Viavi Solutions Inc (VIAV) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the JDSU fiscal 2008 second quarter earnings conference call. My name is Mikeada, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Ms. Michelle Levine, Director of Investor Relations. Please proceed, ma'am.

Welcome to JDSU's fiscal 2008 second 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 sections of our report on Form 10-Q filed November 11, 2007.

The forward-looking statements, including guidance, provided during this call are valid only as of today's date, February 5, 2008, and JDSU undertakes no obligation to update these statement as we move through quarter.

Please note that all numbers are non-GAAP unless otherwise stated. A detailed reconciliation of these non-GAAP 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 turn the call over to Kevin.

Good afternoon. JDSU has made continued progress on numerous fronts this quarter, including our fundamental financial metrics, innovation, and strategic advances. Highlights for JDSU's fiscal second quarter 2008 non-GAAP results include a book to bill for the Company as a whole greater than 1, with three out of four business segments having a book to bill greater than 1. Revenue of $399.2 million, growth of almost 12% from fiscal Q1 of 2008, 9% from Q2 fiscal 2007, and 10.5% growth for the first half of fiscal 2008 compared to the first half of fiscal 2007.

All of four business segments saw revenue growth and improved gross margins quarter over quarter. Gross margins of 46.3%, an improvement of 5 percentage points compared with 41.3% last quarter, and almost 6 percentage points above the 40.6% posted one year ago. Gross margins benefited from favorable segment mix with Test and Measurement representing 49% of the business, Optical Communications 33%, Advanced Optical Technologies 12%, and Lasers 6%.

JDSU's adjusted EBITDA as a percentage of revenue was 15.5%, up from 6.6% in Q1 '08 and 9.3% from one year ago. The Company was free cash flow positive for the fourth quarter in a row. Free cash flow reached 10% of revenue, and balance sheet metrics continued to improve as reflected in our inventory levels and debt balance. Operating margins were 11.4% compared with 2.2% last quarter, a level associated with our long-term operating margin goal of greater than 10%. Last but not least, the Company delivered GAAP net earnings per share of $0.09 for fiscal Q2 '08.

To summarize, in fiscal Q2 we saw across the board financial metric improvement with some overachievement due to seasonality. The Company successfully demonstrated the near-term operating model goals and evidenced progress towards the longer-term projects.

As I move to the results, before discussing the segment reports, I would like to reiterate that our strategy continues to be to execute as a Company comprised of a portfolio of businesses with a focus on optical and broadband innovation. We embrace this view such that the composite Company will be better able to navigate fluctuations in any one constituent business. Dave's results provide continued evidence and support of this strategy.

In the most recent quarter we continued 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.

With that I will now provide more detail on the business segments. First, Communications Test and Measurement. During fiscal Q2 we made a small adjustment within the business and moved our WaveReady product from the Optical Communications segment to our Communications Test and Measurement segment in order to better align the product with our end markets. The revenue from this product for Q1 and Q2 was approximately $4 million to $5 million per quarter.

The financial metrics I will discuss are inclusive of this change, unless otherwise noted. Our second quarter fiscal '08 CommTest revenue was, as adjusted for the WaveReady product, was $198 million, up 14% as compared to the prior quarter. We experienced December quarter seasonality and strong December book and ship demand. We expect that the 15% sequential growth will translate to market share gain in our addressable market.

Our CommTest business is broken down into three principal product business units, field services, lab and production, and service assurance. For fiscal Q2 we saw strong growth across all three business units on a sequential basis. Year-over-year we saw particular strength in lab and production.

The DSAM, the triple play installation and maintenance handheld instrument for cable field technicians, achieved the 50,000 units shipped milestone during the quarter. Other field service instruments, such as the HST, or triple play handheld for telecom technicians, and the T-BERD 6000/8000 platforms continued to also enjoy strong adoption worldwide.

From a geographic perspective we saw strength in all regional markets. Our revenue in this segment was approximately 50% North America, and 50% the combination of EMEA, Asia and Latin America.

Finally, gross margins saw improvement in Q2 when compared with last quarter, mainly due to favorable product mix and higher volumes, which resulted in an improved absorption of overhead.

