Viavi Solutions Inc (VIAV) 2013 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to your Quarter Three 2013 JDSU Earnings Conference Call. My name is Denise, and I'll be event manager today. Throughout the conference you will remain on listen-only.

(Operator Instructions)

We ask that you limit your questions to two questions. Now I'd like to turn the presentation over to your host for today's call, Miss Cherryl Valenzuela, Director of Investor Relations. Please proceed.

Thank you Denise, and welcome to JDSU's Fiscal 2013 Third Quarter Earnings Call. Joining me today are Tom Waechter, CEO; and Rex Jackson, CFO. Alan Lowe and David Heard, leaders of our CCOP and CommTest businesses, respectively, 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 Factor section in Part 1, item 1A, of our current report on 8-K filed December 14, 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 slides and historical financial tables are available on our website. Finally, we are recording this call today, and will make the recording available promptly on our website. I will now turn the call over to Tom.

Thank you Cherryl, and good afternoon everyone. The March quarter presented some revenue challenges, but the JDSU team remained focused on our strategy, delivering solid results in most areas of the business. During the quarter, we delivered innovation that positions us well for growth opportunities in our core markets, closed a strategic acquisition to expand our mobility and software offerings, managed our costs effectively, maintained a strong balance sheet, and benefited from our diverse portfolio.

As we indicated on our last earnings call, we expected a more than seasonal decline in revenue from our fiscal second to fiscal third quarter, due to the timing of annual carrier budget releases, which we expected to begin in Ernest in March later than the February norm. The number of network operator budget releases were indeed delayed well into March, shortening our revenue runway and resulting in revenue of $405.3 million, at the low end of our guidance range, including approximately $400,000 of revenue from the resale acquisition.

Despite a slow start, we closed out the March quarter with a booked-to-bill ratio greater than one for the Company. CCOP's booked-to-bill was greater than one, while OSP and CommTest were approximately one. In light of lower revenue, we effectively managed our costs, delivering Q3 gross margin of 45.9%, and operating margin of 6.8%. Excluding Arieso, gross margin was 46%, and operating margin was 7.2%. Both CCOP and OSP increased gross margin sequentially, and exceeded their operating margin guidance ranges. We maintained strength in our balance sheet and working capital structure. We reduced inventory substantially from the previous quarter, generated $28.2 million of cash from operations, and reported total cash at the end of the quarter of $638.8 million.

Looking ahead, the fundamental growth drivers in our markets, particularly network bandwidth demand, remain strong. We continue to believe that incremental investments in global network upgrades will take place, but the exact timing of these upgrades has become difficult to predict, leading to caution with respect to our revenue timing.

Our outlook is based upon several factors. First, we see major spending by some large carrier customers as they work to align their incremental CapEx and their top strategic priorities. Second, we see a healthy level of carrier network design, bidding, and award activity; but again, the timing of actual deployments is unclear. An example of this is a 100G network deployment announced for one of the larger carriers in China. The timing of actual deployment is not yet known. Finally, we are seeing a faster shift from legacy wire line to high-speed broadband and wireless technologies than we previously expected.

We remain focused on key tenants of our strategy, delivering innovation collaboratively with our customers, and continually improving operational efficiency to drive more profitable growth. On the innovation front, products less than two years old accounted for 64% of our core network-related revenue, a new high, and surpassing our 50% target for the eighth straight quarter.

Highlights of our product initiatives include the following -- in optical communications the building blocks of the network, our datacom and cloud investments are paying dividends. At the recent optical fiber conference in March, we highlighted our 100G CFP2 product. The demand for higher-speed datacom products to enable the cloud remains strong, and we believe our new product offerings are well-positioned to meet the connectivity needs within data centers, from data center to data center, as well as from the cloud to the core networks.

For example, our 40G, GSFP Plus accounted for over 5% of our optical revenue during Q3. 100G coherent line-side component demand is also strong. During Q3, we could not meet all of our customers' demand for this product. We have addressed this capacity constraint, and expect to see continued growth in 100G modulators, receivers, and tunable lasers.

Our TrueFlex line of ROADMs continues to progress on plan. We recorded our first revenue during Q3 on our Twin 1x20 WSS, our first TrueFlex offering, and we expect to release additional variance and different port-count solutions for our customers' needs over the next several quarters. These TrueFlex WSSs will be shipped as both line cards and stand-alone modules for our customers who prefer to develop their own line cards.

Next, our network and service-enablement portfolio continues to evolve towards areas of higher growth, more tightly aligned with carrier spending priorities. We accelerated innovation and purpose-built mobility products during the quarter. With calendar 2013 projected as a take-off year small-cell 4G LTE, we introduced our small-cell assurance solution in February. We also saw healthy bookings in our capacity test and RF test businesses. Arieso, the acquisition we closed in March delivered bookings ahead of plan, and added two new customers at the end of the quarter. We are excited to add Arieso's market-leading, location-aware software solutions to our product portfolio. In total, wireless accounted for approximately 43% of revenue in Q3.

