Viavi Solutions Inc (VIAV) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Viavi Solutions Inc. second-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, today's program is being recorded. I would now like introduce your host for today's program, Mr. Bill Ong, Senior Director, Investor Relations. Please go ahead.

Thank you, Jonathan. Welcome to Viavi Solutions's fiscal second-quarter 2016 earnings call. My name is Bill Ong, Senior Director of Investor Relations. Joining me on today's call are Rick Belluzzo, Chairman of the Board and Interim CEO; and Amar Maletira, CFO. Paul McNab, our Chief Marketing and Strategy Officer, will also join us for Q&A. I'm also pleased to introduce Oleg Khaykin as incoming President and CEO, who is also on the earnings call today.

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 current expectations. We encourage you to review our most recent SEC filings, particularly the risk factors described in those filings. The forward-looking statements, including guidance we provide during this call, are valid only as of today. Viavi undertakes no obligation to update these statements.

Please also note that unless we state otherwise, all results 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 and historical financial tables are available on our website. Finally, we are recording today's call and will make a recording available by 4:30 PM Pacific Time this evening on our website.

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

Thank you, Bill. I am very pleased with our fiscal second-quarter results. Our Q2 performance reflects our continued effort to build on OSP's success and improve the performance of our NSE business. In Q2 we met or exceeded the high end of all of our guidance range metrics. Both OSP and NSE continued to execute well in the first half of fiscal 2016, as we made progress in our long-term strategy to increase profitability.

In half one of FY 2016, we delivered revenue growth of 4.6% and operating income growth of 84.4% when compared to the first half of FY 2015. We also completed the spinoff of our CCOP business and WaveReady product line into Lumentum Holdings. While we are pleased with the progress, we are also committed to expanding upon these achievements in coming quarters.

Let me provide a little more detail on our second quarter. First, OSP delivered solid revenue growth, up 16.2% year on year on the strength of higher demand for anti-counterfeiting products that began in fiscal Q1. We expect robust demand in the anti-counterfeiting business to continue through the rest of fiscal year 2016.

In NSE, our immediate focus has been to stabilize revenue performance and make meaningful improvements in operating costs, leading to substantially improved operating margins. Our focus here resulted in solid execution that drove up revenue 4.7% sequentially and exceeded the guidance range, despite being down -- slightly down 1.4% from a year ago. This reflects a significant improvement over recent quarters.

There was a very modest budget-flush spending at the end of the calendar 2015, as customers' orders largely reflected planned spending to equip their workforce with instruments to test and measure network deployment. We regained any market share in Q2, with solid revenue performance from our Tier 1 service provider, Viavi's area of strength. But additionally, we are also starting to see improved results in the new growth areas such as the channel as we have become more focused on different avenues to market.

One of the clear drivers of success has been the strengthening of our sales and marketing teams. For example, we have seen a significant reversal in sales attrition as a result of a better focus on our overall go-to-market strategy.

On the operating expense side, we continue to drive improvements in decreasing spending, starting with G&A, which was down 19.8% from last year; followed by R&D, down 3.2%. Sales and marketing was slightly up by 1.6% as we focus on our go-to-market plan and regain revenue momentum.

NSE bookings recovered in the quarter, up 6.3% sequentially, with a snap-back in SE orders resulting in a strong book-to-bill ratio not seen since the March quarter of last year. The result of these efforts translates to an overall improvement in NSE's operating profit. Specifically, NSE's operating margin increased threefold sequentially, from 1.5% in fiscal Q1 to 4.6% this quarter, and exceeded the guidance range. NSE operating income of $8 million increased fourfold from the $2 million level a year ago, reflecting significant OpEx control within NSE.

Well, having been interim CEO now for almost six months, I am very pleased with the progress we've made -- we have achieved in realigning NSE's operating expense structure. Our go-to-market and channel strategy is gaining traction as we continue to diversify our customer base with strong growth, including our velocity channel partner program and enterprise business. We are regaining any market share and are focused on aligning our investments and product development to deliver continued growth through innovative solutions. To a large extent, our improved performance has been a result of refocusing on our core instrument business, where we have become much more aggressive while establishing incremental initiatives to expand our business.

On the SE portion of our business, we are pleased with the progress of our enterprise business and see more opportunity to bring our networking solutions to the enterprise data center and cloud customers. It remains a strategic focus to increase our market footprint in enterprise -- diversifying our NSE customer base beyond service providers as well as capitalize on the market growth opportunity in network performance monitoring.

However, we remain challenged managing the transition from our legacy assurance business to new growth opportunities, resulting in a faster decline of legacy than growth in the new solutions. The assurance market is full of disruption opportunities, and Viavi has developed a very strong technology portfolio. We continue to focus on identifying the best opportunities and leveraging our strength in end-to-end assurance and further grow our customer base. In Q2 we added two new deployments from Tier 1 operators using our xSIGHT solution to troubleshoot and transform their network capability.

Nevertheless, we have much more work to do. The OSP business continues to deliver strong profitability, and we are working our ways to extend this core capability into the consumer, industrial, and healthcare markets. This journey to increase profitability and revenue growth is ongoing, but our execution in the past two quarters has demonstrated our progress and commitment to continue this improvement.

