JDS Uniphase's CEO Discusses Q1 2012 Results - Earnings Call Transcript

 |  About: Viavi Solutions Inc. (VIAV)
by: SA Transcripts

JDS Uniphase (JDSU) Q1 2012 Earnings Call November 1, 2011 5:00 PM ET


Good day, ladies and gentlemen, and welcome to the First Quarter 2012 JDS Uniphase Corporation's Earnings Conference Call. My name is Erin, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I will now turn the presentation over to your host for today's conference, Ms. Michelle Schwartz, Senior Director of Investor Relations. Please proceed, ma'am.

Michelle Levine Schwartz

Thank you, operator, and welcome to JDSU's Fiscal 2012 First 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 30, 2011. 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 the 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, supplementary 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 Investors section of our website. I would now like to turn the call over to Tom.

Thomas H. Waechter

Thank you, Michelle, and good afternoon, everyone. JDSU delivered first quarter revenue of $421.1 million, at the high end of our guidance range. Gross margins for the quarter improved from the prior quarter despite lower revenues. Operating expenses declined by over $9 million due to stringent cost controls, resulting in an operating margin of 10.9%, which exceeded our guidance range.

In fiscal Q1, new product revenue remains strong, with 67% of Optical Communications revenue and 56% of CommTest revenue being generated from products less than 2 years old. Additionally, our financial strength continued to provide us with the necessary capital to fund our robust new product pipeline, as cash generated from operations totaled $22.9 million.

On our last call, I highlighted that we expect some short-term revenue volatility due to uncertainty in the macro environment, and that optical customers were reducing their on-hand inventory levels. I'd like to provide an update on these topics, as well as some clarity on the impact with the recent flooding in Thailand.

Significant improvements in our optical customers' inventory levels have been made over the past 6 months. Q1 bookings for some of our key optical products were very encouraging. ROADM bookings were up nearly 25% from last quarter, and were the highest level in the last 3 quarters. Our tunable XFP bookings were up 70% from the prior quarter. 7 out of 12 product lines saw their bookings increase on a sequential basis.

Turning to the situation in Thailand, the floods have created a great deal of hardship on the Thai people, the infrastructure and the ability to do business in the affected areas. I am happy to report that all the JDSU employees in Thailand are safe but many of them have been displaced from their homes due to the flooding. We are doing what we can to help them through this situation.

As for the impact on our business, I'm happy to say that our equipment is safe and dry at this point. The water level at the Pinehurst, Fabrinet facility has been steadily subsiding, and over the past week has dropped by several inches, which is encouraging. Fabrinet has reported that power has been restored to the Pinehurst facilities, and that the equipment is being readied for production.

We are also executing some of our contingency plans in an effort to maximize output to satisfy our customers' top priorities. The timing of achieving full production is still not certain, as water levels are still causing challenges with the infrastructure in the area, but we are very encouraged by the events of the past several days and expect to have some level of production within the next week or 2. While there are a number of logistical challenges, we have been able to ship some existing finished goods to our customers. Dave will talk more about the Thailand situation, when he updates you on our guidance shortly.

Moving on to demand for our products. Broadband drivers remain strong, however, the macro economic environment remains challenging and recent indicators have become more volatile since our last call. As a result, we are seeing our service provider customers implement lengthier CapEx approval processes, and we now expect little to no budget flush in the December quarter.

We cannot predict exactly how long the current macro economic conditions will impact our revenues or when the Fabrinet, Pinehurst facility in Thailand will be back in full production. At the same time, given the healthy underlying fundamentals of our business, we remain focused on meeting our customers needs, profitability, and cash flow generation while continuing to invest in R&D and new products that will further differentiate us in our markets.

I'll now hand the call over to Dave, who will take you through the details of our financial performance in fiscal Q1, and will discuss our outlook for Q2. Following Dave's remarks, I will provide more details on our results, the trends we are seeing, and our strategy moving forward.

David Vellequette

Thank you, Tom. Before I start, please note that all numbers are non-GAAP, unless I state otherwise.

First quarter revenue of $421.1 million was down 10.8% from the prior quarter, and up 2.4% when compared to the first quarter of fiscal 2011. Revenues declined sequentially in each of our business segments as expected. Book-to-bill for lasers was approximately 1. CommTest, Optical Communications, and AOT book-to-bill were each less than 1. Book-to-bill for the total company was also below 1.

The first quarter's gross margin was 47.3% of revenue, up from the previous quarter's gross margin of 46.7% and relatively flat with first quarter fiscal 2011's gross margin. The sequential increase in gross margin was primarily due to segment mix and improved CommTest gross margins. Operating expenses for the first quarter of $152.9 million was down from the prior quarter's $162.3 million, primarily due to lower headcount in CommTest, a direct result of the previously announced restructuring activities and lower corporate spending.

