Viavi Solutions Inc (VIAV) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2013 JDSU earnings conference call. My name is Keith and I'll be your operator for today. At this time all participants are in a listen-only mode. Later on we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, today's conference is being recorded for replay purposes. With that I'd now like to turn the conference over to your host for today, Ms. Cherryl Valenzuela with Investor Relations. Please go ahead.

Great. Thank you, Keith, and welcome to JDSU's fiscal 2013 first-quarter earnings call. Joining me today are Tom Waechter, CEO, and Rex Jackson, Acting CFO. David Heard, President of Comcast, will join us for Q&A. I'd like to remind you that this call will include forward-looking statements about the Company's future financial performance. These 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 our most recent filings with the SEC, particularly the Risk Factors section of our annual report on Form 10-K, filed August 24, 2012. The forward-looking statements, including guidance provided during this call, are valid only as of today. JDSU undertakes no obligation to update these statements. Please also note that all results are non-GAAP unless otherwise stated. We include a detailed reconciliation of these non-GAAP results to our GAAP results, as well as a discussion of their usefulness and limitations, in today's earnings press release. The release, plus our supplementary slide and historical financial tables, are available on our website. We have completed the sale of our hologram business. Accordingly, the operating results from this business are categorized as discontinued operations and are not included in the results we discuss today. Further, we have recasted our historical financial results to reflect this change, and base the financial comparisons we make today on these recasted historical financials. Finally, we are recording this call today and we will make the recording available promptly on our website. I would now like to turn the call over to Tom.

Thank you, Cherryl, and good afternoon, everyone. JDSU delivered first-quarter revenue of $420.9 million, excluding approximately $5 million from our divested hologram business. Gross margin improved sequentially to 45.8%. Operating margin was 9.2% above management guidance. Our balance sheet continues to gain strength. We generated a solid $43 million of cash from operations, and finished with $730 million of total cash. We are pleased with our results, especially given challenging conditions. Like our peers, we are seeing conservative global carrier CapEx spending due to ongoing macroeconomic weakness in Europe, slower growth in China, and uncertainty in the United States. However, the relentless increase in broadband demand remains a powerful driver for our business. We continue to execute on our strategic priorities, which are successfully guiding us through this uncertain period and preparing us to take advantage of a market upturn when it occurs. The top priority is collaborative innovation. For the sixth consecutive quarter, product less than two years old generated more than half of our core network revenue, with 57% in fiscal Q1.

JDSU's support of the network begins with building blocks, including optical components, modules and subsystems. In industry recovery cycles, customer investment technically shows up here first, and we are encouraged by trends we see in this business, which delivered strong year-over-year and sequential revenue growth. We have market-leading positions in the fastest-growing optical communications segments, including ROADMs and Tunable XFP. Fiscal Q1 saw the on-time launch of our Tunable XFP+ product. We generated revenue from this product, which builds on our two-year market leadership in Tunable XFPs. We also have begun beta shipments of our TrueFlex twin, one by 20 WSS, and are currently developing second-generation designs of our Super Transport Blades. We are tracking to achieve revenue from the TrueFlex product suite early in calendar 2013. We are also making good progress with pluggable transceivers to support growing land LAN SAM needs and the cloud for customers building proprietary data center networks. We expect to see robust revenue growth in this market over the next few quarters.

In addition to supplying building blocks for advanced networks, we continue to lead the market for test instruments used to cost-effectively and rapidly build, deploy and maintain next-generation networks. We are focused on our customers' most important requirements, including software-based solutions that allow them to reduce operating expenses, as well as those that support wireless network expansion. With respect to software, PacketPortal, our cloud-based solution, now allows customers to run a variety of network applications from data gathered by JDSU probes, attracted six new customers in Q1. We have now completed more than 20 trials since introducing this solution in February. We recently announced PacketPortal CONNECT, a global program for channel partners, system integrators and application developers that provides a community to expand PacketPortal applications. We believe a disruptive product such as PacketPortal and others we have in development will gain traction even with constrained customer spending, as they enable carriers to monitor network performance remotely and detect problems earlier, often before the impact to the end-user experience. Remote monitoring decreases operating expenses while early detection increases uptime, reserves revenue and allows our customers to better monetize their networks.

Our recent acquisitions that enhance our wireless test product portfolio are also performing well. The GenComm acquisition closed and was accretive to earnings in fiscal Q1, contributing approximately $2 million worth of wireless base station test revenue during the first six weeks in Q1, that was a part of JDSU. The Dyaptive acquisition completed earlier this calendar year had another quarter that exceeded expectations and delivered high-margin capacity test revenue. We are proud to have received several awards for innovation in CommTest. For the second year in a row, Frost & Sullivan recognized JDSU as the industry leader in fiber-optic and ethernet communications test solutions. We also received three awards for PacketPortal and two for our TrueSpeed software offering. Moving from network to our core business segment anti-counterfeiting, the number of countries either using or who have designed-in our new optically variable magnetic pigment under currencies continues to grow, increasing from 20 in fiscal Q4 to 22 in fiscal Q1. With respect to market adjacencies, we reported our highest revenue in five years in our commercial lasers business. Revenue from high-powered laser -- fiber lasers grew as expected from $2.5 million in fiscal Q4 to $6.7 million in fiscal Q1.

