Viavi Solutions Inc.

Good afternoon and thank you for standing by. Welcome to the VIAVI fiscal third quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. Should you require any assistance, please press star zero on your telephone keypad and an operator will assist you. I will now turn the conference over to head of investor relations, Mr. Sagar Hebar. Please go ahead.

Thank you, Sarah. Welcome to VRV Solutions' third quarter fiscal year 2022 earnings call. My name is Sagar Habbar, Head of Investor Relations and Corporate FP&A. Joining me on today's call are Oleg Hyken, President and CEO, and Hank Dirksen, 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. Excuse me. from our current expectation 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. VRP 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 slides, which include historical financial tables, are available on VRV'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 our website. I would now like to turn the call over to Hank.

Thank you, Sagar. Sagar has been with VRV for more than six years as head of corporate financial planning and analysis, and now assumes the additional role as head of investor relations. Bill Ong recently left the firm to pursue a new opportunity after having been with VRV and formerly JDSU for more than eight years, and we wish him great success in his future endeavors. Now on to VRV Q3 results. Fiscal Q3 is a record for VIAVI's March quarter for both revenue and non-GAAP profitability. Third quarter revenue came in at $315.5 million, up 4% year-over-year, exceeding a guidance range of $301 to $315 million. Growth was primarily driven by continued solid performance in our NSE business segment, and improving sequential performance in our OSP segment, albeit down year-over-year. VIAVIC's operating profit margin at 21.5% came in at the high end of our guidance range of 20.5% to 21.5%, improving 130 basis points year-over-year. EPS at 22 cents, increased 22.2% from 18 cents in the prior year, a combination of strong operating performance, a reduced tax rate, and lower share count. The share count of 236.8 million shares is lower than expected because of additional redemption of convertible notes. However, it still includes the dilutive impact of the remaining convertible notes of approximately 4.9 million shares. Now moving to our reported Q3 results by business segment, starting with NSE. NSE revenue at $230.8 million, up 9.3% year-over-year, came in at the low end of our guided range of $229 to $239 million as a result of COVID-related shutdowns in Shenzhen in China late in the quarter. Within NSE, NE revenue increased 7% from a year ago to $204.3 million, reflecting continued strength in our fiber, wireless, and lab and production products. SE revenue at $26.5 million increased 30.5% year-over-year, driven by strength in our assurance and data center products. NSE gross profit margin at 64.4%, increased 20 basis points year-over-year. Within NSE, NE gross profit margin at 63.8% decreased 70 basis points from last year, primarily a result of expedite costs as we proactively secure components to mitigate supply chain constraints. SE gross profit margin at 69.1% increased 800 basis points year-over-year, reflecting both high revenue and favorable product mix. NSE's operating profit margin at 14.9% increased 500 basis points year-over-year, a result of operating leverage on higher revenue and disciplined OPEX management. Now turning to OSP. Third quarter revenue at $84.7 million was down 8.1% from a year ago and improved sequentially by 20%. Revenue exceeded the guided range of $72 to $76 million due to better than expected demand for anti-counterfeiting products during the quarter. Cost profit margin at 55.5% decreased 510 basis points year over year due to lower revenue volume and higher raw material costs. Operating profit margin at 39.3% was near the high end of our guidance range of 37.5% to 39.5%, albeit down 460 basis points year-over-year, a result of the aforementioned offset by disciplined OPEX management. Now turning to the balance sheet. The ending balance of our total cash and short-term investments was $596 million, down 82.1 million compared to a year ago, primarily due to additional retirements of convertible notes as well as investments in organic initiatives including increased inventory levels allowing us to meet and exceed customer demand requirements in an environment of supply chain challenges operating cash flow for the quarter was 28.9 million dollars a decrease of 19.2 million compared to 48.1 million in the year-ago period the reduction is a result of timing of payroll and inventory related payables in addition we invested $19.3 million in capital expenditures during the quarter compared to $8.2 million in the prior year as we continue to build out the new Arizona production facility. As you may recall, we had targeted the reduction of our 2023 and 2024 outstanding convertible nodes. to continue to improve our capital structure. In the first half of 2022, we redeemed approximately $321 million of these notes from the original $685 million in principal value, leading to a remaining outstanding balance at the end of the first half of 2022 of $364 million, or 53% of original principal value. In this quarter, we completed transactions to extinguish an additional $50 million in principal value of convertible nodes at a total reacquisition cost of $65.2 million, bringing the principal value of our combined convertible nodes outstanding to $314.4 million at the end of the third quarter, or 46% of the original principal value. During fiscal Q3, we repurchased 4.7 million shares of our common stock for $78.7 million. This includes 4.2 million shares in the amount of $70.6 billion repurchased under the 2021 Repurchase Plan. This completes the 2021 Repurchase Plan, resulting in a total repurchase of 11.7 million shares for a total amount of $190 million. The balance of 0.5 million shares during the quarter were repurchased under the 2019 share repurchase plan. The remaining authorization under this plan is 96 million at the end of the quarter. We plan to continue to improve our capital structure and provide financial flexibility to allow us to execute our goal objectives. Now on to our guidance. We expect the fiscal fourth quarter 2022 revenue to be approximately $322 million, plus or minus 7 million. Operating profit margin is expected to be 21.5% plus or minus 50 basis points, and EBS to be in the range of 22 cents to 24 cents per share. We expect NSE revenue to be approximately $245 million, plus or minus 5 million, with operating profit margin at 16%, plus or minus 50 basis points. OSP revenue is expected to be approximately $77 million plus or minus $2 million, with operating profit margin at 39% plus or minus 50 basis points. Our tax rate is expected to be between 16% and 17%. We expect other income and expenses to reflect a net expense of approximately $6 million. Share count is approximately 234.5 million shares based upon current stock price levels and includes the dilutive impact of approximately 3.5 million of the remaining profitable notes. With that, I will turn the call over to Oleg.

