Viavi Solutions Inc (VIAV) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the JDSU fiscal 2008 third quarter earnings conference call. My name is Karen 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.

Welcome to the JDSU fiscal 2003 third 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-Q filed February 7, 2008.

The forward-looking statements, including guidance provided during this call, are valid only as of today's date, April 30, 2008. And JDSU undertakes no obligation to update these statements as we move through the 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 limitation, 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 in 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's fiscal Q3 results reflect continued year-over-year momentum improving our financial model, as well as evidence of the need for further work ahead to operate within the desired sustainable long-term financial targets. A summary of JDSU's fiscal third quarter 2008 non-GAAP results are as follows.

Revenues for fiscal Q3 were $384.2 million. And that is the lower end of our stated guidance range, mainly due to the impact of several large customers slowing purchases in the Test and Measurement segment. The decline in revenue consequently resulted in operating margins at the low end of our guidance at 4.1%.

On a sequential basis this seasonal decline in revenue was 3.8% for the Company. On a year-over-year basis revenues for fiscal Q3 2008 grew 6.2% when compared to fiscal Q3 2007.

Year-to-date fiscal 2008 revenues of $1.14 billion have grown 9% compared to the same period in fiscal 2007. Test and Measurement represented 44% of total revenues, Optical Communications 35%, Advanced Optical Technologies 15%, and Lasers 6%. Gross margins for the quarter were 42.6%, down from 46.3% in fiscal Q2, and up from 37.6% in fiscal Q3 '07. The sequential decline is mainly due to the mix between the segments and the product mix within the segments.

Year-over-year all of four businesses improved their gross margins. Operating margins for the quarter of 4.1% was up from less than 1% for the year ago period. All four business segments saw positive operating margins this quarter.

JDSU's adjusted EBITDA as a percentage of revenue was a 8.4% compared to 4.9% for the year ago period. The Company delivered non-GAAP net earnings per share of $0.14 for fiscal Q3 '08, more than double that in fiscal Q3 '07 at $0.06.

The Company was free cash flow positive for the fifth quarter in a row at a approximately $31 million, or slightly more than 8% of revenue. Balance sheet metrics continued to improve as reflected in our inventory levels and debt balance.

Book-to-bill for the Company as a whole was greater than 1. Three out of four business segments had a book-to-bill at 1 or greater. Slightly less than 50% of total revenues came from North America, showing strong geographic diversity.

To summarize, year-over-year results evidenced execution against the plan to achieve the previously discussed long-term financial model. The efficacy of the model was substantiated in fiscal Q2 where we saw some overachievement due to seasonality. In fiscal Q3 we continued to make progress towards realizing our long-term model goals on a sustainable basis.

Moving to 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. Today's results provide continued evidence in support of this strategy.

In fiscal Q3 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 delivered to the access edge, accompanied by video applications and high-definition network requirements.

Now I will provide more detail on the business segments. First, Communications Test and Measurement. Our third quarter fiscal 2008 Test and Measurement revenue, including revenue from the Westover Scientific acquisition, was $169.3 million, down 14% sequentially as compared to the seasonally strong fiscal Q2. Book-to-bill was greater than 1 for the quarter. Year-over-year revenues were relatively flat with only 1.1% growth.

Revenues and bookings in fiscal Q3 were lower than expected, as we saw a small number of North America and European service providers in wireline and cable markets delay certain product purchases to future quarters. Over the past two years the deal size in Test and Measurement has grown. Historically the centroid of deal size was measured in the range of several hundred thousand dollars per deal, accompanied by several million dollar deals. In the most recent quarter we pursued many deals in the single digit million dollar range.

While the advent of this trend, that is the increase in deal size generally and the number of larger deals more specifically, is a positive for the business potential and the positioning of JDSU's product portfolio, it can cause some revenue fluctuations as large projects are pushed to future quarters.

This occurred in fiscal Q3 to four deals, each over $1 million in size, that we had expected to book and ship during the quarter. With this said, overall Test and Measurement revenues in fiscal Q3 associated with the largest North America service providers remain solid, as combined total revenues from these customers were flat from the fiscal Q2 level, although North America revenues in total were down sequentially given seasonality and ordering delays.

Gross margins for the segment were again within our long-term range of 57 to 61%, but below the prior quarter's level due to lower volumes and product mix. Comparing year-to-date fiscal 2008 geographic diversity with year-to-date fiscal 2007, we note the following results and trends for our products.

North America has declined by approximately 10%. We believe the majority of this decline is due to the aggressive investments by cable last year. We do see wireline expanding, although we believe spending will continue to be focused on network buildout-based projects.

We are seeing strength in Latin America, where greenfield buildouts are increasing, with year-to-date growth of over 100%. Europe has shown strength, growing at almost 30% year-to-date compared with the same period in fiscal 2007, with network buildouts remaining steady. Asia increased by 29%, where we are seeing particular strength in India.

Our CommTest business is broken down into three principal product business units. Each unit's product portfolio serves a different stage of network testing, enabling us to manage the ebbs and flow of carrier buildouts.

First, lab and production, which supplies test equipment for development system verification and production, on a year-over-year basis this unit had the strongest performance of the three units. A significant driver of this growth is the transition to 40 G.

