Viavi Solutions Inc. (VIAV) Q2 2013 Earnings Report, Transcript and Summary

Cherryl Valenzuela Thomas H. Waechter - Chief Executive Officer, President and Director Rex S. Jackson - Chief Financial Officer and Executive Vice President Alan S. Lowe - President of Communications & Commercial Optical Products and Executive Vice President

Kevin J. Dennean - Citigroup Inc, Research Division Amitabh Passi - UBS Investment Bank, Research Division Troy D. Jensen - Piper Jaffray Companies, Research Division Kimberly A. Watkins - Morgan Stanley, Research Division Alexander B. Henderson - Needham & Company, LLC, Research Division Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division Natarajan Subrahmanyan - TheJudaGroup, Research Division Simon M. Leopold - Raymond James & Associates, Inc., Research Division James M. Kisner - Jefferies & Company, Inc., Research Division Dave Kang - B. Riley & Co., LLC, Research Division Kent Schofield - Goldman Sachs Group Inc., Research Division Michael Genovese - MKM Partners LLC, Research Division Ian Ing - Lazard Capital Markets LLC, Research Division

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 JDSU Earnings Conference Call. My name is Jeff, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Cherryl Valenzuela, Senior Director of Investor Relations, and you have the floor, ma'am.

Thank you, Jeff. And welcome to JDSU's Fiscal 2013 Second Quarter Earnings Call. Joining me today are Tom Waechter, CEO; and Rex Jackson, CFO. Alan Lowe, President of CCOP, will join us for Q&A. I'd like to remind you that this call will include forward-looking statements about the company's future financial performance. These statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to look at our most recent filings with the SEC, particularly the Risk Factors section in Part I, Item 1a, of our current report on 8K filed December 14, 2012. The forward-looking statements, including guidance provided during this call, are valid only as of today. JDSU undertakes no obligation to update these statements. Please also note that all results are non-GAAP unless otherwise stated. We include a detailed reconciliation of these non-GAAP results to our GAAP results, as well as a discussion of their usefulness and limitations in today's earnings press release. The release plus our supplementary slides and historical financial tables are available on our website. Finally, we are recording this call today and we'll make the recording available promptly on our website. I'd now like to turn the call over to Tom.

