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Edited Transcript of VIAV earnings conference call or presentation 2-May-17 8:30pm GMT

Thomson Reuters StreetEvents

Q3 2017 Viavi Solutions Inc Earnings Call

MILPITAS May 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Viavi Solutions Inc earnings conference call or presentation Tuesday, May 2, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amar Maletira

Viavi Solutions Inc. - CFO and EVP

* Bill Ong

Viavi Solutions Inc. - Head of IR

* Oleg Khaykin

Viavi Solutions Inc. - CEO, President and Director

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Conference Call Participants

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* Alexander B. Henderson

Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology

* Dmitry G. Netis

William Blair & Company L.L.C., Research Division - Equity Research Analyst

* James Martin Kisner

Jefferies LLC, Research Division - Equity Analyst

* Meta A. Marshall

Morgan Stanley, Research Division - VP

* Patrick M. Newton

Stifel, Nicolaus & Company, Incorporated, Research Division - VP and Senior Analyst

* Roderick B. Hall

JP Morgan Chase & Co, Research Division - VP and Senior Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Kelly, and I will be your conference operator today. (Operator Instructions) At this time, I would like to welcome everyone to Viavi Solutions Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Thank you.

Mr. Bill Ong, Head of Investor Relations, you may begin your conference.

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Bill Ong, Viavi Solutions Inc. - Head of IR [2]

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Thank you, Kelly. Welcome to Viavi Solutions Third Quarter Fiscal 2017 Earnings Call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call are Oleg Khaykin, President and CEO; and Amar Maletira, CFO.

Please note, this call will include forward-looking statements about the company's financial performance. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations. We encourage you to review our most recent SEC filings, particularly the risk factors describing those filings. The forward-looking statements, including guidance we provide during this call are valid only as of today. Viavi undertakes no obligation to update these statements.

Please also note that unless we state otherwise, all results except revenue, are non-GAAP. We reconcile these non-GAAP results to our preliminary GAAP financials and discuss their usefulness and limitations in today's earnings release. The release, plus our supplementary slides, which includes historical financial tables, are available on the website.

Finally, we are recording today's call and we'll make the recording available by 4:30 p.m. Pacific Time this evening on our website.

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

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [3]

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Thank you, Bill. Fiscal Q3 Viavi revenue of $196 million met the guidance midpoint. OSP revenue exceeded the guidance range due to better-than-expected demand in our anti-counterfeiting business, while NSE revenue was below the guidance range. Viavi revenue declined 11.1% year-over-year as the growth in the OSP business was offset by the decline in NSE.

Viavi's operating income at $23.4 million declined 10.7% year-over-year. Operating margin of 11.9% was near the guidance midpoint and flat from the prior year, despite lower revenue in fiscal Q3.

Overall, Viavi's operating expenses declined 10.6% year-over-year or $11.7 million, driven by expense reductions across the board. EPS at $0.09 exceeded our guidance range of $0.06 to $0.08. The upside to the high-end of our guidance range of $0.08 was due to some nonoperational benefits.

Now moving to our fiscal third quarter 2017 results by business segment, starting with NSE. NSE revenue at $132.1 million declined 16.6% year-over-year, driven by a 16% decline in the NE segment and an 18.5% decline in the SE segment. NSE gross margin at 64.5% increased 100 basis points year-over-year. This was due to 540 basis points of improvement in SE's gross margin at 61.7%, partially offset by a modest decline of 30 basis points in NE's gross margins at 65.3%. NSE operating expense in the quarter was $89.6 million.

Despite a 10.9% reduction in NSE's operating expenses from a year ago, we still reported a 3.3% operating loss due to the steep decline in NSE revenue.

During the quarter, we executed our previously announced NSE restructuring plan. In Q3, we reduced approximately 6% of our workforce, primarily in the SE business segment. The balance of the 10% workforce reduction or the remaining 4% will largely occur in our fiscal Q4 or the June quarter.

