Viavi Solutions Inc (VIAV) 2017 Q4 法說會逐字稿

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to Q4 2017 Viavi Solutions Inc. Earnings Conference Call. (Operator Instructions) Thank you. I will now turn the call over to Bill Ong, Head of Investor Relations. You may begin your conference.

Thank you, Mike. Welcome to Viavi Solutions Fourth Quarter Fiscal Year-End 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 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 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 our 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.

Thank you, Bill. Fiscal Q4 Viavi revenue of $98.1 million exceeded the guidance midpoint. OSP revenue exceeded the guidance range due to better-than-expected demand in our anticounterfeiting business, while NSE revenue was below the guidance midpoint because of lower-than-expected NE demand. Viavi revenue declined 11.6% year-over-year with the NSE business declining 16.5%, partially offset by the growth of 1% in our OSP business.

Viavi's operating income at $29.8 million declined 1.3% year-over-year. Operating margin of 15% exceeded the guidance range and was up 150 basis points from a year ago despite lower revenue levels. This also represents a record-high operating margin performance since the inception of Viavi. Overall, Viavi's operating expenses declined 15.4% year-over-year or $17.2 million, driven by SE restructuring and expense reductions across the board. EPS at $0.12 exceeded our guidance range of $0.07 to $0.09.

Now moving to our Q4 results by business segment, starting with NSE. NSE revenue at $134.5 million declined 16.5% year-over-year, driven by a 17.6% decline in the NE segment and a 12.2% decline in the SE segment. NSE gross margin at 64.6% decreased 20 basis points year-over-year. NE gross margin of 63.6% declined 130 basis points due to lower volumes in our instrument products, while SE gross margins of 68.1% expanded 350 basis points, driven by favorable product mix in our issuance and data center products. NSE operating expense in the quarter was $85.3 million, a reduction of 16.4% from a year ago levels. This OpEx reduction helped mitigate the impact of the steep decline in NSE revenue as this business posted 1.2% operating margin, which was above the midpoint of our guidance range.

During the quarter, we continued to execute our previously announced SE restructuring plan. This restructuring, which is ahead of schedule and is now largely completed, resulted in a realized OpEx savings that is slightly above the targeted annualized savings of $35 million. As mentioned previously, we have ongoing productivity and efficiency initiatives within NSE to reduce expenses beyond this realized SE restructuring-related savings. In our fiscal Q4, NSE achieved a book-to-bill ratio of above 1.

Now turning to OSP. OSP revenue of $63.6 million increased 1% from year-ago levels, driven by a better-than-expected demand in our anticounterfeiting business. There was no meaningful 3D sensing revenue in our fiscal Q4. Gross margins at 58.6% declined 80 basis points related to product mix. Operating margin of 44.3% improved by 20 basis points from last year due to operating expense management.

Now moving to our fiscal year 2017 performance. For the fiscal year 2017, Viavi's revenue of $811.4 million declined 10.5% with revenue declining in both our NSE and OSP business segments. NSE revenue fell 12% year-on-year with both NE and SE declining 12% each. The NE business was impacted by weak North American service provider spending, while SE's revenue decline was due to restructuring of unprofitable product lines coupled with expected declines in the mature business. The OSP business in fiscal 2017 declined 6.4% from a year ago due to lower demand for our anticounterfeiting pigments resulting from end customary inventory rebalancing that took place in the first half of 2017.

Despite revenue challenges in fiscal 2017, overall, Viavi operating margin at 13.3% improved 50 basis points from fiscal 2016, driven by OpEx reductions of $58 million or 12.7% year-over-year. This OpEx reduction was primarily a result of SE restructuring and across-the-board expense management.

Viavi's fiscal 2017 net income of $94.1 million grew 4.6% from a year ago levels. EPS at $0.40 grew 5.3% compared to fiscal 2016 EPS of $0.38. The fiscal 2017 EPS of $0.40 included $0.01 to $0.02 of onetime benefit from other income and expenses.

Now turning to the balance sheet. Our total cash and short-term investments ending balance was approximately $1.45 billion with total net cash of $378 million. Operating cash flow for the quarter was $33.8 million.

During fiscal Q4, we sold 0.4 million Lumentum shares for a net proceed of $19.7 million with an average selling price of $50.55 per share. Our book cost basis on these shares is approximately $8.57 per share. As a result, we realized, a GAAP-only P&L accounting gain of approximately $16.5 million. As of the end of fiscal 2017, we have liquidated our entire position of Lumentum shares.

In Q4, we repurchased $0.4 million of Viavi stock at a cost basis of $10.62 per share, including commissions. Of the $150 million authorized share buyback, we have repurchased shares worth approximately $96.5 million to-date.

With regards to our original $650 million 2033 convertible note that is puttable and callable in August 2018, we have approximately repurchased $40 million in notional amount in fiscal Q4 2017 and an additional $63.5 million in notional amount to-date in fiscal Q1 2018. Our remaining 2033 note balance now stands at $561.5 million. Our total outstanding debt is slightly above $1 billion, which includes the recent $460 million 2024 note. We'll continue to be opportunistic in repurchasing our Viavi stock and retiring our 2033 convertible note.