Highlights of the quarter are as follows. First, relative to innovation. During the quarter we introduced a series of fiber-optic network test innovations, including a first of its kind OTDR test solution for short and medium haul CWDM network applications, and the first handheld tunable laser source for ROADM DWDM network deployment.

JDSU also introduced a specially designed service assurance solution in advance of the Olympics in Beijing. This new offering allows wireless operators to test service performance at multiple Olympic venues in China months before hundreds of wireless subscribers travel to the games in Beijing next summer.

Relative to customer traction, a large European operator has elected JDSU to provide monitoring and troubleshooting test solutions for its IPTV service. JDSU's NetComplete service assurance system, including IP test probe, will be deployed in more than 80 points of presence across this network.

Lastly, relative to acquisitions on January 7 we acquired the fiber test division of Westover Scientific, a leading provider of proactive fiber inspection test solutions for service providers, equipment manufacturers and premise wiring technicians. The products are designed to proactively inspect fiber-optic connectors, with when contaminated are the number one source for faults in fiber network deployments. The acquisition strengthens JDSU's portfolio and leadership of test solutions in fiber-optic networks.

We remain focused on improving our product portfolio and cost structure to deliver gross margins for this segment in the 57 to 61% range on a sustainable basis at current revenue levels.

Fiscal Q2 gross margins were above the midpoint of this range. As previously discussed, the areas of focus to improve gross margins include the following. Product mix is primary and has two areas of focus. The first is increasing the mix of sales of our organic products, while reducing the mix of products that we simply resell. We believe further gross margin improvements will be achieved by increasing our focus on value engineering, and lowering the cost structure of our supply chain. We believe these activities will improve our overall gross margins and the segment's cash flow.

Next, Optical Communications. Optical Communications total revenue was $129.7 million in the second fiscal quarter, compared to recorded revenue of $116 million in the first quarter of fiscal 2008, which represents almost 12% sequential growth. All three business units in our Optical Communications segment saw sequential growth, with particular strength in our agile optical network unit which includes our ROADM products.

From a customer perspective we increased our revenue at eight out of nine of our top customers in fiscal Q2. We saw booking strength in fiscal Q2 as total bookings increased from the first quarter level. This is the third second quarter of increased bookings.

We saw an improvement in gross margins relative to the last quarter. Also, in fiscal Q2 two out of the three of these business units had gross margins that were greater than 28%, up from last quarter's level. The primary drivers for the gross margin improvements were inventory management, improved factory absorption due to higher utilization, and improved material costs. Other factors contributing to improved gross margins include benefits from transfers to low-cost centers, as well as favorable product mix. For the first time in over a year the segment achieved a positive operating margin of 7.6% for the quarter.

In November we held an Optical Communications virtual analyst presentation. During the presentation, David Gudmundson, President of our Optical Communications segment outlined three strategic principles of the group. I will now provide additional commentary on the segment's performance and strategy under these three categories.

First, technology leadership as it relates to transport transmission of photonics. For transport JDSU's holds the market leadership position in ROADM technology. For fiscal Q2 JDSU's ROADM unit growth was 39% compared with fiscal Q1, as we continue to lead this market. According to industry analysts, the ROADM market is expected to grow from 2006 to 2009 at a cumulative average growth rate of 33%, essentially growing faster than the optical communications overall growth rate.

We hit a new milestone in Q2 as we shipped approximately 2,500 ROADMs in Q2, the highest amount since we began shipping the products. And we saw healthy sequential bookings for ROADMs for Q2.

Next in terms of transmission, our next generation 8 G and 10 G SFP Plus products continue to gain momentum. In Q2 we saw strong customer acceptance and traction. Most notable we expanded our reach to a leading next generation service provider. We currently expect total shipments of these products to reach over 100,000 units by the end of fiscal Q3.

Also in the 10 G market we experienced 32% sequential growth for transceivers and transponders. Our partnership with Mintera proceeds to leverage Mintera's core competency in 40 G transmission and JDSU's 40 G transport and lean manufacturing.