With that, let me turn the call over to Amar.

Thank you, Rick. We remained focused on executing our plan and delivered a solid quarter. Fiscal second-quarter revenue of $232.1 million exceeded our guidance revenue range of $212 million to $228 million, with both NSE and OSP exceeding the midpoint of our guidance as a result of better execution.

Revenue was up 2.5% year-over-year, despite currency headwinds of roughly 3 percentage points. The year-on-year revenue growth was primarily driven by strong performance in our OSP business that offset the slight decline in NSE. Our operating income at $30.5 million grew $11.4 million or 60% year-over-year. Operating margin of 13.1% was up 470 basis points year-over-year and exceeded our guidance of 9.5% to 11.5% as a result of continued strong performance in OSP and solid operating expense management.

Our operating expenses were down 5.8% year-over-year, primarily driven by a reduction in our G&A expenses and optimization of our R&D spend. Recall at our September '14 analyst day, adjusted to exclude Lumentum, we set a net $40 million annualized OpEx savings target by FY 2017. This savings target was measured relative to fiscal Q1 2015 annualized OpEx run rate.

I am pleased to report that we executed well on the unlocked plans and have delivered significant portion of the targeted savings, as reflected in our first half fiscal 2016 operating expenses. We will continue to execute the remaining expense reduction plans and other savings initiatives during the next several quarters while selectively reinvesting some of the savings in our NSE go-to-market initiatives that are targeted at growth areas such as channels, enterprise, and solutions.

We delivered earnings per share of $0.11, which also exceeded the high end of our guidance range of $0.06 to $0.08.

Now, moving to the results by business segment, starting with NSE: while revenue of $173.3 million declined 1.4% year-over-year, we delivered above the high end of our guidance due to good execution in the in NE business, which is our core instrument business. NSE gross margin at 66.4% declined 20 basis points year-over-year due to lower revenue levels.

NSE's operating margin of 4.6% exceeded the guidance range of 1% to 3%. Operating margin expanded 350 basis points year-over-year due to solid OpEx management in this business, as we continued to focus on optimizing operating expenses to align with revenue. As noted earlier, long-term this should create meaningful operating leverage as we grow the top line in NSE.

The network enablement or NE business, which is our core instrument business, staged a solid recovery, growing year on year for the first time in more than five quarters. NE revenue at $136.4 million grew 5.7% from prior year, driven by strength in both wireline field and lab instruments. Our Q2 fiber test field instruments revenue was up double digits sequentially and up high single digits from our year-ago levels, reflecting strength in fiber deployment by our customers.

Access field instruments revenue was also up by more than 50% from our year-ago levels. However, cable test instruments declined in the same period, as customers delayed purchases until the anticipated DOCSIS 3.1 upgrade. This upgrade is expected to occur in the spring. We believe that we are well positioned for this upgrade cycle.

Our lab instruments were strong in the quarter in both fiber and optical transport. This is a good leading indicator of continued demand in fiber test field instruments. NE book-to-bill was slightly below 1. We felt comfortable with the order backlog position entering fiscal Q3. NE posted gross margins of 66.4%, an increase of 80 basis points from a year ago, primarily driven by improved operating efficiencies in the supply chain and a favorable mix.

Moving to service enablement, SE revenue at $36.9 million declined 21.2% from the prior-year period. While the enterprise business within SE, which is our network instruments business, continues to grow, we remain challenged in the assurance business. The legacy assurance portfolio declined at a faster pace compared to the growth in the new opportunities.

Revenue in the new growth opportunities within assurance tends to be lumpy due to long sales cycles and timing of customer acceptances of our solutions. In the first half of fiscal 2016, the new growth opportunities within assurance grew double digits year-over-year, but this was offset by the declines in legacy assurance portfolio.

In SE, for the first time in three quarters, we had a book-to-bill ratio of above 1, and all our deferred revenue in backlog grew year on year and sequentially. These are good leading indicators, but we still have a lot of work to do to drive this business for long-term sustainable growth. SE posted gross margins at 66.4%, a decrease of 280 basis points from a year ago due to lower revenue.

Now, turning to OSP, revenue at $58.8 million met the high end of our guidance and grew 16.2% from year-ago levels. The revenue upside was attributed to the anti-counterfeiting business, driven by increased bank note reprinting volume as well as the growth in the rest of the business. Gross margins at 55.8% was up 300 basis points year-over-year on higher revenue and better absorption. Operating margin at 38.3% exceeded the high end of the guided range and was up 450 basis points year-over-year. The margin expansion was a result of favorable product mix and operating leverage on higher revenue.

Now, turning to the balance sheet, our total cash and short-term investments ending balance was $914.5 million, which includes a 19.9% Lumentum equity investment, valued at $257.5 million. Operating cash flow was negative $1 million, which included separation-related payments of approximately $15 million.

During Q2 we entered into a $40 million accelerated share repurchase program, which was completed in early January. We purchased close to 6.6 million shares with an average cost basis of $6.05. We also announced today that the Board has authorized the repurchase up to $100 million of the Company's common stock through open market or private transactions within the next 12 months. We plan on being opportunistic here, although the timing of the repurchases and the number of shares repurchased will depend on the business and financial market conditions.

