Viavi Solutions Inc (VIAV) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2011 JDSU earnings conference call. My name is Keisha and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would now like to hand the call over to Ms. Michelle Schwartz, Senior Director of Investor Relations. Please proceed.

Thank you, operator. And welcome to JDSU's fiscal 2011 third quarter financial results conference call. Joining me on the call today are Tom Waechter, Chief Executive Officer; and Dave Vellequette, Chief Financial Officer. I'd like to remind you that this call will 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 annual report on Form 10-K filed on August 31, 2010. The forward-looking statements, including guidance, provided during this call are valid only as of today's date 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 limitations is included in today's news release announcing our results, which is available on our website at www.JDSU.com.

As a reminder, the quarterly earnings press release slides and historical financial tables are posted at www.JDSU.com/investors, under the financial information section. Finally, and as a reminder, this call is being recorded and will be available for replay from the investor section of our website. I would now like to turn the call over to Tom.

Thank you, Michelle. And good afternoon, everyone. JDSU delivered strong third quarter results with solid financial performance and market share gains. Overall, the end markets for our products remained strong, and our collaborative innovation continued to gain momentum with new product introductions. In fiscal Q3, we reported revenues of $455.4 million, gross margins of 47.6%, and operating margin of 12.1%. If we compare the same period a year ago, revenues grew nearly 37%. Gross margins grew by 350 basis points, and operating income grew by nearly 150%. This is tremendous progress, as we continue to execute against our strategy and advance our overall financial model. Our success lies in part with our strategy to operate as a diversified technology Company, which allows JDSU as a whole the ability to navigate fluctuations that may occur in any one business segment.

I will now address three recent events in the market. First, the events in Japan are tragic, and have affected the lives of many people. We are thankful that all of our employees in Japan are safe. JDSU and its employees have contributed to the relief effort, and we are committed to helping the people of Japan recover from this unfortunate event. While our business saw very limited impact from the events in Japan during the March quarter, we will continue to monitor the situation closely, and will work with our suppliers in order to fulfill our customer requirements.

Second, with respect to the consolidations we are seeing in our service provider customers, we do not believe we will see any impact in near term demand as a result of recent announcements in the sector. We will continue to work closely with our customers as they continue to build out 2G and 3G networks, and with the roll-outs of 4G and LTE. And finally, recent announcements have caused some uncertainty in the Optical Communications market. We do agree that there is a current slowdown in sequential quarterly demand; at some customers there is an effort to reduce inventory levels. At the same time, we believe market drivers remain strong.

Our Optical Communications business grew nearly 10% quarter-over-quarter, and over 68% year-over-year. Our strategic focus on integrated differentiated products is working. We are both increasing our customer penetration and taking market share. For example, our ROADM and tunable XFP revenue each grew over 20% sequentially, and now represent over 45% of total Optical Communication revenue. We are not immune to volatility in this market, but our portfolio of broadly accepted innovative products is separating us from our competition.

Now, let me hand the call over to Dave, who will take you through the details of our financial performance in Q3, and will discuss our outlook for Q4. Following Dave's remarks, I will provide more details on our results, the trends we are seeing, and our strategy moving forward.

Thank you, Tom.

Before I start, please note that all numbers are non-GAAP unless I state otherwise. Third quarter revenue of $455.4 million was down 4.6% from the prior quarter, and up 36.8% when compared to the third quarter of fiscal 2010. Revenues increased sequentially in our CCOP and AOT segments, and declined as expected in our CommTest segment due to March quarter seasonality. Book-to-bill for CommTest, Lasers and AOT were each above 1, while Optical Communications book-to-bill was below 1. Book-to-bill for the total Company was also below 1. Third quarter gross margin was 47.6% of revenue, down from the previous quarter's gross margin of 48.8%, and up from third quarter fiscal 2010's gross margin of 44.1%. The third quarter sequential decline in gross margin was primarily due to segment mix. The year-over-year improvement in gross margin was due to improved margins in CCOP and in CommTest.

Operating expenses for the third fiscal quarter of $161.9 million were 35.6% of revenue, up slightly from the prior quarter's $159.8 million. The increase in expenses from last quarter was within our stated range, and primarily for higher employer payroll taxes and the impact of the weaker dollar on operating expenses. The fiscal third quarter operating margin for the Company was 12.1%, up from 6.6% for the year-ago period, primarily due to higher revenues and gross margins. Net income was $51 million or $0.22 per share, which compares to $67 million or $0.29 per share for the second fiscal quarter; and $23.2 million or $0.10 per share for the year-ago period. 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 other intangibles of $22.3 million; a $10.9 million charge for stock-based compensation; an acquisition accounting adjustment to revenue of $1.4 million; restructuring and nonrecurring charges totaling $7.6 million; and a $34.9 million tax benefit from the release of a deferred tax valuation allowance for a foreign jurisdiction. Including the noted items, the third quarter fiscal 2011 GAAP net income was $38.6 million or $0.16 per share, which compares to a prior year third quarter GAAP net loss of $11.9 million or a loss of $0.05 per share.

