Good afternoon, my name is Cheryl and I will be your conference operator today. At this time, I would like to welcome everyone to the VIAVI's Q3 Fiscal 2019 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Bill Ong, you may begin your conference..

Thank you, Cheryl. Welcome to VIAVI Solutions' third quarter fiscal year 2019 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 current expectations and estimations. We encourage you to review our most recent annual report and 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 supplemental earnings slide, which include historical financial tables, are available on VIAVI's website.

Finally, we are recording today's call and we 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 Amar..

Thank you, Bill. VIAVI's revenue at $265.2 million grew 21.3% year-on-year and reach the high end of our revenue guidance range. NSE Revenue at $205.4 million was above the mid-point of revenue guidance driven by revenue upside in our wireless and fiber products.

OSP revenue at $59.8 million exceeded the guidance range due to upside from both or anti-counterfeiting and 3D sensing businesses. VIAVI's operating margins at 14.7% exceeded the high end of our guidance and was down 50 basis points year-on-year. EPS at $0.13 reach the high-end of the guidance range and was flat versus a year ago.

Now, moving to a reported Q3 results by business segment starting with NSE. NSE revenue at $205.4 million grew 31.3% year-on-year. Within NSE, annual revenue at $180.5 million increased 42.7% from a year ago levels.

This growth was a result of the acquired AvComm and Wireless businesses and the organic growth in our fiber products across both lab and field instruments. This increase was partially offset by declines primarily in our cable products from a year ago peak levels due to the DOCSIS 3.1 upgrade cycle.

SE revenue at $24.9 million declined 16.7% from a year ago levels driven primarily from a decline in the data center product demand and from the expected runoff in our mature assurance products. This decrease was partially offset by an increase in our growth assurance products.

NSE gross margins at 64.1% decline 60 basis points year-on-year primarily due to gross margin declines in our SE business as a result of have lower volumes and an unfavorable product mix from the continued runoff of a high margin matured assurance solutions and declines in our data center products.

NSE operating margins at 10.1% increased 400 basis points from a year ago levels reflecting the favorable operating leverage from the addition of the acquired AvComm and Wireless businesses and ongoing cost management. NSE's book to bill ratio was below one.

Now, turning to OSP revenue at $59.8 million declined 4% year-on-year from lower 3D sensing revenue, partially offset by growth in our anti-counterfeiting business. Excluding the one-time impact of the revenue recognition in the prior year period, 3D sensing revenue grew significantly year-on-year.

OSP's gross margins at 51.5% declined 110 basis points from a year ago due to lower volumes and the expected under absorption of manufacturing costs from the plant idling of 3D sensing filter capacity. OSP's operating margin at 30.6% declined 740 basis points due to declines in gross margins as well as some targeted investments to support growth.

Turning to the balance sheet. Our total cash and short-term investments ending balance was $537.5 million. Operating cash flow for the quarter was $41.2 million. Of the $200 million authorized for share buybacks, we have repurchase shares worth approximately $146.3 million as of the end of fiscal Q3.

We'll continue to be opportunistic by repurchasing VIAVI stock to offset earnings dilution from stock-based compensation. Now, turning to our guidance. We expect fiscal fourth quarter 2019 revenue for VIAVI to $278 million plus or minus $10 million, operating margins at 16% plus or minus 1% and EPS to be in the range of $0.14 to $0.16.

We expect NSE revenue to be approximately $215 million plus or minus $8 million with operating margin at 11.5% plus or minus 1%. We expect OSP revenue to be approximately $63 million plus or minus $2 million with operating margins at 32% plus or minus 1%.

We are increasing our 3D sensing revenue forecast for fiscal 2019 from approximately $60 million to $65 million. Our cap expense is expected to be approximately $7 million to $8 million. We expect other income and expenses to reflect a net expense of approximately $2 million to $2.5 million. Share count is approximately $232.5 million shares.

And with that, I will turn the call over to Oleg..

Thank you, Amar. While the March quarter is a seasonally weak water for VIAVI, I'm pleased with the results of both NSE and OSP. Both business segments outperformed our expectations in both revenue and non-GAAP operating profits. In NSE, 5G market adoption has resulted in a year-on-year strength in our wireless products.