Next, field services, which supplies both telecom and cable instruments to install and troubleshoot broadband triple play services. This is the largest unit in the segment in terms of revenue. Year-over-year this unit experienced growth as service providers continue to buildout the access layer and offer fiber to the home, or FTTH, as well as new services. We expect demand for field service test products to generally grow.

Finally, service assurance solutions, which ensure quality of services by providing end-to-end network test and monitoring. Revenues declined here year-over-year. Service assurance is usually the last type of testing that is performed once the network is built out and services and applications are made available. Therefore we would expect this unit to lag in growth as service providers are currently at the early stages of services deployment and usage. For example, low single digit percentages of U.S. households are currently using high-definition quality broadband delivered services.

Highlights of the quarter include, first, from an innovation front we recently announced the latest generation of T-BERD optical tester. This is a multiservice application module. This device is a compact 10 G multifunction tester for the installation and maintenance of carrier ethernet and IP services. High bandwidth triple play services are driving new test needs and are a main cause of the rise of 10 GigE circuits and the need for the new handheld Metro Core testers.

In February we announced two T-BERD/MTS-8000 additions, the industries' first field solution to combine 4 G and 10 G Fibre Channel test support, with the traditional transport test capabilities such as SONET/SDH and ethernet OTM.

In March we introduced the industries' first 30 megahertz far-end device for the UltraFED through its leading portfolio of triple play service testers used to turn up and troubleshoot 30 megahertz VDSL2, typically the last mile of technology in FTTx networks.

On the acquisition front on January 7, we announced the acquisition of Westover Scientific, which provides fiber-optic inspection and cleaning solutions. This technology complements JDSU's existing fiber field and lab and production test portfolio.

Moving on to the CommTest business model, we believe that the annual growth rate for this market will continue to be in the 6 to 12% long-term range, as carriers continue to invest in their networks to offer regional broadcast, video and high-definition services. Our efforts to improve the business model for CommTest are focused on reducing the fixed cost structure, given the seasonal nature of the business, as well as improving cash flows. We remain focused on delivering gross margins for the segment in the 57 to 61% on a sustainable basis at current revenue levels.

We will continue to take action to reduce our cost structure and improve our gross margins, which should result in improved operating margins. These actions include the following. First, product mix. We are improving the overall product mix as the percentage of products we resell fully reduces and the higher gross margins of JDSU's developed products increase.

Second, we believe further gross margin improvements will be achieved as we reduce our fixed cost structure in manufacturing. And finally we will create a greater emphasis on hubbing our shared services and disperse resources in concert with our Oracle upgrade. This investment will also focus on improving predictability.

Next, Optical Communications. Optical Communications' total revenue was $136.1 million in the third fiscal quarter compared to revenue of $129.7 million in the second quarter of fiscal 2008, representing almost a 5% sequential growth and a 10% year-over-year growth. All three business units in our Optical Communications segment saw sequential growth.

In general we saw strength in Telecom and some softness in enterprise or datacom. We saw booking strength in fiscal Q3 as total bookings increased from the second quarter level. This is the fourth consecutive quarter of increased bookings.

Gross margins were negatively affected by product mix as it relates to the following. First, the Optical Communications market continues to be very competitive. During the quarter we saw our ASPs decline above our historical range of 2 to 4% per quarter due to shipments associated with specific customer orders -- several specific customer orders. We expect that the sequential ASP reductions for fiscal Q4 will return to our historical range.

Second, as a result of increased demand from our customers, we experienced supply constraints with several of our vendors, as well as capacity constraints in our production capability.

Third, a decrease of the mix of products manufactured in our own internal factories had a negative impact on gross margin. As a result, overhead underabsorption occurred in several productlines, which historically enjoyed very strong gross margins.

With respect to our business units, we continue to have two business units with gross margins within our near-term targeted range of 25 to 30%. The remaining business unit, which operates out of the targeted range, had improved gross margins for the third consecutive quarter.

For the second quarter in a row operating margins were positive at 4.6%, although down from the prior quarter due to higher ASP declines, product mix and slightly higher operating expenses. With regards to geographic mix, we saw sequential growth in all three geographies. Additionally, over the last three quarters our revenue from network equipment manufacturers in Asia-Pac has grown and continues to become a larger percentage of our overall business.

Customer diversity remained about the same as our top ten customers represented over 60% of the business. I will now provide additional commentary on the segment's performance and strategy under three strategic principles of this group, that is, technology leadership, cost leadership and functional integration.

First, technology leadership. For transport JDSU holds the market leadership position in ROADM technology. We hit a new milestone in Q3 as we shipped over 2,500 ROADMs during the quarter, representing approximately 3% sequential growth. This is the highest volume shipped since we began shipping the product. Total ROADM shipments have now surpassed over 20,000 units. Demand for ROADMs continues to exceed supply as bookings of ROADMs grew sequentially. However, capacity was put into place to be able to double our wavelength switching ROADM shipments by the end of the summer.

We are starting to see a wider acceptance of ROADM technology outside of North America. In Q3 we began shipping ROADMs for use in a European network. We see this as a favorable indication for this technology and positive for our opportunity in this market.

Our focused on technology leadership was visible this quarter. During fiscal Q3 we announced the Mini WSS, the Nano, and the Superblade. I will discuss these in more detail shortly.