Now, looking at quarterly revenue by region -- Americas revenue of $208.8 million or 46% of total revenue was down $35.1 million from the prior quarter. The decrease was in Test and Measurement and was due primarily to approximately $20 million of service provider budget flush that was realized in the December quarter, and seasonally lower service provider demand. EMEA revenue of $127.2 million or 28% of total revenue was up $5.7 million compared to the prior quarter, due primarily to strength in our Optical Communications business and in our AOT segment. Asia-Pacific revenue was $119.4 million or 26% of total revenue, up $7.6 million from the prior quarter, primarily due to higher demand for Optical Communications products.

Moving to the segments -- In the CCOP segment, the breakout of key metrics for Optical Communications and Lasers is as follows. Optical Communications revenue in fiscal Q3 was $184.7 million, up 9.7% when compared to the prior quarter's revenue; and up 68.1% when compared to the prior year. We saw particular strength in ROADMs, circuit packs and tunable XFPs. All of the geographic regions grew sequentially. Quarterly ASP decline was 3.9%, which was below our expectations.

Gross margin for the quarter was 32.9%, flat with the prior quarter, and within our target range of 30% to 35%. During the quarter, we continued to increase our test capacity for a number of our products, which allowed us to expand our VMI portfolio for two major customers and reduce our product lead times. In our Lasers business, third quarter revenue of $24.7 million was up 8.8% when compared to the prior quarter, and up 31.9% compared to the prior year due to the demand for our solid state lasers used in semiconductor, LED, and micro machining applications. Gross margins were 46.8%, up from the prior quarter. Total CCOP revenue was $209.4 million, up 9.6% from the prior quarter. Gross margin was 34.6% and operating income was $39.6 million, or 18.9% of revenue. The increase in operating profit was primarily due to higher revenue. Our sustainable targeted CCOP operating model has operating margins of 16% to 20% when revenues are above $190 million on a quarterly basis.

Now moving on to our CommTest segment -- As a reminder, the March quarter revenue is typically seasonally lower than the December quarter. As expected, the March quarter revenue of $189.2 million was down 10.5% from December quarter's revenue, after adjusting the December quarter revenue for $20 million of calendar year-end customer budget flush. On a year-over-year basis, third quarter revenue was up 29.9% from the prior fiscal year. Q3 organic revenue growth, which excludes revenue from the NSD products and from third party complementary products, was up 15% year-over-year. On a sequential basis, Asia-Pacific revenues grew modestly, while EMEA and the Americas revenues declined primarily due to seasonality. Fiscal Q3 gross margin for CommTest of 61.9% exceeded our targeted range of 57% to 61%, and increased by 700 basis points from the prior year's Q3 gross margin of 54.9%. The gross margin improvement was driven by revenue from the NSD acquisition, which was completed after fiscal Q3 last year; and from favorable product mix, as 45% of CommTest revenue came from products introduced in the last two years.

As a result of the higher gross margin, CommTest operating profit was $22.6 million, or 11.9% of revenue; which compares to $11.5 million, or 7.9% of revenue in the prior year. The operating profit is below our targeted range due to seasonal revenue levels, and our current investment levels in R&D, and selling costs. CommTest revenues tend to be seasonal with the June and December quarter ends typically the strongest, and the March and September quarter ends being lower. As previously noted, our targeted CommTest operating model is for operating margins of 20% to 23% when quarterly revenues are greater than $215 million. Our operating expenses for the CommTest segment are currently above the targeted range as a percentage of revenue, as we continue to invest in products for mobile, video, and Ethernet backhaul. We are expanding our sales presence in high growth markets also, such as Eastern Europe, Africa, and Asia. As part of this investment focus we have started transitioning investment away from certain products that are not hitting our profitability targets. This transition will be completed over the next several quarters, and resulted in a restructuring charge of $6.8 million in the fiscal third quarter.

For the Advanced Optical Technologies, or AOT segment, fiscal Q3 revenue was $56.8 million, up 3.8% when compared to the prior quarter. We saw revenue increases in our currency, transaction card, and thin film businesses. As previously noted, currency products will see demand fluctuate according to the level of bank note printing needs. Fiscal Q3 gross margin for our AOT business was 48.3%, up slightly from 48% in the prior quarter, due to product mix. AOT operating profit for the quarter was $17.9 million, or 31.5% of revenue, slightly below our operating profit target range of 32% to 35%.

As a reminder, JDSU's total Company targeted operating margin range is 14% to 17% when quarterly revenues are $460 million or greater and gross margins are 49% or higher. Also, JDSU's revenues are impacted by seasonal buying patterns of our customers. The March and September quarter revenues tend to be lower than the December and June quarter revenues. Carrier buying patterns impact the December and March quarters, while EMEA customer buying patterns impact the September quarter. Moving to the balance sheet. For fiscal Q3, 2011, the Company generated $52.9 million of cash from operations. Capital expenditures totaled approximately $34.2 million. At the end of fiscal Q3, the Company held over $700 million in total cash and short-term investments. Headcount as of April 2, 2011, was 5,028.