Thank you, Cherryl, and good afternoon, everyone. JDSU delivered a strong second quarter with revenue at the high end of our guidance range and operating margin that significantly exceeded guidance. Revenue was $429.4 million, up from last quarter and, as expected, did not include any contribution from seasonal budget flush activity as service providers continued to spend cautiously and selectively. Gross margin was 48%, the highest in 8 quarters, primarily driven by record gross margin in CommTest. Operating expenses of $157.2 million were up only slightly from the previous quarter, resulting in operating income of $49 million or 11.4% of revenue. This exceeded our guidance and represented our highest operating margin in 6 quarters. In fact, all 3 business segments outperformed their operating margin guidance. Our balance sheet and working capital structure are solid. We generated $59.4 million of cash from operations, the highest in 8 quarters, and reported total cash at the end of the quarter of $740.2 million. We are well-positioned for calendar 2013. Recent announcements and customer dialogue point to increased global network infrastructure investment this year. We are pleased that announced new spending plans will target areas where JDSU offers market-leading and differentiated solutions, such as broadband network buildout, network visibility, mobility, Ethernet deployment and 100G. Based on our current visibility, we expect to see the impact of increased network investments in our June quarter. Collaborative innovation is a core value at JDSU, a critical competitive differentiator and a key driver of profitability. All 3 of our segments are focused on aligning our product portfolio to meet our customers' current and future needs. Products less than 2 years old accounted for 54% of our core network-related revenue, surpassing our 50% target for the seventh straight quarter. We continue to demonstrate our market and technological leadership across the diverse markets we serve. First, in our network building blocks business, we are improving network agility. Our TrueFlex line of ROADMs is on plan. We are collaborating with our customers to ensure that our entire line of TrueFlex products meets the needs of both today's networks as well as the next generation of colorless, directionless and contentionless networks that will extend beyond the 100G retransmission rate. Our Twin 1x20 TrueFlex ROADM is on track for its scheduled general release this quarter. Our new design pipeline of line cards is at the highest level in years, as we continue to demonstrate to our customers that we provide them with differentiated solutions to meet their needs at the line card level. We are also ramping volume of our 40G and 100G coherent components and began production volume of our 40G coherent transponder module, using many of these advanced components. We had our first revenue shipments of our 100G line card in Q2 and expect production release of our first custom 100G line card this summer. At the same time, we are advancing our initiative to grow our pluggable business to address the ever-growing demands of the data center and the cloud. We are in the final qualification stage of multiple new customer wins and expect this business will grow faster for us than most of our other product areas, as we take significant share at the top-tier NAMs [ph] and network cloud providers who address this market. Next, our network service enablement portfolio continues to expand with the addition of high-margin, high-growth potential software and mobility solution. For example, last week, we announced a new software solution, StrataSync, a hosted cloud-based asset, configuration and test data management platform that leverages and builds upon JDSU's market-leading installed base with field test instrument. StrataSync provides our customers instant access to the network data generated by these widely deployed instruments, dramatically increasing the productivity of field technician workforces. StrataSync complements other new products like PacketPortal by increasing the network visibility customer's need to truly optimize the networks. It will become widely available in March. PacketPortal continued to gain traction. To date, we have 11 customers and 23 completed trials. Service providers are asking their network equipment manufacturers to certify PacketPortal for use on their platforms and include it in future equipment orders. We grew our mobility business over 10% year on year. In fiscal Q2, we leveraged recent acquisitions in RF test and capacity test across our installed base, including Tier 1 LTE customers. In our core anti-counterfeiting market, central banks continue to express interest in next generation overt features to support upcoming redesigns of bank notes. The number of countries who are either using or have designed in our newly optically variable magnetic pigment, OVMP, on their currencies continues to grow, increasing from 20 in fiscal Q1 to 38 in fiscal Q2. The EUR 5 is the latest banknote to feature OVMP and will be introduced this May across the Eurozone. Now turning to market adjacencies. The new product pipeline in our Commercial Lasers business continues to grow. Revenue from high-kilowatt fiber lasers was $7 million, up slightly from the previous quarter. Additionally, we are on trials with customers with new higher powered Q Series lasers for semiconductor micromachining and high-speed precision tuning. Finally, with respect to gesture recognition, we signed our fourth customer in December, further extending our leadership in this market. We are pleased about the growing interest in this technology across a number of different applications. And as previously noted, we have multiple development projects with customers underway. We expect to ramp volume production on a next-gen gaming platform application this spring. Our goal to drive lean operational efficiencies in concert with top line growth is making good progress. We have captured significant annualized cost savings in CommTest through consolidation of our contract manufacturing footprint and outsourcing our repair services. The benefit of these initiatives is becoming more evident, as CommTest reported gross margin within its target model and operating margin approaching the target model at lower than target revenue in fiscal Q2. Year-on-year, CommTest operating income grew over 25% on essentially flat revenue. CCOP's margins also benefited from initiatives to drive greater operational efficiency through supply chain optimization, multisourcing and design cost reduction. With that, I'll now hand the call over to Rex, who will take you through the details of our financial performance in fiscal Q2 and our outlook for Q3.