Thank you, Henk. The second half of fiscal 2022 is off to a good start. During fiscal Q3, we have achieved the new historical highs in revenue and non-GAAP profitability. I'm pleased with both NFC and OSP performance in delivering strong results despite supply chain challenges and COVID-related shutdowns in China. The NE segment growth was driven by fiber and wireless. Fiber grew double-digit percentages from the same period of last year as North American service providers upgrade and expand their networks with fiber. Optical lab and production business also saw strong customer demand driven by 400 gigi and initial deployment of 800 gigi. Wireless demand continues to be strong, up mid-single-digit percentage from a year ago levels, as customer mix shifts from NAMs to O-RAN deployment. Demand for cable products moderated cyclically lower. The SE business segment had a robust Q3, with revenues growing 30% year-on-year. We saw strong growth in assurance solutions and data center products. We expect SE to benefit from the anticipated strong market demand for 5G and growth in network traffic. We continue to execute successfully despite supply chain shortages. Our ability to secure critical components, build inventory, and meet customer demands has been a great differentiator and enabled us to grow revenue and market share. Now turning to OSP. The OSP business segment delivered better than expected revenue and profitability, with revenue exceeding our guidance range. Although our Q3 anti-counterfeiting product revenue decreased year on year, as central banks globally moderated their demand from COVID high stimulus spending, it was up 20% quarter on quarter as 3D sensing and anti-counterfeiting demand recovered from the December quarter. Looking ahead, we expect Q4 revenue to be up year-on-year, benefiting from stronger anti-counterfeiting and 3D sensing demand. Fiscal 2022 is expected to be another record year for revenue and profitability at Viavi. Fiscal 2022 is also the last year of our three-year guidance provided during the analyst day in September 2019. We are proud to have exceeded our three-year targets despite the global pandemic and challenges in the supply chain. As we plan the next phase of our growth, we will be hosting an analyst day in Boston on September 13th, 2022 to outline our strategy and goals for the next three year cycle. Please save the date and we hope to see you there. We will continue to provide more information regarding the event in the coming months. In conclusion, I would like to thank my VIAVE team for another quarter of strong performance and express my appreciation to our supply chain partners customers and our shareholders for their support. I will now turn the call over to Sagar. Thank you, Oleg.