Our investments in Ethernet also reflected in the roll-out of a major Ethernet assurance project and launch of new products, including JMap, a powerful micro-probe for Ethernet and IP performance assurance. We also are maintaining our global leadership in optical transport, in particular with continued strong shipments of 100G in areas including Asia, where China is building the world's largest 100G network.

Packet portal continues to gain traction. We added eight new customers in fiscal 2013 to bring our total to 18, highlighted by our first initial network roll-out from a leading cable operator for a VoIP application. We have now totaled 46 ongoing and completed trials with an approximately 60% close rate, and made progress with NIMs on certifications and selling agreements. The adoption cycle for PacketPortal is lengthy, but we believe our customers can achieve quick and significant payback in acquiring highly granular visibility at the network edge. As we mentioned during our Analyst Day in February, we believe PacketPortal can contribute $10 million to $15 million of high gross margin revenue in fiscal 2014.

In order to focus on higher growth areas, we decided in Q3 to exit a number of legacy low-speed wire line product lines. As wireless becomes a greater focus for operators, we will continue to prioritize our investments in mobility, Ethernet, 100G, network visibility, and other areas that are vitally important to our customers. CommTest's record 65% of revenue from products less than two years old underscores our commitment to this transition.

Now moving on to our core anti-counterfeiting market, anti-counterfeiting products grew 13% sequentially, mostly driven by currency products. Our OVMP technology is now on 72 denominations in 41 countries. We expect some variability this calendar year, due to customer inventory adjustments related to currency pigments.

Now turning to market adjacencies, beginning with lasers. We had continued solid demand for our solid state lasers in Q3 for high-speed precision cutting and component miniaturization. Revenue from high-kilowatt fiber lasers was $3.8 million, compared to $7 million in the previous quarter, as a result of a customer inventory adjustment. We expect fiber laser revenue to grow in Q4.

Finally, with respect to gesture recognition, we have started volume shipments for a next-gen gaming platform, and expect to ramp production of both our laser diodes and optical filters in 4Q. The first-gen gaming operation contributed peak revenue, with nearly 4% of JDSU's total quarterly revenue. We expect that this new platform could ramp to similar peak levels of revenue. With that, I'll now hand the call over to Rex.

Thank you, Tom. Third-quarter revenue was $405.3 million, at the low end of our guidance due to the seasonality and budget delays Tom discussed earlier, and slightly up over the same quarter of last year. Consolidated revenue from the Americas was $194.1 million, or 48% of total revenue. EMEA was $95.1 million, or 23%, and Asia-Pacific revenue was $116.1 million, or 29%, reflecting a slight positive shift towards the Asia-Pacific region for the quarter. Gross margin of 45.9% was lower sequentially, compared to 48% in the previous quarter, due primarily to lower CommTest segment mix and gross margin. Year on year, gross margin improved from 45.6%.

Operating expenses were $158.4 million, up $1.2 million sequentially, mostly due to beginning of calendar year payroll expenses. This led to an operating margin of 6.8%, down from 11.4% sequentially, and 7.2% year on year. Net income for the quarter was $24.1 million, or $0.10 per share, down from $42.3 million, or $0.18 in the prior quarter, and almost flat compared to $24.6 million, or $0.10, last year.

The Arieso acquisition, which we completed in early March, contributed as expected approximately $400,000 of revenue, and incurred a Q3 operating loss of $1.6 million. As Tom noted, excluding Arieso, our gross margin would have been 46%, and our operating income would have been 7.2%, flat to last year.

Looking ahead for at least the near term, we expect to recognize revenue from Arieso irratibly, which means it will take time to build the revenue base under US GAAP. Accordingly, we expect Arieso to be accretive to CommTest's gross margin by the third quarter of fiscal '14, and to be break-even or better on operating income by the fourth quarter of fiscal '14.

Please note our non-GAAP results exclude, among other items, an $11.3-million inventory write-off and $2.2 million of accelerated amortization of related intangibles, which are primarily due to our decision to exit our low-speed wire line product lines in CommTest as part of our plan to prune our portfolio of low-performing products, and focus our efforts on wireless, mobility, and other initiatives important to our customers. These exited products contributed approximately $1 million of low-margin revenue in Q3.

Moving to the segments, CommTest delivered consolidated revenue, inclusive of Arieso, of $174.2 million, down from last year's third quarter of $177.8 million. CommTest, which sells directly to carriers, saw orders back-end loaded, with some slipping out of fiscal Q3, and experienced higher than usual competitive pricing pressure in certain wire line test areas. The decline in revenue, along with unfavorable product mix, higher excess and obsolete inventory charges, and certain transitional charges associated with CommTest's move to a more fully out-sourced manufacturing model, led to lower sequential gross margin of 59.1%, down from 64.4%. We expect CommTest gross margins to recover in the fourth quarter.