We're also pleased to announce our third gesture recognition customer, who plans to use our laser diodes and optical filters in the new personal computing application. This win underscores our market leadership in gesture recognition and opens another application for our technology, joining gaming and home entertainment. I will now move to providing an update on our initiatives to drive business model improvements. As you know, part of our plan to reach our target business model is to improve gross margins through more favorable product mix. We are consistently enhancing our product portfolio and margin profile by adding innovative products and, where appropriate, pruning businesses that do not meet our margin targets or no longer a good fit with our long-term strategy. In fiscal Q1 we completed the sale of our hologram business. This divestiture enables us to sharpen our focus on anti-counterfeiting solutions through our renamed Optical Security and Performance, or OSP segment, formerly known as Advanced Optical Technologies, or AOT.

We also made the decision in Q1 to discontinue our investment in concentrated photovoltaic, or CPV technologies, as market opportunities for solar are currently limited. We'll continue to monitor this market should conditions change. Also, we continued to pursue operational efficiencies across the Company, improved inventory management, material cost reductions and refinement of our outsourcing model. We recently completed the outsourcing [lee] repair business and are steadily consolidating our contract manufacturer relationships to improve performance and cost in our CommTest business. With that, I'll now hand the call over to Rex, who will take you through the details of our financial performance in fiscal Q1, and will discuss our outlook for Q2.

Thank you, Tom. First-quarter revenue of $420.9 million was down from $434 million in the prior quarter, and slightly up from $416.1 million last year. The 3% sequential decline resulted from seasonality and slower carrier spending in CommTest. Book-to-bill for the Company and all three business segments was below 1. Book-to-bill for CCOP was less than 1, primarily due to two customer transitions to vendor-managed inventory, or VMI, which causes a one-time hit to bookings because lead times are reduced to zero. 40% of optical mitigations revenue was from VMI. First-quarter gross margin was 45.8%, up sequentially from 45.3% on lower revenue, reflecting cost improvements and a $2.3 million out-of-period accounting adjustment, which yielded a gross margin benefit of approximately 0.5 point. Operating expenses of $154 million were down $4.3 million from the prior quarter. This decline and the one-time adjustment I just referenced a moment ago, improved operating margin from 8.8% last quarter to 9.2% on lower revenue. Net income for the quarter was $35 million or $0.15 per share, comparable on lower revenue to $35.4 million or $0.15 per share for the prior fiscal quarter, but reflecting good cost controls and better margins. Current-quarter results are lower compared to $41.2 million or $0.18 per share for the year-ago period, due to product mix and slightly higher OpEx.

Now looking at quarterly revenue by region, Americas was $209.8 million, or 50% of total revenue. EMEA was $97 million, or 23% of total revenue. And Asia-Pac was $114.1 million, or 27% of total revenue. Americas revenue declined following a very strong fourth quarter, particularly in CommTest. EMEA remains a challenge. And Asia-Pac revenue grew, most notably in optical communications. Moving to the segments, CCOP, consisting of our optical communications and lasers businesses, delivered revenue of $194.9 million, gross margin of 30.1%, and operating margin of 12.2%. All improvements over the prior quarter, when we reported revenue of $185 million, gross margin of 27.8%, and operating margin of 8.5%. Within the segment, optical communications had another solid quarter. Revenue grew almost 5% sequentially to $163 million, driven by strength in ROADMs, tunable transceivers and modulators. ROADM revenue grew 11% sequentially and accounted for 24% of optical communication's revenue. Within this product category, our Super Transport Blade product line grew more than 18% sequentially. Tunable XFP revenue grew more than 27% sequentially and accounted for more than 13% of up optical communications' revenue.

Optical communications' gross margin was 27.5%, or three percentage points better than last quarter's 24.5%, due to favorable product mix and better overhead absorption. The sequential ASP decline for optical communications was 3.1% at the midpoint of our historical 2% to 4% range. Our lasers business contributed $31.9 million of revenue versus $29.6 million last quarter. Gross margin was 43.3%, down from 45.1% last quarter, due to a one-time write-down of our CPV inventory. Excluding this inventory charge, lasers' gross margin would have been 45.9%, up almost a point from the prior quarter. Now moving onto CommTest. CommTest delivered revenue of $169.5 million, gross margin of 62.1%, and operating margin of 9.9 %. This compares to revenue of $196.2 million, gross margin of 60.3%, and operating margin of 13.3% in the previous quarter. The 13.6% sequential revenue decline resulted from seasonally lower demand in the summer months, compounded by slow carrier spending. CommTest gross margin improved from the previous quarter, due to the one-time accounting adjustment I mentioned earlier and favorable product mix. Operating margin was lower as a result of lower revenue, partially offset by the accounting adjustment.

Next, our Optical Security & Performance segment delivered revenue of $56.5 million, gross margin of 51%, and operating margin of 37.5%, exceeding its target model of 34% to 37% operating margin, with quarterly revenues greater than $52 million. This compares to revenue of $52.8 million, gross margin of 51.1%, and operating margin of 36.9% from the previous quarter. Revenue and margins grew as a result of a particularly strong quarter for currency pigments. Total anti-counterfeiting revenue grew 17% sequentially. The sale of our holographic business results at a slight adjustment to JDSU's overall Company target model. Our targeted operating margin range remains 14% to 17%, but at quarterly revenue of $477 million or greater and gross margin of 49% or higher.