Finally relative to photonics, last quarter we announced at the ILMZ, 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. In Q2 we announced that the new 10 G tunable TOSA, or 10 G transmitter optical subassembly, which is the smallest tunable optical transmitter in the industry. This TOSA uses our ILMZ photonic integrated circuits that functionally integrates a tunable laser and modulator into a chip that can fit on the tip of your finger. We believe a more compact and integrated approach toward tunable lasers is critical, as service providers strive for greater efficiency in their network, as well as the ability to provide more wavelengths.

Finally, last week we announced an Avalanche Photo Detector, APD, chip designed for GPON networks that enable data transmission for fiber to the home. The new chip provides high functionality at a low cost, making it attractive for fiber to the home deployments.

The second strategic principle for Optical Communications is cost leadership. We have a number of initiatives in place to drive cost leadership, including lean manufacturing, vertical integration, and Asia manufacturing. JDSU is implementing our own lean manufacturing initiatives to have a strategic interlock with our customers. The result is a more integrated partnership with our customers over time. For JDSU our lean manufacturing initiatives have begun to, and are expected to continue to result in improved production cycles, lower manufacturing overhead and labor, variance reductions, inventory reductions, and building material localization.

Finally relative to functional integration, as discussed earlier we have recently announced two new products that are functionally integrated, the ILMZ PIC and the new TOSA. We expect me moving forward with this as a key strategic principle with our future roadmaps and platforms. We expect that these three strategic initiatives when fully implemented will enable the Optical Communications business to achieve and sustain the following business model targets, near-term 20 to 30% gross margins, 5 to 15% operating income. We believe the above initiatives move the segment to the higher end of the gross margin range.

Moving on to our Advanced Optical Technologies segment, fiscal Q2 revenue for AOT was approximately $50 million, representing growth of 3.8% compared to the first quarter of fiscal 2008, and up 23% compared to the second quarter of 2007. This quarter AOT generated operating income of approximately 40%, 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, we expect the trend of this business to have some level of surges and ebbs.

During the quarter we announced the acquisition of American Bank Note and Holograms (sic - see press release), ABNH. The acquisition represents a significant milestone for the AOT business segment. It fortifies our overt and covert security product portfolio by enhancing our defractive optics and magnetic technologies, including holograms for security applications, along with related manufacturing and marketing expertise, and a leading position in the transaction card market.

JDSU already produces high-performance color chips (technical difficulty) inks and labels, and optical additives for security. These pigments can be found on currency notes of over 100 countries. As the market continues to shift toward security solutions, we believe we are well-positioned for this market shift.

As stated at the time of the announcement, we expect the acquisition to close no later than the end of fiscal Q3, and that it will be accretive to non-GAAP earnings.

In Commercial Lasers, the second quarter of fiscal 2008 revenue was $22.2 million, up by 12% from $19.9 million in the first fiscal quarter of 2008, and down 12% compared with the second quarter of fiscal year 2007. This business continues to be impacted by lower demand from the semiconductor manufacturing customers.

We are encouraged by bookings in the quarter. We saw double-digit sequential growth compared with last quarter. The increase in bookings is associated with new customers in Asian and Europe.

We saw a significant improvement in gross margins in fiscal Q2 compared with fiscal Q1 due to inventory and scrap reductions, improvements in productivity and direct materials costs, as well as increases in gas laser pricing. 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, our engagements with biomedical and material processing customers continue to be strong and growing.

Focusing on our laser platform gross margin expansion initiatives we note the following. We believe that gross margin upside will come from increasing solid-state laser volumes in concert with lean manufacturing initiatives, now focused on increasing productivity, reducing scrap, driving inventory turns up and our supply chain costs down. We believe these initiatives once fully implemented will result in double-digit margin improvement.

Now let me turn to Company advancements. I would also like to highlight Company advancements that have taken place since our last earnings report. At the end of November a jury ruled unanimously in favor of the Company on all counts in a six-year-old securities class-action lawsuit filed by Connecticut Retirement Plans and Trust Funds against the Company. This was an important outcome for JDSU, and we view it as a significant step towards putting in the past legacy risks, and allowing us to fully focus our attention on the business. We're extremely gratified by the jury's verdict, as we have always believed that the plaintiffs claims were without merit. While final judgment has not yet been entered, and there are related cases still pending, we hope that we will be able to successfully resolve all such matters.