On the transmission front our next generation 8 G and 10 G SFP Plus products continued to gain momentum. In fiscal Q2 we saw strong customer acceptance and traction. We overachieved our expected total shipments of these products at over 100,000 units in fiscal Q3.

Products that saw healthy double-digit sequential growth are as follows -- tunables, datacom components driven by the growth of our 10 G TOSA/ROSA, transceivers and transponders also in the 10 G market. In addition, customer interest in our tunable XFP PIC product remains strong. With regards to 100 G at OFC this past February we performed a live demonstration of 100 Gbps data rate connectivity using parallel optics.

Finally Photonics, we saw healthy double-digit growth for our undersea products where we are seeing more buildouts taking place. And we expect this area to continue to be a growing market for JDSU for some period.

In summary for technology leadership demand of our optical components continues to trend upward. Orders in the telecom segment are particular strong. At the close of fiscal Q2 JDSU maintained the number one market position for eight consecutive years, according to Ovum-RHK.

In fiscal Q3 we have experienced continued momentum and growth, especially in ROADMs and optical amplifiers and transport, tunables and SFP Plus and VCSELs in the transmission area, and undersea in photonics. We continue to believe that the annual long-term growth potential for this market continues to be in that 5 to 15% range, fueled by telecom's move to DWDM meshed architectures.

The second strategical principle for Optical Communications was cost leadership. JDSU is implementing our own lean manufacturing initiatives, which are designed to improve our 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. This quarter inventory reductions continued to assist in year-over-year cash flow improvement.

Finally, of functional integration we recently introduced a number of our leading products at OFC this past February, including the new Superblade and the Nano WSS technology. Earlier in the quarter we announced the availability of the Mini WSS technology. Increased use of voice, video and data applications among consumers has placed strains on network bandwidth, pushing the need for Agile Optical technology all the way from the core infrastructure to the outer edge of the networks. JDSU is at the forefront of developing technology to support these trends.

The AON super transport blade is a single slot blade solution that delivers all major functions required for optical network transport. The new platform will integrate major transport functions that use to require multiple blades onto a single blame, dramatically reducing size, cost and power requirements for network equipment manufacturers and service providers.

We also introduced the Agile Optical Network embedded operating system. This telecom grade application framework supports all the optical functions within JDSU's new AON Superblade, allowing it to seamlessly integrate within network equipment manufacturers' and service providers' networks.

JDSU invented the first nano wavelength selectable switch, WSS technology. The Nano WSS includes technology extracted from the Mini WSS, and will enable JDSU to develop denser and more highly integrated optical solutions, such as the AON Superblade. The Mini WSS is half the size of a typical WSS offering. The Mini WSS is designed to provide a compact and low-cost solution for traffic management in the Metro and access areas of DWDM networks.

So far customers have demonstrated enthusiasm for these new products, as we have already been awarded some design wins. We are very encouraged by this customer traction. R&D spend will increase somewhat in this segment in order to continue to invest in the business and to respond to customer requests for design proposals.

We expect that these three strategic initiatives of technology leadership, cost leadership, and functional integration when fully implemented will enable the Optical Communications business to achieve and sustain the following business model targets near term, 25 to 30% gross margin and 5 to 15% operating income.

Moving on to our Advanced Optical Technologies segment, on February 13 we announced the close of the acquisition of American Bank Note and Holographics. AOT financial results include seven weeks of ABNH revenue.

Fiscal Q3 revenue for AOT was approximately $56 million, representing growth of 12% compared to the second quarter fiscal 2008, and up 22% compared to the third quarter of 2007. Excluding the revenue from ABNH year-over-year growth was 12%.

The currency market has provided strength for this business, driven by pre Olympic currency printing in China, general inflationary trends, convergence of new denominations and redesign activities. As we have noted before, we expect the trending of this business to have some level of surges and ebbs.

This quarter the AOT team generated operating income of approximately 36.6%. Favorable mix, higher volumes and improved factory absorption contributed to the healthy margin. Gross margins continue to be strong, as we continue to execute well in this business. Favorable mix, as well as revenue from ABNH, contributed to this performance. The integration of ABNH is proceeding, and we are experiencing some early customer acceptance of an overall solution strategy of technology from ABNH and JDSU's Flex products.

In Commercial Lasers our third quarter fiscal 2008 revenue was $23 million. The second quarter in a row of sequential increase, and up 3.6% from the second fiscal quarter of fiscal 2008, and down 6.5% compared with the third quarter of fiscal 2007.

The business continues to be impacted by lower demand from the semiconductor manufacturing equipment customers, and therefore the book-to-bill for the quarter was less than 1. Once again we saw significant improvement in gross margins quarter over quarter. The fiscal Q3 gross margins improved due to increased productivity and lower direct materials cost. The contribution margin was positive in fiscal Q3 due to improvements in gross margin.

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. Also during the quarter we initiated key partnerships in Japan and China, which we expect to advance our international efforts.

Focusing on our laser platform gross margin expansion initiatives we iterate the following. We believe 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 a 10 to 12% gross margin improvement.