CommTest turned in operating margin of 7.5%, compared to 18.1% in the prior quarter, and 11.3% in the prior year. Without Arieso, CommTest revenue would have been $173.8 million, below its guidance range. Gross margin would have been 59.4%, and operating margin would have been 8.4%, within its guidance range, despite lower revenue.

Turning to CCOP, which consists of our optical communications and lasers business, in fiscal Q3 CCOP delivered revenue of $179.2 million, just below the low end of its guidance range. Gross margin improved sequentially from 30.9% to 31.8%. Operating margin was thus 10.7%, topping the guidance range. Booked-to-bill ratios for both the optical and laser businesses were greater than one. Within the segment, optical communications reported revenue of $152.9 million, down 1.7% sequentially, and up 6.8% year over year. Vendor-managed inventory, or VMI, was approximately 43% of optical revenue, compared with 48% last quarter. Eight of 12 product lines grew sequentially, with notable growth in transport products.

Total ROADM revenue grew 7.2% sequentially to 21% of total optical revenue, reflecting what we believe is a market-share gain. Combined, tunable XFP and tunable XFP Plus revenue was14% of optical revenue, or basically flat quarter to quarter. Optical communications gross margin improved to 29%, from 28.3% last quarter despite lower revenue, due primarily to product mix and cost improvements throughout the quarter. The sequential ASP decline in fiscal Q3 was 5.1%, in line with expectations, and within the typical range for March. The lasers business contributed $26.3 million of revenue, versus $30.2 million last quarter, due to an inventory correction at our fiber lasers customer. Gross margin improved sequentially to 48%, from 44.4%, as a result of product mix and cost-improvement initiatives.

Next, our OSP segment delivered revenue of $51.9 million, exceeding our guidance range on strength and currency pigments. Gross margin improved sequentially from 50.1%, from 47.9%, and operating margin of 35.8% improved from 33.6%. These results place OSP within its target operating model.

Moving to cash and our balance sheet, in fiscal Q3 the Company generated $28.2 million of cash from operations, while capital expenditures totaled $13.4 million. At the end of fiscal Q3, the Company held $638.8 million in total cash investments. Net cash was $479.2 million. We recently issued a tender offer for our outstanding convertible debt due in 2026, and plan to have this fully repaid by the end of Q4.

Now to our Q4 guidance. We indicated previously that we expected to see positive impact of increased network investments in our June quarter. We believe public commentary by key customers and others continue to support that view. The continuing delays by certain significant customers lead us to be cautious. Looking forward in CommTest, we expect higher revenue, and recovery in gross and operating margins. In CCOP, we also expect better revenue, including higher lasers revenue and new gesture recognition revenue. For OSP, we expect lower revenue, primarily due to customer inventory adjustments, and correspondingly lower gross and operating margins.

Specifically then on a sequential basis, for CommTest we expect revenue to increase approximately 7% to 11%, including $1 million to $2 million of revenue from Arieso. For CCOP, we expect revenue to also increase approximately 7% to 11%. For OSP, we expect revenue to decrease approximately 6% to 12%. We expect our operating expenses to increase $6 million to $11 million sequentially, reflecting a full quarter of Arieso of $4.5 million -- excuse me -- $4 million to $5 million, continuing investments in R&D, and higher variable compensation.

Now looking at the operating margins for the segments, we expect CommTest operating margin to be 9.5% to 11.5%, CCOP operating margin to be 10% to 12%, and OSP operating margin to be 31% to 33%. We expect net expenses for taxes, interest, and other income to be approximately $4 million to $5 million. We expect our share count for calculating EPS to be approximately 242 million shares. We expect capital equipment purchases to be 3.5% to 4.5% of revenue.

Taking into consideration the factors above, we expect fourth-quarter revenue for the Company to be between $420 million and $440 million, and our non-GAAP operating margin to be between 7% and 9% -- again, including more than a point of incremental operating loss from Arieso. I would now like to turn the call back over to Tom.

Thanks, Rex. While fiscal Q3 was more challenging than expected on the top line, the confidence in JDSU's opportunities going forward remain strong, with same qualities that we discussed during our Analyst Day in mid-February. Our innovation engine and portfolio alignment with our customers' strategic priorities are solid. We are well-positioned to help our customers meet diverse needs, from building next-gen networks, ensuring network visibility, supporting brand protection and anti-counterfeiting, and delivering innovative new laser and gesture recognition technologies.

In addition, we are improving leverage in our operating model, maintaining a strong balance sheet, and consistently generating cash. While the timing of network investments is not exactly as forecasted during our previous earnings call, we believe we are positioned favorably for growth opportunities as they occur. Operator, we will now take questions. >> Operator

(Operator Instructions)

Your first question comes from the line of Kevin Dennean from Citi. Please proceed.

