Viavi Solutions Inc. (VIAV) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Viavi Solutions fiscal fourth quarter 2015 earnings conference call. [Operator Instructions] I would now like to hand the conference over to Bill Ong, Senior Director of Investor Relations. Please go ahead.

Thank you, Karen. Welcome to Viavi Solutions first earnings call, where we will discuss our fiscal fourth quarter and full year 2015 financial results. My name is Bill Ong, Senior Director of Investor Relations. Joining me today are Rick Belluzzo, Chairman of the Board; and Rex Jackson, CFO. Paul McNab, our Chief Marketing and Strategy Officer and CTO will join us for the Q&A. As many of you know, this afternoon we announced that Tom Waechter has stepped down as President and CEO of Viavi, effective today. Rick Belluzzo will serve as Interim CEO during the executive search process. Tom has agreed to assist Rick in the transition matters as we move forward. 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 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 otherwise stated, all results are non-GAAP. We reconcile these non-GAAP results to our GAAP financials, and discuss their usefulness and limitation in today's earnings release. The release plus our supplemental slides and historical financial tables are available on our website. Finally, we are recording today's call and will make the recording available by 4:15 Pacific Time on our website. I would now like to turn the call over to Rex.

Thank you, Bill, and welcome everyone to Viavi Solutions first earnings call, following the successful completion of the separation of our communications and commercial optical products business on August 1, 2015. JDSU's fiscal fourth quarter 2015 revenue was $427.7 million, down 4.7% year-on-year, but above our guidance midpoint of $423 million. CCOP, network enablement and optical security and performance products, exceeded their respective revenue guidance midpoints. Service enablement was $2.9 million below its guidance midpoint. Our consolidated gross margin was 47.8%, down 220 basis points from last year's fourth quarter, as OSP's strong 510 basis point improvement and SE's 10 point improvement were offset by CCOP and NE gross margin declines of 150 basis points and 180 basis points, respectively. We reduced Q4 operating expenses by 8.6% versus a year ago from $185.1 million last Q4 to $169.2 million this year. Operating margin was 8.2%, at the high-end of our guidance range, but 50 basis points below year ago, as lower revenue and gross margin were not fully offset by operating expense reductions. EPS at $0.13 was at the high-end of our guidance range, but down from $0.14 a year ago. For the year, revenue at $1.71 billion declined 2% from fiscal 2014's $1.74 billion, while gross margin improved by 50 basis points to a record 48.6% versus 48.1% last year. Operating margin at 8.7% was flat year-on-year, while net income of $126.6 million declined 4.9% from last year's $133.1 million. And EPS at $0.53 was $0.03 lower than last year's $0.56, both due to lower revenue levels. Turning to the business segments. We're covering CCOP's fourth quarter and full year here, since CCOP was part of JDSU for all of fiscal 2015. The Lumentum team will hold its own call at 2:30 PM Pacific today, during which they will provide their first quarter of fiscal 2016 outlook and take questions. CCOP revenue at $203.5 million exceeded our guidance midpoint of $202 million and was up 3.4% year-on-year. Operating margin at 10.4% was at the high-end of guidance and up 20 basis points year-on-year. Both optical communications and commercial lasers book-to-bill ratios were greater than 1. Optical communications revenue at $173.5 million was up 11.1% year-on-year. Optical communications' ASP declines were 3.1% sequentially, consistent with our expectations. Continued success in Datacom moved optical communications mix to 70% telecom, 24% Datacom and 6% consumer and industrial. Higher speed transmission revenue, defined as Telecom and Datacom 40G and 100G, continue to increase as a percentage, hitting 50% versus last year's 41%, with the balance being 10G speeds and below. Datacom revenue of $41.7 million was up 58.6% year-on-year and set another record, driven by growth in higher speed transmission products. Telecom revenues of $120.7 million were up 4.9% year-on-year, with growth in nearly all product lines, including notable strength in submarine products and from TrueFlex ROADMs up 18% sequentially. The consumer and industrial was down 23.9% year-on-year due to 3D sensing declines. We were pleased to see a 23.1% sequential improvement from Q3's low level, mainly due to improved 3D sensing revenue. Commercial lasers revenue at $30 million was down 26.3% year-on-year. Fiber laser sales were down due to continued customer inventory management through the quarter, and a component supply issue encountered in June, which impacted the production of one fiber laser variant, which has since been resolved. CCOP gross margin at 31.8% declined 150 basis points from a year ago, primarily due to an unfavorable product mix as commercial lasers represented a smaller portion of our net revenue than in the prior year. Optical communications gross margin was 30.2%, up 130 basis points year-on-year on higher revenues and improvements in product mix with a higher proportion of revenue from new Datacom and Telecom products. Commercial lasers gross margin was 41.3%, down 860 basis points year-on-year, mainly due to lower revenue levels and under utilization of recent manufacturing capacity increases. CCOP operating margin was 10.4% at the high-end of guidance and up 20 basis points year-over-year on higher revenue coupled with lower operating expenses related to restructuring activities executed in 2015. Full year CCOP revenues increased 2.6% to $815.1 million versus $794.1 million a year ago, primarily due to a 16% increase year-on-year in commercial lasers. Optical communications grew less than 1%, but excluding the significant decline in 3D sensing