We are currently ahead of schedule to deliver the targeted annualized net OpEx savings of $35 million. Beyond the stated restructuring plan, we also have additional levers to reduce NSE expenses. The total aggregate charges for this restructuring plan, majority of which is related to severance, is approximately $25 million year-to-date, with a balance of up to $5 million to be incurred through the rest of the calendar year 2017. NSE achieved a book-to-bill ratio of above 1.

Turning to OSP. Revenue of $63.9 million increased 2.9% from year-ago levels, driven by a better-than-expected recovery in our anti-counterfeiting business. Gross margin at 57.4% declined 40 basis points due to product mix. Operating margin of 43.5% improved by 110 basis points from last year, reflecting good management of operating expenses.

Now moving to the balance sheet. Our total cash and short-term investments ending balance was approximately $1.45 billion, with total net cash of $345 million. Operating cash flow for the quarter was $17.3 million.

During fiscal Q3, we sold 1.3 million Lumentum shares for a net proceed of $62.1 million with an average selling price of $48.80 per share. Our book cost basis on these shares is approximately $8.57 per share. As a result, we realized, on a GAAP only P&L an accounting gain of approximately $51.2 million.

As of the last day of fiscal Q3, we have remaining 0.4 million shares of Lumentum valued at $20.8 million.

We repurchased a total of 5.2 million shares of Viavi stock during the quarter, at a cost basis of $9.91 per share, including commissions, for a total of $51.9 million. Of the $150 million share buyback program to date, we have repurchased shares worth approximately $96 million. We will continue to be opportunistic in monetizing our remaining Lumentum position and repurchasing our Viavi stock.

In March, we completed our $460 million senior convertible note offering, which included our initial purchases exercising their over-allotment option of $60 million. These notes have a 1% interest rate, a conversion price of $13.22 per share and will mature in March 2024, unless earlier converted or repurchased.

Viavi received $451.2 million in net proceeds. We intend to use these net proceeds, together with cash-on-hand, for opportunistically refinancing our outstanding 0.625% senior convertible notes due 2023 as well as for general corporate purposes.

Now onto our guidance.

We expect fiscal fourth quarter 2017 revenue for Viavi to be in the range of $188 million to $204 million, operating margin at 13%, plus or minus 1%, and EPS to be $0.07 to $0.09. We expect NSE revenue to be at $137 million, plus or minus $6 million, with operating margin at 1%, plus or minus 1%. We expect OSP revenue to be at $59 million, plus or minus $2 million, with operating margin at 41%, plus or minus 1%.

There was no meaningful 3D sensing revenue in fiscal Q3, and we do not expect it in the current fiscal fourth quarter. While we are seeing the expected recovery in OSP's core revenue in second half fiscal 2017, the anti-counterfeiting demand remains cyclical. Our tax expense is expected to be approximately $5 million. We expect other income and expenses to reflect the net expense of approximately $1.5 million and our share counts to be approximately 235 million shares.

With that, I will turn the call to Oleg.

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [4]

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Thank you, Amar. We exceeded our EPS guidance range as OSP came in above expectations due to a stronger-than-expected anti-counterfeiting demand, and in part, offset weaker-than-expected NSE revenue that was impacted by weaker service provider and enterprise spend.

The March quarter is historically challenging for the NE core instruments business. North American service providers spending was seasonably weak, and while there was some instrumentation buying taking place, it was at lower rates than historical. That said, our year-to-date core instruments revenue outside the North America was up nicely year-on-year.

Fiber instrument sales softened in the quarter as we saw optical spending starting to cool given the significant amount of fiber deployment over the past 12 to 18 months. Customers are assessing their optical deployment needs as they rebalance their supply-demand requirements.

On the positive trends, cable demand was meaningfully up as customers finally starting to upgrade to DOCSIS 3.1. We expect cable spending trend to follow a rolling wave pattern and take place over multiple quarters.