Great, thanks very much. I guess a question either for Alan or maybe Rex. If we were to strip out gesture and lasers from CCOP, should we expect the rest of the business to grow in June?

Well, we don't really break it down to that level, and I think that's a good question with respect to the overall 7% to 11% we expect. A good portion of that is from gesture recognition growth, but I think at this point in time we don't want to break down how much telecom or datacom is going to grow. It's going to be what it is, and since we have such high VMI content, it's really hard to say.

Okay. Alan, just two quick follow-ups. ASP was down about 5% this quarter. How are we thinking about pricing for optical comm components for the balance of the year?

Well, it's hard to say what's going to happen in the out quarters but we don't see anything that's atypical in the June quarter. We predict it to be within the 2% to 3% range, which is seasonably typical for that quarter.

Okay. The drop in VMI as a percentage of revenues, what happened there?

Yes, that happens when some customers change their manufacturing facility or their hub location and they will give us discrete orders. There's really no change with respect to what happened with those customers. It's just a matter of when they bring up a new hub or new manufacturing location, they give us discrete orders because they don't know how to deal with VMI quite yet, but those transitions are done.

Okay, terrific. I'll drop back into the queue. Thank you.

Thanks, Kevin.

Your next question comes from the line of Amitabh Passi from UBS.

Hi guys. This is actually Jim Hillier for Amitabh. On the OpEx front, you're seeing a bump in OpEx, up $6 million to $11 million sequentially. I guess when we're thinking about this, is this just sort of the run rate trend we should be expecting going forward, given that much of the increase is coming from Arieso, and do you sport of expect that to run through mid-2014? Also, if you just sort of talk about the methodology behind the deal, given that this is going to prove to be a bit of a drag in terms of OpEx?

This is Rex. I'll take the first part of the call and then I'll turn it over to David. As far as the operating expense base line, our goal was to give you the tool to be able to work with Arieso from an OpEx perspective. I would expect that number to be consistent going forward, and you should just build that in. R&D is also a place where we put an enormous amount of focus in the Company. Both CommTest and CCOP, in particular, are continuing their investments in that area, so I would expect to see that component of it hold, as well. The variable comp just varies based on quarterly performance. Something along the lines of the range we are giving you is probably a good thing to work with going forward.

As I mentioned in my script commentary from a revenue perspective, we are banging through, building the base of revenue for Arieso from a rateable perspective, so it's going to take us some time under US GAAP to get that built up. I gave you the quarters when I think that things would turn for us. But one of the things we are contemplating doing in at least the near term is giving you a sense of booking some cash as we move through the next two or three quarters, so you can see the underlying strength of that business. From a strategy standpoint, I'll turn it over to David.

Yes, so good point on the investment piece. Obviously, we are seeing very strong demand, as we talked about in Analyst Day for the explosion of growth of small cells. We talked about software enabling the network. You're hearing a lot of about software-defined networks. Arieso gives us that visibility to the edge of those small cells. As Rex mentioned, we are seeing strong order demand ahead of plan for that business, and growing quite dramatically. It's a timing impact of the investment that we make in actual dollars of both cash and expense, to continue to fuel that growing business. That does yield orders and cash flow, but as we take the impacts of that software over time, I think that [ERR] will catch up that Rex just went through, but obviously our commitment to continuing that investment is based on the strong customer response and active market demand.

Great. Thanks for that. Then just a quick follow-up. Could you discuss linearity in the quarter, and if you were starting to see any bit of pick-up in the (inaudible - technical difficulty).

Yes, I think typically this March quarter is back-end loaded, and we saw it even more so this quarter. As we mentioned, we are expecting that to somewhat repeat itself, maybe not to that extreme in the June quarter, just because of the timing of the release of these budgets.

Got it. Thanks very much.

You're welcome.

Your next question comes from the line of Mark Sue from RBC Capital Markets.

Thank you, Tom. Just if we think about the timing of the release of the budgets after the initial strong indications that we had in the earlier part of the year, does it feel that at least from an inclination and in the case (inaudible - technical difficulty) those things are still there, the trend in April, is that going to support that things can come back quite readily, and the money that didn't get spent now, does that imply some subsequent catch-up in the subsequent quarters? Just your thoughts on how things might plan out over the next few quarters would be helpful?

Okay. Sure, Mark. Yes, I think we believe that the total business opportunities haven't gone away. What we are hearing from our customers, what we've heard publicly, the spend rate is still going to be pretty close to what we expected for 2013, so that says now that they have even less time in the calendar year to spend it. So we are preparing, we are being cautious, but we are preparing so we are ready to take advantage of those order releases when they happen. Again, we think we are very well aligned with the technology that is needed out there by our customer base to improve visibility into the networks and efficiently help them build out these networks in a restricted period of time. Feel good about that alignment, but we are more cautious than we were previously, just seeing what had happened in the March quarter and just the timing of these releases.