The first quarter operating margin for the company was 10.9%, up from 10.8% for the year ago period, due to lower operating expenses as a percentage of revenue. Net income for the quarter was $40.9 million or $0.18 per share, which compares to $53.9 million or $0.23 per share for the prior fiscal quarter, and to $44.8 million or $0.20 per share for the year ago period.

The year ago period benefited from a favorable tax provision. A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. Our non-GAAP operating income excludes, among other items, amortization of acquired technology and other intangibles of $21.2 million, an $11.6 million charge for stock-based compensation, and a $7.4 million accrual for a legal dispute.

Including the noted items, the fiscal first quarter 2012 GAAP net loss was $5.8 million or a loss of $0.03 per share, which compares to a prior year first quarter GAAP net income of approximately $100,000, or break even earnings per share. Now looking at quarterly revenue by region.

Americas revenue of $212.4 million or 50% of total revenue was down $17.7 million from the prior quarter. The decrease was due primarily to CommTest experiencing lower demand due to macroeconomic conditions and typical summer seasonality.

EMEA revenue of $101 million, or 24% of total revenue, was down $21.5 million compared to the prior quarter due primarily to seasonal demand in CommTest and inventory adjustments in Optical Communications business. Asia-Pacific revenue was $107.7 million or 26% of total revenue, down $12 million from the prior quarter. An increase in AOT and laser revenues was offset by a slight decline in CommTest revenue, as well as a decline in Optical Communications revenue, primarily driven by lower demand for gesture recognition components.

Moving to the segments. First to the CCOP segment. Total CCOP revenue was $180.3 million, down 10.9% from the prior quarter and within our guidance of down 10% to 13%. Gross margin was 32.3% and operating income was $25.6 million or 14.2% of revenue. The decline in operating profit was primarily due to lower optical revenue and gross margin. Geographically, our optical business saw strength in the Americas and a decline in Europe and Asia, whereas lasers saw a decline in the Americas, with solid growth in Asia and a slight increase in Europe.

Optical Communications revenue in fiscal Q1 was $150.1 million, down 14% when compared to the previous quarter's revenue and up 5% when compared to the prior year. 6 out of 12 product lines grew sequentially, including our pluggable products for LAN/SAN application. As expected, gesture recognition revenue declined to less than 2% of total JDSU revenue and accounted for more than 50% of the sequential decline in optical revenue.

Revenue for ROADMs and tunable XFPs declined, primarily due to customer inventory correction. Quarterly ASP decline was 2.7%, which was below the midpoint of our historical range of 2% to 4% sequentially.

Gross margin for the quarter was 28.8%, down from the prior quarter's 31.1% and just below our target range of 30% to 35%. Gross margins declined due to product mix and lower volumes. Product lead times during the quarter were 4 to 6 weeks for the majority of our optical products, allowing our customers to respond better to their customer requirements.

We anticipate that lead times for our Fabrinet assembled products, due to the complications from the flooding, will be extended during Q2. This includes our ROADMs, our tunable XFPs, some of our amplifiers, and some of our other low volume products.

In our lasers business, which includes not only Commercial Lasers, but also our photovoltaic business, first quarter revenue of $30.2 million was up 8.6% compared to the prior quarter, and up 20.8% compared to the prior year due to strength in our Q series solid state lasers, our CPV solar cells, and our recently introduced, 4 kW fiber laser. We recognized approximately $2 million of revenue from our kilowatt fiber laser in the quarter. Gross margins were 49.3%, up from the prior quarter, primarily due to growth in our solid-state lasers.

As a reminder, the majority of our commercial laser products are manufactured at Fabrinet in Thailand and is subject to supply chain disruption due to the flooding.

Finally, our targeted CCOP operating margins of 16% to 20% when revenues are above $190 million.

Now moving on to our CommTest segment. Fiscal Q1 revenue of $185.2 million was down 12.4% from the prior quarter's revenue due to macroeconomic conditions and typical summer seasonality. On a year-over-year basis, first quarter revenue was up 1.3%. On a sequential basis, each geographic region saw revenues decline, except Latin America, which had a slight increase.

Fiscal Q1 gross margin for CommTest was 61.9%, which compares to a gross margin of 59.3% for the previous quarter and 60.7% for the year ago quarter. Gross margin improvement was mainly driven by favorable product mix, as 56% of CommTest revenue came from products introduced in the last 2 years.

CommTest operating profit was $24.1 million or 13% of revenue, which compares to $21.7 million or 11.9% of revenue in the prior year. The higher operating margin was driven by higher gross margin. Our targeted CommTest operating model is for operating margins of 20% to 23% when revenues are greater than $215 million in gross margins are at or above the higher end of the 57% to 61% targeted range.