Thank you, Tom. Second quarter revenue of $429.4 million was at the high end of our guidance. As Tom mentioned, we did not see the typical year-end budget flush spending in North American service providers. You may recall that last year's Q2 revenue included approximately $5 million of budget flush. Revenue from the Americas is $214.1 million or approximately 50% of total revenue. EMEA revenue was $102.3 million or approximately 24%. And Asia Pacific revenue was $113 million or approximately 26%. The sequential increase in the Americas and EMEA regions were both primarily a result of stronger CommTest demand while Asia Pacific was sequentially flat. Year-on-year, the Americas and Asia Pacific regions grew mostly driven by CCOP, while EMEA was flat. Favorable product mix, good operating expense controls and better operational leverage drove margin expansion. Gross margin grew to 48% and operating margin of 11.4% significantly exceeded our guidance range. Net income for the quarter was $42.3 million or $0.18 per share, compared to $35 million or $0.15 in the prior quarter and $36.3 million or $0.16 last year. Book-to-bill for the company is below 1. Book-to-bill for OSP was greater than 1, CommTest was at 1 and CCOP was less than 1. Bookings for CCOP reflected timing of orders related to year end price negotiation. We expect CCOP's bookings to normalize in the current quarter. Moving to the segments. CommTest delivered revenue of $195.4 million, at the high end of our guidance, driven by demand for Ethernet, mobility, 100G and cloud solution, all areas of high priority for our customers. Revenue from all 3 major geographic regions grew sequentially. Year-on-year revenue declined by less than 1%, as organic growth and recent acquisitions effectively offset portfolio pruning and the lack of a year-end budget flush. As Tom mentioned earlier, CommTest delivered gross margin of 64.4%, a record high reflecting a sequential increase of 2.3 percentage points and year-on-year improvement of 4.2 points. The gross margin improvement, combined with effective OpEx management, resulted in segment operating profit of $35.3 million or 18.1% of revenue, the highest operating margin for the segment since December 2010. Turning to CCOP, which consists of our Optical Communications and Lasers businesses. In fiscal Q2, CCOP delivered revenue of $185.8 million, gross margin of 30.9% and operating margin of 11.4%. Within the segment, Optical Communications reported revenue of $155.6 million, a sequential decline of $7.6 million. Total ROADM revenue declined 23% sequentially to 20% of Optical revenue compared to 24% last quarter. These sequential declines reflect, as expected, the impact of the large optical customers' transition to vendor-managed inventory, which grew to 46% of optical revenue from 40% last quarter and to the timing of key customer programs. Tunable XFP revenue was flat on absolute dollars sequentially and represented 14% of Optical revenue. We recognized a small amount of Tunable SFP+ revenue in fiscal Q2. Optical Communications gross margin improved to 28.3% on lower revenue from 27.5% last quarter, due primarily to cost improvements throughout the quarter. The sequential ASP decline in fiscal Q2 was 1.2%. We expect the sequential ASP decline in fiscal Q3 to be approximately 5%, in line with recent beginning of calendar year ASP declines. The lasers business contributed $30.2 million of revenue versus $31.9 million last quarter due to slightly lower demand for solid state lasers. Gross margin improved sequentially to 44.4% as a result of cost improvement initiatives. Next, our OSP segment delivered revenue of $48.2 million, gross margin of 47.9% and operating margin of 33.6%. Sequential revenue decline was expected and largely due to customer inventory adjustments at calendar year-end. Gross margin and operating margin both declined sequentially on lower revenue. Moving to cash in our balance sheet. For fiscal Q2, the company generated $59.4 million of cash from operations, while capital expenditures totaled $15.5 million. At the end of fiscal Q2, the company held $740.2 million in total cash and investments and net cash was $534.6 million. Now to our Q3 guidance. Based on normal seasonality, particularly in CommTest, we would expect some decline in revenue from our fiscal second to fiscal third quarter. Further, as Tom indicated earlier, we expect our customers to begin releasing their capital budgets in earnest in March and thus expect a positive impact of increased network investments in our June quarter. With these factors in mind, in CommTest, we expect lighter revenue and corresponding impacts on gross margin and operating margin. In CCOP, we expect a flattish quarter with a slight increase in optical components being offset by a decline in lasers. And for OSP, we expect a slight increase in revenue and consistent performance on profitability. Specifically then on a sequential basis, for CommTest, we expect revenue to be down by 6% to 10%. For CCOP, we expect revenue to be flat plus or minus 3%. For OSP, we expect revenue to be up 2% to 6%. The company's operating expenses are expected to be flat to up $4 million, primarily reflecting continuing investments in R&D and beginning of calendar year payroll impact. Now looking at the operating margins for the segments. Both CommTest and CCOP operating margins are expected to be 8% to 10%. OSP operating margin is expected to be 32% to 34%. Taxes, interest and other income are expected to result in a net expense of approximately $5 million to $6 million. Share count for calculating EPS is expected to be approximately 240 million shares. We expect capital equipment purchases to be between 4% to 5% of revenue. Taking into consideration the factors above, we expect second quarter revenue to be $405 million to $425 million and our non-GAAP operating margin to be between 6.5% and 8.5%. I'll now turn the call back to Tom.

Thanks, Rex. Fiscal Q2 was a well executed quarter for the company, highlighted by better-than-expected revenue and gross margin in CommTest and outperformance in operating margin across all 3 businesses. We maintained a strong balance sheet and, sequentially, grew cash generated from operations while continuing to invest in innovation and paying down debt. The long-term outlook for JDSU is positive. We are extending our market share and our served addressable markets, particularly in the areas of field test, Datacom and gesture recognition, effectively balancing our strategic investment profile with prudent cost management and making significant progress in achieving our target model. Operator, we'll now take some questions.

[Operator Instructions] Our first question comes from the line of Kevin Dennean with Citi.

Tom and Alan, a question for you both. Tom, in your opening comments, you clearly sound confident in 2013 and you mentioned that we should see the impact of improving network builds in the June quarter. So I guess, can you both give us a little bit of a sense of what sort of conversations are you having with your customers? Are they coming to you with specific network build plans or are you hearing this directly from the carriers? Or is it that you're just seeing folks like AT&T take CapEx higher? And then second part of the question is, should we think about this improving trend to benefit CommTest and CCOP equally? Or do you think we're going to see a bigger benefit in one side of the business versus the other?