I see. Just if I could -- if you have any thoughts on what the root cause that might have been for the carriers to all of a sudden slow down their typical release of budgets that will be helpful from your dialogue with your customers. Also, as we think about kind of the inclination, the CapEx budget, for the most part which are firm for the year, foretell a June quarter which might mark the bottom for a lot of the revenues per segment for JDSU, and can you actually see how these tick in September, December?

I think David Heard is on the line here, and he works pretty regularly and his team with directly with the operators, so let me have him take the first part of that and kind of what he's hearing from his operators.

I think Alan and I are both seeing a bit of the same thing, kind of three fundamental factors we are seeing out there. First is a delay of the budget release with carriers, some of them making public investments as if they're going to spend more. It was about two to three weeks more than normal, which obviously causes a very back-end loaded quarter. The second piece of that is they are shifting, making wilder shifts in technology, really moving from the legacy technologies to the broadband, high-speed mobile technologies.

You get the third impact with the first two. The third impact is that tends to stall deployment, so there may be design wins that we are seeing out in the market. We may see relatively decent funnels in front of us and real conversations with customers that we've been having throughout the year and at Analyst Day that just take a bit longer. I think as you've heard the ecosystem network equipment manufacturers, carriers, and some of our competitors talk, those are the three fundamental dynamics I think we are seeing at play.

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

A couple questions. First on the gross margin, I wanted to dig into a couple of shifts that happened. The Americas on a geography basis was weak, as we EMEA on a sequential basis. Can you gave some reasons for that? I'm wondering were those impacts the CommTest business, and are those higher gross margins because it's CommTest, and so therefore did those impact the gross margin in CommTest as to why it was down to 59% from 64% the prior quarter?

Ehud, I'll try to hit more directly what I think is the question you're posing about the significant reduction quarter over quarter in the CommTest gross margin. There are a number of factors that were hitting that. I wouldn't tie it to geography. I would just tie it to a number of factors.

Clearly, one contributor is lower revenue -- a significant decline in revenue from Q2 to Q3; slightly higher E&O than we customarily have flow throw the COGS line. There was some fairly unusual but significant pricing pressure in one of the key product areas for CommTest that flowed through this quarter. Then there's some additional transitional charges that we incurred as part of CommTest's aggressive move to a much more fully out-sourced manufacturing model such as some overhead versus purely expense moves that flowed through. As I said in the script portion, we do think this is a one-time event. We're going to recover next quarter. I don't know if there's a geography question that you want to address, David?

I think it's just -- good pick-up on the general loading of where our revenues were. Just to reiterate Rex's point, as we discussed in prior Analyst Meetings, we're making a very aggressive supply chain move that gives us confidence in our gross margins going forward, where we've halved the number of both locations and contract manufacturers here over the last 18 months. So there were some inventory as well as accounting changes that as Rex said, we don't view will be re-occurring. That gives us, again, confidence in our gross margins going forward.

We did see a little bit different of a mix with that significant shift of two to three weeks within our portfolio that was more concentrated on access hand-helds prior to the up-take of our StrataSync software package that goes on those that we announced later in the quarter. I think those things together, along with the volume, were the root cause there. Yes, that has a geographic impact, just given the profile of our revenue mix for the quarter.

The reason I ask, it sounds like there's a little bit of a product mix with that software piece as well; because if you look back either at the September quarter or to the year-ago quarter in March 2012, you had revenues that were close. In September they were what, $170 million, and in March they were $178, so similar levels of revenue. That's why I wasn't going for the volume as being the issue why sequentially the gross margin was as low as it was, because those two quarters you were doing 62% gross margin, not the 59%. I was trying to come up with a base line. Are we now at a lower gross margin level for a mid-$170s million revenue --

No.

and is that geographically based? It sounds like it's a little more product-based than geographically based?

No. I think the bigger issue is as you transition out to the contract manufacturer, that's a relatively large piece of the equation. Rex was doing the bridge over from our Q2, which was appropriate to do that walk-through. So no, I don't believe that there's a change there, we've got confidence going forward. In fact, as we move to the supply chain, that's part of what has given us that confidence and that trend going forward, just some transitory costs that we are going through.

Okay, so it sounds like one time in nature. On the other side, looking at the other direction on optical comms, your gross margin went from 28.3% to 29%, yet your revenue was down a couple million. Is that a mix issue, and is that because on the positive side, and we look at the strength in revenues this quarter as being a driver of that?

Yes, I think it's a combination of partially mixed but really more the strong revenue from products less than two years old. We had 62% of our revenue from products less than two years old, and I think it was near 50% in the second quarter. That contributes very positively to our overall gross margin. Then at the same time, we've had a lot of focus on driving scrap reduction and yield improvement and elimination of waste, and we are starting to see some of the benefits of that.