Other corporate activities. First, acquisitions. During fiscal Q3 we closed two acquisitions. On January 7 the Westover Scientific acquisition was closed, and on February 13 the acquisition of ABNH was closed. Both companies had an EBITDA divided by revenue that is greater than 15%.

Second, relative to the class-action lawsuit, final judgment was entered by the judge in favor of JDSU in late March. We expect that this matter is therefore concluded.

Last, during the quarter we added Marti Menacho to the executive management team as JDSU's Chief Information Officer. Marti is leading our multiquarter project upgrade to a more current release of Oracle ERP.

In summary, we set out at the beginning of fiscal 2008 with the intention to advance JDSU's business model. We expected each business within the portfolio to continue to improve its operating results. Three quarters into this fiscal year, we have moved towards achieving our model of sustainable gross margins in the range of 43 to 47%, and operating margins at or above 10%.

The efficacy of the model was substantial last quarter -- was substantiated last quarter. Year-over-year financial performance improvements for the first three quarters of the fiscal year evident in the structural improvements in the business model. With our continued focus on business model advances, we remain confident of exiting the calendar year at more sustainable levels.

There is a strong focus on gross margin expansion and predictability in all operating segments. At the corporate level we are simultaneously investing in critical operational systems to better manage utilization for seasonality and complexity reduction. At the same time we will continue to seek opportunities to strategically expand our product portfolio through partnerships and acquisitions.

In closing, I would like to thank JDSU's employees whose continued commitment has advanced the Company's business model. And with that, I will hand the call over to Dave.

Before I start, please note that all numbers on non-GAAP unless I state otherwise. Third quarter revenues of $384.2 million, which included revenue from our Westover Scientific and ABNH acquisitions, was down 3.8% from our seasonally strong second quarter, and at the lower end of our stated range, primarily due to order push outs from several of our Test and Measurement customers.

In a year-over-year basis, third quarter revenue grew 6.2% when compared to the third quarter of fiscal 2007. This growth was driven by the Optical Communications and AOT segments. On a year-to-date basis fiscal 2008 revenues of $1.14 billion grew 9% when compared to the same nine-month period for fiscal 2007. This revenue growth was primarily in the CommTest and AOT segments.

Third quarter gross profit of $163.5 million or 42.6% of revenue was down from the previous quarter's seasonally high gross margin of 46.3%, and up from the Q3 2007 gross margin of 37.6%. On a year-over-year basis gross margins improved in each of our segments.

Operating expense for the quarter of $147.6 million or 38.4% of revenue included expenses associated with the acquisitions of ABNH and Westover Scientific, and temporary expenses associated with both our change management initiative and our ERP upgrade activities. These temporary costs in total represented approximately 1.1% of revenue.

Our operating income for the quarter increased to $15.9 million or 4.1% of revenue versus fiscal Q3 2007 operating income of $3.3 million or less than 1% of revenue. Net income for the quarter increased to $31.2 million or $0.14 per share when compared to fiscal Q3 2007 net income of $12.3 million or $0.06 per share. Net income for the quarter was favorably impacted by the release of an international tax accrual.

Adjusted EBITDA for the third quarter was $32.3 million or 8.4% of revenue, which compares to adjusted EBITDA of $17.7 million or 4.9% of revenue in the prior year. A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release.

Our third quarter non-GAAP results exclude, among other items, amortization of acquired technology and intangibles of $20.5 million and an $11.3 million charge related to stock-based compensation. Including these items, our third quarter GAAP net loss was $6.2 million or a loss of $0.03 per share, which compares to a prior year net loss of $14.2 million or a loss of $0.07 per share.

Moving to the segments. In the CommTest segment third quarter revenue of $169.3 million was down 14.3% from the seasonally strong December quarter, and at the lower end of our expected range, primarily due to order and delivery push outs from several customers. On a year-over-year basis quarterly revenues increased 1% due to acquisition-related revenue.

The CommTest operating profit decreased to $22.8 million or 13.5% of revenue versus $48.5 million or 24.6% of revenue in the prior quarter, primarily due to lower revenue, lower gross margins and higher operating expenses. The higher operating expenses were associated with the Westover acquisition, foreign currency impacts, and temporary costs associated with change management initiatives.

In the CommTest segment we are engaging in a number of change management initiatives focused on our selling structure and our business operations. These initiatives are requiring temporary investments, and we expect the majority of these initiatives will be completed by the end of the calendar year.

In the Optical Communications segment revenue for the quarter of $136.1 million was up 4.9% when compared to the prior quarter. And each of the three business units experienced sequential revenue growth. On a year-over-year basis the quarterly Optical Communications revenue grew 9.6%.

The Optical Communications quarterly operating profit of $6.3 million or 4.6% of revenue was down from the prior quarter's operating profit of $9.9 million due to the product mix, targeted pricing actions with several customers, supply constraints, and the fact that the previous quarter's operating profit benefited by more than $1 million from customer funded development.

On a year-over-year basis the third quarter operating profit improved by $10 million when compared to prior year's operating loss of $3.7 million, reflecting the impact of the cost reduction initiatives that were implemented over the last year. We believe that we have a gross margin improvement opportunity in the high single digit percentages that will be realized as we execute against our lean manufacturing initiatives and as we increase utilization of our factory.