For the advanced optical technologies or AOT segment, fiscal Q1 revenue was $55.6 million, down 5.3% when compared to the prior quarter due to a decline in demand for our currency, transaction card, and gesture recognition products. As previously noted, demand for currency products will fluctuate according to the level of bank note printing. Fiscal Q1 gross margin for AOT business was 47.1%, down from 49.4% in the prior quarter due to volumes and product mix.

AOT operating profit for the quarter was $17.5 million or 31.5% of revenue, down from 34.1% for the prior quarter due to the lower gross margin. The AOT target operating model is for operating margins of 32% to 35% when quarterly revenue is greater than $55 million.

As a reminder, JDSU's total company targeted operating margin range is 14% to 17% when quarterly revenues for the company are $460 million or greater and gross margins are 49% or higher.

Moving to the balance sheet. For fiscal Q1 2012, the company generated $22.9 million of cash from operations. Capital expenditures totaled $21.2 million, and at the end of fiscal Q1, the company held over $723.3 million in total cash and investments. Headcount as of October 1, 2011 was 4,929.

Now to our Q2 guidance. First, some points to consider as you think about our financial performance over the coming quarter. Based on our current visibility, we expect below normal seasonal revenue levels in CommTest, due to continued weak demand from EMEA service providers, and lower demand from Americas service providers, including little to no end of year budget flush. Therefore, we expect CommTest revenue to be flat to up 4% from the previous quarter. AOT revenues are also expected to be flat to up 4% sequentially.

For CCOP, we believe that the September quarter would have been the low point in revenue for the fiscal year, had the Thailand flooding not occurred. As we saw in the quarter, customer inventory levels during Q1 reduced to more targeted levels combined with stronger bookings. Without the impact of flooding in Thailand, we believe our Q2 CCOP revenue guidance would have been a sequential growth in the low to mid single-digit percent.

Given the current conditions in Thailand and the uncertainty of the ramp to full production, our revenue guidance for Q2 is for a sequential reduction of 15% to 25% from Q1. The 25% number being driven by an assumption of continued challenges in Thailand, and a slow and gradual return to production.

While we are implementing our contingency plans and are encouraged by the events over the past week in Thailand, we cannot be assured that our plans will be successful, or the rate at which production will ramp, which leads us to this wide guidance range. This guidance estimates a $35 million to $45 million revenue impact due to the flood.

The company's operating expenses for Q2 are expected to increase by less than $5 million sequentially, primarily due to our annual employee merit increase and certain R&D investment activity. Now looking at operating margins for the segments.

CommTest operating margins are estimated to be between 12.5% and 14.5%. AOT operating margins are expected to be between 30% and 32%, and CCOP operating margins, due to the wider revenue range and incremental costs being incurred to attempt to bring production back on, are expected to be between 3% and 7%.

Axis, interest, and other income are expected to result in a net expense of $4 million to $6 million. Share count for calculating EPS is expected to be approximately 234 million shares. Capital equipment purchases will be approximately 5% of revenue. Given the current macro economic conditions and the impact on our CCOP business from the Thailand flooding, we are providing a broader guidance range for the December quarter.

Taking into consideration the factors above, we expect second quarter revenue to be between $375 million and $405 million, and our non-GAAP operating margin to be between 5.5% and 8.5%. I will now turn the call back to Tom.

Thomas H. Waechter

Thanks, Dave. I will now provide fiscal Q1 highlights from each of our business segments. I will start with the CCOP segment, first Optical Communications. Innovation remains robust as we saw 67% of revenue from products less than 2 years old. ROADMs were 28% of optical revenue with strong booking. Book-to-bill was nearly 1, following 3 consecutive quarters of book-to-bill less than 1, due to the inventory build up.

During the quarter, Infonetics identified JDSU as the leading provider of ROADM products for the first half of the calendar year at over 50% market share as we took significant share from a major competitor. In Q1, we also secured an increase in share at a major customer for our 50 gigahertz ROADM, expanding our leadership position into the second half of fiscal year '12.

Tunable XFP revenue was 10% of optical revenue. Bookings were up 70% quarter-over-quarter and book-to-bill was over 1. Super Transport Blade revenues were up 18% and bookings increased by 28% quarter-over-quarter. 40G demand continues to gain momentum as we are winning new slots at the component level, and with our new 40G module. In the second half of FY '12, we will launch our coherent 40G solution line-side module, and additional 40G client-side solutions to add to our existing portfolio.

100G design activity is also strong, and customers are engaging with us on new partnerships. In Q1, we increased our shipments of 100G coherent receivers and coherent modulators, and made significant progress in the development of our 100G coherent solutions and client-side solutions. Our vertical integration of 100G components provides us with a competitive advantage as we develop and introduce our 100G module solution. As we introduce these products over the next several quarters, we will provide additional updates.