revenues from 2014 to 2015, the remainder of the optical communications portfolio grew 8% for the year. Operating margin for the year declined from 11.8% in fiscal 2014 to 11.1% in fiscal 2015, due to a decline in gross margin, driven by a less favorable product mix, including the impact of lower 3D sensing revenues in fiscal 2015, and to a lesser extent an increase in R&D spending, including key programs in 100G Datacom, TrueFlex ROADMs, kilowatt class fiber lasers and ultrafast laser products. Turning now to network enablement. Revenue at $137.6 million was above our guidance midpoint of $132 million. However, NE revenue declined 16.9% from last year's $165.5 million, due principally to lower Media Access and Content revenue and to a lesser extent lower revenue in Ethernet and fiber test. NE gross margin at 64.4% was 180 basis points down from Q4 2014's 66.2%, due to lower sales volume and product mix. Despite a 12% reduction in operating expenses versus last year's fourth quarter, NE operating margin at 16.1% declined 430 basis points on lower revenue and gross margin. Full year NE revenue declined 11.7% to $532.2 million versus a year ago at $602.4 million, primarily from significant weakness in MAC and Ethernet test demand and modest weakness in fiber test. Despite the revenue decline, gross margin at fiscal 2015 at 65.6% improved 80 basis points from a year ago at 64.8%. Operating margin declined 60 basis points to 17% versus a year ago due to lower revenue. SE revenue at $36.1 million was below our guidance midpoint of $39 million and 17.2% below last year's Q4 revenue of $43.6 million. The current miss is primarily from RAN Solutions and to a lesser extent from location intelligence, due to unexpected delays in project and development deliveries to gain customer acceptances and commence revenue. The year-over-year decline reflects the known and significant weakness from mature products together with our more recent timing issues on mobile assurance and analytics products. SE gross margin was effectively flat year-on-year. SE's operating margin loss increased 800 basis points from negative 10.8% a year ago to an 18.8% loss this past quarter, due to lower revenue. NE had a positive book-to-bill ratio, while SE was well below 1. As we've discussed last quarter, SE's deferred revenue and backlog mix shows continued percentage shift towards growth products and a decline in mature products. SE's growth products are defined as location intelligence, Enterprise, xSIGHT, Ethernet Assurance, PacketPortal and JMEP. Mature products are defined as legacy-assurance and wireline, protocol test and RAN test. Deferred revenue and backlog for SE's growth products increased by approximately 36% year-on-year, and was offset by an approximately 40% year-on-year decline in SE's mature products. While the mix between growth versus mature products has shifted from 45% to 55% mix last year to the current two-thirds, one-thirds, mature declined faster than our growth products grew in Q4 fiscal 2015. Our primary focus in NSE is to drive bookings, development, deliveries and acceptance is harder to get SE on track. Full year SE revenue increased to $169 million from $145.9 million a year ago, up 15.8%, due primarily to our Network Instruments acquisition. SE's gross margin increased 680 basis points to 68.2% versus a year ago at 61.4%, and its operating loss improved from 17.3% a year ago to 10.7%, both on higher revenue and better mix, reflecting the benefit from our acquisitions and newer software-based products. Turning to OSP. Revenue of $50.5 million was just above our guidance midpoint and up 18.5% from Q4 of last year. Book-to-bill was about 1. Gross margin at 55.8% rose 510 basis points from last year's 50.7%. Of this increase, approximately 340 basis points were due to significantly higher anti-counterfeiting revenue in the current quarter and a continued progress on manufacturing efficiencies. The remainder was due to a one-time 170-point benefit from a tax duty refund. Gross margin drop-through drove operating margin to 41.8%, exceeding our guidance range of 36% to 38% and increasing operating margin 850 basis points versus a year ago. Full year OSP revenue decreased 4% to $192.8 million versus $200.8 million a year ago, primarily due to last-time buys, as we exited several low margin product lines in fiscal 2014. Excluding the $23.8 million in last-time buy revenue last year, OSP's full year revenue increased 8.9% year-on-year. Fiscal 2015 gross margin at 54.1% increased 400 basis points from 50.1% from a year ago through the benefit of the last-time buy exit and improved manufacturing efficiencies. OSP's operating margin at 38.8% versus 35.9% reflects the aforementioned higher gross profit drop-through versus a year ago. Turning to the balance sheet. Cash increased sequentially from $815.5 million to $839.4 million with operating cash flow of $47.8 million for Q4. Regarding our $50 million cost reduction target, we continue to expect to meet that target, as we exit fiscal 2016, measured by comparing our Q4 fiscal 2016 annualized exit rate versus $500 million of total fiscal 2014 operating expenses for Viavi, which excludes CCOP, and includes $12 million to adjust for the fact that we acquired Network Instruments in mid-fiscal 2014. One final note, before turning the call over to Rick, as you all know, for fiscal 2014 and 2015 we split NSE into two segments, NE and SE. These two segments are still very different businesses, but overtime we expect our products to become more integrated and for this segmentation to be less relevant. Further and in immediate term, allocations have led to quarterly variances to such an extent that I have recommended to analysts that they put NE and SE back together again, below the gross margin line. With this in mind, going forward, we are planning to report NE and SE separately with respect to book-to-bill, revenue and gross margin, but to recombine them with respect to operating expenses and operating margin. I would now like to turn the call over to Rick.