As we entered into the calendar year we announced two acquisitions, ABNH, and Westover Scientific. They both fortify the portfolios of the business segments and are consistent with our financial model of a double-digit EBITDA over revenue ratio. We expect non-GAAP EPS to be accretive for both acquisitions.

JDSU has achieved a six-year high relative to our overall business model advancements in free cash flow. We begin calendar '08 substantiating the efficacy of our long term business model with the objective of long-term sustainability.

As I move to the summary, as described on our last call, fiscal year 2008 will be a year in which JDSU intends to advance its business model, as each business within the portfolio expects to continue to improve individual operating results. There's a strong focus on gross margin and cash flow improvement in all operating segments. At the same time, we will continue to seek opportunities to strategically expand our product portfolio through partnership and acquisition.

The Company's successfully executed against its goals in the first half of fiscal 2008. We have achieved our near-term goals of gross margins of approximately 40% or greater, operating expenses in the range of 35 to 38%, and operating margins in the range of 2 to 5%. We are now moving towards achieving our long-term model of sustainable gross margins in the range of 43 to 47%, and operating margins at or above 10%.

While these metrics were actually achieved this quarter, we expect to generally operate to these targets by the end of calendar '08. Nevertheless, the efficacy of the model was substantiated this quarter. Over time we will evaluate the potential for operating at a more aggressive model.

I want to note that while the current health of U.S. economic environment is uncertain, our customers have communicated a continued focus to support capacity and deployment requirements. That said, we will judiciously keep a pulse of customer activity and sentiment as we proceed through the calendar of 2008.

Finally, I would like to thank JDSU's employees, whose continued commitment and incredible efforts made these results possible. With that, I will hand the call over to Dave.

Before I start, please note that all numbers are non-GAAP unless I state otherwise. Second quarter revenue of $399.2 million was up 11.8% from the first quarter. We experienced typical December seasonality during the quarter in the CommTest segment, and saw sequential revenue growth in all four segments.

Second quarter gross profit of $185 million or 46.3% of revenue was up from the previous quarter's 41.3%. We saw improved gross margins in all four of our business segments, primarily due to favorable product mix and the impact of our gross margin initiatives, which resulted in improved factory utilizations and lower manufacturing variances.

Operating expense for the quarter was $139.4 million, or 34.9% of revenue, which is slightly lower than the previous quarter's $139.6 million, or 39.1% of revenue. Our operating expenses for the second quarter benefited from a number of factors, which included seasonally lower fringe rates, lower vacation accruals, and the impact of the holiday shutdown. All of the segments benefited from these factors. In addition, the Optical Communications segment benefited from an increase in customer funding for non-recurring engineering.

These items taken as a whole reduced the total operating expenses for the quarter by slightly more than 1% of revenue. The higher revenue, improved gross margins, and lower operating expenses resulted in increased operating income and net income. Operating income increased to $45.6 million or 11.4% of revenue versus an operating income of $7.8 million or 2.2% of revenue in the prior quarter. Net income increased to $50.2 million or $0.22 per share versus $18 million or $0.08 per share for the previous quarter.

Adjusted EBITDA in the second quarter was $62.3 million or 15.6% of revenue, which compares to adjusted EBITDA of $23.7 million or 6.6% of revenue in the prior quarter. A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. Our second quarter non-GAAP results excludes, among other items, amortization of acquired technology and intangibles of $19.4 million and a $14.5 million charge related to stock-based compensation. Including these items, quarterly GAAP net income was $21.2 million or $0.09 per share compared with a loss of $6.9 million or a loss of $0.03 per share last quarter.

