Viavi Solutions Inc (VIAV) 2008 Q1 法說會逐字稿

Good day and ladies and gentlemen and welcome to the JDSU fiscal 2008 first-quarter earnings call. My name is Eric and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question and answer session toward the end of the conference. (OPERATOR INSTRUCTIONS).

I would now like to turn your presentation over to your host for today's call, Ms. Michelle Levine, Director of Investor Relations.

Thank you, operator, and welcome to JDSU's fiscal 2008 first-quarter financial results conference call. Joining me on the call today are Kevin Kennedy, Chief Executive Officer and Dave Vellequette, Chief Financial Officer. 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 management's current expectations. We encourage you to look at the Company's most recent filings with the SEC, particularly the risk factors section of our report on Form 10-K filed August 29, 2007. The forward-looking statements, including guidance provided during this call, are valid only as of today's date, October 31, 2007, and JDSU undertakes no obligation to update these statements as we move through the quarter. Our comments today will include non-GAAP measures. A detailed reconciliation of these non-GAAP results or GAAP results as well as a discussion of their usefulness and limitations are included in today's news release announcing our results available on our web site at www.JDSU.com.

Finally and as a reminder, this call is being recorded and will be available for replay on the investor portion of our web site at www.JDSU.com/investors. I would now like to turn the call over to Kevin.

Thank you, Michelle, and good afternoon. Highlights for JDSU's fiscal first-quarter 2008 non-GAAP results include but are not limited to first-quarter revenue of $357.2 million, growth of approximately 2% from Q4 of fiscal 2007 and 12% from Q1 of fiscal 2007. Gross margins of 41.3%, an improvement from 37.4% last quarter and 34.7% one year ago. For the second consecutive quarter, the book to bill ratio for the Optical Communications business was greater than 1.

JDSU's adjusted EBITDA as a percentage of revenue was positive 6.6%, twice that of last quarter. Operating margins were 2.2% within our near-term target of 2% to 5%. Three out of four of our business segments saw operating margin improvement compared with last quarter. And finally, we were free cash flow positive for the third quarter in a row and balance sheet metrics continued to improve as reflected in our lower days sales outstanding, inventory levels and [debt] (inaudible).

To summarize, we saw key financial metrics improve sequentially as well as year-over-year as we continue to focus and execute on our goal of improving our business model.

Before discussing the more detailed segment reports, I would like to reiterate that our strategy continues to be to execute at the Company comprised of a portfolio of businesses with a focus on optical and broadband innovation. We embrace this view such that the composite company would be better able to navigate fluctuations than any one constituent business. We continue to see favorable end market indicators for broadband services and network buildouts and we believe broadband capacity will continue to expand as higher data rates are being delivered to the access edge, accompanied by video applications.

We also believe that as network operators respond to changing loads and consumer dynamics, networks must be agile in order to rapidly respond to the resulting changes in traffic patterns.

Following customer visits this quarter, a number of observations about the market which may have relevance are as follows. In general, network equipment manufacturers in Optimal Communications express cautious optimism in the foreseeable future based on their awareness of our (technical difficulty) activity. Relative to a sampling of conversations with European customers, there are number of forces conspiring to potentially increase the emphasis on fiber extending closer to the subscriber, including the following. One, depending upon a number of factors, there is a sense in operational cost and maintenance that a fiber infrastructure can be as much as an order of magnitude less expensive to maintaining copper. Two, in at least one domain, a regulatory body is considering an influence that will drive an earlier embrace of fiber reach into the access layer. Three, video and HDTV updates may require the need for optics sooner than originally forecasted due to capacity and fault tolerance limitations of copper. Fourth, copper costs are increasing as the metal itself is rising in value. As the raw cost of copper rises, the affordability of optics improves. And fifth, as [relative] economics improve due to smaller, more optimized configurations, it is more likely that service provider will embrace ROADM architectures in smaller or more fragmented pockets of domain. The end result is that the optical layer and components business, as well as test and measurement equipment, could see an increase in demand as the realization of deeper fiber penetration occurs on a horizon of several years.

For example, in Europe and elsewhere.

With that, I will now provide more detail on the business segments; first, Optical Communications. I would like to begin by reminding you that we will be hosting a virtual analyst presentation next week on November 8. The virtual analyst presentation will be led by David [Goodmanton], President of our Optical Communications segment. David will discuss the business' market opportunity, strategy, growth drivers and product portfolio.

