Lumentum Holdings Inc. (LITE) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Lumentum Fiscal First Quarter 2016 Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Chris Coldren, Vice President of Strategy and Corporate Development. Sir, you may begin.

Thank you, operator. Welcome to Lumentum's First Quarter Fiscal 2016 Earnings Call. My name is Chris Coldren, Vice President of Strategy and Corporate Development. Joining me on today's call are Alan Lowe, President and Chief Executive Officer; and Aaron Tachibana, Chief Financial Officer. As we discuss our first quarter results, please note that we separated from JDSU, now named Viavi Solutions, and became an independent public company on August 1, 2015, 5 weeks into the first quarter of fiscal 2016. Our first quarter results, therefore, include certain allocated costs from Viavi that will not be incurred in future quarters. Where possible, we will highlight these nonrecurring expenses and their impact. This call will include forward-looking statements, including statements regarding Lumentum's expected financial performance and cost structure, trends and our position in our markets and expectations related to our customers and our products. 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 our fiscal 2015 amended 10-K filed on September 29, 2015. The forward-looking statements we provide during this call, including projections for future performance, are based on our reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements, except as required by applicable law. We also note that the financial results reported today are subject to the completion of Lumentum's quarter end closing and review processes, and actual results could differ materially from these preliminary results. Please also note, unless otherwise stated, all results and projections are non-GAAP. Non-GAAP financials should not be considered as a substitute for or superior to financials prepared in accordance with GAAP. Our press release with our first quarter of fiscal 2016 results is available on our website, www.lumentum.com, under the Investors section, and includes additional details about our non-GAAP financial measures and a reconciliation between our GAAP to non-GAAP results. Our website also has our latest SEC filings, which we encourage you to review, and supplementary slides relating to today's earnings release. Finally, a recording of today's call will be available by 6:00 p.m. Pacific time this evening on our website. Now I'd like to turn the call over to Alan for first quarter business highlights.

Thank you, Chris. We solidly executed our plans in our first quarter as Lumentum, and I want to thank our employees for their hard work and dedication during the spinout that allowed us to perform from the start. Our first quarter fiscal 2016 revenue at $212.6 million was above the midpoint of our guidance of $205 million to $215 million. In our August conference call, we provided guidance which equated [ph] to non-GAAP operating margins of approximately 5% to 8%, assuming we were a stand-alone company for the entire quarter. Had we been stand-alone for the entire quarter, our operating margins would have been 8.3%, and our earnings per share would have been $0.29. Aaron will discuss this in more detail shortly. Now for more details on our business performance. First quarter optical communications revenue were $177 million. As expected, we saw strong growth in our Telecom products. Telecom revenue grew to $132.7 million, up $6.8 million or approximately 5%, sequentially. Telecom growth was driven primarily by the rapid growth of our industry-leading TrueFlex ROADMs. We saw our overall ROADM revenue grow by more than 15% sequentially, with our TrueFlex ROADMs and Blades growing more than 27%. We are currently on allocation for our TrueFlex ROADMs and are adding capacity to satisfy the strong demand from multiple customers. We believe that this strong demand is due to share gains at key customers supplying into metro deployments as well as broad market adoption due to our superior product performance. In addition, our pump laser revenue grew approximately 18% to a revenue level we have not achieved since 2006 as our customers continue to ramp shipments for new optical network infrastructure. This situation is typically a good leading indicator for further network deployments. Datacom revenue declined to $35.7 million, down from $41.7 million in the prior quarter and consistent with our commentary on our last call. We are very pleased with our 100 gig Datacom pipeline and believe our new QSFP28 offerings will more than make up for the declines in lower speed Datacom revenues during calendar 2016. Industrial and consumer revenue was $8.6 million and declined $2.6 million quarter-on-quarter due to an industrial diode laser customer delaying orders. 3D sensing revenue remained flat from the prior quarter. Commercial lasers revenue at $35.6 million was up $5.6 million or approximately 19% quarter-on-quarter. Laser's growth was primarily driven by our kilowatt fiber laser, which approximately doubled sequentially and achieved year-on-year growth with our second-highest fiber laser quarter ever. Our solid-state laser revenue was down as these products served manufacturing markets which we believe have slowed. Because we entered the quarter with strong backlog of previously placed orders and the high relative percentage of our business in which we have DMI arrangements with our customers, our book-to-bill was below 1 for both optical communications and lasers. I will now turn the call over to Aaron for financial results and highlights.