Moving to the segments. In the CommTest segment, second quarter revenues of $197.5 million was up 14% from the prior quarter as we experienced December quarter seasonality, as well as favorable impact from sales denominated in foreign currencies. The segment's operating profit increased to $49 million or 24.8% of revenues versus $26.8 million or 15.5% of revenue in the prior quarter, primarily due to higher revenue and improved gross margins. The improved gross margins were the result of favorable mix within the segment, improved factory utilizations due to the higher volumes, and a favorable net impact from foreign exchange rates.

In the Optical Communications segment revenue of $129.7 million was up 11.8% when compared to the prior quarter, as we saw sequential growth in each of our three business units. The segment achieved operating profit of $9.9 million or 7.6% of revenue, an improvement from a loss of $3.3 million or negative 2.8% of revenue in the prior quarter.

The operating profit resulted from higher revenues, gross margins and lower operating expenses. The higher gross margins were due to favorable product mix and the impact from our cost reduction initiatives, which resulted in improved factory utilizations and lower manufacturing variances. The lower operating expenses were also due to our cost reduction initiatives and due to higher than usual customer funded non-recurring engineering.

Our Advance Optical Technologies, or AOT segment's quarterly revenue was $49.8 million, up 3.8% from the prior quarter. AOT operating profit for the quarter was $20.1 million or 40.4% of revenue, compared with $18.3 million or 38.1% 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 second quarter revenue of $22.2 million increased 11.6% from the prior quarter. Lasers had an operating loss of $300,000, an improvement from last quarter's operating loss of $2.5 million, primarily due to improved gross margins.

Now looking at revenue by region. During the year the geographical dispersion of our revenues remained balanced. In the second quarter of fiscal 2008 the Americas contributed 53% of revenues, EMEA 28%, and Asia-Pacific 19%. Geographic dispersion remained relatively unchanged compared to the prior quarter.

Moving to the balance sheet. For the fourth quarter in a row the Company was free cash flow positive, generating just over $40 million due to improved operating results. We have now increased our net cash balance to approximately $445 million, representing a $117 million increase from a year ago. Total cash, cash equivalents and short-term investments and restricted cash totaled $1.1 billion.

Finally, the zero coupon bonds have put call provisions effective November 2008, therefore the balance outstanding is now classified as a current liability on our balance sheet.

Headcount as of December 29, 2007 was 6,509, up from 6,459 last quarter. On an annualized basis our revenue per headcount improved to $245,000, up from $221,000 last quarter.

While our markets are generally favorable, we remain focused on improving our operating model on a sustainable basis. Our long-term operating model targets at the current revenue levels are gross margin of approximately 43 to 47%, operating expense of 35% or less, and operating margin of 10% or greater. The results for this quarter show that we can execute in these ranges. At the same time we will continue to focus on the segment gross margins as we still see opportunity to improve. We expect that these improvements will reduce the impact of segment mix on our operating margins.

With these gross margin improvements and at the current revenue levels, we believe we can sustainably execute at our long-term operating models by the end of the 2008 calendar year.

Now looking forward. Some points to consider as you think about our financial performance over the coming quarters. We continue to have low visibility into the current quarter's demand for the CommTest segment due to the budget release cycle that is typical with the carriers as they begin their new fiscal year. Due to different gross margin targets for each of our segments, we expect that the product mix in Q3 2008 will result in lower overall gross margins when compared to our Q2 level.

Q3 operating expenses are expected to increase due to the nearly full quarter impact from the Westover Scientific acquisition, lower non-recurring engineering funding, and higher fringe and benefit costs. Additionally, we have just commenced on a multiquarter project to upgrade to a more current release of our Oracle ERP. This project is expected to be completed by the end of the calendar year at a cost of $25 million to $35 million, with approximately 50% of the cost being expensed as incurred. We expect our quarterly tax provisions to range between $3 million and $5 million.

Now to our financial guidance for the third quarter. Please note the guidance is not include revenue from ABNH acquisition which has not yet closed. Taking into consideration the factors above, and based on our current visibility, we expect third quarter revenue to be in the range of $380 million to $402 million, and non-GAAP operating margin to be in the 4 to 7% range.

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

(OPERATOR INSTRUCTIONS). Ehud Gelblum, JP Morgan.