Now to our Q4 guidance. First, some points to consider as you think about our financial performance over the coming quarter. Based on our current visibility, we expect CommTest revenues to grow sequentially between 6% and 13%. AOT revenues to be down sequentially 2% to 4%. And CCOP revenues to be down 2% to 4% sequentially. Operating expenses are expected to increase up to $4 million to $5 million sequentially, primarily for increased investment in R&D and selling costs. CommTest operating margins are estimated to be between 14% and 17%, due to higher revenue. AOT operating margins are expected to be between 28% and 30%, due to lower revenue. And CCOP operating margins are expected to decline by approximately 1 percentage point due to increased R&D investment.

Taxes, interest and other income are expected to result in a net expense of $6 million to $7 million. Share count for calculating earnings per share is expected to be approximately 237 million shares. Capital equipment purchases will be between 4% and 5% of revenue as we continue to invest in expanding our manufacturing and test capacity for AOT and Optical Communications products. Taking into consideration the factors above, and based on our current visibility, we expect fourth quarter revenue to be between $455 million and $475 million; and our non-GAAP operating margin to be between 11.5% and 13.5%.

I will now turn the call back to Tom.

Thanks, Dave. Now, I will provide Q3 highlights from each of our business segments. I will start with the CCOP segment. First, Optical Communications. The strength in revenue was driven primarily by growth in ROADMs, tunables, circuit packs, which includes our Super Transport Blade, plugables as well as gesture recognition products. Our customers are clearly recognizing our technology leadership, and we believe we are gaining market share across the majority of our customer base. Revenue from products introduced within the last two years accounted for 65% of total revenue in fiscal Q3. We expect our new product revenue to continue to grow in the near term.

Tunable XFPs grew by over 35% sequentially, and accounted for over 13% of total Optical Communications revenue. Our penetration across the customer base was strong, having shipped to 37 customers, many with multiple applications. We believe demand will remain strong as customers continue to design the tunable XFP into more applications within their optical network. We continue to ship our second generation tunable XFP, replacing 300 pin transponders in the regional and long haul markets. This quarter we began revenue shipments into the new applications at four major customers.

Our tunable XFP portfolio is the broadest in the market, and we expect to continue to expand on it. ROADM revenue grew over 20% sequentially, and represents 35% of total optical revenue. Our Super Transport Blade revenue grew over 37% sequentially. Given the strength across the ROADM portfolio, we believe we continue to gain market share. We expect that the demand for ROADM products will continue to grow over the long term. We may see some ebb and flow on a quarterly basis, depending on specific network buildouts over the next few quarters. This longer term growth is expected in the core of the network as dynamic bandwidth requirements drive the need for flexibility, and in low port count ROADMs to address the steady demand for applications in Metro where fewer ports are required.

We also expect to see growth in ROADMs moving out to the edge of the network, although full scale adoption is likely to be 1 to 2 years out. Through close collaboration with our customers, we are seeing strong demand for our 40 and 100 gigabit products. This quarter we announced the release of new 40G and 100G optical components. Our ability to leverage in-house fabrication capabilities in indium phosphide, gallium arsenide PLCs, and lithium niobate materials, enables high performance in cost competitive component solutions across these various data formats and data rates. This in turn allows the service providers to deploy 40G and 100G optical links in a cost effective manner where ever increased bandwidth is required in the network.

We continue to gain traction in gesture recognition. The total revenue for the Company continues to be less than 4% of JDSU revenue. We are currently working with over 5 customers to expand the applications of gesture recognition technology. The market is still in its infancy, but the potential new markets include further gaming applications, multi-media living room applications, and portable applications such as gesture recognition on notebooks. We have confidence in the optical market as drivers remain strong; but, as noted by our guidance, current demand from our customers is choppy in the short-term as lead times decline and network equipment manufacturer inventories are being reviewed to align with the end customer demand. We still see strong growth in the optical market; but in the near term, we expect some slowdown in growth.

Turning to our Lasers business within the CCOP segment; we saw an 8.8% increase in Lasers revenue due to strength in our Q series solid state laser for LED, semiconductor, and micro machining applications. Traction with our partner, Amada, remains very strong. The recently launched 4-kilowatt fiber laser incorporated into the Amada laser cutting system for material processing applications enables up to 3 times faster processing speeds on thick materials as compared to traditional CO2 laser technologies. We are shipping in low volumes and are on track to be in full production by September quarter if not sooner. In March, we announced our plans to develop a second generation suite of kilowatt fiber lasers with Amada. We are also developing a new fiber-based class of pulse lasers that enable faster and more accurate micro machining of materials in cutting and marking applications. We expect first revenue for these new Lasers to start during the second half of fiscal 2012.