Thank you, Alan. As Alan highlighted, net revenue for the quarter was $212.6 million and above the midpoint of our guidance of $205 million to $215 million. GAAP gross margin was 31.5% for the first quarter and increased 110 basis points quarter-to-quarter. GAAP operating margin was a loss of 1.2% and GAAP loss per share $0.01. Our non-GAAP gross margin was 32.8% and increased 80 basis points relative to the prior quarter due to higher optical communications gross margins, resulting from the cost reduction and favorable mix of new products. Non-GAAP operating margin for the first quarter was 7.4%. Non-GAAP earnings per share were $0.26 based on a fully diluted share count of 59.7 million, $200,000 in tax expense and immaterial other interest and expense. Please note that all reported results include allocations from Viavi for the 5-week step period when we were still part of Viavi. Now that we have 3 months of stand-alone operations under our belt, we have actual run rate SG&A costs. Our stand-alone SG&A costs are significantly lower than those allocated to us by Viavi. For the first quarter, had we been stand-alone for the entirety of the quarter, our operating margin would've been 8.3% and earnings per share would have been $0.29. Please note that in our press release, our GAAP and non-GAAP results are qualified with the word preliminary. Earlier today, we filed for an extension with the SEC to give us an additional 5 days to file our 10-Q for the first fiscal quarter of 2016. As of today, the allocated costs and our opening balance sheet from the Viavi step period are not yet finalized. We will use the additional 5 days to finalize the step-period results along with Viavi, who also reported similar preliminary results. The allocated SG&A costs do not have any relationship to the stand-alone cost of Lumentum but do need to be finalized for compliance purposes. Optical Communications revenue was $177 million, which was a decline of approximately 1% relative to the prior quarter, driven by a $6 million decline in Datacom revenues. Telecom revenues increased $6.8 million sequentially to $132.7 million, inclusive of WaveReady revenues, which declined by $400,000 sequentially. Optical Communications gross margin was up 110 basis points to 31.5% as we saw the benefit of cost reduction activities and more favorable mix of new products. Note, the prior quarter's gross margin to which we are comparing includes the impact of WaveReady, which adds approximately 40 basis points to the CCOP segment gross margins Viavi reported for the fourth quarter of 2015. Our Optical Communications gross margin at 31.5% was the highest it's been in over 2 years. Commercial Lasers revenue was $35.6 million, an increase of approximately 19% quarter-on-quarter, driven by sequential fiber laser growth. Gross margin at 39.9% declined 150 basis points, primarily due to the impact of timing of annual price reduction, compared with planned cost reduction. Reported operating expenses totaled $54.1 million, with R&D expense of $32 million and SG&A expense at $22.1 million. The SG&A expense included allocated costs from Viavi based on our expense structure as a stand-alone company was $2 million higher than it would have been on a stand-alone basis. Our income tax expense was $0.2 million for GAAP -- a non-GAAP tax rate of 1.4%. At the time of separation from Viavi, we were able to establish an entity structure for Lumentum that would allow for single-digit tax rate for the first couple of years as a stand-alone public company and then remain below 12% to 13% longer term. We were able to utilize approximately $1.1 billion of Viavi's net operating losses to provide Lumentum with an optimized structure going forward. During the quarter, we had 2 customers that each contributed 10% or more of our revenue. Our cash balance was $142 million at the end of Q1 and increased approximately $4.5 million from the initial capitalization of about $137.6 million. While we are not providing long term guidance, we believe the path to double-digit operating margins is in sight. First, we believe we have a high level of leverage over our operating expenses and SG&A expenses, in particular. The nature of our business is such that revenue growth was driven primarily by increases in sales to the customers, with which we are currently engaged, versus adding a significant number of new customers. Second, we believe we have growth opportunities in both Optical Communications and our Lasers business that each alone could drive incremental margins sufficient for 10% or higher operating margins at the consolidated Lumentum level. I will turn the call over to Alan for guidance for the second quarter of fiscal 2016 and closing remarks.