For 40G and 100G applications, we currently have 18 design wins and 39 more in process with 20 customers. We continue to focus on our Optical Communications technology leadership with the development of new products. During the quarter, we announced a new suite of 5 products to be rolled out in the second half of calendar 2012, critical to the buildout of next-generation optical networks, or what we are referring to as self-aware networks.

Self-aware networks are needed to support the growing volume of high-bandwidth and unpredictable traffic, and require new architecture and a new set of compact, high-performance, and cost-effective components. Our development of this product suite is based on several years of collaboration with customers to understand the requirements of next-generation networks. Included in this product portfolio is our twin WSS product, 2 independent, 1x20 WSSs integrated into a compact form factor. This co-packaging saves space and cost for the customer, and can support the needed colorless, directionless, and contentionless capabilities.

Now turning to our lasers business. In fiscal Q1, we achieved the highest revenue for this business in over 2 years. The growth is due to strength in solar, Q Series solid-state lasers and high-power fiber lasers for macromachining application. We are currently developing a second-generation suite of kilowatt fiber lasers with Amada due to strong end customer interest. We are also developing a fiber-based class of pulse lasers, which is expected to ship during the second half of calendar 2012.

Now the CommTest segment. CommTest performance for Q1 reflects solid operational progress evidenced by improved gross margins at 61.9% and lower operating expenses despite a softer spending environment as carriers are becoming more cautious with CapEx spending. Q1 revenue from products less than 2 years old represents 56% of total revenue, as we continue to collaborate closely with customers to bring innovation to the market.

Macroeconomic conditions in Europe and North America are causing increased scrutiny of orders and delays in placement, but the fundamental demand for more bandwidth, access and quality improvement continue to grow. Asia-Pacific and Latin America are investing aggressively. Although we are seeing China starting to moderate the rate of build out, investment levels remain healthy. Bookings from high-growth markets increased 18% year-over-year, with strength in Brazil, China, Indonesia and Korea.

This quarter, we saw our customers spend more on access to support service activations for millions of new mobile, cable, and IPTV subscribers, as well as business ethernet deployments that push out our more discretionary spending for metro projects, and continued spending to upgrade the core to 100G to support the huge increases in content-heavy traffic.

On the access side, we are seeing momentum in our newly released HST module that test Bonded VDSL2/ADSL2 to support IPTV testing. Also, our investment in the T-BERD MTS-5800 is being well-accepted in high-growth markets, proving our success in developing products for these markets.

Our Fiber business, recognized by Frost & Sullivan as the worldwide leader in fiber test, launched 5 new products during the quarter to support 14% year-on-year revenue growth. As carriers cope with increasing bandwidth demand, we continue to see strong traction for 100G test, shipping 26 units to 15 customers during the quarter.

100G revenue in Q1 was up 41% year-on-year, and 11% sequentially. In the cable market, Infonetics projections for DOCSIS 3.0 deployment indicates 60% compounded annual growth rate for 2010 through 2015 for cable market subscribers. We saw strong year-over-year growth for our PathTrak product, and expect continued growth as DOCSIS 3.0 is deployed.

Our products are being recognized in the industry for their technology leadership. JDSU was honored with Frost & Sullivan's 2011 Global Customer Value Enhancement Award for JDSU's market-leading xDSL test solutions used by service providers worldwide to provide high-quality broadband services. Finally, JDSU earned high marks in Broadband Technology Reports' 2011 Diamond Technology Reviews for the roll our products play in ensuring customer quality for advanced broadband service deployment.

During the quarter, we had 10 new product launches. Key launches of note are as follows: In fiber-optic, we launched ONMSi for remote fiber optic testing that allows service providers to achieve 30% less downtime by using our technology during troubleshooting than with conventional methods.

We also introduced a new drive test solution for LTE test capabilities, which expands the range of LTE networks and equipment tested, allowing service providers to test with a single tool. We also introduced a new release of our award-winning smart protocol analyzer, this release brings enhanced LTE and 3G testing capabilities to help manufacturers develop LTE products faster, and service providers to build out networks more quickly, and operate them more effectively.

Lastly, we introduced the first optical transport network multichannel test solution for 10G, 40G, and 100G networks. This solution enables service providers to accelerate the development and deployment of high-speed OTN based equipment for more cost effective transmission of high-bandwidth traffic.

We will continue to support our customers' requirements and invest in R&D to keep our innovation pipeline strong to support test in major minutes with 3G and LTE mobility, video, IPTV, and broadband deployment.

Now onto our remaining segment, advanced optical technologies or AOT. Revenues for the quarter were impacted by the slowing global economy, especially in the currency and transaction part. We continued to invest in the growth of this highly profitable business, including the upgrade of our production capability and prevalent technology platforms to more efficiently produce security threat product, expected to come online in fiscal Q2.

