Viavi Solutions Inc (VIAV) 2024 Q2 法說會逐字稿

Hello, everyone. My name is Rob. Welcome to the Viavi Solutions's second-quarter fiscal year 2024 earnings call. (Operator Instructions)

I'll now turn the conference over to Ilan Daskal, Viavi Solutions' CFO. Please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to Viavi Solutions' second-quarter fiscal year 2024 earnings calls. My name is Ilan Daskal, Viavi Solution's CFO. And with me on today's call is Oleg Khaykin, our President and CEO.

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 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 that we provided during this call are valid only as of today. Viavi undertakes no obligation to update these statements.

Please also note that unless we state otherwise, all results discussed on this call, 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. Their release, as well as our supplemental earnings slides, which include historical financial tables, are available on Viavi's website at www.investor.viavisolutions.com. Finally, we are recording today's call and we'll make the recording available on our website by 4:30 PM Pacific Time, this evening.

Now I would like to review the results of the second quarter of fiscal year 2024.

Net revenue for the quarter was $254.5 million, which was above the midpoint of our guidance range of $240 million to $260 million. Revenue was up sequentially by 2.7% -- excuse me, and on a year-over-year basis was down 10.5%.

Operating margin for the second fiscal quarter was 13.2% and exceeded the high end of our guidance range of 9.6% to 12.8%. Operating margin increased 80 basis points from the prior quarter, and on a year-over-year basis was down 300 basis points.

EPS at $0.11 exceeded the high end of our guidance range of $0.6 to $0.10, and was up $0.02 sequentially, and on a year-over-year basis was down $0.03.

Moving on to our Q2 results by business segment. NSE revenue for the second fiscal quarter came in at $179.6 million, which is above the midpoint of our guidance range of $169 million to $185 million.

On a year-over-year basis, revenue was down 13.3%, primarily due to lower CapEx spend by names and weaker spend by service providers. NE revenue for the quarter was $155.5 million, which is a 15.2% year-over-year decline. SE revenue was $24.1 million and grew 1.3% from the same period last year.

NSE gross margin for the quarter was 63.4%, which is 100 basis points lower on a year-over-year basis. NE gross margin was 62.5%, which is a decrease of 190 basis points from the same period last year, and was primarily due to a combination of product mix and lower volume. SE gross margin was 68.9%, which is an increase of 460 basis points from the same period last year, and benefited from higher margin product mix.

NSE's operating margin was 3.6%, which is an increase of 270 basis points sequentially, and a decrease of 530 basis points on a year-over-year basis. NSE operating margin was above the midpoint of our guidance range of 0% to 4%.

OSP revenue for the second fiscal quarter came in at $74.9 million, which was at the high end of our guidance range of $71 million to $75 million, and was down 3.2% on a year-over-year basis. OSP gross margin was 52.1%, which is a decrease of 20 basis points from the same period last year. And was primarily due to lower volume and unfavorable product mix.

OSP operating margin was 36.4%, which is 140 basis points lower sequentially and increased 90 basis points on a year-over-year basis. OSP the operating margin exceeded the high end of our guidance range of 32.5%, so 34.5%.

Moving on to the balance sheet and cash flow. Total cash and short-term investments at the end of Q2 was $571.8 million compared to $489.7 million in the same period last year. Cash flow from operating activities for the quarter was $20.4 million versus $46.2 million in the same period last year.

We have not purchased any shares of our stock in the second quarter, as we plan to retire the outstanding balance of our March 2024 convertible notes in the amount of $96.4 million.

The fully diluted share count for the quarter was 223.5 million shares down from 227.1 million shares in the prior quarter, and was 2 -- versus 222 million shares in our guidance for the second quarter.

CapEx for the quarter was [$5.8 million], which is $12.3 million lower versus the same period last year when we are completing the construction of our new facility in Chandler.