We also continue to see significant strength in our fiber products across both lab and field instruments. Cable revenue declined year-on-year from the North America peak cyclical demand for DOCSIS 3.1 in early calendar 2018. However, the cable demand improved quarter-on-quarter driven by demand from European cable customers.

SE business segment revenue perform below our expectations driven by weaker demand from the data center customers. That's said, we anticipate data center product demand to pick up through the rest of calendar year. Moving on to OSP. The anti-counterfeiting products performed in line with our expectations driven by steady banknotes reprintment.

In addition, we have a bank note redesigned pipeline which could drive upside to the steady state reprint forecast. However, the visibility into the redesigned currencies launch dates is limited. Our 3D sensing products were seasonally down in Q3.

We expect a small recovery in 3D sensing in fiscal Q4 and a strong rebound in growth in the first half of the fiscal 2020. Looking ahead into the fiscal 2020, we expect the secular growth trends in 5G wireless, fiber and 3D sensing that began last year to continue. Fiscal 2019 is a milestone year for VIAVI.

During this fiscal year, we have achieved ahead of schedule our turnaround goals that we outlined during the September, 2016 Analysts Day. We're now ready to launch the next phase of VIAVI's transformation. We will be hosting an Analyst Day event on September 12, 2019 in Santa Clara, California to outline our going-forward strategy and goals.

Please save the date and we will provide more regarding the event in the coming months. In conclusion, I'd like to thank my VIAVI team and express my appreciation to our customers and our shareholders for their support. I will now turn the call over to Bill..

Thank you, Oleg. Cheryl, let's begin the question-and-answer session. We also have to limit discussion to one question and one follow-up..

The first question comes from Alex Henderson of Needham. Please go ahead. Your line is open..

Thank you very much. So, I was hoping you could just talk a little bit about the cadence in the cable business and what you think things are going to look like as we get into the back half a little bit. I realize you only gave one quarter guidance.

But the guide that you gave here and the print you gave, it sounds like they're pretty much straight up the center line of expectations. So, I was wondering if you expect a little bit of better spend in the cable business in the back half of the year and what you're seeing in the service provider piece accordingly. .

Sure. Thank you. Listen, I mean clearly, when the deployment of new technology, new standards starts in the first several quarters, you have a huge demand, mainly driven by North American operators.

Once the initial deployment of by North American operators slows down, there are still a significant chunk of cable business for the new standard that comes out of Europe, Latin America, so on and so forth.

So there is some lagging factor here, but also in North America, once the deployment of the installation tools goes down, there are still a lot of other life cycle upgrades that happen such as fiber monitoring, network monitoring, leakage detection and other types of things.

I mean, it doesn't mean we grow our revenue with North American operators goes to zero. It just obviously drops off into more steady state run rate, which is below the peak levels. So, clearly, as a rule of thumb, I think the strongest demand in cable, you generally get somewhere in the middle of the calendar year, say June and the September quarter.

In the first quarter of the year there is delay for budgets releases and to the extent there's any unused CapEx left then you may see a pop in the fourth quarter. But generally, I mean, the cyclicality in our business is you see more product demand in the middle of the calendar year.

But in terms of the -- give you a quarterly run rate, it really comes down to who is spending and when and so on and so forth.

And reality, for us it's less the account managers that we have on cable providers, I mean they always have other ways to extract revenue in any given quarter by shifting to other products and different value propositions during the lifecycle of any given technology. .

So, is it just last year it was much more heavily front end waited and this year it's more linear or is that kind of a fair summary?.

Yes, I mean, last year I remember that's when the 3.1 DOCSIS started getting deployed in earnest by major cable operators in the North America. So, that drove significant peak demand. So, that's why when I say we look at our March quarter last year to this quarter, I mean, I look at our cable revenue this quarter, that's nothing to sneeze at.

It's actually-- we're pretty happy with that run rate. But when you compare it to a cable demand in March, quarter of 2018, it's significantly down because that was the first quarter where we saw a significant demand for handheld tools..

Your next question comes from the line of Vijay Bhagavath of Deutsche Bank. Please go ahead. Your line is open. .