Now, turning to our guidance, we expect fiscal third-quarter revenue for Viavi to be in the range of $210 million to $226 million; operating margin at 11.7%, plus or minus 1%; and EPS to be $0.07 to $0.09. We expect NSE revenue to be $155 million to $167 million, with the operating margin at 2.5%, plus or minus 1%.

For NSE our March quarter is a seasonally weak revenue quarter, since it is the start of annual budget cycles for our service providers. Also, it is worth noting that we have seasonally higher expenses in this quarter due to increased payroll and other employee-related taxes and benefits.

For OSP, we expect revenue to be $55 million to $59 million, with operating margins at 37.5%, plus or minus 1%. OSP continues to benefit from some large-volume banknote printing demand that is benefiting Q3, which we expect to moderate but still remain healthy in Q4 in the mid-$50 million revenue range.

Our tax expense is expected to be in the range of $4.5 million to $5 million. We expect other income and expenses to be a net expense of $1.5 million to $2 million; and our share count to be approximately 234.5 million shares, with the lower share count reflecting the recently completed $40 million stock buyback. We recognize that the current macro environment is uncertain, and carrier spending has always been and will remain unpredictable. Overall, we believe we have factored the various macro risks in our guidance and our internal execution plans.

With that, I'll return the call to Rick for some closing commentary.

Thank you, Amar. Today, we are very excited to announce that Oleg Khaykin has been named CEO and Board member for Viavi Solutions. This appointment will be effective tomorrow, and I will work with Oleg to execute a smooth transition. The Viavi Board began the search process in mid-August, and we conducted an exhaustive process to ultimately reach this point.

As I stated in the past, we were committed to find a strong leader with experience as a technology CEO that has successfully completed and operational transformation. I believe that we have that person in Oleg, who brings more than 28 years of industry experience and successfully led the transformation of International Rectifier until its acquisition by Infineon AG in 2015. His resume is impressive and includes roles as an advisor at Silverlake Partners and (technical difficulty) the challenges that Viavi. I believe that Oleg will embrace the recent progress that we have made and extend the gains further. So, Oleg, congratulations, and I look forward to working with you.

In closing, I would like to express my thanks to our employees, our business partners, and shareholders. I would like to thank the Board for giving me this opportunity. It has been an exciting six months, and I am proud of the progress that the Viavi team has made on many, many fronts. This executive team has been outstanding to work with. I appreciate all the support I have received, and I am even more enthusiastic about the future of the Company.

I will continue as Chairman and be fully supportive of this management team. Let me turn the call over to Oleg for some comments.

Thank you, Rick. First, I would like to thank Rick for all the heavy lifting he has done in the past six months. It has made it easier for me to hit the ground running. And I am very excited to be here and agree with Rick about the opportunities and challenges at Viavi. I look forward to taking the Company to the next level of profitability and revenue growth, and I hope to meet many of you at various investor conferences and meetings in the coming weeks and months. Thank you.

Thank you, Oleg. Before I begin the question-and-answer session, we originally issued a save-the-date for our analyst day event scheduled for next month, March 15. We will be rescheduling our analyst day event at a later date to accommodate our new CEO's schedule. We will provide notice to our investors with a new date in the coming weeks.

Jonathan, let's begin the question-and-answer session. I would like to ask everyone to limit their discussion to one question and one follow-up.

(Operator Instructions) Patrick Newton, Stifel.

Oleg, welcome to the team. Rick and Amar, thank you for taking my questions. I guess just jumping right in and putting Oleg on the spot -- or, I guess, for Oleg and Rick: when we think about the Viavi transformation -- and, Rick, you highlighted that is why you hired Oleg -- does this transformation potentially consist of asset sales, exiting businesses, or in investing, acquiring to fix SE to accelerate growth? I know it's very early, but how should investors think about where the transformation could occur?

Well, I will make my comment here, then I will let Oleg add to it, since he has only been here -- you know, around the office for a day or so here.

Over the last six months, we have spent a lot of time digging into all the product lines, and all the opportunities, where we invest; and a couple of the conclusions from that are: first and foremost, I believe our core instrument business, the portfolio we have today, with maybe some slight adjustments here and there -- but basically that portfolio has a lot of potential in it. We showed that this quarter, and we believe we have more.

We are still not fully reaching the edge of the reach for the Company. So we are making investments, frankly, to improve revenue. We believe we could take our instrument technology in other segments, where there is growth; wireless -- we still have more opportunities. So I would like us to think about the instrument business as a slow-growth market, where I believe we could grow with the market for better.

On the assurance side of the business -- let me go to enterprise, then, for moment. So we have made some investments in enterprise. We are delivering growth there. I believe we have more we could clearly do in bringing network technology and expertise to the data center and the cloud. And I think that is something we will continue to work on and invest in. And we are building a stronger go-to-market there today so that we can capture a bigger part of the market. But that is already starting to show good results.

And then, in the assurance business, which is where we've had this challenge of some decline in the traditional business and the growth segments, I believe that we have -- it's a faster-growing market. We have a very strong set of technologies. And we are building that capability which will, I think, represent a longer-term growth opportunity.

