Good day, ladies and gentlemen, and welcome to the Viavi Solutions Inc. Second Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Bill Ong, Senior Director, Investor Relations. Please go ahead. .

Thank you, Jonathan. Welcome to Viavi Solutions 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's 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 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 Rick. .

Well, thank you, Bill. I'm 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 continue to execute well in the first half of fiscal 2016 as we made progress in our long-term strategy to increase profitability. In half 1 of FY '16, we delivered revenue growth of 4.6% and operating income growth of 84.4% when compared to the first half of FY '15.

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 anticounterfeiting products that began in fiscal Q1. We expect robust demand in the anticounterfeiting 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 NE market share in Q2 with solid revenue performance from our Tier 1 service provider, the obvious 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 clear driver of success has been the strengthening of our sales and marketing teams. For example, we have seen a significant reversal of 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 is 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 snapback 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..

While having been interim CEO now for almost 6 months, I'm very pleased with the progress we've made -- we've 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 NE market share and are focused on aligning our investments and product developments to deliver continued growth through innovative solutions.

To a large extent, our improved performance has been the 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 the 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 in leveraging our strength in end-to-end assurance and further grow our customer base. In Q2, we added 2 new develop -- deployments for our -- 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 on ways to extend this core capability into the consumer, industrial and health care markets.

This journey to increase profitability and revenue growth is ongoing, but our execution in the past 2 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 remain 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 reduction in our G&A expenses and optimization of our R&D spend.

Recall, at our September 2014 Analyst Day, adjusted to exclude Lumentum, we set a net $40 million annualized OpEx savings target by FY '17. This savings target was measured related to fiscal Q1 2015 annualized OpEx run rate.

I'm 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 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 continue 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 5 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 under 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 feel 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.

So 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 3 quarters, we had a book-to-bill ratio of above 1, and all our deferred revenue and 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 anticounterfeiting business, driven by increased banknote 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 our 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 of up to 100 million of company's common stock to 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 benefit..

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 risk in our guidance and in our internal execution plans..

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

Well, thank you, Amar. Today, we're very excited to announce that Oleg Khaykin has been named CEO and Board Member for Viavi Solutions. His 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 an 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 résumé is impressive and includes roles as an adviser at Silver Lake Partners and operational roles at Amkor, Conexant and Motorola.

He spent 8 years at the Boston Consulting Group and has a BS in Electrical and Computer Engineering from Carnegie Mellon and an MBA from Northwestern. In short, Oleg has an ideal background to lead Viavi Solutions..

Over the last few months, Oleg and I have spent a considerable amount of time together discussing the opportunities and challenges at Viavi. I believe that Oleg will embrace the recent progress 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 6 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 6 months. He has made it easier for me to hit the ground running. And I'm very excited to be here and agree with Rick about the opportunities and challenges of 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 we begin the question-and-answer session, we originally issued a change of date notice 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. [Operator Instructions].

[Operator Instructions] Our first question comes from the line of Patrick Newton from Stifel. .

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's why you hired Oleg, does this transformation potentially consist of asset sales, exiting businesses or investing, acquiring to fix SE to accelerate growth.

I know it's very early but where should -- or how should investors think about where the transformation could occur?.

Well, I'll make my comment here, and then I'll let Oleg add to it since he's only been around the office a day or so here. Over the last 6 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 is -- has a lot of potential in it. We showed that this quarter, and we believe we have more.

We're still not fully reaching the edge of the reach for the company so we're making investments, frankly, to improve revenue. We believe we could take our instrument technology in other segments where there's growth. Wireless, we still have more opportunity.

So I would like us to think about the instrument business as a slow-growth market where I believe we can grow with the market or better. On the assurance side of the business -- or let me go to Enterprise then for a moment. So we've made some investments in Enterprise. We're 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's something we will continue to work on and invest in. And we're building a stronger go-to-market there today so that we can capture a bigger part of the market, but that's already starting to show good results.

And then in 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 the faster growing market, we have a very strong set of technologies, and we're building that capability, which will, I think, represent a longer-term growth opportunity.

So that's 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've 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 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're going to -- as I said, at least up till now, my view is that we can do those in steps, we can 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 3 months, I'll 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's 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 at what cost we deliver this technology and services and, more importantly, really make sure that the money that we spent beyond the operational support of our businesses is spent in a focused manner, spent aggressively where we can make meaningful movements in the needle in 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 churn is growing the bottom line, which is the operating income. .

I would also mention on OSP, we view OSP as a growth opportunity as well. There's 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. And so that's another new approach we've taken, is how do we take that strength and find segments where we can 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 those in our -- 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, 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 are talking about another full shift in service provider sentiment just in the last few weeks on the negative side. I'm curious if you have any commentary there.

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

Let me just say something about the market. I'll 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're working probably our funnel in the next 6 months as big as it's been. It takes longer to close business, and maybe that's a reflection a little bit on the economic environment. But where we had some wins, we really do have unique capability. Customer feedback is very enthusiastic.