In our Optical Communications segment, total revenue was $121 million in the first fiscal quarter compared to $113 million in the fourth quarter of fiscal 2007. The segment experienced a sequential increase of over 7% mainly due to increased shipments of agile optical network, or AON products, as well as a full quarter of Picolight revenue. We saw bookings strength during the first fiscal quarter as total bookings increased from the fourth quarter level and the book to bill ending the quarter was greater than one. With this second consecutive quarter of book to bill greater than one, there is a cautiously improving trend in this network equipment manufacturer market. And, we saw an improvement of gross margins relative to the last quarter.

For the quarter, nine out of 12 product lines experienced sequential revenue increases. Of those nine product lines, eight experienced double-digit percent of sequential growth with agile products evidencing strength relative to legacy products. During the quarter, we saw healthy sequential bookings in our agile optic network portfolio for ROADMs and tunables, and indicators are beginning to show more of an evolution to a broader market. We are continuing to invest in pluggables, agile products such as ROADMs and tunables, and products for the metro market. All three of our major Optical Communications market segments, including long-haul, which includes undersea, metro and datacom saw sequential growth.

We continue to focus on innovation. Specifically, we are focused on functional integration as service providers strive for greater efficiencies in their networks and network equipment providers look for a decrease within cost, power and footprint. For example, this quarter, we announced a new photonic integrated circuit that combines a tunable laser and an optical modulator. Tunable lasers are a key element required for the successful deployment of agile optical networks. This new solution may be introduced into a carrier's existing network without architectural changes.

During the quarter, we also announced a strategic partnership with Mintera. A high bit rate optical transport system solutions leader to support 40-gig capability. The partnership offers network equipment manufacturers a 40-gig transmission solution, combining Mintera's 40-gig technology with JDSU's 40-gig capable Optical Communications products. JDSU and Mintera will join forces to create a go to market strategy that includes joint product development and aligned manufacturing for new 40-gig solutions, starting with the creation of a multi-source agreement, or MSA, 300-pin transponder module.

As discussed in our last call, we have initiatives in place to continue to improve gross margin in all business segments. In Optical Communications, we are doing the following. First, we're focused on driving our revenues to a higher post pause level which will improve factory utilization while at the same time we're reducing our inventory investment. During this quarter, revenue growth did help improve gross margins as we realized slightly improved factory utilization and benefits from our cost reduction activities. Albeit more growth is needed to fully absorb our current overhead [structure]. Second, mix will continue to play an important role. By the end of fiscal Q1 '08, two of our three Optical Communications businesses have attained gross margins of 25% or greater. Additionally, we anticipate structural improvements to gross margin from having (inaudible) and other (inaudible) product [in house].

Third, we have a significant amount of work underway that could be operationally classified as lean initiatives. These include manufacturing overhead reduction, manufacturing headcount reduction, variance reduction, inventory reductions, procurement spending reduction and bill of material localization. Finally, we have a renewed level of focus on value engineering, that is redesign for products and processes to improve gross margins.

We believe healthy gross margins for this industry are 30 to 40%. With top-line growth and execution against our noted initiatives, we will continue to target our execution in this range.

Now onto Communications Test and Measurement. The complexity associated with the service providers' transition to IP networks and broadband Triple Play service delivery, as well as the expansion of fiber optic network capacity continue to drive growth in our Communications Test and Measurement segment. JDSU is well positioned to address this trend across the network and service delivery cycle. For example, our 10-gig and 40-gig test solutions address the increasing capacity requirement for equipment manufacturers and service providers. Our modular field service and premises wiring instruments provide field technicians with all-in-one tools for the efficient installation and maintenance of IPTV, voiceover IP and high-speed access and other services. And our service assurance system enabled network and services monitoring to ensure quality of service help our customers reduce subscriber churn.

Our first quarter fiscal '08 revenue was $168 million, down 2% as compared to $171 million in the prior quarter and 44% growth compared to first quarter of fiscal 2007 revenue. Year-over-year revenue growth was driven by our field service instruments with broadband access networks and fiber optic test solutions as well as [acquisition]. The revenue results reflected strength in all regional markets. Business experienced typical order patterns in the summer months with lower bookings in the quarter as compared to the prior quarter. Bookings were up year-over-year. Finally, gross margins improved in Q1 when compared with each of the last two quarters.

We did see strength this quarter for products such as the HST, the Triple Play field service instrument for telecommunications service providers, T-BERD platform for fiber optic network testing, addressing high-growth opportunities such as fiber characterization and ROADM network test, and our NetComplete portfolio for broadband and IP service [assurance].

We also continue to bring innovative new products to market, including the recent introduction of the ONT-503, a portable 40-gig solution for lab and service verification test. This quarter, we appointed Thomas Walker as President of the CommTest business with responsibilities for CommTest global sales, product development and operations. Tom brings excellent public company, key level global operational and management experience along with his deep knowledge of the telecommunications marketplace. Tom's immediate priorities include gross margin expansion and continued growth. (inaudible) will continue with JDSU and will support Tom.