Well, thank you, Rex, and welcome to our call. First, I would like to discuss our recent management announcements. As our press release relayed and Bill covered earlier, Tom Waechter stepped down as CEO, effective today. I have agreed with the Board to serve as Interim CEO full time, while we conduct a search process to determine a successor. After achieving the major milestone on August 1, 2015, of separating JDSU into two public companies, and leading the company through significant changes during his more than six year tenure as CEO, Tom will now be pursuing other business and personal interests. I would like to thank him for his many contributions and for being willing to support me through this transition. We also announced today that as part of the Board's ongoing assessment of the company's post spin-off, we will enlarge our Board from five to eight Directors, adding the new Chief Executive Officer and two new independent Directors. And then finally, late last week we announced that Amar Maletira accepted the position as CFO and is expected start on September 9. Amar has more than 20 years of experience in the technology industry. He served as VP and CFO of the Americas Enterprise Services group at HP, as well as other roles in FP&A and Investor Relations. He also served as a CEO of an IT consulting start-up firm and has spent time in sales. Amar has strong operation and financial execution experience that should help put Viavi on a profitable growth path, particularly as the NSE business undergoes continued transformation. Rex will remain with us through the end of Q1, but I would like to take this opportunity to thank him for the four-and-a-half years of service at JDSU, as CFO and SVP of Business Services, particularly for his key role in completing the separation. With the separation successfully completed, I am convinced that our strategy for both OSP and NSE are compelling, and this solid execution will lead to higher profitability and growth. My immediate focus will clearly be on NSE. Market and customer dynamics have been challenging for NSE, but our execution need significant improvement. I have confidence in our well-established NE portfolio and in the end-to-end solution strategy of our developing SE business. So we will pursue aggressively three priorities, improving our go-to-market capability and execution; continuing to make R&D investment decision to put Viavi in a stronger growth position; and better managing our cost structure and infrastructure to drive profitability. In NSE, we will quickly make changes and improvements to achieve these three priorities. In the meantime, we will simultaneously move the OSP business with a recent solid performance and strong outlook forward. Regarding my role, I have served under Board for eight years and as Chairman for the past two. As Interim CEO, I will leverage my relationship with the team and knowledge of the company to drive change and improvements right now. Now on to guidance. For NSE, we expect Q1 typically a seasonally weak quarter to be lower than expected due to continued low spend in our sales area from a key carrier account, the lighter bookings we saw in Q4 as well as the transfer of our WaveReady product line to Lumentum, which averaged $5 million per quarter last year. We expect NSE revenue to be $151 million plus or minus $6 million. Going forward, we are fully allocating all corporate costs, which increases OSP's expenses by approximately $7 million per year with the balance being allocated to NSE. Therefore, on a fully allocated basis, we expect operating margins for NSE to be a loss of 4%, plus or minus 2 percentage points. Switching to OSP, in addition to returning to quarters of $50 million or more, OSP is benefiting this quarter from additional orders triggered by reprints of currencies with large banknote volume requirements. Accordingly, we expect revenue to be very strong at $61 million, plus or minus $2 million, with operating margin again on a fully allocated basis of 40%, plus or minus 1 percentage point. We have good visibility for OSP's second quarter and expect it to be in the mid-to-high $50 million range. Fiscal second half is expected to return to more normal revenue levels in the low-$50 million. For Viavi, as a whole, we expect fiscal first quarter revenue to be $212 million, plus or minus $8 million and non-GAAP operating margin to be approximately 9%, plus or minus 1.5 percentage points. On a non-GAAP EPS basis, our guidance is $0.06 per share, plus or minus $0.02. Looking forward, we will focus on restoring our bookings to stronger levels, developing and converting more funnel for SE's growth portfolio and improving performance in Q2 and beyond. Meanwhile, it is clear, we will need to continue to focus on and deliver higher profitability. Our operating margin for fiscal 2013 to 2015 has been steady at 8.7%. We expect to beat that slightly as Viavi in Q1 despite much lower revenue for NSE and the fact that Q1 is a 14 week quarter with approximately $8 million of additional OpEx with our correspondingly higher revenue. We expect to improve further through fiscal 2016 to a second half range of 12% to 14% with further improvements thereafter coming from our cost reductions programs. I would like to thank our employees, our business partners and shareholders, as we are now Viavi Solutions. I will turn the call now back over to Bill, who will begin the Q&A session.

