Bill Ong - IR Amar Maletira - EVP and CFO Oleg Khaykin - President and CEO.

Patrick Newton - Stifel, Nicolaus & Company Dmitry Netis - William Blair Rod Hall - JP Morgan James Kisner - Jefferies & Company Michael Genovese - MKM Partners Alex Henderson - Needham & Company Richard Shannon - Craig-Hallum Meta Marshall - Morgan Stanley.

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 2017 Viavi Solutions Inc. Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [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 include 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 the website. I would now like to turn the call over to Amar..

Thank you, Bill. Fiscal Q4 Viavi revenue of 198.1 million exceeded the guidance midpoint. OSP revenue exceeded the guidance range due to better than expected demand in our anti-counterfeiting business while NSE revenue was below the guidance 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 Assurance and Data Center products. NSE operating expense in the quarter was 85.3 million, a reduction of 16.4% from 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 resulting 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 anti-counterfeiting 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 anti-counterfeiting pigments resulting from end customer inventory rebalancing that took place in the first half of 2017.

Despite revenue challenges in fiscal 2017, overall Viavi operating margin at 13.3% includes 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 the 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 one-time 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 portable 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 convertible 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 9th, 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%. Anti-counterfeiting product demand remains cyclical. We expect lower demand in first half fiscal 2018 and an expected 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 of 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 anti-counterfeiting revenue in our December quarter and a higher OPEX investments primarily in R&D for 3D Sensing will pressure OSPs 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 anti-counterfeiting 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 a share count to be approximately 235 million shares. With that I'll 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's slowdown that negatively impacted our customers.

The data center or enterprise products grew double-digit percentage from a year ago helped by several of our large deals that closed in the quarter. One element of our big NE focus SE strategy is to drive the consolidation in field instruments. Our recent acquisition of Trilithic is in line with our strategy.

Trilithic is based in Indianapolis and has been selling broadband instruments for over 30 years. Their portfolio nicely compliments 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 now to OSP, revenue for anti-counterfeiting products was higher than expected in Q4 driven by a stronger customer demand. Anti-counterfeiting is a cyclical business characterized by stronger first half calendar year followed by a weaker second half. We expect our anti-counterfeiting products to follow a similar cycle in fiscal 2018.

3D Sensing represents a major growth opportunity for OSP, the -- authentication using facial recognition is expected to be a key feature in the upcoming smart phones. With our differentiated technology and strong IP we are well positioned with all major OEMs. Fiscal 2017 was my first full year as the 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 over 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 will be participating at CITIC Securities CLSA Investor [indiscernible] and Morgan Stanley's [indiscernible] on August 22nd and 24th respectively. Mike, let's begin the question-and-answer session. We ask everyone to limit discussion to one question and one follow-up. .

[Operator Instructions]. Your first question is from Patrick Newton from Stifel..

Yeah, good afternoon Oleg and Amar, thank you for taking my questions. 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 and 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 two things; one is our lead time is fairly short, I mean in a matter of weeks.

So we don't -- unlike companies that make silicon and rely on foundries, I mean we don't have a three-four month lead time which by the way is very good because as you can imagine in this business forecasting from customer is very volatile, and if you're not – and 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, 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 how the acceptant [ph] works.

When you ship an optic component, you perform electrical and functional tests 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, but But only once the module is assembled and you get the acceptance that the module functionally works, you recognize the revenue.

So we ship our product into a hub, it gets pulled from the hub by the module integrator, they build the module which takes a very few days between the time they pull the parts and the time they final test them. But once they are final tested, the revenue is recognized.

So for us, we are 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 deminimus 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 zero to maximum, they are working their way up and obviously we are lagging exactly that ramp by about one quarter. So I expect already a nice revenue in the December quarter, and it will reach its full run rate in Q3, which is the March quarter for us. .

And if I can just add as we had committed to you guys that we will 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 2018 in 3D Sensing.

As Oleg mentioned, very less revenue in Q1, we will start ramping up from a revenue recognition perspective in Q2 but a full written in Q3 and Q4. So most of this revenue and significant portion of the revenue is expected to be recognized in the second half of fiscal, which is the March and the June quarter..

Great, I appreciate the details.

I guess as my follow-up question, the repurchase of the converts, I think is a bullish sign, is that would imply that you anticipate your stock to hit higher, but I'm curious as far as the decision to buyback the converts as opposed to just buying back the common stock given that the convert’s 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 now, 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 two and half 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 will 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 the 460 million of new converts, so we still have a billion dollars of converts out there. So we'll be quite opportunistic on how we buyback our converts going forward. We're not going in and buying a bunch, we have a good sort of plan in place that we're executing.