Now on to our guidance. We expect fiscal first quarter 2018 revenue for Viavi to be in the range of $173 million to $193 million; operating margin at 12%, plus or minus 1%; and EPS to be $0.06 to $0.09. We expect NSE revenue to be at $130 million, plus or minus $8 million; with operating margin at 1%, plus or minus 1%.

On August 9, we closed the acquisition of Trilithic, Inc. Our NSE guidance includes a couple of million dollars in revenue and a small amount of OpEx from Trilithic for the September quarter stub period. Oleg will discuss more about this acquisition in his prepared remarks.

For fiscal first quarter, we expect OSP revenue to be at $53 million, plus or minus $2 million; with operating margin at 39%, plus or minus 1%. Anticounterfeiting product demand remains cyclical. We expect lower demand in first half fiscal 2018 and then expect a recovery in demand in the second half. Although we already started to ship 3D sensing products, we expect no meaningful 3D sensing revenue in fiscal Q1 due to revenue recognition timing. We do expect a modest revenue for 3D sensing in Q2 and reaching a full run-rate in Q3.

Overall, OSP revenue in the second half of fiscal 2018 is expected to be much higher than the first half. We also expect that a sequential decline in anticounterfeiting revenue in our December quarter and a higher OpEx investments, primarily in R&D, for 3D sensing will pressure OSP's operating margins in the short term in fiscal Q2. The operating margin for OSP is expected to recover in fiscal Q3 with higher volumes in anticounterfeiting and 3D sensing.

Our tax expense for fiscal first quarter is expected to be approximately $4 million. We expect other income and expenses to reflect a net expense of approximately $0.5 million and our share count to be approximately 235 million shares.

With that, I will turn the call over to Oleg.

Thank you, Amar. We had a solid finish to fiscal 2017. Our net income and EPS were both up year-on-year. Q4 came in at $0.12 EPS and exceeded our guidance range.

Stronger OSP demand and performance more than offset slightly weaker NE instruments results. While the June quarter is historically a seasonally stronger quarter for NE instruments, we were disappointed with the NE revenue that was up only 1.5% sequentially. Although the sequential increase for field instruments was positive, especially for cable driven by DOCSIS 3.1 deployment, it was more than offset by weakness in lab and production test equipment, particularly as a result of China slowdown that negatively impacted our customers. The data center or enterprise products grew double-digit percentage from a year ago, helped by several large deals that closed in the quarter.

One element of our Big NE, Focused SE strategy is to drive the consolidation in field instruments. Our recent acquisition of Trilithic is in line with that strategy. Trilithic is based in Indianapolis and has been selling broadband instruments for over 30 years. Their portfolio nicely complements Viavi's products and enhances our ability to gain share outside of North America. Trilithic's trailing 12 months revenue was in mid-$20 million range, and the acquisition is expected to be accretive in this fiscal year.

Moving on to OSP. Our revenue for anticounterfeiting products was higher than expected in Q4, driven by stronger customer demand. Anticounterfeiting is a cyclical business characterized by stronger first half calendar year followed by a weaker second half. We expect our anticounterfeiting products to follow a similar cycle in fiscal 2018. 3D sensing represents a major growth opportunity for OSP. Security authentication using facial recognition is expected to be a key feature in the upcoming smartphones. With our differentiated technology and strong IP, we are well positioned with all major OEMs.

Fiscal 2017 was my first full year as a CEO at Viavi. I'm pleased with the many transformational changes we initiated and the progress to-date. Some of the notable achievements include: First, successful restructuring of the SE business segment resulting in more than $35 million of operating cost reduction with minimum impact on our customers; Second, we secured technical, commercial and manufacturing leadership position for Viavi in the emerging 3D sensing market; Third, we revamped and streamlined our product line management sales and R&D leadership organization; And lastly, we launched corporate development strategy to drive operational scale and monetization of NOL assets by acquiring Trilithic this month.

In conclusion, I would like to thank my Viavi team and express my appreciation to our customers and shareholders for their support.

I will now turn the call over to Bill.

Thank you, Oleg. This quarter, we'll be participating at the CITIC Securities-CLSA Investor Bus Tour and Morgan Stanley's Valley Bus Tour at our Milpitas office on August 22 and 24, respectively.

Mike, the let's begin the question-and-answer session. (Operator Instructions)

(Operator Instructions) Your first question is from Patrick Newton from Stifel.

I guess my first one is just on the 3D sensing and the timing of your revenue ramp. If we just look at what we've heard from other suppliers in the supply chain, you seem to be a little bit later. So perhaps you could help us understand your lead times and maybe give us little more detail on when your filter is incorporated in the supply chain, whether at the wafer level, in the actual module or are you coding on the optics that could occur post assembly that would explain some of the rev rec differentiation?

