Viavi Solutions Inc (VIAV) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First-Quarter 2015 JDSU Earnings conference call. My name is Jackie, and I will be your operator for today.

(Operator Instructions)

I would now like to turn the conference over to Mr. Bill Ong, Senior Director of Investor Relations. Please proceed, sir.

Thank you, Jackie. Welcome to JDSU's fiscal first-quarter 2015 earnings call. My name is Bill Ong, Senior Director of Investor Relations.

Joining me on today's call is Tom Waechter, CEO, and Rex Jackson, CFO. Alan Lowe, President of our Communications and Commercial Optical Products business unit, CCOP, and Senior President of SpinCo will also join us for Q&A.

Please note, this call will include forward-looking statements about the Company's financial performance, and plans to separate the business into two independent publicly traded companies. These statements are subject to risks and uncertainties, and could cause actual results to differ materially from our current expectations. We encourage you to review our most recent filings with the SEC, particularly the Risk Factors in part 1, item 1A of our annual report on Form 10-K filed with the SEC on August 26, 2014.

The forward-looking statements, including guidance, that we provide during this call are valid only as of today. JDSU undertakes no obligation to update these statements. Please note, also that unless otherwise stated, all results are non-GAAP, which excludes, among other items, amortization of acquired technology and other intangibles, stock-based compensation and restructuring charges.

We also expect to exclude certain costs we have incurred, and will be incurring as we prepare for and execute the separation. We include a detailed reconciliation of these non-GAAP results to our GAAP financials, 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 the website.

Finally, we are recording this call today, and will make the recording available by 6:00 PM Pacific time this evening on our website.

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

Thank you, Bill, and welcome to those joining the call today. Given our recently announced plans to separate into two public companies, we have shortened our prepared remarks today to allow more time for Q&A.

Focusing first on our quarterly results, our fiscal first-quarter 2015 revenue at $433.6 million exceeded the high end of our guidance range. Book-to-bill exceeded 1 for both CCOP and our Optical Security and Performance business segments, but was below 1 for Network Enablement, Service Enablement and JDSU as a whole.

Gross margin was 49%, with Network Enablement at 66.3%, a fourth consecutive quarterly record. Service Enablement at 69.1%, and commercial lasers at 50.7%, also records.

Service Enablement was profitable and ahead of our schedule. Earnings-per-share also exceeded guidance significantly at $0.14 per share.

Turning to our separation strategy. With several years of heavy lifting behind us and our business segments operationally fit, investing to win and targeting growth in a number of new areas, we are confident that this is the ideal time for the separation. As I highlighted in our mid-August earnings call in FY14, we completed several acquisitions to strengthen Service Enablement, phased out lower margin products within OSP, reestablished CCOP in datacom, and gained further traction in Commercial Lasers.

As our results show, what will be the new CCOP, which we refer to as SpinCo, and the new Network Enablement, Service Enablement, and OSP, which we refer to as NewCo are starting out the FY15 with a strong foundation and solid financial results, providing positive momentum as we move closer to completing the spin.

The timing is right for both SpinCo and NewCo to sharpen their focus on growth opportunities, as networks scale to higher transmission speeds, 40G, and data centers, and enterprise, 100G, and long haul, and metro and move towards software-based architectural changes, including software defined networks, and network function virtualization.

SpinCo will emerge with a clean balance sheet, a number-one position in optical telecom, and share growth in datacom. SpinCo's Commercial Laser business is entering a new growth phase, in both micro-machining and macro-machining. And this quarter, posted its second consecutive quarterly revenue and gross margin record.

Alan Lowe has strengthened his core Management team by adding Aaron Tachibana as CFO Designate. Aaron is presently JDSU's Vice President of Finance and Global Controller.

We continue to target the third quarter of 2015 to complete the separation, and are confident we can achieve that goal.

With NewCo consisting of Network Enablement, Service Enablement, and OSP, we have the unique opportunity to deliver greater value to our customers by providing unmatched end-to-end network visibility across service provider and enterprise networks. Our customers need this visibility to profitably scale in order to meet unrelenting demand in the ongoing proliferation of connected devices and applications.

I will remain as CEO, and Rex continues as CFO of NewCo. Paul McNab, who recently joined us as Chief Marketing and Strategy Officer, will also serve on the NewCo Senior Management team. Paul's extensive experience includes 16 years at Cisco in executive marketing strategy and engineering roles, as well as founding a startup that developed disruptive software-based network solutions.

NE and SE investments made over the last several years uniquely position NewCo to deliver new solutions that address the virtualized network of the future. As we execute NE and SE restructuring initiatives, we'll do so with our NewCo strategic vision in mind, and look forward to sharing more information about the roadmap to realize this vision as we move closer to the separation.

I'll now turn the call over to Rex.

Thank you, Tom. Consistent with prior earnings calls, we have a supplemental earnings slide deck posted on JDSU.com that provides current quarter earnings results and next-quarter guidance outlook.

JDSU's fiscal first-quarter 2015 revenue was $433.6 million, and exceeded our revenue guidance range of $405 million to $425 million. Gross margin at 49% improved 270 basis points from a year ago, reflecting continued operational discipline, favorable product mix from SE, strength in Commercial Lasers, and OSP's last time buy product exit last year.