Moving on to our guidance. For the third fiscal quarter of 2024, we expect revenue in the range of $245 million and $253 million. Operating margin is expected to be 10.4% plus or minus 160 basis points, and EPS to be between $0.05 and $0.09.

We expect NSE revenue to be approximately $176 million, plus or minus $3 million, with an operating margin of 1.5%, plus or minus 150 basis points.

OSP revenue is expected to be approximately $73 million, plus or minus $1 million, with an operating margin of 31.8%, plus or minus 200 basis points.

Our tax expenses for the third quarter are expected to be around $8 million as a result of jurisdictional mix. We expect other income and expenses to reflect a net expense of approximately $3 million, and the share count is expected to be around 224.7 million shares.

With that, I will turn the call over to Oleg. Oleg?

Thank you, Ilan, and welcome to your first earnings call at Viavi. The fiscal second quarter 2024 came in stronger than expected. The revenue was slightly above the midpoint of our guidance helped by stronger demand for 400 gig and 800 gig fiber, [Mi/Aero], and SE products. EPS came in above the high end of our guidance, driven by a richer margin revenue mix and lower OpEx.

In the near term, we expect stronger demand in the above product areas to help offset continued weakness in the service provider spend.

Starting with NSE, the second fiscal quarter NSE revenue came in above the midpoint of our guidance range. Although the NSE revenue declined on a year-over-year basis driven by a slowdown in 5G and fiber build-outs by major service providers, there was a number of bright spots. Fiber 11 production has continued to recover, driven by stronger in 800-gig demand, offsetting weakness in computing and storage.

Aerospace and defense products saw a robust growth, driven by strong demand for avionics; and PNT, or positioning, navigation, and timing products. And the new SE products continued to perform well, resulting in a slight year-over-year growth despite the decline in service provider spend.

Looking ahead, we expect continued demand recovery and growth in our Fiber 11 production, aerospace and defense, and SE products compensating for the continued near-term weakness in the service provider spend.

Now, turning to OSP. OSP declines on a year-over-year basis, primarily driven by lower demand for anti-counterfeiting products. This decline was partially offset by strong 3D sensing demands. Overall, OSP results came in at higher end of our guidance range.

In the March quarter, we expect all three to be slightly down from the December quarter with a stronger demand for anti-counterfeiting products offsetting the seasonal decline in 3D sensing. Looking ahead to calendar '24, we expect telecom service provider spend to continue to be soft with the notable exception of the North American cable operators. We expect cable spend to ramp in the middle or second half of calendar year 2024.

That said, our strategy in the past six years to diversify outside the service providers into level production and aerospace and defense makes it easier to ride out the telecom cycle downturn. 11 production spend is seeing a faster recovery versus service providers during by the demand -- for the new technologies such as 800 gig in Open RAN.

Recently, ERP was awarded a $21.7 million grant by NTIA to create an advanced test lab to empower and accelerate the development of Open RAN technologies and components. These award reflects we have is technology leadership in 5G, upcoming 6G, and [Auret].

Our aerospace and defense products are seeing strong demand and growth driven by the next-gen avionics, and they need to protect critical infrastructure and assets against jamming, spoofing, and cyber warfare. In conclusion, I'd like to thank my Viavi team for managing in this challenging environment, and express my appreciation to our employees, customers, and shareholders for their support.

For that, I will now turn back to the operator and Q&A.

(Operator Instructions) Michael Genovese, Rosenblatt.

Great. Thanks a lot. Oleg, first question is just on the service provider market. Just to understand, make sure I heard the comments right, it sounds like you're saying all of '24 calendar expects to be weak there. Is cable getting better at the end of the year first of all? Did I hear that right?

And secondly, did your expectations change in the last three months? Like, has the carrier stuff and telecoms have gotten more pushed out or was that consistent with three months ago?

Well, so again, I'm going to say -- look, the reality is I don't know what the second half is going to look like from service providers. We know the demand will be somewhat stronger in the June quarter. It's always stronger.