Sure, Patrick. Well, I think I've talked about it before. But let me -- first of all, we always said the timing of shipments was really going to be December quarter. And we've been saying it for over a year. So I think -- I don't want to toot our own horn, but I think our expectations and guidance were spot on as well as the volumes. In terms of recognition, we supply a filter, so it's a passive component. As such, there's 2 things. One is our lead time is fairly short, I mean, in a matter of weeks. So we don't -- unlike a company that makes silicon and rely on foundries, I mean, we don't have a 3, 4 months lead time, which by the way is very good because as you can imagine, in this business, forecasting from customers is very volatile and if you're not -- if you have a long lead time, which on one hand is good because you recognize revenue earlier. On the negative side, you may get stuck with a lot of obsolete inventory. So in that respect, our risk of obsolete inventory is very low, but also, our revenue recognition is delayed as such. So on one hand, we have a much shorter lead time, matter of weeks. The second one is one how the acceptance work. When you ship an optic component, you perform electrical and functional test before you ship it. So the moment it hits a hub, you recognize the revenue. When you ship a filter, you do not know if that filter functionally works until you mate it with the rest of the module and functionally test the module. So only once the module is assembled and you get the acceptance, the module functionally works, we recognize the revenue. So we ship our products into a hub. It gets pulled from the hub by the module integrator. They build the module, which takes very few days, between the time they pull the parts and the time they final test them. But once they final test it, the revenue is recognized. So for us, we're already active in this quarter. We are actively ramping up and shipping the products. Most of them will start getting pulled probably already in September. So we'll get some de minimis revenue in September. But really that whole thing is going to ramp up through the December quarter and will reach its full run-rate in the March quarter. And the run-rate is really driven -- ramp is more driven by customer. As you can imagine, as they start production, they don't go from 0 to maximum. They're working their way up, and obviously, we are lagging exactly that ramp by about 1 quarter. So I expect already nice revenue in the December quarter, and it will reach its full run-rate in Q3, which is a March quarter for us.

If I can just add, as we have committed to you guys that we'll give you more color on the whole 3D sensing opportunity in fiscal 2018. Patrick, we expect about $35 million to $45 million of revenue for fiscal '18 in 3D sensing. As Oleg mentioned, very less revenue in Q1. We start ramping up from a revenue recognition perspective in Q2 but a full run-rate in Q3 and Q4. So this -- so most of this revenue and significant portion of the revenue is expected to be recognized in the second half of our fiscal, which is the March and the June quarter.

Great. Appreciate the details. And I guess this is my follow-up question. The repurchase of the converts, I think, is a bullish sign. It would imply that you anticipate your stock to head higher. But I'm curious as far as the decision to buy back the converts as opposed to just buying back the common stock given that the convert strike price is substantially higher than the equity today. What drove the decision between converts versus buying the equity?

So I think -- so as we said, we'll be opportunistically buying back both the converts as well as our shares. And so we had put a plan in place to buy some converts. We did about $103.5 million of convert buybacks in the last, say, 2.5 months or so. We'll be very opportunistic going forward, too. We had bought a lot of shares in the March quarter when we did the new converts. We spent roughly about $50 million on share buybacks. And so we will continue to do share buybacks and we'll continue to do convert repurchase. We still have about $550 million of converts still outstanding out there, which is our old converts. And on top of that, you add $460 million of new converts. So we still have $1 billion of converts out there. So we'll be quite opportunistic on how we buy back our converts going forward. If we're not going in and buying a bunch, we have a good sort of plan in place that we are executing. And we have been very optimistic in the way we pick up those converts when we see a dip in stock price, et cetera.

Your next question is from Dmitry Netis from William Blair.

I have 2 questions: one NSE, one OSP. So starting with the NSE. You're guiding -- well, I mean, you're saying your book-to-bill is above 1. Guidance is coming in a bit lower than what you did last quarter. Can you just walk through the puts and takes there and what's causing pressure? What are the areas that you think still need to be worked out? And how do you think that's going to shake out through the rest of the year now that maybe you're setting the bar a little bit low to yourself and there's some potentially drivers that could upside the revenue as we go through the year?

Sure, Dmitry. So as you know, our NSE business has several components. There is the SE, which is software, and then there is the NE, which is instrumentation. And we are disproportionately exposed to the North American spend and mainly the Tier 1 customers in North America. And I tell you, I think even historically, September quarter is our bottom quarter in any case. But there is this fundamental reluctance or hold on spending, what I call, OpEx, CapEx. While the big players, they're digging trenches, they're laying fiber, the area where they really are holding back and managing their expenses is what you call the operational CapEx, which is the instruments for the field force. And we've seen a number of them put kind of a stop spend or reduce spend measures in the June quarter. And so far, they are maintaining it into the September quarter. Now eventually, these things, they have to open up because they're spending a lot of money putting in infrastructure. But ultimately, as you try to turn on the new services and new things, you need to start spending money. So we've seen a lot of that hold back in cable late last year or early this year. But now the cable is -- DOCSIS 3.1 is in full ramp mode and we're seeing very good traction there. We are still waiting to see spend on G.fast and fiber-to-the-home deployments even though everybody is talking about how many miles of fiber they're laying. Well, they're laying the fiber but they're not really turning on the circuits. So in that respect, North America has been very much a disappointment. That said, we've seen very nice growth in Asia Pacific outside of China, and I'll talk about China separately. And we've seen very nice traction in Europe so -- and Latin America. So China is a specific story. I mean, there, a lot of our business really goes to production test equipment for fiber module manufacturers. And we all know that they've been seeing a big slowdown, and that obviously impacted us. On the other hand, when we look at production test equipment for NAMs, the equipment manufacturers, they're actually still buying pretty aggressively and we feel pretty good there. So when you take all of these things together, just the fundamental impact of Tier 1s really pulling back on the OpEx, CapEx in North America, that's really what's hurting us the most in that space, okay. So that's on the NE side. Now you asked me about the upside. Well, to the extent -- right now, we're taking a fairly conservative view that, that trend will continue through the rest of this calendar year. And that's baked into our Q1 and kind of Q2 directional guidance. To the extent they -- that thing gets lifted and they start spending, it will obviously be a welcome upside to our NE revenues.