The areas of focus to improve both gross margins include the following. Product mix is primary and has two areas of focus. The first is increasing the mix of the sales of our organic product versus those that we simply resell. Second is concentrating on increased to North American sales operators (inaudible) to purchase more fully configured units. The strong growth of our field service portfolio was a key driver of gross margin improvement this quarter.

Our next area of focus is on lean based initiatives to improve cash flow and drive improved supply chain management (inaudible). And finally, as in Optical Communications, we're increasing our focus within CommTest on value engineering. As mentioned in our March analyst call, successful execution of these initiatives is expected to move our target gross margin in CommTest from a range of 55% to 59% to a range of 57% to 61%.

In relation to CommTest growth, we would like to highlight the following. Year-over-year market or industry growth is 5% to 8%. We expect JDSU organic growth to exceed the market by a few points when we're executing well. CommTest revenue generally peaks in the December quarter. Peak revenue versus nadir is between 1.1 and 1.2. The CommTest model is evolving and we're focused on improving predictability. As said, the model is one of high turns and visibility is low in select North American wireless accounts.

Moving on to our Advanced Optical Technologies segment, fiscal Q1 revenue for AOT was approximately $48 million, representing growth of 7% compared to $45 million in the fourth quarter of fiscal 2007 and up 22% compared to $39 million in the first quarter of 2007. This quarter, the Advanced Optical Technologies segment generated operating income of approximately 38% as we saw gross margin improvement on a sequential basis due to favorable mix and improved operational execution. Once again, the currency market has provided upside for this business driven by new currency note introductions around the world. As we have noted before, the trending of this business will have some levels of surges and ebbs.

Brand protection labels for our customers in the pharmaceutical, imaging supplies, electronics and other industries are growing in popularity. This quarter, we announced the addition of a unique anticounterfeiting covert security solution called [CHARMS] to extend our portfolio of solutions for the authentication market.

In the custom optics business, we're beginning to see increases in volume from the participation in the entertainment market enabled by our proprietary [UCP-1] technology. Gross margin improvement this quarter was mainly due to product mix and improved factory utilization. Our gross margin improvement initiatives in the AOT segment, again, consistent with the May analyst call, are focused on promoting our legacy applications in concert with adding new business to our universal coatings platform to drive better utilization. And volume, which will accelerate gross margin improvement for the coated optics and label business.

Now to Commercial Lasers. First quarter fiscal 2008 revenue was $20 million, down by 10% from $22 million in the fourth fiscal quarter of '07 and down 17% compared to $24 million first quarter fiscal year 2007. Inventory reserves were taken due to end of life exposures and slow-moving inventory that negatively affected gross margins in the quarter. We are encouraged by bookings in the quarter which saw growth compared with last quarter. In particular, bookings traction for our FCD488 solid-state fiber laser product was positive. Our Commercial Laser business serves a relatively small number of customers, so quarterly performance is impacted by spending cycles. Furthermore, semiconductor industry activity has declined which we believe to be temporary. On the other hand, the biomedical and machining-related customers continue to be healthy.

Last month, we announced the appointment of Alan Lowe to lead our Commercial Lasers business. Alan brings sea-level public company background and over 20 years experience in general management, operation sales and business development to JDSU. Alan's efforts are currently focus on margin expansion and lean manufacturing initiatives and working with customers to accelerate new solid-state design wins.

Focusing on our laser platform gross margin expansion initiatives, we note the following. The critical factor is mix with solid state laser revenues having a favorable impact on gross margin. Gross margin upside will come from increasing solid-state laser volumes in concert with lean manufacturing initiatives already in process. For example, this quarter, we shipped our first FCD lasers from Shenzhen and plan to ramp up production in fiscal Q2 with the full production transfer completed in early calendar 2008. Additionally, we're focused on driving inventory turns up and our supply chain costs down which will result in improved gross margins. We believe the aggregate of these initiatives, once fully implemented, will result in double-digit gross margin improvement.

Now for an update on corporate initiatives. On October 22, the jury trial began in the securities class action that commenced in March 2002. The trial is expected to continue to or shortly after Thanksgiving. We believe that the factual allegations and circumstances underlying this class-action and the related actions are without merit and we intend to continue to vigorously defend ourselves in the trial. For a summary of the proceedings and the risks associated therewith, I would refer you to our quarterly and annual reports filed with the SEC, in particular our recently filed report on Form 10-K for the fiscal year ended June 30, 2007.

