JDS Uniphase F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

JDS Uniphase Corp. (JDSU)

F1Q08 (Qtr End 9/30/07) Earnings Call

October 31, 2007 5:00 pm ET

Executives

Michelle Levine - Director of IR

Kevin Kennedy - CEO

Dave Vellequette - CFO

Analysts

Ehud Gelblum - J.P. Morgan

Jeff Evenson - Sanford Bernstein

John Harmon - Needham & Company

Paras Bhargava - BMO Capital Markets

Cobb Sadler - Deutsche Bank

Dayle Hogg - GMP Securities

Subu Subrahmanyan - Sanders & Morris

Presentation

Operator

Good day, ladies and gentlemen. And welcome to the JDSU Fiscal 2008 First Quarter Earnings Call. My name is Eric and I will be your coordinator for today. (Operator Instructions)

I would now like to turn your presentation over to your host for today’s call with. Michelle Levine, Director of Investor Relations. Please proceed.

Michelle Levine

Thank you, operator and welcome to JDSU's fiscal 2008 first quarter financial results conference call. Joining me on the call today are Kevin Kennedy, Chief Executive Officer and Dave Vellequette, Chief Financial Officer.

I would like to remind you that this call is likely to include forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to look at the company's most recent filings with the SEC, particularly the risk factors section of our report on Form 10-K filed August 29, 2007.

The forward-looking statements, including guidance provided during this call, are valid only as of today's date, October 31, 2007 and JDSU undertakes no obligation to update these statements as we move through the quarter. Our comments today will include non-GAAP measures. A detailed reconciliation of these non-GAAP results to our GAAP results, as well as a discussion of their usefulness and limitations, is included in today's news release announcing our results, available on our website at www.jdsu.com.

Finally and as a reminder, this call is being recorded and will be available for replay from the investor portion of our website at www.jdsu.com/investors.

I would now like to turn the call over to Kevin.

Kevin Kennedy

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

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

To summarize, we saw key financial metrics improved sequentially as well as year-over-year, as we continue to focus and execute on our goal of improving our business model. Before discussing the more detail segment reports, I’d like to reiterate that our strategy continues to be to execute as a company comprising the portfolio businesses for the focus on optical and broadband innovation.

We embraced this new sets of composite companies will be better able to navigate fluctuation in anyone individual business. We continue to see favorable end market indicators for broadband services and network ROADMs and we believe broadband capacity will continue to expand at higher data rates are being delivered through the access edge accompanied by video application.

We also believe that as network operator’s response in changing loads and consumer dynamic, networks will be agile in order to rapidly respond to the resulting changes in traffic patterns. Online customer visit this quarter, number of observations within the market, which are relevant are as follows.

In general, network equipment manufacturers in Optical Communications expressed cautious optimism in the foreseeable future based on their awareness of our [fee] activity. Relative to a sampling of conversations with European customers there are number of forces conspiring to potentially increase the emphasis on fiber extending closer to the subscriber include the following.

One, depending upon a number of factors, there is sense at operational costs and maintenance of fiber infrastructure can be as much as in order of magnitude less expenses to maintain than copper. [Viewing] at least one domain, our regulatory body is considering influence that we are driving earlier embrace of fiber reach into exit player.

Free video on HDTV update maybe required a need to optic sooner going to originally forecast due to capacity and [pull] power limitation of copper. Both copper costs are increasing as the metal sells with license value at broadcast of copper raises the affordability of optics improves.

And fifth as soon as the economics improved, due to more and more optimize configuration, but is more likely to service providers will embrace modem architectures and smaller or more fragmented optical domain.

The end results that the optical layer and components business, as well as test and measurement equipment, could see an increasing demand as the realization of deeper fiber penetration first on horizon of several years. For example in Europe in-house work

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

In our Optical Communications segment, total revenue was $121 million in the first fiscal quarter, compared to $113 million in the fourth quarter of fiscal 2007. The segment experienced a sequential increase of over 7% mainly due to increased shipments of agile optical network or AON products as well as the full quarter of Picolight revenue. We saw booking strength during the first fiscal quarter, as total bookings increased from the fourth quarter level and the book-to-bill ending the quarter was greater than 1.

With the second consecutive quarter of book-to-bill greater than 1, there is a cautiously improving trend in the network equipment manufacturer market. And we saw an improvement of gross margin relative to the last quarter. For the quarter, nine out of 12 product lines experienced sequential increases. Of those nine product lines, eight experienced double-digit percent and sequential growth. For the agile products evidenced some strength relative to the legacy products.