The access business was -- also saw its first sequential revenue uptick in more than a year. Our service providers are beginning to deploy G.fast copper access technology. We expect G.fast technology adoption also to take place over multiple quarters.

The data center, or Enterprise business, came in weaker due to a lackluster enterprise customer spending and some order pushouts. That said, we expect to see a recovery in this business in the fourth quarter, helped by expected seasonally stronger demand and several deals pushed out from Q3.

During Q3, we launched a major restructuring of our Service Enablement business. Major cost and personnel reduction notwithstanding, we are successfully managing a soft landing for this business as we reframe it around a smaller focused, profitable and sustainable core business.

Moving on to OSP. The anticounterfeiting business is rebounding stronger than we expected in the second half of fiscal 2017. We expect anticounterfeiting business to continue to follow its historical cyclicality as our customers rebalance their inventories to match market demand. OSP operating margins were better-than-expected due to high revenue levels from a year ago.

Regarding 3D sensing, we continue to work with our customers to meet their demand requirements and timelines. As we stated in prior earnings calls, we will provide an update on 3D sensing in our fiscal Q4 earnings call in mid-August.

In conclusion, I would like to express my thanks to our customers and employees for their continued support of Viavi.

I will now turn the call over to Bill.

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Bill Ong, Viavi Solutions Inc. - Head of IR [5]

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Thank you, Oleg. This quarter, we will be participating at Stifel's Technology Investor Conference in San Francisco on June 5, and William Blair Investor Conference in Chicago on June 14. Kelly, let's begin the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Rod Hall from JPMorgan.

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Roderick B. Hall, JP Morgan Chase & Co, Research Division - VP and Senior Analyst [2]

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Oleg, I wanted to come back to NSE a little bit and just see if we could get any further color on your visibility there. Obviously, that whole carrier spending environment has been pretty volatile. And just help us understand how much confidence you've got that these deals do come back in, in Q4? And also maybe talk to us a little bit about the trajectory of the OpEx there in NSE? Do you expect that trajectory to continue to come down? Or what should we be modeling there from an OpEx point of view? Then I have one follow-up.

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [3]

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Sure. Thank you, Rod. Well, I mean, as you can imagine -- well, there's really 2 stories in NSE, right? There is North America and then the rest of the world, right? So our primarily downward push has really been down in the last, say, 12... kind of on 3 quarters by fundamentally pullback of spending by North American operators and significant M&A activity in both cable and telecom space. So as such, we've seen a lot less willingness to spend money, and clearly, that impacted our instrumentation sales. Now in terms of the rest of the world, we've had a very nice growth year-to-date, year-on-year across all our other geographies in both SE as well as NE. So when I look at it, I say, "Okay, is it market share loss? Is it just a systemic lower spend?" There's clearly different spending pattern emerging between North American operators and the rest of the world. I guess some of it is in part because there's been significant spending in North America in 2015, '16 fiscal years, so some of them are now working to digest it. But also because of the significant M&A. There's kind of a hold on decisions of where to spend, how to spend until the companies figure out what they need. Now that said, the biggest impact was spending on instrumentation at the edge, which is access and cable. And I would say, it was really the story, I would say, behind the June, September and December quarters, where we're finally now seeing -- although it's been delayed, we expected it to be sooner -- is finally we're seeing the upgrade, the DOCSIS 3.1 and G.fast, and that's starting to pick up the spend among the NSE customers. On the Enterprise side, we've seen pretty healthy demand. We had some pretty significant deals that somehow just got pushed -- didn't quite make it into the March quarter. And -- but generally, I would say the climate was -- spending was weaker than we thought in the past, although we felt our business was doing pretty well. We expect this quarter to be meaningfully better, and we recognized some of those deals that slipped into the fourth quarter, and seasonally, we see usually better spend in the June quarter. In the Enterprise business, it's kind of June quarter and December quarter are the biggest -- especially December quarter, are the biggest cyclical spenders. So that's where we're looking at in there. Within our Service Enablement business, clearly, we've done significant restructuring. We're actually ahead of our schedule in terms of the cost take down, and we expect to realize most of it by the end of this fiscal quarter, with some trickle remaining through the end of the year. Having a significant amount of turmoil, as you can imagine, when you are restructuring a business unit with that kind of magnitude, we actually managed a very nice, I would say, soft landing with our customer base. We avoided a major customer pushback, and actually, we think we worked out pretty good transition with all of our key accounts on the (inaudible) technology. So in that respect, I'd say, if I were to characterize NSE's biggest headwind last quarter, it was really on the instrumentation and North American service providers. Looking at this quarter, we're actually seeing better climate for instruments. We -- for the first time, we got actually book-to-bill ratio above 1, so -- and we are cautiously optimistic that this trend will continue to build over the year, as we're seeing growth and recovery in the access and cable demand, which is the edge, which is where the biggest volumes are. And although we're seeing some slowdown in fiber, I -- it's still -- demand is still fairly healthy, but it's no longer growing quarter-on-quarter as it did before. So that hopefully gives you more color.

