Viavi Solutions Inc.

Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the VIB Solutions fiscal second quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you'd like to withdraw your question, press star one again. I would now like to turn the conference over to Sagar Habar, Head of Investor Relations. Please go ahead.

Thank you, Regina. Welcome to BRV Solutions' second quarter fiscal year 2023 earnings call. My name is Sagar Habar, Head of Investor Relations for BRV Solutions. Joining me on today's call are Oleg Hykin, 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 from our current expectations and estimation. 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. BRV 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 limitation in today's earnings release. The release plus our supplemental earnings slides, which include historical financial tables, are available on VRV's website at www.investor.vrvsolutions.com. 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. Fiscal Q2 2023 slightly exceeded our lowered expectations. mainly as a result of anticipated headwinds in service provider spending. Fiscal Q2 revenue came in at $284.5 million, down 9.6% year-over-year, and above our guidance range of $261 to $281 million. We have this operating profit margin of 16.2%, decreased 550 basis points from last quarter and 710 basis points from prior year, although above a guidance range of 13.9 to 14.9%. EPS at 14 cents per share was down 41.7% from the prior year and 39.1% from the prior quarter results and exceeded the guidance range of 10 to 12 cents per share. The current share count was 227.1 million during the quarter, down from 242.3 million shares in the prior year, as we continue to improve the quality of the balance sheet. Cash flow from operations was $46.2 million versus $22.2 million in the prior year. And year-to-date, cash flow from operations continues to be strong, at $72.8 million compared to $75.6 million last year during the first half. Now moving to our reported Q2 results by business segment, starting with NSE. NSE quarterly revenue was impacted by lower service provider spend at $207.1 million and declined 15.2% year-over-year, slightly ahead of our guidance range of $187 to $203 million, although on lower levels compared to prior year, and as the quarter progressed, demand patterns stabilized within NSE. NE revenue of $179.7 million declined 16.2% year-over-year, driven by the weakness in service provider spending. SE revenue at $27.4 million decreased 8.1% from last year. NSE gross profit margin at 64.4% decreased 90 basis points year over year. Within NSE and E gross profit margin at 64.1% decreased 30 basis points from the prior year, primarily due to decline in volume. SE gross profit margin at 66.8% decreased 500 basis points from last year primarily due to product mix. NSE, gross profit margin, operating profit margin at 8.9% exceeded our guidance range of 5.5% to 6.5%, albeit down 980 basis points year over year. Now turning to OSP. Second quarter revenue at $77.4 million was up 9.6% year-over-year. Revenue was near the high end of our guidance range of $74 million to $78 million. Gross profit margin at 52.3% decreased 390 basis points from the prior year, mainly a result of startup costs in our new Arizona facility. Operating profit margin at 35.5% was within our guidance range of 35 to 37%, down 370 basis points from a year ago. On February 1st, 2023, the company approved a restructuring and workforce reduction plan to improve operational efficiencies and better align the company's workforce with the current business needs and strategic growth opportunities. The company expects approximately 5% its global workforce to be affected and estimates it will incur charges of approximately 15 million dollars in connection with this plan the company anticipates the plan to be substantially complete by the end of fiscal 2023 now turning to the balance sheet the ending balance of our total cash and short-term investments was $489.7 million, down $27.4 million sequentially as a result of capital deployment towards both acquisitions and stock repurchases. As mentioned earlier, operating cash flow for the quarter was $46.2 million, an increase of $24 million year-over-year. The increase was a result of solid collections. In addition, we invested $18.1 million in capital expenditures during the quarter, compared to $14.8 million in the prior quarter, primarily due to complete the build-out of our new Arizona production facility. During fiscal Q2, we repurchased 2.2 million shares of our common stock for $25.2 million under the share repurchase program announced in September. leaving a remaining balance of $274.8 million worth of shares authorized for repurchase. As you may recall, in September, we announced that the Board authorized a new common stock repurchase program for up to $300 million. In addition, we successfully closed the acquisition of Jackson Labs in fiscal Q2 2023. The total purchase consideration comprised of approximately $49.9 million in cash and contingent consideration of up to $117 million in cash based on the achievement of certain operational and revenue targets to be achieved over a three-year period. This transaction provides VIAVI a leadership position in a resilient P&T, supporting government and service providers in protecting their key infrastructure and assets. The transaction allows us to leverage our existing go-to-market model and utilizes U.S. federal NOLs. Now on to our guidance. We expect the fiscal third quarter 2022 revenue to be approximately 266 million dollars plus or minus 10 million. Operating profit margin is expected to be 13.6 percent plus or minus 60 basis points, and EPS to be in the range of $0.10 to $0.12 per share. We expect NSE revenue to be approximately $197 million, plus or minus $8 million, with operating profit margin at 7.7%, plus or minus 50 basis points. expected to be approximately 69 million plus or minus 2 million with operating profit margins of 30.5% plus or minus 100 basis points. Our tax rate is expected to be between 23 and 25% as a result of jurisdictional mix. We expect our income expenses to reflect a net expense of approximately $4.5 million. Share count is expected to be around 226 million shares based on current stock price levels. With that, I will turn the call over to Oleg.