Thank you, Rick. I would like to ask everyone to limit discussion to one question and one follow-up. Please focus your questions on the NE, SE and OSP businesses. Lumentum will be hosting a call at 2:30 PM Pacific, 5:30 PM Eastern during which they will provide Q1 guidance and take questions. Accordingly, we will not to be taking questions related to CCOP other than how it impacted consolidated JDSU. Karen, let's begin the question-and-answer session.

[Operator Instructions] Our first question comes from the line of Alex Henderson from Needham & Company.

I was hoping you could help us out a little bit with some granularity between the NE and SE revenue guidance for the September quarter? Obviously, it looks quite a bit weaker than what we've been modeling for the two combined, but I'm not sure where to allocate that weakness? Is it mostly in the NE side or is it also a decline sequentially in the SE side of the business? And could you talk a little bit about, to the extent that do you think that that's a temporary swing in the numbers or whether that's something that is going to persist?

We're expecting SE to get back above $40 million for next quarter in the 43-ish range with the balance in NE.

So that's a pretty steep decline in NE double-digit. So I assume, even if I adjust out the $5 million, $6 million that was set over Lumentum, I know that's seasonally a weak period, but it's down considerably year-over-year. And I think if you look at that large customer's CapEx, it was mainly down in the first half at a steep rate. In the back half, as they do 55% versus 45% in the year ago, that should be closer to flat. So what's driving that down on a year-over-year basis?

So I think we've been cautious in our Q1 guide, largely because we didn't see a meaningful uptick from a bookings perspective in Q4. So there is a lot more pressure on us in Q1 from a book and ship perspective. That tends to be backend loaded as you know for the NE business. So we've decided to approach the quarter conservatively. And then hopefully, some of the things that have been said out in the press reported about the major carriers from a CapEx perspective will play out to our benefit.

One last question, if I could. Are you going to provide a pro forma income statement for the total Viavi company that you can then use cleanly to model off of?

We can do that.

And our next question comes from the line of Patrick Newton from Stifel.

I guess Rex's just dovetailing of that pro forma statement. For doing that, what's the timeframe?

Since I have Bill in the room here, I don't want to over-commit two of us. What do you think, Bill?

We'll try to provide the information in the public forum. I'll get back to you on the exact timing.

And then two more housekeeping questions. As you said WaveReady was about $5 million a quarter, what was the actual WaveReady revenue for NE in the fourth quarter? And then can you help us understand post the split, what level of NOLs are held at Viavi?

So the businesses was $20 million total last year. Q4 was high-3s, almost 4. Obviously, that will be discontinued ops when we report going forward. And then your second question was, I'm sorry.

The level of NOLs at Viavi, post the split?

So those people are focused on the federal NOLs. We used about a quarter of our NOLs in connection with the various transactions associated with the split. So we're probably still at low-4s, between 4 and 4.5, that's the split.

Low-4?

Yes.

I guess, as we think about the shift away from Tom and Rick, you're standing in as the Interim CEO, could you help us understand what you're looking for in the new Chief Executive? And how investor should think about Viavi not having, or I guess, will be having a new CEO and CFO. And how that should impact, trying to turnaround and grow the SE business and the willingness and ability for the company to affect M&A? And then I guess, Rick, is your hat potentially in the ring for the permanent position?

Yes, so let me respond. I mean, first of all, as we went through the discussion on this transition, my willingness to do this is only based on the fact that we have to move the company forward with the decisions we need to make to drive the success of the company. So my intent is not just to kind of keep the lights on. I've been involved with this business for a while. I've been working with team. And I think the spin took a lot of energy and lot of effort, and so we're really going to focus in with this team to move the business forward. A Lot of it's going to be in the way we build out our sales capability. I mean, this is an enterprise sales business. I've had a lot of experience there. So I'm going to put a lot of energy and effort with the team to move things forward. As far as the kind of person, I think this is a very desirable interesting job. We've really identified a strategy that we're very committed to, that has an opportunity to be in growth segments of the industry. There needs to be someone who is comfortable with kind of innovation and driving the product program to take advantage of those growth segments that we've outlined. But we also need to have an operational focus for the individual, because with the complexity of our history and the recent spin, there is work to be done to improve just the overall fundamentals and execution of the company, so it will embrace all of those areas. And as far as your last point, we are doing the search for our new CEO, and my intention is not to be a candidate for that, but to drive the business forward aggressively during the interim period. We don't want to lose any time. I personally believe the company is a great opportunity in a very disruptive segment with interesting technology. And we're going to move as aggressively as we can, that's the Board's intent and I intent to be a big part of that.

