Viavi Solutions Inc (VIAV) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2015 JDSU earnings conference call. My name is Alex and I will be your operator for today. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

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

Thank you, Alex, and welcome to JDSU's fiscal third-quarter 2015 earnings call. My name is Bill Ong, Senior Director of Investor Relations.

Joining me today on today's call is Tom Waechter, CEO; and Rex Jackson, CFO. Also joining us on the call, Alan Lowe, President of our Communications and Commercial Optical Products business segment or CCOP and CEO-designate of Lumentum. Aaron Tachibana, JDSU Global Controller and CFO-designate of Lumentum, and Chris Coldren, VP of Business Development for CCOP and Lumentum's Investor Relations designate.

Please note this call will include forward-looking statements about the Company's financial performance and plans to separate into two independent publicly traded companies. These statements are subject to risks and uncertainties that 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 described in those filings.

The forward-looking statements, including guidance we provide during this call, are valid only as of today. JDSU undertakes no obligation to update these statements. Please also note that unless otherwise stated, all results are non-GAAP. We include a reconciliation of these non-GAAP results to our GAAP financials as well as a discussion of the usefulness and limitations in today's earnings press release.

The release plus our supplementary slides and historical financial tables are available on our website.

Finally, we are recording today's call and will make the recording available by 6 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 everyone on the call. Our fiscal third-quarter revenue was at the lower end of our guidance range at $410.7 million while operating margin of 7.6% and EPS of $0.12 exceeded guidance. CCOP and network enablement achieved their midpoints.

Service enablement and the optical security and performance product segments were below revenue guidance. NE and OSP both exceeded operating margin guidance at 20.1% and 39.5%, respectively, on strong gross margins and effective expense controls, enabling us to surpass our EPS expectations.

The carrier spending environment continues to be challenging. Revenue from our traditionally largest tier 1 US carrier customer is down by more than 30% for the first nine months of this year versus last year, driving a decline in overall NE/SE revenues.

We limited this decline through our continuing efforts to diversify our solutions and our customer base. This particular customer's spend volatility is not unique to JDSU and has had widespread impact on the industry supply chain.

The reported Q1 2015 CapEx was particularly light, down more than 30% from a year-ago levels. However, if their capital plans hold for full-year 2015, we may see a better second half spend. We remain cautious until it happens.

I am pleased with the progress we are making our next-generation products and technologies which continue to gain traction. To continue diversifying our customer base in the markets we serve, we are focusing our investments on location intelligence, mobile assurance and analytics, application aware network performance management, and cloud-enabled evolved instruments.

Deferred revenue and backlog for next-generation service enablement products is improving as SE deferred revenue and backlog mix shifted from a 45 to 55 growth versus mature product mix a year ago to a 70/30 product mix this past quarter. We illustrate this portfolio shift in our supplementary slides.

Looking ahead to our planned separation, we followed our Form 10 in February and recently filed our first amendment in response to SEC comments. We have also announced the new names for both companies. We look forward to the formal introduction of our Viavi solutions and Lumentum brands later this year.

We continue to expect to complete the separation by the calendar third quarter and believe it will provide a catalyst for increased shareholder value.

I'll now turn the call over to Rex.

Thank you, Tom. Consistent with prior earnings calls we have slides posted on JDSU.com supporting today's commentary. To allow more time for Q&A, I will keep my comments brief.

Revenue of $410.7 million was below our guidance midpoint of $418 million. SE was $6 million below are guidance midpoint of $45 million due largely to lower than expected enterprise solutions revenue, the primary book and ship component of SE, and timing in our radio access network, location intelligence, and PacketPortal solutions portfolio.

NE revenue of $128.1 million achieved our guidance midpoint. OSP revenue of $48.4 million was below are $50 million guidance midpoint due to timing of Bank Note redesign printing campaigns in its anti-counterfeiting segment.

While both NE and SE saw seasonal sequential declines in revenue, gross margins for both segments increased sequentially due to favorable product mix and operational efficiencies. NE operating margin improved 330 basis points sequentially and 630 basis points year on year from higher gross margins and better expense controls.

SE's below target revenue materially and negatively impacted its operating margin. Despite OSP's sequential and year-on-year revenue declines, operating margin improved 230 basis points and 390 basis points, respectively, due to favorable manufacturing variances, stable operating expenses, and the exit of lower margin business lines last year.

For JDSU overall, favorable product mix and operational improvements drove better than expected EPS of $0.12, up from $0.10 a year ago.

At the end of FY2014, we separated NSE into NE and SE to provide greater transparency into the expected continued profitability of NE and the continued transition of SE towards growth in areas consistent with our strategy.

Despite an approximate 12% decline in NE revenue in FY2015 versus FY2014, using the midpoint of Q4 guidance, NE's operating margin percentage for this year should be approximately flat versus last year. While SE has demonstrated year-on-year revenue growth even with the expected decline in mature products, below target model revenue this quarter and next is delaying operating profitability into FY2016.