Now moving on to the CommTest segment; the overall solid performance in CommTest demonstrates our global market leadership and reflects our alignment with our customers as they look to improve the quality of service and reduce operating expenses in their increasingly complex and higher-speed networks, especially in the fast growing areas of video and mobility. I will discuss these two areas in more detail.

Mobile traffic continues to grow on 2G and 3G networks, and we see growth in LTE, although we believe that we are still in the early stages for this market. According to the global mobile suppliers association, there are 140 LTE commitments across 56 countries, with 17 LTE networks currently deployed. Our products for drive test, protocol test, and real-time session trace, are being utilized for early deployment in the lab and in the field. This calendar year we expect to see more operators moving from predeployment testing to launching networks followed by service assurance. Our unique end-to-end LTE solution puts us in a position of strength with our customers to capitalize on all three of these stages. During Q3, we reported revenue for LTE test in new and existing customers across all geographies. For LTE projects, we currently are working with approximately 42 customers on protocol tests, 25 customers on drive tests, and 12 customers for service assurance.

In Q3, we also announced that CSL, Hong Kong's largest mobile communications operator, selected JDSU's access LTE Service Assurance Solution to support their LTE network deployment. JDSU is being recognized in the industry for our LTE products. We earned the Internet Telephony Product of the Year for our Signalling Analyzer Real Time, or SART, LTE test solution. SART improves performance monitoring and helps ensure network quality. Video continues to dominate network traffic and according to third parties, it is expected to be 90% of consumer traffic by 2014.

Our revenue is driven by this dramatic increase in video traffic, both wireline and wireless, as our customers need to manage quality of service and reduce cost. As a result, T1 carriers worldwide are taking advantage of our end-to-end video product portfolio. For example, our PathTrack product, which detects trouble to the street address level, grew revenue 33% year on year. Our Home Performance Management product, which extends quality of service, visibility into the home, has helped the European carrier gain a 2.5 times better than expected improvement in operating cost. Our HST, or Handheld Services Tester, saw significant revenue growth, as we experienced strong demand for copper test as carriers seek higher speed from copper. And our Q3 fiber test growth was up 24% year on year.

Finally, as previously announced, we were recognized by Frost & Sullivan as the global fiberoptic test market leader. The proliferation of tablets, SmartPhones, and other devices, along with rapidly growing video demand, is requiring higher speeds in the network. 100G is showing increasing deployment with service providers globally. Our Q3 revenue for 100G saw 114% growth year on year. As 40G and 100G migrate to the field, our presence in the labs positions us with a competitive advantage to earn revenue as these higher speed networks are deployed. These strong drivers are compelling carriers to spend in order to meet customer demand and manage network growth and complexity. As I mentioned earlier, we don't expect global carrier consolidation to have any short-term impact on our outlook.

This quarter we booked 18 deals greater than $1 million each across the globe, including a double-digit multi-million dollar North American deal for NSD Services that spans a 3-year period. In addition, we are penetrating new accounts, especially in Asia, which include sales of SART LTE testing, 100G, and drive test sales for 3G networks. We continue to see a pull from our customers for more intelligent software support systems to collect, analyze, predict, and recommend actions to address the unprecedented mix of complicated traffic on the network. For example, in Q3 we booked 8 optical network management system deals, illustrating our strength in creating software solutions to provide centralized visibility into fiber networks. JDSU's continued focus on collaborative innovation with our customers results in products and features introduced within the last two years, accounting for over 45% of CommTest revenue in fiscal Q3. Through collaborative innovation, we released a number of new products, as well as product and software upgrades, including the following.

JDSU's fiber complete test solution for the T-BERD MTS-4000, which combines the capabilities of 10 instruments into one, lowering CapEx and minimizing testing time by 40%. The ONT-600 Multiport Test Module for the development of next generation high capacity optical network elements. It's a low cost solution delivering carrier Ethernet, optical transport networks, and 100G services, ensuring the rapid design and verification of network elements. We announced advanced features for our Ethernet assurance test solution that reduced the turn-up time for Ethernet and mobile backhaul networks by greater than 50%. And the new JDSU FI-60 live fiber identifier, which easily detects a user's optical signal without disconnecting fiber or disrupting network traffic.

Our innovation engine is gaining momentum. We will continue to invest in R&D in order to ensure we continue our leadership position in key market segments. Our remaining segment is Advanced Optical Technologies, or AOT. Revenues for the quarter included growth in currency, thin film, and continued recovery in the transaction card market, due to an expanding economic recovery. Our new Suzhou facility, which provides a strategic platform for JDSU to grow our optical coatings business, is now operational, staffed, and meeting expected financial targets.

Operator, we'll now take questions.

(Operator Instructions). Your first question comes from the line of Kevin Dennean with Citi. Please proceed.

