Viavi Solutions Inc (VIAV) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2014 JDSU earnings conference call. My name is Brei, and I will be your operator for today.

(Operator instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Jim Monroe, Vice President, Corporate Communications. Please proceed, sir.

Thanks, Brie, and welcome to JDSU's fiscal 2014 first-quarter earnings call. Joining me today are Tom Waechter, President and CEO, and Rex Jackson, CFO. David Heard, President of our Network and Service Enablement business, and Alan Lowe, President of our Communications and Commercial Optical Product segment are also here for Q&A. I would 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 in part one, item 1A in our 10-K filed August 23, 2013. 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 non -- to our GAAP results, as well as a discussion of their usefulness and limitation in today's earnings press release. The release plus our supplementary slides are historical -- 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 now would like to turn the call over to Tom.

Thank you, Jim. Our first quarter highlighted the advantages of JDSU's diverse portfolio, reflected growth in solutions that support growing bandwidth demand and the expansion of cloud networks, and demonstrated momentum in our adjacent markets. We are executing well against our strategic priorities, collaborative innovation, expansion in high-growth markets, and disciplined focused on operational improvements. JDSU's Q1 revenue was $429 million, at the high end of our guidance range of $410 million to $430 million. Gross margins were 46.3%, and operating margin was 8.3% above the midpoint of our guidance. Earnings per share was $0.13.

We delivered positive operating cash flow for the 28th consecutive quarter, with our cash balance at quarter-end of approximately $1.1 billion. We generated $29.5 million of cash from operations in Q1, and completed a senior convertible debt offering of $650 million on favorable terms. We used $100 million of the proceeds to concurrently repurchase 7.4 million shares of JDSU's outstanding common stock, returning value to our shareholders. We intend to use the balance of the proceeds from the convert for general corporate purposes, including potential strategic transactions. Bookings varied by business segment. Book-to-bill for communications and commercial optical products or CCOP was above 1, with demand stemming from network capacity build, including 100G solutions, as well as other optical telecom products. Book-to-bill for network and service enablement, or NSE dropped below 1 on weak order intake in North America, including the US government. Book-to-bill for optical security and performance products or OSP was approximately 1. Overall, JDSU's book-to-bill was below 1.

JDSU's focus on collaborative innovation continues to drive strong customer adoption of new products. Network-related revenue from new products less than two years old was 64%, marking the 10th consecutive quarter that we have delivered new product revenue ahead of our 50% target. Collaborative innovation is all about matching JDSU innovation expertise with customer's needs. New optical communications solutions like our TrueFlex ROADM, network enablement solutions like the T-BERD 8000 for 100G, our new gesture platform and next-generation anti-counterfeiting solutions are hitting the mark.

Now I would like to provide commentary on four specific trends, how they are impacting JDSU's performance today, and how we see them evolving. First, network bandwidth demand. The industry is striving to add bandwidth for subscribers, using an ever-expanding number of applications across a multitude of connected devices, while maintaining quality of service and profitability. In Q1 this trend drove growth for JDSU solutions that support the build-out of network capacity, including optical component and network enablement products for 40G and 100G deployment, and broadband access including FTTx.

We believe the current industry focus on core network capacity build-out is a necessary precursor to small cell and LTE deployments, which though somewhat delayed will ultimately drive capacity for high-bandwidth traffic to even greater levels. In addition, as network capacity is added and the internet of things expands, we believe that customers will increasingly turn to service enablement solutions that optimize application performance and the subscriber experience. While it is difficult to know the timing, service enablement investments have typically followed periods of network capacity build out. JDSU is well-positioned with a service enablement strategy and product pipeline that is aligned with the industry's transition to software-defined networks and the virtualization of network management.

Second, cloud networking. The cloud is driving and enabling the proliferation of enterprise and consumer applications. As a result, data centers are expanding, which is driving strong sequential and year-over-year growth of JDSU's optical communication products for the datacom market. JDSU's datacom solutions grew faster than the market in Q1. This trend is further diversifying our customer base to include global web services and social networking companies. Today, the cloud opportunity for JDSU is driven by connectivity and capacity within and between data centers. As this continues, JDSU customers that manage secure cloud-based networks will require the same network and application performance visibility required by public network operators. As a result, we believe continued data center expansion will increase the need for our solutions, providing increased cloud network visibility and control to enable optimized performance.

Third, momentum in our adjacent markets. The potential and excitement around gesture recognition applications including computing, home entertainment and mobile device interaction is growing. As expected, we saw strong Q1 growth for our gesture recognition products, as we continue to ramp of our second-generation gaming solution. As we have previously noted, Q1 was a peak quarter, reflecting the ramp-up prior to the holiday season. We are pleased by our progress with a variety of customers to develop new gesture applications, and believe the early leadership we have established in this market gives us a competitive advantage.

Because we have proven reliability while producing in large volume, we are well-positioned be the launch supplier as new applications come to market in 2014 and 2015. And as this happens, we believe the cyclicality of this part of our business will lessen. Overall, commercial lasers revenue in Q1 was flat. JDSU will join Amada, our key fiber laser partner, for an exciting announcement at the upcoming FabTech show in Chicago. We look forward to sharing more about our fiber laser strategy then. We think the future is bright in both of these adjacent markets.