Tara, let us begin the question and answer session. We ask everyone to limit discussion to one question and one follow-up. Please go ahead.

Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. One moment, please. Your first question comes from the line of Alex Henderson with Needham. Please go ahead.

Great, thanks. So first of all, congratulations, good quarter. You made a comment fairly late in the quarter. You saw some pressures on supply chains out of China. It seems pretty clear that China's gotten worse in April. Is there additional pressures evident in 2Q, and can you quantify the magnitude of the impacts for the two quarters? And while we're on the subject, did the change in conditions in Europe as a result of the war on Russia have any impact on demand in the media? And do you have any operational exposure to Russia or Ukraine? Thanks.

Sure. Thank you, Alex. So, you know, in China, I would say it kind of was a one-time impact that kind of, you know, permanently shifted some supply because what they've done is they increased the amount of days in quarantine your incoming products and your outgoing products have to be. So once you've done that adjustment, and it roughly cost us, I'd say probably about $8 million in revenue shipment, which is all kind of it's coming in the June quarter, that's part of the reason the June quarter is going to be extremely strong. And I think once that's factored in, it's now, you know, that new lag and lead time is built in, so now the product is flowing accordingly. And it was really just the way, you know, just put additional requirements for incoming components to sit some few days in quarantine and then outgoing components have to go in quarantine. So that's now all fully factored in in our guidance for the June quarter. As to the situation in Europe, VIAVI overall, I think we have about maybe eight to $10 million of revenue in that region. And that's all now been factored in. And we have some salespeople in the region that we have been working to either to move or let go. So that's where we are.

So just to be clear, $8 to $10 million annually or quarterly?

Annually, annually, annually.

Right, right. And so that's been backed out of the forecast and zero exposure at this point. No receivable exposure. Perfect. And the last question that was in that opening salvo was, has there been a change in demand in EMEA as a result of the war causing either cancellations, longer close time. I did notice your European business was a little bit weaker than we had expected. Any change in demand conditions?

No, I think there is no impact. I mean, in the quarter, it's a few hundred thousand dollars, so it didn't really move the needle one way or the other. But in general, in Western Europe, no impact.

Thank you. Thanks, Alex.

Thank you. Your next question comes from the line of Tim Savageau with Northland Capital Markets. Please go ahead.

Hi, good afternoon, and congrats on the good results. I'm going to follow up on a comment you made, Oleg, about double-digit growth in fiber in the quarter, which is pretty strong, and kind of lever off some commentary from very large fiber suppliers such as Corning talking about, you know, expectations, you know, even at their scale for double-digit growth for many years, maybe to be enhanced by some of these infrastructure stimulus projects. I mean, do you think that type of double-digit growth in fiber is sustainable over a period of time, or is anything in particular driving that this quarter? Can I have a follow-up?

Well, I mean, I don't think anything is sustainable at 20%. I think you got to look at the March quarter a year ago. That's where a lot of things were just starting to recover, so you have obviously an easier compare, although March quarter was already quite good for us last year as well. So I would say what's been driving it is several major players are aggressively ramping up their fiber, they already deployed it. They've been deploying fiber for many years. Now they're turning it on and they are turning on new customers. And that requires significant spend on field instrumentation and outfitting all their techs with all the equipment. And we have pretty much one significant chunk of that business. And, you know, Also, in some ways, thanks to our amazing job of our supply chain organization, we're able to deliver the product where none of our competitors can even source the components. So that's why I said, you know, in my comments, the prowess of our supply chain management has really been instrumental in not only benefiting from this increased spend and fiber, but also capturing share for the remaining business. Because a lot of you know, major players, they would give you, let's say, 70%, 80%, and they would have a second source for 20%, 30%. And if second source cannot deliver, then you take the entire 100%. So that clearly has been an additional icing on the cake.