Thank you, Aaron. We project revenue for the second quarter fiscal 2016 to be in the range of $212 million to $222 million, with operating margins in the range of 7.5% to 9.5% and earnings per share to be in the range of $0.26 to $0.30. Our expectation for the second quarter include growth in Optical Communications revenue. Telecom revenues are projected to be up quarter-on-quarter as we continue to see increasing demand across many of our product lines, especially our TrueFlex ROADMs. Looking to the longer term, we believe our ROADM-based products to be a growth-driver for total Lumentum revenues as we believe the North American metro deployments expected to begin next calendar year are the start of a larger cycle of network upgrades around the world in the coming years. Network operators in China, who have not historically purchased ROADMs, are taking steps to start deploying ROADMs within the next year. On 100-gig Telecom, we expect continued strength and discrete components. We continue to make progress in developing our 100G CFP2-ACO product based on our unique single transmitter chip approach, which we -- which will provide our customers with a higher density, lower power consumption and lower cost they need to shift away from the current discrete solutions. Datacom revenue is projected to be roughly flat quarter-on-quarter. With strong customer traction, we expect increased revenue this quarter from our market-leading 100 gig QSFP28 transceivers. The 100 gig Datacom upgrade cycle, which we anticipate to commence in the next calendar year will also be a significant potential driver of revenue growth for Lumentum. Demand for our commercial lasers is likely to be approximately flat to slightly down quarter-on-quarter. December quarter is seasonally slower for lasers for semiconductor processing applications, and we are seeing softness in these markets more broadly. While not a contributor in growth in the first quarter, we continue to make solid progress on design wins for our new ultrafast laser products and expect they will be a growth driver for us in quarters to come. Fiber laser demand over the long term should be strong as the conversion from CO2 to fiber lasers is still relatively low. Our industrial and consumer revenue is expected to increase modestly, sequentially. We continue to expect our 3D sensing revenue to modestly grow throughout the fiscal year as we are now shifting production volume for new personal computer applications. Furthermore, we believe this business can continue to strengthen over the longer term as more consumer electronic devices incorporate 3D sensing capabilities. We expect that our operating expenses will remain approximately flat relative to the reported non-GAAP operating expenses in the first quarter. We expect lower SG&A expenses than our reported numbers due to having an entire quarter of our lower stand-alone cost structure. But this will be offset by both annual salary increases and higher R&D expenses as we continue to introduce and ramp our new differentiated products to exploit the market opportunities we have ahead. In closing, I would like to thank our customers, our suppliers, our shareholders and especially our employers who have performed incredibly during the first few months of Lumentum. I do believe the future is bright at Lumentum. With that said, I will turn the call back over to Chris to begin the Q&A session.

Thank you, Alan. Operator, let's begin the question-and-answer session.

[Operator Instructions] And our first question comes from the line of Simon Leopold with Raymond James.

This is Victor Chiu in for Simon Leopold. Can you give us a sense of the volumes you're seeing around 10G and the data center and maybe the current degree of competition relative to demand? And maybe, I guess, the question I'm kinda drive -- trying to drive at, is there anything you can do to increase the margins in 10G? Or is that part of the business commoditized to the point where there's not too much upside left to the margins there?

So this is Chris. At least for our revenues, short-reach 10 gig and below is a small percentage of our total revenues, and we don't break that out. I think, in terms of the margins on those project -- products, I think they are what the market bears at this point.

And I think, just to add to that, I think, we have decisions to make, whether or not we invest R&D dollars to redesign a 10 gig product to increase those margins or put those R&D resources in next-generation 100 gig, and we've chosen to really focus on the leading time-to-market 100 gig products that are coming to market right now.

Okay. Along those lines, there seems to be an increase in appetite for some of the major web scale players in deploying Whitebox equipment. And some of your competitors use less stringent transceivers aimed at DC applications. So, I guess, do you have an alternative solution for the DC application I guess and I guess I'm trying to -- try to -- if there's something there that might be able to increase margins as well if that's something that you're focused on?

Yes, we have a whole portfolio of 100G products that will be coming to market between now and the end of next year, really focused on what you say, the really different requirements that the data centers have over the typical Telecom customer of ours. And the technology ranges from our in-house indium phosphide technology and Vixel technology to silicon photonics. So based on the requirements of the given customers, the different technologies and applications to meet the price point and reliability differences between the different customers really drives where we put our R&D dollars. Now Chris, do you want to add to that?

No. I think that's pretty clear.

And our next question comes from the line of Alex Henderson with Needham.

Well, you must feel great having your first quarter as a public company. Congratulations.

Thanks, Alex. It does feel good.

I guess, my first question is really on this Datacom piece because it seems like you've kind of pared out some of the products that were going into that Datacom 10 gig side of it, mainly because of this pressure on the short-reach piece. Is that an accurate read that you're essentially backing away from some of the pixel-based products that are short-reach in nature in the 10 gig?

I wouldn't say we're backing away. I'd say that the competition's getting more fierce, and therefore we're losing some share in some of the shorter reach applications. I would say, just for clarification, we have a 40 gig product that was very large volume that we weren't totally vertically integrated on. And therefore, we had a less competitive product offering than some of the vertically integrated guys. And that's why we're focused on solely vertical integration on all of our 100 gig products to be able to maintain that competitive nature and the margins we need going forward. So I'd say it's a combination of both 40 gig, that's really 10-gig based and 10 gig that is going to decline over time.

Well, could you help us get our arms around what portion of the Datacom business is 10-gig-, 40-gig-related that is exposed to that pressure? And what portion is indium phosphide based a little longer reach, not under those type of pressures more tunable-related or alternatively 100-gig-related?