Beyond that, I just think -- I mean, clearly, it's not getting any worse. It's getting a little better. But I would still prefer to think of it as a flat to slightly recovering as the modus operandi, because I think they're still pretty weak. But the point is we are seeing -- it's coming in, but it's not as dramatic as I would have liked to see.

Now, the area that is stronger is the cable. In fact, we were expecting cable to start spending and coming in the first half of calendar year. But as you probably know, there were some delays driven by technology readiness in deploying the GAA architecture by some of the vendors and as such, the ramp is being pushed back one or two quarters.

So we know it's coming. We're already seeing some orders, but despite that we were expecting in the March quarter got pushed out. That's why we are guiding March quarter flat to slightly down. It was going to be slightly up in the absence of that slowdown.

I mean, let's put it this way, I feel a lot better about the environment in which we're operating than we were even a quarter or two quarters ago. I just don't want to get ahead of our skis on service provider recovery, because when I see it, I'll believe it, I mean -- so I think there's still got a lot of balance sheet issues that needs to address before they really start spending significantly.

(multiple speaker) So thinking of that abundance of caution, I mean, do I feel better about what's going on? The answer's yes. Am I seeing big dollars coming in? The answer is no.

And now, one thing is -- what we did see interesting is we're seeing pretty good traction on our service enablement products with the new architecture, AI apps, which drive OpEx reduction and things like -- capital avoidance.

So there, we are seeing a pretty good traction, both on the instrumentation particularly with fiber deployment. I think there is a pause. That may at least last six months. Maybe towards the second half of the year, things will get better.

But at this point. I think it's -- my crystal ball is telling me I'm not seeing anything dramatic changing.

Understand. Understand. Great, next question. This 800 G fiber lab in production sounds very interesting. And I think you've probably had either two or three quarters of measurable revenues there. So I assume that that is increasing, and any color you can give us on that? I'm not sure whether you would answer this question, but how much of any of that represents either now? Or what it could be in the future would be very helpful.

Well -- so I mean, there are 11 production business, I would say, on any -- let's see. If I think about the -- we have our network enablement and the FC, so network came on, it was about 87%. I'd say, our level production is, I think -- but also includes wireless, it's about 40%. And of that, I'd say fiber lab and high-performance computing is roughly half of that, right? So maybe 20%.

And now, with the storage building a slowdown, we saw that computing and storage was weaker. I mean, all of that business, it really bottomed out around the June quarter. But what's really been driving the recovery of that business is the fiber production and the fiber lab demand.

And it's driven by 400 gig and 800 gig products, right? So I think -- so what I'd say is it's now -- first of all, its recovering and continue to grow. I think the same players who are building telecom modules, and are more recently these AI data center modules are buying the equipment, I've been trying to ascertain like for so many million ports how much equipment is being bought, I think we're probably not there in terms of truly understanding how the CapEx spend is linked to that because it's still early in the game.

But exactly same equipment that they use on the coherent telecom module line, they're using it also on building the data center modules for the AI applications.

Perfect. Great. Yeah, it sounds like -- going forward that will be interesting to figure that out, that relationship. I can't wait to get an update on that.

Okay. Last question for me. I'm sorry to take so much time, but I'd like to ask Ilan a question, which is, can you just help me understand the -- because the revenues were pretty good for the quarter, the earnings were good, revenue guidance was good. I'm just still not seeing the reason why the EPS guidance is lower. So could you explain that to me?

Thanks for the question. So as you know, our third fiscal quarter, seasonality perspective is usually lower than the second quarter. So if you think about it on a consecutive basis.

Then also when you have the beginning of the calendar year, there are some incremental costs associated with employee related. And that drives in terms of the OpEx. But again, as Oleg mentioned earlier, the traditional seasonality when you think about it is building up really nicely when you think about the rest of the year, including the fourth quarter yesterday.

