Viavi Solutions Inc (VIAV) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Viavi first-quarter 2017 earnings conference call. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Bill Ong. Sir, you may begin.

Thank you, Katlee. Welcome to Viavi Solutions' first-quarter fiscal 2017 earnings call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call is Oleg Khaykin, President and CEO; and Amar Maletira, 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. We encourage you to review our most recent SEC filings, particularly the risk factors described in those filings.

The forward-looking statements, including guidance we provide during this call, are valid only as of today. Viavi undertakes no obligation to update these statements.

Please also note that, unless 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 supplementary slides which include the historical financial tables, are available on our website.

Finally, we are recording today's call and will make this call available by 4.30 p.m. Pacific time this evening on our website. I would now like to turn the call over to Amar.

Thank you, Bill. Fiscal Q1 Viavi revenue of $210.8 million was below our guidance midpoint of $209 million as NSE delivered revenue above its guidance midpoint.

Revenue decline of 8.2% year over year was driven by the expected pullback of OSP revenue from its peak of $64.2 million a year ago and also the expected steep decline in SE revenue. Viavi's operating income at $27.5 million declined 4.2% year over year. Operating margin at 13% exceeded the high end of the guidance range and was up 50 basis points year over year as the result of good operating expense management.

Overall, Viavi operating expenses declined 12.4% year-over-year of $14.6 million, driven by G&A expense reduction and R&D spend optimization. EPS at $0.09 exceeded the high end of the guidance range and a 12.5% increase from the $0.08 a year ago.

Now moving to the results by business segment, starting with the NSE performance. NSE revenue at $155 million declined 6.3% year over year, driven by a 24% decline in the SE segment which was partially offset by NE, which grew roughly 1%. As a reminder, although Q1 2017 is a normal 13-week quarter, the year-ago quarter was slightly longer at 14 weeks. The year-on-year SE revenue decline was impacted by the steep decline in mature products as well as the decline in the enterprise business.

NE revenue was slightly up from a year ago driven by mid-single-digit growth in our lab instrument business, while our field instrument business was flat. We saw continued strength in our fiber products, which grew double digits, partially offset by softness in access and metro products.

NSE gross margins at 63.7% declines 220 basis points year over year. This decrease was primarily due to gross margin reduction in our SE segment, which decreased 11.2 percentage points compared to the same period a year ago on unfavorable product mix from lower enterprise revenue, coupled with lower-margin pass-through hardware mix in our growth assurance business as a result of acceptance of our solution by a key customer.

NE gross margins at 65.3% include 90 basis points on favorable mix and good cost management. NSE's operating margin at 2.6% increased 110 basis points year over year primarily due to continued operating expense reduction in this business. The book-to-bill ratio for both NE and SE was below 1.

Now turning to OSP, OSP revenue of $55.8 million declined 15.1% from year-ago levels, driven by the expected inventory adjustment in our anti-counterfeiting business. Gross margin at 56.6% fell 100 basis points on lower volumes and unfavorable product mix. However, through better operating expense control, operating margin of 41.9% improved by 90 basis points from last year.

Moving to the balance sheet, our total cash and short-term investments, the ending balance was approximately $1 billion. This includes the remaining 3.4 million shares of Lumentum, valued at $141.1 million as of the last day of fiscal Q1.

Also during the quarter, our OSP segment received an advance payment from a customer to extend capacity to meet their long-term needs. During fiscal Q1, we sold 3.9 million Lumentum shares for a net proceed of $114.6 million. Our booked cost basis on the share is approximately $8.57 per share. As a result, we realized on a GAAP-only P&L an accounting gain of approximately $81.5 million.

Under the share buyback program previously announced in February 2016 and subsequently increased to $150 million, we have repurchased since program inception 5.4 million shares of Viavi stock at a cost basis of $7.41 for a total of approximately $39.7 million. We will continue to be opportunistic in monetizing our Lumentum position and also repurchasing our Viavi stock.

Operating cash flow for the quarter was $10.3 million.