Moving to cash on our balance sheet. For fiscal Q1, as Tom mentioned earlier, the Company generated $43.1 million of cash from operations, while capital expenditures totaled $17.8 million. During the quarter, we repurchased $50 million of outstanding convertible debt. At the end of fiscal Q1, the Company held $730.3 million in total cash and investments. Subsequent to quarter-end, we retired an additional $50 million of debt. As of today, the face value our convertible debt is $211 million, and is due in May 2013. Net inventories grew from $174.5 million to $177.3 million sequentially, primarily due to a balance sheet reclass from prepaid assets held by our contract manufacturers to inventory. In summary, we believe Q1 was a very solid quarter for the Company under current market conditions and relative to our competitors, with revenue meeting our expectations, good cash flow and better-than-expected profitability.

Now to our Q2 guidance, some points to consider. Based on our current visibility, we expect a seasonal recovery in CommTest, but below normal levels due to continued weak demand from service providers and the fact that we are not forecasting an end-of-year budget flush. In CCOP we expect another solid quarter, but anticipate a one-time mid-single digit impact on December revenue due to customer transitions to VMI, begun this quarter. And in OSP we anticipate lower sequential demand for currency pigments, due to customer inventory adjustments and the shorter lead times associated with our additional capacity. Therefore on a sequential basis, for CommTest, we expect revenue to be up by 9% to 15%. For CCOP, we expect revenue to be flat to down 5%. For OSP, we expect revenue to be down 11% to 18%. The Company's operating expenses are expected to increase by $5 million to $7 million, primarily reflecting variable compensation and annual merit payroll increases.

Now looking at the operating margins for the segments. CommTest is expected to be 15% to 17%. CCOP is expected to be 8% to 10%. And OSP is expected to be 29% to 31%. Taxes, interest and other income are expected to result in a net expense of approximately $5 million to $6 million. Share count for calculating EPS is expected to be approximately 237.5 million shares. We expect capital equipment purchases to be approximately 4% to 4.5% of revenue. Taking into consideration the factors above, we expect second-quarter revenue to be between $410 million and $430 million, and our non-GAAP operating margin to be between 7.5% and 9.5%. Please note that we are closely monitoring the impact of severe storms on the East Coast this week on our operations and those of our customers in the region. We have not reflected any potential negative impacts in the guidance we provided today. I will now turn the call back to Tom.

Thanks, Rex. Our fiscal Q1 results demonstrate the underlying strength of our business model in the midst of challenging market conditions. We continue to progress our business model and have initiatives we are working on in order to reach our target operating models in both our CCOP and CommTest business. We expect to see significant benefits from these initiatives over the next several quarters. For our OSP business unit, we exceeded our target model. We will continue our record of strong operational execution and we will focus on things in our control, such as a market-leading product portfolio aligned with high-growth opportunities, a variable cost structure with increasing scale and leverage, and a robust balance sheet. These are winning attributes in today's marketplace and help to differentiate us from our competition. Operator, we'll now take questions.

(Operator Instructions)

Amitabh Passi, UBS.

Hi, thank you. Tom, my first question, I was hoping you could maybe drill down into some of the geographic trends. You know, North America came in weak. You talked about EMEA being still a very cautious. Yet it looks like revenues are stabilizing just around $100 million. And so I want to understand maybe just some of the geographic dynamics. And then I had a follow-up. I can wait to ask that.

Yes. I think EMEA, we have seen has kind of flatten out now. I don't think it's really decreasing from the previous point. But it is starting to flatten out. And again, we're all focusing and eager for it to come back up. But I think there's some macroeconomic conditions there we have to all deal with for that to happen. I think Americas was primarily -- the reduction was around CommTest. We had a strong previous quarter in the Americas. We still see a lot of demand being generated in the Americas. So we think that's a continued growth opportunity. There are some reservations on spending right now until we get through the political elections and see how some of the policies will turn out. But I think the underlying fundamentals are strong, and we do see some pockets of strength in Asia. Our new business opportunity, the acquisition of GenComm in Seoul, Korea, puts us in a real position of strength in Korea now. More presence in Asia as well. So continue to see Asia as a growth area for us. It was 27% of our revenue this last quarter, and that's a healthy percentage for us.

Just as a follow-up. CCOP operating margin guidance, 8% to 10%. You just did 12%. Your guiding revenue is flat to modestly down. Just trying to understand the 200-basis point reduction. And also struggling to see at your $168 million target level, how do you get to 32.5% gross margin, given your 27.5% with revenue just slightly lower?

On Q2 guidance, we do have CCOP coming down by up to 5%, as far as revenue is concerned. So if you look historically at some of the revenue levels in CCOP, you can see it's pretty sensitive, you know, below the range we're at now. And you get some leverage as you go above the range. So that's one of the issues. Mix is always an issue as well, both geographic and product. And then the question is, what's the laser content going to be, as we mentioned? I think Tom mentioned this. The fiber laser ramp that we're on carries lower margins to the rest of the lasers business. So it's a mix of factors affecting CCOP for Q2. And then I think your second question, Amitabh, was about the model?