Yeah. So there's a lot of the statutory cost accrual that happens in the first quarter of the calendar year. And on the OSP, you notice there's a lower margin because the cyclicality of a 3D sensing the second half of the fiscal year is a much lower utilization. So there's more under-absorption in that respect.

Now, that said, the anti-counterfeiting is coming back. So it's offset some of it, but not all of it. And last quarter, the 3D sensing was quite strong.

Okay. Great. Thanks so much for all the answers for the question. Thank you. Thanks again.

Thank you.

Tim Savageaux, Northland Capital.

Okay. I figured it out. Good afternoon. Oleg, can you remind us of your lead times in service provider fiber test?

Generally, if we get an order, I'd say within two months we can turn it around. So it's always in a quarter more or less. Now, except for some things like if it's a -- some products are very quick. Like, for example, fiber scope and things like that. Other products, like when you're buying a whole bench or you have a mems switches and things like that, if we have them in inventory, we can turn it around within, I'd say, two to three months.

And where would you assess your service provider customer inventories to be with your product?

Zero. I mean it's all just in time.

Right. And I guess the reason I ask you this is that throughout the early part of reports here from both -- some of your bigger peers, Corning, IKEA, as well as some of the bigger service providers, we have seen some early indications of project based increases and plans for '24. And I'm just trying to reconcile what's been a pretty consistent drumbeat here with what we're hearing from you.

And I think there could be -- you typically -- you lead these things, but I don't know. Might you lag at this point because of the lead times? I wonder (multiple speakers) are you seeing some of the same things?

I don't think we are allowed to (multiple speakers) once they decide. When they tell these guys they are going to do a project, they may tell it to them before they tell us. Because once they're ready to start building, they just place an order and within two months, they get their equipment. It's pretty quick.

Makes sense. I'll pass it along.

Alex Henderson, Needham & Company.

Thanks. Could you give us a little bit more granularity on the size of the 3D sensing in the quarter and the expectation for 3D sensing in the March quarter?

Well, so generally, Alex, 3D sensing, half of the annual demand comes in in the September and December quarter. So two-thirds comes in in the September and December quarter, and one-third comes in March and the June quarter. So I'll say we ran right around $20 million, $25 million in the quarter.

And so in the quarter, you're looking at, what, $10 million or so?

This quarter?

Yes, the March quarter.

I think, maybe a little more than $10 million, but (multiple speakers). Yeah, it's about -- $10 million plus minus $1.5 million.

Right. And could you give us an update on the plant in Phoenix? It's now fully operational, all of the benefits, of the cost improvement, or in the mechanics of the fitting business at this point? Is that correct?

Yeah. So what we're seeing now -- so that's when you know where people are running out of inventory. And so you start seeing a lot of unforecasted spot orders popping up, like, hurry up and ship as soon as you can.

So we're starting to see more and more of these type of things popping up. They're not big orders, but it's telling us, the inventory is starting to deplete itself in the channel. So in the March quarter, we're expecting a little bit stronger demand from what we were thinking maybe even three months ago. So that's actually helping us to offset some of the 3D sensing decline quarter on quarter.

Generally, it is fully operational and we still have more capacity for additional growth there. So it's not in terms of [full utilization, it's not yet there] in terms of the availability that we can get.

Fully operational, but not full capacity. Right, of course.

Alex, let me give you a correction. Actually, 3D sensing is going to be closer about $16 million in this quarter, one six.

$16 million. Perfect. Thanks.

Yeah, I'm thinking end of year.

So going back to some split on the 800-gig products, just to be clear. So the ratio of ports to equipment is quite low, right? I mean, we're talking about double-digit port per ratio there. I assume that this is predominantly going into -- the production side of it is not going into the field deployment. And you're talking about how many products can go through a test and measurement process in any given period, but that's a sampling process. So the ratio is very high relative to the total number of ports that go across that equipment, right?

Well, I mean, it varies, right. So when you start production, you tend to do a lot more test. So you have a lower number of ports per, let's say, $1 million of equipment.

