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JDS Uniphase Corporation (JDSU)

February 14, 2013 3:30 pm ET

Executives

Cherryl Valenzuela

Thomas H. Waechter - Chief Executive Officer, President and Director

Alan S. Lowe - President of Communications & Commercial Optical Products and Executive Vice President

David W. Heard - Executive Vice President and President of Communications Test & Measurement Business Segment

Luke M. Scrivanich - Senior Vice President and General Manager of Optical Security & Performance Products

Rex S. Jackson - Chief Financial Officer and Executive Vice President

Analysts

Alexander B. Henderson - Needham & Company, LLC, Research Division

James M. Kisner - Jefferies & Company, Inc., Research Division

Mark McKechnie - Evercore Partners Inc., Research Division

Kimberly A. Watkins - Morgan Stanley, Research Division

Ian Ing - Lazard Capital Markets LLC, Research Division

Troy D. Jensen - Piper Jaffray Companies, Research Division

Kevin J. Dennean - Citigroup Inc, Research Division

Kent Schofield - Goldman Sachs Group Inc., Research Division

Cherryl Valenzuela

Great. Well, good afternoon, everyone. I'm Cherryl Valenzuela with Investor Relations, and I'd like to welcome everyone here in the room as well as those on the webcast to JDSU's 2013 Analyst Day.

As you can see from our agenda, you'll be hearing from the business leaders today to talk about JDSU's vision and strategy for delivering shareholder value. The first half of our program features presentations from our CEO as well as leaders of our 2 largest business segments, followed by Q&A with those 3 gentlemen. We'll then break for 30 minutes, reconvene here for the second half, which will feature 2 additional formal presentations, followed by a second Q&A session with the entire management team. We ask that you hold questions for OSP as well as our CFO until the second Q&A. The live webcast will also stream through the second Q&A. Meanwhile for those of you in San Francisco, we certainly hope that you'll join us for a cocktail reception with management until about 6:30 p.m. or so.

In terms of where things are going to take place, we will have formal presentations and Q&A in this conference room, conference room Alexandras. [ph] Across the elevator lobby is conference room Victor [ph], where we'll have our break, our cocktail reception as well as product demos of StrataSync, and restrooms are down that way as well.

So before we get started, I'd like to remind you that certain statements in the presentation constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1934. Forward-looking statements are all statements made by us other than those dealing specifically with historical matters and any statements we make about the conduct of our business or finances up to this moment. All other statements made by us are forward-looking statements, which include any information provided on future business operations and guidance regarding our future financial performance. Actual results may differ materially from those projected in the forward-looking statements. Factors that could cause actual results to materially differ from those in the forward-looking statements are discussed in the company's Securities and Exchange Commission filings, particularly the Risk Factors section in Part 1, Item 1A of our current report on 8-K filed December 14, 2012. Please note that all numbers are non-GAAP unless otherwise stated.

Okay. Let's get started with a short video that sort of highlights the ways that JDSU delivers technology with diverse and far-reaching impact.

[Presentation]

Cherryl Valenzuela

And now, I'd like to welcome JDSU's President and CEO, Tom Waechter.

Thomas H. Waechter

And good afternoon, everyone, here in San Francisco and those on the webcast. Good to see everyone, and I think we'll have a productive day here. You'll get to hear from a number of our members of our leadership team talk specifically about their business, and actually have a chance to ask them questions as well.

So as I think about JDSU and the investment thesis, the thing that immediately pops to mind is a technology with impact. And you could see on the video, we're very proud of our technology and we really do positively impact our customers and their customers' lives everyday with this innovation. We tend to call it collaborative innovation because we work very closely with our customers on that innovation.

Management team. It's a team I'm very proud of and probably more importantly, have a lot of confidence in. It's put solid strategy together, has done a lot of heavy lifting over the last few years, and I really think can drive us to our ultimate goals and objectives for the company and bring a lot of value to the shareholders.

Market leadership. You'll see from our 3 business leaders that the markets where we do play in, we are leaders. And we typically have a differentiation in the technology and the solutions that we provide. And a compelling market drivers, so I'll talk a little bit more about those a little bit later in the presentation. But we do see across our businesses, both the core market and the adjacencies, very strong growth drivers today and out into the future.

So what I'm going to talk about today is our strategy for growth, a high-level view, and then some of the accomplishments we've seen out of that strategy. So if you look at an overview across the JDSU, this is fiscal year '12 on the left-hand side here, revenues of about $1.7 billion. Across the 3 business segments, we serve 4 markets, 2 of those we consider core markets, the network visibility and agility and anti-counterfeiting are the cores we talk about. And then we have 2 main adjacencies, which are commercial lasers and gesture recognition, and you'll hear some more detail about that a little bit later.

Again, we're very innovative. We have 2,400 patents out there, and we do a lot to protect our intellectual property because we think that's very important. Approximately 4,500 employees spread out, we have a very global footprint. That's a real advantage for JDSU. But I think, importantly, we're very close to the customers, and that's not just sales and service activity, we also do R&D out into the major geographic regions very close to our customer base. And that's very important to get close strategically to our customers and be able to provide this collaborative type of innovation to our customers on a global basis.

To talk about the management team, most of the leadership team is here today, so it's -- you'll hear from most of them through presentations, but also get to talk to them during the social hour, et cetera. So the 3 leaders at the top are the leaders of our business groups. David Heard, Communications Test and Measurement. David's up front here. You'll hear from David. Alan Lowe, Communications and Commercial Optical Products. Alan, right here. And Luke Scrivanich, Optical Security and Performance Products, Luke. Judy Kay and Brett Hooper aren't here today, but they're a very important part of our business in driving the strategy forward. Rex Jackson, our Chief Financial Officer, is here with us today. Rex is over here on the side. And then Andrew Pollack, our General Counsel, is here. He won't be speaking today, but Andy is here as well. So we have a good representation, I think, of our management team. And again, I -- as I said, I have a very high confidence level on this team to set strategy and actually drive and achieve those goals that we set out in front of us. I think I have a very good track record of doing that.

So I talked about compelling markets. If you look at the left-hand side, the orange box, almost $20 billion in total available market through our network businesses, whether it's the service enablement or building the network agility. I probably don't have to speak a lot about the market drivers. You all know that there is a lot more devices out there, intelligent devices hooked up to the network, real time, almost full-time networking going on with those devices, a lot more applications, a lot more videos. So we see those drivers strong, growing and continue to increase out into the future.

Our anti-counterfeiting business, almost $3 billion of available -- total available market, again, very strong drivers. The ability to counterfeit is improving out there because of the technology that's available to those counterfeiters. So we need to make sure that we keep driving our technology and our capabilities forward, and we are doing that on a regular basis; you'll hear about that from Luke.

Commercial Lasers, we're very excited about that. It's $5.3 billion TAM. And I think you know we've had some new entries into that market with our kilowatt fiber lasers. Alan will talk about that and some of the excitement around our growth and the opportunities in that market. The drivers are very clear. Manufacturers out there want to be able to cut, weld at a much higher speed with much lower energy consumption. And some of our new products have 70% less energy consumption than the traditional ways of cutting and welding and much higher throughput than those traditional mechanisms.

Gesture recognition. Alan also will talk about that. We have a $50 million TAM. That's just really at its infancy, so it's very difficult for us to state exactly what the TAM is. Alan will talk about second generation of our gaming, the gaming products coming out and then 3 additional customers that we brought onboard. So I think you'll see that TAM grow with time.

Strategic priorities. These have been pretty consistent over the last few years. We've had 5 of them. I would say the 2 that -- and they're all focused around our customer. So how do we better support our customers? How do we get more strategically aligned with our customer base? The 2 that we tend to spend a lot of time and focus on are the collaborative innovation that I've already talked about; you'll hear more about that, and then the employee commitment. So those are the 2 areas that we think bring us the closest to our customer base, and we've had some really good success there. I'll talk about some successes and just give you examples of each one of these areas.

So we talk about collaborative innovation. I think the network agility part really comes to mind, going to help our customers to build agility into their networks. Started out with a 300-pin transponder. A few years ago, we came out with a tunable XFP. We are out to market for over 2 years without a competitor on the markets. We had a really nice lead on the technology. And that was really accomplished through working with our customers, understanding where the networks are going, what their needs were out into the future and actually being able to provide them the technology and solutions. We now recently introduced the tunable SFP+. And some of our competitors are starting to come to market with a tunable XFP, we've come out with SFP+. Smaller form factors, lower power consumption. Again, we think we have a very significant lead technology-wise out there in the market against our competitors. Why are we excited about -- we see this as a CAGR of 20% to 22%. You don't find those type of growth areas very often, and so we see this as a really nice area for us to grow and a good example of our collaborative innovation with our customer base.

Strategic acquisitions. The last 2 that we did in calendar year '12, 2012, were focused around mobility and a bigger play in that mobility market. We did the Dyaptive acquisition in January and GenComm in July. Both of those businesses are doing very well for us. They've exceeded what our initial expectations were. And again, just more traffic out there, more mobility.

One thing I noticed as I was looking closer at this slide, this is the Ohio State Stadium. So I know that David Heard, who spent quite a bit of time there during his undergraduate studies, probably slipped that slide in on me. Go Buckeyes, right? Yes, you did get through in 4 years. I didn't mean that was an extended period of time. You did make it in 4. So go back and check that transcript, you'll see it for sure.

And then the right-hand side, again we're excited about these types of growth rates. They're very, very significant. By the way, I grew up about 1.5 hour drive from there as well.

Talk about global presence. Immediately the anti-counterfeiting comes to mind. We're in over 105 countries, so very global customer base. Luke will talk in more detail about that. Recently, we 2x-ed, doubled our capacity in China for developing and manufacturing these pigments, and that increased our capacity 27% on a global basis. And we're seeing that capacity fill up very quickly based on the demand drivers out there in the market.

Employee engagement. This is something I really believe strongly in. If you look at very successful companies, there's a very strong correlation between the commitment of their employees, the engagement of their employees and their success. So we started over 4 years ago on some very strong programs to emphasize employee engagement, employee empowerment. How do we get our employees more involved in setting the strategy and really helping us to drive the strategy, and how do they support the evolution of the company in those achievements? We do an employee survey every year. We've just launched our fifth -- I believe, it's our fourth or fifth survey. We're launching that in February. And each year, we've seen an improvement in our performance as far as how our employees see that, as far as how they are engaged and ability to relate to the company and where we're going. And we're going to continue to drive that up into the right.

Lean and scalable operations. Keep in mind these numbers. We actually, over that 3-year period, grew our top line by 32%, while we took down manufacturing footprint by 75%. So it gives us a lot more flexibility dealing with our CMs. Our facilities footprint came down 35%. That's about 1 million square feet of space that we've consolidate -- consolidated. Headcount down by 36%. And for the first time in the history of the company, we got on one global ERP system. So it sure makes sharing data a lot easier around the world. And we expect as we grow the top line that proportionately, we're not going to need to increase our operating expenses at the same rate.

So just a few numbers to keep in mind before we go into the specific business units. Over the last 3 years, revenue growth of 32%, so top line improvement. From fiscal year '09 to '12, we increased our R&D spend by 49%. So as we are taking total expenses down, we have increased R&D and we really believe in that. I don't care if it's a soft market or a strong market, we're going to invest heavily in R&D because we're seeing that payback. And how do we judge that? We've set a target a few years ago to get over -- at or over 50% of revenue from new products, defining new products as those being introduced in the last -- within the last 2 years. We've had 7 straight quarters where we've done over 50%. And some of those quarters were in the high 50% range. CommTest, in the December quarter, hit 58%.

Operational improvement. If we look at operating income as a percentage of revenue or operating margin and we look at a percentage change over that 3-year period, it's gone up 531%. So we hear from Rex a little bit later, he'll talk about the leverage in our model. As we see incremental revenue, you could see it in the December quarter. As we see incremental revenue, we see quite a high percentage of that drop to the bottom line. And that's one of the areas that we're very excited about where we've gotten with this business model as we see our ability now to start growing the top line at a quicker rate.

So let me end up, before I turn it off to Alan, where I started. Technology with impact, collaborative innovation, just a small sampling of our global customer base that we're very close to and have a very strategic relationship. On the bottom and the sides of this chart, you'll see some of those awards that we actually received from our customers. It's a very significant recognition and also from the industry in general, some things that we're very proud of. With that, I'll turn it over to Alan.

Alan S. Lowe

Thank you, Tom. They'll be passing out my presentation here in a minute, but why don't I go ahead and get started? My name is Alan Lowe. I've been with JDSU about 5.5 years. And I have to say, I'm more excited today than I have been in those 5.5 years because of many things, one of which is the outlook for our business as well as the pipeline and new products and the collaboration that Tom talked about with our customers.

So what I want to do today is provide you an overview of CCOP, what we do, talk about the challenges that our customers are having and our customers' customers are having, and how we at CCOP are innovating collaboratively with our customers to able to provide them differentiated products, like what Tom talked about in the tunable XFP and tunable SFP, across the broad range of products that we offer to our customers.

Then I'll talk about the Commercial Lasers business and what we're doing there to grow that business, which is very attractive and large, and we're still a small player in that area as well as gesture recognition, and the pipeline for the future there looks quite bright as well. And then I'll finish on talking about the gaps to our business model that we talked about last year at the same time, and how we're going to close that gap, both on the top line as well as on the margin.

So fiscal '12, we were over -- just over $700 million in revenue. And you can see the split out of optical comms and lasers. Large market, over $6 billion market, and we participate in almost all of it, $5.6 million -- $5.6 billion. Our market focus is on, really, 3 areas in the optical communication area, which is transport, transmission as well as data comm. And I'm going to talk about each of those 3 areas in a minute, and then fiber laser and gesture recognition. We focus on being #1 in the markets that we try to be #1 at. And I'm very happy to say that we're #1 in ROADMs and have been for quite some time, tunables, super transport blades and gesture recognition. We're going to maintain #1 position in those areas and focus on becoming #1 in other areas, and I'll talk about that as well. We have about 1,500 employees. The adjacent markets TAMs and SAMs are interesting, both on the laser side but on the gesture recognition side. If you look back over the couple of years that we've been participating in gesture recognition, as a company, we've done just under $90 million of sales. And I'll talk about why that's exciting today and in 2014 and beyond.