Yes, exactly. I think you said 32.5% gross margin at $168 million. You are at $163 million and 27.5%. So, again, just trying to figure out is it just purely volume, or are there other elements --

So from everything that I've seen us do, we give out CCOP on a blended basis. I don't think we give a specific CCOP target model. If we do -- I view it on a blended basis so obviously, lasers needs to hit its 20%-plus, as far as the revenue is concerned. I think the challenge in CCOP is going to continue to be pricing. That's the biggest battle they have, and the fact that the innovation ramp that we have in this business requires not only significant R&D investment, but continued R&D and R&D investment. So, you know, no question that we are not at the model as we speak. I think we're gaining market share and we are succeeding as a business, but we're working hard to hit the model.

Yes. I think the mix of new products was encouraging, or the more highly integrated products this last quarter. You know, ROADMs was up 11% quarter-on-quarter, Super Transport Blade was up 18%, and the Tunable SFP+ was up 27%, so we're seeing nice growth there. If we can continue this growth pattern, that's obviously going to help our mix and their gross margin line as we go forward. And maybe we continue to show very strong presence and strong market position with those integrated products.

Okay, thank you. I'll jump back in queue.

Kent Schofield, Goldman Sachs.

Thank you. Just to clarify, can you walk us through one more time on the CCOP in terms of the mid single-digit impact to guidance and inventories? What's going on there again?

So in this quarter we had CCOP moving a couple of its customers to vendor-managed inventory. What happens when they do that is your lead time goes to essentially zero. So obviously that means we need to maintain more inventory on our customers' behalf, but not a big number. So really, with essentially zero lead times, they don't need to book ahead and they don't need to buy ahead. So as you make this transition, there is a one-time hole -- basically, it's a hole you have to fill.

And you're quantifying that around mid-single digits?

That's right. For Q2.

For Q2, got you. Okay. And then with -- thinking about Q2, you commented that you're not looking for a budget release. Can you just kind of talk a little bit about how you got to that expectation? Do you think that's conservative enough, given the environment? Or do you think you're being conservative?

Yes, so obviously -- this is David. We're staying very, very close to our customers in deployment times. Especially times like these when we're helping them repair networks that are down. You know, I think as we look at their deployment schedules and we look at the US carrier percentage of our total, and it's exit rate in Q1, and their planned deployments for Q2, we are not seeing a budget flush as we normally would in quarter. If you look at AT&T's announced CapEx and you look at Verizon's announced CapEx, they are down year-over-year, between 7% and 10%, and they reaffirmed that in their public guidance. So we think that that's prudent for us to not assume any budget flush in terms of their contribution at the end of this year.

Okay, thank you for that detail.

Patrick Newton, Stifel Nicolaus.

Yes, thank you for taking my question. I guess, Dave, I want to hop on to that answer that you just had on the carrier CapEx side. I absolutely agree with you that the annual is down kind of in the 7% to 10% type of range. But if we look at the second half of 2012 implied, over second half of 2011, and we look at their full-year guidance, we're actually looking at a fourth quarter that should be up fairly substantially, roughly 10% sequentially, for both Verizon and AT&T. And we saw that 2011 was very front-half loaded. And, whereas 2012 is looking like more of a stereotypical backend-load. So if that is the case, do you anticipate that your expectation of no budget flush could prove somewhat conservative? And is this just a matter of you having elevated caution built into your guidance, as you've just not seen the move in orders at this point?

I think, again, our view as we stay very close to those customers -- in fact, those large US-based customers are in our top five customers list. So when you look at the linear rate of growth between Q1 and Q2, from a CapEx perspective, and you kind of plot out the sequential growth that we're talking about in our 9% to 15%, that is indeed considered in that growth. In addition to the impacts that Tom spoke of, of the muted European environment, for our Q2 guidance. So I think we're being very, very rational. We're very plugged in to the main customer projects going out there. We're also not just looking at that totality of their CapEx. It's where they're spending their dollars. And I think the encouraging point that Tom spoke of earlier in our prepared remarks are that we're making increasingly better -- getting better penetration and better pocket-share of our organic wireless investments that we've made over the last year, as well as our inorganic wireless investments. And trying to increase our overall exposure to wireless, LTE and the things that are mattering most to the carrier challenge that they're going through today.

That's very helpful, Dave. And then I guess one for Tom. I think you should be pretty well-advanced in your annual pricing negotiations for telecom. And I think that Rex even alluded to one of the biggest challenges in telecom is the pricing. So I was wondering, how are those negotiations progressing at this point, relative to historical norms? And the, could you also talk about pricing pressure on newer products like Tunable XFPs and ROADMs? I think over the last couple of years, that's where we've seen the largest annual pricing erosion. Thank you.

Yes, I'll go to first the Tunable XFPs and ROADMs. I think really we have in that area one major competitor. I think the products have been in the market for a couple of years now from our perspective. And I think we saw, you know, the aggressive pricing this previous annual negotiation, this past year. So we don't expect that to get any more intense as we go into this year. We think that's flattening out some. As Rex mentioned, our ASP erosion this past quarter in Q1 was 3.1, just about in the middle of our range. I would say also going into the negotiations that typically happen towards the end of the calendar year, setting up the next calendar year, we're feeling well-positioned with our new products, the differentiated products, and continue to make progress there. So we feel pretty comfortable. And we have not seen as aggressive a stance going into this negotiation as we did last year. But it's still early on and we need to see how it progresses over the next couple of months. But we did, at least with one large customer, we had negotiated a multi-year contract, so we know already what that pricing is going into next year. So it helps set a base there.