First-quarter revenue grew 1.1% from a year ago. However, excluding approximately $30 million of 3-D sensing and last time buy revenues in last year's first quarter, our core network laser and anti-counterfeiting businesses' combined revenue grew 8.7% year on year.

Operating expenses at $173 million declined 6.5% sequentially from $185.1 million, on tighter expense controls and benefits from restructuring activities initiated in FY14. Operating margin at 9.1% exceeded guidance of 6% to 8% on higher than expected revenue, and up from 8.3% last year, driving a better than expected EPS at $0.14, flat to last quarter and up from $0.13 a year ago.

On the balance sheet, total cash at $880.9 million remained strong. Operating cash flow of $40.8 million continues our string of eight straight years of positive cash flow.

Since our CCOP spinoff announcement on September 10th, we've made great progress in separating assets and resources, including personnel, between the pending two new companies. We will set up SpinCo to be lean, with sufficient capital and no long-term debt. We have received a lot of questions about our net operating loss carry- forwards since our Analyst Day event in September.

We have about $6 billion of US federal NOLs, and about $3 billion of US state level and international NOLs. We expect substantially all of these NOLs will stay with NewCo, as we believe this is where they can provide the greatest long-term value. However, we do expect our tax assets will enable us to establish SpinCo with an effective forward US tax rate substantially below full domestic rates.

We remain confident that we can hit our $50 million savings target we announced at Analyst Day. The cost reductions are expected to be approximately one-quarter to one-third in COGS, and the balance in OpEx.

We'll be taking associated restructuring charges beginning in Q2, with the majority of the charges in Q3 and Q4, and a goal of taking substantially all charges in FY15. Accordingly, while we expect some savings in FY15, the primary impact will be seen in FY16.

Finally, we also expect to incur some incremental make before break expenses associated with site and team consolidations this year and next, which we will identify each quarter and confirm in later calls. We'll continue to expect the cash costs to separate the Company and achieve the estimated $50 million in annual savings is $75 million to $100 million, trending to the high end of that range.

Turning now back to the first fiscal quarter. CCOP ended the quarter with a book-to-bill ratio above 1. Optical Communications was above parity, and Commercial Lasers was below.

CCOP revenue of $209.3 million was up 2.3% from the first quarter of last year, and reached the top end of our guidance range of $200 million to $210 million. Optical Communications revenue of $167.1 million declined 5.2% from a year ago, reflecting lower 3-D sensing revenue of approximately $22 million, partially offset by higher telecom and datacom revenues.

The Optical Component pricing decline was 3.8% quarter-on-quarter, higher than typical first quarters. However, we continue to expect ASP declines through FY15 will be consistent with our recent ranges of 10% to 14%.

Commercial Laser revenue achieved its second consecutive record at $42.2 million, up 48.6% from a year ago, driven by strength from Gen2 fiber lasers. Fiber laser revenue was $12.4 million, up 12.7% from the prior quarter, as our partner Amada continues to ramp our Gen2 fiber laser use for industrial cutting applications.

We also saw typical seasonal strength in our micro-machining or solid-state lasers, as customers add capacity in anticipation of the holiday consumer electronics ramp. We also continue to be pleased with the progress of our ultra fast laser business, as we continue to see major OEMs with these products for testing and product development. We expect these efforts to drive continued strength in calendar 2015.

CCOP's gross margin at 32.5% increased 50 basis points from a year ago, reflecting primarily higher commercial laser mix. Optical Communications' gross margin at 27.9% declined 160 basis points from a year ago, reflecting primarily lower fab absorption from the decline in 3-D sensing revenue.

Commercial Lasers' gross margin reached record levels of 50.7%, and rose by 320 basis points compared to last year. And by 80 basis points compared to the prior-quarter record on higher volume levels.

Operating margin at 12% decreased by 130 basis points from a year ago, and was at the bottom end of the guidance range of 12% to 14%, due to higher levels of R&D spending to support key product and market initiatives.

Fiscal Q1 sales mix was 75% telecom, 18% datacom, and 7% consumer and other versus a year ago's 66%, 17%, and 17%, respectively. Our 3-D sensing revenue declined by more than $4 million sequentially, which we believe should be the low point as we have started to ship production units for PC-related applications.

Datacom revenue grew 2.4% year-on-year, and was up 14.8% sequentially. The higher speed transmission, defined as 40G and 100G, continues to grow, and represents more than 48% of overall transmission revenue versus the prior quarter at 41%. 40G and 100G modulators in the telecom business experienced 29% sequential revenue growth.

For fiscal Q2 guidance, we expect CCOP revenue to be $205 million, plus or minus $5 million. And operating margin to be 11.5%, plus or minus 1 percentage point.

However, low target operating margin guidance reflects expected lower laser revenue, along with continued growth in R&D. Our CCOP revenue midpoint guidance of $205 million versus $198 million in Q2 of last year, reflects a 3.5% year-on-year increase, driven by commercial lasers, telecom and datacom, and offsetting approximately $15 million lower year-on-year second-quarter 3-D sensing revenue.

As we indicated last quarter, we saw a very strong book-to-bill ratio for our submarine product line, which translated into a two-fold submarine revenue increase in fiscal Q1. New transoceanic cables typically proceed new greenfield network deployments where the cables terminate. Accordingly, we see the submarine business as a positive leading indicator for our Optical Communications portfolio in calendar 2015.