Well, I'd say that the hyperscale data center guys have not made the conversion to 100 gig yet and are mainly installing 40 gig, both short-reach and more 2-kilometer reach type of applications. And those are the kind of applications, frankly, that we're not as competitive as we need to be. On the 100 gig, I could see that by the middle of next calendar year, that transition starts in a meaningful way, away from 40 gig to 100 gig, and that could come in, in short-reach 100 gig to 2-kilometer to 10-kilometer. So today, most of our 100 gig products are going not within the data center, but more between data center or intercampus, and most of those are LR4s or really 10-kilometer and shorter applications that we have for CFP4 and CFP2.

So just to wrap up the question around this. So the current revenue rate of $35 million is predominantly in 10-gig-related products or 40-gig-related products and not in longer reach or a higher-speed elements? Is that right?

I wouldn't say that. We don't break down the speed of the Datacom. But I would say that we will be getting -- we have meaningful revenues today in 100 gig CFP2, CFP4, and we're starting production volume this quarter on our QSFP28, 2 kilometer and below application, that we think is leading the market in -- by months, if not quarters.

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

On the competition being fierce on the Vixel side of the business, could you help me understand, is that coming from your traditional Vixel competitors? Or is this more some of the newer entrants that have been emboldened by being able to buy some components and piece together solutions?

I'd say probably the driving force is more the new competitors that are popping up. Whether they are buying components and making modules with lower costs or lower-margin expectations or not, it's not clear to me. But I'd say mostly from the newer entrants.

All right, that's helpful. And then you gave us on the pump laser that, that's the highest level of revenues since 2006. I was wondering if you could give a similar statistic on your ROADM business. And then, if we think about ROADM, you talked about China being an area that could potentially be a growth driver. You talked about the metro rollout in North America aiding. I'm curious if you were surprised by the level of strength in the ROADM business ahead of some pretty material drivers on the horizon?

Yes. I guess, I was surprised a little bit in the demand of the ROADMs. And I think, as I made it -- the comments in the script, I think it's due to the fact that we're gaining share and outperforming our competitors, and therefore, our main customers are asking for more and more ROADMs from us that we're having to respond to. As far as China is concerned, I was in China all last week, and the customers there and the network providers are all talking about the need for deploying ROADMs, which they haven't done in the past. And I expect that to start rolling out within calendar 2016. As far as historic ROADM -- do you have that, Chris? Just a second. The peak was 2011 when the last metro deployments were in full force.

Yes, well, we're certainly not at that level at this point.

Yes, but keep in mind, we're still deploying first office applications for the North American metro deployments. I could easily see getting back to those 2011-type levels when the real metro deployments roll out in a meaningful way.

Okay, that's ultimately what I was hoping to hear.

Does that -- did it help?

Yes, yes. And then just one more, if I may, on the Laser gross margin. I'm curious is there any pricing pressure you're seeing on fiber from Amada that is keeping those margins relatively depressed at their historical levels? Or is it coming from fab utilization or the other side of your business?

Well, we don't comment [Audio Gap] customer especially when they're pretty much our whole fiber laser business. But I will say that we work very closely with all of our customers to make sure that their products are competitive against their competitors. And so I would say that at the tool level, there are aggressive price expectations that working together with our customers we respond to, and then we need to work together to drive our costs down to allow us to get our margins back up. And I think, that's what you saw in Q1, where prices went down faster than our costs have gone down, but we have plans in place to really improve upon our cost structure and drive that kind of improvement over time.

And our next question comes from the line of Jorge Rivas with Craig-Hallum Capital.

I wanted to dig in a little more on the ROADM product line. I'm wondering if you guys can tell us about the mix between your TrueFlex and your legacy ROADM.

Yes, we can. It's about 50%.

50...

And obviously, the -- obviously, the TrueFlex is growing and the legacy stuff is flat to down.

Right, okay. And then what -- also your pump lasers, impressive quarter for those. And wondering what kind of gross margins those have? Are those above corporate average? Below corporate average? In line?

We don't break out specific margins by product line. But I will say, in general, products that have high wafer content, as we grow that business, the variable margins are above our corporate average. So you can imagine that as we go to new levels of revenue for products that are heavy wafer content-based which our Telecom pumps are that you would imagine that, that growth in revenue has a very good variable margin.

Okay, excellent. And then one last question for me. So it seems like with the headwinds on 10 gig and 40 gig, is this [Audio Gap] affecting your [Audio Gap]

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

I had a question about gross margin, which I guess was based on a combination of mix and some cost adjustments or reductions you've been able to achieve. If we think about calendar 2016 and the annual price adjustments, how confident are you in your ability in keep gross margin, I guess, flat and even show some more improvement across calendar 2016? [Technical Difficulty]

Sorry, if that's -- for some reason, we got cut off, Jorge. So if you could repeat your question, that would be great.

