Viavi Solutions Inc.

Ladies and gentlemen, thank you for standing by and welcome to the VIAVE Solutions first quarter fiscal year 2021 earnings call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. May I ask that you please limit yourself to one question and one follow-up. Please be advised that today's conference is being recorded. If you require further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Bill Ong, Head of Investor Relations. Thank you. Please go ahead, sir. Thank you, Tiffany.

Welcome to BRB Solutions' first quarter fiscal year 2021 earnings call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call are Ola Hagen, President and CEO, and Amal Malhotra, CFO. Please note, this call will include forward-looking statements about the company's financial performance. These statements are subject to risk and uncertainty that could cause actual results to differ materially from current expectations estimations. We encourage you to review our most recent annual report and SEC filings, particularly the risk factors described in those filings. The forelooking statements, including guidance we provide during this call, are valid only as of today. The FBI undertakes no obligation to update these statements. Please also note that unless we state otherwise, all results are set revenue or non-GAAP. We reconcile these non-GAAP results to our preliminary GAAP financials and discuss the usefulness and limitation in today's earnings release. The release plus our supplemental earnings slide, which includes historic financial tables, are available on BRB's website. Finally, we are recording today's call and will 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 first quarter revenue at $284.7 million declined 5% on a year-on-year basis, but grew 6.8% sequentially, reflecting both seasonal OSP strength and stabilization in NSE revenue. We are operating margin at 21.3% is a record for a September quarter and presents a 370 basis points increase from a year-ago levels driven by margin expansion in OSP. EPS at $0.21 was up $0.03 both year-on-year and sequentially. Q1 revenue at $284.7 million was above our positive preannounced results of $282 to $284 million, as well as our initial guidance of $258 to $282 million. EPS at $0.21 was also above our positive preannounced results of $0.18 to $0.19, and our initial guidance range of $0.14 to $0.16. Now moving to our reported Q&A results by business segment, starting with NSE. NSE revenue at 183.5 million declined 16.5% year-on-year. Within NSE, NE revenue at 162.1 million declined 18.5% from a year ago, primarily due to the pandemic-related declines in field instruments. SE revenue increased modestly, up 2.4% from last year's levels. NSE gross margins at 64.2% improved 20 basis points year-on-year. Within NSE, NE gross margins at 63.8% declined 60 basis points from a year ago, primarily due to lower volume. SE gross margin at 66.8% increased 650 basis points year-on-year due to favorable product mix. NSE's operating margins at 7.2% decreased 290 basis points year-on-year due to lower revenue offset by a reduction in operating expenses reflecting disciplined expense management, ongoing efficiency programs, and lower variable expenses such as travel and entertainment, events, commission, et cetera, due to the pandemic. Now turning to OSP. OSP had a record quarter with revenue at $101.2 million, up 26.5% from last year, reflecting strong anti-counterfeiting and pre-desensing revenues, as well as solid aerospace and defense product demand. Gross margins at 60.3% was up 620 basis points year-on-year because of higher volume and better manufacturing absorption. OSP delivered record operating margins at 46.7%, up 870 basis points compared to last year as a result of higher gross margins and tight expense control. Now turning to the balance sheet. Our total cash and short-term investments ending balance was $595.5 million, which was an increase of $51.5 million sequentially. Our operating cash flow for the quarter was a record $63.9 million. In fiscal 2021 year to date, we repurchased approximately $13 million of VRV stock at an average cost basis of $12.24 per share. Overall, we have repurchased approximately $57.5 million of the total of $200 million authorized share buyback announced in September 2019 at an average cost basis of $12.05 per share. We continue to be opportunistic in our share repurchase. Now turning to our guidance. We expect fiscal second quarter 2021 revenue for VRV to be approximately $290 million, plus or minus $10 million, operating margin at between 19% to 20%, and EPS to be in the range of $0.18 to $0.20. We expect NSE revenue to be approximately $205 million, plus or minus $8 million, with operating margins at 11% plus or minus 50 basis points. We expect OSP revenue to be approximately $85 million, plus or minus $2 million, with operating margins at 40% plus or minus 100 basis points. Our tax expense is expected to be approximately 18% to 20%. We expect other income and expense to reflect a net expense of approximately $3 million. We estimate our share count to be approximately 233 million shares. On October 21st, the company announced my resignation as VIAVI's CFO, effective on November 20th. It was a difficult decision. It is a privilege to serve at VIAVI for more than five years. It's been a real pleasure supporting and partnering with OLLIC and the leadership team. We are a stronger company today. I'm committed to an orderly transition of my CFO duties following my departure and until a successor is identified, Our current global controller, Pam Event, will serve as the interim CFO. Additionally, I've entered into a consulting agreement with VIAVI for an anticipated period of six months after my departure. With that, I will turn the call over to Oleg.