All right, that's helpful. It sounds like it's pretty sustainable. Lastly, you said you gained share in ROADMs. Do you know maybe from who you may have gained the share and what types of customers geographically, and some of the end-user customers you were getting the share from?

That's a tough one, Ehud. Until they announce what they have done, it's really hard for me to predict. I think we just like to partner with our in customers and make sure we provide them the best customer support and products that they need to win in the market, and we think that our products help them win. So we are just focused on that, and when we gain share, we're happy about it, and when our customers gain share, we're even more happy about it. It's really hard for me to comment on what our competitors are doing.

Your next question comes from the line of Alex Henderson from Needham & Company. Please proceed.

Thanks. I was wondering if you could give me a couple of clarifications to start. You said that the discontinued some revenues in the T&M, and you said it was $1 million in the 3Q period. What was the discontinued revenues in the prior quarter that -- did it step down for the full quarter, or just part of the quarter? How do we think about that?

It was the $1 million in Q3, as I stated it, and it was probably $2 million to $3 million the quarter before that -- probably higher than that the preceding quarter. It's been coming down very rapidly. We saw it as one -- as a product line having very little revenue going forward, but if you're trying to sort of figure out what to take out, that should give you a sense of it.

Okay, thanks. Second, within the ROADM piece, are you seeing a shift in the mix to higher port counts from the one by two, one by fours? Are you going to the one by end type port counts?

I'm not sure we have seen a shift in our typical one by nine compared to our one by two and one by four. What we are seeing is the introduction of the Twin one by 20, where we saw our first quarter of revenue in Q3, and we expect that revenue to continue to grow as customers build out new core networks using our one by 20 type of ROADM technology and our TrueFlex technology.

One last clarification. The strong demand you were citing in Coherent, can you give us a sense of what portion of your revenues are coming from Coherent? I was under the impression it was around 10%. You're breaking out QSFP, which is under 10%. Am I correct in that assessment?

Alex, to be honest, I don't have that number, but I'd guess you're probably in the ball park range.

Okay.

If not a little light.

Okay, great. The question I really wanted to ask is on the T&M side. You've given us margin guidance of 11% for the June quarter. Normally your June and December quarters are seasonally stronger-margin quarters. You're on the record of talking about operating margins of up in excess of 20%, so you're half of where you need to be in what should be a seasonally stronger quarter for that business. As we look out into the back half, given the back-end weighting that you're talking about relative to service providers, should we be thinking about addressing a steep ramp in those margins towards those targets, or are we mired here at the lower levels? Normally it declines sequentially into the September quarter, so how should we think about that?

Yes, from I think a historic perspective, when you look at our numbers we have a high degree of operating leverage above -- take that $170 million number and the $215 million. It's a very high degree. In addition, as we continue to -- as we talked about work in the supply chain through the end of the fiscal year, which was our target that we stayed consistent with and that we're tracking to and we see the up-take of software.

On top of that, we're now adding -- the good news about the software business, both the acquisitions we are doing like Arieso and our existing software business is it's sticky, high-margin, good for the business model. The bad news is, you have a bit of that cost assumption prior to getting to the revenue. I think when you put those things together, we are still feeling comfortable with our operating model that we've been consistent with going forward on the 64% to 66% gross margins, and at that $215 million level being pretty comfortable at the operating income being well above 20%.

Your next question comes from the line of Patrick Newton from Stifel. Please proceed.

Good afternoon. Thanks for taking my questions. I guess a multi-part question on gesture recognition. I'm trying to understand what its contribution to revenue was in the quarter. I believe you had commented that it could -- this current win in gaming has a potential to reach 4% of total sales if it's similarly successful to the prior win. Would that happen in this calendar year? I guess lastly while on the subject, are you generating any revenue from your other gesture wins?

Well, the last one is easy. No. As we said in prior calls, we are working with multiple customers of which the first one ramps this year, and the others ramp in 2014. The revenue from this new product ramp in Q3 was relatively small, and it's ramping in a more meaningful way in Q4. Could it achieve peak revenue from what we saw in the first -- in this year? I think so, if it successfully takes off as a product.

Okay. I think implicitly that would be -- that would imply that if you got anywhere near that 4% level, assuming that's the high end of your guidance and you're talking about lasers increasing sequentially as well, that would imply that the remainder of your optical business could be flat to down?

Well, I'm not saying that we are going to get to the peak revenue in this quarter. I thought you said calendar year. We're not going to break it out that granularly, but as you go through any new product ramp, there is a time to ramp up and to get to those kind of peak volumes. You can't do that overnight.

Your next question comes from the line of Subu Subrahmanyan from Juda Group. Please proceed.

Thank you. I have two questions. First on the budget, just to revisit that. Tom, I think even on the last call you had expected some delayed budgets released. I'm wondering if incrementally there's a further surprise on that? Now that budgets have been released, I'm trying to understand kind of the ongoing caution related to that. Now that you've seen the releases, are they at lower levels than earlier expected, which caused some caution for June as well?