So that is how I think the portfolio is. Now what we have to do is, in addition to driving that growth across the segments, as I've described, we have to become more efficient. We have talked about simplifying our structure, focusing our R&D investments, and doing a number of things that gets our operating expense structure to the point where the combination of that and some revenue growth will deliver a really nice profit improvement.

And I would just lastly say that within all of that, we have some decisions to make. We have some work to do. We have some investments. But I think we are going to -- as I said, at least up till now, my view was that we could do those in steps. We could incrementally make improvements and changes. But we don't want to take our eye off the opportunity to win in the market, to grow business -- because we're in a growth segment, and our results should reflect that.

Thank you, Rick. I very much second what Rick just mentioned, but I think it's a bit too early for me to give you the prescription and exactly what I'll be doing. I think within three months, I will be able to provide you with a lot more color.

But generally, everything starts with the top line. And first and foremost, you really need to focus on taking back some share. And I think Rick very well pointed out that there is opportunities for us to gain the share back. And we are in the growing markets, and we should reflect it.

But, also, the second part of the equation is meaningfully improving the OpEx productivity. Viavi is a very gross-margin-rich Company. It operates in the markets that, in many ways, pay premium for excellence in technology and service. But we also have to be mindful of at what cost we deliver these technology and services; and, more importantly, we make sure that the money that we spend beyond the operational support of our businesses is spent in a focused manner; spent aggressively, where we can make meaningful movements in the needle on the market share and the growth; and, also, execute well in the R&D and other functions in the Company. So all these things taken together -- to me the ultimate reflection of improved shareholder return is growing the bottom line, which is the operating income.

I would also mention on OSP, you know, we view OSP as a growth opportunity as well. There is some significant technology there. We've applied it to a very attractive market; and yet we think there's a lot more going on there.

So that's another new approach we've taken, is -- how do we take that strength and find segments where we could also grow? So I'd like everyone to think about Viavi not as a -- purely just as a cost-cutting story. There is some of that, but I certainly believe we have a lot of growth potential. And we have more work to do to make sure we can deliver that in our results.

Great. And then for my follow-up, I just want to dig in on the SE segment, trying to understand revenue, and demand, and margin. I guess on the revenue side, could you help us understand the relative size of the assurance business? It seems like the sequential downtick and year-over-year downtick is quite aggressive, just given what I thought was the relative size of the assurance business.

On demand, you've had a couple of competitors that have talked about a noticeable shift in service provider sentiment, just in the last few weeks, on the negative side. I am curious if you have any commentary there.

And then on margin, Amar, you did talk about gross margin being due to lower returns. But I would assume that had a positive mix impact on software. So I am a little bit surprised on the magnitude of the downtick in gross margin and was wondering if you could give us a few more points as to the why? Thank you.

Let me just say something about the market. I will let Amar address the numbers. We are still building this business, so the big macro market trends may not affect us as much, and yet these projects are harder to close. And I think we would say that we feel we have a very rich funnel of opportunity. We are working -- probably our funnel is, in the next six months, as big as it has been. It takes longer to close business, and maybe that's a reflection a little bit on the economic environment.

But where we have had some wins, we really do have unique capability; customer feedback is very enthusiastic. It is just -- it takes longer. And I think the market slowdown can potentially add to that. But we still feel that, given our size, we can push through here and make some meaningful gains.

So the first question, Patrick -- let me just see if I can address that -- the mix between assurance and the enterprise. It's roughly about 70% is assurance and 30% is enterprise in the SE space. And the 30% is growing.

Now, when you look at the assurance space, there are two portfolios in that. One is the new opportunities, which is actually -- if you look at first half, we grew very high double digits in that particular portfolio. And then the second piece is the legacy of the mature piece of the assurance portfolio that is running off very rapidly.

So on the reason why the margins were down is because the new piece of the portfolio, the growth opportunities -- the revenue is very lumpy. So we win deals; we basically book the order; in some cases, we defer revenue. As you can see, our deferred revenue in backlog position actually increased sequentially about 16% in SE business. And that revenue actually starts showing up once we deliver the solution and gain acceptance.

And when that revenue starts showing up, it comes in with a very high profit drop. So when you have periods where the lumpy revenue does not show up, you see pressure in your gross margins. And that is exactly what happened this quarter.

Great. Thank you for taking my questions and for the clarity. Good luck.

Rod Hall, JPMorgan.

Thanks for taking my questions. This is Ashwin on behalf of Rod.

I have one question for Rick. Your announced $100 million share repurchase program was just about, I think, 8% of your market cap. But as we look forward, how should we think about capital return program here? Are there any other assets you are planning to monetize? And is that included here in the $100 million program? And kind of tied to that, can you talk about visibility in the business now -- particularly on the NE segment? And then I have a follow-up.

I don't know if I followed your question on $100 million. Is the question --?

I was going to -- I was just trying to understand the rationale behind the program. Like, why did you make the announcement now? Do you feel like you have better visibility in the business? Also, going forward, how should we think about that?

Yes, so on that, I would say -- first of all, I am sure every -- this is my last day as a CEO, but I'm sure every CEO feels their shares are undervalued. We certainly feel that when you do a sum-of-the-parts analysis, however you want to look at it, that we are undervalued. So buying our shares back is not a bad decision.