We are also increasing our production capacity to serve ramping demand of security pigment. This capacity addition is on plan and is scheduled to be commissioned by the end of fiscal Q4. Both of these capital investments support the demand forecast from our banknote and security customer. We also continue to focus on 3D glasses and projector color wheels as growth drivers for this segment. Applications include cinema, 3D rides at theme parks, and education.

Operator, we'll now take questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Nathan Johnsen from Pacific Crest Securities.

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

Two quick ones. One, just in looking at the bookings spike in optical, I was wondering what if any of that bookings spike be attributed to customer behavior associated with concern surrounding the flooding in Thailand. And then secondly, you guys have highlighted the self-aware networks and then clearly an area of differentiation for you. I was curious how many competitors you guys see as having the necessary components to follow you guys into that demand?

Thomas H. Waechter

Maybe to address your first question regarding the uptick we saw in optical bookings for the quarter. The bookings really were recorded before any knowledge of the Thailand flooding or any impacts from Thailand's flooding were identified. So I would say there really wasn't any anticipation or any impact from those. So healthy bookings in the quarter. I think as far as the self-aware networks, we do expect competitors to be out there. But as we've demonstrated, I think on some of our recent technologies, we plan to jump out ahead in this area and lead from a technology standpoint to solve our customers' needs in this area.

David Vellequette

I think additional color is to the first 4 weeks of this quarter, we saw orders in the optical space also coming in at a slightly higher rate than the previous quarter through the first 4 weeks. So that's why we are encouraged with the statement we made about September being what we thought would be low, if it wasn't for the floods in Thailand.

Nathan Johnsen - Pacific Crest Securities, Inc., Research Division

One last thing from me, just on the gross margin line. Any potential implications just typically having to scramble to meet demand, particularly with the constraints that you guys are dealing with, can have a persistent headwind to gross margin. Do you guys anticipate gross margins to be under pressure for optical through any period of time passes or...

David Vellequette

As far as -- so if you exclude the Thailand impact, just normal course of business, I think, we think we'll see our normal -- we're going through the contract negotiations now. Over the year, we see a typical 2% to 4% impact from ASPs, but we don't see any unusual gross margin impact on the business.


And your next question comes from the line of Alex Henderson from Miller Tabak.

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

If we could just delve into a couple of those issues a little bit more detail would be helpful. First, the negotiation on pricing I would assume is going on as we speak, relative to the price adjustments that are typically made January 1. So is there going to be any adjustment to those price discussions that would impact the rate of change in pricing in the first quarter of next year or into the second quarter because of the tightness on supply as a result of the flooding? And second I know it's almost impossible to get your arms around the timing of when you're going to get that facility back up, but would you expect the costs associated with bringing the facility back up in Thailand to be a cost that increases beyond the December quarter and continues to impact you into the first quarter, or will those lines be up and running by the end of the year and therefore no incremental pressure? And conversely would you get that revenue back that you lost in the December quarter, in the first quarter, in a nonseasonal fashion as they make up for the lost orders in 1Q, or in the December quarter. I know that's a lot of material but it's all related.

David Vellequette

Let me see. This is Dave. Let me see if I can work on that. One, as you may recall, before when we had shortages of supply, we noted that the customers don't really tolerate inappropriate pricing behavior so we don't expect the prices to change dramatically from what's being negotiated now just because of the floods in Thailand. Second, with regards to the carryover of any revenue, we believe there will be some carryover of revenue. At the same time, as our customers will be looking for other folks that can meet their immediate needs, so that portion could potentially be diverted elsewhere and so it will really be a factor of how quickly we bring the revenue or the production lines back on track. As we noted in the call, as you asked about the costs rolling into December, we believe we can get the factory from what we know right now, to a higher level of production. Obviously, we'll have much more information week by week, and we expect by the end of the quarter, we'd be ramped up to full production, provided there are no other logistic issues that get -- that interfere with that. So I think we're in sort of a wait and see to see if we can get back to full production. That's why we gave that range, but we certainly anticipate we will get to full production by the end of the quarter.


And your next question comes from the line of William Stein from Crédit Suisse.

William Stein - Crédit Suisse AG, Research Division

If we can delve into the Thai flood just a little more, if you can comment on how you're seeing customers react. We saw post the Japan earthquake and tsunami, we saw customers try to pull in as many component orders as possible. Are you seeing any of that behavior? And also related to that, how do you expect to adjust your supply chain going forward as it relates to other contract manufacturers in addition to Fabrinet? And as a follow-up, I wanted to ask in the CommTest business, whether there was a pull in from Q4 into Q3, like we saw with one of your competitors.