However, as Tom discussed earlier, where pleased to see SE's backlog and deferred revenue mix steadily and favorably shifting. SE's growth products backlog and deferred revenue grew by nearly 60% year on year, offsetting SE's mature products decline of approximately 45% year on year.

SE's growth products are defined as location intelligence, Enterprise, xSIGHT, Ethernet Assurance, PacketPortal and JMEP, and mature products are defined as legacy assurance and wireline, protocol and RAN test.

Although we continue to work on top-line growth, we're pleased to see progress migrating our portfolio to solutions that enable our customers' moves to new network architectures and have better growth potential.

Turning to the balance sheet, cash remains healthy at $815.5 million. Operating cash flow was negative $22.9 million in Q3 because our odd quarters are typically materially lighter on cash flow. We incurred separation expenses, as expected, and we reduced our accounts payable in preparation for the spend.

Looking forward, we remain on track to achieve net $50 million in cost reductions and are also on track to take substantially all associated charges in FY2015.

We expect $8 million to $9 million of savings at Lumentum with the balance coming from Viavi through reductions in corporate G&A expenses and COGS operating expenses in NE and SE. We will continue to invest in our go-forward strategy as we make these changes in FY16 and thus expect to substantially meet our combined $50 million target as we exit FY2016 measured by comparing our Q4 FY2016 annualized exit rate versus our FY2014 total operating expenses, plus $12 million to normalize for the fact that we acquired Network Instruments in mid-fiscal 2014.

With regards to our pre-separation operating model targets reflected in our supplementary slides, we have demonstrated that at or slightly below target revenue levels, we can achieve our gross and operating margin targets for all four business segments. We now need to demonstrate as separate companies we can deliver on the models of top-line requirements consistently.

Looking forward to Q4, network enablement revenues expected to be $132 million plus or minus $5 million with an operating margin of 17% plus or minus one percentage point. Service enablement revenues is expected to be $39 million plus or minus $2.5 million with an operating margin loss of 18% plus or minus 2 percentage points, again below our previous expectations due to a lower than expected revenue level for Q4. This segment needs to approach $50 million a quarter in revenue to achieve breakeven or better on its bottom line.

We expect Q4 OSP revenue to be $50 million plus or minus $1 million with operating margin of 37% plus or minus one percentage point. We are pleased to see OSP returning to the $50 million per quarter revenue level.

I'll now turn the call over to Alan.

Thank you, Rex. As Tom stated earlier, we filed our Form 10 in late February and last week we filed our first amendment. We've announced our new name Lumentum, which reflects light, power, and driving forward, the core of our products and of our business. Our team is excited by the opportunities in front of us and the significant progress we have made toward this separation.

Now on to our Q3 results. CCOP Q3 results revenue was $195.2 million and met the midpoint of our guidance range of $190 million to $200 million. Optical communications revenue of $163.7 million was flat versus last year while offsetting a net $7 million decline in 3D sensing revenue from the year-ago period.

Excluding 3D sensing, optical communications revenue increased 4.5% year on year, driven by Datacom growth which was up 23.2%. Datacom's strength was led by higher speed 40-gig and 100-gig transmission products including 40-gig QSFP+, 100-gig CFP2, and 100-gig CFP4 products.

More recently, the sampling of our 100-gig QSFP 28 products position us for continued leadership and growth. Telecom revenue in Q3 was down 1.4% from last year primarily impacted by ASP declines, which were greater than unit volume increases. However, within telecom we are seeing strengthen our ROADM, modulator, pump laser, and submarine product lines, which are all up more than 10% year over year.

In our ROADM product lines, we have seen particular strength from our newer TrueFlex products, which are moving from lab trials to new network deployments. Our TrueFlex products are key to recently announced North American metro deployments which could support continued growth for us in the coming year.

3D sensing revenue fell below $2 million during the quarter. Optical communications revenue mix was 71% telecom, 23% Datacom, and 6% consumer and other, as compared to Q3 of last year at 72%, 19%, and 9%, respectively.

Our higher speed transmission defined as 40G and 100G increased to 48% of our mix versus a year ago at 44%. 100G revenue doubled versus last year.

Turning to commercial lasers, revenue of $31.5 million grew 1.9% year on year but declined 21.3% sequentially due to seasonal weakness from solid-state laser products and softness in our fiber laser business.

Fiber laser sales were down due to customer inventory management. Q3 fiber laser revenue was just under $10 million following three consecutive record revenue quarters. We did, however, see growth in our ultrafast and gas laser product lines and expect our second-generation PicoBlade 2 to fuel growth in fiscal year 2016 in applications such as glass cutting.

In Q3, both optical communications and commercial lasers had book-to-bill ratio is below one due to a combination of orders that pushed into Q4 and having a higher than usual proportion of revenue from customers who previously placed longer-term orders with delivery dates spanning multiple quarters.