So more about collaborative innovation, but what our customers are really asking for is faster speeds in the network. We have a portfolio of technologies and products that address 100 gigabit per second data rates. And we can take those products and put them into specific custom line cards like you see here in the picture. We're focused on connecting to the cloud. And if you look back 3 years ago, our Datacom business was relatively small. And we've been saying we're investing and we have been investing over the last 3 years, and that's starting to pay off. I'll talk about that as well with our Datacom pluggable.

Decreasing cost and size. This is an extremely cost-competitive market that we're in. And we've been focusing on both driving the cost of our supply chain and product down, but also doing it through photonic integration. And what I mean by that is really putting more and more function at the chip level. And you can see on this fingertip, it's a chip with a tunable laser and a modulator, where in the past, that was a very large product. This is sitting on a tip of a fingertip. This is a tunable XFP chip. That's at the heart of some of our technology.

And then the bandwidth demands are dynamic. The service providers don't know where the next viral video is going to come from. And so we have talked to the service providers to figure out what is it that they need to be able to dynamically switch that bandwidth, and how do they do it today? How do they want to do it in the future? And our TrueFlex product really addresses the future product, the future requirements of those networks, and I'll talk about that as well. So all of what we do is really enable network agility, as Tom indicated. And we really do that to address this market, which is compelling. The overall optical communication market has been growing at 13%. You can see the last couple of years has been kind of flat. And I believe that that flatness in the market is really driving pent-up demand and why we said in the earnings call that we believe that after -- in the June quarter and beyond, business will strengthen and the demand for building out networks, both existing networks as well as new next-generation networks, is going to be very, very strong.

We're focused on, again, the leading segments, tunables, ROADMs, 100G, and -- then I'll talk a little bit more about the Datacom focus as well.

So connecting to the cloud is growing faster and faster than we even expected when we said that's important 3 years ago. Data center connectivity within data centers, as well as from data center to data center, and then connecting with data centers to the core networks is what our customers are focused on as well. Mobile applications and mobile networks, Tom's charts show that 2014 mobile traffic on the network will be bigger than wireline traffic in the network. And when I saw that, I said, "Wow! 3 or 4 years ago, mobile traffic was single-digit percentage of network traffic. And now, next year, it's going to be more than 50%." And that's going to continue to grow at the rates that we've been seeing over the last several years. So that's a huge part of what's driving both mobile network, but it has to get on to the core network as well, and that's what's driving the agility and the network speed.

And then consumer video. I mean, that's what's driving also the mobile as well as video at home. And these items at the bottom are really what drive our customers and their customers to work with JDSU. So to provide faster bandwidth, as I said before, here is an example. The modulator on the upper left-hand side, 100-gig modulator, were in production and have been for several quarters, as well as a coherent receiver. We do many, many types of products like this. And we sell those to vertically integrated customers, where they have their own DSP chip. But we also take those products and we incorporate them into what our customers want us to do for 100-gig line cards. So this is an example of -- you can see there's actually 2 receivers and 2 modulators and 2 tunable lasers on a single flat card. And so we're providing this custom application to one of our customers. And through all of our integration at the photonic level, we've been able to increase the density, lower the power consumption and the heat that's produced by 2 100-gig coherent transmission cards.

Also we're doing that through driving the size and power down, as I said before. Again, this is tunable SFP+. And we're just at the beginning of that ramp as customers have been designing those into their line cards and now are starting to deploy those out into the networks.

So for WDM, the transmission CAGR is -- we estimate between 8% and 10% going forward, and that makes this a pretty exciting area to participate.

Through the network -- the dynamic network, we went out over the last several years and talked to the service providers and said, "We are going to come back and develop ROADMs and optical channel monitors and other products for future networks, not just 100-gig networks, but future networks that could go 400 gigabits or a terabit." And so what we did was we came out and designed and worked with our customers collaboratively to design what we call the TrueFlex line of products. These products -- the first one, of which we're going to release to production next month, is our Twin 1x20 TrueFlex product. And over the last 6 months, nearly every single network equipment manufacturer that we talked to gets excited about it, and most have adopted this architecture for their next generation of systems. So we're extremely excited and believe that the last 3 years of development of this product is going to start paying off.

And how I can tell is because if you look on the right-hand side of this chart, we have 18 customer products designed in at the line card. So we're working with our customers to design line cards. We have 18 in development today. If you look back 2 years ago, we had 6. And that's driving a large part of our business today, those 6 line cards we had in development 2 years ago. And now, we have 3x as many. So the adoption of our TrueFlex products is happening today. And that's why I'm confident that the second half of this year, calendar year, is going to be extremely strong as we deploy these into networks. CAGR 10% to 13%, nice area, and we expect to grow much faster than the market in this area with our TrueFlex products.

Connecting to the cloud. As I said before, our market share in this was very small 3 years ago. And we put a concerted effort out to really drive our R&D spend to meet the needs of our customers, provide them with differentiation through photonic integration, miniaturization and lower power consumption, and this is paying off as well. We've been now designed in and being pulled by 2 major network equipment manufacturers, where we've had little footprint in this area. And this is really, as I said before, connecting within the data center, connecting between data centers and connecting to the data center from the core network. We're very excited about it, and it really expands what has been our traditional telecom's SAM by 50%. And I'll talk about that in just a second -- or I'll talk about it now.

You can see here that the SAM for Datacom, almost $2 billion and growing faster than telecom. So as we get into that market, where we have little footprint, now being pulled by several major customers of ours, we expect that business to grow even faster than what we think the CAGR of the market is. So together, $5.6 billion, we're going to grow faster than the market because of all the things I talked about in the new product development and collaboration with our customers, it's very, very exciting. The largest funnel we've had, not just in blades but across the board that we've had in years.

Let me shift gears and talk about the adjacent markets and what we're doing on both lasers and gesture recognition. At CCOP, we really have a mindset of saving money. And we have this picture that we could have paid for. On the left-hand side of gesture recognition, the stock saying, "You pay for it, and you get to use it in a presentation." But we really save money. This is a picture of my kids playing with a game station. And my son on the left, he's got quite a good vertical leap. He must have gotten it from his mother. But we're -- also we're a customer of that as well as a supplier to that. And what's really exciting about this is we expect to ramp the next-generation product in the June quarter. And the value or the revenue that we put into each one of those products is more than twice per unit than what we had in the first generation, because we're adding more components and more value to our customer in that area. So that's ramping imminently.

But what's even more exciting is what we're doing both in home entertainment and on personal computers. So the numbers for game stations, it's in the 10 million to 20 million units a year, but computing, home entertainment, 10x that. So it's very, very exciting, and we expect those to be launching in 2014.

And then we're also working and talking with people about smartphone and tablet, so controlling your smartphone and tablet with gestures. That takes a lot of innovation, a lot of collaboration with our customers to make the camera itself so very small that it fits into the bevel of the phone or the tablet. But we believe that's really more of a future thing that we're working on to drive additional demand for gesture recognition, so a very exciting part of growth. And while Tom showed our TAM or SAM at $50 million, that's really what we think today is. But as we grow into these new applications, it could be extremely exciting.

Okay. Lasers. Tom talked about our partnership with Amada and on the fiber lasers. I don't know if you've all seen, but Tuesday Amada announced that they bought a company in Japan called Miyachi. Miyachi is -- expands their product portfolio. They've already talked to us about putting our laser products and developing additional laser products to fit into their new acquisition. So that's expanding our footprint just within Amada. And then beyond Amada, I think, is exciting as well. So you can see that TAM is growing about 11%. The place we participate is growing much faster at 19%. And then since 2009, our lasers business has grown 22% on a compound annual growth rate. So we're in the interesting parts of the market. We're growing faster than even that, and there's a ton of TAM that we're not addressing yet today, so a big market and a big focus for future growth as well.

So today, we really participate in a couple of areas. In the laser market, the macro side, which is our initial partnership with Amada. Today, we produce kilowatt fiber laser engines from 2 to 4 watt -- kilowatts, but the market itself is $1.5 billion. And the fiber laser market will grow and eat into what today's market is mostly dominated by, which is the CO2 market. And so the more we can drive the costs down, power efficiency up and the size of fiber laser down, will really determine how fast that TAM becomes part of our SAM. And so that's what we're working with Amada initially in R&D, to drive those future functions and differentiation so that the fiber laser becomes the clear and obvious choice for our customers going forward as opposed to some of the older technologies, such as CO2.

On the micro material processing, on the right-hand side, some of the things that are happening to drive growth in that area are miniaturization of mobile devices. So today, the mobile devices are getting smaller and smaller with more function, and you only do that through smaller componentry. And so now, much of the componentry within those smart devices are being cut with micromachining lasers as well as the displays on those devices. And so we're working with our customers to really provide unique applications that are specific to what material they're cutting, how they want to cut it and how fast they want to cut it. So enabling miniaturization with precision is driving older technology to newer laser-type technology to get the size and precision that they need.

So a lot of this is also driven by our telecom expertise. So the fiber laser, for instance, is pumped by the similar kinds of pumps that sit under the ocean for 20 years with high reliability and never breaks. So that's also attractive to our customers is the reliability focus that we have on telecom that we then apply to the laser products.

So how are we going to get to our business model? The December quarter, our revenue was $186 million. We've said that we'll meet our business model when revenues get to $210 million. And as I've taken you through kind of what we're focused on, on the telecom space and on the Datacom space, and gesture and lasers, we think that those items will drive our business to over $210 million per quarter, as we deploy those 18 blades that I talked about, as we deploy Datacom pluggables to those few customers that I talked about, and then as we introduce the next generation of fiber laser as well as ramp gesture recognition that I talked about, which should be in the fourth fiscal quarter of this year.

So that's how we drive the top line. Here's a recap of our business model and how we're doing it, where the gaps are with respect to our September quarter and our December quarter. You see our gross margin was between 30% and 31%, and our operating margin was 11.4% and 12.2%. So we have gap. And as you'll hear from Rex a little bit later on, incremental revenue for our business in optical comms drops about 50% to the bottom line, and lasers drops even more than that. So driving the top line to $210 million, and I think we have a credible plan, incredible product portfolio and pipeline that gets us there, will get us incrementally to the gross margin and operating margin.

But we're not resting on that because we have to drive additional -- additional cost reductions to keep up with the ASP reductions. And we're doing that through really better product mix. So as we introduce these new products, we have higher value to our customers, and those products will be introduced at higher margins. But we also have control over our supply chain, consolidating our supply chain, doing more with fewer, but also having second sources. And then also driving what we call internally the cost of quality or the yield improvement, scrap reduction, operational efficiency to drive internal costs down as well.

So you put all that together, you have a top line of over $210 million. I feel very confident that we'll be in the 33% to 35% gross margin. And then we'll control our operating expenses but, at the same time, still grow R&D through this to be able to fall within that operating margin target.

So with that, why CCOP? And this is really the value proposition to our customers. We have a leading optical position in telecom. We're really getting pull from our customers on products like TrueFlex. The service providers tell our customers what they want, and they're also working with us to be able to provide their customers with what they need for the dynamic networks. We're expanding our footprint into Datacom, gesture recognition and fiber lasers, as well as micromachining lasers, and we are positioned for growth. And I think over the next few quarters, we'll show you that that growth is going to happen and that operating margin and operating leverage really produces bottom line performance.

So with that, I'd like to thank you for your attention, and I'll turn the podium over to our President of CommTest, David Heard.

David W. Heard

--

[Audio Gap]

-- exciting to see where technology is at the roots of where it's certainly happening deep in the labs. And I have the privileged position to be able to work with Alan and get that customer intimacy early, early on in the optical R&D labs to see what's going to impact the network as we go down that cycle 12, 18 and 24 months down the cycle. So it's really a great partnership, that customer intimacy that Alan talks about is very much part of our business. So where Alan has it with those design engineers with the network equipment manufacturers, ours are with the carriers that are providing the very service you use every day.

And so today, what I want to talk to you about is really a business for JDSU called network and service enablement. And I'm going to talk to you about 5 things around network and service enablement. First, I'm going to talk to you a bit about what does that mean? Historically, people have thought of us as a test and measurement company. We have 90 years of experience through acquisition of testing particular points in the network. I'm going to talk to you about what a huge evolution is going on and revolution is going on in networks around the world.

Two, I'm going to talk to you about some compelling market drivers, not real macro, second derivative market drivers of real problems our customers are looking at and real problems that we can solve and that we are solving. Lastly, I'm going to talk to you on those market drivers about the growth plans. What do we do on the body? So how are we solving those problems in some pretty important areas for the customer, in terms of what it means for you as an end subscriber and what it means for them as an operator.

I'm going to wrap that all up with end-to-end and the value of having an end-to-end portfolio and how important that is for our customers. Again, we have a real unique advantage because not only do we have the end-to-end for network service enablement, but the building blocks that they're building the networks on, we get that advanced preview that Alan just went through.

Then lastly, I'm sure that you're interested I -- as we put together this material, we really tried to think back to the questions you asked over the year, the big issues that you brought up with us last year. We'll talk a bit about how does that translate into a business model for investors. And so we'll kind of open it up to give you kind of a little bit of transparency to what we've seen happen over last year and where things are going for the future.

Net-net, this is kind of a snapshot of our network and service enablement business. We operate distinctly in kind of 5 key market areas that we're going to talk about. And that is data center and cloud, media access and content, so all the devices to get you on these big, big high-bandwidth networks, and then to make sure that the content coming across them is pure, high definition. Obviously, the mobile network, broadband network and infrastructure, so all that traffic has to ride over a grand backbone in the access metro and transport network. And then I think the newest thing that our customers are really looking for is all that traffic has to be coordinated. It's no longer about the plumbing. It's about the services going through the network, and they need an incredible amount of visibility to be able to manage this. I mean the pace of change is just historic and epic as it relates to the customers we're serving.

The global customers, a lot of -- I think last year, you guys were asking kind of how do your -- how does your customer breakdown go? This is kind of a rough pie chart to the size of our customer base. A large majority of them are the telecommunication service providers that serve you today, both mobile and fixed line. Cable operators, network equipment manufacturers. And we do have a business with enterprise and government, and we'll talk to you about our solutions in that.

When you think about us and try to do who do we compete with, it's very interesting because there's 3 real markets in the historic test and measurement business that you think through. One is field test. Traditionally, roughly 65%, 70% of our business. So you take players like EXFO out in the field that make field instruments. That's typically one of the competitors we may see out there. You may see Anritsu, another player that provides field instruments out in the network.