Okay. And did international still kind of grew in double digits for you this quarter as it did last quarter?

So the international, Europe actually remarkably, given all the vacations, was pretty robust. It was flat to slightly up. Latin America was fine. APJ, which is for us Asia Pacific and Japan excluding China, was up very nicely. And China was kind of, I'd say, bimodal. To the extent you are selling to NAMs, that business did really well. But the big pullback was from the module manufacturers who build fiber optic modules given the current glut in the industry. So as that inventory wears itself out, we expect in the second half of the year some of that spend to return.

Okay. That's very helpful commentary. Let me move real quick on the..

I would say if I look at North America, its telecom providers Tier 1 is -- I mean, on one hand, we have a very big share there. On the other hand, that's obviously been a curse for the past 9 to 12 months.

Right, right. Now a lot of it has to do with the consolidation, I'd imagine. So once you threw the consolidation...

Well, you're right. Consolidation drives a lot of it, but, there are certain things. They have a long-term contract for CapEx, capital spending, and now they cannot get out of those. So they have to spend money. But in return, to manage their earnings, a lot of them are putting severe restrictions on what you call OpEx, CapEx and other OpEx expenses. And a lot of the instrumentation for field falls under the OpEx for them rather than CapEx.

All right. That's very good commentary. And then on the OSP, it's kind of my last question there. The $35 million to $40 million of revenue opportunity that you guys have given us where we can start actually rolling some of that into our models, any other color as far as the unit volumes that, that could represent? And what are some of the other operational targets as far as the growth of operating margins that we could use as we build our models here?

Well, Dmitry, I'll start and then I'll turn over to Amar regarding the operating margin. So it's $35 million to $45 billion range of revenue we gave, right?

Yes.

One thing is -- I'm not going to do is talk about the volumes because from there, you can get my ASP. So obviously, I'm not interested in any of my competitors understanding my ASP structure. But I think overall, our -- while the operating profit in that business will be less than our usual OSP, it's going to be significantly above our corporate average. I don't know if you have anything to add to that.

So I think -- so let me -- for your modeling purposes, Dmitry, as you asked this question, so me just give a little bit of additional color on OSP. So as we said, in my prepared remarks, the anticounterfeiting pigment demand is cyclical. We'll see a low demand in first half and a recovery expected in the second half, similar to what we saw in 2017. So in Q2, the OSP core revenue will be at its lowest level. It will sequentially decline from the Q1 levels, and this decline will be partially offset by some additional revenue that will come from 3D sensing as we are starting to ship 3D sensing products in Q1. And so that should offset it. But overall, I think the total OSP revenue should be in the low $50 million range in Q2. Now since the volumes are low and we are also making some OpEx investments in R&D for 3D sensing and next-generation products, we will see the operating margins in Q2 to be somewhere in the mid- to -- so mid-30% and slightly north of mid-30%. However, this should recover in Q3 and Q4 in the 38% to 40% operating margin range as the volumes come back for anticounterfeiting as well as the 3D sensing revenue. So we do expect a second half bounce-back in anticounterfeiting. We have some limited visibility, to be honest, so we cannot accurately predict the magnitude of recovery in anticounterfeiting. But we do believe that the core business will be somewhere in the mid- to high $50 million range. And on top of that, you add the 3D sensing revenue to it. So that's what we are thinking from our plans perspective. And as you know, our philosophy on how we talk to you guys and the Street and guide has not changed in the last 2 years. We want to plan a bit conservatively and go execute aggressively, and that philosophy remains. And we'll continue to update you guys as we go through the year.

Your next question is from Rod Hall from JPMorgan.

I just want to start with, I guess, the 3D revenue again and see if you guess could talk about a little bit about the linearity of that December quarter. Do you expect it to be heavily weighted towards December? Or do you think it's kind of -- just give us anything you can on linearity there. And I'm also curious about the trajectory of quarter-on-quarter revenues in the March quarter. So is it possible that, that March quarter is equal to or is it even possible it's higher than the December quarter? And then I have a follow-up.