CCOP gross margin at 30.3% declined 210 basis points from a year ago due to an unfavorable product mix from both optical communications and commercial lasers. Optical communications gross margin was 27.9% and declined 140 basis points due to lower 3D sensing revenue from the year-ago level.

Q3 optical communications ASPs declined 4.7% sequentially, consistent with historical trends, versus a 4.9% sequential decline in Q3 last year. Please note that the March quarter is seasonally weak as it typically experiences the largest quarterly price declines during the year.

Commercial lasers gross margin was 43.2% and declined 570 basis points due to a less favorable product mix. CCOP operating margins of 8.9% was below the midpoint of our guidance range of 8.5% to 10.5% and was down 260 basis points from the year-ago period. Largely driven by lower gross margins versus Q3 of last year and higher-than-anticipated payroll related accruals.

Looking forward to Q4, we expect CCOP revenue to be $202 million, plus or minus $5 million. We expect optical communications revenue to be up sequentially driven by continued growth in Datacom as well as growth in key telecom products.

Commercial lasers are expected to be up modestly with solid-state lasers coming off a seasonally weaker period, and expected growth from our ultrafast laser products. The lower proportion of higher gross margin commercial lasers in the overall CCOP revenue mix limits blended gross margin. This, along with continued growth in critical R&D, puts us at a segment operating margin in the 8.5% to 10.5% range for Q4.

As we look further ahead, there are several growth drivers we expect to benefit Lumentum over the intermediate to long-term. Datacom demand is expected to remain robust, particularly at higher data rates. We are well positioned with our high data rate Datacom portfolio including QSFP+, CFP2, CFP4, and now our QSFP28 products, which have strong customer traction.

Telecom metro buildouts expected to begin in late calendar 2015 and into 2016 should drive significant ROADM and transport line card demand as well as demand for 100G transmission components and modules. Demand for our commercial laser products is also expected to be strong. Our newly introduced kilowatt class direct diode and high-powered fiber laser products, including turnkey systems, complement our existing solutions and position us well in the macro materials processing market.

Higher power version of our successful Q-switched solid-state lasers and ultrafast lasers specifically designed for OEM machine tool applications are being designed into our customers' tools now. Manufacturing these lasers using our low-cost contract manufacturing model position us well in the micro material processing market.

We expect 3D sensing revenue to gradually recover as we have started to shift production units for new PCs and other electronic device applications. We believe this business could strengthen further over the longer term as more consumer electronic devices increasingly incorporate 3D sensing capabilities.

As we transition from CCOP to Lumentum, we expect to be more agile and greater business flexibility. We are well along in the efforts to establish Lumentum as a standalone company with separate dedicated facilities, dedicated IT, finance, marketing, HR, and other support functions. Had the expected Lumentum stand-alone and public company cost been formed by CCOP over the past 12 to 24 months, we estimate that our reported operating margins would have been approximately 4% plus or minus 0.5% lower than our historically reported CCOP segment operating margin.

Finally, I would like to thank our employees, business partners, and our customers for their strong support to get us to this point as well as we approach operational readiness in the coming months.

Now, I would like to turn the call back over to Tom.

Thanks, Alan. We expect JDSU's fiscal fourth-quarter revenues to be $423 million plus or minus $10 million and non-GAAP operating margin to be 7.5% plus or minus one percentage point. Our non-GAAP EPS guidance is $0.11 plus or minus $0.02.

Caution continues to characterize carrier spending, impacting any segment results for most of the spending attenuation coming from one major US tier 1 service provider. However, we are pleased with the gross margin expansion reflecting new product adoption during the past year.

As we look ahead, we believe Viavi Solutions is well positioned to capture opportunities created by the industry's transition to new network architectures and the need for increased network, and application visibility.

NE is expected to be flat low growth businesses as we strive to improve operational efficiencies and drive incrementally higher operating margins. The SE business represents a strong growth opportunity, and we are striving for more consistent deferred revenue flow, which in turn would expand operating profitability.

The OSP business provides cash flow predictability and is pursuing growth opportunities in the consumer electronics, healthcare, and government markets.

Our teams are excited as we approach our launch date as two independent more agile companies poised to capitalize on the opportunities of advanced optical network adoption, fiber supplanting CO2 industrial lasers, the need for network and application visibility driving demand for NE and SE solutions, and the continued adoption of optically variable magnetic pigment and other solutions for banknote anti-counterfeiting.

I would like to thank our employees, business partners, and shareholders as JDSU enters an exciting new phase as Lumentum and Viavi Solutions.

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

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

(Operator Instructions) Amitabh Passi, UBS.

Tom, I guess if I look at just the financials at a high level, it looks like fiscal 2015 we are going to exit again with revenues roughly flat from fiscal 2012. Earnings are now kind of stuck in this $0.50 to $0.60 range.