Commercial Lasers are expected to be slightly down sequentially reflecting seasonally softer micro-machining sales, while fiber lasers are expected to grow further in fiscal Q2. Our product pipeline in lasers is strong.

At our Analyst Day event, we previewed the 6 kilowatt fiber laser to address our new entry into the welding market, a $350 million SAM opportunity for CCOP. We are also broadening our nanosecond laser product line with a higher power, higher productivity Q switch laser that is expected to be released to production by the end of FY15.

Last week, we introduced our direct diode laser that provides up to 2 kilowatts of power used for sheet metal cutting applications, and complements our Gen2 fiber laser product. DDL has significant advantages over CO2 laser-based systems in processing speed, beam quality, and overall cost of ownership.

Turning to the NewCo businesses. As a reference point, NSE revenue of $181 million was up 5.3% from last year's $171.9 million. NSE gross margin expanded 490 basis points versus last year to 67%, reflecting the contributions from Service Enablement.

Network Enablement and Service Enablement's book-to-bill ratios were below 1. NE's revenue of $132.8 million declined 8.5% from a year ago, but exceeded our guidance of $120 million to $130 million.

Lighter bookings in the year-on-year revenue decline reflect the softer North American carrier spending environment impacted by architectural discussions, and M&A distractions at our customer base. This was partially offset by year-on-year strength in Cable, Fiber, Video, and Base Station Test.

Gross margin at 66.3% improved 270 basis points from last year, primarily due to higher margin product mix, and to a lesser degree from supply chain efficiencies. Operating margin at 15.1% declined 40 basis points year-on-year, but exceeded our guidance range of 10% to 12%.

Despite year-on-year revenue declines from our service provider customers, new customers from new products allowed NE to expand gross margins and deliver a double-digit operating margin. We expect operating margins to continue to be healthy due to a combination of new products, expense controls, restructuring activities, and improved gross margin.

For SE, revenue reached $48.2 million, growing 79.9% year-on-year and exceeding our guidance range of $40 million to $45 million. The upside was driven by enterprise strength from network instruments, along with early customer acceptances on a number of projects. The year-on-year revenue increases also came from other elements of our SE portfolio, including Location Intelligence, RAN solutions, PacketPortal, and Mobile Assurance.

Gross margin was a record 69.1%, up 1,500 basis points from last year. And SE turned profitable, with operating margin at 1.7%, above the guidance range of the margin loss of 7.5% to 4.5%.

Profitability was driven by high margin enterprise business from the network instruments, higher revenues in our other SE businesses. Lower allocations of sales expenses based on relative bookings between NE and SE, and controls in discretionary spending.

Moving on to OSP, revenue of $43.3 million was down 17.5% from a year ago, up 1.6% quarter-on-quarter and just above the midpoint of our guidance range of $42 million to $44 million. The year-on-year revenue decline reflects our FY14 exit of the lower margin thin film cutting businesses, which contributed approximately $6 million in Q1 of last year.

Sequential revenue improvement reflects growth in our anti-counterfeiting business and a slight increase in our government business. OSP's book-to-bill ratio was above 1 in the quarter.

Gross margin at 53.6% improved 370 basis points versus a year ago on lower revenue levels, which reflects the benefits of our product exits last year. Operating margin at 36.7% improved 30 basis points from a year ago, from the aforementioned gross margin benefits, despite substantially lower revenue and exceeded the guidance range of 34% to 36%.

Looking forward to Q2, Network Enablement revenue is expected to be $140 million, plus or minus $5 million, with an operating margin of 20%, plus or minus 1 percentage point. Service Enablement revenue is expected to be $50 million, plus or minus $2.5 million, with an operating margin loss of 9% plus or minus 2 percentage points.

NE bookings are expected to be relatively lighter in fiscal Q2, reflecting the weak carrier spending environment, while SE bookings are expected to show continued strength. NE operating margins are expected to improve, while SE operating margins are expected to be highly variable. As NE and SE relative bookings variability impacts cost allocations, and thus materially impacts operating profit or loss.

As a result, it will continue to be useful to look at NE and SE on both a separate and a combined basis in making historical comparisons. Overall operating margin improvements reflect supply chain efficiencies, high cost controls, and increasing high-margin SE revenue.

We expect OSP revenue to be $50 million, plus or minus $1 million, with operating margin of 37.5%, plus or minus 1 percentage point. The improvements are coming from anti-counterfeiting and OSP's focus on higher-margin products. We are also continuing to invest in the consumer electronics, government, and healthcare markets to position OSP for growth in calendar 2015.

I'll now turn the call back over to Tom.

Thanks, Rex.

For overall JDSU, we expect the fiscal second-quarter revenue to be $445 million, plus or minus $12 million and non-GAAP operating margin to be 9.5%, plus or minus 1 percentage point. Our revenue midpoint of $445 million is down 0.6% from last year's $447.6 million.

We would point out that approximately $26 million in revenue from a year ago is attributed to the 3-D sensing and OSP last time buys that is largely being made up in fiscal Q2 this year from revenue in our Networking markets. Thus, our year-over-year revenue growth of 5.6% in our core businesses reflects networking market share gains.

We have also widened our revenue guidance range of $20 million to $24 million to reflect current macro uncertainty. Our non-GAAP EPS guidance of $0.15, plus or minus $0.03, has likewise been extended from a range of $0.04 to $0.06.