As you get with experience curve, and you feel comfortable, you start decontenting the task. So you spend less time on the tester. So yes, the equipment predominantly goes into the production lines. I mean, you have all these factories in China and other places that are building these modules.

So when they start, they generally use more intensive testing and then as they get more comfortable, they start reducing and doing more of the sample testing or less extensive testing per module. So that's why it's continuously moving target.

I mean, in one case with a dealer one project, we have gauged -- it came on at about $0.40 per module of CapEx for module of capacity. So if you're doing a port, you need about $0.40 investment per port on the capacity lines. So you build a, let's say, 1.5 million units a week align.

So you probably -- I mean, I think it works out to about $0.40, so about $300,000 for that capacity that you've got to invest. But it's only one data point and other people do it differently. So they spend more -- I mean, it's still very early to tell.

Yeah. So we've already seen a very significant ramp in productions of both NV link and InfiniBand products going into the AI clusters. And from what I can tell, you really haven't seen any meaningful contribution from that at this point.

So should we then think that, as we move into the second and third phase of production ramping, that the sampling rates actually go up, and therefore we shouldn't be looking at the rate of growth in AI as the primary driver of the overall demand curve as opposed to the sampling percentage?

Well, I wouldn't go that far, because remember, the first thing they did is they redeployed the same lines that were building telecom coherent business has dropped quite significantly. They redeployed those assets to the AI data centers.

And when you also think about it, if you're just doing some alignment, or let's say, InfiniBand, you're putting photonic integrated circuit aligning with the processor, that is really more a semiconductor packaging. When you're actually building the actual module with lasers and everything else, that's where you tend to use more of our optical test equipment.

I see. Okay. Just going back to the telecom piece for a second. There's obviously a very large inventory glut out there of telecom equipment that has to be absorbed. Has there been any build in inventory in your product areas? Or is that just -- simply that didn't happen because they weren't constrained as much on those type of products? Thanks.

So we have no inventory in the channel. I mean, pretty much the orders got turned off at, say, December quarter of calendar 2022. So if anything a lot of the inventory in the field is getting long in the tooth. And we know that there is a lot of wear and tear and there needs to be a replacement coming up.

So we actually are already seeing signs that people say, hey, I will need to replace. I mean, what would be the terms? What will be the lead times?

So in that respect, people will swab the assets. They will swab the assets, they will cannibalize, and then they'll have to do a wholesale replacement. So when I say kind of flattish 2024, or like the -- I just don't think -- I know they need to do it. I just don't know if they can afford a massive replacement, but there could be a good chance that in the second half, we'll see more and more of these type of things popping up. But I don't have that visibility beyond six months.

All right. Thank you.

Sure. Thanks.

Meta Marshall, Morgan Stanley.

Great. Thanks. Oleg, you mentioned you are more encouraged about cable spending earlier in the year. Just wanted to get a sense. Is that DOCSIS 4.0? Is that just their networks are running hotter? Just given some of the comments you just had to Alex, just what is the trigger to that investment?

And then on the flip side, since you think that wireless may take a little bit longer, just, what do you think should be the early signs of wireless or domain things?

So if I look at -- so cable, right? First, I think we know is going to be happening. It was actually -- we were expecting some of the orders start popping up in the March quarter and then accelerating into June. From what we've heard, and I'm not going to name any names, but there's been a delay in some of the core technology development by leading infrastructure providers.

So I think that is being pushed by one to two quarters, in terms of getting the software ready and everything needs to be working. So I think that's where we are with cable. But I do see, actually, cable happening this year.

On the -- what was your second part of your question?

Just on the wireless side.

The wireless. Yes. So the wireless, well, we all know you've seen the Ericsson, Nokia, Samsung, and all the deployments with T-Mobile, Verizon, AT&T. So that has slowed down. So the area of where we are seeing less is on the field equipment, and a lot of the people who are sales related to deployment.