Yes, you're going down the path of separation, you've streamlined businesses, you've gotten rid of low profitability segments. But yet we're not seeing any incremental leverage in the model. Is it time to maybe perhaps rethink that beyond separation is something bolder or different acquired within the context of larger scale consolidation or divestitures, or some of the way to unlock value?

I think, obviously, we haven't been getting the top-line growth overall for the business. So that's one of the main focuses. And as you saw probably in the package that went out with the earnings slides, we are seeing quite a bit of growth in the deferred revenue and backlog for the growth section of SE.

So, we would expect as we look out in time is that start to contributing more to the revenue line. So that will definitely help because we've been making pretty heavy investments in those areas.

As well, we have the $50 million net of costs coming out of the business structure combination of about $8 million for Lumentum and the rest coming out of Viavi. So that will help.

But I think you can see the leverage in the model. The main thing is getting that top-line growth, and I think we're well aligned in those areas where we believe that the operators and the data center folks, hyperscale guys are going to be spending money.

And then maybe just as a follow-up -- so given that you have a backlog of over $100 million in SE, how do we think about revenues being recognized in the P&L? And then just on the $50 million of OpEx savings, should we expect that to start kicking in, in your first fiscal quarter, i.e., total OpEx on a combined basis down $9 million, $10 million, maybe more?

Yes, I think as far as the $50 million, you saw a little bit of it this quarter. It's a small amount. We expect most of it to start happening in Q1 of FY2016. It will come over the quarters as we move through in 2016. There will be a little bit of a spill over into the first quarter or two of 2017. But the bulk of it will happen in FY2016 is what our plan is. And you can see a little bit of trickling out already. But we do in some cases have additional spending going on just to get prepared for the separation, etc.

And the SE revenues?

We will give more detail on how the SE revenues, the deferred and backlog will build and what part of that will be dropping in. We did put, as I mentioned, a slide in the deck that went out with the earnings package that helped, I think, to understand how quickly the legacy products are dropping off and the kind of growth rate we are seeing in the higher growth SE products or the next generation. So I plan with FY2016 is to give more granularity on that as far as how that's going to grow and what part is going to drop into revenue in each quarter.

Okay, thank you.

Mark Sue, RBC Capital Markets

Tom, appreciate the growth in deferred revenues and how that should flow into the top line for the SE business. On the NE side, it doesn't seem to be growing and, if anything, it's actually contracting. And we recognize the CapEx cycle, so there's some cyclicality in there. But, also structurally, is there a challenge here for the traditional NE business, considering it's still a large part of the organization? And maybe your thoughts on reversing that trend for the traditional NE business as the SE ramps?

You know, as we mentioned and, again, showed in the slides, we have a large tier 1 customer in North America that has cut back their spending significantly. It's down about 30% approximately. So if you take that out, we are up in NE about 2.6% or approximately 3%.

So, not the growth rate we want to see there, but we are seeing growth in other customers and we are diversifying. And I think also the steps we are taking around virtualization of the instruments, what we call evolved instruments, tying those into the cloud and then those being grouped into our overall platform as instruments is going to also help with the sales. But we don't see that as a high-growth area, but we have been seeing degradation there especially around that largest customer.

If that picks back up, that will be beneficial. We're not planning on that right now. Again, we're looking at how do we grow in other areas as we move forward.

Okay, that's helpful. And Alan, maybe a question for you. If we looked at your exposure to hyper scale datacenters, maybe your positioning particularly with a larger ones, who are sourcing directly from you, and the move towards 100 gig -- the pipeline of activity, just the overall comment there would be helpful. And if you're seeing more direct from these guys versus distribution.

Yes, we do very little in distribution, so the conversations we are having with the hyper scale datacenters guys is direct. And I think, as I mentioned during the script, the progress we made on our QSFP28 100-gig product where we can give those customer samples today of working products, and I believe the feedback we've been getting so far is where the first ones to give working samples that meet the criteria they need positions us very, very well to have a lead position as the transition in the hyper scale datacenters move from 40 gig to 100 gig. So I'm very encouraged with our progress and with our engagements with those guys.

That's helpful. Thank you. Good luck, gentlemen.

Patrick Newton, Stifel.

Alan I wanted to dive in on the laser side with the revenue definitely behind our expectations. Could you highlight if there was any share loss at all on the instrumentation side of that business?

And then with fiber, you talk about strong demand post this inventory pause. Can you help us quantify this or how quickly you can reach peak revenue levels seen in the prior September quarter?

And then just a little bit more clarity on the gross margin side in helping us understand the 800 basis point sequential decline. You did touch on mix, but I don't think that really explains the magnitude of the down tick, especially when I think that you have communicated that the fiber laser business is margin accretive and was over 30% of the laser mix in this quarter.

Okay, I think you're only allowed one question Patrick. No, I'm kidding. So as far as share loss, I don't believe we lost many share. I think if you look at the industries we participate in, the micro-machining business is typically slower this quarter in the March quarter as the holiday has gone by, and there's capacity there. As they look forward to the next season, we'll see a pickup in our Q-switched solid-state lasers where the margins are better than the average laser gross margin.