Okay. Kevin, I'll start it and then I'll turn it over to Alan. From a customer perspective, let me address the operators and I'll ask Alan to address the NAM [ph] part of it. We're hearing it from multiple sources. We have seen a number of the network operators around the world publicly talk about increased spending based on deployment, especially around wireless, backhaul, et cetera. So we're hearing it publicly but we're also hearing it in our direct commentary and discussions with our key customers that they are planning an additional spending, primarily this year, for most of those operators. And we're starting to get into more detail of exactly where that spending is going to be. And again, we feel very bullish about being in a good position, where the spending is going to actually happen. Let me turn it over to Alan to talk about what he is seeing with the NAMs [ph]. And I'll come back and talk about the balance between CCOP and CommTest.

I have been out talking to the customers over the last several weeks. And while they're waiting for the messages and POs from their customers, the discussions that we have with our NAMs [ph] is that it's coming. It's just a matter of timing until the budgets get released and when they start seeing orders and then place orders on us. That said, we have seen a pickup in orders in January compared to October. So we're pretty confident of the fact that spending is going to increase in the June quarter as a result of this pent-up demand.

Thanks, Alan. And I'd say, Kevin, the balance between where we'll see the increase -- CCOP, our special optical components, has been very strong the last 6 quarters or so. So I expect probably the biggest uptick to come initially in CommTest because we probably are starting at a lower run rate level comparatively, but I do believe, over time, that it will be shared across both businesses, primarily because of the differentiated technology we have in both those businesses, adding the agility to the network from the optical component side and then the enablement and a lot of the new software capabilities and network visibility that we're building into our CommTest products and solutions.

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

First question, I think your guiding revenue is up on a year-over-year basis, yet operating margins are slightly below. Just trying to understand some of the puts and takes, driving your operating margins coming lower than expectations. And then just as a followup, I thought I heard you say your expectation was for price decline of 5% sequentially in 3Q. I was wondering if you could elaborate on that and why price decline is accelerating 2Q to 3Q?

I'll take the price decline and then I'll ask Rex if he'll take the other part of the question. We said that the price decline in optical components in the December quarter was around 1.2%, which is really below the average we see of 2% to 4%. Typically in the March quarter, our third fiscal quarter, is when the results of annual price negotiations and budget contracts hit the hardest. Last year, we said we anticipate it to be 6% in the March quarter. I think it actually turned out to be about 4.8% because of mix. This year we're saying 5%, which is actually lower than what we guided to last year for the same quarter. So we don't really see that accelerating at this point, but I would have to say that pricing continues to be pretty aggressive in this space.

And then on the year-over-year comparison, the range does suggest some upward mobility from comparable quarter last year. We would expect our blended gross margin to be comparable or better. As you can see, the operating expenses are going up as well and that would be the primary driver of a not larger increment on the bottom line.

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

On gross margins, you did a great job. I know it's been a focus for the company. Can you talk about -- is there more work to do regarding the cost control side of the gross margins, specifically in CommTest? Or is the leverage from here just going to be more on volumes?

Yes, I'll talk about the gross margins at CommTest. And I would like to have Alan make a few comments on the CCOP side, because there's a lot of work going on there. I think with CommTest, 2 things happening is the mix continues to move in a favorable direction. Their revenue from new products was 58% this last quarter, so that continues to help us. We definitely get better gross margins out of the newer differentiated products. But they also have been working very hard on the supply chain initiatives to reduce the number of CMs, which is happening on a regular basis now, which gives us more leverage in the remaining CMs and then also going back into the supply chain getting material cost down. So, I would say we still have room to improve in both the mix, especially as things like PacketPortal start coming onstream and higher volumes with some very nice gross margins. And we still have work to do and, I think, things that we can accomplish in the supply chain side of it. Alan, you want to add a few comments on the CCOP side?

Yes, sure. We have similar efforts going on with our supply chain, but I think there's a bigger opportunity internally as we continue to focus on driving our yield improvements and cost improvements and efficiencies through both our fabs as well as our CMs. That said, there's also a step function that we expect in gross margin from new products, as we release our TrueFlex line of products as well as our next generation of ROADM line cards. And then thirdly, we expect to see improvements as we fill our fab and our production capacity with the next generation of gesture recognition products that Tom indicated we'd be ramping this springtime. So it's a combination of all of those factors that we expect to grow our gross margins.