And Tom, that was a multi-year that you just negotiated?

No. We negotiated last year at this time a two-year contract with one of our major customers, so we know what that pricing is going into next calendar year.

Alright, thank you for taking my questions.

Mark Sue, RBC Capital Markets.

Thank you. Tom, if I look at the major carriers, their incentive is to reduce CapEx, which is what they've been doing over the last several years. And over in Europe, they seem to be quite challenged and they're cutting their dividends. Which leaves very little for CapEx. This seems like it's going to go on for a while. With that being said, any thoughts on how you might be able to increase profitability for next year and get to your target business model faster? Or is there some thoughts to possibly adjust the models so that you can have -- you can protect your earnings and your gross margins and profitability? Anything that you might be doing differently in a demand environment that's somewhat muted?

Yes, I think, Mark, good question. I think primarily around the network operators, and primarily that's our CommTest business, we will talk about it initially and then I'll turn it over to David for some more color on it. But we really are moving into areas where we're helping the operators reduce their OpEx and their churn of their customer base. So I think we're really getting into a sweet spot. Obviously everybody's trying to hold back on CapEx as much as possible. But wherever you can bring solutions, where you can help them reduce their OpEx, improve the performance of network and reduce their churn, we're finding they're very willing to invest and spend money. So I think David can mention a few of the product areas we're working on where we are really seeing some good success. And that's where we're driving very hard to get the share of the customers' wallet in these areas. David?

Yes, thanks, Mark, good question. I mean obviously, operator OpEx is a multiple of their CapEx. And you're right, it's becoming increasingly more sensitive. And so a lot of the demands we're getting from the carrier are to find ways to reduce head count in their network, be able to improve how much throughput they're getting across their existing infrastructure, and reduce their overall exposure from an income statement perspective. So a lot of these decisions that used to be made by the CTOs -- boy, there's a heck of a lot of CFO involvement. So the products that we're investing in and have been investing in heavily and are firmly committed to -- things like PacketPortal, you know, getting the ability to see what's going on at the edge of the network without having to dispatch trucks and crews out to the edge of the network, and move up to understand what's going on with the traffic, allows them to get more traffic across their existing network.

And so our progress on doing over 20 trials, and now over eight purchase orders in the six to seven months that we've been out publicly talking about this, we are getting extreme pull from the carriers. Albeit as we've said on prior earnings calls, that takes time to germinate. But really drives business case payback that, as we've said, are under 12 months -- in some cases, under 6 months. As we look at the amount of cell sites connecting all of our mobile devices, moving those from the traditional SONET/SDH environment into ethernet back haul is a 6 to 10 times cost-reduction, in terms of the amount of throughput you have to put over that. And our tools, instruments and software like TrueSpeed that enable us to not only put the infrastructure there but then tell what service is going across that, are in much greater demand. I think in the future, you know I think we can do a better job of not only explaining our correlation to carrier CapEx, but also the correlation to carrier OpEx, as well as the production of new devices connecting to the network. Because there's still a piece of our portfolio that's going back, like Dyaptive, to test the load that those devices put on to the network.

I see. And we should expect more doubling down of packet Oracle-type solutions and I guess more active pruning of the low-end commodity optical components?

Yes. I think in our quarterly results this last quarter in Q1, you saw probably a $3 million-ish year-over-year pruning element of what we did in our overall portfolio. You saw gross margin in much better shape on -- albeit a lower revenue trajectory. And that includes investment in things like PacketPortal that are really in its early stages and not yet to scale in terms of revenue. So when you look back at that business model, you're talking about two-plus points of investment in an overall operating income that we're investing on a quarterly basis in that, that we're feeling very good about our return in terms of operator interest. And as we know, in periods like this when operators are very distracted, in disruptive periods, we've been very impressed at their engagement in this technology. It's a firm affirmation, as well as purchase orders health. Did I kind of get your question, Mark?

That's helpful. And you would assume that the net result of it is just actively -- it's margin and contributions that are more important than just trying to grow revenues?

It is. But ultimately, as you adopt, when you think about moving visibility out to the edge of the network, it's kind of Metcalfe's Law. I mean, you're really getting more points of presence out in the network, so we prior have talked about things like PacketPortal being $1 billion kind of total potential market opportunity as it matures. That will certainly have a top line impact. We're just rational in terms of, we know it takes the carrier time to implement these technologies.

Troy Jensen, Piper Jaffray.

Hey, quick question for Tom. Within your guys' optical components segment or CCOP, what percent of your revenues are in Datacom products versus Telco products?

We haven't broken that down between Datacom and Telco. But we did mention that the pluggables for Datacom is growing quite rapidly. So we are seeing a high-growth percentage in the Datacom pluggables. And we see that continuing with some of the major customers were working with. But we haven't broken down that percentage. But I would say that, you know, the Datacom is definitely growing more rapidly at this point than the Telecom.

Could you tell us if Datacom is a profitable business segment for you guys?

Did you say profitable?

Yes, profitable.