It just takes longer, and I think the market slowdown can potentially add to that. But we still feel that, given our size, that we can push through here and make some meaningful gains. .

So the first question, Patrick, let me 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 piece, there are 2 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 or the mature piece of the assurance portfolio that's running off very rapidly, right? 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 booked the order. In some cases, we defer revenue.

As you can see, our deferred revenue and 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 doesn't show up, you see pressure in your gross margins, and that's exactly what happened this quarter. .

Our next question comes from the line of Rod Hall from JPMorgan. .

This is Ashwin on behalf of Rod. I have one question for Rick. You announced $100 million of share repurchase program, which is about, I think, 8% of your market cap.

But as we look forward, how should we think about $100 million program here? Are there any other assets you are buying to monetize? And is that included in your $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 the $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? And now do you feel like you have a bit of visibility in the business or -- I would say going forward, how should we think about that?.

Yes, so on that, I would say, first of all, I'm sure every -- this is my last day as the 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 and everyone will 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're a smaller company, and we also have gotten 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, I think, 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.

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, I mean, so we see a path there. And of course, or else we wouldn't have provided it. So I think 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're excited about that.

And I would also say I think we get some benefit by just the fact that this business used to be a lot larger for us, it's come down, and we're reasserting ourselves to be clear.

And so our opportunity to gain business, I think, it's 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. .

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

Yes, so I'll comment on that. So on the access side of the business, we saw major growth as you mentioned. We saw the xDSL 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'll see that increase potentially from new technologies like G.fast taking off both in North America and Europe. So we feel very comfortable on moving forward on the access side of the business.

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

Our next question comes from the line of Alex Henderson from Needham. .

This is Josh Buchalter on behalf of Alex. Firstly, obviously, there's 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, do you want to take that?.

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

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

Yes. I think that's 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, right, so give you a little bit more color there. We achieved almost 80% of the net targeted savings from the unlock program, which has spin-related restructuring.

And if you think about it, how we achieved it, this was a result of multiple initiatives. We were rightsizing the organization, it became from JDSU to Viavi, a much smaller organization while also offshoring certain subfunctions within IT and finance, and we're 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, et cetera, 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's how you should measure us, and we will give you more color and also a formal model during the Analyst Day. .

Okay, great. And then as my follow-up, we're seeing some mixed data points from throughout the industry this quarter. I was hoping you can 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. .

Yes. So let me start with the second question about seasonality, right, 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 3-year average, it's 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, a backlog visibility and also rollover of a couple of bookings and shipments from Q2 to early Q3, that's providing us some reasonable confidence that we'll be able to hit our guidance. .

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

The macro environment. .

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

Yes, so on the macro side, particularly both from the carriers and the enterprise. On the carrier side, we're still seeing capital spending driving towards LTE and the buildout of the backbone both on the front haul and the backhaul, and from a fiber perspective.

We're also seeing, as you've heard earlier on, major uptick in our fiber instruments and lab instruments from the 100-gig buildout 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. .

Our next question comes from the line of James Kisner from Jefferies LLC. .

So I guess I just want to start again. People have asked this question in different ways, but I was hoping you'd give a little more detail on the cost savings. You said that you achieved a significant amount of that, I think, $42 million in net annualized cost savings that you hope to achieve previously by the June quarter.

Can you kind of quantify how much? And also should we interpret your comment on reinvesting some of the savings that the visible portion of those savings is largely behind us?.

I think what Amar said is that 80% of that $40 million number has been realized. I would just say that number was established a long time ago, and we 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're going to invest, that we're finished with improving here. I think we still believe that we have to improve our operating leverage and be able to continue to improve our productivity and operating expenses.

And just -- and what I've said is, and results reflect that, is that we're going to lead with G&A, we're 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.

I mean we had a serious problem around revenue that job 1 here has been we have to turn that around. And so we've turned that around, and so we didn't want to be reengineering sales and marketing. In fact, we believe they're our 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 promise not to do and I haven't done since I've been in this job for 6 months was to make commitments that were outside of my range of influence.

And so one of those areas is around our operating expense structure on 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's going to take more work.

But exactly what those levels are, you can expect us to communicate as soon as Oleg has a view on them. .

Okay. That's helpful. And 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's 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 even introduce something larger, take consolidated industry given the pullback of some valuations.

And sort of related, your updated thoughts on your plans [indiscernible]?.

Well, I'll start 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've done in the past, 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 6 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 instruments side, and -- but that's not something that I've built a position on.

And I would, again, not to defer everything to Oleg, but I think that's another area that he'll come to grips with and come up with a perspective on how we should move forward. .

And I think just -- I would add, I mean, clearly, M&A is a tool in the corporate development. That's an important tool.

But my feeling, first and foremost, is you got to fix your house first, you 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're going to do is compound complexity.

So I think, first we got to do is focus on getting us in order and becoming very profitable, and then we'll definitely look wider and further. .

And I would add, part of my conservatism on M&A is I feel it goes back to the discussions we've had about sales and marketing, is 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 business is an example of that. Our initial acquisition there did not perform well.