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

It's Kim Watkins in for Ehud today. First, I just wanted to clarify your comments about interior budget release in March. Is that any different than you've seen in prior years? It seems like we're usually talking about that happening. Is it delayed in any way? And if you could provide any color on why that may be, if it is. And then the second question is, geographically, it looks like Europe, for the first time in a really long time, maybe 5 to 6 quarters, saw a sequential uptick, and one of the reasons you talked about was CommTest, but if you could just provide us any more granularity of the drivers there it would be helpful.

Okay. I think as far as CapEx timing, typically what we see is kind of mid-February going into the beginning of March is the typical timing. We think it's going to be slightly delayed this year. We do believe in talking to some of our key accounts that because there are some increases coming through in the budgets, that it's going to take them a little bit more time to allocate that out. That's pretty consistent with what we're hearing. So that's why we believe it'll be a little bit delayed this year, more probably into March, which really cuts the runway short of getting deliveries out in that remaining time frame. So that's why we believe we'll start seeing the business pick up in March, but most of that will be reflected in the financials in the June quarter. I think as far as your question around Europe, as we said, even last quarter, Europe, we believe, for us, has bottomed out. We -- now, consistently, it's been 24% of our revenue the last 2 quarters. It was typically running 25% to 26% before we hit the financial issues and crisis in Europe. So we think it is bottoming out. And we do see some significant orders on the table with network operators for the CommTest business in Europe because they do need to spend -- they continue to have more devices hooked up to the networks. So there is -- there are some decent-sized orders out there that we are working on. But overall, there is a dampening of the spending in Europe and we don't see that coming back strongly over the next few quarters.

That's really helpful. Can I just sneak one more in? Rex, did we get in optical comms and later book-to-bill? I may have missed it. I didn't see one in there. I didn't hear one.

The book-to-bill? I think you're asking about the book-to-bill for the 3 segments.

Well, no. Specifically for lasers and optical communications, in the past, you've given that out.

Okay. So in both cases, those were below 1.

Our next question comes from the line of Alex Henderson with Needham & Company. Alexander B. Henderson - Needham & Company, LLC, Research Division: I was hoping you could give us a little bit more clarity on what's going on in the line card business, the comments around that segment being down sequentially. It seemed a little weaker than I would've thought. Can you talk a little bit about the timing of when you expect the new line cards based off of the liquid crystal and silicon technology actually impacting the numbers. And a similar question around the Tunable XFP, I was a little surprised at the sequential there.

Alex, this is Alan. As we said in the last earnings call, we had expected one of our large ROADM customers to move to VMI. So part of that reduction was due to that transition, where we hold their inventory as opposed to them holding the inventory. We expect that to now be normalized. And then part of it also was that ROADM deployments are very project based. And so based on where a service provider deploys a new network transport system really dictates when the NIMs need the product. So I don't -- I wouldn't read anything into the reduction last quarter with respect to share loss. And I would say that -- as the introductory comments talked about, our ROADM line card pipeline of new products is as big as it's ever been, both on MEMs-based products as well as on the LCoS-based products. So we do have additional new design work going on MEMs-based products as well as LCoS. And as we talked that the LCoS module Twin 1x20 will be released this quarter and the line card will be released in this summer time. Alexander B. Henderson - Needham & Company, LLC, Research Division: And the Tunable XFP side of it?

Yes. Tunable XFP, similar. One of our large Tunable XFP customers moved to VMI as well, and I think we are expecting that business to grow this quarter. But I think when we've had the dominant market share for 3 years in a row, there is new incumbents coming into the market that will take share. But our effort is really to drive further cost reductions and ability to continue to maintain our share as well as to drive new products like the Tunable SFP+ that we are starting to see initial revenue on.

Our next question comes from the line of Patrick Newton with Stifle, Nicolaus. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: I guess for Tom or Rex to dive into the op margin question from earlier on a segment basis. I'm a little bit perplexed by the CommTest op margin guidance. I think you're guiding for CommTest revenue to be up year-over-year. If we look at the midpoint of your revenue guidance range, it's well within a range we've seen over the last 10 quarters. You should have a gross margin tailwind due to your higher software mix and supply chain optimization that you talked about benefiting the current quarter, I would assume, would be ongoing. But you're guiding for operating margin to be at the midpoint, the lowest level since March of 2010. So could you help us understand what assumptions are based on this outlook? The guide just looks overly conservative.