Our AOT segment's quarterly revenue was $55.8 million, up 12% from the prior quarter. AOT revenue growth was primarily driven from the ABNH acquisition, which closed in the middle of February. On a year-over-year basis the quarterly revenue growth was 22.4%, of which organic growth was 11.6%. AOT operating profit for the quarter was $20.4 million or 36.6% of revenue. We expect that the operating profits for AOT will fluctuate by 1 to 3 percentage points as demand tends to have a level of ebbs and surges in this segment.

In our Commercial Lasers business third quarter revenue of $23 million increased 3.6% from the prior quarter. Lasers had an operating profit of $900,000, an improvement from last quarter's operating loss of $300,000, primarily due to improved gross margins. We believe that we have a double-digit gross margin improvement opportunity in this segment as we increase our solid-state laser volumes in concert with implementing lean manufacturing processes.

Now looking at revenue by region. During the year the geographical mix of our revenue has remained balanced. In the third quarter of fiscal 2008 the Americas contributed 52% of revenue, EMEA 29%, and Asia-Pacific 19%. Geographic diversity remained relatively unchanged compared to the prior quarter.

Moving to the balance sheet. For the fifth quarter in a row the Company was free cash flow positive, generating $31 million. Our net cash balance was approximately $422 million, and total cash and investments exceeded $1 billion. Headcount as of March 29, 2008 was 6,745, up from 6,509 last quarter. The increase in headcount is primarily the result of the Westover Scientific and ABNH acquisitions.

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 a revenue level of $400 million per quarter are -- gross margins of 43 to 47%, operating expense of 35% or less, and an operating margin of 10% or greater.

Each of our business segments is engaged in improving their gross margins, with our largest opportunities as a percentage of revenue in the Optical Communications and the Commercial Lasers businesses. We expect that these improvements will reduce the impact of segment mix on our operating margin.

We're also focused on reducing our cost structure and are currently investing in change management activities and upgrading our ERP system. These activities are designed to reduce the cost of our manufacturing operations and our SG&A. The resulting savings from these activities, along with the completion of the temporary investments required to identify and mitigate -- and migrate to these more efficient cost models is expected to reduce our quarterly operating expenses by the end of the calendar year by approximately 2% of revenue and improve our gross margins. Successful execution of these activities we believe will enable us to sustainable execute at our long-term operating model.

Finally, we have been notified today that we have received final court approval with regard to security litigation in connection with our sale of a subsidiary in 2001. We expect to realize in the fourth quarter a GAAP only nonoperating gain of more than $50 million.

Now looking forward. Some points to consider as you think about our financial performance over the coming quarters. Visibility across our businesses has not changed, but the CommTest business continues to be a short lead time book and ship business. As we prepare the CommTest business for further growth and scale, we have initiated some change management activities which could cause some risk during a period of transition.

The AOT segment has benefited from incremental demand over the past several quarters. This segment can experience ebbs and surges in demand. Optical Communications products, due to increasing demand, experienced supply and capacity constraints in the last quarter and may continue to do so.

Total operating expenses for the fourth quarter are expected to increase by approximately 1% of revenue, reflecting a full quarter's expense for the ABNH acquisition, investment in Optical Communications R&D, and a full quarter spend on the ERP upgrade project. Finally, we expect our quarterly tax provision to range between $3 million and $5 million.

Taking into consideration the factors above, and based on our current visibility, we expect the fourth quarter revenue to be in the range of $381 million to $403 million, and non-GAAP operating margin to be in the 2 to 5% range.

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

(OPERATOR INSTRUCTIONS). Ehud Gelblum, JP Morgan.

A couple of questions. First of all, a couple of housekeeping and then just get to some more things about some of the strategic issues going on. The tax issue, Dave, you said there was a release of the European provision. How large was that? And how much did that impact, if we were to back that out?

Yes. It wasn't Europe. I didn't say European. I said an international, and it was basically a statute of limitations as far as how far the legal authority could go back from an audit. And the benefit was about $7 million.

That obviously -- that is one time in nature and doesn't continue from there?

That is correct.

On ABNH, given the information you gave about growth in AOT would have been 12% without it. We're coming up with that ABNH was a little less than $5 million this quarter. Is that the right math we should come up with? And is that the right runrate we should expecting going forward?

That is the correct math. Remember, we closed the deal in the middle of February. And it was a public company, and so it was running I believe at a slightly over $8 million per quarter level historically. That is the reference I give you.

So the $5 million is consistent with the $8 million, if you take into account the timing, or was there something lost in the acquisition (multiple speakers).

That is reasonable relationship.

Was the operating margin on that business any higher than your standard AOT?

No.

On to a little more strategic questions. I understand a little bit more about what happened in Test and Measurement with respect to the push outs. You said you saw North America in both telco and cable. At what point did the -- can you comment a little bit on the linearity in the quarter, and it what point you realized these push outs were happening?

And you mentioned that you had generally seen more $100,000 plus deals and some $1 million plus deals, and now you are seeing more $1 million plus deals. Does that mean given that the total revenue isn't going up right now sequentially, does that mean that you have fewer customers than you had before, and fewer larger customers?

Let me give you sort of a background. The first thing to note is when we bought the CommTest team it was a $90 million to $100 million a quarter business. And I think the average deal size was between $100,000 and $200,000. And you may have $1 million, or $2 million, $3 million orders.