And finally, turning to our anti-counterfeiting business and our OSP business, some thoughts on currency trends. Even in the digital age, the need for cash is still growing. As populations soar in major economies in Asia, JDSU is ready to support steady banknote growth driven by the ubiquity, security, and convenience that cash offers. In Q1, JDSU delivered 7% sequential growth in this business as adoption of our next-generation security pigments continued to grow. Today 44 countries use our next-generation pigment solutions, known as SPARK, in their banknote designs. During the quarter, SPARK growth was driven by wins in Africa and Latin America. We also recorded the first order for our new ChromaGuard thread with our lead customer. The ChromaGuard thread foil complements our existing offerings, and opens up new real estate for us in currencies worldwide.

Moving from market trends, a final comment on our continued progress on operational efficiency. Our supply chain continued to improve as we gained cost efficiencies, and lowered inventories for the third consecutive quarter. As a result, we delivered solid gross margin improvements across our three business segments. We were also particularly pleased with the progress of our anti-counterfeiting business, which delivered operating margin of 36.4%, at the high-end of our target model, while beginning to exit a number of product lines as we discussed last quarter. I will now turn it over to Rex.

Thank you, Tom. JDSU's consolidated first-quarter revenue of $429 million was up 1.8% sequentially, and 1.9% year-over-year. The Americas accounted for $199.2 million or 46.4% of total revenue, while EMEA contributed $104 million or 24.3%, and Asia-Pacific $125.8 million or 29.3%. EMEA was up slightly from Q4, while the Americas revenue was down slightly due to lower North America demand. Asia-Pacific revenue was also slightly down sequentially. Gross margin of 46.3% increased from 46.1% in June, and 45.8% last year. All three segments expanded gross margins sequentially, including 2 points of improvement in the NSE segment. CCOP, margin improved 1.1 points sequentially, and increased 1.9 points from last year.

Operating expenses were $163.1 million, down slightly from Q4 and up from $154 million from last year, primarily due to FY '13 acquisitions, and our continuing investments in R&D, yielding operating margin of 8.3%, up from 7.2% sequentially, but down from 9.2% year-on-year. Net income for the quarter was $30.2 million or $0.13 per share, essentially flat from $30.4 million or $0.13 per share last quarter, and down from $35 million or $0.15 per share last year. Please note that our Q1 non-GAAP results exclude among other items, amortization of acquired technology and other intangibles, stock-based compensation, and restructuring charges.

Now moving to the segments, starting with CCOP, which consists of our optical communications and lasers businesses. CCOP revenue for Q1 was $204.6 million, up 12.2% from Q4 and 5% year-over-year. This growth was driven by renewed telecom product strength, and continued growth of our datacom portfolio. Book-to-bill for the quarter was above 1 for optical communications, and below 1 for commercial lasers. Overall, CCOP book-to-bill was greater than 1. Revenue for optical communications was $176.2 million, up 14.3% from Q4, with telecom, datacom and gesture recognition all recording double-digit percentage growth.

Commercial lasers recorded $28.4 million of revenue, up slightly from $28.2 million in the prior quarter, as demand for lasers and semiconductor applications offset softness for other microfabrication applications and a flat quarter for fiber lasers. Demand for 40/100G telecom solutions was healthy in Q1. We continue to expect to participate in the 100G adoption in China, and believe that opportunity should begin building in calendar 2014. The increase we are seeing in telecom demand is usually an indicator of future demand for transmission products to support metro and access networks, including our tunable XFP and tunable SFP+.

Our TrueFlex ROADMs grew as expected, tripling off a small revenue base from Q4, as we completed qualifications and started to ramp into live network deployments. As Tom said, cloud networking is driving growth in our datacom business. We have a strong product pipeline for this market and excellent customer engagement for our 10G, 40G and 100G solutions. Optical communications revenue from products less than two years old was a record 68%.

As indicated earlier, our gesture recognition business grew significantly in Q1. We expect a decline in Q2, but remain excited about new gesture applications we are working on with multiple customers. CCOP gross margin increased in Q1 to 32%, up from 30.9% in Q4. Gross margin for our optical communications business was 29.5%, up from 28.2% the prior quarter due to increased revenue and increased operational improvements. Gross margin for commercial lasers was 47.5%, up from 45.4% the prior quarter. Optical communications average selling price in Q1 decreased 2.6%, below the midpoint of our quarterly expectations. CCOP segment operating margin for the quarter was 13.3%, above our guidance range of 10% to12% due to the significant increase in revenue, good control of operating expenses, continued improvement in product cost reduction.

Moving to networks and service enablement, NSE revenue was $171.9 million, down 9.4% from Q4. As Tom mentioned, customers are currently focused on network enablement solutions to increased network capacity. As a result, NSE's broadband and networking portfolio, including 100G, FTTx, and broadband access products grew 17% year-on-year, versus market growth of just 5%. Mobility network enablement strength in capacity test, drive test and protocol test partially offset the slow rollout of LTE in Asia PAC. For our RF test, we secured 10 new customers, and won significant deals in EMEA and Latin America.

NSE's cloud and data center business maintained share during the quarter, and we have seen strong pre-bookings for the new 40G version of our Xgig storage solution, which is optimized for both lab and portable field service and data center applications. As Tom mentioned, service enablement solutions from NSE's network visibility and control segment lagged as the industry focuses on core network expansion. NSE revenue from new products was healthy at 60% for the quarter. NSE gross margin was 62.1%, up from 60.1% as expected. Net inventory declined $4.8 million, with global turns improving to 6.3. Operating expenses of $82.4 million decreased $300,000 sequentially, but were up $6.6 million year-over-year primarily due to acquisitions in fiscal 2013, and ongoing R&D investments. This resulted in operating margin of 7.3%, compared to 9.5% in June, on higher revenue, and 9.9% last year.