And we have been very opportunistic in the way we pick up those converts when we see a dip in stock price, etc..

Thank you for taking my questions. Good luck. .

Thank you. .

Your next question is from Dmitry Netis from William Blair. Your line is open..

Okay, thank you very much guys. I have two questions one NSE, one OSP. So starting with the NSE, you are guiding Oleg, 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 are setting the bar a little bit low to yourself and there is some potentially positive 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 that we are disproportionately exposed to the North American stand and mainly the tier one customers in North America.

And you know 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 there 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 stop spend or reduce spend measures in the June quarter and so far they're 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 news services and 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 are seeing very good traction there. We're 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 service.

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 and Latin America. So China is a specific story.

I mean there a lot of our business really goes to sell production test equipments for fiber module manufacturers and we all know that they have been seeing a big slowdown and it obviously impacted us.

On the other hand when we look at production test equipment for NIMS, the equipment manufacturers they actually are still buying pretty aggressively and we feel pretty good there.

So when you take all of these things together, just a fundamental impact of the tier ones really pulling back on the OPEX and CAPEX in North America, that's really what's hurting us the most in that space. Okay, so that is on the NE side..

Okay. .

You asked 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 that thing gets lifted and they start spending.

Obviously it will be a welcome upside for our NE revenues..

Okay, and did international still kind of grow in double-digits for you this quarter as it did last quarter?.

So the international -- Europe actually remarkably given all the indications 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 by model to the extent you are selling to NIMS, that business did really well but the big pull back was from the module manufacturers who build fiber optic modules given the current glock in the industry. So that inventory wears itself out. We expect in the second half of the year some of that spend to return. .

Okay, that is very helpful commentary. Let me move real quick on the….

I would say if I look at North America its telecom provider is tier one. 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 had to do with the consolidation I would imagine. So once you're through the consolidation….

Well you are right, consolidation drives a lot of it but there are certain things, they have a long-term contract for CAPEX, capital spending. And they cannot get out of those so they have to spend their 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..

Alright, that's very good commentary, thank you.

And then on the OSP is 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?.

So Dmitry I'll start and then I'll turn over to Amar regarding the operating margin. So it's $35 million to $45 million range revenue we gave, right. One thing is I'm not going to do is talk about the volumes because from there you can get my ASPs. Obviously I'm not interested in any of my competitors understanding my ASP structure.

But I think overall 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 Amar..

So I think let me for your modeling purposes Dmitry as you asked this question so, let me just give you a little bit of additional color on OSP. So as we said in my prepared remarks, the anti-counterfeiting pigment demand is cyclical. We'll see a low demand in the 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 was sequentially declined 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 a 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 anti-counterfeiting as well as the 3D Sensing revenue. So we do expect a second half bounce back in anti-counterfeiting.

We have some limited visibility to be honest so we cannot accurately predict the magnitude of recovery in anti-counterfeiting. 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 perspectives.

And as you know a philosophy on how we talk to you guys and the Street and guide has not changed in the last two 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 roll through the year. .

Okay Amar, appreciate it. Keep up the good work guys. Thank you. .

Thank you. .

Your next question is from Rod Hall from JP Morgan..

Yeah hi guys, thanks for the question.

I just wanted to start with the I guess 3D revenue again and see if you guys could talk a little bit about the linearity of that December quarter, do you expect it to be heavily weighted toward December or do you think it’s kind of just thought if you could 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 the March quarter is equal to or is it even possible it is higher than the December quarter and then I have a follow up?.

Yes, so Rod let me let me take this and Oleg will jump in here. So I think that's a great question. So December quarter -- so the total is 35 million to 45 million for the full year. A 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 2018.

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 a 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 to you guys later..

And if you just look at the 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 zero to maximum capacity. They kind of step up at over like 8 to 12 weeks.

So there is a gradual ramp and then it'll reach this kind of the peak run rate and for us it is 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 the December quarter and that will be reflected in the March quarter of revenue perspective..

Okay 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 it happen sooner than that?.

Well I mean I think obviously we are ramping as quickly as we can, right. So I mean we have a -- I mean first we have a 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 start up has been fully already factored in and we're pretty satisfied with our yields, the quality, and the ramp. So we are doing pretty nicely in terms of the customer demand. .

And 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 is 100% at one customer at this point in time. .

Okay, and then can you just say on the tier one, has anything changed with respect to tier one broadband deployment plans, it seems like we pick things up for a multiple and people that are involved in that, including you guys now, it seems like there's been some kind of a change in terms of let's say home past plans in the last two or three months.

I'm just curious if you think that that is the case or is it just kind of typical budget control…?.