Then you have lab and production, which we do have lab and production gear early on with the network equipment manufacturers as well as with the service providers. And typically, the competitors in that space are people like Spirent, people like Ixia. And that's where they play. They typically don't have field implements out with the carriers; they're back deep in the labs. And then the last place is in the service assurance market, and that typically where you see players like Tektronix that you may see out in the market, NetScout and others that are really trying to pull together some of the service.

We are in all 3 of those segments. And I'm going to talk to you about why that's important. We play to win. And Alan said it, we like to be #1 on what we do. We have a long history of that. We are the best at understanding what a carrier or a workgroup needs. We know the guys that crawl in the sewers, crawl up towers and drive into central offices and data centers. We understand their methods of operation and how they design and develop tools, instruments and software to solve problems, and that's what we do.

Now the need is just much greater. It's not just about the particular problem they're solving when they're in that data center, it's giving them visibility to what could be going on upstream that's causing them a problem that they're seeing in that data center location? So again, #1 in all these fields, and you see our employee base that makes it all happen, okay?

So network and service enablement, really, this is my periodic table of elements of how do you create network and service enablement. There's really 4 building blocks for that, one of which you're very familiar with. It's that -- those instruments. Those instruments now need to be cloud-enabled. When a service provider came to your house and a guy had an instrument and he drove a truck to your home and got out and tested your service, once he tested and enabled your service, when he got done, he threw it at the back of his Ford 150. And that was it. If there was another problem at your house, you call up the service provider. They're calling out another truck, another guy is coming out. That information that was gathered at that network location is gone. As the leader of instruments around the world with hundreds of thousands of technicians trained carrying our gear, we've cloud-enabled these instruments now. To capture that information, the service providers don't have repeat calls. So they can better utilize information in a cloud-enabled network. We have a demo out here called StrataSync that we'll talk about that givens our customers that network visibility and again gives them of faster time to resolve problems on a lower cost, gives us some nice software revenue and pretty sticky when you're the market leader.

Intelligent probes, you can't have enough technicians out in the market, especially with machine to machine. And so when you think about this, you have to have probes out in the network. Last year, I talked about taking probes that are this big and shrinking them down to the size that fits in the palm of your hand. That's what we're seeing out in the network, getting those to the edge as fast as humanly possible. You have to be able to do that as well out in the network, have the software to tie it together and then be able to have the systems to be able to guarantee you a service level or you're going to churn. And so we are the only players that are positioned to have all those building blocks in our repertoire, have a history of designing, developing and leading in that field. And we have the relationship and a seat at the table with our customers. That intimacy Alan talked about, we have really moved up the chain from somebody who they thought about sold tools and instruments to somebody that's really helping them with the critical problems in their network.

So again, service enablement is a big part of what we're doing. When you think about the big trends that have really -- we are very, very focused on how to solve these. It is absolutely a wireless world with Ethernet everywhere. Ethernet is the protocol, these small cells, cell sites to give you coverage and capacity gains everywhere have to be connected via Ethernet. This is a big investment area for us.

Applications are driving the experience. It's no longer how many bars are over your head in terms of the mobile phone. You have an average of 40 applications running on your mobile phone at any one particular time. It's about how your interaction in that mix of applications is working that keeps you happy as a customer.

Software is defining the network. You hear big, fancy works like software-defined networks and Big Data. It is no doubt that Big Data -- I think I read something the other day that said the data created in the last 2 years is 90% of the data that resides today. And I'll show you some things that are happening in the network that kind of blow your mind to go, "How could that possibly be?" and some solutions we're doing to be able to solve that. In the mobile world, just to give you an example, the amount of mobile data that's on the network today is the same. It's 12x that that was on the Internet in 2000. And that's on the mobile network. And when you talk to customers that I've grown up with for the last 20, 25 years, these are difficult problems for them to solve. So how do you do that? You have an end-to-end solution. You're not just testing at one point in the network. It's not just about putting the plumbing together. You have to know where the heck is the content coming from? What service level am I supposed to agree to so I can deliver a service like FaceTime in high-definition quality in the back of a moving vehicle? It's a whole different game for the service provider and the need for end-to-end. Again, we're uniquely positioned.

So those 5 areas that we have are all around that business. Just to give you an indication because you asked, that media access and content business for us is roughly about 20%, 20% to 25% of our business mix; Mobility, 40%, in the 40s percent of our business; the broadband network and infrastructure, it's about 20%, 25% of our business. As you get down to the cloud a data center, it's a small piece of our business today but very strategic. And we think together with the network visibility business, we're going to see some interesting opportunities for us to be able to parlay that into the future. So that business is about 5% of our overall business at any one given time and the network visibility and control, as you'll probably ask me about PacketPortal, this is an area where we're creating a disruption and it's about 10% of our business. We're seeing our customers in this area really come up with true capacity problems in the network, meaning the things they've chosen to provide this service don't scale with Big Data, with the kind of mobile data growth that's growth going on in the network.

So a lot of people have been asking, "So talk to me. That's great. But those are great trends. Are your customer spending in those areas?" We didn't wait for a press release to come out from AT&T. They're one of our largest customers. We work with them very, very intimately every day. And so we've known that these areas are areas that they are absolutely growing too, the investments we're making off to the right directly aligned with what they publicly announced. It's nice for me to be able to put this up because typically, we can't talk about what our customers are doing. They've made this public. And so mobile data for them, big view, we've got an end-to-end portfolio to help them in mobile data. U-verse, that's their IPTV MIDI access and content corollary. And then for their business services, it's all about business-class Ethernet, carrier-class Ethernet. So again, I could put this up literally for every customer we have around the world and that would align with our investment portfolio of it. But it truly is the key problems that our customers are facing is making this end-to-end portfolio.

If -- can you go back a slide? Can I do that? There we go. When you look at the CAGRs here, it's interesting because these are aggregate CAGRs. So you look at mobility and you may say, "Geez, only 8% mobility." Well, 2G technologies, even service assurance for 2G technologies are going down. We're investing in technologies in this space that are growing faster than the CAGR. Our goal is solving the next problem that's out there today, not tacking on to the one that's going downhill. So you'll see when we talk about investments we're making in the space, we're talking about investments that are, again, above and beyond the growth rates demonstrated up there. So let me talk about where we're investing. First place, in broadband. Last year, I talked to you about the fact that we lead in broadband. We're the #1 player in that field. We're #1 in fiber. We're #1 in 100-gig. We're #1 in cable. We have all those service technicians out there and we talked about moving up the stack. Because typically, we were Layer 1, Layer 2, putting the plumbing together and that what our carriers needed, was the ability to manage the service and the applications across the service. Last year, we talked about a new software application called TrueSpeed that service providers could download onto their instrument. They could then see what the true technology speed at Layers 3 and 4 is across the network, not just Layer 1 and 2. It's been selling very well, a couple million dollars a quarter, software for us, allows them to troubleshoot and see what their customers really see, a great win-win. You'll see us move up even further, up Layers 4 through 7. So we can start telling where the applications are going.

In addition to that, that demo out here in StrataSync is all about taking that unbelievable granular information from all those service interactions and pulling them together to enable a workforce, workforce productivity software on a platform that's very sticky that we already have that contributes software to us. We've been working with our customers in developing this technology so it's nothing new. We're literally out there with 10 service providers today. I expect that revenue to kick in in our Q4, meaning just to begin to see the beginnings of that. And as we continue to roll that out around the world, it not only will provide our customers with a greater efficiency, it'll provide us, again, with additional software revenues going forward. 100-gig has been growing very, very large for us. Many service providers in the transport are skipping 40 gig. So when I look last year when I talked to you and now, that business is almost up; it's over 40%. So along with moving up the stack, Ethernet is what it's all about in terms of connecting all these points in the network. In connecting mobile cell sites, including small cells. And there's going to be a lot of small cells out there because there's only one limited view out for the carriers, and that's spectrum. And one of the ways I can use more spectrum is put a heck of a lot of small cells out. I've seen a forecast up to 3 million of them going out. We connect those -- why do we -- how do we do this? Well, one, the cost of getting Ethernet out there has been proven as 80% less.

But when you roll out a new technology, our customers have to go down the learning curve. If you have more than 20 milliseconds of delay in an Ethernet network, your video, your session is over and you're in trouble. And that's very different than traditional networks.

So our goal is pushing down the learning curve. We're in the early innings. Only 30% of the existing locations are converted to Ethernet. We're #1 in this space. We grew year-over-year from last year, 20% in this space. It was accretive to our business model. And now you start to add all these small cells, they all have to come up via carrier Ethernet.

We found out through our PacketPortal engagements, of which we'll talk about, have grown, that the need of the service provider, not just to activate Ethernet but then to monitor the service. The Ethernet service assurance is growing like a weed. And they needed something small, something that might fit in the palm of your hand that could actually activate Ethernet and then monitor the small cells. So we have a new product that will be coming out as part of the PacketPortal family, not yet fully announced, but we'll be talking about it at Mobile World Congress, called J-MEP [ph], and that is, again, a micro Ethernet probe that fits in the palm of your hand and actually activates and monitors small cells out in a network. And if you think of the size of the small cell now fitting into -- fitting also into 2 of your hands like this, this is the only way for service providers. So we're pretty excited about this space. And as Tom mentioned and as Alan mentioned, we continue to use our innovation to solve customer problems.

Along with that, it is no doubt it's a wireless world. We've been making acquisitions in the space. We've made 2 in the last year since we talked last year, 1 per base station test. We didn't have a product to test all these base stations and all these small cells that are going to come out in the network. And another to do capacity test in the lab and production field, to say, "What is the load that's on the cell site and how can it work better?" So now can we not only -- they're moving fiber all the way up the cell site. We have the end to end, test the cell site, test the fiber going down the cell site, test the Ethernet, drive test the network, assure the network. We truly become the end to end service assurance player for network and service enablement for our customers.

This is currently roughly 40% of our business. It should be 60% within 2 years. Clearly, a focus area for us. We've got organic investments locked and loaded and we continue to add the right inorganic things for our customers. Again, 11% up year-over-year. We've got some technologies in that space we expect to grow far ahead of that 11% number.

Last year, we talked about big data. I gave you an example of big data. PacketInsight was a product last year. We just announced no customers. It was fresh out of the lab, ready to go out to the field. This is almost achieving a -- it's a couple million dollars per quarter right now. It's an appliance that takes care of big data. With as much big data that's out there, this allows you to collect the data and do something with it real-time. The 400x faster in terms of search and extraction allows the service provider to do something with the network condition rather than 3 days down the road in real-time, before it affects their subscriber. This is a really important piece of the network.

We expect the adoption to continue to get larger. It is an appliance, so it's a little bit easier. It's not a whole new architecture. It's an appliance that they put in the network. We would fill up this room with servers if we tried to collect all the information that your devices were creating during this session. This is a way for them to only look at what they really need to manage their subscriber base. It's impacting the business model today. It's accretive to our business model and it's putting us in a whole new growth space.

PacketPortal. A lot of questions on this. Last year, at this time, is actually when we did our introduction. It's been quite a whirlwind. It wasn't -- the year was not the year in terms of CapEx spend, where people were saying, "Boy, let's just throw it all down." We all saw that, right? People weren't throwing hoards of money out on new capital spend, and they were very judicious with their resources. And what I mean is you can't even go in a lab or get a trial or get out to the field with anybody when they're that tight on their own OpEx and CapEx.

We moved from 6 trials to 36 trials, 8 big applications, 14 paid customers. Remember what I said last year. First, they trialed the technology. They take their resources to do that. Then they put it in a very small deployment. Then they figure out how their methods or procedures are going to change, usually move from a couple of hundred thousand dollar deployment to $1 million or so deployment. And then when they scale, that's where we start to see the big numbers. This is a sales cycle that takes anywhere from 12 to 18 months. And the nice thing about software is it builds a nice annuity. The tough thing about software is revenue recognition VSOE. Planning that out and understanding when that's going to hit is a little bit more difficult. It was a difficult year, but, wow, the adoption was big on behalf of the service provider. We expect this business to scale in '14, to begin to scale. We're not putting wildish predictions out there. We're talking about thinking about revenues that may be $10 million, $15 million, $20 million to begin with. But we're already working on individual projects with individual carriers that are that large. So again, we're very enthusiastic. We continue to invest in the technology. We're very committed because the feedback from the customers has been very, very large.

Three big applications right now, 3 big applications that seemed to be hot, one of which is in the deployment of small cell that we just talked about in concert with the J-MEP [ph] technology. The second element is for video assurance. So looking at the content along with video assurance. And the last is in business Ethernet services, again, attached with rolling more end points out to the network. So we're seeing those big applications over and over because they're the biggest problems on behalf of the customers. It's a big TAM. Remember, this is software, okay?

So lastly, just back to our customer, the most important person. Big data is going on, lots of smartphones. Remember when I talked about the signaling messages, meaning the collision that's going on in the network? Your mobile device in 2G, 11 messages per session; 3G, 91; 4G, not 4G advanced, 4G now, 200. Now wait until we get to advanced, wait until we get to machine-to-machine. Again, this causes costs and complexity for our customers. That's why we're here. That's what you need network and service enablement across the network, at each point in the network. And again, in partnership with Alan, we even to get to see it before it even hits the network when it's still in the labs with the folks that are making the equipment out there.

So again, I think we're in the best position when you look at who we compete against to pull that all together and we have a trusted seat with our customers.

A lot of people have been asking, so, what have we been doing for the last year? It was not, again -- I mean Alan Glassman [ph], I don't mean Tom, I mean analyst. When you look at what we've done over the last year, what we've been trying to do is we committed to you last year to improve the business model and to start putting investments in the right areas to grow because that's where we want to be.

So when you look at last year this time, same quarter this year, about flat revenues. There was no budget flush, unfortunately. It wasn't, again, a vibrant year for capital spend. We've pruned some of the portfolio. We continue to say these are things that just don't make sense for network and service enablement. We didn't have the budget flush. We did some small M&A in the year but strategic, of Dyaptive and GenComm. And we continue to grow in the strategic areas where we've made the investments. And you see that off to the right.

While we did that, the operating profit year-to-year, quarter-to-quarter, was up 26%. So the team has done a nice job but there is a lot more work to do. And the key for us is then growing to get to that model. And in the area -- the Ethernet, we talked about the growth at 20% mobile '11 and data centers 16.

We have a strategic portion of the data center. We have a product called Xgig. We are VCE certified, which if you think of VMware and you think of Cisco and you think of EMC, there's a lot of growth going on in the sand, as Alan talked about. And our ability to test there and then ultimately tie this with PacketPortal for network visibility is a big market. We've got enough lined up in the carrier market today. It's forward opportunity for us to be able to take advantage of.