Switching to OSP. OSP revenue for Q1 was $52.5 million, an increase of 6.7% from Q4, but down 7.1% from Q1 of fiscal 2013. OSP sequential growth was driven by strength in our security pigments, used primarily for banknote anti-counterfeiting. OSP thin-film products, an element of our gesture recognition solution also grew in Q1 due to the ramp of our gaming application. OSP gross margins increased in Q1 to 49.9% from 49.2% in Q4, due to higher revenue, favorable product mix, and better factory utilization. OSP segment operating margin for quarter was 36.4%, at the high end of its target model.

As we announced in August, we are exiting several OSP product lines that no longer meet our performance requirements. This includes certain thin-film coating products for the office automation custom display and solar markets, representing approximately $6 million of revenue per quarter historically. We had originally planned to complete this exits by December, but will extend production into the March quarter based on customer requests. Accordingly, we expect customer last-time buys to have a positive impact on revenue in fiscal Q2 and Q3, but with some margin pressure due to product mix. After we complete these product line exits, we expect our profit margins to improve, and we will evaluate revising our target model for OSP upward at that time.

Now to our Q2 guidance. As Tom indicated Q1 bookings varied, with strength in optical communications, but lighter NSE bookings. Looking forward, in NSE we expect a mid-single-digit budget flush from cable operators, but are not currently including telecom budget flush in our guidance. In CCOP, we expect higher optical communications revenue in telecom and datacom that will offset the expected decline in gesture and lower lasers revenue due to slower demand for lasers used in micromachining. In OSP, we expect higher revenue driven by last-time buys for product lines that we are exiting. Specifically then, on a sequential basis, we expect NSE revenue to be flat to up 5%. CCOP revenue to be approximately flat plus or minus 2%, and OSP revenue to increase between 2% to 5%. We expect our operating expenses to increase 2% to 3%, reflecting primarily annual merit increases.

And looking at the operating margins for the segments, we expect NSE operating margins to be 8% to 10%. CCOP operating margin to be 12% to 14%, and OSP operating margin to be 34% to 36%. We expect net expense for taxes, interest and other income to be approximately $5 million to $7 million. We expect our share count for calculating EPS to be approximate 237 million shares, lower than last quarter given our 7.4 million share concurrent buyback in Q1. We expect capital equipment purchases to be 3% to 4% of revenue. Taking into consideration the factors above, we expect second-quarter revenue to be between $420 million and $440 million, and our non-GAAP operating margin to be between 8.5% to 10.5%. I would now like to turn the call back over to Tom.

JDSU continues to deliver solid results in a dynamic environment. A consistent focus on our strategic priorities including collaborative innovation, and the balance that our diversified portfolio provides are key drivers of this performance. In our network related businesses, solutions that support core network capacity expansion performed well, as industry investments currently focused in this area. While small cell and LTE deployments have been delayed, and the timing of these projects are difficult to predict, we believe we are well-positioned for these opportunities, as well as increased demand for service enablement solutions that typically follows periods of network expansion. I am pleased with the profitable performance of our OSP business, as we exit legacy product lines and position the business for the best opportunities in the market it serves. And finally, we are excited about our expanding market opportunities, and the momentum we are seeing in our gesture recognition and commercial laser businesses. With that operator, please open the lines for Q&A.

(Operator instructions)

And your first question comes from the line of Mark Sue with RBC Capital Markets

Thank you. I am trying to get a sense of the lack of growth within the test and measurement in NSE's segment. It has been flat to down for almost eight quarters now, in a row. And if I look at it from even on an annual basis, it is down almost $60 million on an annual basis from its peak, and that is despite adding some of the acquisitions. So it comes down to investors asking us, is it really the timing? It has been quite sometime since we have actually seen that growth -- that business grow? How long should we wait? Is it execution? Is it competition? Any granularity in terms of region or segment, LTE, field tests or anything like that would be helpful, just understanding what you might do to grow this business, going ahead?

Okay. I will take the first part of that Mark, and then I will take -- turn it over to David Heard. I think some of your questions are -- parts of your question are around, is it competition? We believe in the traditional part of our test business, we are actually winning share, in the instruments -- field test instruments, we are winning share, and we believe we are expanding quickly into the mobility and network visibility parts of the business. So I don't think it is a competitive issue. We do believe that the network operator spending has been quite lumpy, and we expect that that will start rectifying itself as we get into the first part of the next calendar year, as the small cell deployment and the -- things like LTE deployment pick up. David, do you have additional color to add to that?

Yes, sure. Thanks, Tom. Yes, I think year-over- year, I think on revenue we were up about 1% -- and 4% when you take into account the fact, that over the last two years we talked about taking out some of those legacy low-speed products that aren't going to be appropriate, as we look to the forward direction of the network. And so, I think we have put the investments in the right place. I think you are going to see a lot more software-driven across the platform. What you are seeing in the uplift of the gross margins, we are investing in that now, because we are engaged with the operators, and we know what their needs are on a forward basis. If you look at us now versus two years ago, Mark, we are now -- still around -- we are now around 40% in the wireless and mobile infrastructure field, where we weren't. That is where the spend is going.