Of course, in general we have about doubled the size of the business in the 2.5 years that we've had it. What we have noticed is that the percentage of -- and Dave will probably correct me. In fact, I will let Dave give you the numbers. But we monitor two things, the numbers of deals over $0.5 million have actually changed quite dramatically just in the nine-month. And in this particular quarter the number of deals over $1 million would probably be measured in the tens of deals as opposed to, if you back to 2.5 years ago, one or two.

So what we are seeing is as we have grown, Test and Measurement is actually becoming more relevant. Deal sizes are beginning getting bigger. All those are very good things. The other side of that, however, is that larger deals usually have more signoffs. They take longer to get across the goal line. And of course in this particular quarter, as we have been very clear, budgets get released late in the quarter. And so it is very back end loaded. Basically it is either going to happen to you in March, and then you've got to figure out if you can ship it or not.

On one hand, I think it is a growing pain and a positive that we do have larger deals. That has been happening to us gradually, but with an accelerant I would say in the last nine months. This is the toughest quarter for visibility. It is about budgets being released, and it is all about what actually falls in the month of March. Dave, you have some numbers on -- at $0.5 million mark what has changed?

Yes, when we look back three quarters, we were doing less than 20% of our deals were $0.5 million or larger. And in the most recent quarter we had sightly over 30% of our CommTest deals greater than $500,000.

So at a strategic level, I think this is a good thing on the practical execution side of it. It makes the quarters more volatile, if you will, especially if you have budgets that only get released two-thirds of the way into the quarter.

But the things that got slipped out, at what point did you realize they got slipped out? And were you given any indication as to why or whether they will be recovered next quarter?

I think if I took the big deals in general, which I will argue was on maybe tens, we probably closed over two-thirds of what we thought we were chasing. In the cases of the ones that impacted revenue for the quarter, we had one that was signed off in the late weeks of March. It was going through the signoff at one level. The final signature cut that level. And then what we were told they would take shipment for it, and this particular quarter was reduced yet again. That is just one example of the dynamic that occurs in the last weeks of the quarter.

Paras Bhargava, BMO.

On the CommTest side are you happy with the capacity that you are at? Have you done any -- I'm picking up that you might have culled some activities and maybe reduced the size of the workforce. I am just wondering, first of all, is that going on, and is that sort of normal stuff, or is there something structural that you're trying to change?

I think from a headcount level and -- number one, we think this business is going to continue to grow in scale and become a $1 billion business and will grow accordingly. I would say that, as I have mentioned to you before, where the headcount exists is probably not where I think the headcount needs to be in the future. We have probably more G&A dispersed in regional offices than is required. We probably have different choices to make in terms of what our manufacturing structure looks like, and where our R&D is located, and so forth and so on. I think we're making -- we're going through a set of change management decisions that puts and concentrates more and more of our talent in the place for us to scale in the future. But it is not a dissatisfaction with the structure per se.

And it is not related to the potential slowdown? Because you know with the growth you have had, it is not in the last year or so, it is not hard to imagine that you might have added more people than maybe you needed, and now you're pulling back a little bit.

I would say most of our structural changes are predicated upon where we think the headcount needs to be. Of course, a lot of it is you have to get the systems put in place. I will say that we're actually -- and I hope I have been explicit by this, when I look at the size -- or the size of the funnel or opportunity that we're pursuing, we are happy that we're pursuing it. The downside is we didn't bring in as much of that funnel into this quarter as we had hoped.

It is going to happen any quarter. I'm just trying to understand some of these structural changes. On the cable side, were cable revenues actually down in that cable customer segment year-over-year in this quarter, or do you to measure it that way?

I don't know the answer to that on the call. I'm going to see if Dave does.

Yes, they were -- if you recall about a year ago cable customers were in an investment mode, and they have been reducing their level of investment over the last four quarters and sort of hit a constant level. But compared to a year ago it is at a different level of investment.

When you're talking about the longer-term 6 to 12% growth rate, which sounds reasonable for that market, that would assume cable customers would give back a little more or would they be at this level?

I think it looks at all the puts and takes of growth in Asia, Latin America, and it is just our belief of where we have products what we think each product growth rate is going to deliver us.

One housekeeping item. What was the share count at the end of the quarter? It looks like ABH happened a little bit later and the average share count was a little low. I'm just wondering what the average share count will be next quarter.

The average share count will go up about 5 to 6 million shares, because you're right, because ABNH was only in for a portion of the quarter.

Cobb Sadler, Deutsche Bank.

I have a question on -- you talked about pricing within the Optical business it may be a little more aggressive than it had been in the past. Was that -- and you kind of talked about it like it might be onetime in major. Was that primarily on the tunable laser side or was it across the board?

What we said in the prepared comments is it was customer related. I would say that tunable is one of the areas that generally has higher ASP tension. Whether I can specifically correlate those two statements for you right now, I don't have that knowledge on the call. But for us it was basically delivered by two customers or several customers. But you would also be correct that it is aggressive in the tunables space as well.

Just overall revenue growth in the quarter, was legacy -- can you tell us the legacy type components? Are you seeing some tightness even there, or was it really just your high-growth items that kind of pulled the quarter up about 5%?