We have invested in Enterprise go-to-market, our sales capability in channels, and now we're 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.

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

Our next question comes from the line of Dmitry Netis from William Blair. .

Oleg, congrats on the exciting opportunity. .

Thank you. .

Let's -- kind of ask a question on the customer front. I think you gave a number on your top 5 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 5 customers. .

So on those top 5 customers from a year-on-year growth, we saw a 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 5 customers. .

Great. Okay. That's very helpful.

And then on kind of spending of those -- your customers, like 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 Tier 1s 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 of 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. It's a -- 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're -- 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. So these things affect our business. And given all of the talk in the industry, we obviously have to be cautious.

But I would say nothing like specific that we're concerned about any particular service provider or that there's some declining or narrowing of opportunity. .

Okay. Very good. That's 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 1 -- about 1.

You had a strong deferred revenue base there, which ultimately will translate into revenue. So are we looking for a strong kind of 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'm 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'd 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, our deferred revenue will increase here. So when deal volumes converged to recognized 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'll cede the floor.

The service insurance (sic) [assurance] market is quite interesting, and we're starting to see this transition to the virtual probe 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're starting to see some smaller players getting in the game, and they're 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'm 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 sort of in that virtual NFV market pan out the way we're seeing it from some of the smaller competitors out there?.

So let's start on the NE side. So we've been migrating, and well, let's say adding a lot of NFV functionality to our instruments, like TrueSpeed and TrueSite, which we've had available for over 18 months now that we have delivered to customers for that period of time, so we're already making a move there.

So on our instruments business, I would say we are actually ahead of the competition, and we established competitors on migrating that business towards 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 and technology that's 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 have seen increased competition there, we do actually think we are highly competitive on that side and we've -- so like in the last quarter or 2 -- 3 new logos that we'd 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's the incumbents today that need to really make the transition to virtualization. .

I mean it's the first inning in this game. I mean there's going to be wins and losses and a lot of work and a lot of opportunity, but we feel good about our position. .

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

First, I just want to start with a clarification. I didn't hear anything in 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 didn't give any information on OSP book-to-bill, but it's -- suffice to say, it's greater than 1. That's the reason we are seeing this trend going into the second half, and that's reflected in our revenue guidance. On NSE, we said the book-to-bill was slightly lesser than 1.

SE was -- when you 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 the rest of the year reflects the fact that we can see -- 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've been since the March quarter of last year but... .

That was SE bookings. .

That was SE bookings. Okay, got it. I guess on my question, you yourself mentioned you think the stock is undervalued, sum 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 the 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 monetizable that is? Was it easy to separate? Are there -- do you think that there would be buyers out there that would want to buy that business if it were for sale?.

So I'll just make a couple of comments. First of all, we do run them. OSP is a fairly independent unit. It's a very different business. That would be point number 1. Point number 2 is, remember, we just completed a spin, and I can tell you spins are not easy.

And so our focus was to have a successful spin of the Lumentum business, which we are pleased that the teams did all the successful process that they've had. That's number two.

Number three is, hey, the business is on an uptick where we're 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's a good thing.

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

And then I would again -- 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'm sure, in that process. But we're driving greater value throughout the company and using NOLs to our best capability.

And that, right now, has been the plan for the company. .

Great. I appreciate that answer.

One final clarification, just on the discussion of service assurance and the SE business, legacy versus next gen, I didn't hear any mention of geo location, is that still an area of focus?.

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 inside of that. So we still actually have that business. So yes, that is still part of our portfolio.

And so our value-add actually is increasing with the combination of location intelligence and xSIGHT that gives us a true end-to-end mobility offering, and that drove candidly some of the wins you've seen over the last couple of quarters.

I mean that's a combination of our xSIGHT core mobility and our location intelligence RAN access, and that has driven a lot of our recent wins. .

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

Our final question comes from the line of James Faucette from Morgan Stanley. .

This is Meta Marshall on James' line. A couple of quick questions. If you could just kind of give some context for some of the channel program changes that you've made.

I think we're 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 seem to be improvement on channel wins. .

Let me make a couple of comments, and then I will let Paul dig a little deeper on it. So first of all, as we've said, a lot of parts of our business, especially in the instrument area, and then the Enterprise business, of course, is being kind of diffused.

There are contractors doing service, and there are a bunch -- a move we believe over time that moves 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's 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 NIMs and other ways that we can leverage revenue through partners to reach customers rather than just doing it all ourselves. And so that's been an area of particular focus in the last year.

We 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, in North America, a lot of our business has been directly 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 3 tiers of channel partner, what we call authorized, premier and elite partners. We have a contrabass [ph] revenue-driven MDF to fund those partners, and we continue to sum those up at a rapid rate.

We've invested in channel marketing in every region to support those partners. On the sales side, we've hired channel managers to help support those partners as they scale. We've 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've 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's been a big investment. So channel to date has been a big focus for us, and we've started seeing the return on that the last quarter or so. .

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..