And our next question comes from the line of Mark Sue from RBC Capital Markets.

If we set the CapEx environment aside from the North American service providers and we look at the multi-year trends in both NE and SE, they haven't really been growing, while competitors who sell network visibility and analytics solutions to both enterprises and service providers are showing at a relative topline growth. You did mention, improving your go-to-market and execution. Is there a refresh in the products portfolio that needs to occur or what are some of the thoughts in terms of regaining back and trying to grow faster than the market, because I think that's the concern for the outlook for both NE and SE?

So yes, and let me just talk on the product side first. So what we plan to do is, and we already kicked this off, Mark, a week or so ago is, look at our overall portfolio management and look at the overall solution lifecycle and what the expense to revenue ratios are. So we've already kicked off that process. So that is already underway. And on the sales go-to-market side, we're looking at, and we're just going through this now, as Rick said, focus on our go-to-market, how we will move forward from a go-to-market perspective based on our core competency. With regard to the vendors you said playing in the different spaces, there is a mix of field instruments, as you know, and you're not difficult to be forwarding in lab instruments. So yes, there is no question we can perform better than we have. We think on the field instrument side, as we've said in the past, there has been an impact due to CapEx. And as Rick said, we think in the second half this year, we haven't built into our numbers for fiscal '16, but we think there's potential upside, if things do turnaround on the CapEx side for our field instruments business. On the SE side of the business, candidly we have to improve our profitable growth. We have been investing on the SE side of the business. We think there is an awful lot of upside. I have discussed with you a few times our strategy on platform and we really do think that will be a differentiation moving forward through FY '16.

I would just add to that. Let me just add that, I feel we have a sufficient product and solution portfolio today to do better in the market. So there is a big component I think to our overall execution. I would say that as point number one. And then point number two is, clearly we are going to invest, as I said in my script. We're going to invest more in areas, where growth exists and where we can be on the right side of opportunities, and the right side the market is going. So I don't want you to have the impression that we've got to go away and invent a bunch of products to be able to get our performance back. I believe we can get our performance improved with what we have, but clearly we can make investments and intent to make investments and prioritize the things that are going to give us a more opportunity going forward.

With the split now done, and you're taking a special look at things, what are the long-term plan for the OSP business, I'm not sure, investors ask us whether it fits within the organization, so will there be review on OSP? And there's also value in the NOLs, any thoughts on how Viavi might be able to utilize these NOLs?

So Rick, you want to start that, then I'll come behind you.

So first of all on OSP, we have said that business up to be pretty self standing. We report that way. And we are making decisions around the business. We have a very good team there, and they are driving that business forward. I would just say, as we've demonstrated that we will make the moves that we need to make over time to get the most shareholder value and to position the businesses for a success. So we haven't made decisions on OSP, but we'll continue to monitor that as things progress and there is timing to these changes in a way. We viewed a change with CCOP really quite some time ago, but felt we needed to get some time behind this and get the product lined, positioned in a better place, which ultimately led to the spin that we just completed. So I would just stay tuned and we'll be as transparent as we can be about our strategy and intentions with our business, the performance of it right now, which is particularly, very, very solid and we think it's a very good business. And on NOLs maybe Rex you could help me. I think we have more work to do on NOLs. Clearly, it's a big number. We are going to evaluate now other strategies that could potentially allow us to capitalize on that value more. And also Rex mentioned that we did do some things during the spin that utilized some of those to setup Lumentum momentum more efficiently as well as the overall spin. So if you could expect to hear more from us on our path forward with NOLs, clearly to become more profitable as soon as possible is going to be the first priority.

And our next question comes from the line of Amitabh Passi from UBS.

I had question and then a follow-up. On my question, I think last quarter you said, excluding your large tier 1 customer in the U.S. I think the rest of NE had actually grown somewhere between 2.5% and 3% year-over-year. I just wanted to get a recalibration, if we looked at your performance in fiscal 4Q and your guidance for fiscal 1Q, how is the rest of the NE business performing, excluding the pressures you're seeing at your large tier 1 operator?