We would also say that now that the spin is completed, we are a smaller company. And we also have got a lot of those costs behind us. And so given our improved results and all, we just feel it's a good step forward to take some shares off the table and to do a repurchase. We think it's a good time.

And as Amar said, we want to be opportunistic about it and make smart choices there. But we would certainly fully intend and are encouraged about moving forward to spend that money wisely and reduce our share count. So that's what I would say about that.

On visibility, you know, I think -- on one hand to me, I want to have caution, because I see all the things that are happening in the marketplace. I get concerned, of course, in the first-quarter -- calendar quarter -- about budget release and all these things. You know, having said all that, I think we would say that Q3 is typically a challenging quarter.

But I would say that we -- as we look at funnels, and we look at progress, we feel that we can stand behind the guidance we have. So we see a path there, and -- of course, or else we would not have provided it. So I think that the market is okay.

There are a lot of trends that are in the marketplace. We talked about DOCSIS 3.1, 100 gig, all of these trends that I think will lead to more instrumentation. And so we are excited about that. And I would also say I think we get some benefit by just the fact that, you know, this business used to be a lot larger for us. It has come down. And we are reasserting ourselves, to be clear.

And so our opportunity to gain business -- I think it is widely known we have good products in the industry. And I think that our sales and marketing capability is getting better. And so all of those things make us feel like we can be positive.

Thanks for the color. If I could follow up, your comment on the access market -- that it grew by about 50% year-over-year for you -- I just was curious to know if there are any specific targets of customer verticals -- is it Tier-1 driven, or is it Tier-2 or Tier-3 driven, where you saw the pick-up?

Yes, I will comment on that. So in the access side of the business, we saw major growth, as you mentioned; and we saw the xDSL sell side of that market really grow substantially -- both in the Tier 1, but also in the rest of the service provider market as well. We think over the next 12 months, we will see that increase, potentially, from new technologies like G.Fast taking off both in North America and Europe. So we feel very comfortable and moving forward on the access side of the business.

And we mentioned on cable -- that was down a little bit, because maybe a slight lull as we see DOCSIS 3.1 start to take off in spring this year.

Great. Thank you, and congratulations, Oleg.

Thank you.

Alex Henderson, Needham.

This is Josh Buchalter on behalf of Alex. Congratulations on the results, and thank you for taking my question. Firstly, obviously there has been work done to cut costs. Is there kind of a long-term target where you see OpEx, whether on a dollar basis or as a percentage of sales?

Amar, you want to take that?

Yes. So if I understood, you are looking for a long-term expense-to-revenue ratio? Is that what -- sorry, I couldn't hear you properly.

Yes, sorry. I sometimes have issues with the mic. Yes, I was mainly looking for some more color on, longer-term, how you think about OpEx -- whether there is a dollar goal or a percent of sales?

Yes, I think that is clear. Thank you so much. So let me just take it back to -- in my prepared remarks, I did mention that we made a tremendous amount of progress in our unlock program. So giving you a little bit more color there, we achieved almost 80% of the net targeted savings from the unlock program, which was spend-related restructuring. And if you think about it, how we achieved it, this was a result of multiple initiatives.

Now, we were rightsizing the organizations that came from JDSU to Viavi, a much smaller organization. We were also off-shoring certain sub-functions within IT and finance; and we were also driving nonlabor cost reductions.

Now, just keep in mind, this is still ongoing. And if you think about it, how we achieved it, this was a result of multiple initiatives.

Now, we were rightsizing the organizations that came from JDSU to Viavi, a much smaller organization. We were also off-shoring certain sub-functions within IT and finance; and we were also driving nonlabor cost reductions.

Now, just keep in mind, this is still ongoing. We have a lot of work to still do as we continue to execute on the remaining unlock savings program. Additionally, we have initiatives in place that we are working on around simplification, process standardization, automation, etc., which should also result into incremental savings over a period of time.

But also keep in mind that we will reinvest some of it back into the growth areas that Rick mentioned -- in growth areas such as channel, enterprise, and solutions -- because we have to be very mindful of where we make those investments. So we are focused, and we remain focused on improving our operating margin performance continuously. And that is how you should measure us. and we remain focused on improving our operating margin performance continuously. And that is how you should measure us. And we will give you more color and also a formal model during the analyst day.

Okay, great, thank you. And as my follow-up, we have seen some mixed data points from -- throughout the industry this quarter. I was hoping you could maybe characterize the macro environment. And also, how should we think about your normal seasonality heading into the March quarter? I know you mentioned it qualitatively, but any typical trend either way would be helpful. Thank you.

Yes, so let me start with the first -- the second question about seasonality, and then Rick can jump in on the macro if he has some commentary on that. So from a seasonality perspective, if you look at the midpoint of our guidance, which is $161 million in NSE revenue, it is actually down 11.3% sequentially. And when you compare with your historical three-year average, it is actually down about 9.8%. So, there is some conservatism in our guidance from that perspective.

And as Rick alluded to earlier, we also see a combination of the higher deferred revenue that we talked about earlier, our backlog visibility, and also rollover of a couple of bookings and shipments from Q2 to early Q3. That is providing us some reasonable confidence that we will be able to hit our guidance.

And I am sorry; I had trouble hearing the first part of your question.