Thomas H. Waechter

I think as far as the first question around flooding in Thailand. First of all, our customers are trying to get clarity, obviously, as to when we're going to be back up and running. We did note in our earnings call that we were able to ship some finished goods that were already completed, so that's I think helping with some of the immediate customer needs. But I think primarily, they want to get clarity and see what type of contingency planning they might need to make during this period of time. I haven't seen any kind of what I'd call abnormal behavior. I think everybody's being rational at this point and just trying to understand the facts and we're providing those on a daily -- updates on a daily basis, and being very transparent with our customers so they can do the best they can to meet their end customers needs. I'm not sure on the CommTest statement, if you could just repeat that question on the pull in?

William Stein - Crédit Suisse AG, Research Division

So one of your competitors in the CommTest service assurance space talked about earlier than expected rev rec in calendar Q3 that they previously expected to happen in Q4 in North America in particular. Did you see any of that? Is that at all part of what's driving the below seasonal outlook or the no budget flush for you for calendar Q4 for that business? And is that a view based on kind of what you see in backlog now or is this just a matter of kind of being conservative relative to the macro?

Thomas H. Waechter

I think -- and to answer your question, at calendar Q3, we didn't see really any pulling of Q4 orders that we're aware of, nothing significant. So I don't think that's not impacting Q4. I think Q4 is primarily knowing what the macroeconomic climate is now. Look at some of the larger carriers and what they've announced as far as spending and how that's proportioned out in the year, gives us the inclination that Q4 is going to not have robust budget flush and be slower than what we normally see in the December quarter. I think Europe's been soft for a number of quarters and we're starting to see a bit of that more hesitancy in North America on the spending.

David Vellequette

And the lengthier, as we noted on the call, the lengthier approval cycles that appear to be getting implemented by the carriers.


And your next question comes from the line of Subu Subrahmanyan from Sanders Morris.

Natarajan Subu Subrahmanyan

I have some follow-up questions on the Optical Comm side as well. Dave, could you talk about what the level of exposure is from the revenue perspective to Fabrinet if you could quantify that? And I'm just trying to understand between having almost had a month of production in the current quarter, some finished goods, what the assumption is for the range of revenue impact, $35 million versus $45 million, I assume that the Pinehurst facility does not come back at all during the course of the quarter? And then I know you're not guiding to March, but directionally, should we expect revenues for Optical Comm to be back to a normalized level in the March quarter? Or could this be a multi-quarter impact?

David Vellequette

You asked the question about how much revenue we do out of Fabrinet. And as we said, our Commercial Lasers are done out of there, plus the ROADMs and tunable XFPs and some of our amps. So if you take just those numbers, you can see that it can affect greater than or right around approximately 50% of the revenue that we reported last quarter. Now obviously that's what goes through Fabrinet, not all of that is impacted by the events that are occurring and that's what we've basically contemplated in the guidance we gave. And on the $35 million to $45 million on that question that's just basically looking at what we know right now and basically ranging it as I stated in the guidance at what rate we can bring back on the production. We didn't really talk about at this point how that is by product line because we're assessing at what rate each of the factories is coming up in the product line.

Natarajan Subu Subrahmanyan

Is it fair to say though you expect, both of those, expect some production starting to happen in the current quarter? Or does the $45 million not assume any recovery at all with production in the current quarter?

Thomas H. Waechter

We're expecting a level of production. It's really just a matter of how much production, right? So if we had, had assumed zero production for the quarter from this point on, the range would have been greater.

Natarajan Subu Subrahmanyan

And for March, would you expect to be back to a steady run rate, meaning the $150 million you did last quarter, plus or minus a little bit back to the March quarter level?

David Vellequette

Again, the visibility is pretty limited right now and I think that right now, our focus is on getting the production back online for this quarter. And as we get better visibility into that, we'll be able to get a better focus on what the opportunity is for the March quarter.


Your next question comes from the line of Todd Kaufman from Raymond James.

Todd Kaufman - Raymond James

Steve, can I just get a clarification on that last question? You said 50% of CCOP comes through Fabrinet, and is that all coming through only historically this Pinehurst facility?

David Vellequette

We're only in the Pinehurst facility in a number of buildings there. I believe it's 2 different buildings that are in Pinehurst. I think there's 3 total buildings there at Pinehurst. And yes, we've basically said the Commercial Lasers are manufactured there, ROADMs and our tunable XFPs and if you just look at the numbers, which we disclosed there, you can see that it's roughly 50% of the revenue that we did in the last quarter.

Todd Kaufman - Raymond James

So it looks like you're guiding down, I don't know, $45 million sequentially. It would seem as though if there's extended difficulties with those facilities that there's additional revenue at risk if those facilities did not get back online.

David Vellequette

The range we gave is what we believe the revenue that -- the risk is if they don't come online at all, again, in our projection is that we will get a level of production out of those facilities.

Todd Kaufman - Raymond James

So assuming there's more difficulty and extends further, you would not be able to do the $150 million in CCOP revenue and the December quarter would be something even worse than that?