Yes. So let me -- so Rod, let me take this and Oleg will jump in here. So I think -- that's a great question. So December quarter -- so let -- so the total is $35 million to $45 million for the full year, okay. Significant portion of that will be in Q3 and Q4, which is our March quarter and June quarter, which is the second half of fiscal '18, and December being a modest revenue. So going from December to March, there will be a substantial jump in revenue for 3D sensing because we expect to ship a huge volume in our December quarter. But the revenue will actually start showing up after acceptance, which is typically 90 days window, mainly towards -- in the March quarter. So you should expect a substantial significant jump from December quarter to March quarter in 3D sensing revenue. And in June quarter, I think it will be flattish to slightly low. So we expect March quarter to be the highest level of revenue for 3D sensing as we see it today. But we will come and update you guys later.

And if you just look at revenue run-rate, Rod, I mean, what December reflects is kind of the trajectory of September quarter shipments. And as you can imagine, manufacturers, when they place orders, they don't take their production line from 0 to maximum capacity. They kind of step up at -- over like 8 to 12 weeks. So there is a gradual ramp, and then it will reach the kind of peak run-rate. And for us, we effectively look at it as a lag of about a quarter. So for us, really the first quarter of true full run-rate, we expect to reach maximum run-rate somewhere in December quarter. And that will be reflected in the March quarter.

Of revenue perspective.

Of revenue perspective, yes.

And is there anything that you could -- anything that you could talk to, Oleg, with regards to when you're kind of hitting peak in that December quarter? Is it really the month of December that you're at peak output? Or does that happen sooner than that?

Well, I mean, I think, obviously, we are ramping as quickly as we can, right. So I mean, we have -- I mean, so we have an ramp plan given to us by the customer. And we are keeping very nicely on that ramp with all the yields and everything. We are now -- I mean, I think our startup has been fully already factored in and we are pretty satisfied with our yield, the quality and the ramp. So we are doing pretty nicely in terms of the customer demand.

You guys are still 100% share or most of the share on the filters? Or what do you think your share position is?

As far as I'm concerned, it's 100% at one customer at this point in time.

Okay. And then can you just say on the Tier 1s -- has anything changed with respect to Tier 1 broadband deployment plans? It seems like we picked things up from multiple other people that are involved in that and including you guys now in test, it seems like there has been some kind of a change in terms of, let's say, homes passed plans in the last 2 or 3 months. Just curious if you think that, that is the case. Or is it just kind of typical budget control and delays and what have you?

Yes, I think you have to bifurcate here. Let's talk about cable. I think cable is now -- is not an issue. It's ramping up. So Tier 1 cable guys are deploying DOCSIS 3.1. And there, we see healthy instrument demand and pull-through. It's a bit different story in G.fast. While we do look at the DSLAM installation, they look pretty good and those are usually kind of leading indicators. We are seeing a slower deployment of G.fast instruments to the field force to turn on the circuits. And that is the piece, I think, that is being managed. So it's being somewhat deployed. And fiber-to-the-home, I think, there are a number of opportunities. But they are mainly more of kind of phase, kind of test marketing yet, and it's not in the kind of full deployment run rate. And we think that's probably going to be more of a next fiscal year story in terms of the next-generation fiber-to-the-home deployment.

Your next question comes from James Kisner from Jefferies.

So back on 3D sensing. Just regarding the competitive situation, you mentioned that one this year, pricing information. I mean, it sounded to me like you've been pretty confident that you pretty much have all the share of this application in the near term. And I think you said in the conferences you have some contracts to protect you for a period of time. But you talk about just (inaudible) again. Do you still think you're going to have pretty much all the share of this application and for how long?

Well, I mean, I don't know how long. I mean, we intend to keep as much of it as possible. And we have a number of elements in both commercial and technical differentiation that, for all practical reasons, position us very well. So there's a couple of things to tell you. Obviously, nothing is permanent in the world, but you start, first of all, with IP. Unless somebody has figured out how to do a low-angle shift filter without violating our IP, they can talk all they want about their share and we'll just see them in court. But if they do have it, it will be fine. But at this point -- at that point, we would have shipped 100 million filters in our manufacturing lines and our experience will be so much further ahead that they will be playing a catch-up. So our whole idea is to set up our pricing, our contracts in such a way that we exploit the early leadership to get further ahead in the economies of scale and the experience curve that it will be challenging for every Johnny-come-lately to catch up with us on quality, performance, yield and price. And so that's the goal we are going. We're not going to maximize. We could have easily maximized our profit in the first 2 quarters by charging much higher price. But what we decided to do from the very beginning is to aggressively defend our IP, grab maximum share based on our technical performance and then drive aggressively down the experience curve to position ourselves in such a cost position that we are able to sweep every major Tier 1 OEM and deliver the solutions they are looking for. So hey, you know what, there's always going to be somebody who thinks they are going to grab a share. Let them go spend it. But I will just tell them put up or shut up, show me the product and show me the money. And I've got both at this point in time.

I mean, do you anticipate pricing to kind of follow a normal kind of annual decline as volumes ramp, you see reduced cost? Does that mean pricing should come down (inaudible) over time?