So if you were to look at the -- first of all, look at the revenue and you look at the ranges, the revenue is roughly approximately the same. I wouldn't peg it but you're in the same ballpark. From a gross margin standpoint, we don't expect at the lower revenue level for this quarter to achieve the 64.4% that we achieved last quarter. So, I would expect, both through a combination of lower revenue and mix, to be slightly down. And then we've got from a operating expense standpoint some continued investment in R&D to support some of the new products that we've talked about and also the beginning of the year payroll tax and other impacts. So there is some downward pressure on the operating margin for Q3. I would tell you that, that clearly, based on Q2, that operating margin is very, very sensitive to the top line.

Our next question comes from the line of Subu Subrahmanyan with TheJudaGroup.

Tom, on your comments on the June uptick coming from CommTest, June is traditionally a quarter-over-quarter stronger quarter for Test normally. So do you see something which seems to be somewhat over and above the normal quarter-over-quarter uptick? Or are you seeing anything [ph] that there can be some year-over-year growth there? And then on optical com, I wanted to ask if how much of that uptick, slight uptick, you see in December -- March is recovery from inventory issues in December? And can you talk about margin there with the lower volume and lower ROADM revenue, you still had a gross margin uptick. Can you comment on what drove that.

Okay. I'll take the first part and then I'll turn it over to Alan on the optical component side. I think we're not giving guidance for the June quarter. We're not giving guidance beyond this quarter. But I did feel like it was important to talk about trend. And it is a trend we're seeing where we believe there's going to, overall, be an uptick in the spend by the operators in calendar year 2013. As they get through their budgeting and we start seeing those orders flow more in the March timeframe, that would really put the primary lift that we're going to see in the June timeframe and beyond. So other than that, I wouldn't quantify it any more than just that trend that we're seeing. Alan, do you want to talk about the optical component side?

Yes. So the drop in revenue was more or less expected, as we talked about in our guidance from the last quarter, again, partially due to this VMI transition. I would say the improvement in gross margin came from twofold, one, 1.2% ASP reduction is on the very low end of ASP reduction as well as we had some significant improvements in our overall costs, both from the supply chain management standpoint as well as the internal yield and cost improvements.

Understood, Alan. I guess my question was, is that business that was impacted by VMI reduction in December improving in March, which is driving the slight increase in your March optical com guidance?

I think that's fair to say.

Our next question comes from the line of Simon Leopold with Raymond James. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: I was hoping you could just follow up on that VMI answer. If you -- do you have the ability to quantify maybe what the effect was on the December quarter and what the rough impact is on the sequential, easier comparison on the March outlook? And then in terms of the mobility exposure, you did highlight what sounds like very good growth coming from that vertical. Could you give us an idea of the portion of business that's currently coming from mobility and how you expect that to perform relatively over the, let's say, next several quarters?

Okay. I'll ask Alan to talk about VMI, and then I'll talk about the mobile growth.

Yes. I'd say VMI accounted for 50% or so of the reduction in the Optical Com's revenue in the December quarter. And now that, that transition is mostly complete, that will then now more return to a normalized basis. And so therefore, we don't believe that we'll be taking an impact to VMI nearly as much in the March quarter. And therefore, we think that the Optical Com's revenue will go up in the March quarter as a result. Did that answer your question? Simon M. Leopold - Raymond James & Associates, Inc., Research Division: Kind of. I guess what I -- I'm assuming that you have an easier sequential comparison in the March quarter versus the December. So I'm trying to get some idea of how much of an incremental tailwind you're getting from that easier comparison versus just pure demand improvement?

I would say rough estimation is, if all things were considered equal, it would probably be flat.

Our next question comes from the line of James Kisner with Jefferies & Company. James M. Kisner - Jefferies & Company, Inc., Research Division: I just want to follow up back on the CommTest profitability. I mean... [Technical Difficulty]

It looks like we're having issues with Mr. Kisner's phone. I'm going to move on to our next analyst. It comes from the line of Dave Kang with B. Riley & Co. Dave Kang - B. Riley & Co., LLC, Research Division: So I'm just trying to understand this VMI impact and trying to understand the math here. So your optical revenue declined about $8 million sequentially. And Alan, you said about 50% of that, which is about $4 million, is from VMI. Now, if I look at ROADM sales, it declined about $8 million. So basically $4 million is from VMI. So the other $4 million is from what? Just a natural slowdown or can I get more color on that?

Yes. I think with ROADM deployments, they're very project based. So the timing of a project deployment may have been delayed or not. I mean, I think if you look at our customers where we have ROADMs and ROADM line cards, we don't believe we lost any share. So I'd say that it has to do with the end network buildouts then it's really a timing thing, and that's why we think that ROADMs will grow in the March quarter and in the balance of the year because we're pretty confident in deployments going forward. Dave Kang - B. Riley & Co., LLC, Research Division: So should we expect that $4 million, which was impacted by VMI for ROADM, should we expect that $4 million to go up -- to be made up in the March quarter?