Yes, I mean, if I look at the gross margins that we're running on those products and the investment from an operating expense standpoint, yes, they would be profitable for us. And would mostly most likely bring up the average that we've been running in that business. So I would say they're profitable and on the higher end of the average.

Okay, alright, perfect. And then, one quick question. I know you guys are not going to give us specific guidance on the March quarter, but if you could just talk to it a little bit. Historically, it's down sequentially. But historically, we're up sequentially pretty strong in the December quarter. So do you think we're going to have, you know, similar type of seasonality in March? Or is it going to be more muted, given that we're not seeing a flush this year?

You know, we just don't have the visibility out that far, Troy. So we don't know at this point. And you know, we see the demand continuing to grow in the networks, right? The drivers are strong. So we're always hopeful that we'll see a pick-up. But at this point we just don't have the visibility to speak out beyond the December quarter here.

Okay, that's great. If I could sneak in one more. On VMI, I guess, I would assume that most the VMI movement has kind of already happened. So how much -- I think you quoted a percentage of business as VMI, and do you think it's going to -- could you restate that number? I didn't catch it. What's the end number here going to be? Is this going to be a continual kind of effect on the growth rate here?

Yes, I think it's about 40% right now. And I think if we go back a year, year-and-a-half, it was probably more like 20%. So it has seen a pretty big increase over the last year-and-a-half to two years. And I think especially this last quarter or two, because we had one large customer go over to VMI and another pretty good-sized customer, so I think that had a pretty significant impact this last quarter-on-quarter. I believe it's a trend that we'll continue seeing more VMI. Does it get to 50%? I don't know for sure. But it has grown significantly over the last year-and-a-half to two years. And accelerated here probably in the last couple quarters with one large and pretty good-sized customer moving over.

Got it.

One thing to keep in mind. Most people when they think about VMI, they think about a huge number of weeks of inventory that you're required to keep on hand for your customers. The VMI we just enacted this last quarter, we do have to maintain inventory, but it's only between one and two weeks for most of the products. So it does move inventory onto our balance sheet and it does raise the bar on us, operationally. But once you work through it, it's not actually a negative -- a big, negative thing.

Great, I understand. Well, good luck going forward, gentlemen.

Alex Henderson, Needham & Company.

Hello, gentlemen. Just piling up on the VDI stuff because I wanted to make sure that we had the mechanics straight on it. And so the impact quarter-to-quarter as we go into 2Q, you're talking about it roughly a 5% swing in the numbers -- as a result of it. What was the impact on the margin within the segment in your guidance? Would it have been a slightly larger percentage impact on margins? And does that fall back out if you assume the same percentage when you go into the March quarter? Would that fall back out?

So you asked the question, does VMI have a margin impact?

Well, I assume that if you have less revenues, that you're going to have less margin.

Right.

So is the margin impact leveraged as a result of that? Would the margins have been different if you didn't have the VMI transition?

So in Q1, I don't think there was any margin impact. They would have been mainly a bookings impact. In Q2 you see about a -- it's not a percentage, it's a mid single-digit dollar number impact on CCOP. And the margin impact would not be on the products involved. It would just be on an overall absorption and hitting the -- you know, flowing things through the P&L basis. But there's no fundamental issue in terms of selling price or the margins of the products themselves.

So as we look out into the March quarter, would we get -- assuming the same percentage, you would get that business back? It would pick it back up?

You would --

It would be tighter?

This impact should be gone for these customers in Q2. It's totally transitional.

Okay, second question. The sequential weakness in the component business. Can you give us a little bit of sense of what portions of the market -- what portion of that business line is impacted by it?

Actually, I think our components business is doing quite well right now. We had a big uptick from last quarter to this quarter, about -- I think it's 5%. In the script. And --

Talking about the guidance.

Again, if you were to exclude the impact of VMI that I referred to, the mid single-digit, you'd be flat.

Again, but if we were looking at what it's impacting, is there a segment that it's impacting more than another?

No. I think there's no one product that would cause it not to be growing more rapidly than that. It's really across the demand structure.

The last question, just on the technical stuff was, you made a comment about the book-to-bill being below 1 in all three segments. And then you kind of backed off on the CCOP piece, saying that that was an impact of the change to VDI. Would it have been 1 or below 1 if you hadn't made that transition?

And so I'll answer for all three. So CommTest was pretty close to 1. OSP was below 1. And if you had CCOP recover, you know, the bookings impact to the VMI, you'd be close to 1. You wouldn't get past it.

Okay, great, thank you.

James Kisner, Jeffries & Company.

Alright, thanks for taking my questions. Just want to revisit the operating margin model on CommTest. And then, I'm looking at your gross margin for the quarter. And it looks like it would have been about 60.7% with the one-timers. Just wondering, are you where you wanted to be for this quarter in terms of the operating model for CommTest and the revenue contribution from PacketPortal? And I guess for the coming quarter, you know, I think you said in the past that you thought that in the December quarter you'd have the structure in place to hit those operating margins in your target range of 20%, 23%. Are we there? Do you expect to be there?