Thank you, Ammar. Before I start, I would like to take this opportunity to thank you for a great contribution to VIAVI over the past five years and wish you success in your new role. Now back to Q1 results. I'm pleased with our strong Q1 performance as we saw OSP deliver an all-time record quarterly revenue and profitability, and NSC saw early signs of stabilizing demand environment. The NE business segment was down double-digit percentage year-on-year and sequentially, reflecting weakness in sales instruments. Despite the challenging environment early in the quarter, we saw the orders for field instruments begin to stabilize and recover later in the quarter and continue to improve into Q2 as service providers started to resume their field operations activity. The demand for wireless lab equipment was down modestly after an all-time record quarter in June, and we expect it to be up in the seasonally stronger December quarter. Overall, we expect Q2 revenue for NSC to be up significantly, reflecting continued demand recovery in field instruments and seasonal strength in Levin production equipment. Although macroeconomic uncertainty remains, we anticipate 5G wireless and fiber to lead the recovery in early calendar 2021 and 5G field revenue to become more meaningful in the second half of calendar 2021 as the build-out of 5G network accelerates. As major carriers prepare to build out their 5G networks, we have significantly expanded our RF field test instrumentation portfolio to help them automate and streamline the network build-out and qualification. We've also introduced the industry-leading 5G ORAN lab and test suite to support open standards and interpretability and network virtualization. On the fiber side, we're seeing the acceleration of 800 gigi adoption by network equipment manufacturers to support the next wave of network and data center traffic. We expect our field instruments, O-RAN and 800 gigi, to drive NFC growth over the next several years. Now turning to OSP. The OSP business segment saw its first 100 million plus quarter driven by strong demand across all three of its product groups. anti-counterfeiting, 3D sensing, and aerospace and defense. We expect OSP strength to continue into Q2 with modest seasonal pullback in 3D sensing and anti-counterfeiting. Three years ago, our 3D sensing product consisted of one filter in one device in one application. Today, our 3D sensing product line consists of filters and optical diffusers going into multiple customers, multiple products, and multiple applications. As a result, we now expect 3D sensing revenue in fiscal 2021 to increase 10% to 20% year-on-year. We expect our anti-counterfeiting product demand to continue to remain robust for the next several quarters, driven by fiscal stimulus spending and banknote redesign. Aerospace and defense-related product demand is expected to remain strong for the remainder of this fiscal year. Overall, our long-term secular growth drivers in 5G wireless, fiber, and 3D sensing remain intact, and we expect to continue to drive higher levels of revenue and profitability. In conclusion, I would like to express my appreciation to the VIAVI team for its strong execution during these challenging times. I wish all our employees, supply chain partners, customers, and our shareholders to stay safe and healthy. I will now turn the call over to Bill.

Thank you, Oleg. This call will be participating at the following investor events virtually. NAVI's 2020 Annual Shareholders Meeting on November 11th, CEPA's 2020 Midwest 101 Growth Investor Conference on November 12th, and MKM Partners' Investor Conference on December 15th. Tiffany, let's begin the question and answer session. I ask everyone to limit the discussion to one question and one follow-up.

At this time, if you'd like to ask a question, please press star followed by the number 1 on your telephone keypad. Your first question comes from the line of John Marchetti with CFO. Your line is open.

Thanks very much. And, Amer, let me be the first of what I'm sure will be many people to congratulate you on your new role, although we'll be sad to see you go. Oleg, I wanted to follow up on your comments around seeing some improvements in that field business. And I'm curious, just to get your take on whether or not it's a scenario where the service providers themselves have started to maybe adapt to the new environment, or if their networks are now at the point where they really do need to get out in the field to start doing some of this upgrade work.