I don't think we're going to give specific guidance about that. But I would say that our expectations are that ROADMs do grow in the March quarter. Dave Kang - B. Riley & Co., LLC, Research Division: Got it. And one follow-up question, if I may. So Asia -- overall, Asia sales were flat, flattish, on a sequential basis. I was wondering if you can provide a little bit more granularity as far as the optical components, how did they do in Q2 and what should we expect in Q3?

I don't think we break out regional sales by segment. Rex, do you want to elaborate on that?

I don't think -- we don't forecast regional sales by segment, correct.

No we don't. But, I think, overall, if I look at the company, we continue to get good traction in Asia. It's a focus area for us. We have a significant amount of employees in Asia today and we have quite a bit of R&D that's going on in Asia. So I think that's really paying off in that market. We see China starting to pick back up with pretty strong 100 gig deployment now, the largest in the world, and we think we're going to participate nicely in that. So we think that's going to be a reasonable growth engine going forward. So we expect -- if I look back last year, Asia for us is probably more like 23%, 24% revenue and now it's 26%. And I think that will continue to grow for us. Dave Kang - B. Riley & Co., LLC, Research Division: And Tom, is China the biggest component of the Asian business there?

It would normally be, if not every quarter, but I would say on average, it's the largest component. Although we do very good business in Japan as well, India is going well, Australia so, Korea. So we have a number of good entries into Asia, but I would say, overall, on average, China will probably be the largest component.

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

If I could ask 1 question to help clarify on the CommTest side of things. If I look at the revenues in December 2011 versus December 2012, they're roughly equal, but you do have about a 4, 4.5 point difference in the gross margin. If you could help us to understand how much of that is actually driven by the cost reductions that we should think of as more permanent versus the product mix, I think that would help us to understand the March guidance a little bit.

Okay. To give you a rough estimate, I would approximate it at about half-and-half, plus or minus 10%, 15%. But I'd say it's about half-and-half. From what we're seeing, I would say that now, we still have runway on the cost reduction, so we'll continue to see improvement. But we would expect some of the newer, especially software, products to start kicking into the next few quarters at a more rapid level. So I'd say that will probably start outstripping -- the mix savings will start outstripping the cost savings as we get out into the middle of this calendar year.

Great. And maybe just one quick follow-up on the PacketPortal side of things. You mentioned 11 customers. Can you remind us how that kind of compares to the previous quarter? You've given some different metrics there in terms of deployments versus customers, that sort of thing.

Yes. It's basically 2 additional customers since last quarter and a number of new trials that we've completed. But on the customer side, it's 2 additional customers.

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

First on CommTest, you made a statement that there was no North American budget flush, yet AT&T spent about $700 million more than most people expected them to in the fourth quarter. So my question is were you supply constrained at all in CommTest in the calendar fourth quarter? Was any of that going on? And then I have a follow-up on CCOP afterwards.

We were not supply constrained, although I'd say if you look at CommTest inventory, it did come down. So we didn't -- in a normal year, where we expect budget flush, we will build some inventory of products that are likely to fall into that category. Knowing that there wasn't going to be a budget flush this year, we didn't build that inventory. So we were not supply constrained. But if there was a surprise orders that came in, it would've been harder to respond because we kept the inventory tight.

Okay that's helpful. Then on CCOP, I mean, I just -- it feels like I've heard 3 different answers. We talked about VMI being 50%, but yet you also, in the prepared remarks, talked about maybe the annual pricing negotiations causing some delay in ordering in the December quarter. I'm wondering, is that typical? Is that something you saw different this year, in terms of -- can you just give you more color on that comment. And is that the other -- is that 25% and lack of budget flush of 25% and VMI was 50%? Is that the right way to think about it?

Michael, this is Alan. I'd say that the VMI we talked about really impacted the revenue for the quarter and the annual negotiations impact the bookings for the quarter. So as we go through the month of November and December, we're negotiating with our customers to get their annual contracts done and sometimes goes -- go into January without conclusion, or they spill into January where we have agreement but the orders don't get released for the beginning of calendar '13. So hopefully that clarifies it. And as I said earlier, we've now seen the order rates in January be better than October. So the negotiations are behind us. And we think now that the order rates will normalize with respect to book-to-bill.