I don't recall the commentary from last quarter, but I would definitely say that we do see some continuing downside impact from a particular large customer that we're historically working with. I think the total in terms of FY '15 versus FY '16, our revenue for that quarter was down something on the order of 30% to 35%. So we haven't seen that come back fully yet, though it's not as bad as it was two, three quarters ago. So we're guardedly optimistic that we'll see some signs of buying for that customer in the first half and hopefully picking up in the second.

And then Rex just on, I wanted to get some clarification on the OpEx commentary. I think you talked about a baseline of $500 million for fiscal '14. I thought previously, you had also said, roughly $40 million or the $50 million could be realized in Viavi. I just wanted to get a clear sense are we looking at $440 million or $450 million of OpEx run rate as we exit fiscal '16, is that at the right level relative to fiscal '14 at $500 million?

Yes, so I think your recollections are quite good. About 10 of it of it is Lumentum and the balance is Viavi. And yes, as we run the formula, it is a Q4 times 4 exit rate in '16 compared to '14.

And our next question comes from the line of Rod Hall from JPMorgan.

I guess I wanted to shift gears and ask about OSP. The guidance is significantly higher than we've seen in our model for several years actually, for the history of our model. So I just wanted to try to get a little bit more color on that. I know you've said that there're additional orders. How sustainable is that level of revenue? Are you pulling revenue into that quarter from the December quarter? Just help us understand how the flow of those OSP revenues look as we moved out next quarter?

Sure, no problem. So no question that OSP is running extremely warmly at the moment. The guide that we have for their Q1, I believe would be a record. It's being driven by some opportunities that we have with our main anti-counterfeiting customer. For some inflation related reprints, there's a lot of reprint activity out there in a couple of areas where people have inflationary currency, so it's just a short-term demand. It makes for a very nice Q1, Q2 for us. As we said in the script, after the 61 midpoint Q1, we expect Q2 would also benefit from this trend or this event and be in the high-50s. But then we would expect the second half to be back at a more normalized between 50, 55, call it mid-to-low 50s per quarter.

And Rex is the margin contribution, as we go through this revenue bump, any different or do we expect margins to be roughly similar?

I think you would see them as similar. Obviously, the dollar drop-through looks great, which it is, but it doesn't move the actual percentage up that much, so it would be fairly consistent. Keep in mind that OSP last quarter was able to get minus the one-time benefit we mentioned of 40% operating margin. We're anticipating that they would be able to do that in Q1, even moving to a full allocation model of absorbing, the additional expense is associated with the way that we're dong the full allocation. So they're going to be at a very healthy rate of 40% or better.

And do you think that will sustain itself or is that just over the next couple of quarters and then -- ?

I think that margin percentage is sustainable. If we were to drop for some reason well below 50, which I don't expect then you'd have to relocate the percentage, but as long as I say north of 50, that should be fine.

And our next question comes from the line of James Kisner from Jefferies.

This is Jason North for James. Could you give any qualitative comments around the M&A funnel and what markets you're focused on?

Paul, you want to take that?

Yes. To Rick's point, we believe there is major growth opportunity as we move on develop the platform we've all heard me talk about. And so if we can maintain, if not, grow share on the wireline side, but we see our mobility assurance has been a major growth opportunity. Our location intelligence, building out a big data capability, a major performance opportunity. And our Enterprise, again, we saw good growth on this past quarter moving forward, hopefully, on the Enterprise side. And by Enterprise, I do mean both private cloud and public cloud. And so what we plan to do is, is some of you've heard me pitch based on moving forward where we're bringing both our Instruments business and our SE business increasingly coming together to deliver this platform. And that was the point Rick's mentioned earlier on, below the gross margin level, we are going to see convergence of any indices. Any future M&A activity will be typically kind of made by partner perspective will be based on that integrated platform. So that is very different from what we've had before. And we have a very clear strategy that Rick mentioned. And any holes identified in that strategy, we will make build-buy-partner decision to fit into a very clear architecture that I've spent some time sharing with you.

Also a follow-up, for the 20% stake in Lumentum, any plans for that?

Yes, so we have a limitation on being able to move that at all in the first six months, but a commitment to put that out into the market before the third anniversary of the split. So we would expect to do something sort of at the right time and in orderly way, so as to maximize the value and not dent them in anyway that we can avoid.

And last one here. You've said in terms of the large customers are creating some depression here or a bit of a headwind here in FQ1 in terms of typical FQ4 seasonality, and if you would expect that, or any other puts and takes around that?

That's a tough one. And I say that only because if you look back at FY '15, the normal even quarter seasonality that we've experienced over the last several years didn't really happened, so hard to forecast that just yet. There should be some benefit to the fact that it's December and June, but we need to get through the rest of this quarter before we can declare on that.

And our next question comes from the line of Jorge Rivas from Craig-Hallum.