When you look at the ecosystem -- I think you are just seeing a bit of a delay in the spend, as carriers move from the macro LTE base station build-out for an initial coverage, down into capacity and application performance in small cell deployment, that was supposed to happen kind of back half of the calendar year this year. But now looks like it is going to be the first half of the calendar next year. So I think we feel pretty good about where we put the investments. We are starting to see that growth. And we are starting to see both of our funnel fill, as well as it is matched to what the customers are going to need in service enablement. And we are taking share in the ultra-broadband piece of our business -- (Multiple Speakers) -- we have improved business model.

With a focus of improving the portfolio in test and measurement and overall, does that mean that we should actually think about -- should we even factor revenue growth in this business going ahead, and looking forward? Or is it more higher profit contributions that we should think about? Just considering, it has been several quarters in a row, where you would meet and then kind of lower the outlook. And I think a lot of it is just related to this business. So maybe all the analysts could kind of revisit whether the market really is growing, and maybe your assumptions for that?

Yes -- I think a good question. I think when we look at the market on a go-forward basis, I think as we mentioned in our last earnings call, I think a good portion of that pruning is really behind us. As we look forward, I think what we have experienced as we look at our first quarter, and we look at our outlook for the first half of the year, it is indeed around that large portion of the spend, that is around the mobile architecture moving to small cell and SDN. So fundamentally, I think our competitors in the industry believe that is a growing market. We continue to believe that is a growing market. We are investing in stickier software that will be reoccurring, and build a more solid business model going forward.

Okay. That's helpful. Thank you, gentlemen.

Thanks.

Thanks, Mark.

Your next question comes from the line of Kent Schofield with Goldman Sachs

The NSE question, as we think about the operating structure of that business and look at the operating margins, are there any plans to look at that until we get the ramp-up in spend? Or do you think with the R&D projects and such that you will continue at that current spend levels?

Well, I think, we have shown the improvement in the gross margin. So I think we are on track with the mix, and what we are doing in the supply chain to continue to improve the gross margin. I think from an operating expense standpoint, we have been investing heavily especially in the new software developments, where that is not showing up into the revenue yet. So we will continue to invest in the software. It is a matter of the timing, and some of these network visibility solutions, it is really a matter of timing, when that starts showing up in the revenue and offsets that -- those additional operating expenses.

And we did have an acquisition in a pure software space that we, again, until we have the revenue recognition caught up in the Q3, Q4 of this fiscal year, we will see the expenses, but not really much realization of revenue. So I think there are other areas where we are reducing operating expenses and gaining efficiencies, and put some new tools in the -- in for the sales and direct sales and sales channels, and we expect that will gain us some efficiencies as we go forward, as those tools have just really been implemented in the last couple of quarters.

Okay. And then you did mention for September, some weakness around federal. Was that -- is that all significant, or something that we should expect to continue going into the December quarter? Or was that more of a modest impact?

David, you want to take that?

Sure. Yes, typically September ends our year with the federal government, the US federal government. So we had some muted expectations built into the quarter, given the sequester. But we did not have built-in a shutdown of the supply chain, which did have an impact. We don't believe that is a go forward -- while some budget was lost for the fiscal year for last year, the needs are still there in the government. So we believe we will see that rollout as -- again back to timing, as we get to the remainder of our year and their new fiscal year. But typically, this month is typically very heavy. The last month of Q1 is typically over 60% of our government business for that quarter, 60% to 70%. And again, we did not expect a complete shutdown of the supply chain.

Okay. Thanks for the detail.

Thanks.

your next question comes from the line of Alex Henderson with Needham & Company.

Great effort, perfect timing. I was hoping you could just give us a sense of the size of the government business, relative to how much exposure there is? And obviously, the September quarter is their fiscal year-end. So is that meaningful issue in the December quarter, just to follow-up on that? So what is the rough scaling of that, on a seasonal basis?

I think from a government exposure, most of what we saw as far as the downward pressure, was in the NSE side of the business. So again, I ask David, if you could give a little more color on that?

Yes Q1, typically is when we factor in our largest government quarter, which also tends to be book, ship, turns business. So it is a lot milder and already contemplated into -- (Multiple Speakers).

10% in the quarter -- (Multiple Speakers).

Pardon?

Is it 10% of your revenues in the quarter? And is less than 5% or so in typical quarters?

It is about double the effect in Q1, than it is normally.

But what is the size of the business relative that we are talking about here? Is it 5% to 10% of NSE revenues?

Of NSE total, you are in the 5% to 6%, 7% of total revenue annually.

Great, thanks. The second question is --

And typically heavier weighting in the September quarter.

The second question is, you have talked a lot about supply chain realignment, and cost cutting. And you spend a year and a half trying to really address the cost side of the equation. We are supposed to be seeing a margin expansion story in the test and measurement business over time. You have got target margins in the 20% to 23% vicinity, and yet here we are in a single-digits for -- and guidance that it is well below what is normally than margins, in what is seasonably strong quarter for the December quarter, typically. So how do we get any confidence in the rebound in the margin percentages in the test and measurement segment as we go forward?

Alex, part of that revised, as we said in our model on the revenue levels, so we -- the model calls for $215 million or more per quarter. We have been pretty far off of that on a quarterly basis right now. And as you look around industry, I think it is -- being seen by most of our competitors as well, if not all of them that there has been a softness of the network operators right now. So, yes, we have brought the gross margins about 2.5 percentage points quarter-on-quarter, and we expect that to continue to improve. So we think we are in good shape on driving the gross margin improvements. The key to getting to the operating income is the top line growth, and then also starting to see the spend on the software development level off, and then that start generating revenue at a higher gross margin than the average in this kind of mid 60% level would be much higher, higher than that.