Got it. And I wouldn't hold you to 20. I was just trying to get you to 10 there. But that's fair enough.

Well, I think higher single-digit growth is obviously – for the foreseeable future is something we can definitely strive for.

Okay, I'll take that. And the follow-up is on the wireless side where you mentioned mid-single-digit growth. I wonder if you've seen a material contribution on the wireless field instrumentation side. And to the extent you really haven't yet, and that's more second half, can that take wireless growth to the same level rate as fiber or maybe even greater for a while at least?

Well, I don't think wireless will ever be as big as fiber because fiber is just fundamentally a much bigger market. And if you think about the number of fiber techs ultimately we'll need in this country, it's in tens of thousands. Whereas the wireless industry is obviously much more compact. There you have about maybe several thousand right and we feel very good about our position in the wireless field and you know we've upgraded our you know goal for entering this market now to be more like a third of the market instead of a quarter and we already seeing orders coming in and and it's starting to ramp and I do believe in the second half will be a much stronger in terms of deployment so So when I talk about the wireless, it's traditional NAMs taking their deliveries, but we're also now seeing more and more orders coming in from new entries as well as service providers as they're deploying ORAN. And we feel particularly good about our position in the ORAN. And it's kind of in ways, you know, if you think about ORAN as in between the NAM equipment and the field equipment, we actually, having strong position in both, it really makes us a, by far, the best choice for O-RAN deployment in the industry. And we feel, you know, as things really pick up pace, O-RAN could become a major growth driver for the wireless business, where traditionally it was more driven by NEMS demand. And with the unbundling or kind of opening up architecture for 5G to other players, A, it's increasing the number of customers for us. It's increasing the number of test points that need to be tested. And it also increases number of applications, not only being a service provider, but also increasingly private networks. So in that respect, I think the market expansion for the infrastructure test with the emergence of the open RAN network is actually expanding our addressable market significantly on the infrastructure side. And of course, as that gets bigger, it actually creates even more flywheel effect on our field instruments for the wireless instruments.

Got it. Thanks very much. Appreciate it.

Your next question comes from the line of Semek Chatterjee of J.P. Morgan. Please go ahead.

Hi. Thanks for taking my questions. I guess for my first one, Oleg, if I can take you back to your comments about the targets issued at the 2019 Analyst Day. And when I look back, I think at that point you issued a growth target of 2 to 5 percent CAGR, revenue CAGR. Obviously, the cadence through the three years didn't plan, probably track as you expected because we started with a tough year initially after that analyst day. But for the last two years, you've been, or last fiscal year and this year, you're on track to hit the high end or be higher, be above the high end of your range that you're guided to. And so I'm curious, like, how are you thinking about sustainability of the growth beyond sort of the 2% to 5% above the high end of that range that you've issued in the past? Are you thinking about the current growth rates being higher primarily on account of pent-up demand, or do you see some of the drivers that's helping you deliver this growth being more sustainable as you sort of think about the next two to three years? And then have a follow-up, please.

So, well, you know, if I think about it, Clearly, we did not foresee the global pandemic. We thought there may be a recession or so, and we figured we'll handily blow away through our growth. So we had plenty of buffers built in, and obviously it proved to be a heck of a lot tougher, but we still exceeded on the top line and significantly exceeded on the bottom line through the operating leverage. In terms of what we're seeing is, you know, the market actually has improved in the dynamics. Before, it was very much driven by DSL and cable on the field instruments. And today, we fundamentally have a much more diverse and more dynamic, I would say, higher growth environment where fiber is becoming a major play in the field instrumentation. And wireless, with our new wireless tools, it's opening up new markets. some of the new segments like O-RAN with a 5G and our revamped SE business, we actually think we're going to be in a higher growth segment than we were while we were restructuring the business, kind of from the JDS uniphase days to the modern VIAVI. So we actually, you know, I don't want anybody to steal my thunder for the analyst day, but we do feel that the next three years, we are much more optimistic about the next three years than we were about the last three years. Because the first three years was really stabilize the patient. The last three years was get the patient into fighting shape and start kicking butt in the market. And I think going forward, it's all about full speed ahead. So we feel that the dynamics of our end markets, our diversity of our end markets, and the new applications that we are playing in are actually going to be a more dynamic environment in the coming three years than what we've seen in the last three years.