Macro environment.

Yes, sorry, just about the macro environment. I apologize for that.

Yes, so on the macro side, if you look at it both from the carriers and the enterprise -- on the carrier side, we are still seeing capital spending and driving towards LTE and the buildout of the backbone, both on the front-haul and the backhaul from a fiber perspective.

We are also seeing, as you have heard earlier on, major uptick in our fiber instruments and lab instruments from the 100-gig build-out there. Though on the macroeconomic side, on the enterprise, we see some weakness there globally. However, because our market share there is still small and growing, that we don't see has impacted us in Q1/Q2. We've had very good growth, and we continue to see that moving forward.

Thank you. That's very helpful. And congratulations again.

James Kisner, Jefferies LLC.

I guess I just want to start again. People have asked this question in different ways, but I was hoping you would give a little more detail on the cost savings. You said that you achieved a significant amount of that, I think, [$40 million] (corrected by company after the call) in net annualized cost savings that you hoped to achieve previously by the June quarter. Could you kind of quantify how much? And also, should we interpret your comment on reinvestments of the savings that the visible portion of the savings is largely behind us?

I think what Amar said is that 80% of that --

80%.

80%.

-- $40 million number has been realized. I would just say that number was established a long time ago. We've made so many changes since then that we've embraced that. Those programs which affected G&A, R&D -- a number of areas which I think have been a part of our success here -- are the results. And we built on that.

And so I would not interpret that says that now we are going to invest, that we are finished with improvement here. I think we still believe that we have to improve our operating leverage and be able to continue to improve our productivity on operating expenses.

And just -- and what I have said is results reflect that; is that we are going to lead with G&A. We are following with R&D. And so G&A was down double digits. R&D was down single digits. But on the sales and marketing side, our first priority is to regain momentum. If you remember, in Q4 of last year, our NSE business was down in high double digits. We had a serious problem around revenue that -- job one here has been we have to turn that around.

And so we have turned that around. And so we did not want to be reengineering sales and marketing. In fact, we believe there are areas of investment. So I would see that program continuing, with continued work in both improving our productivity with R&D; the simplification programs to drive G&A; and a much slower response, and maybe even some investment here and there around sales and marketing, so we can increase coverage in some areas so that we can keep our revenue moving in the right direction.

Now, one thing I promised not to do, and I haven't done since I've been in this job for six months, was to make commitments that were outside of my range of influence. So one of those areas is around our operating expense structure in our business model. And I think that we've got to give Oleg a chance to get his arms around it and look at the business. And I think he shares the view that this business should be more profitable, and that is to take more work. But exactly what those levels are, you can expect us to communicate as soon as Oleg has a view on that.

Okay, that's helpful. Just as a follow-up here, you guys have talked in the past about trying to drive more software content in the business, both organically and inorganically. Recognizing Oleg is just joining here, but what are your latest thoughts on M&A and the status of the M&A funnel? Are you still actively pursuing acquisitions? Might you consider something larger to consolidate the industry, given the pullback in some valuations? I guess, relatedly, any updated thoughts on your plans for the Lumentum stake?

I am going to on M&A. I felt in the time when I returned to the Company that the divestiture took a lot of work, took a lot of capacity in the Company. And we have had a lot and still have work to do to integrate what we have done in the past and to really make fundamental improvements in the Company before we were in the M&A game.

And so that has been my horizon for the last six months. I didn't feel like it was time for us to do more. There are clearly opportunities to do things in the areas of enterprise, in the areas of assurance. There could be consolidation moves on the instrument side. But that is something that I have built a position on. And I would -- again, not to defer everything to Oleg, but I think that is another area that he will come to grips with and come up with a perspective on how we should move forward.

And I would add -- clearly, M&A is a tool in the corporate development. It is an important tool. But my feeling first and foremost is you have got to fix your house first. You've got to generate -- become as efficient as you can get, because if you acquire another company and you still have a lot of loose ends, all you are going to do is compound complexity. So I think first we've got to do is focus on getting us in order and becoming very profitable. And then we will definitely look wider and further.

Yes, and I would add -- part of my conservatism on M&A is, you know, I feel it goes back to the discussions we have had about sales and marketing. I think for M&A to work, you really have to have a strong sales and marketing platform, because you buy assets, and you want to be able to leverage those to higher volume than what they were when you bought them.

We struggled with that. And I think that my strong commitment around building sales and marketing was really partially built on the fact that we needed to have a strong go-to-market platform. I think the enterprise businesses is an example of that. Our initial acquisitions there did not perform well. We have invested in enterprise go-to-market, our sales capability, and channels. And now we are seeing those numbers improve and our results improve. So we want to keep moving on that and believe that's a requirement before other M&A would make a lot of sense.

That's great. Thanks --.

I'm sorry; on the Lumentum stake, you asked -- I think we're in a position today where legally we have the opportunity to sell, but we haven't made any decision. Again, I think it is something we will -- we are analyzing and going to sort out what the right choice is in our capital structure.

Great, thanks; and congrats to Oleg, and welcome. Thanks.

Dmitry Netis, William Blair.