During the quarter, we saw healthy sequential bookings in our agile optical network portfolio for ROADMs and tunables. And indicators are beginning to show more than evolution to a broader market. We are continuing to invest in pluggables, agile products such as ROADMs and tunables and products for the metro markets. All three of our major Optical Communications market segment including long haul, which includes undersea, metro and datacom saw sequential growth.

We continue to focus on innovations. Specifically, we are focused on functional integration as service providers strive for greater efficiencies in their networks and network equipment providers look for decreases in cost, power and equipment. For example this quarter, we announced a new photonic integrated circuit that combines a tunable laser and an optical modulator. Tunable lasers are key elements in part for the success of the deployment of agile optical networks. This new solution maybe introduced into existing network without architectural changes.

During the quarter, we also announced a strategic partnership with Mintera, a high bit-rate optical transport system solutions leader to support 40 gig capabilities. The partnership offers network equipment manufacturers of 40-Gig transmission solution combining Mintera’s 40-Gig technology with the JDSU’s 40-G optical communication products.

JDSU and Mintera will join forces to create a go-to-market strategy that includes joint product development and line manufacturing for new 40G solutions starting with a creation of a multi-source agreement or MSA 310 transponder module.

As discussed on our last call, we have initiatives in place to continue to improve gross margin in all business segment. In Optical Communication, we are doing the following. First, we are focused on driving our revenues to a higher post past level, which will improve factory utilization, well at the same time we are reducing our inventory investment.

During this quarter revenue growth did help improved gross margins as we have realized slightly improved factory utilizations and benefits from our cost reduction activity. There would be more growth is needed to fully absorb our current overhead charge.

Second, mix will continue to play an important role. By the end of fiscal Q1 '08 two of our three Optical Communications businesses have obtained gross margin of 25% or greater. Additionally, we anticipate structural improvements to gross margin having VCSELs and other Picolight products compound.

Third, we have a significant amount of work underway that could be operationally classified as lean initiative. These include manufacturing overhead reduction, manufacturing headcount reduction, variance reduction, inventory reductions, procurement spending reduction and bill of material localization.

And finally, we have renewed level of focus on value engineering that is redesigned to products and processes to improve gross margins. We believe healthy gross margins for this industry are 30% to 40% with top line growth and execution against our noted initiatives. We will continue to target our execution in this range.

Now on to Communications Test and Measurement, the complexity associated with the service provider transition to IP networks and broadband triple-play service installation as well as the expansion of fiber optic network capacity continues to drive growth in our Communication Test and Measurement sector.

JDSU is well positioned to address this trend across the network and service delivery cycle. For example, our 10 gig and 40 gig test solutions address the increase in capacity requirements, while equipment manufacturers and service providers.

Our modular field services and premises instruments provide field technician with all in one tool for the efficient installation and maintenance of IPTV, voice-over-IP and high speed access and other services. And our service assurance system enable network and services monitoring to ensure quality of service therefore our customers reduce subscribe return.

Our first quarter fiscal ’08 revenue was $168 million down 2%, as compared to $171 million in the prior quarter and 44% growth compared to the first quarter of fiscal 2007 revenue. Year-over-year revenue growth was driven by our field service instrument, the broadband access networks and fiber optic test solution as well as acquisition. The revenue results reflected strength in all regional markets. Business experienced typical order patterns in the summer months with lower bookings in the quarter, as compared to the prior quarter. Bookings were up year-over-year.

Finally, gross margins improved in Q1, when compared with each of the last two quarters. We did see strength this quarter for products such as the HST, the triple-play, field service instrument for telecommunication service providers, T-BERD platforms for fiber optic network testing versus high growth opportunities such as fiber verification and grow the network fast and our net complete portfolio of the broadband and IP service assurance.

We also continue to bring innovative new products to the market including the recent introduction of the ONT-503, a portable 40-Gig solutions for lab and service verification sector. This quarter we appointed Thomas Waechter as President of the CommTest business with responsibility for CommTest global sales, product development and operations.

Tom brings excellent public company, new level global operational and management experience along with deep knowledge of telecommunication market segment. Tom’s immediate priorities good gross margin expansion and continued growth. Helmut Berg will continue with JDSU and will support Tom.