Since April, our business has navigated a transition of three out of four of our segment business leaders. A current team has been assembled mindful of the phase of the company, focusing on growth, albeit with a focus on the details to improve the efficiency of the business model of each individual business. As described on our last call, fiscal year 2008 will be a year in which JDSU intends to advance its business models as each business within the portfolio expects to continue to improve individual operating results. There is a strong focus on gross margin and cash flow improvement in all operating segments. At the same time, we continue to seek opportunities to strategically expand our product portfolio through partnership and acquisition. The goals we set forth remain intact. In the near-term, our sustainable models is gross margins at approximately 40%, operating expenses in the range of 35% to 38% and operating margins in the range of 2% to 5%. Our long-term model calls for gross margins in the range of 43% to 47% and operating margins at or above 10%.

In summary, the markets we participate in are favorable and in Q1 we evidenced the continued trend of favorable financial metrics. With that, I will hand the call over to Dave.

Thank you, Kevin. Before I start, please note that all numbers are non-GAAP unless I state otherwise. First-quarter revenues of $357.2 million was up 1.8% from the fourth quarter and up 12.3% from first quarter revenue of a year ago. First-quarter gross profit of $147.4 million, or 41.3% of revenue, was up from the previous quarter's 37.4%. We saw improved margins in three out of four of our business segments due to product mix and the impact of our gross margin initiative.

Operating expenses for the quarter increased to $139.6 million and were 39.1% of revenue. The increase is primarily in R&D spending resulting from full quarter impact of the Innocor and Picolight acquisitions. Our operating income for the quarter was $7.8 million compared with an operating loss of $4.3 million in prior quarter. Adjusted EBITDA in the fourth quarter was $23.7 million, or 6.6% of revenue which compares to an adjusted EBITDA of $11.7 million, or 3.3% of revenue in the prior quarter. First quarter net income was $18 million, or $0.08 per share. This compares with fourth quarter net income of $15 million, or $0.07 per share.

A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. Our first quarter non-GAAP results exclude among other items amortization of acquired technology and intangibles of $18.9 million and an $11 million charge related to stock-based compensation. Including these items, quarterly GAAP net loss was $6.9 million for a loss of $0.03 per share.

Moving to the segments. In the Communications, Test and Measurement, or CommTest segment, first-quarter revenue of $168 million was down 2% from the prior quarter's revenue of $171.3 million and up by 43.8% from Q1 fiscal '07. Operating profit increased for the quarter to $26.3 million, or 15.7% of revenue versus $26.2 million, or 15.3% of revenue in the prior quarter, primarily due to improved gross margins.

In the Optical Communications segment, revenue was $121.3 million, was up by 7.6% when compared to the prior quarter and down 12.1% from a year ago. Operating loss in the segment was $2.9 million or 2.4% of revenue, an improvement from a loss of $9.2 million or 8.2% of revenue in the prior quarter due to improved gross margins which were partially offset by higher operating expenses resulting from the Picolight acquisition.

Our Advanced Optical Technologies, or AOT, segment quarterly revenue was $48 million, up 7.4% from the prior quarter and up 22.1% from the prior year. AOT operating profit for the quarter was $18.3 million or 38.1% of revenue compared with $13.1 million or 29.3% for the prior quarter. The increase in operating profit was the result of higher gross margins due to product mix and improved factory utilization. In our Commercial Lasers business, first quarter revenue of $19.9 million declined 10% from the prior quarter and declined 17.4% from the prior year. Due to lower first-quarter revenue, Lasers had an operating loss of $2.5 million.

Now looking at revenue by region. Over the last year, the geographical dispersion of our revenues remained balanced. In the first quarter of fiscal 2008, the Americas contributed 54% of revenue, EMEA 28% and Asia-Pacific 18%. We saw a slight decline in Asia versus last quarter, but revenue was above historical levels.

Moving to the balance sheet, for the third quarter in a row, the Company was free cash flow positive, generating approximately $27 million. This was the result of lower capital expenditures, improved days sales outstanding and reduced inventory levels. We also reduced our debt balance during the quarter by $75 million. The cash, cash equivalents, short-term investments and restricted cash at the end of the fourth quarter totaled more than $1.1 billion.

Headcount as of September 29 was 6459, down from 6688 last quarter, primarily due to reductions in Optical Communications.

While our markets are generally favorable, we remain focused on improving our operating model. As Kevin stated, our near-term sustainable operating model targets are gross margin of approximately 40%, operating expense in a range of 35% to 38% and operating margin of 2% to 5%. We believe we can achieve this model by the end of this calendar year. Longer-term, we believe we can achieve gross margins of 43% to 47% and an operating margin of 10% or more.