Thank you, Henk. Fiscal second quarter of 2023 came in above our guidance range, driven by better-than-expected NSC performance, helped by stabilization in service providers' demand and spend. Our OSP business grew year over year and came in within the guidance range. starting with NSE. NSE declined on a year-over-year and sequential basis. During the December quarter, we continued to see continuation of general pullback in service providers' OPEX and CAPEX spend that started during the last three weeks of September. In addition, we also did not see any meaningful year-end budget flush. Decline in NE was primarily driven by weaker demand in our fiber and wireless lab products by Tier 1 service providers and wireless NAMs, responding to reduced business outlook. This was partially offset by stronger demand for our wireless field instruments, driven by the 5G T-band infrastructure deployment. In addition, we saw strong traction for the recently acquired Jackson Labs resilient P&T product. I'm pleased with the market momentum for resilient P&T technology, as it increasingly becomes a must-have. by the government and service providers as they adopt resilient P&T technology to protect their strategic infrastructure and assets. Looking at the current quarter, we expect the demand softness to persist as many of our customers are continuing to pare back their CapEx and OpEx in face of weakening and market conditions. That said, we are encouraged with the service provider spend stabilization and are starting to see early signs of near-term recovery. We expect field instruments demand to start picking up by mid-calendar 2023 as service providers retrench and rebalance their CAPEX and OPEX plants and resume their fiber network build-outs and 5G C-band expansion. This is expected to drive the recovery in demand for our fiber and field RF products. In addition, we also expect several major cable operators to start upgrading their networks during 2023. which is expected to drive the demand for our cable-filled instruments. Our SE business segment grew 14.2% sequentially, in line with our expectations. We expect SE revenue to remain steady at the current levels for the remainder of fiscal 2023. Now, turning to OSP. OSP increased 9.6% year-over-year, driven by growth in both anti-counterfeiting as well as 3G sensing products, and performed in line with our expectations. Looking ahead, we expect second half of fiscal 2023 to be weaker, with quarterly core OSP revenue moderating to about $55 million per quarter, driven by weaker anti-counterfeiting product demand as some of our major end customers pull back on fiscal stimulus. We also expect weaker year-on-year demand for 3D sensing products in the second half of fiscal 2023, driven by lower end customer demand. In view of weaker near-term demand environment, we're implementing a limited restructuring plan for our NSC and OSP businesses, intended to align our operating expenses with the expected lower near-term customer demand and to redeploy investment to strategic growth areas in order to position BIAVI for accelerated revenue and profitability growth as end markets recover. In conclusion, I'd like to thank my VIAVI team for managing in this challenging environment and express my appreciation to our employees, customers, supply chain partners, and shareholders for their support. I will now turn the call over to Sagar.

Thank you, Oleg. This quarter, we'll be participating at Morgan Stanley's TMD Conference in San Francisco on March 6th. We will also be attending the MWC in Barcelona and OFC in San Diego. Regina, let us begin the Q&A session. We ask everyone to limit the discussion to one question and one follow-up.