In closing, network industry's trends are moving rapidly. Disruptive technologies like SDN and NFV are emerging, while 100G extends into the metro market, and 40G is being installed in our tier 1 data centers. Near-term, US carrier spending remains weak, with initiatives such as the main 2.0 expected to improve network investment efficiency while creating technological disruptions in the industry. We believe creating SpinCo and NewCo will put these new Companies in a stronger position to capture additional opportunities as the markets evolve.

I would like to thank our employees, business partners, and shareholders for your interest and continued support of JDSU.

I'll turn the call over to Bill to begin the Q&A session.

Thank you, Tom. I'd like to ask everyone to limit their discussion to one question and one follow-up. Jackie, let's begin the question-and-answer session.

(Operator Instructions)

Amitabh Passi, UBS.

Can you hear me now?

Yes we can, Amitabh

Hey, Tom. Just a couple of questions for me.

First just on the SE side, if you could help clarify where the outside supplies came from. You obviously had breakeven much sooner than anticipated, but you've then guiding against an operating loss in the next quarter. So I was a little confused by some of the ebb and flow in SE in particular.

Yes, we had a strong quarter in SE. Part of it was network instruments, some larger projects around Mobile Assurance, and then RAN.

Part of the fluctuation you'll see in the profitability will be how we allocate cost based on bookings. And as you know, SE will tend to be a bit lumpy on the bookings because of the large size of some of these projects.

So, what happened is projected into next quarter is that we're going to have a significant amount of bookings which will attract larger allocation of costs. So that's causing the lumpiness.

We still believe that by our fiscal Q4, we'll be able to get to a consistent breakeven or profitability. But between now and then, it will be a bit lumpy. Based on those allocations primarily.

Okay. Just as a quick follow-up for you, Rex. Does your guidance for the December quarter incorporate any separation related expenses within OpEx? I'm just wondering, is that included in the $0.15 plus or minus $0.03, or are you going to pro forma that out?

It does not include any expenses, and we will be taking that out and making it very visible.

Okay. I'll step back in the queue. Thanks.

Thanks

Dmitry Netis, William Blair.

Thank you. I have two questions.

One is, could you give us a lay of the land in terms of the North America carriers? I understand how you're guiding for next quarter, but is there any hope for a recovery in 2015?

Do expect that to be in the first half, second half? How do you view the CapEx environment in North America specifically, and what your visibility is like on that front?

And then also, if you could comment on other parts of the world. For example, what you're seeing in EMEA and Asia, it sounds like those two markets came back, or actually were pretty strong this quarter. Do you expect that to continue in the forthcoming months or quarters? Thank you

Dmitry, I'll talk about the NAM carriers which is mostly the NSE business. So we do continue to see weakness in North America. We do see one of the four major tier 1 carriers that we support in North America is at a reasonable run rate, the other three are well below what we would normally see.

So that continues to be weak. Again, we believe most of it is because of the destructive nature of what's going on with the architectural shifts in SDN and NFV, as well as some M&A activity that's out there.

So we don't, as I mentioned on the last earnings call, I didn't expect any type of recovery until we get into our second half of our fiscal year. And I think that's still pretty accurate.

We don't have great visibility. But we do know that in most cases of those North American carriers they are getting behind on their investments. So there's some indication that that will pick up, but still limited visibility.

I think I'll touch on NSE for the rest of world, and then have Alan speak to from a CCOP standpoint. We did see Europe picking up somewhat, EMEA, including the extended areas. So that is not fully rebounded, but we do see some pick up there.

We saw reasonable strength in parts of Asia. But from an NSE standpoint, not as much as we had in fact inspected in China. Latin America is reasonable, Brazil, somewhat Argentina, so we're seeing some reasonable activity and probably a little bit better than what we planned coming out of Latin America for the NSE business.

Alan, do you want to comment on CCOP?

Yes. I think for CCOP we're seeing strength as we had expected on 100G throughout the world, with particular strength in China. As Rex had indicated, we saw 30% growth in 100G and 40G modulator shipments, and I think that was pretty broad based.

I think what we're seeing North America greenfields networks are very slow, but a lot of activity around next-generation of ROADM deployments and colorless directionless. So we saw, for instance, our book-to-bill on next-generation ROADMs are very strong.

It is a leading indicator that we're making good progress there. But I would say that the timing of those major deployments are still up in the air and I think 2015 I think the carriers in North America will have to deploy those new next-generation networks.

EMEA, we saw strength in EMEA. But again, those were the NEMs that we're seeing particularly, and where those end up going it's hard for us to track.

As a follow-up on the NSE side, I failed to mention we do see some pick up in activity in India that's looking a lot healthier for the NSE business

Okay, gentlemen, thank you. That's much appreciated for that color.

My second question is on, for Alan actually, on the Optical Communications side. As I looked at your gross margins, we're a bit light this quarter. Do you expect that to rebound, or how should we think about the gross margin going forward in Optical Communications?

I think our expectations are that pricing is less aggressive in the current Q2. But as we're in the middle of the annual price negotiations, and those haven't been settled out, it's still premature to know where the second half or the beginning of the second half gross margins will be in Optical Comms.