Now looking forward, some points to consider as you think about our financial performance over the coming quarter. Due to the different gross margin targets for each of our segments, gross margins will be impacted by changes in product mix and by geographic dispersion. Specific to the AOT segment, Q1 gross margin exceeded our sustainable range due to a favorable mix and maybe challenged to maintain the same strength in gross margins in subsequent quarters. Our CommTest business is a high turns business and in the December quarter, there was visibility due to the lower bookings in the September quarter and the majority of the turns business is the result of the carrier budget flush that typically is booked at the end of November and during September.

Finally our Optical Communications segment continues to improve and, as Kevin noted, two of the three businesses have attained gross margins of 25% or greater. That said, the reduced revenue levels as results of our customers' lean initiatives and customer consolidation activities have resulted in a two to three quarter phase shift with regards to achieving gross margins in the 30% to 40% range.

With regards our cost structure, through the first quarter of fiscal '08, we have implemented programs that provide over $6 million of quarterly cost savings, most of which impacts our gross margin. As stated previously, by the end of fiscal Q2, we will have implemented programs that will increase this savings to $8 million on a quarterly basis. These savings are relative to our fiscal Q3 2007 spending levels.

With respect to operating expenses, Q2 operating expenses are expected to be near the mid point of our range of 35% to 38%. Also, due to the debt retirement activity, our interest income will decline by more than $1 million when compared to fiscal Q1 2008. Finally, we expect our quarterly tax provision to range between 2 and $4 million.

Now to our financial guidance for the second quarter. Based on our current visibility, we expect second quarter revenue to be in the range of $372 million to $394 million.

Operator, we're now ready to begin the Q&A.

(OPERATOR INSTRUCTIONS). Ehud Gelblum, J.P. Morgan.

A couple of quick questions. First of all, we understand that the book to bill on the AOT business -- sorry -- on the T&M business -- too many acronyms -- was significantly less than 1, and is that cause for the lower guidance?

As I said, it is typically less than one in that particular quarter; that's normal. It was actually strong relative to year-over-year. The guidance that I tried to give you is that the ratio of the peak or the nadir as we've used it in the past used to be 1.1 to 1.3. I've tried to narrow that to 1.1 to 1.2 for the following reasons. One is, we moved the end of the fiscal year to the -- of the CommTest team to our JDSU fiscal year. We saw greater strength in the June quarter and less strength in -- the fiscal Q1 ends up probably being stronger. It went down less than people might have anticipated, so the costs were off of a higher base. You would expect that ratio to be less. The second thing is, we have expanded our portfolio through acquisition, and that ratio or the physics of a budget flush is primarily associated with the dollars that are available in service providers or carriers for what I would call field service equipment. The same physics wouldn't be applicable to the parts of the portfolio that would go to the network equipment manufacturers, for example. But because the portfolio has grown outside the field service area, you would not apply that same full ratio to the full revenues stream. So a number of conspiring factors, but the net of it is that the ratio is smaller. And, finally, we do have some lower visibility than probably six months ago in some of the wireless carriers, and that is not a unique story. We're not highly exposed, but those are really the forces that made us be -- provide the guidance that we have.

I want to pick up on the wireless carriers in a moment, but first of all, when we use that 1.1 to 1.2 calculation from the peak to nadir, which quarter now that you have realigned the fiscal year end to be more in [conduction] with yours, which quarter now is officially the peak quarter?

The peak is never a question, it's the December quarter.

It's still the December quarter. So this should still be your best quarter of the year?

For the CommTest team, that's correct.

Just not necessarily as high? I'm just trying to correlate that vis-a-vis kind of what we had been looking for, and obviously you don't necessary what our model was. But in terms of your components of your guidance, can you walk us through kind of what you had been expecting growth rate wise for the other businesses as well?

Ehud, we sort of comprehend all possibilities in the guidance that we give you of $372 million to $394 million. So, no.

So we should assume relatively similar types of growth in each one that we saw this quarter? I guess more specifically, in the Optical Communications components side, it seems that we're getting a break from the inventory problems we've had in the past. Is that for the most part over, so we can expect to see that sort of somewhat rebounding?

At the end of the day, the book-to-bill was greater than 1. Book-to-bill was greater than 1 in Lasers. We know that we have a budget flush phenomenon in a strong quarter in CommTest. And since we did $357 million, and we're giving you a range of $372 million to $394 million, you should presume that there is a general buoyancy to the largesse of the business. So there is a lot of pieces of data there for you to triangulate with.

Right, definitely it can. The last thing, you mentioned wireless in the Test and Measurement business. What is your exposure to wireless? Can you tell us percentage wise.

I don't know it off the top of my head. It's relatively small. There's two areas. One is wireless service (technical difficulty), which is single digit millions of dollars total. And then, wireless backhauls. So that's probably a bigger number, but it's not an earth-shattering number.