What we continue to see CapEx being spent is on product development. So we have not seen significant decline in the R&D CapEx for 5G. And now, we are seeing some of the elements of 6G popping up. It is just the -- generally, I think the wireless infrastructure is a bit more muted in terms of aggressiveness, I would say, in Europe and North America.

Now, that said, India is doing pretty well, but it's obviously -- I wish the margins were better in India. But I think clearly, the demand is -- right now, India is one of the few bright spots for infrastructure deployments.

Great. Thank you.

Ruben Roy, Stifel.

Yes, thank you. Oleg, just had a couple of quick questions, really follow ups. I think you've talked about a little bit of this in answer to the prior questions, but just in terms of service provider. It sounded to me like you're saying that you are having conversations, right? So last quarter, I think you've talked about not seeing decommits. I would imagine if that's still the case.

But also with some of the service providers still figuring out their budgets for this year, is that giving you a little bit of -- I wouldn't call it hope, but the visibility, I guess, into thinking that you can still turn out and what should be a normal seasonal year, meaning, June up and then September a little bit down like usual? Is that driving that or any further detail in our conversations?

So I think this year, I mean, I don't want to jump too far ahead. But actually, September may actually be stronger this year than normal, because the cable is maybe happening in September as it gets pushed, right?

But generally, I say what we see from service providers there is a very healthy churns business; things go bad and just replacements and things like that. What generally drives the -- like another, like, I say, 20% more, which makes a big difference is whenever they are doing build-outs or upgrades to their networks. And right now, what I don't see -- I mean, at least at this time in terms of the turns business, it's like orders coming in and they get released and there's no problem.

So the ongoing business is going pretty well. People maintaining their network. They're just keeping things running.

What I'm not seeing yet is the people doing big step functions and expanding capacity or upgrading their network or extending the network. Some of these projects are a little bit more -- I mean, we know they are being planned, I know there's plans for that, I just don't know when they're going to decide to pull the rip chord and launch it.

And I just -- looking at the general environment in the telecom sector, I think they prefer -- if for every quarter they don't do it, they just bank more cash and retire more debt. So I think one -- we're just looking at it from competitive approach. As cable guys start upgrading their networks, I think some of the service providers will see a need to get back to extending their networks.

So I think -- I don't want to be a kill joy, but I just don't see a cash burning hole in the service provider's pocket. So they need to go and start digging in, laying new fiber, or aggressively starting deployment.

The area where we do see fairly good momentum, but it's on a much smaller like an order of magnitude, smaller scale, are these Tier 2, Tier 3, primarily private equity funded fiber operators who are laying fiber in anticipation of data centers coming to the area; or service providers extending 5G networks to the area; or they're finally needing a fiber to extend their network into some of these rural communities.

So that is one piece that is ongoing. But it's an order of magnitude, smaller amount of volume than somebody like AT&T, Verizon, or British Telecom, or Deutsche Telekom would spend on an annualized basis.

Right. Thanks for all that detail, Oleg. And then just a quick follow-up for Ilan. I might have missed this on the balance sheet discussion is, are you where you need to be then on leverage? And do you expect to come back into the markets to repurchase in the near term? I'm going to miss that probably.

Yeah. So probably for the next quarter or two, we will be focused more obviously on the retiring of the converts and it continues -- the overall buyback continues to be part of our capital allocation model, right? I mean, we are not deviating from the overall strategy, but probably on the buyback for the next one to two quarters, we'll be more muted about it.

We just decided to bank some cash, so we can retire as a whole converts. In a way, it's a synthetic share buyback, because you're avoiding dilution down the road.

Right, right. Got it. Okay. Well, thank you very gentlemen. Thank you.

Thanks.

There are no further questions at this time. I will now turn the call back over to Ilan Daskal for some final closing remarks.

Great. Thank you, operator. This concludes our earnings call for today, and thank you, everyone, for joining today's call.

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