Last question on the same subject though. You must have made a comment that you are expecting seasonality to substantially diminish. Can you elucidate what you meant by that, and why that would occur?

I think we said that specifically, around gesture recognition. And what is happening now is that, our initial customer is in the gaming industry, and a lot of those sales build up for the Christmas season. As we get into some of these other applications, we don't think it is going to be as a seasonal, based around the Christmas season as the gaming products. So as those start layering on, we will see less of that seasonality effect. But the gaming products right now, we are seeing a ramp to the December quarter, and that starts dropping off for a quarter or two.

Great, thanks.

Your next question comes from the line of James Kisner with Jefferies LLC.

Thank you. I guess I want to just drill down a little bit on PacketPortal. I believe in February, at your Analyst Day, you said that you thought you would do $10 million to $15 million this year in PacketPortal revenue. I am kind of wondering sort of where we are, and do you still expect to hit that kind of number for PacketPortal? And separately, on seasonality on com test, does it make sense that Q1 would kind of be less than historical, given -- sorry, calendar Q1 would be less than historical, given the lack of flush in Q4, calendar Q4? Thanks.

David, you want to address those two?

Yes, that's fine. So I think, and to Alex's earlier point, I think when you look year-over-year at the NSE business model, and you look at what we are investing, both in PacketPortal in building up a book of business to move forward on, the sticky software revenue as well as our software acquisitions -- you are seeing kind of -- as Rex mentioned in the script, a $6 million impact to that bottom line, that two things are happening. One, we are not yet realizing the revenue and getting the gross margins which would even be more improved, than the 62.1% that we are at. And number two, you see it is as kind of a year-over-year negative impact to the bottom line.

So as we continue with our software acquisition, booking business in a growing space -- again, a little bit more muted due to software architectures, where our customers are going --. but equally bullish on a go forward basis. And the same for PacketPortal, we expect that to improve to the range, based on a bit of the shift of timing. I think currently now, we are still looking at the low-end of the PacketPortal range. We have added three new customers in the quarter. We have got 47 plus trials now complete. We have got two new partners that we signed up, in terms of go to market with the product. And we have a unique new application going out around that small cell technology, that we expect to really help us as we get to commercial market. And as Tom mentioned, that will have significant uplift to the model, and be able to show the hard work that we have done over the last two years.

Thank you.

Your next question comes from the line of Joseph Wolf with Barclays.

Hi, good afternoon. This is [Tavi Rovner] for Joseph. I was wondering if you could give us a rough revenue trend by segment for each of the geographies?

(Multiple Speakers). We can give it overall, what we --

Yes, something -- not something precise, just to see some kind of trend.

What we typically do for the company, if you look over the long haul, US North America tends to be around half, with the balance is split between EMEA and Asia PAC. We have not been breaking that down by segment

Okay, thank you. That's it for me.

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

Congrats on the nice quarter, gentlemen.

Thanks, Troy.

Yes, I will give David a break, maybe a question for Alan here. I know you talked about CCOP being flat, and gesture being been down, and telco being up. Is there any way you can just quantify the growth that you expect to see in the data and telcos segment here during the December quarter?

Yes, thanks, Troy. I was feeling a little lonely and left out here. I think as Tom mentioned, the gesture recognition is seasonal, and the peak season or quarter for us is the September quarter. So we are seeing a considerable drop in gesture in the December quarter that is up, and we are also seeing a softening in lasers. But both of those reductions in revenue are really offset by continued double-digit growth in datacom and telecom. And just for a data point, our telecom bookings in fiscal Q1 increased from Q4 by 60%. And so we think it is a pretty good indicator that we are back in the beginning of a pretty strong telecom buildout.

Did you say bookings were up 60% or 16%?

6, 0. Given the June quarter was light, but if you remember, we had record bookings in the June quarter overall. But our telecom bookings were up 60% in the September quarter.

Wow, okay, perfect. Okay, and then Alan just a follow-up, CCOP margins were the highest they have been in two years. If you could just touch on that? And maybe some thoughts on the pricing negotiation, and what it means for 2014?

Well, I mean, pricing is always a challenge in our business and in our industry, and what we focus on is driving continued operational improvements and supply chain improvements. And we are continuing to make good progress there. So as we said, 2.6% reduction in the September quarter. Typically that is larger in the March quarter, and we will see what happens in the current quarter. But we are not expecting anything out of the norm for the December quarter from typical price reduction. Was that -- was there a second part of your question, Troy?

Yes, I guess, I was thinking about the negotiations for '14, calendar '14?

Well, they are ongoing now. We have settled a few of them already, and trying to get ahead of some of the uncertainty, that competitive landscape has created opportunities to close business earlier. And some of the changes in the landscape provide us that opportunity to go ahead and lock in share for 2014. So I think from that perspective, we are pretty happy with where we are with our customer engagements and negotiations for '14.

All right. Good luck, gentlemen.

Thank you.

Your next question comes from the line of Michael Genovese with MKM Partners.

Thanks for the question. I guess, my question is about the CapEx environment in general. And specifically, did something happen in October in service provider CapEx? Did things get a little bit worse? And if you could just comment about the two sides, NSE and CCOP, if you are seeing any different CapEx trends across those two businesses? Or if you can characterize CapEx spending overall? That would be great. Thank you.