As a reminder, to ask a question, simply press star 1 on your telephone keypad. Our first question comes from the line of Amiri Hosseini with Susquehanna. Please go ahead.

Yes, thanks for taking my question. Just in terms of what you just described, for LSE and OSP in the near term. Should I expect a kind of a flat to down quarterly trend into the last quarter of the fiscal year and then a more meaningful pickup into next fiscal year?

So I would say, you know, seasonally, March quarter is one of our weaker quarters. And I think even though in the last two years, because of the constrained supply Seasonality was not as pronounced. I think this time around we are seeing seasonality returning. So I would actually expect, I think typically our fourth quarter, we start seeing pickups. So I would expect the fourth quarter to be stronger than the third quarter. And, you know, I'd say as it goes to September, it's a little bit too far out, outside of our outlook. But I would expect it also to be coming in stronger, especially for OSP.

Okay, and then specific to OSB, as we look into the next couple of quarters, how do you see the mix evolving? The NSC benefits from a pickup lower base, especially as the service providers have become more cautious, that could actually play to your favor if the compares are easier. But I'm not so sure if the compares are relevant as I think about OSP into next fiscal year. Any color would be appreciated.

Well, let me just start and see if I'm addressing your question. So when we think about OSP, you've got to think of it two ways, right? There's fundamentally two major segments in there. There's anti-counterfeiting, and then there's a 3D sensing. When the demand for smartphones is very strong, you know, so you have effectively, if both anti-counterfeiting and 3D sensing are running strong, right, strong demand, you're in the $90 million quarterly run rate. When both of them are running weak, as what we see like this quarter, right, 3D sensing demand is lower and anti-counterfeiting is lower, you're closer to about $70 million, right? quarterly run rate. When either one of them is strong and the other one is weak, you're in about $80 million range. So we think over the next two quarters, there's headwinds for both 3D sensing, there's a lower outlook demand for the smartphones, and we're also seeing a number of major economies are pulling back on fiscal stimulus, so it may take them a little bit longer to work through the inventories of product they already have. So we think that's also going to be on the lower end. So we are, you know, clearly March quarter we see, you know, more clear demand. So we are saying to be in a neighborhood of like high 60, like $70 million. I think Q4, if intake counterfeiting comes back a little stronger or smartphone comes in stronger, it may be better. But we are for the abundance of caution saying first half to be in the $70 million. range per quarter for OSP. So, I'm not sure if I answered your question.

Yes, you did. That's helpful. I go back into the queue. Thank you. Thank you.

Your next question comes from the line of Alex Henderson with Needham. Please go ahead.

Thanks. So, a couple of clarifications just to be clear. The WIPP is going to be completed by the June quarter. You've talked about the size of the cost, but I didn't see any indication of what you think the benefits to results might be and what your intended use of that benefit will be, whether it will be investing in something else or whether it will actually show true to the bottom line. So could you give us some sense of what the cost reduction scale of benefits might be and what you're going to do with it?

Sure. So 5% of our workforce will be impacted. The majority will be focused in the NSE business, a little bit in the OSP business, and we'll be targeting operating expenditures most notably. So about $500 million of OPEX, 5% of the workforce. So call that a $25 million annualized benefit, of which we'll see the impact in the December quarter. on a full basis.

Okay. And then going back to the OSP business for a second. So in the December quarter, we're talking about about $24, $25 million worth of 3D sensing. And I assume when you're talking about the March quarter that the $55 million number was just the the counterfeiting, and could you give us some sense of what you think we're looking at in terms of... That's correct. It sounds like it's coming down into the $15 to $18 million range in both the June and March quarters. Is that correct?

That's exactly right. It's about $55 million for core or anti-counterfeit, and then another $14 to $15 million or so for a 3D sensing product line.

If I could just steal one more. Jackson Labs, can you give us some sense of what it contributed in the December quarter, what it might contribute in the forward quarters?

A couple of billion dollars in revenues and maybe rounded to half a penny, a penny in EPS.

Thank you.

Your next question comes from the line of Michael Genovese with Rosenblatt Securities.

Please go ahead.

Great, thanks.