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Roderick B. Hall, JP Morgan Chase & Co, Research Division - VP and Senior Analyst [4]

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Yes, that's really helpful. And just a really quick follow-up. Can you just say whether -- give a yes, or no answer on 3D sensing. Should we expect revenue in fiscal Q1? Is that when we would expect revenue to start? And I know you want to give more detail the next earnings report?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [5]

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So you're talking about 3D sensing, you mean?

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Roderick B. Hall, JP Morgan Chase & Co, Research Division - VP and Senior Analyst [6]

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Yes.

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [7]

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Okay, yes. So well you're trying to steal my fourth quarter thunder, but yes, we are expected to start shipping production in Q1, so we'll see some initial revenue, but the way it generally works is we produce the product, we ship them into the hub. Only as the product gets full from the hub and passes incoming inspection, the revenue gets recognized. So there is some lag between the shipment of the product and the time you're going to recognize revenue. So we do expect to start shipping production in Q1. How much of the revenue gets recognized, we're not certain at the time. But the ramp will happen, say, between Q1, Q2 and Q3 of next fiscal year.

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Operator [8]

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Your next question comes from Dmitry Netis of William Blair.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [9]

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Pretty decent guidance given the environment we're in. I have a couple questions. One, I just want to kind of get a little clarification on the instrumentation side of the business. Oleg, can you -- if I were to sort of ask for your kind of give me a product mix there. If I combine cable and access in one category, and then fiber and maybe everything else in another, is that a roughly 50-50 split? Anything kind of you can tell us just to kind of see the magnitude of the cable access business starting so reaccelerate here for you and how impactful it may be going forward?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [10]

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All right. So we don't give the mix. But as you can imagine, we combine cable and access. I mean, you could actually say it's all access, right? That's the edge. That is the single biggest bucket because of the volume at the edge. So I don't want to go and start providing the mix, but cable and access is a significant chunk of revenue, right? Fiber is somewhat smaller than a combination of the cable and access, and the rest would be Metro. So the biggest -- if I would look at the cable and access, let's say, 2 years ago, that was easily over 50% of the revenue, right? So there's been significant pullback, as customer said, "Hey, why am I going to buy equipment if I'm going to be transitioning to 3.1 DOCSIS and the G.fast?" Well, throw into the mix significant amount of M&A, some slippage on schedules, and that the revenue dropped significantly in the past 3 quarters or so. And just now, finally, in this fiscal third quarter, we are starting to see a pullback in both of these product lines and volumes starting to increase as DOCSIS 3.1 and G.fast is starting to ramp.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [11]