As far as fiber is concerned, the drop in fiber laser revenue this quarter was really an adjustment in the inventory levels at our main customer. And we still don't have revenues outside of our main customer Amada.

So, we have a whole portfolio of products that we announced at Photonics West that I think over the next year or so we should be able to add to our customer base. But we do expect that over the next couple of quarters we will get back to the kind of revenue levels we had at our peak time on fiber lasers, not necessarily this quarter.

And as far as the gross margin drop, we've been adding capacity which increases our depreciation. So as the revenue drops in lasers, it's very good on the upside and it's not so good on the downside, because there is a fixed portion of our operation that doesn't get absorbed.

Great. Thank you. And then I guess on the Datacom side of the business, I really wanted to dive into if there's outsized demand on the multimode or single-mode side of your portfolio. And then with visibility, can you talk about the growth potential of Datacom over the next several quarters kind of weighing some of the opportunities you're seeing on hyper scale against the fact that more and more competition is really targeting this market?

I'll let Chris answer that.

Hey Patrick, this is Chris Coldren. So the single mode versus multimode question. So we certainly see strength in both. Obviously for us the higher speed, higher data rate is generally single-mode products, and so I think for us that's where we're going to see the largest growth drivers or increase in demand. But we definitely have strong multimode business as well. But more to the 10-gig rates. Did that answer your question, Patrick?

I think he's off.

Alex Henderson, Needham.

Thanks. So I was hoping you could just do a couple of clarifications. You said the enterprise weakness, I assume that's the Network Instruments business. Is that correct?

That's correct, yes.

And can you give us any reason why that was particularly weak?

I think it was really performance on our side and execution. So we are taking measures to improve that. But I think the market is still strong, and our products are products are in demand in the market. I think it was more of an execution issue on our side.

Second question, we've got a lot of seasonal noise and turbulence in the industrial laser piece. To the extent that we were to look at this on a full-year basis as opposed to just a quarterly up, quarterly down kind of jerk around. What you think the rate of growth of that business should be over the next couple years? What is the trajectory that we should be anticipating?

Yes, I think if you look at the overall lasers business, the growth rate of that market, of the total TAM is probably mid-single digits. I think the places where we participate, where we've added things like the ultrafast lasers and fiber laser and, more importantly, the direct diode laser where we are replacing CO2 lasers. I'd say that that's probably a low-teens kind of growth rate, if you set aside seasonality in all of that other stuff. So, I would expect 10% to 15% growth rate would be the norm over the longer term for our laser business.

And then one product question. Can you give us an update on where you are on your 100-gig CFP2 coherent module for the long haul/metro market, what the timeline you expect for sampling on that product?

We had a demonstration at OFC last month where we had our customers and to kick the tires. And, as I have said in the past, we believe that our product, while we're not first a sample, will be first to volume because of the design aspects of the single-chip, much like our tunable XFP, we have a single integrated chip with our tunable laser and modulator. And we believe that we will both be able to get the time to cost and time to volume that our customers need. I think will be sampling in the next few months with meaningful volume not until really calendar 2016.

That's a dual chip. Right? So the receiver is on a separate chip?

Receiver is separate, yes. The laser and the modulator is a single chip.

Rod Hall, JPMorgan.

Thanks for the question. I wanted to circle back around to the SE business in this slide 10 that you guys are showing on deferred revenue. I've got a couple of questions on that deferred revenue and then maybe one more on SE. So, I guess the first question is: what is the gross margin profile of that deferred revenue? It seems at this point that it may not be all that great considering what's happening with your gross margin guidance for SE. But I'd like to hear from you what you think the profile of that is. Is it significantly below what we're seeing for NE? Just give us some color on that.

The other thing that I'd question on that deferred revenue graph is that the absolute level of it is pretty static; let's call it $100,000 to $120,000. And so, I'm not sure I understand why you guys are so confident that that deferred revenue absolute level is all of a sudden is going to grow, which would then imply that we get growth in the SE/NE combined business. But why wouldn't that deferred revenue just pop out with the mix shifting towards the growth businesses but the absolute level remaining about the same? Thanks.

I think as far as the gross margin, we ran over 70% this past quarter for SE, so we would expect that what's in the backlog -- I don't have the exact breakdown for you, obviously, but I would expect it to be accretive to our overall margins for NE/SE. So it should be higher than what we are running overall today and bring the average up.

I think as far as the deferred and backlog, we've seen it pretty quick acceleration of the drop-off of the legacy products to 2G, 3G primarily. We do think that's going to slow down here. It won't keep it -- accelerate at that same rate, and we do see with what opportunities we have in front of us with the next generation of products, the opportunity to grow that at even faster pace, because we're just really getting some of those technologies in front of customers.