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

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

In relation to CommTest growth, we would like to highlight the following. Year-over-year market or industry growth is 5% to 8%. We expect JDSU organic growth to exceed the market by 2.1, we are executing well. CommTest revenue generally peaks in the December quarter, big revenue versus [nearly] between 1.1 and 1.2. The CommTest model is evolving and we are focused on improving predictability. That said the model is one of high turns and visibility as low in like North American wireless account.

Moving on to our Advance Optical Technology segment fiscal Q1 revenue for AOT was approximately $48 million representing growth of 7%, deferred to $45 million in the fourth quarter of fiscal 2007 and up 22% compared to 39% in the first quarter of 2007. This quarter the advanced optical technology segment generated operating income of approximately 38% and we saw gross margin improvement on a sequential basis due to favorable mix and improved operational execution.

Once again, the currency market has provided upside for this business, driven by new currency note introductions around the world. As we have noted before, the trending of this business will have some levels of surge in the [net].

Brand protection labels for our customers in the pharmaceutical, imagining supplies, electronics and other industries are growing popularity. This quarter we have announced the addition of Unique Anti-Counterfeiting Covert Security Solution called Charms to expand our portfolio solutions for our communication market.

In the Custom Optics business we are beginning to see increases in volumes from the participation in the entertainment market enabled by our proprietary [UCT1] technology. Gross margin improvements this quarter was mainly due to product mix and improved back to utilization.

Our gross margin improvement initiative in the AOT segment again, consistent with the May analyst call, are focused on loading our legacy applications in concert with adding new business to our universal coatings platform; drive greater utilization and volume which will accelerate gross margin improvement for the coated optics and labels businesses.

Now to Commercial Lasers, first quarter fiscal 2008 revenue was $20 million, down by 10% from the $24 million in the fourth fiscal quarter of ‘07 and down 17% compared to $24 million in the first quarter fiscal year 2007. Inventory reserves were taken due to end of life exposures, the slow moving inventory that negatively affect the gross margins in the quarter.

We are encouraged by bookings in the quarter that saw growth compared with past quarter. In particular, bookings traction for our FCD- 488 solid-state fiber laser mostly positive. Our commercial laser business service a relative small number of customers. The quarterly performance is impacted by spending type. Furthermore, semiconductor industry actively has declined, which we believe to be temporary.

On the other hand, biomedical and machining related customers continue to be healthy. Last month, we announced the appointment of Alan Lowe to lead our Commercial Laser Business. Alan brings two level public company background and over 20 years experience in general management, operational sales and business talent to JDSU. Alan’s efforts are currently focused on margin expansion, and Lean manufacturing initiatives and working with customers to accelerate new solid-state design wins.

Focusing on our laser platform gross margin expansion initiatives, we note the following. Critical factors mix, the solid-state laser revenues having a favorable impact on gross margins. Gross margin upside will come from increasing solid-sate laser volumes with Lean manufacturing initiatives already in process. For example, this quarter, we shipped our first FCD lasers (inaudible) and to ramp up production for fiscal 2Q, but the full production transport we created in early calendar 2008. Additionally, we are focused on driving inventory turns up and our supply chain costs down, as a result of improved gross margins. We believe, in aggregate the Lean initiatives once fully implemented will result in double digit gross margin improvement.

Now for an update on corporate initiatives. On October 22nd [the trial] (inaudible) that commenced in March 2002. Files expected to continue to or shortly after Thanksgiving. We believe that the factual allegation and circumstances underlying this past action and the related actions were without (inaudible) we intend to continue to vigorously depend ourselves. For summary of the proceedings and the risks associated therewith, I’d refer you to our quarterly and annual reports filed with the SEC in particular our recently filed report on Form 10-K for the fiscal year ended June 30, 2007.

Since April, our businesses navigate a transition of three out of four of our segment business leaders. The current theme has been assembled mindful of the base of the company, focusing on growth, albeit with the focused on the details to improve the efficiency of the business model of each individual business. As described on our last call, fiscal year 2008 would be a year with JDSU intend to advance its business model of each business within the portfolio expects to continue to improve individual operating results. There is a strong focus on gross margin and cash flow improvement on all operating segment.