Let me -- I'll take the first part and then turn it over to David. I think as far as what we said for the December quarter, we said we would have structurally the model in place but we needed to get to the $215 million in revenue. And without the budget flush in the December quarter, we're not going to get to the $215 million in revenue. So I think, you know, we are dependent on the top line being at that level. So it's very difficult to get to that model without hitting that $215 million or above at this point. I'll turn it over to David to give a little bit more detail on where he is on the model and what he sees going forward.

Yes, in terms of the new products which, as Tom mentioned, were 57% and a little bit more software content, as we talked about the model improvement, I think we're feeling comfortable that the, as you should say, structure is there on the new product mix and on the software content. As we look at our supply chain consolidation and repair outsourcing that Tom also mentioned during the prepared remarks, we are on target in terms of our execution against those plans. And again, if you look at where we were at the beginning of the year in terms of CapEx predictions from the carriers, if those all kind of stayed true when you do the math back to the $215 million, we are feeling like we've got that structure together in the model to be able to hit the business model 64 to 66, and 20 points at the bottom line as we committed to at the Analyst Day, and we've talked to each quarter.

That's great. And as a follow-up, on OSP, I mean, you've got a pretty significant -- I understand you've got this adjustment for inventory sequentially. And it's a pretty big guide down for this coming quarter. Just wondering just going forward, should we expect more volatility in that business with the holograms out of there? As you think perhaps a one-time event, can you just give any color on OSP volatility here?

Yes. I don't expect it to be volatile going forward. It has been a very steady business for us, even during the recessionary period. It stayed within some pretty close guard bands, as far as the revenue. So I don't expect that. I do think it's end of fiscal year-calendar year for major customer. They've got some inventory adjustments to be made. It was impacted by bringing [beta aid] on in the kind of July timeframe. I think the customer built some inventory because that was a 21-month project, and it's difficult to be exact on those kind of projects. We did hit our bring-up date and therefore, we've got the capacity now where they can back off inventory in the short-term. But we don't see that being lengthy and we don't see the lumpiness returning. Because we won't be adding another system anytime in the future where we add significant capacity into the model.

Subu Subrahmanyan, The Juda Group.

Thank you. I wanted to ask a question about the test business, as well. I wanted to understand, given the trends in test businesses, talk about some of the areas of growth. Can you give us a sense of what the mix is today? Wireless, wire line, how will you slice it? And what parts are growing versus what parts are not? And how do you think about kind of the consolidated mix? Also on margin, I know you've discussed this before, but CommTest operating margin is at even -- couple of years, of course, kind of low, and well below the goals you've had in the 20%, 23% range. Of course, revenues next quarter don't get to that level. But is there some model shift that you have to make to get to that 20% to 23% on that 16 basis?

Yes. Let me unbundle that question into the couple of parts that you asked. I think first, on the business model piece. I think we maintain consistency in terms of the overall major impacts to get us to the business model. First and foremost is the product mix, which we've been in the process of pruning. And making sure our investments are in a lot more intelligent products with a lot more software content. And we're making great progress there. I think you've heard about PacketPortal and PacketInsight and a lot of the products that we're putting out into the network to help carriers, not just on the CapEx but the OpEx side. So, I think a checkmark there. Our supply chain consolidation continues to maintain its tracking and its contribution into savings that will continue over the coming quarters to be able to meet the model constraints.

And then lastly, to your point in the conductivity piece on the volume. Obviously, you know, we had a $215 million target model. Obviously, overall carrier CapEx has had an impact there. But I think what we feel good about is, we're putting a lot more of our investments in things that we believe will have higher-than-market growth rates going forward. And a couple of those are certainly in the software area that we talked about, which is PacketPortal and PacketInsight. But all of them are really tracking the one wonder of the network, which is mobility. And so we continue to increase our investments overall in terms of R&D, in mobility. So we are having organic growth from R&D in the mobility sector. Going all the way from the antenna, if you look at a tower and you see the antenna up at -- you're now beginning to put fiber up that antenna instead of the traditional very large cable. You're starting to connect the cell sites that are connected to those antennas via the network, via ethernet back haul. And if you look at our organic portfolio, we're very much honing in that portfolio on connecting those cell sites and what's flowing across them.

So the instruments and appliances to be able to connect that and then to collect the information via PacketPortal, PacketInsight, that goes across the mobile network. The two inorganic investments you've seen us make here recently, GenComm actually tests the base stations that are connected to the network and have leading instrumentation. And we've already been winning in major service providers there. And with the advent of small cells now hitting the network, that is a great growth opportunity for the future. And we expect small cell technology to be significantly increased in calendar 2013. And then lastly, as we've talked about on other calls, as you get the cell sites and you have to understand the capacity across them, Dyaptive systems, which we again pulled in the quarter before last, is testing the overall capacity across those networks. So again, very, very much around the traffic going across the network and the number of cell sites across the network.

Ehud Gelblum, Morgan Stanley.

Thanks, appreciate it, guys. Trying to tie in a couple questions that were asked before and some of the ways you had answered them and just trying to dig a little deeper. One of them into the areas, Tom, when you were saying you are getting further in the Datacom business and you expect your Datacom business to grow pretty well over the next couple of quarters. And then, you have obviously a large competitor who started to come into your tunables and business and your Super Transport Blade business. You seem to indicate that after some aggressive pricing from that competitor in your businesses, that seems to have abated. A little more comment about the pricing situation in those segments and how you see them treating it.