It is hard to just take one question. In that case, why don't I say that you -- I think, Kevin, you had mentioned that you had taken share on the ROADM side, and the optical components business obviously was very strong -- relatively fairly strong. It has bounced back again for the last two quarters. Can you go into some detail on the shares where you think you have picked up share in optical components? Give a little bit more color on that and where you are seeing competition.

If I can get a clarification, Dave, on some of the numbers. Can you parse out some revenues from some of the acquisitions, and how much revenue this quarter and how much revenue in your guidance next quarter came from inorganic growth?

I will give it a shot. I didn't make any comments on shares. What I did try to highlight was where we felt we had significant strength for quarter over quarter growth. And you are correct, ROADM was one of the areas that we had very strong quarter on quarter growth. Some of our transmission modules, another place where we had strong quarter on quarter growth. There were only two or three that I cited in the script as particularly strong. Probably the only other important fact was that we grew revenues in 8 of 9 Tier 1 or Tier1/Tier 2 customers, so it was fairly broadly based.

I thought you said that when -- I'm sorry, I thought you said that when the quarter is over and you will be looking back at it, you thought you grew faster than the market.

That was a comment that we made relative to the CommTest results.

I understand. (technical difficulty).

In the guidance for Westover we talked previously when we did the acquisition that revenue from Westover is about $16 million per year. That is what we contemplated in our guidance. It is on roughly that annual runrate.

Todd Koffman, Raymond James.

Just a clarification. I thought I heard you say that your book to bill was greater than 1 in three out of your four segments. I just want to get clarification that the segment that it was below 1 was the Test and Measurement, or is that not accurate?

That is accurate, and that is normal for that particular quarter because we have such a high amount of turns in the end of the quarter.

Can I just get a quick follow-up to that? Some of your competitors in the Optical Communications segment have talked about visibility being very limited. With that segment seeing a good book to bill, you have seen fairly decent visibility, or what is your thinking on the Optical Communications segment?

I think we have sent the message that in general we have not particularly great visibility across the Company in Optical Comms and Test and Measurement. That will be true. I would say our interlock process on one hand is giving us better conversations. On the other hand, as you lean your system out, you tend to have less visibility, plus you can turn at a higher rate. So I would say our visibility continues to be measured in weeks, not quarters. And that is really where we are.

John Harmon, Needham & Company.

You talked about mix being favorable in your Optical Components segment. I was wondering if you could maybe sketch out which couple of productlines that might have contributed? And just also talk about was the high level of profitability in this segment -- congratulations to those involved with it -- was it a fluke or is it pretty sustainable from now on?

Try me again. We didn't hear the opening part, so if you can just repeat it.

I'm sorry. Which products have higher margins that help to contribute to the profitability of your Optical Components segment, and how sustainable is it looking ahead?

I would say we mentioned that there are two business units in particular that are at this 28% and above. As you know from prior calls, the IP photonics piece has always been one of the best performing in terms of gross margin. And clearly our growth in ROADMs didn't hurt us. You should assume that our switching products are good. But that is the only detail we gave in terms of gross margin. Now you had a second part of the question that might have been for Dave.

Yes. How sustainable is this profitability, was it -- did the stars line up right or are you in a much better place and more likely to be profitable now?

Let me try to -- I think the gross margin structures of the business units are trending in a favorable light. We have been working hard to raise them. So (technical difficulty) kind of thing is sustainable, and in fact we continue to improve. I think we had a significant growth, and we ran very high on all of our factories, so that level of it gave us a little bit of overachievement. I think Dave has tried to identify for you where we think we will be in the next quarter or two by giving you an operating margin range. But that we will actually be sustainable at these kind of levels by the end of calendar '08.

Paras Bhargava, BMO Capital Markets.

The first time I have said this in years, Kevin, congratulations. That was well done this quarter. I have been covering this Company for a long time. Those are the best results I have seen.

Now just more on the last question in terms of sustainability. You have guided relatively cautiously for the last couple of years. How do you see the market, the end demand? We had an inventory cycle last year, what are you seeing in terms of end demand, because I know one of the things that drove this quarter had to be operating leverage?