We've got them in the labs and sampling, so were not even into volume and on a number of those products. So, we would expect that to accelerate, and we would expect the legacy products not to come off at the same rate that they have been over the last two years.

I guess -- I don't know, Tom I guess when people just stand back and they look at these numbers and the trajectory of the margins in SE, it's really hard to buy into the idea that this is a good business for you long-term. Just to put it really bluntly. I'm just trying to understand what it is that you would say to people on the call here to convince them that this really is a good business to continue throwing investment after and chasing?

Yes, I think, we have to see the path to get to $50 million of revenue a quarter, then we get to the profitability and then there's pretty high leverage in the model. You can actually see the jump in year on year in the gross margins even in the small increase in revenue. So you can see that leverage. So it's really the leverage and it has to be the belief that we can get to the $50 million plus revenue a quarter, and that at those type of gross margins level, the slowing down the pace of the investment in R&D, which has been very heavy over the last couple of years especially in this software development arena.

Okay, all right. All right, thank you.

Troy Jensen, Piper Jaffray.

Maybe start off with Tom. You had alluded to little bit of caution here on telco spending. With respect to the second half ramp, when would you start seeing evidence or data points from your customers that we are actually going to experience second half ramp. When do we kind of throw that out and start to think about 2016?

We would be pretty far into probably the June month to see that because we typically have a book and ship in those products. And it's typically 2 to 4 weeks timeframe of leadtimes on those products that the operators buy that aren't the more complex solution type products. So, we'll be into the June month, I think, before we really see that, if we are going to see that ramp in the second half of the calendar year.

All right, understood. And then for Alan, you alluded to growth in CCOP coming from Datacom. Are you expecting telco to be stable or decline here in the June quarter?

I think we should see some growth in telecom, especially as the large North America carrier starts deploying the metro buildouts in a meaningful way. I think if you just look at our ROADM quarter on quarter, our ROADM revenue was up 30%. And that's just to do lab and first office deployment. So, I think we're going to see significant growth in the second half, really around ROADMs and the line cards this metro application. And that will also pull along 100G components and modules as well.

If I could just throw one more in here. I know it's more than we're supposed to. But what are the chances of you guys actually doing the spin here before the end of your June quarter, given it is the end of your fiscal year, and start the fiscal year fresh?

I don't think there's a high likelihood of that happening before the end of June month -- of the month of June.

All right. Understood. Thanks, guys.

Simon Leopold, Raymond James.

A quick clarification that you may have given, so I apologize if I missed it. But what percentage of the optical communications business came from Datacom versus telecom?

It was 23% Datacom, and 71% telecom, and 6% consumer and other.

That's right. Okay, yes, I got the 6% consumer of other -- that's where missed. Okay, great. And then in terms of the trending, I wanted to touch a little bit on what was going on from the geographic perspective.

Part of it is, I'm not sure whether there's a significant variation among the business units in terms of the geographic mix. But I'd like to get a better understanding of, one, the implications of foreign exchange rates changes and my guess is that affects the NSE businesses more than the other portions. And also, trying to get a better understanding in particular of the dynamic of Asia-Pacific falling off significantly. How much of that is seasonality, and how much of that is FX and what other issues might be affecting that?

So first of all, your observation about probably affects NE/SE more so than the other two business units is directionally -- that's directionally true. As far as the overall impact is concerned, if you did a comparison between this year and the Q3 of last year basically locking in the rate for this quarter as it was the same last year, the delta on revenue would be about $6 million. The delta on OpEx would be just under $6 million.

And as we said on many occasions, so that the net impact to the bottom line is the material. But there definitely is downward pressure on both the revenue line and OpEx. That would not be the primary explanation of variations, however, in geographic revenue. That's just a mix and seasonality issue.

Simon, this is Alan. Just add to that, the vast, vast majority of the CCOP business is in US dollars but the currency change does make Japanese competitors maybe more competitive. So, I'd say that that that's what we're seeing the impact. Not necessarily an impact on foreign exchange directly with respect to our sales to our customers.

So that leads me to ask -- and I understand what you just described. Does that lead you to do some discounting in order to compete against those Japanese competitors who have some advantages now or do you maintain your price?

Well, it depends. I think market pricing is market pricing, and so we are really focused on having products that no one else can make in the Datacom space, as well as in the transmission and transport space. So where we have Japanese competitors and they are qualified, yes, the market conditions are different. But as you can see from our ASP reductions last quarter, it was no different than it has been in the past. So I think our continued focus is leading-edge products and technology that differentiate for our customers and add value to them.

Such as to wrap up that point, is factor in Asia-Pacific being down 21% sequentially in March?

I don't think so. I think we saw some particular strength in North America with, I think, the CCOP products, optical communications, and a couple of large customers here. And we did see strength in North America with some of our cable operators from an NSE standpoint. So I think that was probably more timing of those orders and the strength of those two areas that drove North America a bit higher.