At the same time, we continue to seek opportunities to strategically expand our product portfolio through partnership and acquisitions. For those, who have set forth remain on path, in the near term our sustainable model as gross margins add approximately 40%, operating expenses in the range of 35% to 38%, and operating margins in the range of 2% to 5%. A long-term model cost for gross margins in the range of 43% to 47% and operating margins at or above 10%. In summary, the markets, we are participating are favorable and in Q1, we evidenced the continue trend of favorable financial metrics.

And with that, I will hand the call over to Dave.

Dave Vellequette

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

Operating expenses for the quarter increased to $139.6 million and were 39.1% of revenue. The increase is primarily in R&D spending resulting from the full quarter impact of the Innocor and Picolight acquisitions.

Our operating income for the quarter was $7.8 million compared with an operating loss of $4.3 million in the prior quarter. Adjusted EBITDA in the fourth quarter was $23.7 million or 6.6% of revenue, which compares to an adjusted EBITDA of $11.7 million or 3.3% of revenue in the prior quarter. First quarter net income was $18 million or $0.08 per share. This compares with fourth quarter net income of $15 million or $0.07 per share.

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

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

In the Optical Communications segment revenue was $121.3 million was up by 7.6%, when compared to the prior quarter and down 12.1% from a year ago. Operating loss in the segment was $2.9 million or 2.4% of revenue and improvement from a loss of $9.2 million or 8.2% of revenue in the prior quarter due to improved gross margins which will partially offset by higher operating expenses resulting from the Picolight acquisition or Advanced Optical Technologies or AOT segment quarterly revenue were $48 million up 7.4% from the prior quarter and up 22.1% from the prior year.

AOT operating profit for the quarter were 18.3 million or 38.1% of revenue compared with $13.1 million or 29.3% for the prior quarter. The increase in operating profit with the result of higher gross margin due to product mix and improved factory utilization.

In our Commercial Lasers business, first quarter revenue up $19.9 million decline 10% from the prior quarter and decline 17.4% from the prior year. Due to lower first quarter revenue laser had an operating loss of $2.5 million.

Now looking at revenue by region, over the last year the geographical dispersion of our revenues remained balance. In the first quarter of fiscal 2008 the Americas contributed 54% of revenue, EMEA 28% and Asia-Pacific 18%, results slight decline in Asia versus last quarter of revenues above historical level.

Moving to the balance sheet, for the third quarter in a row, the company was free cash flow positive, generating approximately $27 million. This was the result of lower capital expenditures, improved days sales outstanding and reduced inventory levels. We also reduced our debt balance during the quarter by $75 million.

The cash, cash equivalent, short term investments and restricted cash at the end of the fourth quarter totaled more than $1.1 billion. Headcount as of September 29th was 6459 down from 6688 last quarter primarily due to reductions in Optical Communications. While, our markets are generally favorable, we remain focused on improving our operating model. Kevin stated our near term sustainable operating model targets are, gross margin were approximately 40%, operating expense in the range of 35% to 38% and operating margin of 2% to 5%.

We believe we can achieve this model by the end of this calendar year. Longer-term, we believe, we can achieve gross margins of 43% to 47% and operating margin of 10% or more. Now looking forward, the points to consider, as you think about our financial performance over the coming quarters.

Due to the different gross margin targets each of our segments, gross margin would be impacted by changes in product mix and by geographic dispersions. Specific to the ALT segment, Q1 gross margin exceeded our sustainable range due to our favorable mix and maybe challenged to maintain name strength in gross margins in the subsequent quarters.

Our CommTest business is a high turn business, and in the December quarter with less visibility due to the lower bookings in the September quarter, and a majority of the turn business is the result of carrier budget [price] that typically booked at the end of November and during December.

Finally our Optical Communications segment continues to improve and as Kevin noted, two of the three businesses have a same gross margins of 25% or greater. That’s said, the reduced revenue levels, as a result of our customers’ lean initiative and customer consolidation activities have resulted in a two to three quarters space shift with regards to achieving gross margins in the 30% to 40% range.

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

With respect to operating expenses, Q2 operating expenses are expect to be near the mid-point of our range 35% to 38%. Also due to the debt retirement activity, our interest income will decline by more than $1 million, when compared to fiscal Q1, 2008.

Finally, we expect our quarterly tax provision to range between $2 million and $4 million. Now, to our financial guidance for the second quarter. Based on our current visibility, we expect second quarter revenue to be in range of $372 million to $394 million.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ehud Gelblum with J.P. Morgan. Please proceed.

Ehud Gelblum - J.P. Morgan

Hello, can you hear me?