Okay? So we showed this chart last year. This is kind of quarter-to-quarter. Again, we had some nice performance. What did we do? Well, we put this chart up last year. We did some portfolio pruning. We did take the supply chain leverage to where we wanted to get it to, meaning we reduced the numbers of CMs we were dealing with. We continued outsourcing of our repair operations. And then we put in, again, the right strategic M&A for growth.

Now what's next? Look, we have to grow. The focus is clearly on customer problems and growth, leveraging our innovation, scale and PacketPortal. And we still have quite a bit of supply chain and efficiency that we can work within the model, keeping very focused. So we still have work ahead of us. Everybody is asking about what's the outlook for carrier spend. Again, I think we see the demand in the network. This tends to be the tough quarter, as we said on the earnings call. This tends to be that tough quarter where they're doling out the budgets. Now they're doling out larger -- guys like AT&T are saying, "Now we're going to spend $14 billion additional." How do we spend it? It's not just for us about the CapEx spend, it's about the OpEx spend and where they're spending it. And that's why this customer intimacy is so important.

So hopefully this gave you -- again, try to balance the inbound of what's come in over the last year, but we can answer the rest in Q&A if Tom and Alan will come up.

So again, just a final thought there. Big market continuing to grow. We're investing in the markets that are growing faster. I think we're uniquely positioned to win. We talked about some pretty hot markets that we're investing in. And we've had some strong business and model performance but we're not getting carried away. We've got some work to do there. We've got to continue to work, continue to drive that investment. And, again, the outlook, again, we're very close with our customers. And we're waiting for them to get through the capital planning cycles and their operating planning cycles.

Question-and-Answer Session

Thomas H. Waechter

We have some microphones. There's some question up front.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Alex Henderson at Needham. I'm looking at the revenue growth plan in the optic component space. And it shows $186 million going to $210 million, and it puts up a number of areas that are incremental growth. What it doesn't -- also does, as a result of that, is it has that existing piece excluding those incremental new areas such as gesture recognition and fiber and Datacom flat to down, which seems incongruous to me. Can you talk a little bit about why that would be the case? Or if that's just the way the bar is.

David W. Heard

I'm going to blame the graphic designer on that. I think what we're trying to depict is that even if the market doesn't grow and we just grow with our new products, that we're going to be able to make that market model of $210 million per quarter. So at $186 million, we need $24 million per quarter to grow, if my math is right. And we think we can get that with limited growth in the market. So if the OpComm's market remains stagnant or doesn't grow, we still think with the incremental opportunities we have in gesture and fiber and Datacom, we can get there. Now if the market grows faster, we'll get to that model faster. And I truly believe that's what's going to happen, though.

Alexander B. Henderson - Needham & Company, LLC, Research Division

So, if I could just follow -- but if I were to look at that other portion, can you give us some sense, under normal growth environments, if there's such a thing in the optical space, what that might look like? I mean, are we still talking about 5% to 10% growth in that core piece?

David W. Heard

Well, we think that maybe it's 5% to 10% in the normal course of business. But for WDM, because SONET/SDH is going down, that we believe, I think, we said between 9% and 12% is where we think the WDM growth will be on a long-term sustainable path. But as you say, optical growth is not predictable. And I think if you were to put the next 4 years looking back, we'd get there. It just wouldn't be 9% to 12% every year.

Alexander B. Henderson - Needham & Company, LLC, Research Division

So one last question. You made a lot of comments on the last call about a pickup in conditions, booking the whole team up there. Can you give us a little bit more sense of where the perception was that spending was going to be larger, may take a little longer? How much of that is coming from service providers directly? How much of that is coming from talking to the network equipment vendors? How much of that is listening to research analysts -- looking at AT&T's budget?

Thomas H. Waechter

That's quite a bear trap you got right there. Look, we're paying attention to our customers. And so we're, again, sitting at the planning table, sitting with our customers. So we're really trying to base our views of the future based on what we're hearing from them. I think that the gross build plans that we see from our customers give us that confidence. I think any trepidation you ever see from us, and you're probably seeing this from other companies in the space, or how quickly the people get these new expanded grand plans for investment through their own companies and released out to the community, to the vendor community and partner community.

Alan S. Lowe

Right. So I think during the earnings call we said we'd triangulated a bunch of information, right, from different sources. The prime one that we depend on is, directly, as David was saying from our customers, we spent a lot of time close to our customers, and we see those market drivers. But also there's been public announcements by our customers. And I think it's pretty consistent that they're going to spend more as we look out into the future, especially in calendar year 2013 here. So I think those are the prime sources of the information. And as David mentioned, the March quarter is the budget quarter. It's always unpredictable when those get released and can you respond in time to what's released in that quarter. But that's why we said in the June quarter, we believe we'll see a pickup because the budgets are normally released by March. And you would see the full impact of that going into the June quarter.

Unknown Analyst

I had a couple of clarifications, Tom. I think just in the overall TAM, if I added your numbers, it came to out about $27 billion, $28 billion. I believe, last year the number was $22 billion. I was just hoping you could help us bridge the incremental TAM. And then just on the gesture recognition market, if I just looked at the units, smartphones, tablets, computing, 1.7 billion, 1.8 billion, yet you're talking about a TAM of only $50 million. I was trying to understand the rationale in terms of how you're thinking about the TAM for gesture recognition, given just the opportunity?

Thomas H. Waechter

Maybe I'll take the overall TAM and then Alan could take the gesture. But I do believe, if you look back at the TAM, the biggest increase in the TAM was in the commercial laser products. Because I think -- I believe, I have to go back and check exactly, but I think we're about $1 billion last year and we've increased that almost 2x or more from last year. So that's probably the largest increase in the overall TAM, as you add them up individually.

Alan S. Lowe

I think for gesture, there's no industry analyst who says what the TAM is today. And so, as I said before, we've shipped over the last couple of years almost $90 million of product into that space. So that's kind of how we came up with what we think today's TAM is. And it's not a whole lot of science. Could it be $25 million? Could it be $300 million this year? It's really hard to say. I think from our perspective, the important part is that the new applications will grow at the TAM dramatically faster than anything else that we're dealing with. And I think that's what's exciting to us. The new applications, though, however, don't come into play until 2014, other than gaming. So we're working on ramping gaming today. And then the next ramps are home entertainment and personal computers and that'll be really 2014. So the TAM in 2014, I think, will be dramatically different than $50 million -- calendar. Don't get me wrong. We're working with those customers today, shipping the products today, but it's really in the development stages.

Unknown Analyst

On the contest side, June is normally a stronger quarter, just turning from a seasonality perspective, plus you have some more positive commentary from the carriers this year. So if you look at the overall optimism on June, is it tied more to CommTest than Optical, Tom? Is it possible to provide any color on where the optimism is coming from related to June?

Thomas H. Waechter

I think when we said June, it is across the networking business, both CommTest and the Optical components. And I also talked about the gesture recognition ramp of the Generation 2 product, which has a pretty significant impact there also.

Unknown Analyst

So, it's is broad-based. And then, Alan, if you looked at last year, you saw June and September to be better quarters for Optical Com. And then from September to March, this is relatively flat. What kind of indications other than, of course, your new products itself, are you receiving and give you confidence, given lead times are relatively short? And the line card customers, were they formerly WSS customers turning to line card customers? Are they incrementally new opportunities? How should we think of those?

Alan S. Lowe

I would say they're both -- some of the line cards are for new customers and some are existing line customers, if that makes sense. So it's a breadth within the existing customers as well as penetrating new customers for line cards.

So I think to your question, "What's causing this growth in June," it's these new products, it's Datacom and it's gesture. So Datacom pull from our customers, where we haven't had much footprint in Datacom in the past, is real. It's happening now and we're buying capital, frankly, for a ramp in that quarter.

James M. Kisner - Jefferies & Company, Inc., Research Division

James Kisner with Jefferies. I'll start with a question for Dave. You threw out a number, $10 million to $15 million initially for PacketPortal. I just want to really just clarify that comment. Was that sort of a, whittling it down a little bit, is that forecast for '14? What was that? Like we're not forecasting a crazy number where $8 million to $10 million, was that for a year? A quarter? What time of period were you talking about here?

David W. Heard

Yes, I should probably clarify that. We're thinking about that for the year and understanding that if adoption, again, goes quicker or slower, you're going to be the first to know once we're building that into our quarterly guidance.

Alan S. Lowe

FY -- fiscal '14.

David W. Heard

Fiscal '14, correct.

James M. Kisner - Jefferies & Company, Inc., Research Division

And then just a question to Alan. On Commercial Lasers, could you talk a little bit about the sort of the near-term outlook? I see that you have an 11% CAGR that you guided down for this coming quarter on Commercial Lasers. Should we expect kind of -- should this mean it's sort of flat for a little while before some of these new opportunities emerge? Or could this year see a big recovery in Commercial Lasers we expect that to grow this year?

Alan S. Lowe

Yes, I think we said on the earnings call that we're seeing lasers down, offset by Op Comm's up in the March quarter. And that's really a result of semiconductor slowdown, because a lot of the tools go into micro-machining for semiconductor or semiconductor-related industries. So if semiconductor comes back and it's starting to feel like maybe it is, that'll grow the micro-machining part of the business, which is really what's fluctuating between quarter to quarter. Did that make sense?

James M. Kisner - Jefferies & Company, Inc., Research Division

Yes. So I guess I'm still kind of wondering what do you think for this calendar year should be, I guess, assuming that that, let's say, micro-machining is flat, it's out. Is that you probably just take it off and hold it as growth this year? I mean I'm just trying to feel for what kind of growth we should be expecting for those businesses in aggregate for this calendar year?

David W. Heard

Yes. So just for the people listening online I'm going to try to repeat the question, because you didn't have a mic. But the question is really, what do we expecting in the out quarters for micro-machining and can fiber laser make up for that? It's hard for me to really look beyond the next quarter or so. I do get the sense that semiconductor industry, as a whole, is starting to do little bit better or at least anticipate better outlook for the second half for the calendar year. And I also think that more and more of the mobile devices are relying on laser-machined screens and components to go into them that should drive incremental micro-machining and lasers in the second half. I can't predict what's going to happen to the world economy and semiconductor, but it feels better.

James M. Kisner - Jefferies & Company, Inc., Research Division

[indiscernible]

David W. Heard

Well, I think it's a question of how fast our customers sell to their customers and that's really dependent upon -- now they've had their first installed base. Are the second and third tools that those existing customers going to happened? Or are they going to proliferate? That's really, honestly, a little bit of an unknown we're working closely with our lead customer today to try to determine, so. I did my best to avoid answering your question, I guess.

Unknown Analyst

Alan, I want to extend that fiber laser question further. I guess you talked about Amada and the acquisition of Miyachi. Help us understand your fiber laser strategy. Amada is a big company, big OEM in Japan, but it's one OEM that's largely relegated to one geography. So how long of an exclusivity agreement do you have with that? Beyond Amada, how should we think about your strategy in fiber lasers? Are you really gunning to be a #2 player to IPG? Or is this just kind of, at this point, it doesn't feel like the strategy's there, at least from a street perception of how you're going to drive your costs down, how are you going to scale that business, how are you going to get those margins to be accretive to your average. So if you could walk us through what the next step is beyond Amada and the duration of that agreement, then I have a separate question.

Alan S. Lowe

Yes. Well, the agreement between us and Amada is highly confidential. So I'm not going to be able to talk about that. But what I will say is our strategy is for us to support Amada in the fullest way we possibly can and proliferate beyond Amada in our second generation of fiber laser because at that point, we really drive our diode pumps cost down to an extremely competitive level. And at that point, I think we can compete head-to-head with IPG. And Amada might help us do that. So I think it's a question of what's the right timing, what's the right product and we believe it's the next generation of products that will take us beyond Amada. But our focus primary and first and foremost is to satisfy Amada. And now with the new acquisition, we're going to be busy helping them as well.

Unknown Analyst

And does competing head-to-head mean on a margin profile or on a price basis?

Alan S. Lowe

Cost basis. I mean, I think cost is what's important. It drives margin. And I think you're insinuating that fiber laser wasn't accretive to my business, and that's not true. It is accretive and it's a good business and we expect to grow it. And I think we will be able to compete more effectively with the second generation outside of our existing customer, head-to-head, both on a price and margin standpoint.

Unknown Analyst

So fiber laser, you just confirmed, is accretive to the 44 and change gross margin that you put up?

Alan S. Lowe

Today, it is. Yes. Initially, going through the ramp, it was a bit of a challenge. But today, we've driven the cost down, we've transferred a lot of supply base to Asia and, as a result of that, it's accretive to us.

Unknown Analyst

Perfect. Then I guess on -- second question is, when you kind of opened up your comments, you said this was the most excited you been in your 10 years at JDSU. I was looking back at my notes from last year and --

Alan S. Lowe

I was excited then too, wasn't I?

Unknown Analyst

Yes, you were pretty excited then too. I think you've...

Alan S. Lowe

I get more and more excited every time I get up here.

Unknown Analyst

Right. So I guess -- that's good. But I guess if we look that you've articulated that some of this excitement is around Datacom. You've articulated that you have some -- a very strong roadmap of TrueFlex and that you should outgrow the broader market. And then you've articulated the public comments that we've seen from the carriers. Is that pretty much of the ball of wax of what's got you excited this time around? Are there any under drivers that I might've missed?

Alan S. Lowe

Well, what's got me excited is that our customers and the service providers are adopting our strategy. So last year, we had a strategy that had hoped that they would. But it was really around what they were telling us they needed. And now, we're releasing our first TrueFlex product next month and the customer poll is unbelievable. Well, not unbelievable, because I believe it. But the service providers, they come to our facility, they look in our lab, they were there today and they saw what we're doing. And then they go and talk to their suppliers and make sure that they're accelerating their effort with us. Not that we're going around our customers, but we need to understand what the service providers need to solve their problems, as David talked about, and that's what I think we've done and we continue to do. And what's got me excited is that that is now turning into 18 blades that's going to hit the market this year.

Mark McKechnie - Evercore Partners Inc., Research Division

Mark McKechnie here from Evercore Partners. I want to ask kind of a loaded question on the data center side, I'm a little new to the story so I apologize. But you talked about internal data center connections between data centers and then data center back to the core. Question I have is you said it was small 3 years ago and it's getting bigger. How big is it now? This business is at $1.9 billion SAM? I mean how penetrated do you feel like you are I don't know if you could break out that number but I'm kind of curious for how big your business is there.