But why was Asia-Pac down?

It's primarily I think just timing of orders from what we've seen. I don't see any -- I don't think it's pricing as you were asking about, and I don't think there's any lost business there that we are aware of.

Keep in mind, Simon, the numbers we talk about are the ship to locations. So they don't always dictate that that's where the customers are. So we have US-based customers that have a ship to Mexico. We also have that same customer ship into Thailand. And so depending on their mix, that number may be misleading with respect to where the end product for at least CCOP ends up. Because they could ship it into Europe or ship it into China or other parts of APAC. Even if we ship it into Mexico --

And most of the commercial laser products show up in Japan, I believe, on revenue. And that's down quarter on quarter.

Yes.

So that's probably a good percentage of it as well.

That's a good point.

Okay, that's helpful. Thank you for taking my questions.

Dmitry Netis, William Blair.

Thank you, gentlemen. A couple of quick ones for me. I just want to revisit the revenue recognition issue. I understand you're going to provide more color, I think, for fiscal 2016 of how that rev rec is going to work. But has the line moved again in terms of the rev rec into the P&L of that backlog in deferred revenue, which you have been projecting to occur I think in Q1 of 2016? So, I am just trying to understand, are we going to get a big chunk of that deferred come into revenue for SE in September quarter, or is that now moved into follow-on quarters? And I understand you're going to give more color, but I just wanted to I guess (multiple speakers) right now.

It's a good question. We don't see a big chunk dropping into Q1 FY2016. It's going to be more linear and I think that was primarily our location intelligence business and the getting to VSOE and the timing of orders and the mix of the customer base.

So, we don't see a big chunk of that dropping into Q1. It's going to be more linear from what we see at this point.

Okay. And then the kind of the guidance on SE, $39 million which is flat basically, sequentially. Does that also include some of the execution issues you had seen in the Network Instruments business, or is this something else going on there? I mean it's just not ticking up, and that's a bit surprising in what is typically a seasonally strong quarter for you guys.

Yes, some of it is continuing build of the deferred revenue, and part of it is that we, although we feel that with the enterprise business our Network Instruments will see improvement, we're not going to get back to the levels we had expected. So that's going to take a quarter or two to achieve those. That is a part of it and the rest is buildup of deferred on next-generation products.

Okay and then my last question is on optical communications gross margins, Alan. I think we understand the laser side, but OC specifically, what drove the margins to decline there sequentially? I know may be the 29% last quarter was a bit abnormal, but still it's from the 2014 levels, it is down. And is it pricing? Is it something else you're seeing? And how do you expect that margin to trend in Q4 and maybe into 2016 fiscal timeframe?

As you recall, we had an ASP reduction in our optical comps business of 4.7%, and we didn't keep up with that on the cost side. I think from a mix perspective that also comes into play. Our 3D sensing revenue was at the low point and that absorbs a lot of overhead in our fabs.

And so, I think it's a combination of under absorption caused by 3D sensing, the ASP decline in the quarter that we are working hard to make up for in Q4 cost reductions. And so I think as we expect gross margins to go up in Q4, because of a combination of lower ASP reductions and continued drive and cost reductions as well as more favorable product mix as we go towards more 100-gig Datacom products as well as our TrueFlex ROADMs. And I expect that to be able to continue into the second half of the calendar year as well.

So we get a bit about tick up there, or should we just project it flat from where we are today kind of as we go into Q4 and then next year?

We don't give guidance beyond the current quarter but I'd say that for this quarter, we expect gross margins to go up for both optical cons and lasers.

Okay. And then maybe last one, what was the operating margin non-GAAP operating margin for the CCOP business on a stand-alone basis?

The segment operating margin was 8.9% and then I think we said -- we have been pretty consistent that if we were a standalone in this quarter that it would be another 4% to plus or minus 0.5% of added G&A costs in public company costs that if we were standalone company, that's where you'd calculate it.

Got it. All right, thank you so much.

Kent Schofield, Goldman Sachs.

Tom, I wanted to come back to the enterprise side of things in SE, just because it's a little bit more of the new market for you, but you've been in there for a while. Can you talk about what you've learned thus far in terms of selling into that space and what you're hoping to fix on the execution side of things?

And then Alan, just a follow-up for you, I know you announced -- I think it was a couple of weeks ago -- a deal with Laser 2000 and it sounded like that was on the fiber laser side of things. Just wanted to understand what that agreement is, and it talked a little bit about exclusivity. So I just wanted to touch base on what exactly that is.

Okay, so I'll start out on the enterprise side. I think we saw this last quarter some fairly strong competition and maybe the quarter before that. And I think it's really the execution is how we get in there and compete against those fairly aggressive competitors.

And we have in the last I'd say 4 to 6 months brought in a new sales leader who I think is getting really good traction. And again, I believe we have very good products. And the execution coming out of the business unit on the development side looks pretty good.