Hi, guys. I'm trying to get the thread on carrier CapEx and OpEx a little bit more clearly because clearly it was a little better than you got it to in the quarter, but you talked about the macro, but yet it seems like calendar 23 spend seems like it's going to be okay, and you're also saying that later in the year. AT&T's guidance was good. I think Verizon's was good on the wireline side and maybe not as good on the CBAN side. So could you just put all of this together and sort of help, what exactly are we saying about CapEx and OpEx and the NFC business operating at a higher level because of those things?

Sure, sure. So I think it's almost like when we had our earnings call in early November, we said, okay, it feels like it's replay of the March quarter of 2020 when the COVID hit. First, there is a panic. And I think a lot of them kind of panicked in September and clamped down. And then usually they step back and they see, well, let's think what we're going to do. Well, let's, you know, they reassess and said, well, we got to take down some CapEx. And by the way, we really could care less about CapEx because We don't get impacted by that, but that's usually where a big money comes out. And then they say, well, you know, we still have the business to run, so we've got to start doing something more on Alpex. We've kind of pulled back too much. So it's usually that second quarter is when a lot of realignment happens. And then in the following quarter, which is where we are right now, there is now a reassessment and planning, okay, so what are we going to do? So the CapEx reductions get communicated to companies And we've seen a number of major NAMs stating that, lo and behold, yes, they're going to get less revenue this year, even though most of them were in denial or ignoring it in October. And so now the, so that's kind of the CapEx plans. But then the OpEx plans come in because, you know, a lot of the equipment is already coming in and came in and needs to be installed, deployed, turned on. Well, you need the tools for that, and that really comes back to us. So we're seeing, you know, you mentioned AT&T, Verizon. I mean, there is not, okay, the world didn't come to an end. Guess what? We still need to build out networks. We need to turn on the services. And let's start thinking about the deliveries and orders. This is why I'm saying we're feeling good that we are starting to see stabilization and the right signals coming out with the, demand for field equipment and it gets even better I mean you've seen the AT&T announcement with BlackRock well now they just have a whole pot of extra money to go and extend the fiber to the states where they were not even playing and that brings a whole different element of competitiveness whereas the cable players now need to respond sooner rather than later and equalize relative performance of cable network versus fiber. So I feel very good that we're going to see a recovery and growth in fiber and cable spend this year. And by the way, last year cable was de minimis. It was kind of a pause here. So I think over the next two years we're going to see a mid, I would say a mid-cycle upgrade of network before they dock this 4.0. And what they're going to try to do is reallocate spectrum in the cable. to have more symmetric bandwidth up and down, right? And, of course, in about two years, we expect the DOCSIS 4.0, which would get you up to maybe up to 10 gigabits in speeds on the cable network. So that's why I feel in fiber and cable, we're going to have some upsides starting in the middle of this year and going on beyond that. And, of course, the 5G C-band deployment is ongoing. And, you know, now that equipment is there, we feel the demand for field instruments will be kind of our time to shine.

Well, you know, I appreciate all that color. And I had a couple of follow-ups in there, and then you would get to the questions. So I'm going to pass it on here. And, again, thanks for the helpful answer.

We'll get back to you. All right, sure.

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

Hi, this is Karanjit Vakaran from Morgan Stanley. Thank you for the question, or for Medha Marshall. Thank you for the question. I guess just, have you seen any changes to behavior from European customers and their spend plans since there seems to be some caution around overbuilding or maybe some rationalization over there? Any sort of geographic trends that you'd want to call out?

So I'll start and I'll turn it over to Hank. I think in the last quarter there's been a lot of volatility regarding the exchange rates. So the European, I mean, there's been some slowdown in deployment, but the problem is more driven, they still spend the same budget, but they were getting fewer, less equipment, right? So actually, you know, all things considered, we see actually EMEA doing pretty well. And, you know, there's a lot of, structural problems. I mean, there's a lot of, you know, volatility of foreign exchange. But, you know, now we're kind of back to where we were in September in terms of euro and pound. And actually, you know, Europe is holding up relatively well, I would say, for us, all things considered.

Okay, that makes sense.