Yes and no because unlike silicon, you're not really living on the Moore's law. You have a fixed reactor. You have a certain processing. Your throughput is not going to be that materially different from the time you start until the time you are running at maximum production, right. So your yield -- and we already started with the yield that is very nice, okay. So everybody can make 1 or 2 parts or a batch, but the trick is to be able to get that same yield over -- and the same uniformity of product over tens of millions of units, right. So now we don't have the ownership on the brilliance. I'm sure there's plenty other smart people in there. But you also have to look at the intellectual property protection, especially the patents that relate to the low-angle shift. And at this point, we have not seen anybody that has a technology that can -- that is -- does not violate our patents in trying to achieve a low-angle shift. So I think between all these elements, yes, I'm sure there is going to be some other players. Some of them may want to take a license. And we welcome discussions on that. But at this point in time, for foreseeable future, between our technological leadership, our operational leadership and the contractual structure of our agreements, I think we are very well positioned to drive -- capture and drive leadership in that particular application.

Last clarification. Just on -- you used to mention -- and this is mostly all 1 OEM driving the near-term opportunity. I mean, how would you characterize the conversations with other OEMs, whether they be PCs or certainly obviously phones, but maybe also PCs or tablets? Do you foresee that you're going to see decent ramp from those other folks next year? Or is it still, kind of, wait and see?

Well, most of them are taking wait and see and want to be a fast follower. Let's put it this way. We are engaged with every major manufacturing out there for both modules as well as the handsets. Some people will rely on module manufacturers to just buy a ready solution. Others want to do it themselves. But it's not just modules. You also got to look at the 3D sensing is going everywhere, automotive and so on. And all the -- everybody knows who's got the technology on the market. Everybody has seen everybody's samples. And when I said in my prepared remarks, there is not a single, what I would call, Tier 1 OEM or module manufacturer with whom we are not deeply engaged. So in that respect, we feel our IP leadership and the early high-volume production demonstration of capability positions us very nicely to maintain leading position in this market.

Just to add to that, we are making certain OpEx investments, including R&D, just to highlight the point that Oleg made in trying to go capture some of the market share out there. So although in the bigger scheme of things, the OpEx investments in OSP is not that material compared to what we see in NSE, but we are making certain OpEx investments in the 3D sensing and other opportunities within OSP.

Your next question comes from Michael Genovese from MKM Partners.

My first question is about SE. At this $30 million revenue level, is this the base that we should think about? Or in fiscal '18, are we going to see more impact from the focused SE strategy? Or is that behind us now?

So I think you should expect SE to decline for 2 reasons. One is as we have indicated earlier, the mature assurance business, which is within SE, will continue to decline. It is -- again, we are trying to renew contracts that we can because it's a high-margin business. And we have been successful in many cases, but we do expect that, the mature assurance business, to continue to decline. That is number one. Number two is as we restructured SE, we basically restructured unprofitable product lines. And so some of those revenues will also tail off. So what you should expect is SE revenue should actually decline in the high teens on a year-on-year basis and the mix of SE to -- as a mix of NSE, should be roughly about 20% of the NSE revenue. So NE would be 80%, SE would be 20% for fiscal year '18. And this is in line with what we have been indicating for the last few quarters.

And this is kind of the near-term kind of next [2 month] guidance. Obviously, we are making select investment in SE, but those are currently in the customer discussions, kind of design win phase. And as they materialize, it will probably decline in kind of next 12 months. And then to the extent our new initiatives are successful, it will start climbing back up.

That's a good point because even within fiscal '18, the growth thesis within SE will be growing. But it will be offset by runoff on the mature side. So it all explains when the mature piece runs soft, I think you should SE growth piece starts growing, not getting offset by the mature runoff.

Okay. And then on the NE, given this environment where we're not really expecting much growth there in the near term sequentially or year-over-year, what are the updated thoughts on consolidation in the space, whether that's buying the whole company or buying a product line or a division out of an existing public or private company. Are you still looking around there? And what are your thoughts these days?

So I mean, we're always looking around. But we also -- we have a pretty good discipline regarding what we want to do. We're not looking just to basically go on a crazy spending streak. I mean, we are very disciplined about the conditions and parameters we are looking for. We are looking at private companies. We are looking at public companies. Clearly among the things we're looking at where can we drive scale and take out either -- get either a revenue synergy or meaningful OpEx synergies. But also, we are looking at some of the transformational opportunities as well. I mean, I would say in the end, I mean, 2 things you look at is, one, the valuation and the other one is actionability. So in terms of big deals, we don't see anything among public peers that is actionable or attractive at current valuations. But there are a number of private opportunities that I think may look interesting.

Your next question is from Alex Henderson with Needham.

So I know you don't really want to go out here, but clearly the question that is going to linger in people's mind is should we take the back half of FY '18 as sort of the run-rate for 3D sensing as we go into and across FY '19? Or should we assume that there is some growth off of that back half rate on a half-by-half basis?