Sure. So, I mean, listen, when the COVID hit, the first tendency for everybody was just suspend everything and put everything on hold to figure out what's going on. Then we saw during the summer, you know, people saying, hey, you know, things actually can work in this environment, and they were adapting their protocols and their procedures, parameters, how they work and how they roll the trucks and what they need to do. And remember, The amount of maintenance works accumulates. It doesn't say things go bad all the time. The problems develop, right? And you can only suspend that kind of work for only so much before your network performance starts to degrade. So we saw throughout the summer things kind of getting back to normalization. You know, they don't move. They're not the fastest adopting companies. Those are big companies with big fleets of technicians and trucks. And then we saw, like, you know, in the September quarter, as quarter went on, Things, you know, say we actually have to do work. We have all these programs that we put on hold and, you know, things starting to come back. And as we enter the December quarter, we're now seeing major service providers in North America to actually moving forward with their network planned upgrades and retrofits and all the maintenance that got delayed. And to be fair to say, I mean, Europe, even throughout the whole thing, continued to be pretty good. So really the big slowdown was very much a North American phenomena, compounded by some weakness in South America, but not a big difference. So now things kind of coming back to life in North America is what's really providing some of that pick-up.

We also saw some recovery in Latin America.

Actually, it's a very good point. Thank you, Omar. Clearly, Latin America has seen a big devaluation, but actually, given that the state of their networks is nowhere near as good as North America, with everybody going to work from home, it really made the need for upgrades and repairs acute. And we're actually seeing, I mean, surprisingly, South America getting very aggressive in buying new equipment and upgrading the networks to improve serviceability.

Thanks. And then if I just shift gears for a moment here, Oleg, into the 3D sensing business, can you help us with some of the seasonality aspects of that? There's been obviously a lot of talk about how your largest customer delayed the launch by a little bit. And I had certainly thought that we might see actually growth in the 3D sensing business for you sequentially into December, just given that things seem to be pushed out a little bit. And I just want to get your sense in terms of seasonality and how this you know, year is maybe a little bit different given some of those pushouts and maybe what we can expect from that business, you know, in the March quarter, whether you're expecting sort of in line or maybe slightly better seasonality there.

So I'll start, and then Ammar will provide more color. So if you look what's going on, typically with the cycle, the September quarter is the biggest quarter for us. Because remember, we ship our products literally just in time. So between the time we ship our filters and they get integrated and they get put in a phone, it's probably at most several weeks. Okay? So in that respect, we don't have that lead lag where some of the active components suppliers might see. So for example, some of them may see bigger demand in June quarter to get ready for the September quarter or how have you, right? So we actually see in terms of when really we probably like better representation over real time out-of-the-door shipment. So September quarter is very strong. The December quarter pulls back a bit, but still very strong. Then the March quarter is a drop. And then June quarter, depending on the new models, we may see some uptake or things of that nature starting to pick up, and then again back to the very strong September quarter. Now, what we are seeing now is more and more products are going into production. The level of volatility, quarter to quarter, first half, second half, is becoming smaller and smaller because, you know, now there's staging of different models launched. Not everything gets launched at the same time. So that's actually good for us because it helps us to smooth out factory loading and absorption much better. And to the extent the Android ecosystem starts to pick up, they run on a somewhat about six-month off cycle where a lot of new models come out in the spring, which actually drives the level of leveling even better for us. So that's what it is. But I think today, clearly, Android is still a much smaller player in the space. Amar?

Yeah, I can just add to what Oleg just said. So first of all, I think if you recall in the last quarter earnings call, we said that 3D sensing will be roughly flattish year on year. Now we expect 3D sensing to be sort of mid-teen growth, between 10 and 20%. So that's point number one, which is more incrementally positive than what we thought entering the fiscal year. Number two is that the growth is going to be both in first half this year versus first half last year, but more so growth in the second half of fiscal 21 versus second half of fiscal 20. So to all its points, the seasonality remains the same. Still, first half is stronger. And in the first half, September is quite strong. Then there'll be slight decline in December. or further decline in the March quarter, and then slight pickup in the June quarter as we get ready for the next model year. So that's how it's spanning out, but you can see the growth is coming more so in the second half versus the first half when you compare year on year. Thanks very much.