Our question comes from the line of Joseph Wolf of Barclays. [Technical Difficulty]

Okay. Sorry about that. It's just Joseph Wolf here. I think the caller before me maybe got cut off. I guess, my question's on gross margin. It's gone to a higher level, and I guess you based it on -- based on both mix and cost reduction. If you look into calendar 2016 and think about mix and the annual price reductions in the Telecom business, how confident are you in your ability to keep margins flat or to even improve them as you go through the year?

Yes, it's -- let me give you my view and then Aaron can add to it. I'd say that gross margin is really a -- the variables that go into it are how new our product is. And I would say that with our TrueFlex ROADMs growing rapidly and 100G Datacom, those kinds of things typically have higher gross margins than some of the legacy products. And so I would expect that as the metro deployments in North America rollout and we get continued 100G modulators in China and tunable lasers and things like that, that overall gross margins should be able to be maintained, even though we're going to have the annual price negotiations that impact both Q2 as well as Q3. So Aaron, you want to...

Thanks, Alan. And so Joseph, yes. So just to talk about the competitive environment. It is competitive, and pricing is always a challenge, and we'll be heading into the early part of calendar 2016 going into price negotiations on the optical component side. But having said that, our teams internally, engineering and operations have been doing a fabulous job with regards to focusing on reducing costs. And I think on our last call, we also articulated that we're looking at some of our manufacturing locations, and we're consolidating where we can. And so we continue to focus on getting better synergies and efficiencies from a cost standpoint. In addition to that, we believe that as we continue to drive more laser revenue with higher gross margin, that will continue to accrete our gross margins as well. And over the last couple of quarters, the laser gross margin has been down a little bit, and some of that has been due to mix, with our solid-state lasers being down. And then in addition to that, we did have to reduce our fiber laser prices a bit in advance of cost reductions. So we still feel very strong that we can accrete our gross margins going forward.

Okay. And then you mentioned book-to-bill below 1. I'm wondering if you could give us as we think about the business going forward, how much of the business you've got visibility on and how we should think about that book-to-bill number with regards to your -- both to your guidance and to how long your bookings stay in some sort of backlog that we should be thinking about when we think about modeling out for a year?

Yes. I think, most of our major customers are on VMI, so book-to-bill doesn't necessarily reflect demand. And while that sounds silly, it's true as more of our business goes to more of our larger customers that are VMI, and if they take share from some of the smaller customers, we're going to see book-to-bills go down as our revenues go up. So I wouldn't worry -- I wouldn't read too much into book-to-bill.

Okay, that's exactly what I was getting at. See how we -- we don't want to read too much into the number you've just given. That -- I think that's all I've got right now.

And our next question comes from the line of Jorge Rivas with Craig-Hallum.

My line got disconnected. I'm not sure why, but I apologize for that. I just have one follow-up on your Web 2.0 business. Is it fair to say that it's -- that part of your business, it's being currently affected by the headwinds on 10 gig lasers?

I would say that the headwinds on 10 gig are more in the enterprise side of the business as opposed to Web 2.0 guys. They transitioned to 40 gig pretty much as the primary speed within a data center. So I'd say that's more in the enterprise side where the 10 gig is still the predominant speed within the enterprises. Chris, you have anything to add?

No, I think that covers it, that and the data center business. At least for us, that's primarily 40 gig and now emerging 100 gig. 10 gig is very focused on enterprise, not exclusively, but primarily.

And our next question comes from the line of Tim Savageaux with Northland Capital.

Several questions about the kind of pump laser comments as well, really a couple of different questions, which, as you know, obviously, 2006 was a while ago, and I guess if we subtract a 0, that's the cycle that we are in then. But I wonder if you guys might be able to provide kind of any historic perspective on kind of what you saw then versus what you're seeing now from an overall industry standpoint, given that you're seeing what you've termed as historic strength in your pump laser business. And I assume that's driving the amplifier business as well. But maybe I'll let you comment on that, too, and then I have a quick follow-up.

Maybe Chris -- it may be good to kind of go through pumps going to amps and why deployment of amps is a good leading indicator for our network.

Well, what I'd say first is that certainly industry structure -- structure has changed a bit in that there's -- I guess, in some ways effectively fewer suppliers as there's been some folks that have exited the pump laser business or become rather not so competitive any longer. Secondly, a lot of our -- at the amplifier level, pump speed and amplifiers, our amplifier business over the end number of years has come down a bit as we've had lower cost. Competitors are able to make a living buying pumps from us and turning those into amplifiers. That's also driven the pump volumes up. But I'd highlight that we're talking about a number that's better part of a decade and with price erosion in this industry, you can imagine volumes are significantly higher today than they were in 2006.

Well, and maybe you seem to sort of indicate that maybe the strength in that business was some sort of indicator about kind of the rest of the sector. I don't want to overstate that. If you feel like there are kind of implications for where we are in the cycle or the rest of the Telecom business or what have you, I'd love you to expand on that.