I think as we roll out new products and 100G on the client side, and the next generation of ROADMs, our emphasis is really to re-jigger the gross margin with new product introductions. And I think we're well on our path forward on that side of the business. So I hope that answers your question.

Okay, thanks.

Mark Sue, RBC Capital Markets.

Thank you, gentlemen. Maybe Alan, on Optical, if we look at the 100 gig side there. How can we think about your share gains near term, and how long that might persist considering competitors are adding capacity. So maybe the sustainability of 100 gig.

And then, Tom, as you progress towards splitting the business, does it preclude any M&A your part or possible divestitures before the split actually happens? And perhaps you can also weave in your comments as is relates to the change in landscape with NetScout and Danaher.

Yes, Mark, on your 100G question, I think we're still in the early stages of deployment. And primarily in the core of the network I think as we go forward, we'll start seeing 100 gig in the metro side in calendar 2015. And I think that will continue to drive volumes of 100G.

We did start volume production out of a contract manufacturer in Asia over the past few months, and that's really unlocking substantial capacity for us. And we're still planning on filling that up, and adding capacity over time. So we're very bullish on the outlook for 100G in the short term, as well as long-term.

On your second question, Mark, on M&A pre-split. There's nothing that precludes us from acquiring businesses, and we are continuing look to our three business segments or business units at opportunities. So there's nothing precluding us from doing that, and if it makes sense for us strategically and there's opportunities there, we obviously move on that.

I think as far as potential divestitures, as I said at our Analyst Day, we clearly have a path that we're going down that we worked with the Board on. And did a lot of due diligence on that we think brings the best value for shareholders. But if we do see interest out there in one of our businesses and we determine that that will bring greater value to the shareholders, we'll obviously pursue that path.

I think as far as the NetScout Danaher merger, I think it's very good for the industry. I think consolidation is good, both on the NSE side and the Optical Component side.

I would say that it wasn't very well received by the NetScout shareholders with their stock being down 20% to 25%. But I think from an industry standpoint, it will be helpful.

That's helpful, Tom. And perhaps as we progress through the process of there's a lot of hard lifting that needs to be done. Does it feel that the time frame is now looking readily achievable? Does it seem like the third-quarter calendar of next year things might actually happen quicker than that?

We believe that milestone is achievable. We've done a lot of work and making a lot of progress on our milestones here. It's conceivable that it could happen sooner, but I sure wouldn't make that commitment at this point.

If we could pull it in, it makes sense, we would definitely do that. As we look at milestones and our approaching those, we are obviously looking at the eye of can we pull them in. But I think we feel very comfortable with the Q3 of next calendar year.

We'll continue to keep everybody updated. If we can do it sooner, we would definitely follow down that path.

Understood. Okay, thank you, gentlemen. Good luck.

Thanks, Mark.

Patrick Newton, Stifel.

Thank you for taking my questions. I guess first on the Optical side, you in your prepared remarks or in your presentation, it talks about record 100G transmission revenue that was up 77% year-over-year. You also talked about 30% growth in 40G and 100G modulators.

Given that I was surprised to see your pricing was down 3.8% in the quarter. And I was wondering if you could discuss which products have been hardest hit by pricing, and where pricing is holding up?

On the question about the 100 gig and 40 gig, one was year-on-year and one was sequential. Was that your question?

No. That was just a statement that given the growth in those, what I would assume are higher-margin products and less price sensitive products. What's driving that 3.8% decline in pricing in the quarter?

I think it's the typical competitive landscape of our business. I think we try to respond to what our customers needs are, and we have competitors in the space that do things to fill up their factory.

And I think some of the consolidation that's happening over the last few quarters is going to be very helpful. I'm not going to get into the particulars of which product lines are seeing a higher ASP reduction. We're really more focused on generating new product introductions to offset that ASP reduction.

Okay. And then, Tom, if we look at your SE business guidance, and we just take that midpoint of $50 million and flatline it through the remainder of the year. SE would grow at about a 30% -- or a 36% year-over-year growth rate in FY15.

Should we think the back half of the year is going to have some type of fall off, or can you help us think about how seasonality should look for SE through the remainder of FY15? And then maybe in the intermediate term, would it be right to think that the SE growth should exceed aggressively your 11% to 12% growth target? While the NE side, given that a lot of the service provider statements you've made is likely to be below that 4% growth target?

We definitely think that SE is going to grow much faster than the NE business. And I think part of it is the nature of what's happening with this move to more software enabled architectures out there in the market.

So, I think there will be less seasonality in SE than there is in NE, because I think that the need for SE is emerging and it will continue to grow. And again, it's coming off a fairly low base. So those percentages I think are achievable.

I don't believe that it's going to drop off in the second half of the fiscal year, but like other things we just don't have great visibility. So we're always cautious until we're moving into that period of time.

Great. Thank you for taking my question.

You're welcome.

Rod Hall, JPMorgan.

Hello, guys. Thanks for taking my question. Can you hear me okay, by the way?

Yes, we can.

Just a couple of things I wanted to ask. I know that when you guys announced the CCOP spin, you were still working through some of the tax issues. And I wonder if you'd made any progress on that, and whether you could give us any update on what relevant tax rates might be in the two entities? And any other tax effect that you think would be worth us knowing.