A couple of thoughts, one is that the results are positioned to continue to improve as topline improves. We were asked once before was there a magic number to get to in order to achieve a fairly healthy operating margin leverage, and we had put the number out at 400 and we came amazingly close to that number. You should hold that thought that we had comprehended that that was an important place to get, and in fact the results followed suit.

Relative to the market demand, I would say we've read the papers and things just as everyone else does, so I would say we are proactively probing any potential softness. I have not seen any trend as such. And in fact, my greatest fear is what I don't know. The bad news is we don't have a lot of visibility so we could be the last to know. But bottom line is I felt that the growth in eight out of nine top customers on Optical Comms was a very positive outcome. And I thought the CommTest numbers were positive. So bottom line is I'm not a good bellwether for the future, and we are sensing it, but we haven't sensed a negative trend at this point.

Can I have a follow-up with David? David, in terms of the tax, at some point when you get sustainably profitable, I think you would need a year of sustainable GAAP profitability, you'll have to take, I think it is $2.8 billion of deferred tax assets and put them on your balance sheet, and then start fully taxing. Do you have any expectation on when that will happen?

Actually we did a detailed review with our auditors on that, and they said it is typically a 12 quarter -- sequentially 12 quarters of GAAP profitability, especially given our history, that you have to show that you are -- have turned the corner and you are predictably profitable, as much as that goes. It is more than a year. I think you have asked this before. We do see companies come out faster when it is usually they're going negative because of more business cycles than what we've had here. Right now it is about, I have to show about 12 quarters of in a row of sequential.

That is very helpful, Dave. Thanks.

Jeff Evenson, Sanford Bernstein.

Could you quantify the aggregate benefits of currency impact on both revenue and pro forma earnings for us?

On the revenue, side it was mid single digit millions, and from the bottom line it was low single digit millions.

Subu Subrahmanyan, Sanders Morris.

My question was on gross margin and operating expense trends. It sounds like we should see some sequential decline in gross margin. And the operating expense you said was positively impacted by about 1 percentage point. So given the addition of Westover and what is going on with the other things, should we expect kind of like a $5 million operating expense increase? And then on the gross margin side, other than just mix what else could make it come down from that 46% level?

First on the OpEx side, as I noted, the onetime benefits that we got were -- represented about 1% of revenue. You can do that calculus. The Westover, we talked about it's basically low single digit millions of OpEx per quarter. Those are the two main items. Plus I did note that we will be starting this project on our Oracle ERP, going to the next release, and so that will cause a little money also. That is low single digit millions.

From a gross margin standpoint, it was mix within the segments and mix between the segments that helped favorably on the gross margin. And obviously on the CommTest side, which has target gross margins of 57 to 61, and we were at the higher end of that range, you can see how that helps in the overall gross margin. And that is because of that -- the budget flush activity we see, the high turns. So those factors we believe will result in the margins coming down. Plus the factories ran very well during the period at that revenue level. And the range right now has -- the midpoint of that range would have a revenue level that somebody might have as slightly lower.

Got it. Just to follow-up on the operating margin ramp, from the 4 to 7% you were expecting in March to a sustainable 10% or higher by the end of the year, would you expect that to be a fairly linear one? And, Kevin, 10% or higher, what could higher be especially since the turns rate doesn't seem that long term since we will achieve it in the next three or four quarters?

I think as far as linear, we're just going to call it one quarter at a time, as we see it. We will communicate with you that type of a range. I will let David answer the --.

I don't think we're going to get ourselves to the -- this greater than 14% that we represented on an EBITDA scale first, before we try to up the range. So I would say it was existence proof that we could -- at 400 we would have the portfolio and the leverage and the opportunities for improvement to get there sustainably. But I want to wait until we get to the end of the calendar year before I try to advance the model beyond that.

Ajit Pai, Thomas Weisel Partners.

This is [Spenay Mahn] dialing in for Ajit. I have a couple of quick questions. The first one has to do with mix within the Communications Test side. Could you tell us which of the businesses are -- field test versus lab solutions versus service assurance grew fastest on Q-over-Q and year-over-year basis?