Yes. So let me take this and I'm sure Oleg will jump in here. With the limited visibility we have, I would say maybe back half of fiscal '18 would be sort of a run-rate going forward. Q3 might be unusually higher, but I think Q4 is when you will see some stabilization. So I would say at this point in time, with limited visibility, probably that's roughly directionally right. Again, we'll give more update as we see volumes pick up or as we get all through the year.

If you were look out into -- in the '19 and assuming that the other OEMs come involved, do you think that they could represent 25% to 50% of increase in the target market scaling? Or do you think that the primary customer is the bulk of the market for the foreseeable future?

We do see -- and I'll let Oleg also jump in here. We do see opportunities outside of this one customer. So I think we'll have to see how it all plays out. As Oleg mentioned, we are actively pursuing a lot of opportunities. Those companies are waiting on the fringe to be fast followers. Do we expect some other competitors to come into this space and get some market share? Yes. But in certain applications where we play on the high end, we think we have a very good IP and position in that space. There might be some low-end filters that might be used in certain types of applications. I would say you might see us some other competitors coming in, in that space.

One last question, if I could. On Service Enablement, have you now eliminated the losses for Service Enablement on a quarterly basis going into calendar '18 -- or fiscal year '18? I'm assuming that you saw a loss in the June quarter. But are we now profitable in that business going forward?

Yes. We are profitable in that business going forward on a fully allocated basis. So once we did the assurance business restructuring on a fully allocated basis, that business turned in profit for the first time in the June quarter.

Returned a profit in the June quarter, congratulations.

Yes, slightly. It was not a big profit but it was a profit nonetheless.

First time in many years.

The next question is from Richard Shannon with Craig-Hallum.

Well, maybe just 2 quick ones. On 3D sensing, you talked about a 90-day lag between shipment of the product and acceptance of it. Any way you can detail or see any potential risk of nonacceptance? It seemed you've gone through some work on this. Just want to get your sense of whether there's any material risk that we should be aware of?

Well, at this point, we are not aware. And by the way, lag is less than 90 days. I mean, it's -- I think as the customer reaches full burn rate, we expect this whole turnover really run like a kanban with a much shorter lead times. Ultimately, we'll get back up to how many weeks of inventory they want to have in the hub. But I would say probably 8 weeks is a good average to take. In terms of the acceptance, as I said, the final test is the ultimate determinant of revenue recognition. And at this point, we are satisfied with the yields and stability of our process. And we're not aware of any issues. In fact, actually many of the enhancements that we've done to our process have been able to improve the yield of the overall module, above and beyond what the customer has requested. So in that respect, we feel that our technology really stands out on its own.

Okay. Perfect. Great to hear. My follow-up question for Amar on the OpEx side here. You talked about some -- you've done some kind of headcount reductions but you expect some productivity gains in OpEx. I'm wondering if you can give us any sense, either qualitative or quantitatively, and over what period of time you expect those to occur.

Yes. I think those are more long-term commentary because we do have a number of initiatives right now that we are executing against in terms of improving our processes, implementing new systems, optimizing our expenses across sales, G&A, R&D, et cetera. So there is a big funnel of initiatives that we continue to execute. Some of the savings, we'll start seeing in fiscal '18, a lot of it in '19 and beyond because we have started to plan on how we can go achieve a more optimal OpEx structure in the long term. In fiscal year' 18, if you just take your Q4 '17 exit of $94.5 million in OpEx at the Viavi level and you just annualize it, you will get to fiscal year '18 OpEx, which is about sort of mid-single-digit decline on a year-on-year basis. That's a good way to look at it. Also keep in mind that as we did Trilithic acquisition, we did incur some OpEx, so we have added OpEx. So we will see some additional benefit in OpEx in fiscal year '18. And those additional benefit will really offset the OpEx that we are adding on the Trilithic side. But overall Trilithic will be profit accretive to both NSE as well as to Viavi. And at this point in time, we look at Trilithic as more of a revenue synergy play as well as improvement on COGS because given that -- the scale that we have in our NSE business, we should be able to drive meaningful improvement in their COGS structure in Trilithic. But I know it was an OpEx question, but I just wanted to make sure that you understand that we will be driving down OpEx on a year-on-year basis given all the actions that we have taken so far. We'll continue to drive actions in fiscal '18. Some of that will get offset by the OpEx that we will add on Trilithic. And the long term, we continue to reduce our OpEx in fiscal '19 and beyond.

Next question is from Meta Marshall from Morgan Stanley.

A couple of quick questions. First, your guidance for kind of Q2 on OSP of the low 50s, including 3D sensing, that would kind of imply probably mid- to high 40s on the core OSP business. And I know you guys have mentioned it's normal cyclicality, but it just -- is that the baseline level? Are we seeing kind of anything else more secularly or trends kind of as expected in the core OSP or anticounterfeiting business? And then second, obviously, Tier 1s are a headwind to the NSE business currently, but just update on what you're seeing as far as the competitive environment or traction with initiatives to kind of turn around the core, any business would be helpful.