Great. Thanks very much and congratulations on what I think is a solid -- very solid quarter in clearly a turbulent environment. Just wondering if you could talk a little bit about customer -- what you think customer inventories for CCOP looks like and then if you can give us a sense of some of the moving parts embedded in your down 2% to down 4% sequential guidance. In other words, within that guidance range, what are the thoughts around Lasers, ROADMs and tunable XFPs for June? Thank you.

Okay. So I think on the inventory side, it is spotty with customers. It's not across the entire customer base. And I think it does depend, as we mentioned in the earnings portion -- script portion of this, I think it does depend on roll-out -- specific timing of roll-out of systems. We also saw our VMI go up to approximately 25% of our total revenue in the quarter, up from about 20%. So we are seeing more VMI activity, which gives us better visibility into the market.

I think on the guidance with down 2% to 4%, probably the softest part there would be the ROADMs area as that's probably the area that has the most inventory potential build-up, less so in tunable XFP and Super Transport Blade as we have a unique position there. I'd say that also China, which has been a strong area for us and we actually did see growth quarter on quarter in China, they're probably having more specificity around their deployments and viewing them a lot closer than they did maybe in the previous quarters.

Okay. Terrific. Thank you.

Thanks.

Your next question comes from the line of Ajit Pai with Stifel Nicolaus. Please proceed.

Yes, good afternoon and congratulations on a very solid quarter.

Thanks, Ajit.

A couple of quick questions. The first is the numbers that you gave us for the ROADM and then you also mentioned the growth in the Super Transport Blade, can we assume that those ROADM numbers are independent of any that go into the Super Transport Blade, or are they included in what's included over there?

So what the Super Transport Blade contains as far as ROADMs, that's rolled up into that total number.

It is in the ROADM number?

It's in that ROADM number, yes.

Got it. And then you also talk about trimming, restructuring on the Test and Measurement side certain products that are not profitable enough. Could you give us some color as to what kind of products these are and whether if you get out of those markets and you have new players into that market, whether there's threat of long-term competition from those new players?

First of all, it's a similar path that we took on the optical components side where we looked at our total portfolio, our customer's dependence, so we're not going to cut out any products that our customer would depend solely on us for. I think we're clean from the customer side. Primarily products on the very low end that have lower gross margins, more of our competitors are able to build and ship those products in volume. So that would be primarily low end and not products that our customer depends on us solely for. And it's, again, very similar to what we've done on the optical component side, continue to move into products that have more firmware, more software content, more solutions related to them.

Got it. But then if you look at the gross margins of that business at 61.4, they're above your target and you're planning to restructure it to get out of less profitable businesses. So does that mean that your gross margins for Test and Measurement are likely -- your targets are likely to be increased?

We're not going to announce any target increases but our goal is always to continue to drive those gross margins up. So I think we've had good success on the gross margin side, and we continue to work on the operating expenses to get more efficient there. And I think we've got many lean type of projects going on that will help us and that's part of the restructuring to just get more efficient in that area.

Right. And the LSD acquisition, you excluded it from the revenue and the growth numbers. Could you give us some indication as to progress that you made in that area, what the rough growth is, and the momentum you expect over the next two years out of that business?

We're not breaking out the numbers specifically any longer because we have the business fully integrated. It's actually an integrated part of our business now. I would say we continue to look at that as an area of growth for us. It's those products and services are in strong demand by our customer base, the wireless, the LTE growth we see as very strong going forward and the integration process has gone well. So we won't continue to break those numbers out. I think Dave did mention, though, that a part of the gross margin improvement for CommTest was based on a better mix of the NSD products in there this past quarter.

Got it. And then last question would be just given your cash has been growing again nicely and your last major acquisition you did, what's the acquisition pipeline like right now and strategy over there?

The acquisition pipeline continues to remain robust across all three of our businesses, and that will be a primary use of our cash going forward. We did mention though because we're having I think very good success with our new products, in Optical Comms it was 65% new products last quarter and CommTest was 45%. We're encouraged to continue to look for the right investments in the R&D side as well as to keep this innovation engine going.

Got it. Thank you so much and congratulations again on a solid quarter.

Thanks.

Next question comes from the line of Mark Sue with RBC Capital Markets. Please proceed.

Thank you. If we extrapolate the Optical Communications trends, does it feel as if the June quarter might be sort of the bottom for optical components? Are we starting to see the customers, which are digesting inventory starting to come back in terms of orders? Maybe if you could just kind of give us a sense of what dynamics you're seeing out there.

I'll talk in general about the dynamics, but we really do only give guidance one quarter at a time. So I won't go beyond what we said for the June quarter with specific guidance. We do see the end drivers continue to be strong. We continue to come out with new products and variations of our present products that are in demand for more flexibility and agility in the network. So we believe that that will continue to go in the right direction for us, as far as the demand drivers; and also we believe we're growing market share as we mentioned in the earnings call. So between having -- remaining strong drivers, having the right product I think lining up those needs for agility in the network and then also taking market share, we see a very strong future for our total business.