Your next question comes from the line of Samit Chatterjee with JPMorgan. Your line is open.

Thank you. Hi, thanks for taking my question. I just wanted to start with the NSE and follow up on the NSE segment on the guidance that you gave. I think what you're giving the guidance implies about 12% quarter-on-quarter improvement. And kind of what I'm trying to get to is as you talked about the improvement you're seeing from service providers in terms of their intent to get some activity finally rolling. Is it now that we should be expecting as we go through the year we might have a bit better than seasonal kind of trajectory in NSC through the year for the remaining kind of three quarters? Is there kind of a catch-up activity that might result and we should, as we go through the year, get some better than seasonal trends in that segment? And I have a follow-up. Thank you.

Well, so I think clearly, you know, just NSC, especially North America, is coming off a fairly, you know, low point, right? So there is, you know, things are starting to get back to normal or stabilizing. Now, I don't think you're really going to – I don't believe there's going to be any kind of catch-up because, remember, our customers can only absorb so much at any given time. So if they skip the quarter, that does not mean there's going to be a significant catch-up. However, there is some, and we see some of it may carry over onto the March quarter, which will be a little – with the fiber build-outs that are happening there, we do expect several customers – seasonally to see greater demand for field instrumentation in the March quarter. So I think, you know, we're seeing things returning back to normal and, you know, uh everybody's kind of getting back to work in the december quarter and they're placing orders and some of the orders getting expedited because there is some uh and year-end budget uh flush but not that much and uh but we're also seeing more importantly is um you know some visibility into some cost major customers that they are now looking at a kind of three to six month uh major um upgrade or network build out for a project, and that may result in some orders that will soften the seasonally weak March quarter.

And just to add some additional color on the seasonality, if you compare last year's March quarter, which is fiscal 20, it was actually down close to 20% compared to the December quarter because of the pandemic. And we had a big, you know, because of the shutdown in the month of March. What we expect going forward, typically, when you go from December quarter to the March quarter, the revenue in NSC goes down anywhere between 8% to 10%. And that's how we are looking at modeling NSC in the March quarter, roughly about 8% to 10% decline going from December quarter to March quarter. So going back to sort of normal seasonality, Shamik, although at a lower level. And if there is any uptick and if there is any additional spend, we'll definitely go capture it. But for modeling purposes, we are assuming normal seasonality going forward, maybe at a lower level. And as the year progresses in calendar 2021, we should start seeing the pickup.

Amar, I just wanted to follow up with you on the margin front. At the investor day, when you had issued some long-term targets for fiscal 2022, obviously the landscape changed quite dramatically since you issued those targets. But you were thinking of 19% or 21% operating margin with that level of margin predicated on a higher level of revenue. You're kind of hitting the high end of that already. So if you can kind of maybe help me think about what have you done on the cost side on that, in terms of improvement and kind of why shouldn't I be thinking that you exceed the high end as revenues start to come back to a more normal level that you should be exceeding the high end because of the improvements you've done on the cost side?

Yeah. So I think, see, when you think about our operating expenses and you compare it on a year-on-year basis, there are three things that are clearly impacting it. One is the operational efficiency programs that we continue to run. And this is what we shared with you during the analyst day, the funnel that I showed you. And we continue to execute on that. One of the biggest items on the funnel was migrating VRV to a new ERP system, which we completed at the beginning of this year. And we are starting to see benefit of that. There are other efficiency programs that we are running within that funnel. So that is one. And that is a continuous process and will continue. The second is, you know, we have definitely clamped on expenses. And there are some discretionary expenses and there are non-discretionary expenses. We definitely climbed on some of the discretionary expenses. And third is the benefit from variable expenses because things like travel and entertainment. And still people are in a lockdown. There's not much of travel happening. We also saw sort of commissions come down because the bookings declined here on a year-on-year basis because of the pandemic. And we also saw some event expenses coming down because there are no physical events happening. So those are the variable expenses that we expect to bounce back as the revenue kicks in. And on the operational efficiency side, we will continue to go drive the operational efficiency, and that's part of the long-term plan. So, Shamik, I'm coming back to saying that the 19% to 21%, is the range that we will continue to execute against. You have seen a few quarters. We've already gotten to the high end of the range. But again, there's also a benefit of the variable expenses coming down. So yes, when the revenue comes in, you will have a higher operating leverage in the model. So you should see the benefit out of that. But you'll also see the variable expenses also go up. So I would say I would like to stick to 19% to 21%. I think that's a good range to work with. OK.