So I will take the first question and Oleg will take the second one, Meta. So the OSP business, I think there is -- we believe this is cyclical given the visibility we have. It is similar to what you saw in fiscal year '17 in Q2 because of the inventory rebalancing that happened in fiscal Q1, which is our last September quarter. We saw a decline in OSP revenue in December quarter last year. Similar phenomena happening here. We do expect recovery in the second half. Although we have limited visibility, we know there will be a recovery. And the magnitude of the recovery is something that we'll know as we get into our fiscal Q2, which is our December quarter. So is there a secular downturn? We don't expect that, we expect it to be more cyclical, but we'll provide more color on that in Q2.

All right. And then regarding the competitiveness, I think if I would just kind of step back, several years back, as we said, [GDS] at that time, they've chosen to kind of deemphasize the instrumentation business and focus on the software. As part of this deemphasis, there's a number of programs that the company either did not bid on or did not really pursue. So obviously, as these things take about 2, 3 years to materialize in terms of the total revenue. So in this respect, when I look at competitiveness, everything that we have won we continue to ship and build. The -- what I'm focusing on now more is in terms of what I can't control versus what I can control. I cannot control how our customers choose to spend their money or when they choose to spend their money. What I can control is how we pursue all the new programs and opportunities. And what we are tracking and measuring and driving right now within Viavi is every time a new program comes on the market, I'm looking, are we winning or we are losing or we are coming on par with the competitors? And at least best to my visibility today, not only are we holding our own, we're actually starting to take share back in a number of markets and a number of applications. So those kind of design wins or the program wins in due time will convert into meaningful revenue over the next kind of 12 to 24 months. So at this point in time, I can't control whether they're spending money or not. What I can control is bidding on all the future programs that they're going to deploying. And from point of competitiveness, we come up very strong vis-a-vis the field.

Last question is from Alex Henderson from Needham and Company.

I just wanted to go back to the acquisition that you did. Can you give us a little more granularity? I mean, you said this is a stub period, what does the full quarter look like in terms of revenue and costs? Any kind of metrics around that so we can think about it feathers into the model?

So I'll give you a bit of a strategic color why we did it and Amar will give you the -- a bit more of a -- we don't to -- we're not interested in just taking each product line and start pealing it off because we're not going to be keeping track of every product lines, so on and so forth. If you look at the Trilithic, it's a very interesting product portfolio. I mean, obviously, we know this company extremely well. In fact, a lot of the people in it used to be part of what used to be Acterna, what used to be Wavetech, and they literally are a couple of miles away from our design center in Indianapolis. But what they choose to focus on and what we choose to focus on are 2 different segments. If you look at Viavi products, we are -- all the bells and whistles are highly complex instruments that are used by network and things like that. They choose to focus more on the home market, which is the installers and people who connect. So their products are more point solution product whereas ours are highly programmable, highly sophisticated equipment. If we look at the markets in Europe, Latin America, Asia, they have a much different mix in terms of what they buy between the complex -- all the bells and whistles products, which we have with us for the mature markets like Europe and North America and what they would like to use for their contractors because also, most of the market -- maintenance market in those geographies are done by contractors. So we had a hole in our portfolio in addressing the contractor space. With Trilithic, we are closing that gap and we are now going to go and take share in Latin America, Europe and Asia, in these markets where we have not played before. And that's actually a very nice growing segment. On the other hand, they also had a much stronger position in the cable network infrastructure space with the multi-unit residential unit buildings and things like that where do analytics. And that's the area we have not played and that's where they position us very well as well, giving us new products to put into our channels to sell to our existing customers. And the third one is they have a product line called leakage detection. It is becoming a major problem for a lot of cable operators as they boost the speeds and add more services. All the noise that gets into network from various parts of the network is causing a lot of interference, and the ability to detect the leakage and solve the problem is becoming very big. And for us, it's a very unique technology. They're a leader in that space and we're going to integrate it into our existing products with us, making them even more differentiated. So really from our perspective, when we bought them, the first and foremost rationale was the revenue synergies, being able to put products into our existing channel so we can grab more dollars. The second element was driving cost efficiency, mainly on COGS, with them. And we feel very positive about this particular acquisition. And I'll turn over to Amar to talk about -- just give you color on revenue, but I do not want us to get in the practice of peeling off individual streams.

Yes. So Alex, when you look at the Trilithic lagging 12 months revenue, they're in the mid-$20 million. And if you just quarterize it, it's roughly about $6 million. It's a little north of $6 million per quarter. We closed this business on August 9. So we have about 1.5 months in our September. That's the stub period we are talking about, and that's a couple of million dollars that I was talking about in my prepared remarks that's included within our guidance. Now the quarter may not be as linear every month. So we just -- just a couple of million dollars. But this is -- it's a business that we had acquired. It's profitable. It is -- the operating margins are much higher than what we do in NSE today. In fact, it is closer to the corporate average operating margins. So very profitable business. From a gross margin perspective, it is lower than NSE but a very low OpEx structure. And that's where our focus will be to go improve the gross margins given the scale we have and the buying power we have with NSE and drive revenue in those adjacent areas where there is no overlap.

This concludes our call. I will now turn it back over to Bill Ong for closing remarks.

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

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