I don't think we had an unusual circumstance in terms of legacy components. I would say some of our legacy components we saw slower growth in, which is one of the reasons I mentioned some of our internal factories saw higher overhead underabsorption. But I would say where the market is hot we are -- there is a lot of competition in some of the new areas. Tunables is certainly one of them.

I think you talked about expanding ROADM capacity. And my guess is you've got a carrier that is probably going to deploy via an OEM your ROADM late this year, probably early next year. Are you -- what kind of an impact do you think that will have on overall ROADM business? And what is your current marketshare?

I will leave it to others to let us know what our market share is. I would say there was a point in time when we felt that we would drop below 50%, just because more people were getting into the market. I am less fearful of that today than I was. And you're correct that the nature of what we have just experienced is one or two network equipment manufacturers coming in and asking us to very quickly increase volumes like 100% in a very short period of time. That is why the supply constraint is more about opportunity than it is any other challenge.

Next question please.

Ajit Pai, Thomas Weisel Partners.

Just two quick questions. The first one is how would you prioritize the uses of cash over the next 12 months in terms of further investments, potential buybacks and acquisitions?

The Board reviews our priority scheme each quarter. I think we have mentioned that before. The top priority, although it has been a dwindling need, has been to support restructuring. Something that is new, but is a high priority is the investments we're making in Oracle and infrastructure improvements. So that has not been something that was historically on our priority schema, but it has come up as we entered this new calendar year.

I would say after that we have tended to be focused on a combination of M&A for advancing the business model and then paying back some of the debt so we didn't have a single impulse function. We wanted to ladder that in over time. We have continued to ask the questions about buyback or other, and ultimately it it is a debate on what we think is the best use of cash at any point in time.

I can't tell you where the Board will move the needle next, but I can tell you it is a quarterly debate.

But the big investment in Oracle are behind us now, so what are the quarterly runrates right now as far as that goes? (inaudible) as they are going into the next four quarters?

The Oracle investment is not fully behind us. We actually just started. And Dave, maybe you can provide some more color on that.

Yes. In the last call we talked about the investment being a $25 million to $35 million investment, and it will happen throughout the calendar quarter. We started it -- we just started it in the early February timeframe. And as I noted on the call that this quarter will in fact have a full quarter impact from that investment. And we will be using our cash to buy whatever equipment we need and consulting services, some of those which they have capitalized, etc. It is probably, call it, a full runrate level in this quarter.

Then you're looking at the Optical Communications components business, right now you have talked about you are expecting to get some benefits over there on the cost side. But from a pricing environment I think initially your comments you said that this quarter was down more than it usually is. And you specifically mentioned that today with specialty customers. What gives you confidence that that is going to change, and it is going to sort of resume its normal trajectory for the rest of this year and beyond?

I think it is a -- it was probably two or three things here. One is with that we have got about 17 quarters where it stayed within the bounds of 2 to 4%. So there is a benefit of longevity, longitudinal analysis in numbers.

The second is that generally this kind of thing becomes a bit less intense as the market heats up. While we in capacity discussions you tend to have on those classes of products a bit less conversation on pricing. The market continues to move aggressively. As I noted to you, we had multiple productlines that had double-digit quarter-on-quarter growth. I think it will be self-healing a bit.

We're going to pay attention to it every quarter. We have got aggressive cost reduction plans. I think there is a longitudinal view that is long. And there's a reality that the demand side is favorable, especially on the new products. I hope that helps.

Jeff Evenson, Sanford Bernstein.

A couple of questions related to your guidance. I am just wondering if you could give us a little of color on the components of your interest in other income, and how we should think about modeling that over the remainder of the calendar year, given what looks like a lower interest environment?

I look at that as basically -- it is about a $1 million delta quarter to quarter, other than this item I noted where we expect to have over $50 million come in during the fourth quarter.

And the $1 million delta is from how you model your interest -- your effective interest rate changing over the year?

Yes, it is interest rates.

Now from Kevin's comments I inferred that about 94% of your revenue for the quarter had a book-to-bill greater than 1. And that in the upcoming quarter you'll receive the full benefits of your recent acquisition. Yet your revenue guidance sequentially is minus 1% to plus 5% growth. I am wondering if you could just give us a little bit more color on how you got there.

I think you have seized that we have called out specifically that lasers was 6% of the revenue of the Company, and that was the one that had a book-to-bill below 1. So Dave mentioned that the -- in terms of guidance, it is very simple. We don't start with what we think people want to hear, we start with what we know to be true. We do a bottoms up rollup. Dave and I take a look at how the teams are executing, what other risk factors exist, and then we come up with a number.

I think if we came into the mid range of that, we would actually be guiding up. But fundamentally we think we have captured what we think the downside risk is at the low end and what the top end is possible. Dave, other --?

I think that is really -- it says it.

And to the same process we have used for a while, so that is all I can tell you.

Corning yesterday in its call mentioned that they had seen some slowdowns in the actual deployment of fiber to the home in a couple of places in Europe, given that the EU has set its final decision date for competitive access regulations for October. Have you noticed anything on this? And would you expect in uptick after the EU makes its final decision?