Thank you. Thanks a lot.

Thank you very much.

Your next question comes from the line of Mehdi Hosini with SIG. Your line is open.

Yes, thanks for taking my question. Two follow-ups. Just going back to the OSP and specifically on 3D sensing, one of the key OEM customers has complained about the supply constraint, and that has impacted how many phones they could actually build. And I do understand that you may actually have some higher content in specific products. So my question to you is, what is the most challenging part of the forecasting, the total phone build, or is that the content, which I imagine is a function of the mix, or is it both? And I have a follow-up.

Sure. So, I mean, listen, I'll tell you, first of all, it's not the alley. We have never shut down our customers, and our supply chain has never suffered. So that's not an issue on our side. In terms of forecasting, you know, we are actually in a very good position. See, we have a very short lead time, which means – we get real-time forecast. So for example, when you're going to have a certain device going to have a supply chain problem, and you have a long lead time, your forecast is very volatile. It changes all the time, right? Because if there is a problem, the customer will lower the forecast. And meanwhile, it's too late because you already have a product moving through the supply chain. So in that respect, we don't have to second guess. We get forecasts that is literally deliveries within weeks. And by that point, a lot of the long lead time items are well known to our customers. So what we actually get for them is something that is very close to what number of phones they're going to ship. So in that respect, we don't really suffer much from uncertainty. We have a very high degree of visibility and certainty in our forecast.

In your forecast. So to the extent that the OEM can catch up and be able to get more allocation from their manufacturing partner, Would that drive an upside? Your forecast is always conservative.

So, yeah, I mean, by the time they give us a forecast, they've usually worked out all the kinks or have already factored all the shortfalls, and they just tell us how many units to ship. And by then, the number of units is pretty much finalized. So we never really see a lot of the volatility that may happen one, two, or three months before the delivery date.

Okay, very helpful. And then my second follow-up has to do with the mix looking into December and the first half of calendar year 21. How do you see the mix between 5G wireless and fiber evolving?

Well, let's see. You know, the 5G wireless, which is in the first half, it's mostly lab and production, right? So when you start a new calendar year, all the major NAMs get new budgets. So I would say you're going to see quite a few orders happening in the March and June quarter, right? So that's going to be pretty strong. And then it kind of slows down maybe into September, maybe whatever remains. And then December is usually the weaker stuff, unless they have a budget left over. Now, also, given that the amount of build-out is going to accelerate next year, we expect There should be more demand from NEMS, and we expect the wireless 5G level production to be particularly strong in the first half. Now, the other thing is also happening now is the emergence of ORAN, where you now have a lot of demand for interoperability and interoperability. field verification. And that's a whole new product line that we just released. And, you know, as that starts ramping up and demand for those products starts going up, it will be kind of the icing on the cake. So 5G is kind of, we feel, should be pretty strong first half of the year, at least from what we've seen. Fiber, as I mentioned earlier, we are seeing quite aggressive build-out of fiber taking place in Europe and now also North America, so we expect fiber to be equally pretty strong. And 3D sensing, as I said earlier, first half of the calendar year is seasonally weaker for us now, but to the extent Android ecosystem starts gearing up more on the 3D sensing with world-facing cameras, we may see some pickup in that area, but it's nowhere near going to be as strong as the second half of this calendar year when it comes to 3D sensing. I mean, the main demand for 3D sensing will be second half of the calendar year.