And yet, you still expect the budget flush in your traditional fiscal year end now, despite the potential cautions that you may have been hearing from some of these carriers?

That's correct.

Jeff Evenson, Sanford Bernstein.

I was wondering if you could give us a bit more color on fiber opportunities in Europe, and in particular, maybe some just general guidance on how we could think about your revenue per new subscriber and other things that might be driven just by the change in any number of new additions per year, for example.

Jeff, we don't have a way of providing that kind of calculus today. We're probably more driven by CapEx spending and obviously correlate better to [NEM] success. But I think my opening comments were that, as you know, most of the ROADM architectures were movement towards [some sign of two mesh] investments have become a proclivity of a North American optics market. And while I would not say that we have passed any tipping point in Europe, I would say that the conversations are more somber in the sense that, gee, we have a lot of copper, the application space is moving pretty fast and we may be rethinking what we need to do with fiber. So I saw a greater level of sobriety and people sort of anticipating a future on a shorter horizon than otherwise.

In previous calls, you've talked about suppression of optical spending at some of your customers due to their lean manufacturing programs. Just wondering if you can give us an update on where they are in the process and what you're seeing right now.

So, you know, we have been pretty consistent since probably, I don't know, the end of our last fiscal Q3 that the phenomena was occurring. The fact that this quarter and the quarter prior were both evidence, a book to bill greater than 1 obviously is a sense of cautious optimism. I think the majority of the network equipment manufacturers, if eight of them were going through this kind of process, the majority of them are well through the midpoint. There's a couple that are starting up, one or two. But I would say the trend line is up, and I would say from the sense of order size, we're in a better place than we were several months ago. So data points are positive.

John Harmon, Needham & Co.

I was wondering if you could just outline the components of what is making your optical component business unprofitable, whether it's prices or yields or fab utilization or staffing levels or particular products, just to get a picture of the areas to work on. And secondly, I was wondering if you come up with kind of a vitality index for that business. In other words, what percentage of your revenues come from products that were developed within the last couple of years?

So we'll take the -- see if we can come up with a specific percentage for you for the analyst call in a week or so, but I would say, the fact that our growth and vigor -- we gave you some numbers of nine product lines out of 12 showed growth, eight of those were double-digit. And in general, the growth was in the agile optical networks, which are things that we have invested in most recently as in the last two years versus things that are legacy products. The real message is that the new items are the ones that are growing and the legacy ones certainly have a slower growth rate. In terms of what we need to work on, I think we gave you a pretty good outline of the gross margin initiatives, and maybe I will let Dave try to cover that.

John, I think I talked in my portion here about the incremental savings we expect to have in the Q4. That does come from the -- primarily from the Optical Comms area. It is gross margin focused. Right now, if you look at the numbers, it would imply that we need to do more than 121 to have breakeven in this space. We're working towards where we move that breakeven number down below the 120, then go to 110 and we will work it from there. So I hope that helps to give you a sense of where we think we can move the breakeven for that business down and that the initiatives in this quarter are focused on the Optical Comms gross margin.

You know, John, if you simply go back and look at the line items that we've talked about, the majority of them fall in two camps. One is, we just need more volume to hit the absorption levels that Dave mentioned. The second -- and we came a good piece of the way this quarter in that. The second is the majority of them are what I would call operational execution. Whether it's lean yield improvement, bill of materials localization, these are all things that happen. The significant step forward was, the gross margin on the amount of upside that we had or growth that we had this quarter, we actually flowed through a fair amount of margin dollars, a disproportionate amount of margin dollars, so that was a positive. And secondly, we have migrated to two out of three of our businesses now in this above 25% range. So we have actually seen progress in terms of doing what we told you we would do and we're going to keep on those same items that we enumerated.

Paras Bhargava, BMO Capital Markets.

A question on the CommTest business. How much of the growth, Kevin, was organic, and how much of it was due to the two acquisitions you had in the year?

You know, if you were to take the yearly run rates of the acquisitions, certainly you'd probably be less than 15 million and more than 5. And Dave, you can correct if I'm wrong, but I think it's roughly the yearly number. So a majority of the growth throughout the CommTest has come from organic activity.

It's relatively torrid growth, given -- I think the 5% to 8% number you're talking about is a pretty good number. Where are you gaining share in that business?

Let me answer a different question or give you another dimension to it, and then I'll answer your specific question. You have to recall that fiscal Q1 of last year, we actually had what we felt was as aberrantly low fiscal Q1. A number of -- and probably on the order of 10 million-ish, plus or minus a little bit. And part of it was, is bookings just came in late and we had trouble converting them. And at the same time, we were doing an Oracle implementation that had an impact on the conversion from bookings to revenue as well. So, part of the torrid is just the fact that we were very open that we had execution challenges one year ago. So if you take that into account and the fact that we had a few acquisitions, we still had excellent organic growth, but it's less torrid I guess.