I don't have the breakdown. Let me first level set you that the significant biggest piece of the business by far is the field service piece of the business. And secondly, we had given some notes that year-over-year the lab and production grew the most in terms of quarter over quarter, I don't know that we broke it out. I hope that helps.

The second question I had was there was in the quarter you mentioned there was a customer, I guess customer funded nonrecurring engineering that impacted optical segment margins. How big was that impact?

What happens is our customers will, and usually it is also has -- related to do with their budget, will fund us to expedite some engineering spending. And so that is what that funding is all about. It was part of a number of items I listed that totaled about 1% of our revenue.

Sam Dubinsky, Oppenheimer.

Good quarter. Just a couple of quick questions. Number one, what was the operating margins of the optics business, if you exclude the NREs? And also I believe you reclassified some revenue from the optics segment to a different segment, if I heard correctly earlier in the call?

Yes. We moved about $4 million to $5 million, it was a runrate of revenue out of the Optical Comm segment into the Test and Measurements segment. That was the WaveReady. That product is sold more directly to carriers versus the Optical Comm products are sold more directly to the network equipment manufacturers. We didn't actually break out the amount of the NRE, we just noted that it was a factor in their margins and that they also benefited from the lower vacation and fringe stuff also. We didn't actually break it out that specifically.

If you exclude these factors, or you put them -- if you exclude them, was the business still profitable?

Yes.

Then my question number two is, it seems like there has been some consolidation in this space recently with the OCP getting bought out by Oplink, and Intel selling its transmission business, its telecom-related optics to Emcore. Are you guys seeing any share gains due to this consolidation in the near term? Do you see any increased activity in any of these markets? And then I have a follow-up question.

I would say it is too early to say that we've seen any share gains in either direction. So why don't you hit us with your follow-up question.

On the market for SFP Plus, can you just talk about how that is developing, particularly from a pricing perspective and a margin perspective?

I'm trying to think. Right now it is early in the race. Those people that are winning are people who have something that works and can ship on a very quick basis. So within that, I think we anticipate there could be aggressive pricing in the future, but right now it is about who has the product to deliver to the people who can deploy it today. I think that is the basis of competition.

Paras Bhargava, BMO Capital Markets.

This is a question on the cable segment within CommTest. That is the segment that really drove the very, very high margin growth last year, as I recall. How is that segment doing? And have we sort of hit a point where the year-over-year growth of CommTest has to come back -- regress back to the mean?

You have asked several questions there.

Answer whenever you can.

Let me see what I can break up. I think I say if we were to look at sales of our products in North America, it would be true that we probably have one significant cable customer that we are evidencing softer sales to than we would have a year ago.

That being said, we have sufficient growth -- and this has sort of been a theme for about three quarters -- that we have had fairly strong business in Europe and Asia. And so if we didn't have those other factors that one customer would have disproportionately challenged us. I would say we had strength this quarter. Of course, we did have a very balanced growth. And so I think the answer to your question is the specter of the future more positive or negative I think will be dependent upon how a small number of customers actually buy. The one that you are -- that I'm thinking of hasn't slowed us down yet, but if that became a trend it could.

But are we going to see more normal -- I mean, the test market is probably growing around 10% at best. I think you had said even lower numbers. But say it is growing at 10%. You have been growing at a significantly higher than that. What I'm just asking simply is are the dynamics going to bring you closer to the industry growth rate now?

I think we had a phenomenal four or six quarters. Growing at 25, 30% year-over-year is not something that I think is sustainable. There is a second challenge, which is the growth rates of the test market are highly fragmented. So you see wireless test went very negative for a period of time while broadband happened to be very positive. We happened to be the benefactor of being wholly in broadband and not during wireless.

Do I think the norm of our serviceable markets are in the single digit range? I do going forward. And do I think that we can outpace by a couple of points? I probably believe that we can outpace. So do I think we will be at 30% again over the long haul? No. But do I think this can be a healthy growth business? The answer is yes. Hopefully that helps you.

There are no further questions at this time sir.

Thank you, operator. This concludes our call.

Thank you for your participation in today's conference. You may now disconnect. Have a great day.