Yes, I think the -- there was incremental surprise to -- relating to the budget releases. We did think they would start moving more into March, which a number of them did, the majority of them actually did of the tier ones; but I think just with that actually getting the orders from the customer once the budgets were released was incrementally delayed, so that really impacted us significantly in March.

I think going forward into the June quarter we are cautious, because we are hearing a lot of that type of caution around this in our environment; but I think also with at least one of our major network operator customers, even though their budgets are now mostly released, they are still very slow on the ordering process. We just don't know how long that's going to take them to roll out the order process and for us to get the orders and to be able to then ship out, so we are being cautious. That's probably more concentrated on one major customer, as far as network operators from that perspective.

Understood. So not any ongoing delays, but more kind of anecdotal base and concern for this to continue; is that fair?

Yes, I think the way I would put it is back to those three points I made earlier. Yes, it took a longer period of time and some of the tier ones that were making those technology shifts, which were my second point, took even longer not only to release and get their awards of the design wins, but then the actual deployment schedule. So when we then entered the quarter with less in that kind of coverage that they pushed it out, it just makes it harder to catch up in quarter, and thus a bit of the -- again, the -- I think the judicious and cautiousness that we are using as we look at our current funnel and the expectations for conversion in quarter.

Your next question comes from the line of Simon Leopold from Raymond James.

Hi guys, this is [Toshak Opalush] for Simon Leopold. First of all on the demand environment, when did you start to see the softness in demand? Quite honestly, if I go back a couple of months ago at your analyst meeting, you seemed quite bullish on the service provider opportunities, but clearly March was weaker than expected. Now was your confidence back then based on actual orders, or more poised to commentary by service?

No, I think as we stated back at around Analyst Day that it was really triangulated from what we were hearing directly from our customers as they prepared us from what we could expect, as well as what they were publicly saying out in the markets as far as what their budget size was going to be, and that what we were generally hearing from the media around the environment. So I think that all is very similar today as what we heard at that time frame.

I think in reality what's happened is again the orders took longer to release. David, I think, did a good job of explaining the reasons why primarily the size of the budgets for a number of the operators to shift to some newer technologies even faster, so that does take longer to get through the budget and ordering cycle, and those are probably two of the prime movers. We -- as far as demand drivers, we still see the demand drivers being very strong. We haven't seen anything significantly change there. It's really what we see more around timing and the shift -- faster shift to the newer technologies.

Okay. So now if we shift gears to recognition business, I'm just trying to understand the ramp of this product line. So basically if I look back at the 2010 ramp-up, most of the shipments took place in September and December quarter, and if you only had the minimal revenue the June quarter. But on the call today you mentioned that you expect ramp of the next-gen game console this June. Should we expect revenue from this project to be more linearly distributed throughout the year?

I think for the calendar year -- we don't expect it to be linear for the calendar year. We are probably seeing a little bit earlier ramp in this generation than we did in the first generation, but remember the first generation was a completely new design and completely new application, so probably a little bit further ahead on that perspective for gen two.

I think the other thing to note, and I mentioned this at Analyst Day is that the JDSU content per gesture recognition product is significantly higher in the second generation as compared to the first generation. I think our success is only going to be as successful, if you will, as the product release and the acceptance of the market. As I said, the March quarter revenue was very low and we are starting to ramp it now. We will see after they announce it.

Your next question comes from the line of James Kisner from Jefferies. Please proceed.

Yes, thank you. I believe you mentioned at 100 gig you had some capacity constraints. Can you quantify how much revenue you may have lost as a result of capacity constraints?

Yes, it was mainly in modulators and it was between $1 million and $2 million.

Great. I just want to clarify, you're guiding CCOP to be up but operating margins looks like to be down a little bit. Could you comment on why that is?

I think we guided 10% to 12% operating margin for Q4, and we announced 10.7%, so --

So flat off the increase in revenue, basically at the midpoint?

Sure. I mean, we are certainly going to try hard to do better than that, and that's our current outlook.

Is there any reason, is it because gross margin is going to be lower or mix difference? Is there any texture at all you can give us as to kind of why?

Well, we are continuing to grow our R&D to make sure that we continue to have the kind of quarter we had last quarter with respect to new products. We need to continue to innovate and work with our customers. As we said at the analyst meeting, we had a very large pipeline of blade products, WSS ROADM blades. Those take a lot of material purchases and things and people expenses to get those to market. We're going to continue to invest in that area, to continue to drive our ROADM blades into our customers. I would say OpEx is growing and that partially offsets what you might expect in the growth in gross margin dollars.

Okay, so really to follow up on that, since you mentioned the ROADM line cards. You said that your analog teams expect an extremely second half, partially as a result of these ROADM line cards. Is that subject to the same uncertainty and push-outs that you're seeing in other products, or do you still feel pretty confident about that ROADM ramp in the back half?