So I was wondering if you can provide, and I'm sorry if I missed this on the prepared commentary, but if you can provide more color on what caused the decline on the backlog and deferred revenues for the growth products in the SE segment and whether that 10% decline is a good way to for next quarter.

Yes, I can start and then others can jump in, if they like. So the main driver in Q4 was having more deferred revenue come off than was added. We had a pretty light bookings quarter for SE in Q4, substantially below a ratio of one-to-one. So a good number of deals pushed into Q1. So we've clearly got work to do there to drive bookings and then to get that backup, so that is the main reason.

And the only thing I'd add, as Rick said at the beginning is, we want to accelerate on the growth side, the acceptance and all the vis-à-vis components for some of our large customers, so we can accelerate the acceptance of our offers.

And then one last follow-up. So you have had a couple of disappointing quarters with Network Instruments. So I was wondering how that did in the quarter and what steps are you taking to prevent the lack of execution in the future on that side of the business.

So I think that the good news is we've had some leadership changes in the organization for the Network Instruments organization that I think is quite positive. And so they're looking at actually having -- they had an okay quarter in Q4, they're looking at having a better quarter in Q1. And I even heard the word upside this morning from the person who runs it, so that's always nice to hear that kind of word. Obviously, it's the size it is within the SE organization, but I think we're getting back on track in NI.

And our next question comes from the line of Dave Kang from B. Riley.

Jus wondering if you can just provide a little bit more color or granularity in terms of say, wireless versus wireline. And in wireline, how much is, optical versus copper, any more color between those segments?

You are asking -- that's clearly an NSE question, correct?

Right, correct.

So I don't have a breakdown with me. I do know that our mobility area was pretty healthy, a bright spot in Q4. And I do think we're making inroads competitively there. We do have some other places where we're going in the opposite direction, but I do think the wireless portfolio had a pretty good quarter.

Is that still about 30% of total sales now roughly?

I wouldn't want to do that in my head, and the only reason for that is because NE is smaller than it has been. That would move the number around, so I have not looked at that. So I can get back to you on that.

And what do you see in China, there seems to be some moving parts there?

So in China, we're doing okay in China. I wouldn't say that we're pretty consistent their. It's not a large part of the business when you're looking at it from an NSE perspective. OSP has a manufacturing presence here, which is good, so they're doing well. They're doing well in that market relatively speaking. I do think that we have plans to or at least considering rotating more in favor of the SE portfolio in China and Asia-Pac generally, more so than any, because it's just more difficult to compete on price when you get to China from a hardware perspective.

And is China about what, 10% to 15% of sales, roughly?

Of just NSE?

Yes, just NSE.

It's probably the less. It's less than that.

Less than 10, okay.

It's probably 10 or slightly less.

And then lastly, I mean can you just talk about the competitive landscape, especially the Japanese such as Anritsu. I mean, are they being more aggressive with the pricing, because of the weak yen?

There's some of that, yes. There is some of that, which is interesting, because one of the places where we have done well recently is, as I said earlier, is in wireless area and the products that we have directly compete with Anritsu. So interesting that we will be successful, notwithstanding the yen pressure, but I can't deny there's definitely some pressure.

So how much do you think, as far as a market share, I mean in your first quarter guide how much of that's yen related revenue issue or a market share issue?

Yen related is probably immaterial. Market share is, I don't know what you would call material, but we definitely have some market share issues as we look into Q1. So there're some things, we've got to go fix.

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

Couple of quick ones for me. First, and just to clarify, the guidance does not include the five week stub there from the CCOP, is that correct?

Right. The guidance is Viavi only and CCOP will be discontinued operation. So it's just purely the new company.

And then, on the M&A front, just sort of there was a question raised earlier. But does not having a permanent fee, does that preclude you from doing any M&A?

Rick is heavily involved. We have a CDC committee as part of the Board process, and Rick is heavily involved in that. So myself and Rick, we have very, very regular discussions on any M&A strategy. So that won't have any impact.

And then, again, just to follow-up on a competitive front. NI just got picked up by a key side, sorry. How do you view this acquisition in light of sort of the business you run up against with them? And just in general, there has been some fair amount of consolidation in the industry, but yet we're not really seeing sort of that bearing fruit in terms of price environment easing out. Is there any comment to that or anything you can sort of say to that effect would be interesting for us?

I gave breakup at the very beginning.

But Dmitry, are you referring to NI?

Yes, NI, the French company. I just want to know if you have competed with them, I'd assume so. But just curious to see how that competitor saw dynamic changes?

So obviously, if we were in a competitive situation and M&A is not something that we would talk about. I do know that we have been simultaneously working funnel at the same time that we're trying to get the company split. So I don't think, we're late to any parties that we want to attend. And also from an NI perspective, we've known them pretty well over the last three or four years. And I don't see key sites acquisition of NI as a problem for us.