Alan S. Lowe

Yes. We don't break out telecom to Datacom, but I would say that if you put us up against the SAM, you barely see it.

Mark McKechnie - Evercore Partners Inc., Research Division

You're just getting going.

Alan S. Lowe

We're just getting going. I mean, it's growing. It's growing fast, but at the same time, there's 2 network equipment manufacturers that make up 60% of that consumption and those are the ones we've been focused on and those are the ones we're getting into. So that's what I'm excited about that, because the growth rate of those guys today is pretty phenomenal. We had no footprint or very limited footprint up until now. So that's what...

Mark McKechnie - Evercore Partners Inc., Research Division

Yes and it's interesting, so the design wins that we'll start seeing in the back half of the year and into next year, how we'd look at that?

Alan S. Lowe

Yes, I mean, we're -- now.

Mark McKechnie - Evercore Partners Inc., Research Division

Right, and that's happening now. And then are you taking -- I mean who are you taking share from there? What's letting you break in there? What are you doing differently that's allowing you to break in? And who are you taking that from?

Alan S. Lowe

Well, I mean with -- some of these customers we have a track record of performance on the telecom side, right? So that allows us to build credibility across the portfolio of products and we have good products. We have products that nobody else has. We get in with the product nobody else has and then we proliferate our footprint within the Datacom space.

Mark McKechnie - Evercore Partners Inc., Research Division

They are already used in -- it could be 10-gig going to 40-gig, is it? But it's this areas that they're already shipping products, right, it's not like new applications, you definitely displacing someone there?

Alan S. Lowe

Well, when it's a new application, we're not. we're just trying to be first-in, but then we displace on a 10-gig product, right, as you come in and you say,"Well, can I have some 10-gig business?" and they say, "Yes." And this displaces the guys that are in that market, which are, you know who they are.

Mark McKechnie - Evercore Partners Inc., Research Division

Yes, completely. And then was the margin profile? What should we expect on the margin profile of that business relative to the rest of your business?

Alan S. Lowe

I'd say it's in line with our model of 33% to 36%. And that's why I think I'm pretty confident that as we add that incremental revenue from Datacom penetration and new customers -- that a lot of that flows to the bottom.

Mark McKechnie - Evercore Partners Inc., Research Division

Got you. This is the final one. You said a couple of guys make up 60% of the market. We know who they are, but there's some disruptions going on as well. Do you feel like you're -- are you going to aim at those 2? Or do you feel like you're involved with a lot of the disruptive players that are coming along maybe on the software-defined networking side?

Alan S. Lowe

Yes, I mean, we have footprint in the other 40% of the market. And we're continuing to try to grow that. But I think if we try to focus on doing too many things, then there's no focus. And so our focus is really driving the big chunks of the market and continuing to maintain our share in that other 40% of the market.

Kimberly A. Watkins - Morgan Stanley, Research Division

Kim Watkins from Morgan Stanley. Just had a couple of question, first for you, Alan. On Tunable XFPs, a number of competitors are coming into that market. What do you expect? I mean, you're ramping the SFP+ now. What do you expect overall? Should we expect a decline in the Tunable XFP business matched with growth in the SFP? And could there be a gap there where the whole business kind of shrinks for a couple of quarters? Or what are your expectations for that product?

Alan S. Lowe

I mean I think it depends. And that's kind of a tough question because frankly, I see 1 competitor today in Tunable XFP and then the 3 people making a lot of noise. Whether the 3 people that are making noise start shipping product, it's hard for me to tell. What we focus on is doing what we can control and that's introducing Tunable SFP+, driving cost down in Tunable XFP so that if pricing gets irrational, which is this doesn't seem to be yet, we can have the margin profile we need on Tunable XFP, but at the same time provide value creation for Tunable SFP+, where customers are willing to pay a little bit more for that product because there's a value to them and to their customers.

Kimberly A. Watkins - Morgan Stanley, Research Division

Are there any metrics that you can give us around the SFP+ in terms of design win numbers or...

Alan S. Lowe

It's a lot like how we started with Tunable XFP, which was we had 1 or 2 main guys and they have to design their card, finish their qualifications and then they do a pilot run of hundreds of parts. And then as adoption takes place at their customers, then it really takes off. And we're right between the 2. That's kind of where we're at.

Kimberly A. Watkins - Morgan Stanley, Research Division

Okay, so maybe we're a couple of quarters out from that product line ramping, is that what...

Alan S. Lowe

Right now, I'm constrained with what I can ship.

Kimberly A. Watkins - Morgan Stanley, Research Division

Okay, that's interesting. And then on the contest side, a couple quick ones. One, can you break down that 11% growth in mobile? How much of that was organic and how much was from the acquisitions that you did? And then how much of that mobile piece is legacy versus the 4G piece? How much is focused on the good growth piece of the market? And then I have another one on a different topic.

David W. Heard

Yes. So I don't have the breakdown between the organic piece and the inorganic piece. What I can tell you is most of the investments we've talked about are mined into 4G, the 2G assets and service assurance. I think, overall, you'll find, whether it's Spirent or anybody else out of the network, so that portion of the signaling network is going down. So all of the investments we're now putting in are actually mined to LTE, meaning for LTE, for 3G, big data and LTE. Right now, I think that coverage is roughly 15%, 20% of that whole wireless number. But all the investments that we have now in that space are for 3G, 4G and beyond. So nothing that's really looking back. Part of our portfolio pruning is actually, we looked at things that just weren't going throughout.

Kimberly A. Watkins - Morgan Stanley, Research Division

Okay. But there's a piece of it that's going to be presumably declining as the rest of it?

David W. Heard

Yes. I mean the 2G piece is definitely -- that's what everybody has been experiencing on the service assurance side that's been going down, and that has been mined. The 3G piece is mostly data that's driving that and that is still growing. We forget that still only about 2% of the networks out there or devices are actually enabled for LTE out there. It's eating up about 10% of the network traffic but still very, very small on 4G.

Kimberly A. Watkins - Morgan Stanley, Research Division

Okay. Last question is on PacketPortal. You alluded to this, but more specifically, can you address how PacketPortal fits into an SDN or more virtualized environment, is that compatible or...

David W. Heard

Absolutely. We're starting out with the carrier network. We've got, again, lots of carriers investing their time and money in putting us out in network conditions. So the way PacketPortal works -- it's, again, a smart network application platform. So it's a platform. They put these small devices out at the edge of the network and then they can actually write an application for something that they see going on in the network. So if they would like to check video quality, they can download Wireshark, that's an open source that they can use for free to diagnose video quality. They can write their own application to say, "I want to see that HD content is truly inspected at each level." Or we can write, take one of our application or one of our competitors' applications and put it on the platform. What that open environment allows you to do -- this is SDN, right? This allows you to take feeds from multiple vendors, multiple places in the network, bring all that information together and then plug that into things they're used to. So they have analytics engines and they have customer service engines their folks are trained on. So that becomes that operating system that collects the feeds and then neatly plugs into the customer service systems and network management systems that they're used to dealing with. So when we showed, if you remember the chart, it wasn't just important how many customers we were going through, but who else had certified, for example, our equipment. The network equipment manufacturers working with us. We see them as partners in this, so that when they come in and do a managed service, whether it's an Ericsson or an ALU or a Cisco, well, we're providing them the ability to get network visibility, whether it's a Cisco router, a Juniper router, whoever's equipment is out in the network.

Ian Ing - Lazard Capital Markets LLC, Research Division

Ian Ing, Lazard Capital Markets. Questions for David. First one is, can you talk about more this exposure in small cells versus macro cells. Are you selling more units or more types of equipment? What are the ASPs for equipment versus macro cells?

David W. Heard

So for us, it doesn't matter whether it's the macro cell or a small cell or a femto cell or a Wi-Fi base station, the networks are handing up and down -- believe it or not, they were handing down to Wi-Fi at about 30% off-load to Wi-Fi. And then you found out in places where you get to where the Wi-Fi was horrible, the LTE network's better. So the ability to handle up. Our equipment and services are the same, whether it's a small cell or a macro cell, and that's what's nice for the carrier because they're going to have a blend of those. So just to give you an example, for that dynamic -- and in small cells, it's just starting. I mean these are just now rolling out. This is something that's happened yet. The product we bought from GenComm actually measures the effectiveness of the RF pattern on the base station to make sure there's great coverage there. The Dyaptive company that we bought and that's now our capacity test platform can test how much load it can take of different applications in different traffic out there in the network and, ultimately, we want to pass that information back to the field guy to give them that information on the GenComm box. Our ability then -- fiber is going all the way out to those locations now, and so we sell our fiber products to test, inspect and connect, because fiber is going, again, all the way out to the base station and up the antenna. And then to connect all of that, I talked about Ethernet. It's all about, for us, the instruments, when they're actually provisioning Ethernet, and then having probes that are out in the field to provision, and then continue to assure the Ethernet services to connect. So there's no different price limit. It's how many things are connected to the network and supplying the service provider and the network equipment manufacturer with the cloud-based instruments, the probes and then the software that tie it together. And then that is an assurance platform for them together. Does that answer your question?

Ian Ing - Lazard Capital Markets LLC, Research Division

And then second question, I think you're sort of alluding to this but it sounds like there's more talk of service providers doing Wi-Fi off-load, even Cisco last night was talking extensively about that. Is that a negative for you? Or do you have a play there also?

David W. Heard

No. I mean, it's a positive. If you think about -- for us, not only do we have to handle the RF network but it ultimately has to hit a piece of fiber, it has to hit the metro network, it has to hit a transport network. So for us, and even in the home, it ultimately can hit the home network and we have a leadership position in there and taking the traffic from the home back into the network, the probes along the way to tell where the problem is.

Ian Ing - Lazard Capital Markets LLC, Research Division

Great. And then last question, StrataSync, it sounds like this is some sort of cloud-based solution to help stored-network analytics. It sounds like you have some sort of data center hosting requirements also. So where are you in those investments? Are those sort of in the midst of it right now or those behind you and you can get leverage going forward?

David W. Heard

Great question. First part of that is some of the service providers want to have that in their own walled garden. So they put that in their own data center. We have a third-party partner we use for that; we're not building out. We're not spending lots of capital on data centers in what we do. I think when you talk direct, the overall CapEx that we put out as a group, we are a lot about software development moving into the future. So our CapEx tends to be 1.5%, 1.6% of revenue.

Ian Ing - Lazard Capital Markets LLC, Research Division

So that's where the hosting, basically, is what you're saying.

David W. Heard

Correct.

Unknown Analyst

A couple of questions. First, on the ROADM line card business, it seems like you're pretty optimistic about it. Is it related to the overall market starting to see some take off at 100-gig flex grade ROADM as part of the fundamental design of long-haul systems, while a 10-gig long-haul didn't have as much ROADM? Or is it in a flat market share gain? Because this market really has 2 suppliers at the WSS ROADM level? And I'm just wondering how much of that is market versus your share gain? And then in the Datacom side, of the 2 vendors the NIMs you talked about, 1 of them has traditionally had a preferred vendor strategy for Datacom and has bought only from the preferred vendors. Has that process changed or have you penetrated that preferred vendor strata?

Alan S. Lowe

I'll just say the process hasn't changed. Back from the ROADM question. I'd say that those 18 line cards, some are MEMS-based ROADMs. So those aren't dying. There's some L-Band ROADM line cards being produced. There's some TrueFlex line cards being produced. And so what I'd say is the service providers are thinking that today's networks are 100 gig and they want to make sure that as they go forward with 400 gig or whatever comes next, 200 or 400 or a terabit, that that investment they're making today is going to be worthwhile in the future, as well as that architecture itself going to colorless and directionless and some colorless, directionless and contentionless. And so that's what we designed TrueFlex around, is to focus on enabling those kind of architectures in the future, whether it be 100 gig, 400 gig or terabit. And that's what's got me excited and why I think we're going to gain dramatic share on ROADM as we roll out these next-generation of TrueFlex ROADMs.

Unknown Analyst

So it sounds like the architectural shift drives an increased consumption of ROADMs in general? Not necessarily a share shift, which is driving your optimism?

Alan S. Lowe

Well, I think they generate incremental ROADM sales for me. And that's a result of us having a twin architecture that's really fundamentally designed for the future. If they were to go to another ROADM supplier today, they'd have to put 2 ROADMs on a card and that will take up the entire card. And so the architecture that we put together, I think, is really gaining traction with the service providers and the NIMs.

Unknown Analyst

And Tom, maybe a question for you. when you think about consolidation in this industry, for the first time, I think, through cycles we've seen optical com remained profitable through a down cycle, typically, we would see losses during a down cycle as a couple of vendors of consolidated share grown to a certain size. How do you think about consolidation from this point on in this industry? Your M&A has traditionally focused on test and not on optical com. Does that change as, finally, there are fewer players, does it make more sense?

Thomas H. Waechter

Do you mean JDSU as the consolidator?

Unknown Analyst

Or somebody else, I mean, is the fundamental industry structure changing to a better structure at this point?

Thomas H. Waechter

I think there are still changes going on in our customer base on the optical component side with the NIMs. I think they're going through some restructuring and some changes. I think from our competitors' standpoint, obviously, we have 1 competitor out there that's in difficulty. And that the merger that they put together is not working as planned. So we're watching how that plays out but if you're asking are we in a position to go out and acquire in the space, really pleased with what Alan and his team are doing. I think we're looking forward and I would not want to get bogged down into a bunch of restructuring and putting out a lot of cash to clean something up. So I would prefer to stay on the path we're on, which I think is a really strong path. We've proven our expertise and listening to the customer and providing some advanced technology that others don't have. I think that's the true path to go down and that's really our strategy today.

Troy D. Jensen - Piper Jaffray Companies, Research Division

Troy Jensen from Piper Jaffray. Alan, of the 18 customers have for the line cards, is that consolidated into just a handful of equipment companies? Or maybe stated differently, how many line card opportunities are there with the larger OEMs?

Alan S. Lowe

It's not 18 customers. It's 18 line card designs for a handful of customers.

Troy D. Jensen - Piper Jaffray Companies, Research Division

So what is, if you think about the larger ROADM suppliers, how many line card opportunities are there are at somewhere like a Cisco or SCN [ph]? Like one for every port count, right? 1x2, 1x4, 1x9?