Kevin Kennedy

Hi, Ehud.

Dave Vellequette

Hey, Ehud.

Ehud Gelblum - J.P. Morgan

Hey, how are you guys. A couple of quick questions, first of all we understand the book-to-bill on the AOT business, I’m sorry on the [TNM] business was significantly less than one and is that cost for the lower guidance?

Kevin Kennedy

As I said, it is typically less than one in that particular quarter that’s normal. It was actually strong relative to year-over-year. The guidance that I’m trying to give you is that ratio of peak to the nadir as we use it in the past use to be 1.1 to 1.3.

Ehud Gelblum - J.P. Morgan

Right.

Dave Vellequette

I’m trying to narrow that to 1.1 to 1.2 for the following reasons. One is we move to end of the fiscal year of the contesting to our JDSU fiscal year, we saw greater strength in the June quarter and less strength in the fiscal Q1 ends up probably being stronger, it went down less than people might have anticipated, but the costs were up of higher base. You would expect that ratio to be less effective.

The thing, as we’ve expanded our portfolio through acquisition. And that ratio or the physics of the budget cost is primarily associated with the dollars that are available in the service providers or carriers worldwide across field service equipment. But the same physics wouldn’t be applicable to portfolio that would go. The cost of portfolio has grown outside the field service area you wouldn’t apply that same field ratio to the full revenue stream.

So, a number of conspiring factors, but the net of it is that the ratio is smaller and finally we do have some lower visibility then probably six months ago and some of the wireless carriers and that’s not a unique story. We are not highly exposed, but those are ways that forced us that made us the, to provide the guidance that we have.

Ehud Gelblum - J.P. Morgan

I will catch up with the wireless carries in a moment. But first of all, when we use that 1.1 to 1.2 calculation that’s on the peak to the nadir should we have, which quarter now that you have realigned the fiscal year end to be one actually with yours. Which quarter now officially the peak quarter?

Kevin Kennedy

Peak is never a question for December quarter.

Ehud Gelblum - J.P. Morgan

It’s still the December quarter. So this is, still will be, your best quarter of the year?

Kevin Kennedy

For the CommTest being that's correct.

Ehud Gelblum - J.P. Morgan

Right just not necessarily as I’m just trying to correlate vis-à-vis kind of what you have been looking for obviously you don’t know necessarily what the model was, but in terms of the your components of your guidance. Can you walk us through what had been expecting growth rate was for the other businesses as well?

Kevin Kennedy

Ehud we sort of comprehend all possibilities in the guidance that we gave you 372 to 394.

Ehud Gelblum - J.P. Morgan

Okay. So we assume relatively similar types of growth in each one that we saw this quarter I guess more specifically in Optical Communications component side, it seems we are getting a great from the inventory problems we had in the past. Is that the most part over, so we can expect to see that somewhat rebounding?

Kevin Kennedy

At the end of the day, the booked-to-bill is greater than one. Booked-to-bill is greater than one in lasers. We know that we have a budget plus phenomena in a strong quarter in CommTest and we did 357 and we are giving you a range 372 to 394 you should presume that there is general buoyancy to large rest of the business. So there is a lot of issued a date there for you frankly it will.

Ehud Gelblum - J.P. Morgan

Right, definitely I can. And lastly you mentioned wireless in the customer (inaudible) business what is your exposure to wireless, can you tell us percentage vise?

Dave Vellequette

I don’t know roughly its top of my head. It is relatively small in two areas. One is wireless service foreign which is single digit millions of dollars total and then wireless back-offs. So that's probably a bigger number, but its not mere shadowing number.

Ehud Gelblum - J.P. Morgan

Okay. And you still expect the budget plus in your traditional fiscal year end now, despite the potential cost you may even hearing some of these carriers?

Dave Vellequette

That's correct.

Ehud Gelblum - J.P. Morgan

Okay, terrific. Thanks so much.

Dave Vellequette

Thank you

Operator

Your next question comes from line of Jeff Evenson with Sanford Bernstein. Please proceed.

Jeff Evenson - Sanford Bernstein

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

Kevin Kennedy

Jeff, we don’t have a way of providing that kind of calculus today. We are probably more driven by CapEx spending and obviously correlate better to (inaudible) with test, but I think, my opening comments were that as you know most of the low to market architectures were movement towards (inaudible) to investment a bit come a procreativity of the North American optics market and well, I wouldn’t say that we’ve vest any tipping point in Europe.