Oleg, congrats on the exciting opportunity. Let's -- can I ask a question on the customer front? I think you gave a number on your top five customers last quarter. I was just curious what they had done in terms of the growth rate. I think it was up 40% last quarter. I'm just curious to see what the traction had been this quarter for those top five customers.

So, on the top five customers from a year-on-year growth, we saw growth of 50% this quarter on the NE side and a decline of about 25% on the SE side year-on-year.

And so overall, I think, NSE -- it grew 14%.

Overall we grew 14%.

NSE as a whole business grew 14% with our top five customers.

Great. That's very helpful. Then, on spending, your customers -- your top Tier 1, 2 customers -- as you go and kind of ascertain the spending environment there, you look at sort of the CapEx numbers being put out there by some of the -- you know, Tier 1 is closely watched, which are pretty healthy and pretty robust coming into 2016. You have put something in your press release as far as the macro concerns you may have.

I was just curious if you can reconcile that. Is there anything specific you see? Is there maybe a couple accounts that raised an eyebrow there? And how does that relate to the overall spending with your customer base?

I think we would share your view of the macro environment in terms of service providers. I think the environment is fine; and I would say that it's all about being in the right place, too, by the way. And we think we have a good story there.

But it's hard not to be concerned about the macro environment when you worry about currency, and you worry about potentially a pullback or a delay in budget releases, and all those things. Those things affect our business. And given all of the talk in the industry, we obviously have to be cautious.

I would say nothing, like, specific that we are concerned about -- any particular service provider or that there is some declining or narrowing of opportunity.

Okay, very good. That is what I was trying to get to. Okay, that's helpful.

And then, just the SE and NE -- and I apologize; I might have missed this, since I joined a little bit late. But how should we think about that mix as we progress through the year? I think you said book-to-bill in SE was about 1. You had a strong deferred revenue base there, which ultimately will translate into revenue. So are we looking for a strong back half of the fiscal year with SE? Is that a fair assumption? Just give us some color of how SE might trend.

So I think -- I am not going to give you guidance on the back half, but let me just give you some color on Q3. We believe that SE should sequentially improve its revenue from Q2 to Q3. We know that we are working on certain acceptances in a couple of our top-tier customers, and we are working towards gaining those acceptances. And that should basically show up in the revenue as deferred revenue. We could start recognizing some of those revenues. So we are expecting it to sequentially actually increase from Q2 to Q3.

Over the next couple of quarters, as our deferred revenue and increased VSOE deal volume converge to recognize revenue, that should improve our profitability, too.

Okay, excellent. And kind of related to the SE side -- and this is my last question, and I will cede the floor -- the service assurance market is quite interesting. And we were starting to see this transition to the virtual pro market as it relates to NFV and SDN kind of initiatives with some of the largest Tier 1 operators out there, which are your customers as well. And we are starting to see some smaller players getting in the game, and they are open to them, which is quite interesting.

So maybe -- it's a bit early, and maybe you'll share that with us at the analyst day; but I am just curious to see what gives them sort of the power to kind of move in ahead of some of the more established players like yourself? And why haven't we seen your strategy in that virtual NFV market pan out the way we are seeing it from some of the smaller competitors out there?

So let's start on the NE side. So we have been migrating -- well, let's say adding a lot of NFV functionality to our instruments, like TrueSpeed and TrueSite, which we have had available for over 18 months now that we have delivered to customers for that period of time, sort of already making a move there. So our instruments business, I would say we are actually ahead of the competition, the established competitors, on migrating that business toward virtualization.

On the SE side of the business, specifically on the assurance side of the business, we think we have a very strong capability against the established incumbents, who are still very hardware-focused, with a very small footprint of highly scalable cloud-based technology that is software-based. That we do think actually is a differentiation.

To your point, with a lot of the carriers, where some of them are looking at some of the newer startups, where we are seeing increased competition there -- we do actually think we are highly competitive on that side. And we saw, like, in the last quarter or two, three new logos that we have won over the last quarter or so. So we do think we actually are competitive to the new players against incumbents. So I think it is the incumbents today that need to really make the transition to virtualization.

Okay.

It's the first inning in this game. I mean, there is -- you know, there are going to be wins and losses, and just a lot of work and a lot of opportunity. But we feel good about our position.

All right. We will look forward to hearing more about that at the analyst day. Thank you guys so much.

Michael Genovese, MKM Partners.

Great, thanks. Firstly, just wanted to start with a clarification. I did not hear anything on OSP book-to-bill. And I also got confused about the NSE book-to-bill. So can you just clarify everything you said about book-to-bill so far?

So we did not give any information on OSP book-to-bill. But it's -- suffice to say it's greater than 1. That is the reason we are seeing this trend going into the second half, and that is reflected in our revenue guidance.

On NSE we said the book-to-bill was slightly lesser than 1. SE was [non-revenue] split, NE and SE. NE was less than 1; SE was actually greater than 1. And on the NE side, we were very good in executing all the bookings that were coming in.

So our teams across the board did a fantastic job in executing on NE in Q2. So we are comfortable with the backlog position we have in NE as we go into Q3. We have good visibility there. And so that's, again, reflected in the guidance.

And I think our comment about our -- tend to be more positive about OSP rest of the year reflects the fact that we can see -- you know, we have visibility to that, which was reflected in the positive book-to-bill.