Alan S. Lowe

Yes and no. I mean I think we have established a pretty reliable, good set of products at 1x2, 1x4, 1x9. And so the metro side of the network is not driving for a TrueFlex solution today. And so those are pretty established and those are going to be around for a while. And in fact, we have some MEMS-based low core count because the cost is what's important at the edge of the network. More so than having 400 gig run over an edge of a network. So I think today, those are more a TrueFlex twin or L-Band MEMS. So it's hard to say. I think what's important is that our customers are coming to us and saying, "What do you think about this? Can we do something to differentiate this from somebody else?" And that's kind of what's interesting. But it's the core customers that we have had in the past and we're engaged with a couple others.

Troy D. Jensen - Piper Jaffray Companies, Research Division

And now for David, did you guys say on the earnings call that you had 11 PacketPortal customers and you're saying 14 now?

David W. Heard

Correct.

Troy D. Jensen - Piper Jaffray Companies, Research Division

Perfect. And if you back a year ago, you said you had 6 trials, How many of those 6 trials are in the 14? What is the conversion there?

David W. Heard

Thanks for reminding me. So, again, last year 6 went to 36. The way these things work again, they roll out in the field. The conversion rate has been about 60% to 70%.

Unknown Analyst

So David, I want to ask you a bit about -- you've talked about your CommTest revenue. Did I hear right, you're expecting the mix to shift from 40% to 60%?

David W. Heard

Correct.

Unknown Analyst

That's great. Over what time period are you thinking?

David W. Heard

Two years.

Unknown Analyst

Three years?

David W. Heard

Two years.

Unknown Analyst

Two years. And then, I mean, is that, obviously, because the traffic is cutting over or is there a -- is it a small cell piece? Is there different content, better content, 4G versus 3G? Like kind of...

David W. Heard

Yes, yes and yes.

Unknown Analyst

In that order?

David W. Heard

So far. I think there's a big piece of this that is driven from the small cell initiative of getting both coverage and capacity, because that's what's that about out there. There's a huge piece that's driven by the fact that now it's mobile data. And the mobile data is 60% video. And back to that, the trickiness of Ethernet and making sure that you have no delay in the network, it's an entirely different field for a mobile operator. First mobile operators said, in the first analog rollouts and they were laying out cell sites seriously by circling a shopping mall and saying, "There's money there, there's a golf course, there's money there." It's a very different environment. Data is, when you look at the rates, it's what's paying the bills. When you look at your bill, it's what you're paying for the mobile networks. So that is one of the largest drivers that we see around that mobility number. And then the need to manage all those endpoints via software, it's huge. And you can't get out. If we showed you some laid out the first cell sites, they were the size of this stage and now -- and by the way, we're $1.3 million. And now you're talking about these small cells that can fit in 2 hands. What we get to see from Alan is that miniaturization technology you showed on the fingernail. That's helping us get out closer and closer to the edge to enable all of these devices. So it's very much small cell and then the data and content that goes across it and the need to tie the visibility in.

Unknown Analyst

Kind of. And somewhat related is, what do you think on the wireline side? Like is the wireline falling off or is the wireline flat? Is that how you get there?

David W. Heard

Well the wireline is wireless. So for us, that Ethernet piece is carrying, that's connecting all the wireless traffic. We are seeing, as I've mentioned in the transport, is 100-gig. We have a leadership position in, very, very strong. People are skipping 40-gig sometimes as it relates in the transport networks. You're just going to see 40-gig pushed to the metro. It's going to be amazing what the speeds you're going to want to have to the edge of the network. We even talked about PacketPortal first starting out on 1 gig at the edge of the network, because that's where the cost is. But we've had a lot of discussions and demand from our customers about ultimately moving to even higher speeds there, especially when you get to the data center and enterprise.

Unknown Analyst

And just help me if this is right, but it sounds like, I would wonder, cutting over from 2G, 3G or 4G, if there's better content because it's a different air interface or is it more so just because it's more data cutting over?

David W. Heard

Well, So again 1 protocol interaction -- you have to deal with the legacy because it's still there. So that's where our experience in test of measurement has helped us out as we know how protocols interact. And we do that in the lab, we do it in the field, and then we get the 2 to talk. The need for real-time and, well, I showed that in PacketInsight, to get data out to them quick. That's been the big change. Because you cache data now in a traditional call record, put it in a big vault, a big, big data center in its house, it's taking them 3 or 4 days to go find out what -- call up all the records, put them together and say what's happened? So our whole focus is get it out there quick. Yes, the air interface has changed but it's what's -- and by the way, the frequencies and what they interfere with. LTE actually interferes at certain frequency levels with your cable plant. Now we lead in the cable plant set and now we have RF test and capacity test. So we're seeing all kinds of dynamics between the service providers and how these technologies have to interplay, which is, again, in that network and service NIM.

Unknown Executive

We have time for maybe one more question before the break.

Unknown Analyst

I just want to touch on gesture recognition one more time. So, Alan, are you talking about your expectations for gesture rec as you would evolve into these applications, 10x? Was that a comment just about the size of the installed base? Or was that a comment about your expectations, specifically, about your gesture recognition business, it could perhaps be 10x bigger for each of these applications?

David W. Heard

I think it's the annual number of units sold in those different markets, right. So 250 million TVs, 250 million, 350 million computers or vice versa, something along those lines. And the penetration of gesture recognition into that volume base is going to be dependent upon how successful the first one is, where the applications that make people want to not lose their remote control in their cushion because you have to have more than just a remote control to make it interesting for people. And how fast those applications will be driven out to the family room, on the home entertainment side. And then on the computer side, I think that's going to also be dependent on how fast the penetration of applications that make you want to have gesture recognition on your computer. But if we can do it at the cost that makes it look like a USB port, it's going to be a lot of them out there.

Unknown Analyst

Just a quick follow-up. How are you on the gross margin profile on gesture recognition? Is it closer to optical communications? Or is it a commercial laser kind of margin? I don't know if you answered that before. Could you provide some perspective on that.

David W. Heard

Yes. I haven't mentioned it before but I'd say that it contributes positively to our overall gross margin today. And it's -- from the standpoint of the gross margin of the product itself it's okay, but it lowers the cost of everything else that goes through that fab, because it generates so much demand for wafer capacity and it's the same fab that I do my Tunable XFP, Tunable SFP, next generation 100-gig product, all my [indiscernible] pumps. So by driving more volume through a fixed cost wafer fab, it lowers the cost of all those other products.

Unknown Analyst

[indiscernible]

David W. Heard

Yes.

Cherryl Valenzuela

Okay, let's go to break. [indiscernible]

[break]

Cherryl Valenzuela

All right, everyone. We're going to get restarted. All right, thanks, everyone. I'd like to welcome Luke Scrivanich, who heads up our OSP business.

Luke M. Scrivanich

Good afternoon, everybody. My name is Luke Scrivanich. I'm the General Manager of JDSU's Optical Security and Performance products business. And I'm going to share with you some insights on the intriguing world of anti-counterfeiting and speak to why I believe cash is king and will remain so even in a digital age. And then as central banks and issuing authorities endeavor to stay ahead of the counterfeiters, how that creates growth opportunities for OSP with the adoption of new security features and with new wins on currency redesigns. And so OSP intends to give David and Alan a run for the money. And so OSP's value proposition, our sources of competitive advantage really start with participation in strong markets. These are sustainable markets, large markets, and they have opportunities for growth. We are able to differentiate our product platforms through technology leadership in these markets. We enjoy a privileged position with our customers. They typically call us first to help them in solving compelling problems. We make investments in capacity and capabilities to support our customers, and also drive operational excellence. And all of these factors combine to enable OSP to deliver very strong financial performance. In FY '12, the OSP business was $206 million in revenue with a 35% operating margin, which was in our model. About 2/3 of the business consists of the anti-counterfeiting sector, where we enjoy a #1 market position with anti-counterfeiting pigment. Our materials are deployed in over 105 countries around the world. In anti-counterfeiting, we're primarily speaking about currency authentication and national IDs such as passports and drivers licenses. Now I'm going to focus my presentation on anti-counterfeiting, but I could say that I'm also very proud of the optical filters and thin film optical coatings that we deliver to enhance the performance of our customers' products and some diverse applications from aerospace and defense to 3D cinema to advanced consumer electronics, including gesture recognition.

And so why do people continue to use paper money in a digital age? Approximately 85% of transactions that take place globally are done with cash. This translates to 5 billion to 6 billion cash transactions per day. This requires 375 billion banknotes in circulation, and the average life of a banknote's about 2.5 years. So the banknotes that we need to print, 150 billion banknotes each year. And so why is cash continually used? One, there's trust. Cash is backed by governments around the world. It's secure, particularly with advanced anti-counterfeiting features. It's private. No personal, no banking information is exchanged in a cash transaction. Cash is widely used and accepted and used exclusively by people who are unbanked or have limited banking services. Now you may think that is a phenomena in developing countries. But even in the U.S., the FDIC estimates that 25% of U.S. households either have limited or no access to banking services. They use cash almost exclusively. Cash is also used as a store of value, particularly in low inflationary times where the opportunity costs of carrying cash are low. 2/3 of U.S. $100 bills are actually circulated outside of this country and are primarily used for this purpose. Cash is also fast and convenient to use, and people tend to like to use cash when they manage their week-to-week budgets. So let's talk about security, how governments secure their cash. And this is an example of optically variable ink delivered by our strategic partner, SICPA, that integrates JDSU's optically variable pigment technology. There's 3 key elements for an anti-counterfeiting feature. One, it has to be simple to understand, easy to authenticate. In the case of color shift, that is a level 1 over feature. It needs to be validated within a matter of seconds without the use of tools. Two, the feature needs to be difficult to counterfeit, difficult to simulate. With color shift, even with sophisticated color-copying equipment, counterfeiter cannot copy a color shift. And third, the feature needs to be practical to implement with exclusive supply chains and proven technology used by global security printers on an industrial scale. And so here's an example of a next-generation ink. This is called SPARK, which is also sold by our partner, SICPA. It incorporates JDSU's optically variable magnetic pigment, which is oriented with magnets before the ink is cured. It creates variable color and brightness. And so as you can see, it's very dynamic and highly overt. This is a great security feature.

And so what's driving growth in the anti-counterfeiting market? First is baseline growth. Banknote demand tends to increase by 4% to 5% per year. This is a bigger need for increase in the money supply. And with the growing installed base of ATMs, which have increased the fitness standards for notes to be put back in the circulation, that's single-digit growth. But what could drive this business in a double-digit growth are these next 3 factors. The currency redesign cycles for major countries like the U.S., Europe, China and India. The accelerating adoption of the SPARK technology, the ink I showed on the previous video. What's interesting about SPARK, it tends to have a larger footprint. So JDSU has more content and value per note. It opens up some more countries for this feature and more denominations. Then finally, in thread, this is a business user's windowed security threads, which are embedded in the banknote. This is an area, a market sector that's growing about 15% per year. And JDSU has some new products being introduced, and we have a nice play in this growth opportunity that complements our pigments. And so our materials are deployed in over 105 countries around the world or nearly 400 denominations. It is estimated that approximately 3 billion people touch our product every day, and there's not many companies who can stand up here and make a claim like that. OVI was introduced in the late 1980s. But now, we've reached the tipping point where we're starting to see rapid adoption of the SPARK technology, which is on all those countries in green and red. And so last Analyst Day, a year ago, 17 countries had either adopted or announced that they were going to be deploying the SPARK technology. Today, it's 38 countries and growing, more than double. One of the more recent high-profile announcements was the European Central Bank announcing their new EUR 5 note. Now this is interesting for 3 reasons. One is, as you know, the euro is a global bellwether. The EUR 5 note is the first in the second-series euro that's being introduced. Third, it's the lowest value note in the series, and it has adopted the latest generation technology. And what's relevant about that is that today, the euro only uses OVI on a EUR 50 note and higher. This is expanding the SAM for our business. And this is why we're so bullish about the growth prospects of anti-counterfeiting, particularly in currency authentication. Here's another great example of an expanding market in South Africa. OVI was previously deployed on the 3 highest denominations. With the new South African series, SPARK has moved to those 3 highest denoms, and OVI has now migrated to the 2 lower denoms, the 10 and 20 rand notes. Once again, the overall market, the SAM is expanding. And finally, in the area of new products, as I mentioned, we're in the process of introducing 2 new products. These are thread substrates that are embedded into banknotes. And this enables us to really leverage our technology and channel access in the currency authentication business and diversify our portfolio beyond pigment, but in a way that complements our pigment offerings. This is a very complex supply chain in which we play in. So there are significant barriers to entry for non-incumbents, and it expands our SAM by about $100 million. And so OSP's target operating model, business models -- when our quarterly revenues are greater than $52 million, we deliver operating margin of 34% to 37%. We're able to maintain such high margins because we have high barriers to entry. We have strong intellectual property, scale economies, excellent customer relationships and long-term contracts with our customers. We're locked in. But we're not resting our laurels. We're focusing on strengthening our business model by accelerating top-line growth. We're reinvesting in the core business, as you heard from Tom Waechter earlier. We doubled our capacity in China to support our customer in China. And we're investing in new capabilities and state-of-the-art technology, introducing new products such as OVMP, utilizing SICPA's SPARK ink and those thread products that I mentioned earlier. In addition, we're actively managing our portfolio, pruning the low-growth, nonstrategic products such as the holography business that we divested in late 2012. And so as you can see, I'm very excited about the OSP business, and I hope you appreciate learning a few more details about the intriguing world of anti-counterfeiting, and how OSP is a relevant part of JDSU, and how we're driving value for the company and its shareholders, and how we're giving David and Alan a run for the money. So speaking of money, I would next like to introduce our Chief Financial Officer, Rex Jackson.

Rex S. Jackson

Thank you, Luke. Good afternoon, everyone. So Luke and I are the 2, the new old guys. We're the old new guys. Not sure which. In the company, Luke stepped into OSP. I guess it was the middle of last year, right?