In terms of where we're taking share, I think we've been doing a fairly good job on the field service side. We have had a number of great product ramps, the MTS 8000. And it has actually been in all geographical domains, as we've talked about on the last two calls.

On the protocol there, or the physical side?

Both. I would say we had a resurgence at an optical layer and we have had a lot of success in the cable arena. I think we have mentioned that several times. And then lastly, VoIP as well as video testing, we've done well in.

And I guess you're saying, you're only going to grow 2 or 3% faster. Is that just caution, or do you think the share gain is sort of -- there's a limit to how much share you can gain?

Well, make no mistake, we have been blessed in the success that we have had in cable. So I think there's a practicality that not all carrier franchises go through these hyper growth periods for a protracted period of time. So I think all we're simply stating is, absent some particular sector that grows in a hyper way, we are going to be executing a little bit better than the industry average. And so call it cautious or just a pragmatic way of benchmarking ourselves.

Cobb Sadler, Deutsche Bank.

I just had one quick clarification. The near-term model, the 2% to 5% operating margin, you indicated you hit that by the end of the year. That is calendar or fiscal year?

Calendar.

So right now, you're roughly at 2.2% operating margin, and I know -- it sounds like you had some one-off better then unsustainable upside in a couple of your businesses for the quarter. So literally, we should be looking at kind of flat to modestly up operating margins between now and in December, or have you given some conservative guidance there? Thanks a lot.

Our point there was just to say that the Company has taken the next step in being in what I will call a sustainable model. If you look at the number we had here, the operating expenses were not within that model. So we had two of the three items inside the model. We now need to get the operating expenses inside the model. So the important part here is that you understand the envelope in which we will work. Mix within a segment and mix between a segment can impact how those gross margins fluctuate, and therefore, the operating income. (MULTIPLE SPEAKERS). You are reading it correct that while we got inside the envelope, we would feel it appropriate to wait until we've repeated that performance before we began to think that we had something sustainable.

Okay, so we just look at it as basically unchanged guidance for now. Sounds good. Asia was down a little bit quarter-over-quarter. I know that's kind of a volatile business, but that is -- no major market share losses there, or is it just quarter to quarter fluctuations or market share losses there, I guess is the question.

No market share losses we're aware of. Year-over-year, it's up roughly 10%. So no real issues there. It just becomes buying patterns more than anything.

And the last question. On the Picolight acquisition, do you plan on using most of the VCSELs there internally, or are you continuing to sell them to Picolight's existing customers? What are you planning on doing with your capacity there? Thanks a lot.

Cobb, we will continue to have a merchant business and sell light sources, whether they be VCSELs from Picolight, or frankly our laser diodes on the telecom side outside as well as using vertically integrated. So, we'll do both.

Dayle Hogg, GMP Securities.

Can you just give us the impact on Picolight in the quarter and last quarter so we can get it normalized, for the Optical business?

You know, we don't really break out those. We did have them only in for one month last quarter. Now, we had them for the full quarter this quarter. When we did the acquisition, we talked about people like on an annual basis had been running at about a $40 million a year revenue run rate. But we don't typically go in and break out the specific performance of our acquisitions.

It would be fair to say that the majority of the growth this quarter from last quarter, and I will say the slight majority, came from organic products.

(inaudible) you assume 10 million this quarter and three last quarter, you get about a 1% sequential up. But I guess my question is more around year-over-year it's about down 19% and I was wondering what your thoughts on the growth for this business for the full year will be.

On Optical Communications or Picolight specifically?

No, Optical Communications Group .

I think it's up, if we execute well, it could be in double digits.

And that's including Picolight?

Sure.

And then just maybe on the Test and Measurement, you said the sort of peak to nadir would be about 1.1 to 1.2, but because you have sort of realigned the quarters, can you give us like a dollar figure what the nadir we should use?

No, I could. At the end of the day, the physics of what makes the uptick is a carrier budget flush in December that was more associated with field service products. This year, if you were to go back, you will probably find that fiscal Q3 and fiscal '07 and fiscal Q1 of '08 were running neck and neck to be the softest quarter. So I think what we are basically coming out with is that we have something that is fairly modulated for three quarters, and then we have an uptick, and that sets a new threshold. So I think that is going to continue. So use the backward looking -- the lowest of the backward-looking quarters as the nadir and we are trying to give you a way of predicting a December quarter, which is a peak.

Ajit Pai, Thomas Weisel Partners.

Two quick questions. The first on would be just in terms of the acquisition. You mentioned that your program over there was still active. Can you just give us some indication as to what kind of acquisitions you're looking at, whether it's more diversifying the business or sort of building critical mass in certain businesses?