David Vellequette

We're not assuming that. We're just, like we said, we're assuming that we'll get a level of production out of those facilities and as I said with Subu that if we had assumed that we'd get nothing out of the facilities, we would have given a different range.

Todd Kaufman - Raymond James

Can I just ask a quick follow-up to this, as it relates the competitive landscape, are you significantly disadvantaged relative to some of your competitors in these product areas, who maybe in the same product areas sourcing from different contract manufacturers, or is everyone in the same boat?

Thomas H. Waechter

I would say the majority of our competitors get some level of products out of Thailand. So there's 4 of us probably that are in a somewhat similar situation. One of our competitors has a manufacturing outside of Thailand that probably puts them at, short-term, in a better situation on some of these products.

David Vellequette

There's a number of factors there. Are they also qualified in the same slots that we're qualified in? What are the inventory levels of the customer? So that question is, there's no single answer to that question. There's a number of factors that have to be taken into consideration. I think right now, what we can give you is how we think it's going to impact us.


[Operator Instructions] Your next question comes from the line of Kevin Dennean from Citi.

Kevin J. Dennean - Citigroup Inc, Research Division

Tom or Dave, I'm just wondering if you could talk a little bit about CommTest, it was down seasonally. But could you talk a little bit about how the various pieces performed, in other words, field tests, lab equipment service assurance, and even wireless?

Thomas H. Waechter

Sure. I think as far as field test, it remained reasonably strong during the quarter. That's always a strong point for us. We talked about fiber test being up and being strong quarter-after-quarter and year-over-year. So I think that has held up pretty well. I think lab, on the lab side, as I mentioned, we're continuing to see significant orders from the 100G test equipment so that continues to expand and to grow. I would say service assurance, we continue to focus on an area, a growth area but still remains a smaller part of our total revenue. So I would say that did not grow significantly during the quarter.

Kevin J. Dennean - Citigroup Inc, Research Division

And just one more quick one, and maybe its for both you and Dave. If you could update us on your thoughts around M&A, you've got a healthy cash position, you're generating solid operating cash flows. And valuations in the sector have obviously come way in. At this point in time, or maybe once we get a little bit more clarity on Thailand, and that starts to resolve itself, how should we judge your appetite for M&A, increased, flat, the same? And should we think about the priorities in M&A, still being CommTest, even though component value, optical component valuations have really gotten depressed?

Thomas H. Waechter

I think M&A remains one of our top priorities for our use of our cash, that and investing into innovation for R&D. So that continues to be at the top of the list. We do see a number of opportunities out there. Valuations have pulled in so with some of the uncertainties in the market, et cetera. So we do see a number of opportunities out there that are interesting. I would say because of the fragmented nature of the CommTest market and the areas of -- that we see to be able to continue to build out in places like wireless and the LTE deployment, it does offer a number of opportunities for us that are pretty visible at this point. It doesn't mean we're not looking in the other 2 parts of our business, but I would say that there are -- tend to be more of those kind of opportunities in CommTest because of what I just mentioned.


Your next question comes from the line of Ehud Gelblum form Morgan Stanley.

Kimberly Watkins - Morgan Stanley, Research Division

This is Kim Watkins in for Ehud today. Just had two questions. First on -- I believe that Fabrinet has a new building coming online. I'm just curious if you've entered into any discussions with them of potentially using that building at all to increase your capacity at the Fabrinet site? And secondly, are there any markets leading JDSU to possibly benefit assuming that manufacturing comes on again towards the end of the quarter, perhaps amplifiers kind of come to mind, but are there any others where you could possibly benefit from other competitors having lengthier production limits?

Thomas H. Waechter

Fabrinet is in the process of building a new building, just really adjacent to the main facility or 2 main facilities we're in on the Pinehurst campus. So that is a potential area for expansion of capacity into the future and that was one of the reasons for them bringing that facility on. I think as far as opportunities that may come out of this, out of the flooding conditions in Thailand, there are the potential for some opportunities where we're manufacturing in other locations certain products that some of our competitors will probably be down, not able to produce for a while. So right now, it's I think a little hard to say what the size of that opportunity is, but we do think there are some opportunities out there to fill some of those voids.

Kimberly Watkins - Morgan Stanley, Research Division

So Tom, just to clarify the first one, is there any opportunity for you to use the new building fix to get back online faster?

Thomas H. Waechter

I don't think it's completely -- I don't think the building is completely fitted out at this point. So I think the main focus is going to be on getting the 2 buildings up on the Pinehurst campus that we're in. So I don't see that as a potential today. That hasn't come up as an area where we could get ourselves going faster.


Your next question comes from the line of Cobb Sadler from Catamount Advisers.