Okay, I guess I'm confused, because I thought I heard you say that NSE orders were strong, and stronger than they have been since the March quarter of last year. But --.

That was SE bookings.

That was SE bookings. Okay, got it. Thanks for that clarification. I guess all my questions -- you yourself mentioned you think the stock is undervalued, some of the parts. And it seems like one solution to take care of that would be to monetize one of the parts.

And since we all know a lot about NE business, at least, as telecom equipment analysts, but we don't really know a lot about the OSP business, could you help us understand how monetize-able that is? How -- was it easy to separate? Are there -- do you think that there would be buyers out there that with want to buy that business, if it were for sale?

Just to make a couple of comments: first of all, we do run them as -- OSP is a fairly independent unit. It is a very different business. That would be point number one.

Point number two is, remember, we just completed a spin. And I could tell you that spins are not easy. So our focus was to have a successful spin of the Lumentum business, which we are pleased that the teams did all the successful processes that they have had. That is number two.

Number three is, hey, you know, the business is on an uptick. We are working to participate in that. And so we think the OSP business this year is much more valuable than it was last year. And we think that is a good thing.

And I would also point out: we did not talk much about NOLs, but remember, we also have a large NOL -- back cache of NOLs that make the OSP business particularly good for us. Anytime somebody buys it, it is immediately worth less, because they are going to start paying taxes. So we are working to make every part of Viavi more valuable.

And then I would again -- and to get -- and have completed the Lumentum spin. And I think now we need to obviously think about the future, what the strategy is. We have a new CEO who will engage, I am sure, in that process. But we are driving greater value throughout the Company and using NOLs to our best capability. And that right now is -- has been the plan for the Company.

Great. I appreciate that insert. One final clarification: just in the discussion of service assurance and the SE business, legacy versus next-gen, I did not hear any mention of geolocation. Is that still an area of focus?

Yes, so if we talk about the service assurance business and what we call SE, that has got three components in it. The enterprise that we talked about; the xSIGHT, which is kind of core mobile assurance; and then the local intelligence part is more on the RAN side of that. So we still actually have that business Location Intelligence portfolio -- sorry.

You go ahead, finish, yes.

So, our value-add actually is increasingly the combination of location intelligence and xSIGHT. That gives us a true indwelling mobility offering. And that drove, candidly, some of the wins you have seen over the last couple of quarters -- being that combination of our xSIGHT core mobility and our location intelligence RAM access. And that has driven a lot of our recent wins.

Yes, we had some new logos this quarter for our location intelligence. And we are extending that platform. I mean, there are new capabilities that we are building around to increase its value as well as integrating it around our overall assurance story.

Thanks for the questions.

James Faucette, Morgan Stanley.

This is Meta Marshall on James's line. A couple quick questions. If you could, just kind of give some context for some of the channel program changes that you made. I think we are looking to see -- did you change channel compensation to have them target new customers? Are there changes made to kind of add partners that would help you gain share? Just a little bit of context, since there seemed to be improvement on channel wins.

Let me make a couple comments, then I'm going to let Paul dig a little deeper on it. So first of all, as we have said, a lot of parts of our business, especially in the instrument area -- and then the enterprise business, of course, is being kind of diffuse. There are contractors doing service, and there are a bunch -- a move, we believe, over time that move the business not just to big service providers, but to smaller players geographically, to smaller customers. And so having a more capable channel for that and the enterprise business has been key.

I would say we were a little bit opportunistic about channel up until now. And I think with the Velocity program, we brought the program together, put the appropriate structure behind it around MDF funds and opportunity -- registration, and all the programs -- and believe that it has given us a much more serious, and we could see it reflected in our numbers, a much more serious and capable success there.

I would also say in addition to our program around Velocity, we also have put more effort into NEMs and other ways that we can leverage revenue through partners to reach customers rather than just doing it all ourselves. And so that has been area of particular focus in the last year. We have put investment behind it, funding behind it, a program behind it. And we believe it will help us reach segments of the market that we have not been very effective at reaching up until now.

So just adding to what Rick said: so, obviously, North America -- a lot of our business has been directory increasing and moving that through channel. And in the other theaters and regions, those, to Rick's point, have been a very spotty channel deployment. So we hired Sergio Bea about 9 to 12 months to lead our channel program.

As of a couple of months ago, as you're probably aware, we launched our Velocity program. That has three tiers of channel partner -- what we call authorized, premier, and elite partners. We have a contract-based revenue driven MDF to fund those partners. And we are continuing to sign those up at a rapid rate.

We have invested in channel marketing in every region to support those partners. On the sales side we have hired channel managers to help support those partners as they scale. We have released an update, did a major update to our channel portal and deliver content. We incent where we can those channel partners to leverage all the content -- the channel-ready content we have developed within the marketing team.

So, channel has been a very major initiative for us, critically important; not only in our instruments business, but as Rick said, for our enterprise investments that we've made to grow enterprise. As you know, that typically goes through channel, and that has been a big investment. So channel to date has been a big focus for us. And we started seeing the return on that the last quarter or so.

Great, thank you so much.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Bill Ong.

Thank you, Jonathan. This concludes our earnings call for today. Thank you, everyone.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.