We get this question asked by clients a lot, which is around the 5G field instrument opportunity and also any competitive differentiation or angle you can share versus your peer groups such as a Keysight would be very helpful. And then have a follow-up. .

Sure. I'll start and Amar can jump in. At this point, when we look at 5G, we really don't compete head to head with Keysight. If anything, I think there are 5G place complimentary to what we do. They're mainly focused more on the chip and board engineering and they have various instruments in the RF spectrum.

We're mainly focused on the in the lab, on the system test, system emulation. They will ship to the base station designers. And in terms of field instruments, I mean, Keysight is not really a major player in field instruments. So, there it will be more companies like [indiscernible], for example, or Rohde and Schwarz.

And for us, we are a relative newcomer to field instruments -- I mean in the RF space, but we have extensive expertise and market position in the fiber and wireline. That's said, we do significantly leverage our leadership in the system test and qualification test trying to introduce new instruments for the field deployment.

And while we are very early -- I mean right now it's very much trials, we have our field instruments pretty much with every major service provider are there undergoing evaluations.

And our hope is that as they transition from evaluation to the early deployment, our tool set and our workflow that we provide with our tool set will become a standard that they adopt for their broader technical installation force..

Perfect. A quick follow-on would be, in market and the demand trends are what they are, as you said, cable and just overall North American carriers.

Anything you could do, Oleg, Amar in terms of like portfolio realignment or perhaps M&A that gets you focused on where the demand is with the opportunities in terms of portfolio management and putting money to work?.

Well, sure. I mean, we always look at opportunities and we always look at organic growth opportunities and inorganic. It's always a decision make versus buy. And from that perspective, when we look at potential emanates not different from what we would do when we look at our internal opportunities. It's got to have a good business sense.

It's got to be a creative, it's got to have a reasonable risk return profile and things like that. So, with that in mind, that we always look at different things and if we find a good fit at the right price, obviously we do a deal.

But we also, as we have shown time and time again, we walk when the think a deal gets beyond the level that's reasonable..

Organically, just to do a little bit more color here, I think we've made a lot of progress in those two areas that we've been highlighting, fiber as well as wireless. And when you look at our portfolio today and when you just look at any, which is a core instrument business, wireless and fiber combined is more than 50% of the revenue.

And both as businesses have been growing organically. And when you even look at her fiscal Q4 guidance that we provided, it will be -- all will be organic growth. So, this is all segments NSE except for SE because of the mature assurance runoff.

All the other segments within NSE is going to grow organically year-on-year as well as the segments within OSP are going to grow organically year-on-year. So, I think just from an NSE perspective, we have a very good organic claim. We are making a lot of traction there..

That's right. And, in fact, we had a number of opportunities we saw and we've promptly increased R&D in certain targeted areas to grab extra five, six, seven, $8 million of 5G opportunities that required some additional investment. .

Your next question comes from the line of Jun Zhang of Rosenblatt Securities. Please go ahead. Your line is open. .

Thanks. So, I just wanted to get a little bit idea. Where's the stress coming from in the March quarter? And also, it looks like [indiscernible] better for the June quarter. And this DPS guidance is kind of in line with the [indiscernible].

Is there any increase on the opening cost or if there any impacts on the gross margin side for the June quarter? Thanks. .

So, I start with the March quarter and also do some color on the guidance. So, March quarter we saw a broad-based trend within NSE, mainly in our wireless and fiber business as I mentioned in my prepared remarks. And on OSP side, we saw strength in our anti-counterfeiting business, but also more importantly, strength in our 3D sensing business.

And so, if you note, we took our guidance up from $60 million to $65 million because we are seeing strength on the Android side building up. When it comes to guidance for the June quarter, we did take the revenue guidance up versus where the street was.

We also took our operating margin guidance up and so operating profit dollars or EBITDA is also up versus the street estimates. But we are also increasing our estimates on tax expenses. If you recall, our tax expenses are usually between 16% to 18%. And so, we are guiding through roughly about 18% tax rate as a percentage of PBT.

That's because some of the profit is landing in some tax jurisdictions where we have to pay tax. So, that's where the guidance is. The guidance is actually marginally up versus the street from a revenue and an EBIT perspective, although in line at the EPA. .