I see. Historically, when you do see an inventory correction and if you compare it with what you're seeing now, should -- is the data pointing to a one quarter phenomenon from your comparison of what you've seen in the past?

I think the corrections have been in varying degrees. When I think back over time, we've seen them sometimes be more abrupt and higher percentage change; but this one, as you've seen in our guidance has a lower percentage change quarter sequentially, than I can recall in the most recent periods. So I think it really is more of a balancing inventory levels and also it helps that we're reducing our lead times and able to provide more VMIs. So it gives our customers more confidence in being able to book and ship demand that they get on themselves.

Got it.

Next question, please.

Your next question comes from the line of Subu Subrahmanyan with Sanders Morris. Please proceed.

Thank you. On CommTest, can you talk a little bit about what's going on in terms of seasonal trends, typically into September you talked about general seasonality and June's obviously a stronger quarter. What is typical seasonality for CommTest? And then go back to that, what has been kind of average length of down tick during down cycles? I know we've talked about it in the past, the upside quarters have been about six to eight, what's been average for down ticks and in what way is this similar or different to average down cycle we've seen for optical?

Let me start with the Test and Measurement. As I noted, the carriers tend to -- the European and the US but mostly US tend to do their what we call budget flush at the December quarter and then they release budgets slowly in the March quarter. So that tends to have a March being less than December. And then the September quarter tends to be lower for not only Test and Measurement, but sometimes for optical also, just because of the -- what I call the European vacation situation or EMEA, their purchases in the September quarter tend to be lower than they did in the June quarter, mostly around the vacation situation there in Europe. So that's what we see in the Test and Measurement, and we will probably see some of that in the optical area for September just because EMEA customers buy less in September. I'll let Tom talk about the optical.

So Subu, I think your question around optical is what's the typical number of orders of up cycle and then what's the down cycle that follows that. Traditionally as we've mapped this it's been five, six quarters up and two quarters down on an average; but usually those down cycles have been very hard down cycles, and it's because the capacity has gotten ahead of the demand. And I really don't see that happening this time. I believe the demand is still ahead of the capacity out there in the networks, and we all experience that almost day-to-day on our own activities facing on the network. I think this is more of a short-term timing of network build-outs and some inventory build and some specific customers. So I wouldn't expect this to be a lengthy downturn, and I don't expect it to be a real hard down with the visibility that we have today and the end drivers and what's happening in our intercustomer base.

Next question, please.

Your next question comes from the line of William Stein with Credit Suisse. Please proceed.

Thanks. Just following up on that last one, I think the difference -- a difference today is that you're now doing VMI with more customers and we saw inventory days tick up. So should we expect that to mute the cycle and also perhaps push the downturn out relative to let's say prior cycles or customers that aren't doing, pardon me, competitors that aren't doing as much VMI with their customers?

I think the VMI as I mentioned went from approximately 20% of revenue to 25%. It does give us better visibility. It has less likelihood to build up large amounts of inventory. I'd say the days supply went up more on the CommTest side of the business than Optical Comm and that was primarily around improving some Customer Service issues and getting a better handle around our forecasting on some specific configurations. I don't, again, see that lasting for a lengthy period of time either, but it did grow a little bit larger than we had expected in the specific quarter on the CommTest side.

That's helpful. And one more, if I can. Turning to the operating margin target in the CommTests business. How much of the delta between where we are today and the goal do you expect to be driven by the restructuring that you announced today versus operating leverage from higher revenue? And do you see that target as achievable in the current year?

Well, the restructuring activity will help some; but as I noted on the call, right now we're seeing as you've seen from our gross margins, we're seeing opportunities to invest in products to address these emerging demands, mostly the video, the mobile video, and the LTE. So it's still our goal to get there. Revenues have to be 215 for the quarter. At the same time, right now we think this is a good opportunity to continue to invest in R&D. And also invest in our selling costs in some of these emerging markets where we're seeing some really terrific opportunities. So I don't think -- we're not forecasting that we'll get there in the current quarter. And I think what we'll do is we'll apprise you where we believe we will end up with each quarter as we've done historically, but right now we're in an investment mode in some of this R&D and selling cost area.

Thank you.

Your next question comes from the line of Alex Henderson with Miller Tabak. Please proceed.

Hey, guys.

Hi, Alex.

I was hoping we could get a little bit of clarity on what you're hearing as you talk to the service provider system companies. To what extent they're seeing a pickup in demand from their customers, whether in China or outside of China. We've heard a number of comments that while we've seen a reacceleration and I'm trying to get a handle on whether you're hearing that as well.

You're talking about the end users of the service providers?

One step further out the chain to the actual guy that's putting the stuff in the ground. Have you heard any comments from your customers that would give you some indications of what is going on at the service provider level in China and outside of China?