Got it. Got it. For my follow-up, on the 3D sensing piece of the business, you mentioned you've seen sort of demand pick up from the low point in December, which is contrary to the seasonality on the unit front for your primary customer there. And if I remember correctly, you have a lead down over two to three weeks, which is you generally have been pretty closely aligned to unit demand that the customer sees. It does suggest that the customer might be changing sort of their buying pattern in terms of building a bit more inventory. Just curious to get any more color on that front and does that sort of impact then the timing of the benefit that you see or the ramp that you see into the next product cycle?

Sure. Remember, December was a very unusual quarter in that respect. And our customer actually talked at length about it. The reality is they weren't able to get all the chipsets. So their demand was artificially constrained. And since we have a short lead time, when they knew they could not get all the product they needed, they reduced their number of builds. And it adversely impacted us within quarter, the actual demand. Well, as situation improved in March quarter, they've built more units and they've obviously placed more orders with us. And I do see some level of linearization in the March and June quarter. The builds are a little bit higher because I think traditionally they would build a lot in the second half of the calendar year and clear back in the first half and kind of do the June quarter as a transition to the next product year. I think given the shortages and supply constraints in the December and September quarters, they're now making up some of the volume in the first half of the calendar year. So it's giving us a bit of a stronger demand. And I think, you know, I don't claim to know if it changes their pattern or not, but, you know, reality is we can respond on a dime and, In that respect, I think we are the least of their worries in terms of supply chain.

No, thank you. Thanks for the color. I'll see the floor here. Thank you. Sure.

Thank you. Your next question comes from the line of Medha Marshall with Morgan Stanley. Please go ahead.

Hey, this is Karan Jivakar on Formida. Thank you for the question. So I just have two quick questions. One, are you seeing any disruption in demand from supply chain complications elsewhere in the insulation chain? For example, inability to find labor or availability of equipment. Are you seeing those sort of things differ in demand?

So, well, I think the, I wouldn't say about inability to find labor. I think there's two types of supply chain challenges. One is, especially if you are exposed to China production, as you're probably well aware with the zero COVID policy, they've implemented a number of additional controls that increases the quarantine on incoming components and outgoing products. So as a result, you now have to factor in longer lead time of getting parts into China, getting product manufactured and shipped out of China. But that's a kind of one-time adjustment, and it happened really late, and I'd say in the third quarter, in our March quarter. The second challenge is really the steel components, and it's a very narrow set of components. I'd say, by and large, we don't have an issue anymore with the semiconductor devices or passive components, but the high-performance analog mixed signal and FPGA continue to be still under tight supply. But we do think we're going to see situation improving by summer.

Got it. Okay, thank you. And then just one quick follow-up. You sort of mentioned this earlier in the call that you're seeing share gains. And I just was wondering, are there any particular end markets that you're seeing share gains right now given sort of these supply chain challenges and maybe you being able to mitigate them a little bit better? Thank you.

Well, I'd say in the NFC across the board, we are seeing share gains. Some of them are very tactical. Like, for example, in the field instruments where you have multiple sources, a lot of our competitors just can't deliver the product. They cannot get the parts they need to build their product. and ability of your supply chain to execute versus your competitor, basically customers give you 100% of the business, which is a big deal because once you have 100%, you've got it for the next whole product cycle with replacement parts, with support, so on and so forth. So that's where you pick up, I would say, tactically market share in the field. And then on the advanced technology space, like our wireless business, our 800 gig and so on, having a product and the bleeding edge of performance with the latest standards and far outpacing the competition, we're winning market share by basically extending our technological leadership over our competitors.

Got it. Thank you. Helpful.

There are no further questions at this time. Mr. Habar, I turn the call back over to you.

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

Thank you. You may now disconnect your line.