Got it. Thanks. My second question is about the 5G testing business. So, I think some people concerned with the 5G start deployment in a lot of countries and then the testing equipment demand is probably going to slow down in the networks started deployments.

So, what's your view about this cycle how the VIAVI plays in this whole cycle of 5G deployment? Thanks..

Well, so let me just kind of tell you how it works. So, in our system level test, so right now every time we sell a -- right now it's an engineering test. So, we deliver a rack and stack system with preloaded software. And this is what's driving the demand right now.

Once the production starts, the demand will shift towards load testing, where you are testing the network load and equipment load and its ability to handle traffic. So, it's a different type of test profile but the test demand we expect to be meaningful. But also, remember 5G standard is evolving.

So, there is a nonstop parade of new standards and new extensions and features that come out. And this will become a nonstop -- it becomes annuity revenue stream for us. So, for every system that we've sold since the beginning of 5G deployment up to now and in this quarter and next quarter we'll be sailing licenses for various software upgrades.

So, clearly, I mean maybe on the top line it will be lower revenue in some extent then when you're pressing through cost of goods of a rack and stack system, but on the operating margin contribution, it may actually be higher than what we have today. So, that's sad, when we look at this business, we'll look at it as a life cycle.

Clearly, early on there is a lot of demand for engineering testers. Over time it shifts to production testers and the software upgrades for new features and standard updates and then to the field instrumentation. And then the cycle repeats itself over and over.

So, that's why it's critical for us to bring out and build out a field instrument portfolio that will transition in terms of the volume ramps just as some of the engineering tester business starts to decline. But it's no different than if we look at the cyclicality in 4G and 3G.

That cycle is well understood and it's not that -- the fluctuations between troughs and peaks are not that far apart as some people may suspect. But to the extent that we also win big in the field instrumentation space, we may actually continue to grow our wireless business..

And then in addition to field instrument and instrumentation, we also extend ourselves into the insurance space too..

That's right. So there's also -- a good point, Amar. I mean, when we restructured our SE business, we left several points untouched than it's mainly exactly the technologies that are now maturing and entering the space.

As you go to 5G you need a different type of software for testing at the assurance level, at the service provider level for 5G networks. And 5G is proving to be a much more challenging than many people realized in the field deployment because it's quite different from 4G and 3G.

And we are already seeing significant requests coming in from customers as they struggle with various issues with the reliability and quality of communications. .

Your next question comes from Meta Marshall of Morgan Stanley. Please go ahead. Your line is open. .

Great, thanks. I think AT&T is kind of ending the original kind of homes passed on their fiber deployments and kind of moving on to the homes connected portion of the build out, kind of the direct TV build about.

So, just wondering, are you expecting to kind of see stronger fiber performance second half of the year from that or just if you can kind of speak to trends on fiber increasingly being connected to the homes? And then maybe second, just on RPC, is that any portion of kind of the stronger 3D sensing guide or just has it helped in building relationships? Just the impact of that acquisition would be helpful.

Thanks. .

Maybe I'll start on the AT&T question and Amar, you can pick up the RPC. So, you're right. I mean the AT&T spent last couple of years deploying fiber. However, when we think about connecting fiber to the home, it's not always fiber to the home.

We actually, believe it or not, are starting to see potential for companies like AT&T and others who now have a lot of fiber.

There is actually some near-term demands for G.fast products because many of these networks, they end just within 100 or so feet from the home and it's much more economical just to run the last distance with traditional like a G.fast technology rather than a fiber.

We do see a lot more fiber to the building in Europe because of the density of a subscriber. And density of European cities makes it much more economical to run fiber actually to the building. So, we are seeing more interest in fiber instruments in Asia and Europe in terms of connecting passive optical network to the building. And in the U.S.

we are seeing more of the typical access tools like G.fast and so on, as well as some of the fiber to the curb fiber tools being demanded. But it's not a big swing. However, given that companies -- North American service providers have been very low in the last year, any kind of pickup actually now gives us a meaningful tailwind versus a year ago.

And the question on....