I think specifically within China, we do see some tempering of the pace that was there before on the deployment of networks; and from everything I've seen and heard, I don't believe it's a lack of end user demand. It's more China really specifically tempering that, at least in the short term. I think in North America, we saw some pretty large CapEx numbers out of two of the major network operators this past quarter. I think each one went up $1 billion each in CapEx spend from previous run rates. So that was quite healthy. And I think reasonably typical of what we're seeing in the rest of the parts of the world as well.

One other question in terms of where the demand is. Can you delineate between what you're seeing on 40 gig, 100 gig, and longhaul type transport versus what you're seeing on the access edge in terms of where the inventory is and where the demand is?

I think the demand continues to be strong through all parts of the network, because I think the demands are getting back into the core part of the network. So we are seeing strength in all parts of networks. As we said, the ROADM is getting out more to the access edge, that's happening. But really a large part of that growth will probably be more like a year to two out, two years out; but there is plenty of growth as you could see by our quarter on quarter and year on year numbers increasing for products like ROADM and tunable XFP, it's happening through the entire network.

Great. Thanks.

Your next question comes from the line of Todd Koffman with Raymond James. Please proceed.

Just one more question about this inventory correction. When you look at the level of your --

Todd, we're having trouble hearing you.

Can you hear me now?

That's better. Thanks.

When you look -- one more question about this inventory correction. When you look at the level of your ROADMs at customer inventories relative to where they need to be worked down to, approximately based on their deployment schedules, is that a few quarters or shorter or longer based on your best guess?

We estimated obviously internally, but we don't really have visibility beyond a quarter or two, so it's hard to really have that longer term visibility. But our comments and what we said is we think it's more short-term than a longer term type of issue.

Just one little quick follow-up. You called out this kind of softness in ROADMs, and then I think you called out subsequent to that China. Is that to say that your ROADM inventory adjustment is largely in the geography of China and the other markets around the world you're not seeing that inventory correction or it's pretty broad-based geographically?

What I meant to say is that we're seeing that pretty much across the face of the customers. It is more concentrated in several customers; but our business, our revenue actually grew in China quarter on quarter. So we're having -- seeing nice growth there, even though I think the deployment of networks in China has been somewhat tempered. So it would say that we're growing market share there and we have the right products that are needed for that specific customer base.

Thank you. Very helpful. Good luck.

Thanks.

Next question comes from the line of Nathan Johnsen with Pacific Crest Securities. Please proceed.

Thanks for taking my question. First, just on the competitive front, you guys have clearly seen a lot of gains in tunable XFP, but you have a couple of competitors that are ramping those products or at least expecting to ramp those products shortly. Just curious how JDSU plans to continue to differentiate with that product; and then secondly, you'd mentioned that during the March quarter that ASP reductions had been slightly lower than expected. Was wondering, with the inventory digestion phase if there was a risk of that ASP pressure ramping up? Thank you.

As far as the tunable FXP, we continue to come out with new versions and new models of the tunable XFP. We do have competitors that are talking about bringing the tunable XFP to market. We have not seen that in volume to this point. We're the only one out there shipping these products in volume and we continue to come out with new models and improve technology on the tunable XFP. So our goal is to continue to stay ahead of our competitors and we think we're doing a good job with that at this point. I'll turn the ASP question over to Dave.

As far as question on the ASPs, the level of ASP decline?

Yes, I'm just wondering if given that you saw relatively benign ASP environment in the March quarter if there was a risk of that increasing as you go through the inventory digestion phase.

Usually the March quarter has our highest ASP decline. Historically we go on a 2% to 4% range on a quarterly basis sequentially, and the March quarter is usually higher because we've just finished a large number of negotiations for products; but what happens then is what the mix of products are that we ship can affect how much of a decline we see.

So with our strong growth and our leading products such as the super blades and the tunable XFPs, we actually had an ASP decline that was lower than we had guided to in our last call. Because of that strength. So there's no reason to believe we shouldn't be in the what I'll call the typical range of 2% to 4% quarterly. That's what we -- in the seven years I've been here, that's what we typically do.

I think your one question on the build -- potential build-up of inventory, whether that could have more pressure on ASPs, I think that's always a possibility, but we haven't seen any real indications of that at this time.

And our annual contracts have been completed as of December, so pricing is basically set for a good number of our products for a period of time.

Your next question comes from the line of Troy Jensen with Piper Jaffray. Please proceed.

I'd also like to issue congratulations on a nice quarter, gentlemen. Quick question on the ROADMs here. I'd be curious to know if you could say whether or not you've been able to penetrate Wauwee for ROADM wins.

We don't talk about specific customers, but we have penetrated China with our ROADM product.

So do you feel, how about just more generically, do you feel you've penetrated Chinese OEMs effectively with your ROADM business?

Yes. Primary our ROADM sales would be into them.

Perfect. Just maybe an update on the 50 gig Hertz ROADMs.

Are you asking the volume or -- ?