I would say that the conversations are more somber in sense that we have a lot of copper the applications space is moving pretty fast and we maybe rethinking what we need to do with fiber. So, I saw a greater level of providing and people sort of anticipating a future on a shorter horizon than otherwise.

Jeff Evenson - Sanford Bernstein

Okay. In previous calls you have talked about suppression of optical spending and some of your customers, due to their lean manufacturing programs. Just wondering: If you could give us an update on where they are in the process and what you are seeing right now?

Dave Vellequette

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

Jeff Evenson - Sanford Bernstein

Thanks.

Operator

Your next question is come from the line of John Harmon with Needham & Company. Please proceed.

John Harmon - Needham & Company

Hi, good afternoon.

Kevin Kennedy

Hi, Harmon.

John Harmon - Needham & Company

I was wondering if you could just outline the components of what is making your Optical components business unprofitable, whether its prices or yields or fab utilization or staffing or residual products just to get a picture of universe the areas to work on.

And secondly as long as you come up with kind of vitality in that kind of business. In other words what percentage of your revenues comes from products that were developed within the last couple of years?

Kevin Kennedy

Yeah. We'll take the (inaudible) come out with a specific percentage we for the analysts call on a week or so. But I would say the fact that our growth and bigger, we gave you some numbers of 9 product lines, 12 show growth, 8 of those were double-digit.

In general the growth was in the agile optical networks that the things that we have invested in most recently as in the last two years versus things that are legacy products. The real message is the new items are the ones that are growing in the legacy one certainly have a slower growth rate.

In terms of what we need to work on it I think we gave you pretty good outline of the gross margin in this business maybe I let Dave try to cover that.

Dave Vellequette

Yeah, John I think I talked my portion here about the incremental savings we expect to have in the Q4, that those come from the primarily from the office of comps area. It is gross margin focus right now, if you look at the numbers it would imply that we needed more than 121 we have breakeven in the space.

We were working towards where we get breakeven number down below the 120 get it and then go to 110 and we work it from there. So, I hope that helps to give you sense of where we think we can move the breakeven for that business down and that the initiatives in this quarter are focused on the optical comps gross margin.

Kevin Kennedy

John, if you simply go back and look at the line items that we’ve talked about the majority of them fall in two camps. One is: we just need more volume to hit the absorption level as Dave mentioned. The second, and we came a good piece of the way this quarter from that. The second is: the majority of them what I’d call operational execution, whether it’s lean, yield, improvement, field materials localization these are all things that happened.

But the significant step forward was the gross margin and the amount of upside that we had or the growth we had this quarter. We actually go through a fair amount of margin dollars, disproportion amount of margin dollars, so that was positive. And secondly, it migrates to two out of three of our businesses are now in this above 25% range. So, we’ve actually seen progress in terms of doing what we told we do and we are going to keep on those same items that we enumerated.

John Harmon - Needham & Company

Okay that does help. Thank you.

Operator

Your next question comes from the line of Paras Bhargava with BMO Capital Markets. Please proceed.

Paras Bhargava - BMO Capital Markets

Good afternoon, gentlemen. Question on the CommTest business, how much of the growth Kevin was organic and how much of it was due to the two acquisitions you had in the year?

Kevin Kennedy

If you are to take that the yearly run rate of the acquisition certainly it’s probably less than 15 million and more than 5. And Dave, please correct me if I’m wrong, but, I think that's roughly the early number so majority of the growth throughout the contest has come from organic activity.

Paras Bhargava - BMO Capital Markets

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

Kevin Kennedy

Let me answer different question or give you another dimension to it and then I will answer your specific question. You have to recall that fiscal Q1 of last year we actually have what we felt it was adversely low fiscal Q1 a number probably on the order of 10 millionish plus or minus a little bit. And the part of it was the bookings just came in late and we had trouble converting them and at the same time we are doing it an oracle implementation that has impact on the conversion from booking to revenue as well.

So, part of that, it’s just a fact that we will very open that we had execution challenges one year ago. So, if you take that into account and the fact that we’ve a few acquisitions, we still have excellent organic growth but it less toward, I guess. In terms of where we are taking share, I think we’ve been doing a fairly good job on the field service side. We’ve had a number of great product ramps the MPS 8000 and it’s actually been in all geographical domains, as we talked about on the last two calls.