Luke M. Scrivanich

[indiscernible]

Rex S. Jackson

Yes. But previously, I've been with the unit for quite some time. Therefore, I came into this position with a lot of momentum. I joined the company, let's see, January of 2011 to take over IT, Corporate Marketing, Legal and Corporate Development. And then is now a fair question you might ask yourselves is, "What on earth is a lawyer doing trying to run IT and Corporate Marketing?" But most of my career has been spent trying to take on the things that are really hard and, in some cases, things that other people might not want to do. And therefore, they're fairly challenged and then just banging hard until you successfully break through with them. So we've made huge progress across those 4 organizations over the last 2 years. And so I was delighted when Tom and that the board offered me the opportunity to work with the finance organization directly and to apply my 4-plus years of public company CFO experience, and to bring the finance and the IT organizations under one roof. So we've got a lot of initiatives that we've started over the last 2 to 4 months. We've got a game plan and we're focusing on corporate and shared services above from an efficiency standpoint, and from the standpoint of trying to drive down the expenses as a percentage of revenue in a way that I think is unusual for the company. So I see a lot of opportunities there and a lot of good things ahead. So as I look forward, I have the benefit of actually being last in today's presentation. So I wanted to see if I could capture what I think are 6 things that would be worthwhile to remember from today. If you'd remember more, that's good, but here's 6 key things that I see. As Tom mentioned earlier, we're -- JDSU is a diverse global business. You have 3 business units, very different business models, different seasonality patterns, different cyclicality, but fortunately, all 3 having a full access to a global footprint. So I think that as we look at companies that we might acquire, for example, many of the times you look at them and go wow, if you just had access to a broad sales channel or if you just had this or you just had that. A lot of our key investments for growth are in place in terms of -- from the sales channel standpoint, from an R&D standpoint, from a fixed versus variable cost standpoint. We've just done a lot of those things across the globe to get ourselves ready for the future. We have, as the GM's mentioned, we have leadership in the markets that we serve. And we are the beneficiaries, we think, of strong drivers, and have aligned our businesses accordingly to take advantage of those. The things I'd like to focus on specifically as we close the day are we've got a very solid business performance in recent years at JDSU in the midst of either highly variable conditions, very challenging conditions or both. Through all of that, we've generated strong cash flow and maintained a strong balance sheet. Both of those are weapons for doing good things going forward. We've had very focused R&D. Since we know what the drivers are, we know where to invest. And we very consistently innovated across-the-board in the company in all 3 of the business segments. And then I think between a combination of these things and operational excellence through the company, we've really positioned the company well. So I think I used the term earlier today, but the boat's in great shape, the sales are up. When we catch the wind, we're going to be in really great shape as we hope things improve this year. So if you look forward from a solid performance standpoint, graph to the left. Obviously, FY '11 was a banner year. But if you take a curve through or you take a trend line through both the graph to the left and the graph to the right, what you see is a lot of good improvement over the last several years from a revenue growth standpoint, also from a gross margin and operating margin standpoint. And as you can see here, for the first part of FY '13, notwithstanding the fact that we're still grappling with delayed carrier spend and other market conditions, we are on pace thus far in the first half of FY '13 to outpace last year. You'll also see in the right an uptick in terms of our margin performance. So a good performance under tough conditions. I mentioned earlier, strong cash flow. It's one of my favorite things, if we can generate cash that leads to a solid business. As you could see here, we've done very well over the last several years. The first half of FY '13 was a record as far back as we've looked, but we're on pace for an outstanding year with $103 million in cash generated thus far this year. Actually, Q2 is outstanding at $59 million. That's the third best performance we've had since fiscal 2008. Free cash flow was $44 million, and that's the second best that we've had since fiscal 2008. So outstanding cash flow there obviously gives us the ability to do the other things we need to do in the business. So what do we do with the cash? If you look over that same period I just discussed, we've generated $654 million of cash flow from operations. Acquisitions consumed about just under $250 million of that. We've also retired our debt. We've got an additional payment coming up here in May, which we will take care of. But as we sit here today, we have $535 million net cash. We like to keep a balance of around $300 million from a net operating standpoint, which gives us a buffer to apply strategically. And as we've said today, and as I'll reiterate, we are -- we expect to be acquisitive. Obviously, we do so carefully, but that's money that we have aside for that strategic initiative going forward. This is one of my favorite -- I don't like slides generally but I like this slide. This shows how we've been investing in innovation in the company over the last several years. An outstanding path. It's funny, most people think of R&D as an expense. I don't think our company thinks of it that way. We think of it as an investment. And it really is an important thing for us. You can see we've bumped up the percent of revenue that we're willing to invest. And obviously, the aggregate dollars associated with that are invested -- are going up as well. But we're doing it for the right reasons, and very steady flow of new products are coming out in all 3 of the business units. One of the things we love to talk about, Super Transport Blade, tunable XFP. Those came out all the way back in 2009. Other competitors are just now coming out with those as we've moved on to the tunable SFP+. If you look in David's business, we've got True Speed, PacketPortal, PacketInsight. So software, mobility and other new applications and products to drive not only his top line but also margin expansion. And then you see entries for OSP, the OVMP in FY '12 and more recently the SpectraFlair in 2013. So a steady flow of new products is what drives the top line, gives us margin improvement into the thing that sets us up for the future. Another thing I want to make sure that people go away with is we've been working very hard to build operating leverage in the company. And that's everything from programs to reduce scrap, improve yields, work on our supply chain, consolidate our manufacturing. We shift things that need to be shifted to Asia. We've gotten much more aggressive from the shared services in a corporate expense standpoint. We've finally gotten globally onto a single ERP system. And we've been very careful, obviously keeping customers in line as to how we pruned and managed our product portfolio, all with a view towards maximum growth and maximum profitability. That's not going to let up in the near-term. We are going to continue to work to shrink our footprint. There's some opportunities that we have there. CommTest has made great progress in the CM consolidation standpoint over the last year. I think they have another 6 to 9 months to go in terms of being exactly where they want to be theirs. But the lion's share of that project's behind them. And as I said, there are just a series opportunities to streamline or reduce G&A. I hesitate to throw out numbers since the numbers that are stated get remembered, but I do think there's a point or better than G&A that we can take out relative to the total company. So no CFO presentation is complete without hitting on the target models. And so you've seen these before. These are our quarterly target models. We feel, still feel good about them, stand behind them and believe we have paths in hand, good visibility in terms of how we're going to meet these. So those are unchanged. What's the progress? CommTest, what a great performance in Q2. We hit 64.4% gross margin in the second quarter on revenue, well below the model. Solid progression over the last several years. And one thing that I think Q2 have clearly demonstrated is that CommTest can break through that $170 million, $175 million in revenue level. Their structure is a business is such that they can get -- they just -- their fall-throughs to the bottom line is excellent. I think if you extrapolate with CommTest and you used up a very conservative fall-through rate of, say, 60% of its incremental revenue, even if that allows for us, obviously, to -- that's not assuming growth in gross margins. It's not assuming superior mix than the one you have already, unless you take care of your sales, expenses, et cetera. You just extrapolate that, and you can see the CommTest has its target model in its gun sights. OSP has actually been suddenly in their business model most of the last few quarters. We would be -- we look at taking that up. What we would want to see before we took that up would be some consistent growth on the top line as Luke and the team focus everywhere intently on any anti-counterfeiting opportunities. CCOP, Alan covered this thoroughly. It's all about new products. That's the #1 driver of this business not only in terms of increasing the revenue line, but in driving profitability. Also, there's a number of operational initiatives that Alan has underway to deal with everything, as I said earlier, from scrap, yield, suppliers, et cetera. But it's all hands on deck, and Alan's done a great job of managing that. So if you look ahead, what are we going to keep doing? We're going to keep funding in R&D to drive innovation. We've been doing it for years. It works. It's a real cornerstone of the company, and we think that's the way that we grow the company and improve our margins. We're very focused on operational excellence. I wouldn't guess at what the percentage is in terms of what we've achieved and what we have yet to achieve. But I think we've shown through recent experience and recent performance that we know how to do this. And so there are additional gains that we see in front of us. And we do intend to be acquisitive. We'll be smart about it. We want to expand our addressable markets. We're going to find synergies where we can, but you should expect that we will continue to pursue this steadily the future. And with that, thank you for coming, and I'll turn it over to Tom. Thanks.

Thomas H. Waechter

So I'll just wrap up before we go to the final Q&A with a brief focus on our investment thesis. Again, it's all about technology and technology with impact, in what we call collaborative innovation. Hopefully, you had a better sense today of a number of the new areas that we're working on to continually evolve and really leap frog on the technology and the closeness that we have with our customer base as we do that. You heard from most of the executive team today and again, I hope that gives you a little bit more insight onto why I have such a high-confidence level on this team and their ability to put a solid strategy together and then execute on that strategy and drive to our goals. Market leadership in the markets that we play in, we talked about the 2 core markets and the 2 adjacencies. Very solid positions there and compelling market drivers. I think it's really clear that whether you look at the networking part of the business or the anti-counterfeiting, that there are some very strong drivers out there. And I think we've really well-aligned our products and solutions now up with those drivers. So we get the wallet share of our customer, a larger share of their wallet going forward as they spend. With that, I'll ask the team to come back up, and we'll go into Q&A.

Unknown Analyst

I had a question for Luke. Luke, on OSP, if I look at the trends since '09, the business has been relatively flat. Counterfeiting is $220 million to $230 million range even if I adjust for the holographic divestiture. Can you help us understand again what are the growth drivers going forward? And as you talked about SPARK and the opportunities with Freddie, I think, what's the incremental opportunity per, I don't know, per note for you with these next-generation innovations?

Luke M. Scrivanich

I'm not going to speak to what the price is per note. That's usually confidential information. But in terms of growth, if you look at the growth of the OSP business, overall, it has been flat over the last 3 years. The anti-counterfeiting business has grown. It's that we've seen a decline in the other markets. So they're not growing as fast, but we do believe there's good growth opportunities. We've got a strong pipeline. But that's the area where we're really focused and are trying to accelerate growth. But anticounterfeiting has been a nice growth area for us, but we're really poised now with the addition of the new capacity in Beijing to really start serving some of these big growth opportunities as SPARK gets adopted by major countries such as in Europe, as a great example, in Russia. Brazil is another country that recently adopted SPARK. So when SPARK goes to these major large countries that have large volumes of circulating notes, that's what's going to start driving the anti-counterfeiting business. And then once we get the thread products introduced into the marketplace, there's also tremendous growth opportunity there. So in the last few years, the growth hasn't been that significant, but we're poised for a much higher growth rate moving forward.

Unknown Analyst

And just a quick follow-up. As you look at the time for the other markets, the $3 billion, are there like 1 or 2 interesting opportunities there that you could talk about? Like what drives growth from that segment, the LT 9%?

Luke M. Scrivanich

Yes. What's primarily driving growth in the other markets are opportunities in the consumer electronics field. For example, we are collaborating with CCOP in the gesture recognition business. And so those are big opportunities, and there's opportunities for OSP to place its thin-film optical coatings and optical filters in those consumer electronics applications.

Unknown Analyst

I guess my first question is for Rex. Just on G&A, I want to clarify your point that you thought you could take a point out. Is that like you literally think you could just take, kind of in absolute terms, take G&A down a point? Or are you talking about, on a percentage basis, it'll be less than 10s? So I wanted to clarify that comment first.

Rex S. Jackson

I think we could get a point outside on operating income through G&A improvements.

Unknown Analyst

Okay, that's helpful. And another question for Luke, again related to the currency. I guess I'm just curious, how big can one currency get? I'm just trying to get a sense for how much you could see -- is the euro 3% of the counterfeiting business? Is there -- what's the biggest currency in terms of concentration? I know it's very diversified. It's 105. So on average, it's below 1% per -- but I figured if Europe is a pretty big region, U.S. is a big region. I guess I don't know if there's anything you can all or you could say on the $100 bill. It's just been kind of a ridiculous snafu and not your fault, but just like are we ever going to see business from that?

Luke M. Scrivanich

Well, let me first speak to the regions. You missed 2 major regions. They're cash economies and that's China, which probably represents nearly 20% of the banknotes printed per year globally, and India, with the Indian rupee. That's also a very large region that prints a lot of money. So -- and those are 2 regions in which we have optically variable pigment deployed. In terms of the U.S. $100 banknote, the U.S. Bureau of Engraving and Printing is printing those new notes, and we are participating as they're building a stockpile in anticipation of an eventual circulation of that note. There's no announcement that have been made by the U.S. government. We don't have any information as to when they're going to start circulating, but they are printing those new $100 banknotes, and we are benefiting from that.

Unknown Analyst

Just a follow-up, would you care to venture if any one country where is -- or currency is what the sort of maxed range could be, I mean could it be -- could you have a 5% currency impact in the quarter? Is that possible?

Luke M. Scrivanich

I'm sorry, I didn't really understand.

Unknown Analyst

Could 5% of your business in currency be from one country or one currency?

Luke M. Scrivanich

Yes, it could be. As I mentioned, the 2 big cash economies, China and India, would represent more than 5%.

Unknown Analyst

I guess, Rex, your CCOP gross margin target, 33% to 36%, slight shift from your prior 35% and above. Just want to see what's driving that. Is it mix shift or pricing or cost, et cetera? And then your assumptions on needing improved laser content and op efficiencies, maybe talk about that a little more, too.

Rex S. Jackson

Okay. Let me take the first part of the question. I believe, historically, we've bracketed the gross margin for CCOP at the 33% to 36%. So I don't think of that as a change. So I think in some materials, it's been pegged to 35%, and I don't know where that comes from, but the range has historically been 33% to 36%. And the second part of your question?

Unknown Analyst

Your assumptions on gross margins need improved laser content and op efficiencies. Are those reasonable assumptions looking forward? Or just what sort of range of assumptions do you have on laser content going forward?

Rex S. Jackson

Well, I think in terms of the model, we've always talked about getting lasers up to 20% of the revenue of the unit. That would be the main drivers, just getting the -- you're getting the mix up. In terms of the operational efficiencies, trying to put a number on that. I think I should defer it to Alan on that.

Alan S. Lowe

Yes. I mean, the laser's margin profile was 45% plus or minus a little bit. And as we get to 20% of CCOP at the model, so it's $42 million at 45% plus the balance in Optical Comms in the low 30s. That gets you to the 33% to 35% or 33% to 36% margin. That's how we kind of came up with that 16% to 20% overall operating margin income.

Unknown Analyst

Okay, great. And then last question, this use of net cash for potential acquisition. It sounds like in CCOP, you don't want to roll in consolidating net industry. So is it safe to assume it's more CommTest where you'd be focused for potential acquisitions?

Thomas H. Waechter

Yes. I mean, we typically look across all the 3 businesses, but I think it's fair to say that we still see CommTest as a very large market. It's pretty fragmented still, and there's quite a few opportunities in the wireless space that we think about major spending shift over to the wireless space. So I think it's fair to say that's our major focus, but we don't -- it doesn't preclude us from looking at other areas. But what I did say earlier is we're not looking to consolidate the Optical components space.