Yeah I think you have to bifurcate here. Let's talk about cable. I think cable is now not an issue, it's a ramping up. So tier one 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 thing is being managed. So, it is being somewhat deployed.

And fiber to the home I think there are a number of opportunities but they're mainly more of the 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. .

Okay, great, thanks a lot. Appreciate it. .

Sure. .

Your next question comes from James Kisner from Jefferies..

Thanks guys. So back on 3D Sensing, just regarding the competitor situation you mentioned not wanting to share pricing information. I mean it sounded to me like you've been pretty confident that pretty much all this year of this application in the near-term and I think -- you have some contracts to protect over a period of time.

But can you talk about just -- you have to begin and you still think you're going to have pretty much all of this year 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 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 hundred millions of filters and 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 without some quality performance yield and price. And so that's the goal we're going.

We're not going to maximize, we could have easily maximized our profit in the first two 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 one OEM and deliver the solutions they're looking for.

So you know what there's always going to be somebody who thinks they're going to grab a share. Let them go spend it but I'll just tell him 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 declines since volumes ramp, you see it is going to reduce costs, does that mean pricing should come down…?.

Yes and no, because unlike silicon you're not really living on Moore's Law. You have a fixed reactor, you have a certain process, and your throughput is not going to be that materially different from the time you start till the time you're running at maximum production right. So you yield and we're already started with a yield that is very nice, okay.

So, it's -- there's everybody can make one or two 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 am sure there's plenty of 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 does not violate our patents in trying to achieve a low angle shift.

So I think within 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..

Great, last clarification, just on -- you just mentioned and this is mostly all one OEM driving the near term opportunity.

I mean how would you characterize conversations with other OEMs with the BPCs or I’m certain obviously phones but also PCs or tablets, do you foresee that you’re going to see these ramp from those other folks next year or is it still kind of wait and see? Thanks..

Well, most of them are thinking 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 also more even -- and 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's not a single what I would call a tier one OEM or module manufacturer with whom we're not deeply engaged. So in that respect we feel our IP leadership and the early high volume production demonstration of capabilities positions us very nicely to maintain leading position in this market. .

But just to add to that you know Mike we are making certain OPEX investments including R&D just to highlight the point that Oleg made in trying to go capture some of market share out there.

So although in the bigger scheme of things the OPEX investments in OSP is not that material compared to what you see in NSE but we are making certain OPEX investments in the 3D Sensing and other opportunities within OSP..

Thank you very much..

Your next question comes from Michael Genovese from MKM Partners..

Yes, thanks very much.

My first question is about SE, this $30 million revenue level, is this the base that we should think about or as in fiscal 2018 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 two 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 where we can because it's a high margin business and we have been successful in many cases but we do expect that 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 2018.

And this is in line with what we have been indicating for the last few quarters. .

And it is kind of the near term, kind of mix from our guidance. Obviously we're 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 the 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 2018 the growth pieces within SE will be growing but it will be offset by the run off on the mature side. So it all explains the mature piece are soft. I think you should see SE growth piece starts growing, and not getting offset by the mature runoff..

Okay, thanks for that.

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, I mean are you still looking around there and what are your thoughts these days?.

So, I mean we're always looking around and -- 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're 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 revenue synergy or meaningful OPEX synergies. But also we're looking at some of the transformational opportunities as well. I mean I would say in the end, the two things you look at is one, the evaluation and the other one is actionability.

So in terms of big deals we don't see anything among public tiers that is actionable or attractive at current valuations. But there are a number of private opportunities that I think they look interesting..

Thanks for taking the questions Oleg and Amar. .

Thank you. .

Your next question is from Alex Henderson from Needham and Company..

So, I know you don't really want to go out here but clearly the question that is going to linger in people's minds is should we take the back half of FY 2018 as sort of the run rate for 3D Sensing as we go into and across FY 2019 or should we assume that there's some growth off of that back half rate on a half by half basis?.

Yes, so let me take this and I am sure Oleg will jump in here. With the limited visibility we have I would say maybe back half of fiscal 2018 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 the directionally right. Again we'll give more update as we see volumes pick up or as we role through the year. .

If you were to look out into in the 2019 and assuming that the other OEM's 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 will 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 pushing 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 some other competitors coming in, in that space. .

One last question if I could, on service enablement, have you now eliminated the losses from service enablement on a quarterly basis going into calendar 2018 or fiscal year 2018, I am just assuming that it is not 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 to profit in the June quarter? Congratulations..

Yeah slightly, it was not a big profit but it was a profit nonetheless..

First time in many years. .

Well that's great news, congratulations. Thank you very much..