One other things to balance, just opening that a bit to Richard's point, we try and balance the overall NE segment growth rate compared to the growth rate we mentioned before from a mobility, location intelligence and enterprise perspective. So to Rick's point, and the growth rates in that space are not growing at the rates that we would prefer. So we don't see that to be -- we see that space being marginal impact of acquisition, being marginal impact candidly.

Let me just respond to a couple comments on M&A. M&A has been a part of our history, and we view M&A as a way to build our solution out and to get scale, et cetera. And we certainly expect that to continue. I would say that certainly, when you go through a divestiture like we've been through that takes a lot capacity out of the organization. So I think we're really feeling pretty energized about moving forward now as Viavi, and being able to start to be even more aggressive at all of the options that exist for us, whether its M&A. But really a big part of it is our own organic execution. So I don't want also to think that M&A is the only way we can see growth, because frankly we have a lot internal capability, we have lot opportunity for improvement, and we are going to be pushing these simultaneously. And as has been reinforced, not having the permanent CEO, we're committed as a Board and as management team to not have that slow us down. We just went through all the work of a spin, and we're ready to run and ready to move, and we're not going to let this transition slow the company down for making decisions and moving forward on our strategy.

And just a last one, if I may, on the geo breakdown, it sounds like APAC has done quite well for you. You had mentioned China, which wasn't really a factor. So could you discuss what drove some of the sort of upside there? And was this a one-off, you expect that to kind of fall off as you had into Q1 and forward? And maybe also talk a little bit about the EMEA and what's going on there as well?

So we just want to make sure that I answered the right question, so we did have a good quarter in Asia-Pac from a revenue perspective. Obviously, that's all JDSU's still have CCOP in the numbers. So they do good business there. We obviously do good business at OSP and then we have a smaller footprint. As I described on NSE, we continue to strive to fight in EMEA, but not particularly successful. That's a very, very rough market for most people, and we're no exception to that. So I think what I have not done and will do, when we get to or make sure it gets done for our first quarter earning calls is have a look on how we think NE SE and OSP breakdown from a revenue perspective by geography, I just haven't done that yet.

That was really good, because it sound like what you just said Rex to the upside in the APAC region was mainly from the CCOP side, where a lot of it was due to CCOP?

I think that's fair, and OSP got a little piece of it too.

And our next question comes from the line of James Fawcett from Morgan Stanley.

Most my questions have been answered. But just wanted to get one piece of insight on Ethernet testing, and you called out that that was a source of year-over-year decline, and I was a little bit surprised. Just wondering, if you can help us understand, if you had a particularly stronger last year for that or if there was something else going on in the most recent quarter that negatively impacted that?

So I think we definitely had a year-over-year decline in Ethernet, and I think that's tied principally to a combination of customer execution and pricing issues. It's a little bit of all three. So it is down, and that's something we need to turn around.

And our final question for today comes from the line of Michael Genovese from MKM Partners.

First of all, on the Tier 1 carrier, where there has been this revenue and order weakness, I want to get your perspective on how do you know that it's a spending issue and a CapEx issue and not a competitive and market share issue?

We have our own models internally that we track. And keeping it simple is, if you look at -- well, I want to be clear, on the NE side there has been some market share loss on the NE side. I want to be very clear on that. And on the SE side, we are around 5% on the SE side, when you look at the overall market. On the SE side that includes, and Rick also said, we have a very [indiscernible] et cetera. Overall, I would say is, when you look at the top five of our carrier providers, we have substantial market share in those carrier providers. So if they reduce their CapEx from a competitive perspective, it impacts us more than our competitors. And so in that area, it's not really down to deal loss, it's a set of spin impacted more. When the top-end service providers drop their CapEx, it does impact us more than our competitors.

And then secondly, my follow-up part here is, I am surprised that the bookings trends in SE took a big reversal from where they have been in the last couple quarters, where I think the booking have been strong. So I want to ask you, are there any subcategories of SE trending or Arieso or PacketPortal, where there is any good news bookings wise in the June quarter, where anything good to call out in any of those units?

So the good thing we've had is NI. As we mentioned before, we feel NI has performed well and hopefully moving forward when increasingly perform. Well, as I said earlier on the location intelligence, what we do need to do is accelerate the acceptance. These are quite complex sales deals, and we have to accelerate the acceptance from vis-à-vis perspective with some of our customers. So NI is doing pretty well. We're hoping to improve the acceptance on the LI side of things. And as I said before, the mobility assurance is something, it's an early market for us, we're investing and we are trying to grow that business. But the main areas are LI and NI.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Bill Ong for any closing comments. End of Q&A

Thank you, Karen. This concludes our earnings call for today. Thank you everyone for joining us. Bye.