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Okay, great. And my follow-up is one for you, Oleg, one for Amar. I guess, I just want to get some clarity on the data center business. I suppose that's the Network Instruments business, yes? Can you kind of dive in and kind of explain what exactly is happening? I thought that business was starting to come for you because of the changes you had made recently. Did something else happened there that affected it, number one? Number two is how's the channel doing? If you could comment quickly on kind of the channel, the program you put in place. Are you still happy with the sales leads that you generate from there? And then lastly, to Amar, I just want to kind of pick your brain on the convertible note and see when you think you'll be back on the market maybe buying the old convert out? And how do you feel about sort of keeping the 2 converts on the books at the moment? For whatever reason, I mean, I don't know if it's the M&A thoughts you have or something else, that you would need to maintain that level of cash on the balance sheet, but just give us some thought there.

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [12]

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All right. Well that's -- you squeezed in about 4 questions into 1. But we'll go ahead and do that. So on Enterprise, actually, we still feel very good about our -- that business. We just introduced a new revamped product platform. Our new organization, our sales force, I think 3 quarters of it is less than a couple of quarters on board, and we are seeing good traction. So in fact, I mean as ugly as the March quarter came in, I actually feel pretty good about this business for several reasons. First, well, March is usually the weakest quarter because their busiest and biggest quarter is typically in December. But even in this March quarter, we saw some -- a lot of I would call, firsts. We actually were getting deals in the 7-digit range that we never were getting in the past, and we won. So we're now winning some serious type business. But also, with that kind of serious business, if one of those deals slips from quarter-to-quarter, it hurts meaningfully. So I think I would say -- I mean, I don't want to make excuses for that business, but clearly, as I look at the trajectory and I look at the bookings pipeline that they are building, it's all in the right direction. I'm not going to hold it against them if they got some bookings relatively late and we just couldn't get it to customer in time. But I think the organization is performing well. The product line of doing well. And I'm optimistic on that business unit going forward. And this quarter is obviously going to be a good quarter for them. They have some of these deals that slipped coming this quarter, plus they have quite a few nice design wins that they're going to drive -- we expect a nice revenue from them. So I think it's a business that's still in transition. It's still in turnaround mode. But qualitatively, I like all the indicators that I'm seeing, and we'll give them time to accelerate.

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [13]

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So on the convert and what we are doing about it. As you know, we issued a new convert to, firstly, refinance the existing converts; and secondly, to give us some flexibility from a capital allocation perspective. So we saw the opportunity, took advantage of very favorable market conditions to lock in a local fund rate at a higher conversion price. Now, we do have internal plans here, Dmitry, and I won't talk specifically on the timing, et cetera, but our internal plans have various options. One is we want to opportunistically go in, buy back the old converts when the conditions are appropriate. We do have certain criteria that we have set aside. Number two, we can call it on the first Convert call date of August 20, 2018. And when we call it, we have the flexibility to either settle in cash our stock, any amount of the stock above the conversion price. And number three is as you can see, we are opportunistically also buying back our shares to existing share buyback program, so that if there is a double dilution, we try and offset the dilution proactively. So you can be assured, as we have done in the past with our capital allocation, we have stated our capital allocation goals and priorities, and we have executed against it, and we will do so even in this case. But it was -- our new converts was essentially to refinance our existing converts, and we will do that opportunistically since we still have about 14, 15 months to go.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [14]

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Oh, and my fourth question was in consolidation in M&A. Any comment their real quick?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [15]

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No. We don't comment on these things.

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Operator [16]

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Your next question comes from Patrick Newton of Stifel.

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Patrick M. Newton, Stifel, Nicolaus & Company, Incorporated, Research Division - VP and Senior Analyst [17]

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Just wanted to focus on the cyclicality of the OSP business, what you brought up in your prepared remarks. Is a $60 million run rate in the FY '18, for the full year, I guess, a realistic quarterly level? And I guess the reason I'm asking, I'm trying to understand if the results and guidance represent kind of a high watermark for the OSP business from a cyclical perspective? Or could you still grow from here?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [18]

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So I think -- I don't want to guide fiscal year '18, but just building on my comment, when we said it'll revert back to the cyclical demand. We believe mid-50 to high-50s is the core business. That's the quarterly revenue range that you should be thinking about. Now 3D would be on top of that, but the core business should be mid-50s to high-50s.