Cobb H. Sadler - Catamount Strategic Advisors LLC

I had a question on the CCOP business and your XFP tunables, if I did the math correctly, look to be down pretty strong quarter-on-quarter. ROADMs look to be down a little bit also, but the bookings were really strong. And I understand that you do both the -- you manufacture both of them in Thailand. So how does all that shake out? I mean with the bookings strong, are you going to be able to deliver, given they're manufactured in Thailand?

David Vellequette

So again as I said, the lasers, the tunables, the ROADMs and the amps, those are all impacted by the Thailand situation. And so as we bring the production online, those 2 buildings are impacted that's what they build. And that's what we basically contemplated in the guidance. So we're expecting it to be impacted obviously. And so you would assume that the revenue levels for those products would be down from the quarter we just reported just based on the impact that we talked about. So again, where there's not very many suppliers of the tunable XFPs out there, so we're working with our customers. And on the ROADMs, again comes down to the products that you're designed into if there's a competitor or not, and we're working with our customers again to meet their needs.


And your next question comes from the line of Mark Sue from RBC Capital.

Mark Sue - RBC Capital Markets, LLC, Research Division

Tom, in Optical, if competitors are qualified and they don't rely on Thailand, it sounds like they will gain share in the near-term, but why would that revert longer term? Are customers telling you that they're holding a spot in line for you when things get back to normal?

Thomas H. Waechter

In some cases, we do have contracts with our customers that would give us those opportunities back even though they may, we may be displaced over the short term. In fact, what you just said, happened so that's 1 factor and then I think it also comes down to past performance, quality, delivery, service, total service to the customer. And we think we rank very high with most of our customers in those areas. So if we do get displaced in the short-term, well, we're going to work really hard to get that back and in some cases we're covered contractually once we're back online.

David Vellequette

And the other thing to consider is with this situation in Thailand, other suppliers to our customers could be impacted, which then could affect their total capability of building the end product, which would include our products. I think our customers are still figuring out what those other impacts are.


And your next question comes from the line of Troy Jensen from Piper Jaffray.

Troy D. Jensen - Piper Jaffray Companies, Research Division

Just curious to know if any of the products coming out of the Fabrinet facilities, would they need to be recertified now with customers?

Thomas H. Waechter

No, we don't -- as far as we know, we haven't seen that dialogue with any of the customers. Because we're not going the change the process. We're not changing equipment. In fact, they have all the operators back.

David Vellequette

The facility was dry, so it's really -- it's almost as if they just had a temporary shutdown because there was no breach of the clean rooms.


And your next question comes from the line of Ajit Pai from Stifel, Nicolaus.

Ajit Pai - Stifel, Nicolaus & Co., Inc., Research Division

Just a question on your gross margins and then on your laser business. Your Test and Measurement business had gross margins that were above your target range. So is that reflective of something that could continue, so you'd raise your target range for that business? And then on your laser side, you also had probably the best gross margin we have had since you started providing us some color there. And also a record quarter for revenue when I go back and look that business. So I know you're including photovoltaic products within that, but is that really a record quarter since you started breaking that out? And can we expect the growth over there to continue?

Thomas H. Waechter

I think in lasers we believe it's at least the best quarter we've had in 2 years, so probably since we -- it's pretty close to when we were breaking it out. So I think that's the case. I think lasers -- it's mix, and also the kilowatt fiber laser is being well-received in the field with a modest customer base. I think from a CommTest standpoint of gross margin, that's an area as you know we've been working real hard on bringing that business model up. The mix of new products has continued to grow, 57%, I believe it was this past quarter so it continues to grow pushing well above 50%. I think we're also gaining efficiencies with our outsourced partners through the supply chain now, where we had talked about refining that flow and that process and it's starting to happen. So as far as your question, are we going to move the range up? Not at this point, but we are hitting now pretty consistently above 60% and above the high end of our range.


I will now turn the call over to Tom Waechter for closing remarks.

Thomas H. Waechter

Thanks, operator. As our call concludes, I have some final comments. I'm pleased with the progress JDSU continues to make to further our operating model. This quarter, we improved our gross margins through new product revenue and leveraging our contract manufacturer model.

Our flow of new product introductions has been strong, and we continue to innovate through collaboration with our customers. While the macroeconomic environment and the flooding in Thailand have created a challenging environment in the short to medium term, the underlying fundamentals of our business remain healthy. We remain focused on executing our strategy to address the market trends of broadband demand, focusing on profitability and cash flow generation, while we continue to invest in R&D and new products that will further differentiate us in the marketplace that will benefit the company over the long-term.

I'd like to thank our employees for their hard work and commitment and contributions to JDSU, especially those on the ground in Thailand, who are working tirelessly around the clock to do everything possible to fulfill our customer commitment. We also greatly appreciate our CEM partner, Fabrinet, for all their efforts as well.

Finally, I'd like to also thank our customers, partners, vendors, and long-term shareholders for their continued support of JDSU.

Michelle Levine Schwartz

Thank you again for taking 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. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!