And secondly, I don't know -- I didn't hear the first part of the call, so if you addressed it, I apologize. I just wonder if you could talk about, you've made some management changes in the NSE? I just wonder if you could talk a little bit about the changes, and what drove that and how you see the management of that business going forward? Thanks.

Rex, you want to address that?

On the tax front, in my commentary, we tried to cover the business as comprehensively as we could. We've made a lot of progress in terms of structuring the new CCOP entities going forward, so we've got a pretty good line of sight on what that structure is going to look like. It is one that allows us to take advantage of the fact that we do have a significant tax asset.

Don't have an actual effective tax rate to give you in terms of an actual number right now. We'd hope to be in a position to do that by the next call, if not sooner. But one thing I can definitely say and have said is that it's going to be substantially below full taxpayer rate.

So, I think people can take comfort on that. The other things we've also set on the NOLs, they will stay with NewCo, the NSE, sorry, NE, SE, and OSP businesses. So that they can be further utilized for other purposes to maximize their value, but they're proving to be very useful in setting up CCOP.

I think as far as the management changes, what we recently announced was a change where David Heard who's the President of the NSE business will be transitioning out of the Company in April timeframe. He'll help us through the next quarter, and then a major part of the transition period. David has done a tremendous job for the Company, and is really taking us through unbelievable transition, and a positive transition with that business.

I think the thought process here is that we are going to delayer and remove costs as a result of this initiative. And we didn't feel like we needed both a CEO and a President of the NSE business.

I think as far as the NSE management team leadership team, the leadership team is pretty well intact. They don't envision any major changes in that area.

Okay. And then maybe just one follow-up for you. There have been some mixed indications on the Optical market. One of the big systems companies indicating weaker margins, although it feels like that maybe that's related to a single customer. Another company talking about very solid demand and a stable pricing environment.

You guys don't seem to be -- apart from the pricing coming down a little bit on components faster than usual. Demand environment, it seems like it's pretty good. I just wonder if you could comment on how the visibility looks out there, at least in the component market, and how you feel about the end markets?

Thanks, Rod. I think as I said before, we're seeing strength in 100 gig and very, very strong demand in the cloud and web 2.0 Data Center build outs. I think -- I can't really comment on our two customers and what's going on there. But I will say that I think we're going to continue to see strength in both datacom and on the 100G.

And then the question is, when do the new greenfields get start getting deployed? And I'm a believer that it happens in 2015 calendar, just not sure when those full scale deployments really start rolling out.

Okay. Great, thanks guys.

Thank you.

Alex Henderson, Needham.

Thanks. I just wonder hopefully if you could give us a couple of raw data points on growth rates. You made a comment about PacketPortal contribution, if you could give us a little bit sizing on that. And what the rate of growth was on the datacom product lines, and optical, as well as the ROADM piece?

I'll take PacketPortal first, and then hand it over to Alan on the Optical Component side.

Continuing to make good progress on PacketPortal. It did grow year-on-year, but it's still not a significant part of our revenue.

But we do have three tier 1 revenue customers, both representing wireline and wireless domains today. We did, during the quarter, close our first NEM partnership agreement that was really important for us as a next step. And we are seeing expansion of orders from those tier 1s, and things like VoIP, video, and LTE.

So there's emerging I think three high demand applications for PacketPortal. Ethernet performance and segmentation, carrier managed enterprise, and Mobile Assurance. And we also believe it's directly aligning with the needs and the architectural shifts into SDN and NFV.

So, it does not represent a large amount of our revenue today, a high percentage. But it continues, I think, to be a disruptive technology that's now being well received out there in the marketplace

And as far as the datacom base?

Datacom was up 14.8% sequentially, and ROADM's was substantially flat but with a very strong book-to-bill. And where our true flux ROADMs grew substantially in the quarter.

So again, I think greenfields really are needed to have ROADM deployment and ROADM growth, and the question is, when does that happen? But I think the bookings is a good indicator for us that it's going to happen.

Could you just give us the year-over-year growth rates on datacom?

Datacom was 2.4% up.

Year-over-year?

Yes.

Thank you. And then last question for you is the Arieso pulling [inaudible]. Where are we on getting the full recognition of the revenues, and matching revenues to costs? And all that sort of good stuff on that accounting issue, which has been slowly winding through the Company?

Yes so the outlook on getting VSOE at the moment is, we're probably a number of quarters out before that happens. Having said that, we are able to take most of the revenue that the bookings would generate ratably. So I think we would expect to see steady improvement there, as opposed to something that's lumpy and transformative.

So it will be fully completed in the process, and you'll be one-to-one in 2 or 3 three quarters, you say?

Probably longer than that. I would expect some time probably in FY16 at this point.

Okay. Thank you very much.

Thanks.

Troy Jensen, Piper Jaffray.

Hey, congrats on the nice quarter, gentlemen.

Thank you.

So a couple questions here. Hoping you can touch on Gen2 lasers. It looks like they're pretty strong in the quarter, and what the gross margins are like on those products?

We don't break out the gross margins by product. I think we're still focused on ramping that product, and as volumes come up we'll get the economies of scale and continue to improve that.

I think just the indicator is 50.7% gross margin for our overall lasers business. Those are the numbers that we'll be public with, but we're not going to break out the different products on gross margins.

That's fair. So, Alan, while I got you then, so CCOP was up at the upper end of your range or your guidance for revenues, gross margins were at the lower end. So I'm assuming that's mix, and that's actually why I was asking the Gen2 question about margins to see if that was the reason.