Correct. So yes, at least historically, and it's fairly logical that some of this, whether it be amplifiers and then some cases ROADMs, tend to lead transmission equipments going into Telecom deployments as folks basically light up fiber and the need to deploy their amplifiers from day 1. So certainly, that -- it's difficult to say that -- does that mean we are at the beginning or the top of the cycle, I would argue, it's got to be probably at the beginning, given the last couple of years haven't been great in the space. But we certainly know we're not on the downslope of the cycle given the strength in that business.

Okay, let's hope we're not at the top. So...

Well, I don't think we are. I'm just trying to be fair.

Let me follow-up to -- with a quick geographic question. You didn't sort of mention much there. I mean, you've mentioned China from a ROADM perspective, I wonder about we're seeing some indications of China kind of bouncing back for folks sort of more broadly, and maybe that's sort of covered under your 100 gig discrete commentary. But if you can sort of talk specifically about sort of current demand in China and then also whether there's anything else of note from a geographic perspective in the quarter outlook.

Yes. So like I said, I was in China last week and the networks -- the network operators are awarding bids as we speak for major deployments. And so I would say that I expect the China deployments to pick up over the next couple of quarters. And I think you've heard that from some of our competitors as well. So we're aligned with what they're saying. I would say that the North America metro deployments, we're starting to see the early stages of that in last quarter as well as in this quarter with our ROADMs and super blades that are going into -- again, these are just field trials and -- but they're big field trials. And we expect those to really go into meaningful deployments in the first half of calendar '16. And they should -- so we should see a step-up in both the transport side of the business, so amplifiers and ROADMs and things like that, but as well as the transmission side, some modulators, tunable lasers and receivers and things like that. Europe is a little bit of a question mark for me. I really don't have the kind of visibility I have in both North America and China, but we are seeing kind of okay demand anecdotally from our network equipment manufacturers, but again, we don't see where all of our equipment ends up.

And our next question comes from the line of James Kisner with Jefferies.

This is Jason North for James. I was wondering, when you're looking -- last quarter, I believe, you suggested that Datacom would be flat in calendar '16 and in the script today, you said that with 100G QSFP28 would now -- it's more than offset declines. So you're saying now that you think it's going to grow. And if so, then what changed versus the last earnings call?

I don't recall having said that Datacom will be down in '16. What I do recall was saying that we expected it to be down in fiscal Q1. And I'd say that we're expecting that to be flattish in fiscal Q2 but that I would expect growth from our run rate or exit rate of the calendar year into calendar 2016 as the ASPs [ph] for 100 gig are significantly higher than a 10 gig product, and I think we're going to get lower 10 gig revenue, but higher growth than the reduction in the 100 gig. So I would say 2016 will be an up year for Datacom.

Okay. And on a different note here, looking at the M&A funnel, it's been a while since you've bought anything in the commercial, traditional optic side. Are you active there? What kind of targets are you exploring at this point?

Yes. So this is Aaron. So good question. In terms of the company -- so again, part of our separation here is going to allow us the freedom and flexibility to be able to go and take advantage of different opportunities in the marketplace. And so we're going to be very aggressive in terms of what we look at and what we take on. But at the same time, anything we go look at has to make financial sense. It's got to be good for the shareholder right from an accretion standpoint. And although we haven't publicly released our balance sheet at this point in time, our balance sheet is in good shape, and you folks will see that when we release our 10-Q with the SEC.

And our next question comes from the line of Dave Kang with B. Riley.

First question is you usually talk about 100G modulators. Just wondering how they did in first quarter.

I want to say they were flattish. But we expect that this quarter, they will be up due to the things we talked about before, which primarily is the China deployment at China Mobile.

Got it, got it. Okay. And then regarding your ROADM business, already several questions. Just wondering from now to -- you kind of talked about maybe getting back to 2011 peak. I believe that was over $50 million on a quarterly basis. Are we talking maybe doubling from here? I mean, your run rate is about, what, $25-ish million, something like that?

Yes, we haven't said, but I believe we're more than halfway there.

More than half? Got it, okay. And then on the laser side, you expect that to be kind of flat to down a bit. Is that more of -- I missed your commentary about it. Is it more related to macro headwinds? I think some of your competitors are also talking about some macro-related issues.

Yes, I so think part of that is some -- what's going on in the macro environment -- some would say lasers are down, semi-cap, tool manufacturers are not selling as much into fabs today. So things have been a little bit slower. There's a tiny bit of inventory digestion occurring as well. So we believe that forward... I'm sorry, go ahead.

Sorry. So is it fair to assume maybe your fiber laser will be up but then other laser business will be down so net-net it will be kind of flat to down a little bit? Is that a fair assumption? Or fiber laser will be down as well?