Any color you can get on the traction, if you're willing to give kind of growth rates or just kind of any color on how that's been growing for you.

We did see growth quarter on quarter.

We saw growth in both our 50 and our 100. And the demand for those are based on the -- what solutions were being designed into and how the roll-outs are; but we did see growth in both our 50 gig and our 100 gig space, blind spacing products there.

Last question. Any update on the $100 bill program?

Yes, there's nothing official that has been released by the government yet, but we still continue to believe we're well positioned when they get back into the printing of the new $100 bill. And obviously we'll announce that as soon as we get the word on that.

Next question, please.

Next question comes from the line of Cobb Sadler with Catamount Advisors. Please proceed.

Okay. Thanks a lot for taking the question and good quarter also. I had a question on the AOT business. I think you guided for it to be down 2% to 4% and then the operating margins are in the 28% to 30% range if I have that right. That's down about 240 basis points quarter on quarter. Just kind of looking out over the last several quarters, those margins are really high; but they've come down just a little bit and was wondering whether to see how you're investing more there or whether it's pricing.

We did start about three or four quarters ago investing more to get higher growth because it is very profitable business so the investments do continue. And then part of it is the mix and we just asked about the $100 bill and that flex business does have some ebbs and flows based on when currency's being printed around the world. That usually brings the -- when we do see an uptick in that area, that usually brings additional gross margin and profitability to it.

Okay. Thanks a lot. A quick follow-up on the VMI. I believe you said 25% of revenue is through hubs or VMI situations. Where do you think that could go? I'm assuming like your Super Transport Blades and tunable XFPs won't be through a VMI if I have that correct. Where do you think that number could go?

As you saw in that 25%, historically we talked about it being 20%. We have more of our major customers interested in having VMI for certain products and so there's no reason to think that it couldn't get over 30%.

You can -- we do see VMI for things like Super Transport Blades as well. It's not restricted to individual components. It is available for integrated products as well.

Got it. Thanks very much.

Your next question comes from the line of Joel Achramowicz with Blaylock Robert and Vann. Please proceed.

Thank you for taking my question. Tom, I've asked this question, maybe some additional color on AOT. Looks like we'll probably have a year-over-year somewhat flat performance in that sector; but it's still very high margin business, which is exciting. But can you project out, maybe give us some color on the potential for year-over-year growth into 2011 and 2012 with regard to that sector?

Yes, we're not giving guidance out that far, but it is an area where we're investing and also looking at potential acquisitions to grow the business faster. It's traditionally grown let's say 5% to 6% and so it's not been a high growth business, but we -- our desire is to increase that percentage growth year on year. So we're investing both organically and some of the new developments we have going on inside as well as looking at what might be available on the outside.

So something you're definitely going to focus on?

It's definitely a focus. It's a challenge for the management team of AOT to continue to look at how can we pick up the growth rate in that area.

So we can watch that going forward. And one final follow-up with regard to components in the laser area. That's obviously a nice high margin business as well but it's a small contribution, but it is growing this year. Can you see -- do you expect to hopefully see additional secular growth in that sector?

Yes, I think for the commercial Lasers as we said we're just starting into kind of small preshipments on the kilowatt laser, the fiber kilowatt laser. That will pick up in the second half of this calendar year and then we see pretty strong demand there. We're into also developing the next generation of that. And then we also mentioned the pulse laser, fiber lasers which will be more for the micro machining; and I think if you look at that market and you see some of the announcements out there in the market, that part of the market's very strong. So that we -- we had originally given estimates that we think that getting into the fiber laser business, both the kilowatt and the pulse, would increase our market -- available market by 3X where it was previously and we're just now starting to get into that with the kilowatt shipments. S we believe that's still there and that could be a pretty nice growth area for us. We did have very nice gross margins there and we continue to improve the gross margins in that area, and I would believe with increased volumes that that would help us there as well.

Well, that's it for my questions. Good luck.

Thanks, Joel.

That's the time period today for the Q&A session. I would now like to hand the conference back over to Mr. Tom Waechter for any closing comments.

Thank you, operator. As our call concludes I have some final comments. JDSU delivered strong third quarter results with solid financial performance and market share gains. I am bullish on continued long-term growth opportunities for JDSU.

While the Optical Communications business is seeing a slowdown in demand, we believe the end market drivers remain strong and the inventory adjustments will have a near term impact only. We expect broadband infrastructure growth to continue based on demand from bandwidth intensive applications. We are well positioned with our portfolio of products. We will continue to invest in R&D to take advantage of the opportunities in front of us. I believe this investment will further the advancement of our operating performance.

In closing, I would like to thank our employees for their hard work and dedication. None of this would be possible without their continued focus, commitment, and their contributions. I would also hike to thank our customers, partners, vendors, and long-term shareholders for their continued support of JDSU.

Thank you again for taking the time to join us on this earnings call. We appreciate your interest in JDSU. Have a good evening.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect your lines. Good day.