So I think it's really getting in and being more aggressive in the markets that we are playing, and I think the sales leadership is up to that. And I think we're seeing those improvements, but it's not going to happen overnight.

And as far as the announcement on Laser 2000, I can't talk specifically about the exclusivity arrangement, but what I will say is that this puts a lot more feet on the street knocking on doors and opening up opportunities for us to sell fiber lasers outside of our main partner. And that's the primary reason for the agreement with Laser 2000. And they are a good group of people, and they have a salesforce that's already out knocking on doors.

Great. Thank you, Tom; thank you, Alan.

James Kisner, Jeffries.

Thank you. I guess the first question here is just around the customer that's down 32% year over year. Can you talk about the products that are primarily affected here? Is it primarily the field test instruments. I am just trying to understand also potentially what sort of makes you think -- or I assume you think that's kind of temporary? Is it possible that that business never comes back? Are there software solution displacing field tests long-term and perhaps there's some risk that doesn't really recover? Can you just give us some confidence or commentary around that?

Yes, I think that primarily -- comparing year on year, it's primarily around the instruments business and what we're seeing with the customers move to more software-defined environment that what we are doing with virtualization of instruments tying to the cloud is something that they need and are looking at very strongly. I think it's a timing of the transition, and then we do have in front of the customer more of the service enablement types of solutions, which, again, I think we're getting good traction in the labs, and some areas it's just not being deployed in volumes.

So we are getting through this I think chasm where the traditional products, their overall spend has dropped off pretty significantly. We'll see some of that pick back up we believe as spending loosens up, but then we are going to need to also make this shift successfully to more of software service enablement types of products, which, again, we are working very closely with the customer, and initial feedback in a number of areas is positive. But we need to see that volume actually happen.

Okay. And just as a follow-up, as a clarification here, calendar Q2, your fiscal Q4 is obviously weaker than seasonal. You usually have a pretty big drop-off in Q3, in part due to Europe. You talked about multi-quarter bookings in CCOP. What do you think about sort of seasonality? Would you give us advice on how to model that? Do you still see that being seasonally weak? Or might that Q3 seasonality be a little more muted? Thank you.

You're welcome. I think you're seeing a bit of smoothing of the seasonality now if you look at quarters, the typically high quarters and the lower quarters you're seeing less of a variation. And I think as far as Europe, the business out of Europe was down this past quarter. So, I don't, again, expect the seasonality to hit as hard based on coming off of flatter business in Europe.

Thank you very much.

Our last question comes from the line of Richard Shannon, Craig-Hallum.

Thank you for taking my questions. Did I catch your comments, Tom, correctly that you saw some weakness in the mobility side for an NSE, unlike the last I think couple of quarters where you've seen some strength? And if so, can you help us understand the dynamics there?

Yes, I think, as you saw probably reported by a couple of large operators at least in North America, their wireless spend has been down pretty significantly this last quarter or two. So that's I think reflected in our overall revenue there. I think, again, we have some very good products out there. I think we're getting good traction in the market. It's been a -- year on year, we've seen growth around mobility in some areas growing very rapidly. But I think when some of the major carriers are down in their mobility spend, it's going to impact us. I believe that part is timing. I think mobility will continue to play a really important role in the network and how people communicate, and I think it's a temporary lull on the mobility side.

And to be clear, then it would suggest that that the mobility is concentrated in the US. Is that a fair conclusion?

Our volumes in the US are heavy, but it's not -- I wouldn't say concentrated. We do do a good amount of mobility business around the globe.

Okay, fair enough.

(multiple speakers) [two] large carriers that definitely have an impact that are based in North America.

Okay, my follow-up question is regarding 3D sensing. I think you said you are expecting some improvement here based on some PC applications. A couple of things around that topic. First of all, Intel has been talking about this general segment. I'm assuming you're associated with that in some way. If you could clarify that in any way, and also how fast and far can this move from perhaps maybe this bottom. I know you're a long way from the peak number of quarters ago, but can you give us a thought process or thinking how much that can improve over the next few quarters or so?

No. (laughter). No, I'm kidding. I can't comment on specific customers. I think that the nondisclosure agreements we have with all of our customers prohibit that unless they give us authorization to talk about it. I will say though that the PC applications that we are participating on are typically today on the high-end PCs. And so when or if that transfers down into the midrange or the $599 PC when it becomes -- that's really where the sweet spot is. And we're not there yet.

And so, I would say when that happens, then we should be able to see that business pick up dramatically, because today the majority of the models that we're involved with are more on the higher end PCs where cost points are not as sensitive to added features and added costs. Does that make sense?

Yes, that is helpful. Great, I appreciate the perspective. That's all for me, guys. Thank you.

And there are no additional questions in queue at this time.

Thank you, Alex, we will be participating on a number of investor conferences and events this quarter as listed in the supplemental earnings slide deck posted on our Company's website. This concludes our earnings call for today. Thank you, everyone.

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