If it's down, it's not down materially. I think this is a quarter where typically our solid-state lasers dips down because the semiconductor capital equipment spend in the December quarter is usually not very strong. With that said, as I said in my prepared comments, our ultrafast laser business is doing very well with design-ins. It hasn't turned into huge volume shipments up until last quarter. But I expect that will contribute significantly in our calendar '16 results.

Got it. And then are you still trying to introduce the turnkey lasers? I think, that's kind of what you guys talked about at the Photonics West earlier this year. What's the status on that?

We are. We're talking to other customers outside of our main customer. But again, as I said previously, those kinds of design wins take quarters, if not a year. And so I wouldn't expect to see any really meaningful revenue until the end of this fiscal year or early next year.

So fiscal '17, most likely? Okay. And then, Aaron, what was the CapEx for the quarter? And the...

The CapEx spend was about $12 million for the quarter.

Okay. And should we kind of expect that to be flattish or maybe go down a little bit for the rest of the year?

Yes, so in terms of modeling near term, flattish. And as you model it, you could look at somewhere in the 5% the sales range, in terms of the CapEx, 5% to 6%. And then depending upon programs we've got looking forward, there could be a little bit of lumpiness.

Right, right. And then lastly, regarding your 10% customers, are they the same as the ones in fiscal '14?

We can't really disclose specific customer names, but you can look at our 10-K, and that will give you an idea of who they are and where they're located.

And our next question comes from the line of Rod Hall with JPMorgan.

I just wanted to follow-up on the metro commentary. I guess my main question is whether you guys -- since the last earnings call, you talked about the North American metro builds ramping up in the first part of the year as well. Although it sounded like, if I'm interpreting your tone right, your visibility feels a little bit better here. And I just wondered if you could comment a little bit on visibility for production rollout. Do you feel like that, the information you've gotten in the last quarter has caused you to think that may happen a little bit earlier next year? And then I also wanted just to get you to comment again on long haul BTI [ph] networking and kind of where we stand with that, how deployments are going and whether you think that might be a meaningful driver of revenue next year? And then lastly, on 100 gig in the data center, could you guys comment on whether you've seen any kind of non-core [ph] effect of -- ahead of 100 gig? Do you think people have slowed down on spending on 40 gig networking this year in anticipation of 100 gig? Do you think they just keep right on rolling the 40? Sorry for all the questions, but thanks a lot.

Sure. Chris, do you want to start with the 100 gig in the data center first and then I'll take the metro and...

Correct. Yes, I think it's difficult to say whether there's actual slowdown due to the 100 gig coming, slowdown at 40 gig. We certainly believe there is a little bit of softness in data center purchasing of transceivers here. And I think that's publicly known, and cloud providers have talked about that. But difficult to say whether that's due to waiting to -- for 100 gig to come. I doubt it, given the tone that they tell us, which is they can't add it fast enough. But yet, they are slowing down a little.

Yes. And as far as the metro visibility, absolutely, I feel a lot more comfortable with the visibility I'm getting, and it's this similar products that were going into the main North American metro provider or metro carrier. But it's also -- they're also going into other smaller network and carriers that is adding to our demand on top of the fact that I think we're gaining share dramatically because our product works better. So I think, it's a combination of all of the above that actually may drive our CapEx a little bit higher in the short term to respond to that kind of demand. And I think it will be a multiyear kind of deployment that is pretty exciting. Your last question on long haul and DCI. When we sell a modulator, a tunable laser, it's not clear exactly where it ends up going, but a lot of them are going into data center interconnects, and I know, as we listen to our customers, they're very focused on that business because it is driving a lot of volume. And so today, all of that's being done with discrete components moving to CFP2-ACO, and I think we'll be well-positioned when that market comes to fruition. So Chris, you have anything else to add on that?

No, I think that, as you highlighted, we don't have a lot of visibility to where -- which components are going where. They're largely the same long-haul systems that would be deployed outside of the data center interconnects.

And our next question comes from the line of Doug Clark with Goldman Sachs.

I think, we've covered a lot of ground. So maybe 2 things to kind of revisit from earlier comments. The first was you talked a little bit about your kind of product pipeline a little bit for next year, and you actually included silicon photonics. So I was wondering exactly what applications and what technologies you were planning on addressing with that. If you could talk a little bit about it?

We haven't said specifically -- publicly what we're doing with silicon photonics. But I'd say that it's focused on the -- within data center, 100 gig applications and primarily focused around when servers go to 25 gig. And so I think, we're well-positioned. We've been sampling our key customers with this product that I think in -- to one of the earlier questions, does change the game from what carriers are looking for versus what the hyperscale guys are looking for. So it's within the data center, 500 meters to 2-kilometer kind of reaches that I think is the sweet spot and what we're focused on for our first silicon photonics product.