But likewise, as you get into their Datacom business, are you being aggressive on pricing in their primary business over there? Or is there some way that the two of you have kind of worked together a little bit to make sure that, given the revenue levels in total aren't very strong, that you can sort of, I guess tiptoe your way into the Datacom business, where you can get revenue and not have it impact your gross margins? I guess what I'm wondering is, are we going to be hearing for the next couple quarters that your Datacom business is growing nicely but each quarter the margins and profitability are taking a hit, but don't worry, next quarter or the quarter after that things will get better? I'm just trying to understand if you play the game theory game out for the next year and how you see that? And then I have a follow-up.

Yes, I think it's all about continuing to evolve our products and be in a leadership position with the technology going forward. So as you know, we just -- we said we started generating revenue on our Tunable XFP+, smaller form-factor, lower-power consumption, you've got a lot more of these on a card. We believe that gives us another at least a year to year-and-a-half advantage, and build out the base of the Tunable XFP+. So we're really focused on how do we continue to move our technology forward, solving our customers' problems. We've got leadership positions, so we expect that we're going to be able to continue that position. We are getting competition in the Tunable XFP, to a lesser extent, in the Super Transport Blades, and I think that's already reflected in the pricing. Because as soon as our competitors showed the capability of coming out with the product, even though they work out there in volume, we started seeing that pricing pressure start.

So that's where I think the pricing pressure is already there and the negotiations this past year -- because they had the threat of being, to overcome the market, although they didn't come with much volume, initially. I think that pressure's already there and I think now it's evening itself off. I think on the Datacom side, as I mentioned, the gross margins are at or above our average. So I think that speaks to where we're at on the pricing. Don't feel like we've been overly aggressive on the pricing. I think we've got a very strong technology there. We've built off of some other business with some of those customers who like how we service them and support them on various product lines. And this is another offering in our total product line to them. So I don't believe in any way we've been overly aggressive on pricing to get our foot in the door. We had a natural way to do that, with these customers that already knew us on some other product lines and, again, liked our technical capabilities and the way we support them.

Ian Ing, Lazard Capital Markets.

Yes, thanks for taking my question. This lack of CapEx budget flush in December, do you think it's -- how much of it is a function of carriers being cautious or deployments that were planned perhaps at the start of the year and not ready yet ready still in interop and trial space and perhaps some uncertainty on what to spend on?

Yes, it's a good question. I think it's a prioritization, so it's a little bit of both.

Okay, great. And then this transition to the VMI and hub, I thought you did a good job explaining how you're just moving out the revenue recognition. Is it fair to say that this business was six- to eight-week lead times before, and perhaps VMI gets to the low 60s as you exit Q2?

Yes, I think that is on the average where our lead times are on the optical components business. So it would probably be safe to say it was somewhere in that neighborhood. And now, you know, literally, the lead times have gone to zero for the customer, based on some level of forecasting on how we fill those [conbons] in. So, yes, it makes a big difference from a customer's perspective on when they launch these orders, time wise.

Dave King, B. Riley & Company.

Thank you, good afternoon. So, regarding your guidance for CCOP for the December quarter, just wanted to get more color as far as optical components versus lasers. Without the VMI transition, is it fair to assume that both optical components and lasers will be sort of flat sequentially?

I would say it's a pretty tight range. So I would expect 1 million or 2 million, give or take here.

Sure, right.

Yes, we haven't given the exact breakdown going forward between the two as far as our forecast. But I think lasers remains strong. The fiber -- your kilowatt fiber laser, commercial laser product is doing very well. We see strong demand out there. So we expect that to continue. We do see some fluctuations happening in the semi conductor market, where our traditional laser products are used. So that could have some fluctuation going forward. But I think the demand is quite strong on the kilowatt fiber laser where we should be able to absorb some of those other fluctuations.

Got it. And then within optical component business, is it fair to assume that, since ROADM's [kick], Tunable XFPs and pluggables, since they were so strong last quarter, can we assume those will still be up sequentially? And then others will be maybe down, so that net-net it will be kind of flat? Sort of?

Yes, again, we didn't give the exact breakdown in there. But again, we said flat to down 5%, and a good part of that 5% is this one-time revenue kind of adjustment based on the VMI. So we really don't see anything dropping significantly. So we see a kind of similar mix and pretty similar volume going forward, with the exception of that adjustment for VMI. Which should, as Rex said, should be behind us after the December quarter. Unless we bring in another large customer onto VMI, which we are not visualizing right now for that quarter.

And that will conclude our Q&A session today. I'd like to turn the call back over to Mr. Tom Waechter for some closing remarks.

Thank you, operator. As our call concludes, I would like to thank our employees for their numerous achievements and strong support of our customer base. I'd also like to thank our customers, partners, vendors, and long-term shareholders for their continued interest in JDSU. Our thoughts are with their employees, business partners and shareholders on the East Coast who are impacted by this storm. We are thankful that initial reports indicate that all of our employees in the region are safe. Finally, I'd like to invite shareholders to join us either on-site or online on November 14 for our Annual Shareholder Meeting. Details are available on the Investor Relations website. We look forward to seeing some of you in Milipitas. Have a good evening.

Ladies and gentlemen, that will conclude today's conference. Thank you very much for joining us, and you may now disconnect. Have a great day.