to built up inventory, especially in sub-systems in the higher end DWDM long haul pieces. And secondly, it's concentrated in these shorter order intervals, so that by the time your products are needed again, rather than giving you a 20 week order, you get a four to eight week notification. So, and I can say that because it's very clear which customers those are associated with.

Paras Bhargava, BMO Capital Markets.

Kevin, you mentioned that you want to take your gross margins from, I think it was 55% to 59%, to I believe 59% to 61%, in testing. Where were they this quarter?

Paras, the statement in the script was our target range is 55% to 59%. This quarter they were below the 55%. And our goal that John had stated on the last analyst review was to move them over the next year into the range of 57% to 61%.

57% to 61%. So can you tell us, were they above 50%?

Yes, they were above 50% and below 55%.

Now what exactly happened? Like, you are saying geographic and product mix. Was some of that Service Assurance stuff, which tends to have lower gross margins? Or was there something -- is it that you are going through distribution and that's got -- in some of the other geographies? Can you give us a little more texture, please?

Yes, we tried to be fairly precise, actually, in the script, Paras.

I missed it, sorry.

No, that's okay. Busy script. We ended up having a significantly more success outside of North America. Associated with that are smaller configurations and configurations that come with less gross margin. So it was less an issue of complementary products versus field service products versus whatever. It was really the configurations associated with these non-North American geographies.

Got you. Now, going forward, do you want to go into more software-based solutions to increase your gross margins. I think everybody does. And that's probably the protocol testing, as opposed to the physical layer testing. Is that a good understanding, or is there something else?

I would say we have -- John's comments were in general for the products that we design, cable is an example, or even our telecom field service pieces, we tend to operate in the 60% to 70% gross margin ranges for those. So selling more of that is a significant thing. Selling less of the complementary products structurally is a good thing. And those two things alone will probably structurally move John's gross margins.

And is the target date for that still calendar '08? Do you think you can do that? Because as I look at your products in that segment versus others, I see a shift in competitive intensity there, especially in the gigE, 10-GigE side.

I would say we haven't seen a significant change to our ASPs by virtue of competitive dynamics, partly because of it's a highly fragmented industry right now. So I would say John left with the statement that he felt over the next four or so quarters, he could bring that shift about. And so no change in belief system since that call.

Jeff Osborne, CIBC.

Just wondering, Kevin, if you could update us on your full year calendar year '07 targets for optics? I think you had talked about 5% to 15% growth previously. I was just trying to get a sense of where that plays out in the back half of the year. And then just lastly, if you can talk about gross margin trends, in particular with the Agile Optical Networking products. It seems like the ROADMs and tunable market in particular have been a little bit challenging on the competitive front there.

Let me take them in reverse order. I think we are pleased with the doubling of revenue in tunables this quarter. So not particularly feeling challenged. On the ROADM side, the share that we have, the wins that we've had, continue to feel good about those. We mentioned a number of new design wins on the call. And the fact that metro was continued to grow, while other pieces of the business in particular, the sub-systems business and long haul DWDM declined, we are feeling good about metro in general. In terms of where we think optics will end up, that's another form of guidance. We tried to comprehend guidance for the Company in the numbers that we gave you.

Just a follow-up on the Agile side, would you say that gross margins for Agile Optical Networking are actually above the Optics gross margin? Or are those still below due to lower utilization? Or can you just talk about that in greater detail?

Yes, I think we have gross margin improvement opportunities on all of the new product areas.

Very good. Thank you.

Thank you, sir, I have no further questions. Thank you, again, ladies and gentlemen. This brings your conference call to a close. Please feel free to disconnect your lines now at any time.