Okay, perfect. And then other one was a follow-up to the M&A commentary. Wondering if just as you look at kind of potential targets and I understand kind of accretion is the key goal here, but if it's a combination of -- within the optical comms segment, lasers or kind of which focus you would look to expand further first?

Yes, maybe I can talk about the one that we have done about 1.5 years ago, which was Time-Bandwidth Products in Zurich. It's an ultrafast laser company that we've pulled into Lumentum now. And it's really a huge success for us. I'm really excited about the team and combining the great technology and great team with the infrastructure and go-to-market that we've got. So I wouldn't rule out things like that in the future. But at this point, I'm not sure we can talk too much about whether or not we're going to focus our M&A dollars and focus on optical comms or datacom or telecom or lasers. We are looking at all of them. And when we have something to talk about, we'll let you know.

And our next question comes from the line of James Faucette with Morgan Stanley.

This is Meta Marshall for James. Quick question to kinda -- on the OpEx. With it coming in kind of better than your 5% to 8% guide so early into the split. Was that due to attrition? Or are there positions kind of better outstanding or -- I guess, I'm just trying to get at, are there things that could prevent you from kind of -- could there be a pause in operating margin improvement as you get toward your double-digit target?

Yes, this is Aaron. So in terms of our guide, you kind of see the operating margin guide. And Alan alluded a little bit to the spend rate being flattish. And in Q1, we did separate from Viavi 5 weeks into the quarter. We did have some lower expenses in the area of engineering, primarily due to the timing of the expanses and things of that nature. As we go forward, like we had mentioned, the SG&A model, we're not going to have to add a lot of SG&A costs as we go forwards. So as volume increases, we're going to see that fall to the operating margin line. We will be aggressive and continue to focus on development of new products. So we are going to spend money in R&D. And that's how we're going to continuously accrete our gross margins with these newer products. Having said that, we do have a tiny bit of headwinds because we do have the merit increases here near-term. And then as we get into next quarter, the March quarter, we do have payroll tax reset and some of those types of things that happen.

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

It was not great to see the North American metro billed, sort of reflected in your sequential ROADM numbers. My question is do you expect that this will pull through your transmission components in future quarters? Are you expecting that to happen? Do you have the right sort of form -- technology form factors for the transmission side of the equation that the Cienas and Ciscos are looking for, for the AT&Ts and Verizons of the world?

Yes. I mean, I think that we are a very large player in the discrete components. 100 gig modulators are expected to grow up, to increase this quarter, tunable lasers the same. So I'd say, at least for the foreseeable future, we're doing quite well and we expect those transmission products to follow the transport products. That said, there's a lot of focus on CFP2-ACO, and we do believe that with our unique technology approach, while we might be behind in sampling customers compared to what some others are saying, I would say that our technology approach will get us the kind of manufacturability and cost structure to rapidly take advantage of that market as well.

All right. And then secondly I wanted to sort of reconcile some of the comments about book-to-bill and VMI with some of the other comments about allocation. So do ROADMs ever go into VMI? Would ROADMs be in VMI? And if so, how does that reconcile with -- when they get onto allocation?

Yes. I mean, our largest customers have all of their products go on VMI, regardless of allocation or not. So we love our customers, and we do what they ask us to do and make sure that we treat them fairly so that they don't miss opportunities. So we're increasing our capacity on our ROADMs and our Super Transport Blades, which is the primary product that goes into the North American metro deployments, and those are all going through VMI today. So if those grow, you're not going to see increase in book-to-bill.

Got it. And then finally, if you could just sort of speculate 2 years out from now -- that comment you made was interesting about China wanting to deploy ROADMs for the first time. What could you imagine a couple of years from now China being as a percentage of overall ROADM sales?

Well, higher than it is today, which is 0. So I think that the number of nodes in China, I could imagine over time, equate into what we're talking about with the major North America metro build-outs. And so I think we will have to have a new generation of ROADM to be able to meet the market demands in 2 years, and we're working feverishly on driving continued cost reduction and performance improvements of our ROADM products that should allow us to continue to grow in 2017 and beyond.

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Alan Lowe for any closing remarks.

Great. Thank you, Tamara. And Lumentum delivered on our first quarter as a public company. Our new products, such as our TrueFlex ROADMs, 100G Datacom transceivers and new commercial lasers, are winning in the markets. Our team is really excited to support our customers, grow our business and create shareholder value. We will be discussing our business at several investor relations events in the upcoming weeks. These events are listed on our supplementary slides provided on our website. And as we add new events, they will also be listed on the website in the Investor Relations section. This concludes our call for today. We'd like to thank everyone for attending, and we look forward to talking with you again in another 3 months.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.