Paras Bhargava - BMO Capital Markets

On the protocol there or the fiscal side?

Kevin Kennedy

Both. I would say, we had a resurgence in the, at an optical layer and we both we’ve done had a lot of success in the cable arena. I think, we’ve mention that several times and then lastly VoIP as well as video has done well.

Paras Bhargava - BMO Capital Markets

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

Kevin Kennedy

Make no mistake, we have been blessed in the success that we've had in cable. So, I think, there is a practicality that all carrier franchises go through these hyper growth periods for a protracted period of time. So, all we are simply stating is absent some particular sector that grows in a hyper way, we are going to be executing a little bit better than the industry average in both power cautious or just pragmatic way of benchmarking yourself.

Paras Bhargava - BMO Capital Markets

Thanks Kevin.

Kevin Kennedy

Thanks

Operator

Your next question comes from the line of Cobb Sadler with Deutsche Bank. Please proceed.

Cobb Sadler - Deutsche Bank

Thanks for that. Some quick clarification, the near term model, the 2% to 5% operating margin, you indicated you hit that by the end of the year, that’s calendar or fiscal year?

Kevin Kennedy

Calendar.

Cobb Sadler - Deutsche Bank

Calendar year. Okay, so right now you roughly at what 2.2% operating margin. And now it sounds like you had some one-off, better than unsustainable upside in a couple of your businesses for the quarter, but literally we should be looking at kind of flat to modestly up operating margins between now and in December or have you given some conservative guidance there? Thanks a lot.

Dave Vellequette

Our point there was just to say that the company is taking the next step of being in, what I call, in a sustainable model. If you look at the number we had here, the operating expenses were not within that model. So, we had two of the three items inside the model. We now need to get the operating expenses inside the model. So, the important part here is that you understand the envelop in which we will work and mix in a segment and mix between the segment and an impact, how those gross margins fluctuate and therefore the operating (inaudible).

Cobb Sadler - Deutsche Bank

Okay.

Kevin Kennedy

You are reading it corrected.

Dave Vellequette

We got inside the envelop, we would feel it appropriate and wait until we repeated that performance before began to think that we had something sustainable.

Cobb Sadler - Deutsche Bank

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

Kevin Kennedy

No market share loses that we aware of, year-over-year its up roughly at 10%, so no real issues there, it just becomes buying pattern more than anything.

Cobb Sadler - Deutsche Bank

Okay. And last question, on the Picolight acquisition, did you plan on using most of the [vickful] there internally or you continue to sell them to Picolight's existing customers and what are you planning on doing with your capacity there? Thanks a lot.

Kevin Kennedy

We will continue to have a merchant business and tell light sources, whether they be pixels from Picolight or frankly our laser diodes in the telecom side, outside as well as even vertically integrated. So it will be both.

Cobb Sadler - Deutsche Bank

Got it.

Operator

Your next question comes from line of Dayle Hogg with GMP Securities. Please proceed.

Dayle Hogg - GMP Securities

Hi, thanks, can you just give us the impact on Picolight in the quarter and last quarter we didn’t get it normalized growth for the [Ops] business?

Kevin Kennedy

We don’t really breakup those, we did have them only in for one month last quarter and now we have them for the fourth quarter. This quarter when we did the acquisition we talked about Picolight on an annual basis that's been running at about $40 million a year revenue run rate, but we don’t typically go in and breakout the specific performance of our acquisition.

Dave Vellequette

It would be fair to say that the majority of the growth this quarter from last quarter and I will say a slight majority came from the organic products. I just think it is $10 million this quarter and $3 million last quarters. You get about 1% sequential up, but I guess my questions more around or year-over-year it's about down 19%. I am just wondering what your thoughts on the growth of this business for the full year?

Kevin Kennedy

About communications or Picolight specifically?

Dayle Hogg - GMP Securities

On their Optical Communications Group.

Kevin Kennedy

I think it's up. If we executive well it's going to be in double-digits.

Dayle Hogg - GMP Securities

And that’s including Picolight?

Kevin Kennedy

Sure.

Dayle Hogg - GMP Securities

Okay. Just taking another test of measurement, you said there are sort of [peak-to-need ROE] above 1.1 to 1.2, but because you have to sort of realign the quarters can you think $1 for you what (inaudible) we should us?