Yes, on the RPC. So, Meta, I think the update on the forecast for 3D sensing has two components to it. One, definitely RPC because RPC is contributing to the upside. And number two, also we are seeing on the filter side, the demand has been a sort of stable at least in the last few months with the flagship customer.

But also, on the Android side, we are starting to see some pickup in demand. So, it is a combination mainly on the Android side where we have a pickup of demand as they ramp up both on the filter as well as in the diffuser side. So it's a combination of both. But RPC did add to the upside..

Got it. And maybe just on a follow-up to that, part of the intent with RPC was to grow relationships within the Android ecosystem. Maybe that hasn't been revenue today, but just where are you seeing? Are you seeing kind of that ability to leverage the relationships at RPC hat? And that's it for me. Thanks..

Sure. I mean, we actually have very good relationship on -- the same customers who buy our PC products were buying our filter product. So, in never respect, clearly, we are now a bigger share of mind for them because now we have two sockets that we address. I think our relationship with all the customers is very good.

I mean, my bigger things that I'm watching is to how fast is the Android ecosystem adopting 3D sensing and time of flight or structured light technologies because that's clearly ultimately what drives our demand. .

Your next question comes from the line of Samik Chatterjee of JP Morgan. Please go ahead. Your line is open..

Hi, this is Joe [ph] on for Samik. Just one question from me, guys. I was just curious to see what's driving the data center weaknesses for the past couple of quarters.

Is there any market share dynamics or technology changes that we should know about that's going on there? And then what has given you that confidence that that returns to grow our -- becomes more positive as we progress through the year? Thank you. .

Thank you very much. So, I think was twofold to put things in context, that data center business is roughly sort of little south of 5% of the world NSE business.

Now, what we saw in our March quarter, which is the beginning of the fiscal quarter for a lot of our customers, again, the budget release sort of delayed and so we saw a softness in demand for the data center products.

We have a very good product, we have a great team on the ground executing quite well, and we believe that as the demand starts picking up, we should be getting a fair share of market. So there's no market share loss. It just that the demand was weak.

We're also seeing that the size of the deals are becoming bigger than say a year ago or year and a half ago, which means it just delays the closing time. So, those are the factors. We are not too concerned about it. I think we have good product. We have a good team and we believe that as the demand picks up, we should get a fair share of market..

Your last question comes from the line of Dave Kang of B Riley FBR, please go ahead. Your line is open. .

First question, just kind of curious on the 3D sensing upside, can you maybe just talk about whether that $5 million is -- or the mix of the $5 million between the current quarter and the out quarter in terms of where that upside falls? Just kind of trying to overlay seasonality with incremental customer wins..

Yes. So, I think when you take a look at our $65 million, just to put things in context here again, and as I mentioned it even in my last call, two-thirds of that is in the first half and one-third of the $65 is roughly in the second half. And you should see from a fiscal Q3 to Q4, that number, the 3D sensing revenue is actually slightly growing.

So, we'll see some growth in that number from going from Q3 to Q4. .

Got it. That makes sense. And then I guess you guys kind always downplay the visibility and the bank note business, but calling out the pipeline, I would actually argue that that means you have a little bit better visibility.

Do you kind of expect the refreshes to occur in calendar '19 or is it a longer timeline in terms of pipeline for that business in terms of the new refreshes you guys talked about?.

Yes. So, I think you rightly said we have visibility of the pipeline for redesigns. The timing of those redesigns closing, is something that's uncertain.

So, what we are assuming, not for fiscal Q4, we've already given you guidance for fiscal Q4, but for rest of maybe first half of fiscal '20, we're assuming that the anti-counterfeiting business will be just the reprint volumes will come in, which is roughly plus or minus $50 million run rate. And if the redesigns come, it'll be on top of it.

But for our planning assumptions, we are just assuming reprint volumes in the second calendar half of 2019. It is likely that we can do better than that, but I think we always go with this assumption until we get more visibility..

Yes, so basically, whenever some Central Bank decides to launch a new note, it's an upside. And reality is we get no more than one quarter upfront disability. As you can imagine, central banks keep that information very tight to their chest. .

There are no further questions at this time. I would like to turn the call over to Bill Ong for closing remarks. .

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

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