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Patrick M. Newton, Stifel, Nicolaus & Company, Incorporated, Research Division - VP and Senior Analyst [19]

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Great. That's helpful. And then I guess just looking at the NSE business, I wanted to kind of pick apart the sequential guide. Given the commentary that you had around the NE business benefiting from Enterprise pushouts, and then you also spoke to momentum building for cable in G.fast, should we expect that the SE business will decline sequentially in the June quarter? Or could we see both subsegments grow?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [20]

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No, I think that's a very good question. So when you look at our guidance for NSE, the NSE revenue guidance calls for a 3.7% sequential growth. So roughly about 4% sequential growth at the midpoint. Now within that, as Oleg mentioned, we are seeing some momentum. As you see our book-to-bill was greater than 1. So what we have done is the NE business is projected to actually go up mid-single digits sequentially. On the flip side, the SE restructuring to scale down some of our unprofitable product lines impact the SE revenues. So SE revenue is declining sequentially, high sort of double digits, whereas the NE business is projected to be up mid-single digit.

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Patrick M. Newton, Stifel, Nicolaus & Company, Incorporated, Research Division - VP and Senior Analyst [21]

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And then any color you can given around SE as we look into 2018 given the restructuring?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [22]

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So, again...

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [23]

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No, say, look, clearly when you take out the amount of cost we are taking out, our whole thing about SE is first really about quality of revenue rather than quantity. So by taking out the significant cost and shutting down the product lines, where we don't feel there is a positive upside, we do expect some pullback. It's not a very big pullback from our current run rate, and we'd prefer to give guidance more when we give our 2018 guidance in fourth quarter. But the way I look at it, it's actually, overall, a net major positive. Yes, we're going to lose some low-quality revenue, but we're going to have a significant increase in the operating fall through for that business unit and get it at the very minimum to the breakeven or even profitable.

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [24]

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So it's all about profitable revenue. And if you recall, Patrick, what we mentioned maybe last call as well as in the Analyst Day, SE, as a percentage of the total mix of NSE, is around low-20s to high 20% of the total mix of NSE. As we go restructure and make it more profitable, we expect it to be between 15% and 20% by fiscal year '19. And fiscal year '18 should be more towards the 20% as a percentage of the total mix.

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Operator [25]

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Your next question comes from Alex Henderson of Needham.

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Alexander B. Henderson, Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology [26]

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Yes, I just wanted to go back to the breakout between NE and SE for a second. So if I take the numbers you just gave, 5% sequential growth in SE and take the Network Enablement down by double digits, I'm actually coming out with numbers that are clearly below the low end of your band. I was wondering if you could just make sure that you said that correctly or I heard it correctly?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [27]

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So I -- so sequentially -- you're right, actually. Sequentially, you will see our NE business grow mid-single digits within our guidance. And the SE business, SE business -- so you're right. SE business will be mid to high single digit decline, not double digit decline. So you're absolutely right.

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Alexander B. Henderson, Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology [28]

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Okay. So I had -- I thought you said the NE was going to decline, not the other way around, sorry...

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [29]

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NE year-on-year, not quarter-on-quarter.

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [30]

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NE is going to grow mid single digits sequentially. SE is going to decline mid to high single digits sequentially. And the overall revenue growth for SE year-on-year is going to be -- year-on-year is going to be double-digit decline, so that...