Kevin Kennedy

No, I can't. At the end of the day the physics of what makes the uptick is a carrier budget [plus] in December that is more associated with the field service product. This year if you were to go back, you will probably find that fiscal Q3 of ’07 and fiscal Q1 ’08 were running neck and neck to be the softest quarters.

So I think what we are basically coming out with is that we have something this fairly modulated for three quarters and then we have an uptick in that sets of new threshold. So that’s going to continue. The use of the lowest to backward looking quarters is the [indicator] and we have our candidates. I think the easiest area to see the potential for more acquisition tends to be in the Comcast area that is the economics are more favorable for consolidation. There is a few large players and a large number of smaller ones. Optical Coms the profitability has yet outside the largest in the industry to encourage a prolific M&A other than it was a surgical fortification.

And I think on the more boutique optics businesses that we have, while there could be think that our desirable and small, are you getting them to a do-ability is the harder thing. So Comcast is probably the most likely place for something to occur. I would suggest on the more modest side, in general and Optical Coms will be a fortifying activity not for different kind of people like that.

Dayle Hogg - GMP Securities

All right. So just picking up the Optical Communications business and industry structure is been unstable quite a while and you have sort of abstained from being very active in consolidation rather than technology acquisitions. Do you see that landscape changing any time soon, do you think that level of consolidation is going to accelerate, and what could be the catalyst for the pricing in that environment do actually improve?

Kevin Kennedy

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

Dayle Hogg - GMP Securities

Yeah, got it. And then one question about the tax rate. You've been profitable right now on a GAAP basis, actually not sustainably so. But at what point, how many quarters ahead would you have to get to before you start switching over to set of regular pro forma tax rate, stop taking a reserve against your taxed asset.

Dave Vellequette

Yeah I think, it depends on a number of factors right where is the profit coming from, whether the revenue I should say that US based, you have got in lot of losses then we start to have release evaluation reserves. So it's going be a big for we see that tax rate go up because as we get profitable within each country then we have to release evaluation allowances we can offset the provision.

So its going to be a bit to tell you what every time we have on the call to give you a view of what the tax range will be, so that you can start to see it when its starts to be realized but really is where calling where the profits are going to be realized, in the more business I do in the US about tax for pay for a while.

Dayle Hogg - GMP Securities

Right, when we are assuming our tax rate on over the next two to three years, is it fair to take it from the 12% range right now, take it through, somewhere in the instead of high teens all the way up to 30% over three years.

Dave Vellequette

That would see little bit steepening.

Dayle Hogg - GMP Securities

Okay, I got it. Thank you so much.

Operator

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

Subu Subrahmanyan - Sanders & Morris

Thank you. I have a question on gross margin first, if you can talk about kind of the offsetting factors which would make gross margin potentially go down from the levels this quarter you have, I know you mentioned how your AOT margins, but with higher revenues overall especially in Optical Com would that offset it. And then I wanted to ask about headcount came down about 200, do you see the benefit of lower headcount and OpEx in the September quarter or some of that roll into December?

Kevin Kennedy

First of all, in the headcount area, again I stated is mostly not positive mostly a gross margin benefit grew up as we lowered our cost structure in our manufacturing area. So that’s the headcount.

As far as gross margins go the key about the product mix is if you have more Optical Com's business growing you’re going to likely put a waiting although its positive is an absolute dollar amount you will have waiting down on the overall gross profit of the company. So that’s why we make that point and it is very important about the mix of the segment as far as we’re waiting on the revenue.

Subu Subrahmanyan - Sanders & Morris

Got it and, just a follow-up if you, longer term ranges in terms of operating margins can you talk about kind of timeframes between your near-term range and the longer term range and what are some of the things specifically on the gross margin side that need to happen to get there?

Kevin Kennedy

Well, the things we have talked about before you expect it, each of the groups have gross margin opportunity in the CommTest area, in the AOT it's in the single-digit type range and actually in the last quarter AOT picked up a couple of those points. So it’s very in the few digits in the lasers and the Optical Coms area its double-digit improvement opportunity so far. We saw way to go in both of those segments as far as gross margins go and we have talked about at the end of calendar '08 being a period where not necessarily in a sustainable business on a sustainable basis but we should be able to be in the ranges that we talked about for gross margin and for operating income.

Subu Subrahmanyan - Sanders & Morris

Got it, thank you.

Operator

Ladies and gentlemen this concludes our Q&A session. Thank you for your participation in today's conference. This concludes our presentation and you may now disconnect and have a good day.

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