And I think you said October, I am not sure if you meant September, but what we have been talking about is the September quarter. So we did see, as we mentioned in the script, trends where we saw more of a focus on the core buildout, with 100G really building out the core. And we saw really delays in the deployment of the small cells and LTE, especially TD-LTE in China. I think we are all aware of that. So we did see some bifurcation there, where there is a lot more spending in the core part of the business, and less out into the mobility and the edge than we expected. So it was a little bit more lopsided than we expected. We do believe that, eventually that rights itself, as typically there is a lag in time, and then we start building out the metro and out to the edge. And we do believe that LTE is going to continue to build out strong. So there was quite a split there this past quarter. We think that is going to start improving as we get into next, beginning of next calendar year.

And your next question comes from the line of Patrick Newton with Stifel.

Yes, thanks for taking my questions. I guess, just dovetailing off the comment on China, and pushouts on TD-LTE. I was wondering if you could help us understand what type of contribution you have from these Chinese rollouts built into your December quarter guidance? And then, you seemed to have a reasonable degree of confidence that these LT rollouts -- I'm sorry -- the TD-LTE rollout, so the small cell, I am assuming that is more North American than other geography focused accelerating. Can you help us understand why, what gives you that degree of confidence?

Yes. I -- so first of all, I think as far as what we have built into the December quarter for the TD-LTE buildouts in China is very limited. We do have some volume built into our optical components business, again for the buildout of the 100G as we are starting to see some of that happen, although still on a pretty small-scale. And then we suspect from our discussions with the operators in China, that we are really going to see more of the TD-LTE buildout that will affect the NSE business more the beginning of the next calendar year, calendar year, 2014.

And then the confidence on the kind of small cell and LTE?

Yes, we are very -- have a very high level of confidence that that is a technology that is going to roll out. We do believe it adds some complexity and some new technical challenges, because of where these are deployed on sides of buildings, up poles et cetera. And trying to get these two while being able to talk to each other, and all the backhaul capabilities that are going to need to come off these small cells. So we do believe it is going to happen. We see it on the roadmaps of our major customers. But we do believe they are working through some initial technical issues, before they get these out in the field and in large numbers. I think the complexity there is, if they are deployed in the field, and there is issues with them, the OpEx related to supporting them is very high, as compared to a macro cell. So I think there is a lot of testing out happening today, and ensuring that the technology is pretty bulletproof, before it rolls out into the field.

Okay. And then one -- I guess, a couple of CCOP questions for Alan and/or Rex. On the optical side, can you comment on where lead times stand in general? And I am curious you are seeing any capacity constraints across you portfolio, or any extension of lead times across any specific products? And then, while on the subject of optical, did VMI -- the issue that was prevalent last quarter, did that snap back in the September quarter, as a percentage of revenue?

Let me get the VMI number, while I answer this question on the lead times. I mean, what we have seen, and I think in the last two earnings calls I said, that we have been constrained on 100G modulators, and we continue to be constrained on 100G modulators. While at the same time, hiring people in our Bloomfield facility to grow with the demand, as well as CapEx to grow our capacity in our modulator line. And we expect continued growth through FY '14 on that. So lead times for modulators are challenged today, but we are putting in VMIs on most other products, to be able to respond to our customer demand changes. Because it is uncertain, what they need, when they need it, and we just need to be able to be there for them, and support them.

As far as the VMI is concerned, optical com at VMI last quarter was 38%. And I think one of the things that we saw last quarter was, because some of the concerns over lead times, we did see some hard orders from customers who typically took VMI. And I think that really stabilized the VMI. So I don't think we will see any changes with respect to VMI, as we go forward in our business.

Great. And just one more on that NSE side, David. I have to just keep drilling down on this on the operating target. If I take your midpoint of revenue guidance, in essence relative to your targeted model, you are about $40 million light in the December quarter guide. And on a operating margin side, you would be about $30 million light. So you have somewhere around a 70% to 75% type of incremental operating margin, even if I take into account kind of the $6 million of software investments that haven't really been levered on the revenue side. That is still is 60% incremental operating margin. I am -- I think we all just struggle to see how this target is obtained, even with some of the clear pushes you have made to software. Any more comments would be appreciated.

That's great. Again, if you look at Q1 as proxy, and you look at gross margin of 62.1%. On that level of revenue, without software realization -- revenue recognition realization, that would take the gross margins of that up. Again, that has about a $6 million swing to the bottom line, of where we are at today. If you look at kind of the current environment around Nokia Siemens, and everybody else that has talked about the wireless deployments being down, and again shifted to the right. It is volume-based.

And so, we had a different mix in our quarter due to the government push, and the lack of that mobility piece is, it tends to be higher-margin business for us. So there is probably another 2 points, just on mix that we were off in quarter. And that is where you see the benefits of the work that we have done on the supply chain. So as we return to again, all of the things we are investing in are location intelligence, small cell, All the things that the carriers are saying they absolutely have to go spend on, and are making architectural decisions to do so.

You are seeing M&A happen in that field, because people believe with capital that these are spaces in network visibility where they want to be. That as we get the volume, we should be well on schedule and ahead of pace to the 64% to 66% on the gross margin level, and as the revenue recognition happens. Both for the acquisitions and software, as the deferred revenue falls off, and as we begin to realize the new bookings that we are continuing to see, I think we are feeling comfortable that that is why we are continuing the investment. We have moved to OpEx dollars out of legacy areas into the places that we believe where the puck is going. Hopefully that helps.

Thank you.