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Alexander B. Henderson, Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology [31]

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Going back to the business in the OSP segment for a second, so you obviously had a pretty good spike in margins there in -- or in revenues there. And I assume that, that translates to a little bit more of a spike in margins at the bottom line. As we go back into the $58 million, $59 million a quarter range from the $64 million here in the March quarter, would we then expect some contraction in the operating margins back towards the 40% range?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [32]

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So I think it'll be -- so we always guided between 39% and 41% for the OSP business. So what we believe is given all the operating expense reduction as well as the gross margin focus in that business, we should be more towards the high end of the range, of between 39% and 41%, at the ...

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [33]

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Probably 40% is the safe...

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [34]

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40% is the midpoint, more bias towards the high end.

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Alexander B. Henderson, Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology [35]

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So I was really referring to the -- I know you don't want to give guidance going out. But as you had said, mid- to upper-50s in revenues there. I assume that, that's associating with kind of the midpoint of that 39% to 41% range?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [36]

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I would say given all the work and efficiency work they are doing, it should be more towards the high end.

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [37]

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Yes. So I think traditionally, we always guided high-30s to low-40s. I think given what their team has done and all the improvements they've put in place, we're now comfortably to kind of -- when they reach steady state for them to be at the higher end, which is 40%, 41%.

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [38]

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That's right. And then once we have 3D coming in, I think that should take the margin rate down and -- below 40%, but it should be operating profit dollar-accretive.

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Alexander B. Henderson, Needham & Company, LLC, Research Division - Senior Analyst of Networking and Security Technology [39]

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Sure. Just going back to the cost-cutting program. So it sounds like there's a pretty good slog that came out in the March quarter. You've also got a pretty good slog coming out in the June quarter. So I should be thinking about OpEx declining sequentially, continuing to decline sequentially into the September quarter? Is that the right way to think about it?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [40]

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Yes, that's right. So let me just recap. So when we announced the restructuring last quarter, we baseline the $35 million of net OpEx savings to a Q2 NSE OpEx of $95.7 million, which is our December quarter OpEx of $95.7 million. So we said that's the baseline. Most of that baseline will reduce $35 million of annualized OpEx, which is $8.75 million per -- that is the quarterly OpEx reductions. Now we have gone from $95.7 million to $89.6 million in Q3. And in Q4, we should be getting to almost 90% or more of that savings. So you can -- you should definitely expect a sequential reduction from Q3 to Q4, and that's all incorporated in our guidance.

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Operator [41]

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Your next question comes from James Kisner from Jefferies.

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James Martin Kisner, Jefferies LLC, Research Division - Equity Analyst [42]

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I just want to clarify, did you guys have any impact on the NSE margins during fiscal Q3 from the restructuring? Or is this really just a fixed cost absorption which results in op income margins being below what you guys have thought?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [43]

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We did get benefit from the SE restructuring in our margins in fiscal Q3. But also keep in mind, we did have a big impact from a steep decline in revenue. So that steep decline in revenue in the NE business offset the margin improvements in fiscal Q3. So when the revenue comes back up, I think that's going to create a positive operating leverage in the model.

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James Martin Kisner, Jefferies LLC, Research Division - Equity Analyst [44]

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Okay, great. And just on 3D sensing. Without getting to too much detail, it sounds like you guys are very confident that you'll start shipping in fiscal 1Q. Is that -- I mean, if you guys are shipping to the hub, is there a chance that the part that the filters could then sit in the hub for potentially another product cycle? Or how do you guys think about that in terms of when it gets pulled out? And you guys start recognizing revenue?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [45]

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Sure. So when we had our Analyst Day, there was a lot of talk about -- everybody talking about 3D and so on. We, back then, said listen, "It's too early to talk about it. We'll talk about it as we get closer to it. "Because all along, we knew that we're not going to see hardly any shipments until first quarter of fiscal '19 -- fiscal '18, right? So we do expect to actually do start seeing revenue in the Q1 because it's a -- you don't ship into a hub unless there is a demand, right? So it's basically the hub is purely there to ensure just in time, make sure that everybody ships the parts that they need. And then they pull, they inspect and they consume. So I mean, a lot of the time, and I don't know this particular supply chain now, obviously, we'll learn a lot more once we start shipping. But typically, with these kind of deals, what I had, given my other businesses I ran in the past, parts don't spend more than a week in the hub, it's always continuously turning of the product.