Well, I can tell you that we are going to develop these cards with our customers and they will be successful if our customers are successful. If the service providers deploy these next-generation ROADM line cards that -- we talked directly with the NIMs and with the service providers, and they are pretty excited about what we have coming to market. Again, if they spend, we will be the beneficiary of that. We believe we are very well positioned with our customers and the service providers to make sure that when that spending does pick up, we will be in the right place for them.

From Lazard Capital Markets your next question comes from Ian Ing.

Yes, hi there. This is actually Tyler Radke in for Ian. I wanted to touch on obviously the comment you made on the prior earnings call about seeing the impact of network investment. Really, I think as a follow-up to a question that was asked earlier, when we look at the increase quarter over quarter into June on the CCOP, and we see that it's mainly gesture or a large portion is gesture, I guess Alan, at the Analyst Day you said you've never been more bullish on this segment. So --

I think I used the word excited.

Okay, excited. I guess just trying to understand are you still as excited? If so, can you kind of help us understand how much we should be thinking about this as a gesture recognition opportunity, versus the core optical communication?

Well, the excitement, if you will, comes from really the success we hope to have in gesture recognition, number one; and then number two, 62% of our revenue last quarter came from products less than two years old. That excites me, because that means our customers are counting on us more for their future needs, and the pipeline of products that we are having development to support our customers is really exciting. The data com stuff that Tom talked about, the PFP2, QSFP Plus products -- those are exciting products that our customers -- we have a lot of traction with our customers. We're there when the demand picks up, and we believe we are much better positioned than any of our competitors at this point in time.

Okay. On the CommTest side of things, obviously not hugely surprising that with the push-outs, but if we look at booked-to-bill, I think you said it was roughly flat, and then factor in the guidance, I guess should we think of this as a conservative guide just based on what the discrepancy in bullish commentary from the December earnings call? Or should we look as this is more a reflection on the potential orders that you're seeing out there?

I think it's very consistent with what is being seen in the market is that it's taking longer to get these orders released. Budgets were released late, and so we are reflecting what we are seeing and hearing directly from the customer. Again, we haven't heard anyone take their -- for calendar 2013, we haven't heard anyone take down their total numbers for the year, but it's a fact that the budgets came out later and the release of the orders is pretty slow, especially with some key tier one operators; so we are reflecting that in our guidance.

Yes, I would say it's no change in commentary. It's more of a timing issue, everything pushed to the right by two to three weeks. There was projects that pushed to the right. The good news is the projects that are being funded and the first dollars of the design wins we are seeing are in the same categories we talked about in the December quarter results, as well as at the Analyst Day. Where we see the growth in Ethernet, where we see the growth in mobility, where we see the growth in network visibility, those are all the areas that are consistent.

When we look at a composite of our competition from this quarter to next and we look at the ecosystem, we think that our guidance is prudent, and well-positioned even against the competition because of the fact that Alan mentioned. We had over between us, right, 63%, 64% new product revenue. It's in the areas where people are making those dynamic technology shifts to where they put their dollars.

Your next question comes from the line of Kent Schofield from Goldman Sachs. Please proceed.

Great, thank you. One question -- a little bit on the near term. You said you saw some deal flippage in CommTest, have any of those deals closed thus far?

We are not going to comment on specific deals, but obviously we continue to book orders, but we won't comment on specific orders out of any one customer.

Okay, understood. Looking through longer-term through 2013 with ongoing expectation for the network orders to come through, is there any reason to expect CCOP or CommTest to see those orders sooner than the other?

You mean one business unit to see the orders faster than the other?

Yes.

There are some cases where maybe there's large network build-outs in countries like 100-gig networks that are getting built out where we may be doing the test equipment for the labs of early evaluation where we may see the demand early, and that's where the teams do indeed work together to be able to provide that information. But as both Alan and I talked about, in many cases it's just the speed to deployment in those projects that I think has been difficult for the industry to gauge. Even though they are very large, they are the largest in the world, gauging the timing and the roll-out of those has been the tough piece.

Okay, great. Lastly, on the OSP side of things, you mentioned some variability in the revenues on the OSP side. Should we expect that throughout 2013, or was that just a next-quarter comment?

No. I think we will see it throughout 2013 as we are looking forward right now, we think we will see some of that variability throughout the calendar year. I think originally we thought we would see most of it in the December quarter, but we do think that's going to continue for a while now. I would estimate the best I know right now that it will continue through the calendar year.

Okay. Thank you.

You're welcome.

We have no further questions in queue. I will now turn the call back over to Tom Waechter. Please proceed.

Thank you, operator. As our call concludes, I'd like to thank you for your interest in and continued support of JDSU. To our employees, thanks for your commitment, your focus, and for rapidly moving the ball forward. Have a great evening.

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