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

Hi, thank you. I had a few questions on NSE as well. David, I appreciate the fact that the segment grew 1% plus in the September quarter and a year-over-year basis, in terms of how you reported revenues. But the guidance implies about a 10% decline. And if I assume normal seasonality, it looks like we are going to see between somewhere between 9% and 10% declines for the rest of the fiscal year. So I guess the question for you was, at this stage is normal seasonality the right assumption as you go in the March and June quarters, just given how muted December is? I apologize, if you answered that before. And then related to that, what we should we be thinking about RESO and it's the contribution in the March and June quarters?

Yes. So again, we are not guiding out into the first calendar quarter. But I think due to the timing of the shutdown on the government side and the slowdown on the carrier side of orders in our first fiscal quarter, I think that is, we are expecting to see a book-to-bill above 1 for our Q2. I think it is a timing issue, in terms of the release of orders that is contemplated into our guidance. As we move forward, I will let Rex handle the financial assumptions around the prior acquisitions that we have made.

But again, we are not yet into substantial revenue recognition in this first half of the year, as we described when we did the acquisition. But again, it remains a very exciting space. We continue to see new bookings, new customers in location intelligence. And I think you are seeing a lot about that in the industry, a lot of excitement and need for that from our customer base. Rex?

Yes, when we talk about -- on the most recent acquisition, I would stick with what we have said three to six months ago, which is that we are expecting that acquisition to be -- to have a positive impact from a gross margin perspective by Q3, and to be breakeven or better on the bottom line by Q4. We are still driving to that, and I don't see any reason why we would want to correct that. From a bookings perspective, you do have input or visibility in what they did last year. And we have represented it as a growth business, and I think that still holds true. To David's point, the revenue recognition side of it is the harder part. So I encourage people to track it on a bookings and cash standpoint. But we would expect to see that kicking in over the next -- I would say, one to three quarters.

And then maybe as a follow-up, is there a way to think about how big the China opportunity could be for NSE? I think a lot of clients struggle trying to even, both size the opportunity and also assign a probability to you getting a piece of the business in the NSE side. So any help there, David, would be much appreciated.

Yes. So obviously, those are the three -- the two largest operators in the world are there in China. I think we are well-positioned with them on a daily basis as they go to deploy. I don't think we are ready to talk about that as a percent of business. I think we are optimistic, based on the current plans and design wins we are getting, in that market. And feel good as -- I think we have been consistent on this -- talking about that being a first half calendar, or a second half of our fiscal year uplift on our business.

Okay. And then just final one for me for -- I guess anyone here. Any updated thoughts on the use of cash on your balance sheet at this stage?

Yes, I think again our primary use of the cash would be looking at strategic acquisitions that would be meaningful to where we want to go strategically, and filling out our portfolio. So we would continue to follow down that path.

Okay. I will jump back into queue. Thanks.

Your next question comes from the line of Mark McKechnie with Evercore.

Great, thanks for taking my questions. A couple of clarifying questions. I apologize if I missed some of it. But first on your revenue OpEx guide -- I want to plug that into my model. It seems like we are talking about gross margins going up. Am I right? Sequentially? Rex, can talk about how you expect gross margins to move next quarter or this quarter?

Yes, so if you run the guidance that we gave, you would see to get to the operating margin targets, you would have to have an uplift on two of the main business units, so CCOP and on NSE. I would expect because of the mix issue we mentioned in the script, the OSP margins are going to decline a little bit. But that is a smaller impact on a smaller business.

Got you. And then to clarify on CCOP, if you --your optical communications, up 14% sequential, bookings up, what did you say, 60% sequential. So when you guided that overall group flat, do you on a sequential basis, are you expecting another double-digit sequential growth on optical coms, and a decline in the laser? Or how -- if you could clarify that for me.

Yes, hi, this is Alan Mark. Just to clarify that, the comment I made about 60% increase in bookings, is specific to telecom in the September quarter. So not overall optical coms. And we do expect revenue to be down in gesture recognition in December quarter due to seasonality, as well as revenue in lasers to be down. So both datacom and telecom we expect to grow in the December quarter to offset some of that other softness that we see in gesture and lasers.

Okay, good. That's helpful. And finally, just on the NSE business, if we are looking at no flush in December, and we have heard that from a lot of carriers, right? That -- or your equipment vendors into the carrier space, that December, we are not getting that flush. We are not expecting the flush. Folks asked about that seasonality into March. I would have to think that, March you would buck the trend for sure on seasonality if China Mobile starts kicking up, and you don't have that budget flush in December. I mean, could that be a flattish to down quarter? Or how are we looking for March?

I think as David mentioned, we are not now forecasting out into March. But if I do think back on previous years, where we had almost zero budget flush, we did see less of a drop in the March quarter. So we would expect that type of the pattern if in fact, we don't get any budget flush in December.

Okay, great. Thanks.

(Operator instructions)

And your next question comes from the line of Simon Leopold with Raymond James.

Hi, this is Georgios Kyriakopoulos on for Simon Leopold. First of all, a housekeeping question, you did not provide percent of sales for [ROADMs] and tunable XFP SFP products this quarter. Can you please give us that?

I don't have it at my fingertips. ROADMs were slightly down, and tunables were slightly down. And I think it was really a result of the carriers spending mostly as Tom indicated on the core network buildout. We do expect both ROADMs and tunables -- both SFP+ and tunable XFP to increase in the December quarter. And that is really reflected in some of those strong telecom bookings we saw last quarter, as well as ROADMs to grow as we have seen dramatic increase in demand for our TrueFlex products. And in fact that is another product I meant to mention, with respect to capacity constraints. We are adding capacity to respond to that strong demand on our TrueFlex products.