Could be. I don't think we've seen it as a factor in the lines of businesses that we have. I will tell you what we have seen is that our sense of momentum differs by virtue of whether an operator has pretty positive cash flows at a moment in time or doesn't. We haven't actually seen a psychological pull back. You could sort of tell that from the feedback I provided on the optical comm side.

But in terms of operators making choices, especially if they are more discretionary, if they have good cash flows right now they tend to be moving with their build out. If they are among some of the ones that have lesser cash flows, they are more cautionary with how they spend their money in the quarter. Hope that helps.

It does. Thank you.

Todd Koffman, Raymond James.

In response to an earlier question with regard to the slowdown or weakness in Test and Measurement, you were talking about these larger size deals, and then you said some of the deals were signed off and then they got reduced in size. But in your prepared comments it sounded like you thought some of those larger deals got pushed out. Where they pushed out or they were actually just captured at a smaller dollar value?

We had both. The specific example that I mentioned to you was what it was, where it was signed off, went to another level of approval. The size of it was reduced. And the amount that was approved for shipment in the quarter was reduced yet again. We also have several other deals that were pushed out into this quarter and we are pursuing them. So both cases occurred.

Just a follow-up. On that Test and Measurement business someone asked are you in the process, or are you going to be pruning the workforce in that business? You talked about some transitional issues.

We have and will continue to make adjustments in the workforce depending upon the needs by function, whether we feel like the salesforce is sized right, if we move from direct versus indirect models in different regions. We're going to continue, but I don't think it is something that moves the needle of the business significantly.

Right, one of the other parts is also moving some of the shared services support for that group into more a regional hubbing model, where traditionally been business has had the shared services support located in each office. These are the normal steps you would take as you would go and look for opportunities to reduce the complexity within a model.

Is this movement to the regional hubbing what you were referring to when you talked about some transitional risks?

That would be one of several, yes.

Next question please.

Paul Bonenfant, Morgan Keegan.

Kevin, in the past I think you have talked about CommTest having a revenue pattern with a peak to nadir of in the range of 1.1 to 1.3. And assuming that this quarter is the nadir, do you expect similar -- or do you have similar expectations for this calendar year?

Yes, several comments. You are right that when we first bought the asset and for the first probably 12 to 15 months, 1.1 to 1.3 was the ratios -- or were the ratios. The nadir actually moved around in terms of which quarter we found it in. More recently, and it probably goes back about two quarters or so ago, we adjusted that ratio to a range of 1.1 to 1.2. And as far as I can tell, that ratio is still operative.

In this quarter's results do you get any sense that the fourth quarter budget flush resulted in the build up of inventory at any of your customers in CommTest?

No, I have no -- you know, the nature of this business is people wait until they actually need it. They give you a very short period of time to ship it. If you don't ship it, they will either buy it from somebody else or they will just do without for a period of time. It is not the kind of thing -- it is not a strategic asset that people would stockpile for a long time.

I understand. It was more in the context of the use it or lose it spend that you might see typically at a service provider in the fourth quarter. Going back to something that you said I believe in the remarks, I wanted to make sure I heard correctly. Did you say that within Optical Communications some of your North American customers, some of the larger ones, were actually flat sequentially, which would suggest that the business held up there?

I think the comment that we made was within CommTest. If you look at the very largest service providers that we sell to, the actual revenues that we got from them from Q2 to Q3 were flat.

Switching --.

Next question please.

Sam Dubinsky, Oppenheimer.

A couple of quick questions on the component side. I know enterprise is weak. Question one, can you just summarize what segments of enterprise that was? Was that storage transceivers or was it broad-based? Maybe you could just give some more color. And then I have a couple of follow-ups.

I think the storage for sure would be -- I don't know -- I would say legacy products more generally probably would be true. I don't know how to give you any more insight into that at the moment.

And then on the telecom side, it seems like if you guys are capacity constrained, wouldn't lead times start stretching in this business? And I guess what are lead times today? And I guess is visibility improving over the coming quarters? And will your customers start taking inventory themselves as opposed to pushing inventory onto you guys, I guess? And then one last question.

It is hard for them to build inventory if they can't be given the products to build it up. Secondly, I would say we -- the kind of capacity that we have to rebuild is largely training people in the existing facilities that we have, as well as probably test station. So it is the kind of thing that begins to come on very fairly linearly. And I think we will -- while I said we will achieve a doubling by the end of the summer, there will be a lot of relief month by month.

Than last --.

We need to do to the next question.

Patrick Callery, Piper Jaffray.

One more question on the optical component side. You mentioned telecom is strong, and datacom maybe a little on the weaker side. Can you talk a little bit about how you see those moving into the June quarter with respect to -- I know you've got some capacity constraints, but do you see telecom continuing on that stretch?

Yes. I will come back to say that most generally we don't have a huge amount of visibility. It is certainly measured in four to six weeks. And as our lead times have come down, I think that is true.

I would say that on those things where there are constraints we had better visibility. And I would say the level of engagement between the network equipment manufacturers and suppliers, such as ourselves, on getting our supply chains integrated with each other has been good. So people are spending time on the right things.

I don't see -- right now I don't have any indication to suggest that the business is going to make a change. But it has been running good for four quarters is the real message. Okay?

There are no additional questions at this time. Thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Good day.