Yeah. Just to add, I think even during this situation, we saw a 5G wireless lab and a fiber lab in production. They were quite resilient, quite resilient. And so in addition to the fiber that Oleg mentioned on the field side that will pick up in the first half, As build-outs happen, we also believe that the lab in production will continue to remain strong on the fiber.

That's a very good point. I mean, so clearly, you know, the whole 400 gig build-out is continuing in data center going to fiber backplane. It's driving a lot of demand for fiber optic modules. Now, you may have some mixed change between the customers, given some of the challenges with Huawei. That means some of the other customers are seeing greater demand. So, you know, for us, it just means the demand shifts from one customer to another.

Got it. Thank you. And, Amar, good luck with your endeavor. Thank you. Thanks, man. Thank you very much.

Your next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open.

Hi, thank you for the question. This is Karan Juvikar on Pramita. So we understand that most of your NFC customers are renewal or normal course customers, but just want to dig into how COVID has impacted your ability to sell to new customers or sell different products to existing customers. Thank you.

Sure. So I think, you know, as I've been telling everybody, this environment, as bad as it is and as challenging as it is, really favors the incumbent. And not only incumbent, but incumbent with scale and physical presence. in all the different regions. So in that respect, even though we don't have a lot of the face-to-face contact, we do have service and support in all the regions, and we're working with practically every major telecom out there. So clearly, in terms of the renewal and the placing orders for what's been qualified. We do very well, but you remember also, if people just don't place an order, they also need a lot of support in the field. And actually, we continue to provide live support in the field, supplemented with virtual webinars for our customers. So that's going very well. In terms of the new business, We are now, you know, found a new way, a new normal of working with customers to discuss their plans six, 12, 18 months out. And we are engaging in the proposal stage. We have found ways to ship samples to customers into the labs where they get picked up in a safe manner and get tested. or remotely demonstrated all the way up to the live demonstration in some cases. So I'd say, you know, if you have a geographic footprint that we have and you are locally with all the major customers, I think we have a significant advantage versus some of our customers who are thinly staffed around the world or subscale.

Got it. Thank you. That makes sense. And if I could just have one more follow-up. On the OSP currency piece of your business, is there a way to approximate the upside in the quarter from new designs versus just the increase in volume from reprints in the stimulus? Thank you.

So, listen, I think we don't break that out for obvious reasons. But needless to say, there were three drivers for the anti-converting business strong performance, right? One is we mentioned the stimulus packages creating a lot of printing. Number two is replenishing of the inventory because they have not been printing for during the COVID lockdown. And given that if this lockdown continues, you know, there's a sort of, you know, they're increasing their safety stock. And third, of course, is a redesign that came in, and again, for one of the countries. So this was in line with what we had said in the past. We were expecting a redesign end of calendar 2020, and it came in. And so those were three factors that led to a strong performance in our anti-counterfeiting business.

And I would also add that, you know, as redesigns start coming in, they're increasingly using our more advanced, newer pigments, which obviously has a different ASP. And, you know, that also means they have to start replacing some of the old currency, recalling it, and reprinting to replace it. So it all kind of contributes. And I think, as Ammar said, the fiscal stimulus, it looks like there's going to be multiple waves of it in the coming quarters across the world because everybody's trying to re-stimulate and restart their economies in view of the COVID-related slowdown. And a chunk of it is heavily dependent on having physical cash to inject where it's necessary.

So just to add to that, we have made this comment earlier too. I've been here for five years, 20 plus quarters, and the business is very nicely diversified. And when you look at, and we've been seeing this before, that when NSC is strong, OSP is sort of flattish. When OSP is strong, NSC is flattish. And so it very well counterbalances both the businesses. The key here is the earning potential of the company. because of the execution discipline and the market trends that we are seeing, given these two diversified businesses that we have. So our motto has been to continuously drive the profits up and EPS up, and that's what you're seeing in the last couple of quarters. Even in the COVID situation, we were able to print a growth in EPS on a year-on-year basis. and also delivered a very strong cash flow from operations of close to $64 million. Got it. Thank you.

There are no further questions. Thank you. I will now turn the conference back over to Bill Ong.

Thank you, Tiffany. This concludes our earnings call for the day. Thank you, everyone.

This concludes today's call. Thank you for your participation. You may now disconnect.