I think we had a record gross margin in our lasers business, and record revenues. So I think it was more of a mix in the Optical business, and the lessening of absorption that we got by the substantially lower 3-D sensing revenue from a year ago period.

Okay, that's fair. And I've one for you, Tom, you may or may not be able to answer it, but I'll just throw it out there. Spinning the business off or just selling it, I guess my thought is if you spin it shareholders get fractional position in a company it may or may not want.

If you sell the business, you can put a big chunk of cash on your balance sheet, and do some acquisitions, and strategic moves, and stuff like that. So, can you help me with the decision to spin versus sell CCOP?

We looked at what we think the value of CCOP is as we spin it out, and the progress we think it will make it over the next 2 years to 3 years. And as we looked at that value, we think that's very significant to the shareholders.

With a sale its immediate, and then there really isn't a chance to increase that value. So as I said, we have a very clear strategy and plan of record. And if we find that another option or alternative that comes up that brings better or greater value to the shareholders we'll definitely pursue that.

All right. Well good luck, gentlemen.

Thank you.

James Kisner, Jefferies.

I just have a related question on the CCOP business and the spin. I'm just wondering if you were to sell this business, the CCOP business, prior to the spin, is there some tax liability that's created would you recognize a capital gain that's taxable? And maybe perhaps you could quantify that?

So James if we were to sell CCOP at a value that we could certainly estimate, our NOLs allow us to shelter substantially all of the gain, that would be a tremendous gain, of course. But we would be able to shelter almost all of it.

Okay. And that would come out of capital loss I guess carryforwards, it wouldn't come out of your NOLs right?

No, the NOLs are fine for both operating profits and capital gains.

Okay, that's interesting.

Gains on sales, excuse me, capital gains is not the right term.

Okay. So in some ways, you'd be handing some vale to Uncle Sam in that situation.

James, it's the other way around. We would -- it would be almost a tax-free transaction if we were to sell CCOP, or any of the other business units for that matter.

Okay, but you'd be consuming some of those NOLs was the point.

That's true.

So, just a quick one, just on your recognition and I'll pass. On PCs, I was just curious if you want to tell us if one of the products you're shipping into has recently been announced publicly?

To be honest with you, I don't know. I think for sure you'll see it before the end of the year, if it hasn't already happened.

Okay. Thanks guys.

These products are products that people have to put on the shelf before -- or put them in a warehouse to unveil them. So I think we're still early in that process, and frankly, I'm not aware if they have announced it or not.

Okay, thank you.

Thanks.

Michael Genovese, MKM Partners.

Great. Thanks for taking the question. Two of them.

First to reconcile the NSE business. In the 1Q, you came in higher than your forecast, despite weakness in US tier 1.

And you're guiding I think 2Q to the weakest Q2 sequential growth that I've seen in a lot of years. Does that suggest somehow that the strength outside of the tier 1 that you saw in 1Q goes away? Or just reconcile to me why there's no seasonality benefit at all, and what's going on there in NSE?

I think, again, if you look at what's happening with NAM operators and what's happening in our space with others that have announced and around the space. We're cautious. We don't think there's going to be any type of budget flush like there has been in past years.

And we're cautious with what's happening with the NAM operators. We think it's going to be at least through this fiscal Q2 before they start placing any substantial orders. So it's really based primarily on NAM.

I don't see any retraction of any magnitude in our businesses in the other geographic regions. Some of it's lumpy, but I don't particularly so that retracting.

Okay, got it. And then on the other thing, I feel like we just with the last question before me answered the question about tax implications if CCOP were to be involved in an M&A transaction before the spin. So what I want to ask you about now is tax implications if CCOP does a transaction after the spin, and specifically this IRS rule about tax-free spinoffs and engaging in M&A with partners you've been in previous discussions with?

And I'm not sure whether that's a one-year or a two-year period. So, could you just talk about those implications as far as you know about them? Are there tax implications by doing it after the spin, and would you might have to use the NOLs to shield it if it was M&A post spin? Thanks.

This one is almost above my pay grade, but I'll give it a run. So there are definitely applications post spin. If you've try to do a or if you've done a tax-free distribution and then you engage in acquisition discussions, particularly with people that you may have talked to before the spin.

If you get -- it is a two-year period, is my understanding, and if you get sideways from a tax perspective in that scenario because the NOLs would remain with NewCo they would be of no use to SpinCo in addressing that issue. Having said all of that, I actually we that as a pretty low risk. One would think that anyone out there that's wealthy enough to buy CCOP would understand that and do it before the spin versus after to avoid that problem.

Okay.

Joseph Wolf, Barclay's.

Thank you. A couple of questions.

One is, there was a deal on the tunable laser sector. I was hoping you could address the opportunity in tunables and modules and standalone, and how you're seeing that as we move to 100G. And if the consolidation -- or if the sale actually helps the sector or tells you anything about what the seller thought about gross margins on the addressable market?

Yes, I don't know what was in the seller's mind at the time. But I'll tell you that on the narrow line with 100G tunable lasers, we were behind in that market. But I'm happy to say that last quarter, we had our first volume quarter and we expect to grow that business for CCOP substantially in the second quarter.