And I guess just a quick follow-up just on the strategic activity in the space. I mean, just given sort of the National Instruments announcement, I guess, and maybe more industrial players wanted to get into maybe TNM or the broader industry, I guess, does that change how you think about M&A opportunities or any update to sort of your thoughts around M&A opportunities?

Well, I mean, you know, it's, I mean, even though, I mean, generally National Instruments is in, general category, their business model is very different. They're very much focused on lab and some of the industrial deployments. And, you know, I'm not surprised that, you know, for the longest time, test and measurement has been kind of the Rodney Dangerfield for those who are old enough to remember. He wasn't getting respect. So I think these guys are realizing that it's a very attractive business model. But also, you know, aggressiveness is always greener on the other side. And when I see electrical power industrial companies sticking their nose in our business, they really don't know what they're in for because it's a very different business model. You have to keep spending money and a lot of them are used to relatively low margins and they get enamored by high margins, but they forget that they need to continue to reinvest nonstop in this business. I think, you know, I mean, they're doing what they are doing. I mean, we are running our business, you know, with an eye on the longer-term growth. And I think our testing measurement is a bit different from a lot of what they call industrial or lab-based business. But, you know, it's nice to see that our sector is getting the respect that for the longest time it was not getting.

Got it. Okay, thank you. That's helpful. I'll pass it on to the next. Thank you.

Again, for any questions, simply press star 1 on your telephone keypad, and again, we ask that you limit your questions to one and one follow-up. Our next question will come from the line of Ruben Roy with Steeple. Please go ahead.

Hi. Thank you for taking my question. I had a quick follow-up on the discussion around Mike Genovese's question and the sort of service provider linearity that you're looking at. When you went into the downtick late September quarter, you had characterized that as being sort of broad based. And I guess the question is, is the stabilization you're seeing, which I guess is a little bit of a surprise in the December quarter, given that you thought that this would be a two to three quarter phenomena, you know, was that broad based or was that sort of specific to one or a few customers?

Well, so I mean, if you think our first quarter impact was September quarter, because people just shut down. And during the December quarter, there was a lot of rebalancing, you know, our customers looking at headcount cuts, the CapEx cuts, like the OpEx redistribution. And I would say that we are now entering the third quarter of that. So it's very much in kind of what I said, two, three quarter. And what is happening now, usually in the first calendar quarter, many service providers are setting their budgets for the calendar year, and they are starting to send smoke signals and engage with us in conversations. And the momentum of these conversations, I would say, is a positive one. And they've now taken down some of their up expense reductions. They've reduced their capex, and now they're getting back to business as usual. And when you're spending less money, generally, you want to get the most of what you already have. So you invest in optimization of your network. And since a lot of equipment has been delivered in September, December quarter, now all that equipment needs to be put into production, so to say, and you need equipment to install it, turn it up, and release it into operations, which also requires you to start buying new equipment. instrumentation and software to deploy your network. So that's where I'm saying that this quarter we are seeing things really stabilized and the discussions are now no longer how much can I push out the orders, but let's discuss the timelines and deliveries and what I will be requiring during this calendar year. So the tone is very different from what I would say we saw at the end of September and a bit of a panic in the early October.

okay thanks for that detail like and i guess just a quick follow-up then when you talked about field instruments picking up mid 23 is a combination of what you just talked about plus uh you know sort of the view that the cable guys start to pick up as well so that should help us you know well and that's a big deal because you know in the past yeah in the past two years cables you know the most of the taxes 3.0 was already done

About three years ago four years ago, so there's been cable was kind of running a de minimis so the mere fact There is going to be this and it's not one It's actually several major cable companies are looking to do an upgrade where they bring up They still going to give you one gigabit on the line but they're trying to make it more symmetric up and down and that requires an upgrade and it looks like they are moving forward during this calendar year and And the expectations that the DAX is full at all probably will be two years from now because the chipsets have not been developed yet. And so in many ways it's a response to the aggressive fiber deployment that's happening out there. So in a way, you know, it's part of the response to the competitive pressure from the fiber operators.

Got it. Thank you so much.

I will now hand the conference back over for any closing remarks.

Thank you, Regina.

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