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James Martin Kisner, Jefferies LLC, Research Division - Equity Analyst [46]

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Okay, that's very helpful. So it sounds you guys feel very confident about 3D sensing moving forward in that time frame?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [47]

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Yes. And the thing is when you look at it, in most revenue, in most -- for most things, once it leaves the factory, you recognize the revenue. In this particular case, it's a -- you push the revenue recognition line towards incoming inspection acceptance rather than leaving the dock of your factory.

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James Martin Kisner, Jefferies LLC, Research Division - Equity Analyst [48]

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Okay, great. And just last one last quick question for me. Did you guys see any increase in the prepayments that you guys first announced, I believe it was 3 quarters ago now?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [49]

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Nothing worth commenting.

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Operator [50]

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Your next question comes from Meta Marshall of Morgan Stanley.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [51]

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I just wanted to go into a little bit of the visibility on NSE and just a sense of the time line between kind of when you might know that a carrier is going to deploy G.fast or DOCSIS 3.1 or fiber into a certain city? And then kind of when you would expect to see that equipment revenue? Does that tend to be 3 months, 6 months, just a little bit about that timeline? And then the second question would just be on the prepayment that you received last year. Were there any restrictions as far as other partners that you could work with? Or is it unrestricted?

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [52]

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Sure. So with -- so your first question was on, was it NSE?

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Amar Maletira, Viavi Solutions Inc. - CFO and EVP [53]

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Yes, time line of -- table...

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Oleg Khaykin, Viavi Solutions Inc. - CEO, President and Director [54]

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So I mean the way -- we know all the players, both on cable and telecom side, and their convergence -- conversion to the DOCSIS 3.1 or G.fast, right? So there were roughly no who is doing it. How they were doing it is really a quarter-to-quarter decision, how they do it, and I mean, our visibility on it is, probably at most, 3 months. So we know it's going to happen. In which sequence and when it happens is really subject to their capital decision on quarterly basis within our service provider accounts. So for example, G.fast, I mean, we see -- we were seeing G.fast happening already in some U.S. and European accounts. But it's -- they're not really just flipping the switch and exchanging everybody. It's more like gradually kind of like a successive waves spread over multiple quarters. But one of the things, if you follow the equipment provider reporting, you see they usually get a big -- a pop in orders within 1 to 2 quarters because those are the things our customers need to do to upgrade their central offices. But once they're upgraded, they can actually roll out new modems at a leisurely pace because all of them are backwards-compatible, right? So the retrofit takes time, over a longer period of time, than the consensual office. And instrumentation is pulled largely at the pace of the convergence -- conversion of modems. So in that respect, we know that it's going to happen. It's not the question of if, it's really a question of when. And that is kind of one of these things every quarter, they tell us what they're going to do, and there's very little long-term visibility. So that hopefully answers your first question. The second one, no, any prepayments we take do not limit us from working with anybody else. And from our perspective, prepayment is really a function of the level of risk in capital or business risk that we're being asked to take by a customer. Clearly, the risk is modest and fits within our internal operational guidelines. We don't look for prepayment. But if it's a significant step up in the capital or production capacity, then we definitely look for a prepayment.

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Operator [55]

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Your next -- or your last question comes from Jorge Rivas from Craig-Hallum Capital.

And the caller has removed himself from the queue. So I now turn the call back over to presenters for closing remarks.

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Bill Ong, Viavi Solutions Inc. - Head of IR [56]

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Thank you, Kelly. This concludes our earnings for today, and thank you, everyone.

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Operator [57]

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This concludes today's conference call. You may now disconnect.