So we're broadening out our available revenue per 100 gig port that shipped when we added the tunable lasers to the modulators that we shipped today. I think any kind of consolidation is a good thing, and given the fact that the acquirer already had that technology really just eliminates a competitor in the space. So that's a healthy for us, and for the industry as a whole.

Great. And then I think you touched on this a little bit with the SE discussion and the lumpiness of the margins. But could you talk about any mix? Because it seems like at the higher level of revenue, there's a wider loss and what that means.

Is there that much variability in mix, or is it just the size of the orders? Is it multi-core task, and how at the end of the year or at the end of the fiscal year does that even out?

I think, again, it is lumpy from a booking standpoint, because of the size of some of these orders is just much larger than what we would normally see in the NE business. And as I mentioned earlier, in our fiscal Q2, what we're projecting as far as bookings as a percentage of the overall bookings for NSE increases. And therefore, that draws more expenses based on how we're allocating some of the sales and other expenses to bookings. So I think that's what creates the major lumpiness

Do those bookings have a longer shelf life? Meaning, are those three quarter bookings versus shorter-term bookings for the traditional business?

Yes, so to turn those bookings into revenue definitely takes longer than it does for NE with the instruments. So, yes, it could be 2 to 3X kind of a time frame.

So just one other color point on that, and it's why I made one comment that I made in the script. I think that the best way to look at NE and SE is to look at them from the revenue perspective, and a margin perspective. And then when you get to the bottom line for those two units, I'd put them back together and look at it NSE as a whole.

And the reason for that is, there's a shared salesforce between the two segments. And obviously, we've created the segments to try to give more revenue and margin visibility. But it's a shared salesforce.

The sales expenses are allocated best based on the relative bookings between NE and SE in a given quarter. So as you can imagine, that's going to swing all over the place. But there was not another methodology we felt like we could use. So I would again, start at the top, and when you get to operating income put them back together.

That's helpful. Thank you.

Richard Shannon, Craig Hallum.

Good afternoon, guys. A couple questions for me. First on your datacom business within CCOP.

I think you talked about that business being flattish year-on-year for the September quarter. What's your view going forward here?

What kind of growth can you see? And can you discuss, to any extent, your breadth of customer bases? Is it rather broad, or is it fairly narrow that could drive some lumpiness going forward?

The year-on-year was only up 2.4%, and I think that's lower than the market growth, for sure. I think if you look back a year ago, we had substantial -- one major, major customer deploying cloud data centers in a meaningful way that had taken a little bit of a pause, and now it's starting back up again. I'd say we're expecting Q2 datacom to continue to grow.

And as we introduce new products like our CFP4, where I believe we'll be first to market, I think will substantially gain market share over time. So, the breadth of customer base, there's a handful of guys that make a meaningful impact, so it's not 20. And so as one customer may deploy large amounts of data centers, we'll see that go up and down.

Okay. Thanks for those thoughts, Alan. My second question is on 3-D sensing.

Last quarter you talked about a major PC customer starting to take some pre-production units. I think your comments were some shipments coming here.

Can you give us a sense of how broad the interest here is on the PC space for 3-D sensing? And how long could it be before that business gets back to the levels that you saw with your gaming customers a year ago?

It's really sad to say. I think the breadth of adoption will depend upon the applications that drive it. And as we saw with gaming, if there's a hot game, that the units will sell or there will be incorporated into a different PC model.

So, I think it's still early to determine where and when and how big that is. But as we said earlier, we are now starting to ship production units, and expect to see that grow over the next year or two. I think that the big question is, when will those wow applications hit the market that make people want to spend a little bit extra for a personal computer.

Okay, great. Thanks a lot, guys.

Thank you.

Alex Henderson, Needham.

I've been doing these calls for a long time, and I can't remember ever asking a question on OSP. But I've got to ask one, what's causing the big spike in that business quarter-to-quarter? And is it sustainable, because certainly that's the biggest percentage variance in our model?

So as you know, we pruned out some of the low-margin business ending in the June quarter. And we said that we would backfill that primarily with anti-counterfeiting bank note products.

And that's starting to pick up, both some inflection points around OVMP on some fairly significant currencies, and then we've got the threads coming on board also. So we get more real estate per bank note with the combination of OVMP and the threads. So that's the major driver there.

We have some other new products that are coming on outside of the bank note anti-counterfeiting, and that's starting to pick up. But that really won't make a difference in this second fiscal quarter. It's really around anti-counterfeiting for the bank notes.

So if you look at that, what we said was when we pruned out those low product margins the gross margins and operating margins would pop up 200 basis points to 250 basis points. We've already seen that without the revenue getting back to the previous levels, now the revenue will get back to the $50 million level as we hit fiscal Q2.

And then we would expect we should be able to maintain pretty close to that. And there will be some infection points above that, but it will be hard to predict and a bit lumpy.

So there's no specific big build program that's kicking it up that's going to roll off or anything of that sort? This is a sustainable level going forward?

Yes we believe so, because some of these new designs and the bank notes they go through different denominations, so we think that will last for a while. So there's not like one spike where that's going to happen and then go away. It should last for a period of time.

Super. Thank you

You're welcome.

Ladies and gentlemen, that concludes our Q&A session. And now I would like to turn the call back to Mr. Bill Ong for closing remarks.

Thank you, Jackie, and this concludes the earnings call for today. So thank you, everyone.

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