Okay. And then I am trying to understand your comment from last quarter. When you mentioned the strongest booking in years for test and measurement for NSE. When do you expect to recognize revenue from these bookings? And given the weak guidance, is it fair to assume a less seasonal March quarter?

Yes, I think, again what we said last quarter on the bookings, was it was the largest bookings we had in eight to ten quarters in NSE. And some of the larger orders would spread out over multiple quarters. So I think that is consistent and factual with what we are seeing happen. Again, as I said in, previously, if we do not see budget flush in the December quarter, typically what we have seen in the March quarter is less of a percentage down, then historical. So we are just have to see how that plays out. We are not giving guidance for March yet. But that is typically what we would see.

Okay. Then remaining on the test and measurement segment, historically, wireless has driven upside to your test business. And I think you said that in fiscal 2013, it reached 40% of revenue. Now with LTE deployments likely peaking in North America this year, how do you see this business shaping up over the next few quarters? And also, help us understand the need for your wireless test equipment as carriers add capacity versus deployment. Like for example, if you get a higher portion of carrier CapEx dollars when your customers add capacity or when they deploy a new footprint?

That is an excellent question. So again, I think what we saw is a shift, as people are deploying small cells and more software in the network -- again you are seeing more of our spend, but you are not seeing the revenue right away. You are seeing gross margins over the last two years, if you trend it constantly going up. And you are seeing our spend go up, and you will see us cross the chasm as we get more revenue recognition of the products we have already sold, and the new products launched.

From mobility, you are just seeing a delay in the new small cell architecture, as Tom mentioned. More complicated to be able to hook up to the network. The core is being deployed out there in 100 gig. How you connect those small cells to the core, there are multiple architectures that do that. The good news is, we are very well-positioned with a test equipment and software, to test small cells. Which there is more of when you deploy for capacity, and players like Sprint that announced today that they will be deploying small cells in '14. You are just seeing this over and over, with the carriers talking about how they are going to use the small cell technology.

So we have the test equipment actually test the cell, connecting them to the -- to that big core via metro, which you heard players like Juniper talk about a shift in the spend going towards -- we are number one in the ethernet market, needing to deploy these small cells with very small probes to get network visibility is all what PacketPortal is about. And again, the new applications that we have to be able to allow carriers to do that. And so, we really see that as a -- again, back half of our fiscal, first half of our calendar, when we expected that to be the first half of our fiscal.

And I think that has been corroborated by the entire ecosystem -- and it is a delay. It is not a matter of if, it is a matter of when. And it appears that the when from our engagements is that, first half of the calendar, second half of fiscal. And in particular, China with the two largest mobile operators, same story, which I think we have been consistent on.

Okay. (Multiple Speakers). -- your geographic data, it seems that the EMEA grew strongly this quarter, almost up 20%. Can you offer some color as to what products showed strength within that region? And how should we extrapolate the strength going forward?

Yes, I think from a EMEA standpoint, we did see an improvement. We don't see a strong trajectory in the EMEA. We think we are coming off the bottom, but really we would not say that is an indicator of what is going to happen over the next quarters. We still think that EMEA is going to be pretty cautious in their spending. And we still think that is going to be reasonably soft.

One thing -- we did say that Americas are normally about 50% of our revenue, and EMEA and Asia-Pacific about 25% each. We have seen Asia-Pacific come up, and last quarter it was about 29%. So we are seeing a trend of APAC improving for us. And again, once the China rollout happens, in a larger scale with the 100G and then TD-LTE base stations, we believe that is probably going to increase some more in the future quarters. And I think Alan has an update to a future -- to a previous question.

Yes, just to give you specifics on percentage of optical coms from ROADMs and tunable XFP, SFP, ROADMs was approximately 17% of optical coms revenue, and tunable was approximately 12%, and both had book-to-bills of greater than 1.

Okay. That's helpful. And then, what I mentioned about the EMEA, can you give us some color of which products or strength within that region, that you see more strength in optical (inaudible)?

Yes. So CCOP saw good growth in EMEA, I think again, really based on deployments of the core network. And just because we ship a component or module into EMEA does not necessarily mean that it ends up in EMEA. But I can say that the 100 gig amplifiers and things that would going to the core of the network were exceptionally strong.

Okay. Thank you.

Thank you.

Your next question comes from the line of [Jorge River] with Craig-Hallum.

Hello, this is Jorge for Richard Shannon today. Thanks for taking my question. Sorry if I missed this from your prepared remarks. But did you say that TrueFlex grew 3 times from the fourth quarter?

Yes, it was obviously off of a small base, but the revenue was up 3 times from the previous quarter. So we are getting good traction there, and it is starting to take hold. And again, we think will be a strong performer for us.

Okay. And then, when can we expect this product to reach the $1 million in sales quarterly? Is that something that could happen in next two quarters?

Well, it is already over $1 million.

Okay. And then on the datacom. So on the growth that you are seeing in the datacom, what are the products that are single largest dollar growth contribution?

For datacom, our largest products are 40 gig SFP+, but we have seen a lot of traction on the basic 10 gig SFP+ short reach modules, as well as we have been penetrating or customers with that product.

Okay, that's all for me. Thank you.

Thank you.

(Operator instructions) Ladies and gentlemen, this will conclude the question and answer portion of today's conference. Now like to turn the call over to management for closing remarks.

Thank you operator. As our call concludes, I would like to thank our employees, business partners and long-term shareholders for your interest in and continued support of JDSU. Have a great evening.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.