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

Hi guys, thanks for taking my question well maybe just two quick ones. On 3D Sensing you talked about a 90 day lag between shipment of the product and acceptance of it.

Anyway you can detail or see any potential risk of non-acceptance assuming you've gone through some work on this but just want to get your sense of whether there's any material risk that we should be aware of?.

Well at this point we're not aware of I mean and by the way its lag is than 90 days.

I mean I think as the customer reaches full burn rate we expect this whole turnover really run like a con-bond with a much shorter lead times, it will ultimately will get back up to how many weeks of inventory they want to have in hub but I would say probably eight weeks is a good average to take.

In terms of the acceptance, as I said, the final task 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.

And 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 did some kind of the headcount reductions would you expect some productivity gains in OPEX, I wonder if you can give us any sense either qualitatively or quantitatively and over what period of time you expect those to occur?.

Yeah, 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, etc. So there's a big funnel of initiatives that we continue to execute.

Some of the savings we will start seeing in fiscal 2018, a lot of it in 2019 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 2018 if you just take your Q4 2017 exit of $94.5 million in OPEX at the Viavi level and you just annualize it, you will get to fiscal year 2018 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 added OPEX so we will see some additional benefit in OPEX in fiscal year 2018 and those additional benefit will really offset the OPEX that we're 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 you know -- I know it was an OPEX question but I just wanted to make sure that you understand that we will be driving on OPEX on a year-on-year basis given all the actions that we have taken so far.

We will continue to drive actions in fiscal 2018, some of that will get offset by the OPEX that will add on Trilithic and the long-term we continue to reduce our OPEX in fiscal 2019 and beyond. .

Okay, that's very helpful. Thanks for all the details guys. .

The next question is from Meta Marshall from Morgan Stanley..

Great, thanks guys. A couple of quick questions; first, your guidance for kind of Q2 on OSP of the low 50's including 3D Sensing that would kind of imply probably a mid to high 40's on the core OSP business.

And I know you guys mentioned it's normal cyclicality but 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, your anti-counterfeiting business? And then second, obviously tier ones are a headwind to the NSE business currently but just an update on what you're seeing and as far as the competitive environment or traction with initiatives to kind of turn around the core NE business would be helpful? Thank you..

So I will take the first question and Oleg will take the second one, Meta. So on the OSP business, I think we believe this is cyclical given the visibility we have.

It is similar to what you saw in fiscal year 2017 where 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 the December quarter last year. Similar phenomenon happening here, we do expect recovery in the second half although we have limited visibility.

We know there will be a recovery. 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..

Alright and 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 the de-emphasis 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 two to three years to materialize in terms of total revenue, so in this respect when I look at competitiveness everything that we have won they continue to ship and build. What I'm focusing on now more is in terms of what I can control versus what I can't 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 at are we winning or are we losing or are we coming on par with the competitors.

And at least best to my visibility today not only are we holding our own we are actually starting to take share back in a number of markets and a number of applications. So, those kind of the design wins or the program wins in due time will convert into a meaningful revenue over the next kind of 12 to 24 months.

So at this point in time I can't control whether they are spending money or not, what I can control is bidding on all the future programs that they're going to be deploying. And from point of competitiveness, we've come up very strong vis-à-vis the yield [ph]..

Got it, thanks guys..

The last question is from Alex Henderson from Needham & Company. .

Yes, I just wanted go back to the acquisition that you did, can you give us a little more granularity.

I mean you said this is tough 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 how it feathers into the model?.

So, I would 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 want to -- we're not interested in just taking each product line and start feeling it off because we're not going to be keeping track of every product line so on 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 external, what used to be a waste track. And they are literally couple of miles away from our design center in the Indianapolis.

But what they chose to focus on and what we chose to focus on are two different segments. If you look at Viavi products we are all the bells and whistles highly complex instruments that are used by network tech and things like that. They chose to focus more on the home market which is the installers and people who connect.

So their products are more point solution products or as ours are highly programmable, highly sophisticated equipment.

If we look at the markets in Europe, Latin America, and Asia they have a much different mix in terms of what they buy between complex all the bells and whistles products which Viavi does 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 they do analytics.

And that's an 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 they 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 are a leader in that space and we're going to integrate it into our existing products thus 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 channels 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 speaking [ph] of individual streams..

So Alex, so when you look at the Trilithic lagging 12 months revenue, they were in the mid $20 million. And if you just quarterize it, it's roughly about a little north of $6 million per quarter. We closed this business on August 9th so we have about one and half in our September, that's the stop period we're talking about.

And that's the 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 is -- that we had acquired its 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 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..

Great, thank you..

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