Our next question comes from the line of James Kisner from Jefferies & Company. James M. Kisner - Jefferies & Company, Inc., Research Division: Just to clarify on the CommTest. For the March quarter, not to beat a dead horse, but I mean, some of these [indiscernible] you guys talked about what happen every year like seasonal increase in OpEx and seasonal down tick and gross margin going down. But it does seem like you're about at least 100 bps lower than you would be relative to where you were a year ago. Is there -- is PacketPortal falling off sequentially? Is that a factor? Like is there more detail here in terms of mix that you can give or perhaps even talk about how much lower gross margin will be sequentially?

So I think that probably the best quarter actually for you to look at would be Q1 of this year because that's the most recent quarter where you had revenue at or below the range that we're talking here. Tom covered the gross margin from the standpoint of the -- 60% to 64% is probably half. Cost reductions that definitely stick and the other half could be tied to mix. So Q1 was at 62.1%. If you look at the operating expenses period to period, you'll see that -- well, we are estimating operating expenses, due to the beginning of the year issues relative to Q1, are going to be up several million dollars. As a result of which, there is a direct deduct from bottom line, that's where you see the pressure. And it was -- CommTest's contribution back in Q1 was 9.9% and that's obviously at the high end of the range that we have here. But it really is an OpEx comparison and revenues at lower margin.

I would say, James, we're continuing to spend heavily in R&D. We're very excited about the opportunities we see out there. We just brought out -- announced StrataSync, a new software product for us that I talked about during the call. So we're going to stay on the R&D. This is a seasonally soft quarter in March, but we're not going to pull back in R&D just because it's a soft quarter in March. We see a lot of good opportunities ahead of us. And we're going to stay focused on that R&D and continue to bring these new differentiated products out, especially with a fair amount of software content. James M. Kisner - Jefferies & Company, Inc., Research Division: Okay, great. Just really quick follow-up, on gesture recognition, when you talked about this ramp and this new gaming platform, is this essentially the same kind of -- I mean I understand it's basically the same kind of product, but is the produce [indiscernible] ... [Technical Difficulty]

James, I think we're having technical issues with your line. So, we'll just get you back during call back.

And it looks like we have another question. It comes from the line of Ian Ing with Lazard.

A lot has happened in North American in CapEx headlines since the last call. So AT&T raised their guidance for the next 3 years but then they lowered '13 by a billion and now they're spending on spectrum initially. How has your view changed on 2013 versus last quarter's call?

I think as far as -- compared to last quarter's call, we have more visibility, obviously, and we're working closely with our key customers. So if anything, it's improved from the last quarter's call. It hasn't degradated.

Okay, great. And I know you talked a bit about optics pricing environment in March. I mean, it looks like there are some China entrants doing pluggable optics. Are you seeing them for any sockets you're going after and any sort of long-term impact there? Is it the MSA business or some other aspects of the business?

This is Alan. I didn't really understand the question.

Yes. There's actually some -- it looks like there's some China entrants that are also doing pluggable optics. And then also there's talk of Huawei doing captive solutions down the road. Is that something you're starting to see signs of or it's not apparent at the moment?

Well, I mean, China is always a threat and always something we worry about. I think today we see them mostly in the older, lower transmission speeds, where it's very, very cost competitive and price competitive. And I don't think that's going to go away. I think our focus then is to move up the food chain and up the speed chain, where they don't compete and they're not even in the market with respect to 40 gig, 100 gig pluggables. And so that's our focus as we transition out of some of these lower margin, lower transmission speed pluggables and into the higher data rate ones.

Great. And then last question, 40 gig TrueFlex ROADMs, I mean, are there greenfield opportunities at the moment in emerging markets? Or is it largely 100 gig that you're looking at going forward?

Well, our TrueFlex portfolio is really focused on 100 gig and beyond. And so today's -- many of today's ROADMs are running at 10 gig, 40 gig and 100 gig without any issues. And so our TrueFlex products, of which the first one we released this quarter, is really focused on the next generation of networks. And so we're really excited about the traction we have with our customers, both at the module level as well as at the line card level. So I think as the bottlenecks for capacity continue to increase, customers are going to want to make sure that they have capability of going beyond 100 gig. And that's why our real TrueFlex product line is really focused and designed for the 200, 400 and beyond transmission rates.

Ladies and gentlemen, this will conclude the time we have for questions. I'd now like to turn the presentation back over to Mr. Tom Waechter for closing remarks.

Thank you, operator. As our call concludes, I'd like to thank our employees for their numerous achievements and strong support of our customer base. I would also like to thank our customers, partners, vendors and long-term shareholders for their continued interest in JDSU. Have a great evening.

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