Unknown Analyst

Tom, given your mix of businesses and the growth rates you've attributed to the different segments, what is a kind of an overall growth rate for JDSU? What kind of ranges on an average here is what you think of? And then in terms of the overall allocation, when you add that back in and look at operating margin for the different segments with the overhead back end, is it disproportionately higher in some segments versus the others if we added it back in? Would some -- would it change the margin profile more for some than others or would it be fair to even across?

Thomas H. Waechter

Yes. I think -- I'll get the second part of the question first. The CommTest business has -- tends to have more locations, more sites. It has a bigger sales force because we're covering, I think 4,000 customers whereas in something like Optical Comm, we have a much more concentrated base. So that would typically have more overhead. The general overhead applied to it based on those factors.

Unknown Analyst

With that overhead applied, would those margins be similar for -- would it bridge the gap between the way you look at Optical CCOP margins and CommTest margins? Would it be enough to bridge that difference?

David W. Heard

So the -- let me see if I understand your question. You're talking about the 5% and 6% that's unallocated?

Unknown Analyst

15% to 20% versus the 23% to 26%, where it almost end up if you added back overhead end?

David W. Heard

But you're talking about the 5% and 6% that sits at the bottom?

Unknown Analyst

Yes.

David W. Heard

Yes. So that would have, if we fully allocated that back end, you would have almost no impact on gross margin, if any. So it's purely below the line allocation and at the bottom. And then what we currently do is, I mean, what I assume you currently do is do it based on revenue. I wouldn't steer you to making a heavier allocation one way versus the other.

Luke M. Scrivanich

Sorry, I don't think I was clear. I guess my point was, if I took the actual numbers associated in that overhead number and added it back into the expense structure for CommTest and did the same for Optical, would the operating margin gap between the 2 close? Is there more going into CommTest as a part of the overall overhead? I think Tom was suggesting there is a higher number. I'm just remembering.

Thomas H. Waechter

I was talking about the overhead that's already allocated. I wasn't talking about the 4% or 5%.

Unknown Executive

So those are pieces done on revenue. The answer's no.

Rex S. Jackson

And then I think the first part of your question, what would be the overall typical growth rate for the company? I would say it's somewhere between 6% and 10% to 12% in a kind of a normal environment. Again, we're believing that we're moving into an environment where some of the spend rates are going to pick up, and we're very nicely aligned for that spending.

Unknown Analyst

And question for you, Rex. I guess one is, can you give us an update? I believe you have about $9 billion in NOLs. When did those start to expire in any form that matters? And then secondly, on your acquisition strategy, you talked about having $300 million for operations. I don't believe that was a net cash number. That was just $300 million in cash. And so if I interpret that, are you willing to lever up the company in order to acquire? Is there a certain threshold or level that we should see as too big for you to target? It seems like there are certain assets in the CommTest market that could be quite sizable that would be an asset to GDC or really even in Commercial Lasers. So I'm just trying to get a sense of to-date, you've done a relatively smaller tuck-in, IP-ish types of acquisitions. Give us a sense of size, how big is GDC willing to go, okay?

Rex S. Jackson

So there's 3 issues there on the NOLs. We have into that high single-digit billions in NOLs. Those roll off to a degree every year. So they're aging as we speak. But in terms of big numbers rolling off, that's several years in the future. That's not an immediate concern. As far as the cash question that you asked, the $300 million is a net available. That's just the number that we feel is the appropriate number to keep available for operating the company. In terms of what leverage we would be willing to incur, I think if you look at -- if you go talk to people in the capital markets, there are ratios you can go to, and there's several -- there are breakpoints listed it out there in terms of debt to EBITDA or other types of multiple ratios that you'd want to look at. I think we would want to be prudent. I think we're willed to be aggressive, where it's appropriate for an acquisition that's accretive and strategic, but we would want to stay at a prudent range from a debt perspective. So I think we have a meaningful borrowing capacity if we have reasonable -- reason to go do that. And we could do a sizable transaction if that's what was the right thing to do.

Kevin J. Dennean - Citigroup Inc, Research Division

Kevin Dennean from Citi. A question for Alan. Alan, can you walk us through or remind us again the path of your customers moving towards VMI, how that might've impacted you in the last couple of quarters? What some of the trigger points for customers moving to VMI are? Is it where enough suppliers come in and can offer a similar card? Or is it where they feel your capacity, that equipment can move you to VMI? And last part of this question is, what's your visibility going forward into customers moving additional SKUs to VMI or additional customers moving to VMI?

Alan S. Lowe

Yes. So the trigger is normally around a trade-off between their requirements for us to negotiate pricing versus share. And it's just another lever for us to be able to manipulate to gain more share of the business. So it's a negotiation. And at the end of the day, our largest customers are pretty much all on VMI. I think it's a healthy place for us to be because we have better visibility to their actual pull-through of product, and we don't get surprised. So I would say that we could see more SKUs in the existing customers going to VMI as we put more 100 gig and some other products on the VMI. But it won't take the big step function that we took in the December quarter, where we had a big chunk of a large customer go to VMI. I think we could see 50-plus percent of our revenue in a given quarter come out of VMI as we look forward. And could that get to 60%? It probably could get to 60% as more and more SKUs go to VMI and as we gain more share within those large customers.

Kevin J. Dennean - Citigroup Inc, Research Division

That's helpful. And is there a way that you can help us think about when a customer moves to VMI, how long that impact lasts? Because I would imagine that kind of dampens the revenue growth with that customer? Is it a 1-month transition, a quarter-long, multiple quarters?

Alan S. Lowe

Well, it's something that, as we learn with each customer, more and more SKUs go in over a period of time. So for instance, this last one, it impacted us in bookings in September. It impacted us in revenue in December, and I think it's pretty much over. So it's a 2-quarter thing. One is really a bookings quarter, one is a revenue quarter. And then you have a steady state where you book and ship on the same time, but you've already taken those hits in prior quarters.

David W. Heard

If there's no question or a little pause, I do want to clarify something that I said, and it was brought up in one of the breaks before, which was our business model, to get from $186 million to $210 million, I might have made the implication that I thought that it was going to be a flat year, and that's not nearly the case. I think this year's going to be an up year. First thing, the tunable SFP+ for other products. So I think the overall demand of Optical Comms' product is going up. I was trying to illustrate that if it doesn't go up, our incremental products in new product introduction and optical gesture recognition, lasers and data comp will get us to the model. If I think what happens, happens, meaning if the market grows at 10% or so, we'll get to that model even faster. I just wanted to clarify if I wasn't clear in my prior answer.

Unknown Analyst

Tom, can you just weigh in on the acquisition question, too? Are you contemplating a large acquisition? Is that in the works, and into the question of having capacity to lever doesn't necessarily mean it's part of the strategy? So could you just talk to that...

Thomas H. Waechter

Yes. I wouldn't be able to comment on anything that might be in the works. But I think in general, we do look at various sized acquisitions. And again, in the CommTest space, there are a variety of players that would be accretive to our business model and to fit nicely into our strategy. So they do come in various sizes and shapes, and we are in a process and have been evaluating different sized acquisitions so...

Unknown Analyst

You wouldn't be adverse to a large acquisition if it was the right ?

Thomas H. Waechter

Would not be if it's the right one because if we can fit it into our capital structure, I think as Rex said, we would tend to be more on the conservative side. We wouldn't want to encroach on some of those metrics that put us over the edge on what we actually could borrow. But I think we have a -- the borrowing power to do something of a reasonable size.

Unknown Analyst

And then I just wanted to go back to something that was brought up on the call. It hasn't really been discussed today, but the book-to-bill was below 1 in the Optical Comms business. And the rationale that was given was something around pricing discussions. But last year, I think it was above 1 going into the same quarter. So what happened this year that was different? Because now we're looking at the year where pricing is a little bit more rational, but it seems like it slowed the orders?

Thomas H. Waechter

Yes. So 2 things happened. One is there was no flood in Thailand this quarter. And if you remember in the December quarter of 2011, our revenue was depressed as a result of not being able to ship products. Bookings came because people were trying to assure -- assurance of supply. So that was different. I do think, had everything been in normal course, it would have probably been a -- people wouldn't have placed orders in the December quarter of '11 like they did, and we would've had higher revenue. So would it have been below 1? I don't know. I think that a lot of other competitors were hurt longer than us, and we got some share as a result of that during that booking quarter. So I think what we saw in the December quarter of '12 was more typical where customers start negotiating in October. They don't place orders until things are settled. And I think as we said in the conference call, bookings in January up until the conference call were much better than they were in October. And I think that's kind of resulted in settling the negotiation, giving it back to a normal course of business.

Unknown Analyst

I just wanted a follow-on in the acquisition question. Before people start getting nervous, oh my God, they're going to do a big acquisition and absorb a lot of dilution. Can you give us some sense of how much dilution you might be willing to absorb, and over what timeframe so that we can mitigate the concerns that people might have around that?

Thomas H. Waechter

You're talking about dilution? You're talking to the...

Unknown Analyst

If you were to do an acquisition.

Thomas H. Waechter

Well, I think we've got a good track record of being accretive with our acquisitions. So I think the question would be, if we did a larger acquisition, would that be accretive to the business model? And with the debt we brought on, how much would that dilute? It would depend on the cash equity mix. So our goal is to continue to acquire, to do things that are strategic to the company and to make sure that it's accretive to the shareholders.

Unknown Analyst

So you wouldn't do an acquisition that was dilutive in the first half year or first 2 or 3 quarters?

Thomas H. Waechter

I would not say never, but our primary focus would be, "Does it fit well into our strategy? Can it take us to the next level there? And is it accretive to the shareholders?" And I think we have again a good track record of acquiring things that are immediately accretive.

Unknown Analyst

Tom, just on the M&A piece. As you look across the portfolio, I know it's come up in the context of CommTest. Are there other pieces in your portfolio that you do think has opportunity to bulk up? And then David, maybe for you, within CommTest, I think you listed a whole slew of areas, capacity test, drive test, base station test, any sense of where you think there's still opportunity to fortify that segment further?

Thomas H. Waechter

Yes. I think we're going to across our portfolio of products. Places where it'd be attractive to acquire, I think, the laser side of the business where it's a good business model. Having more bulk there could be helpful, help us to accelerate there. So that would be an interesting area to look at. And that's a possibility. And I think on the anti-counterfeiting side, although we have a very strong share on the banknote side, things like pharmaceuticals, other areas, is there a way to expand our anti-counterfeiting portfolio? We'd also look -- yes, that would be an area that would be a place to look at outside of other than CommTest strength.

Luke M. Scrivanich

Yes. And just your to question in CommTest, those areas that you saw on the slide are actually, those are the areas we have. So if you think about things that continue to glue that together around the mobile network and around software enablement. So it's on the mobile side and the network visibility side. Those are 2 target areas for us, as well as things that take advantage of that cloud and enterprise position we've talked about, our leadership position in the data center and enterprise. I wouldn't want to say anything more than that other than, Alex, back to your point, when we think about these deals in Communication Test and we look at our model, I think we've done a lot of the structural work. We still have work to do on the model and our operating effectiveness to be able to bring on these assets effectively. Most things we look at, our net line ultimately accretive to the model that we put forth, especially when you're talking about software. Certainly, we're always looking to revenue recognition and how it impacts what we go do. But there are also strong generators of cash as we go. And as I mentioned earlier, CommTest only does about 1.5%, 1.6% of our revenue on capital equipment, meaning we're not a big CapEx provider. And so we do see consolidation go on software, mobile, data center and enterprise, and they typically are very accretive, ultimately, to the CommTest model and are strong contributors of cash.

Unknown Analyst

[indiscernible] Can you just remind us the hologram business that guys you divested? What did that sell into again?

Unknown Executive

I'm sorry, what...

Unknown Analyst

The hologram business that you guys divested recently, where did that sell into?

Rex S. Jackson

That's sold to a strategic player in the industry called OpSec.

Unknown Analyst

No, no. As far as -- was that like...

Unknown Executive

Oh as product base? Primarily into transaction cards, credit cards, IDs and some valued documents. But the primary business was transaction cards.

Unknown Analyst

Okay. And then, I think it was a year or 2 ago at the Analyst Day, you guys did talk a lot about pharmaceutical counterfeiting. I just didn't hear about this much this time. Is that still a big piece of opportunity here? Is it a big piece of the revenues? Or any update?

David W. Heard

The pharmaceutical brand authentication's a very interesting business, but it's relatively small. It's a business that I think we have to invest in some additional technology capability in order to effectively grow it. So it's not as significant as what we do in currency authentication, and that's the reason we didn't explicitly discuss the pharmaceutical business today.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Kent Schofield, Goldman Sachs. It's probably for Alan. Looking at the lasers business and the growth there, and then relative to some of your excitement around the rest of your business, how do we get to 20% of revenues for the laser side of things? Is there enough growth there to make that happen?

Alan S. Lowe

Well, yes. I mean, I think if you look at our track record of growth over the -- since 2009, we've been growing 22% a year. So that's through fiber laser mostly, but growth in the fundamental business as well. So we have new products in the macro machining that are coming out in the very short term that should help continue that growth rate of 22% or so. And then whether or not we can generate more business in fiber laser, that's really up to Amada in the short-term to get up to incremental $12 million a quarter because we're about $30 million, $31 million today. We need to be at $42 million. So I think both a combination of just market growth, as well as further penetration into the micro machining, is really what would drive us for that incremental $11 million to $12 million a quarter.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Okay. And there was the example that I think Rex gave on the CommTest side, talking about revenue levels in terms of just what can be dropped to the bottom line prior to reaching the sustainable target model that you have here? Is there some levels that we can talk about in the CCOP side to give us some sense of what's happening in that model until we get to that target model as well?

Alan S. Lowe

Yes. I mean, I think if you take Optical Comms, it's safe to assume that incremental revenue in that business flows 45% to 50% to the bottom because there is such a fixed cost in our fabs. But it's a whole lot less than it used to be. If you look at lasers, that's typically 60% to the bottom, incremental revenue.

Thomas H. Waechter

Any other questions? Looks like we might get to the cocktail hour a little bit earlier than planned.

Cherryl Valenzuela

So cocktails will be available at 5. So in the meantime, we can just stay here for the next 10 minutes or so before heading over to the conference room, Victors [ph], for cocktails. Thank you, everyone.

Thomas H. Waechter

Thank you.

Rex S. Jackson

Thanks.

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