That's fair, Ajit. I would say, at the moment, we don't comprehend or have a particular thirst for large, risky acquisitions. I think our focus is on continuing to achieve gross margin improvement and operational improvement in the businesses that we have. If we were to find fortifying acquisitions under each of the business leaders, we would be open to doing those kinds of things. So I would say, we would have a bias towards lower risk more modest than bigger. I think any of the businesses that we have are candidates. I think the easiest area to see the potential for acquisition tends to be in the contest area. That is, the economics are more favorable for consolidation. There's a few large players and a large number of smaller ones. Optical Comms, the profitability hasn't hit yet outside in the largesse of the industry to encourage a prolific M&A, other than if there was a surgical fortification. And I think on the more boutique optics businesses that we have, while there could be things that are desirable and small, getting them to do-ability is a harder thing. So CommTest is probably the most likely place for something to occur, I would suggest on the more modest side in general, and Optical Comms would be a fortifying activity not far different than a Picolight that we just did.

So just looking at the Optical Communications business and the industry structure has been unfavorable for quite awhile and you sort of abstain from being very active in consolidation, other than sort of technology acquisitions. Do you see that landscape changing any time soon? Do you think that the level of consolidation is going to accelerate, and what would be the catalyst for the pricing in that environment to actually improve?

I don't think there's enough consolidation that could occur over an investor's horizon, let's call that three years, to change the pricing dynamics. To be specific about answering your question -- what conditions would change the potential for mergers or acquisitions? I believe that, as each company becomes more profitable and as their portfolios disperse and there's less overlap. Right now, we have a lot of players that try to look like everyone else. As there's less overlap and the gross margins go up, that could encourage more consolidation in that space. But, we're not exactly there yet.

Got it. One question about the tax rate. You're being profitable right now on a GAAP basis, only -- actually, not sustainably so. By at what point, how many quarters ahead would you have to get to before you start switching over to a sort of regular pro forma tax rate and stop taking a reserve against your tax assets?

I think it depends on a number of factors. Where's the profit coming from, or the revenue I should say, is it U.S.-based where we've got a lot of losses, then we start to have to release the valuation reserves. So it's going to be a bit before we see that tax rate go up, because as we get profitable within each country, then we have to release valuation allowances, but then offset the provision. So it's going to be a bit. Tell you what -- every time we have one of the calls, we'll give you a view of where the tax range will be, so that you can start to see it when it starts to be realized. But it really is about quality and where the profits are going to be realized. And the more business I do in the U.S., the less taxes I will pay for awhile.

Right. So when you're assuming a tax rate over the next two to three years, is it fair to sort of take it from the sort of 12% range right now, take it through somewhere in the high teens, all the way up to 30% over three years?

That would seem a little bit steep to me.

Okay. Got it. Thank you so much.

Subu Subrahmanyan, Sanders Morris.

Thank you. I had a question or gross margin first. If you can talk about the offsetting factors which make gross margins potentially go down from the levels this with you had -- I know you mentioned higher AOT margins -- but with higher revenues overall especially in Optical Comm, would that offset it? And then I want to also ask about headcount. Headcount came down about 200. Can you see a benefit of lower headcount and OpEx in the September quarter? Does some of that roll into December?

First of all, in the headcount area, again as I stated, it was mostly in the Optical Comms, and it's mostly a gross margin benefit for us as we have lowered our cost structure in our manufacturing area. So that's the headcount. As far as gross margins go, the key about the product mix is, if you have more Optical Comms business growing, you're going to likely put a weighting, although it's positive as an absolute dollar amount you will have a weighting down on the overall gross profit of the Company. So that's why we make that point that it's very important about the mix of the segment as far as their waiting on the revenue.

And just a follow-up. Your longer-term ranges in terms of operating margins, can you talk about time frames between your near-term range and your longer-term range, and what are some of the things specifically on the gross margin side that need to happen for you to get there?

The things we've talked about before is the fact that each of the groups have gross margin opportunity. In the CommTest area and in the AOT, it's in the single-digit type range. And actually in the last quarter, AOT picked up a couple of those points. So it's very -- it's a few digits. In the Lasers and the Optical Comms area, it's double-digit opportunities still for us. So, we still have a ways to go on both of those segments as far as their gross margins go. And we talked about at the end of calendar '08 being a period where -- not necessarily in the sustainable business, on a sustainable basis, but we should be able to be in the ranges that we talked about for gross margin and for operating income.

Ladies and gentlemen, this concludes our q-and-a session. Thank you for your participation in today's conference. This concludes our presentation and you may now disconnect. Have a good day.