Now to our guidance. Given the uncertain customer spending environment in North America for our NSE business, we expect fiscal second-quarter 2017 revenue for Viavi to be in the range of $187 million to $207 million, operating margin at 11% plus or minus 1% and EPS to be $0.05 to $0.08. We expect NSE revenue to be at $148 million plus or minus $8 million with operating margin at 1.5% plus or minus 1%. We expect OSP revenue to be at $49 million plus or minus $2 million with operating margin at 40% plus or minus 1%.

Our tax expense is expected to be between $4 million to $4.5 million. We expect other income and expenses to be a net expense of $2 million to $2.5 million and our share count to be approximately 234.5 million shares.

With that I return the call to Oleg.

Thank you, Amar. Our operating margins and EPS exceeded the guidance range. Net income increased to 10.7% from a year ago despite the 8.2% drop in revenue. Network enablement or NE sought revenue strength in fiber test equipment, driven by high demand for 100-gig optical products being offset by weakness in access and Metro products.

Although cable declined for two quarters in a row, cable revenue improved from our year-ago levels as we are starting to see early DOCSIS 3.1 adoption in Europe. We expect the upgrade cycle to remain gradual over the next several years.

In access the G.fast upgrade cycle has been slow but there are signs of service providers deploying technology in early calendar 2017. As a result, we expect to start seeing benefits from G.fast deployment in late fiscal 2017.

Service Enablement or SE became more challenging in Q1 as we continue to pursue a more focused, scaled-down SE business. SE revenue declined 9.4% from a year ago, driven by decline in mature business as service maintenance contracts expire. We have also begun scaling back in our investment in new SE products.

During our August earnings call and during our analyst day in September, we mentioned a challenging carrier discretionary CapEx spending environment in North America. Since then, the level of uncertainty did not improve and, indeed, may have increased. NSE revenue is facing particularly strong headwinds in Q2 as our major North American service providers are either engaged in major M&A activity or post-merger integration which is impacting their spend.

We expect this to be an ongoing trend for the next several quarters as newly announced mergers progress into post-merger integration.

In addition, we have not seen any meaningful end-of-the-year budget flush, in the past two years. And it is still not clear if that would occur in the final quarter of 2016. However, irrespective of a soft business environment in North America, the business climate in Europe and Asia-Pacific remain good.

OSP anti-counterfeiting revenue, as expected, declined both sequentially and year-on-year, due to the customer inventory rebalancing to align with end market demand. The optical coating business addressing the automotive, industrial and military experienced improved demand both sequentially and year-on-year, as we diversify and expand our OSP opportunity beyond our traditional anti-counterfeiting applications.

We are successfully and selectively targeting high-volume consumer 3-D sensing applications in mobile handsets. However, we would like to note that this is still an emerging market and it is too early to discuss any specific short-term impacts.

As we discussed during our September analyst day, we expect fiscal Q2 OSP revenue to decrease sequentially. That said, we expect Q2 to be the low point in OSP revenue and we expect to see the revenue recovery in the second half of fiscal 2017, driven by sequential improvement in anti-counterfeiting business.

Irrespective of the near-term adverse customer dynamics, we continue to pursue our strategy to reduce business complexity, improve operating efficiencies and improve profitability. During the analyst day in September we announced a shift in our strategy toward big NE and focused SE.

I am pleased with our progress to date as we are starting to implement plans for a more focused SE business and developing alternatives for SE product lines that are no longer part of our ongoing strategy. The implementation and execution will take time as it involves fulfilling existing obligations to our customers and possibly identifying suitable partners for future support.

We have a clear strategic NSE roadmap to extend our leadership position in both lab and field instruments while, at the same time, consolidating multiple hardware and software platforms to further increase our operating leverage.

I would like to thank our employees for their hard work in delivering a good fiscal Q1 results and their commitment to execute our new strategy. I also would like to express our thanks to our customers and shareholders for their continued support of Viavi. Now I will hand over to Bill.

Thank you. I'd like to highlight the following upcoming Investor Relations event. We will be participating in William Blair's optical bus tour held at our Milpitas corporate office on December 13. Katlee, let's go to a question-and-answer session.

(Operator Instructions) Jorge Rivas, Craig-Hallum.

First I wanted to dig in on the mix on the SE business between legacy and growth products.

So, is the question the mix between SE legacy and --

Yes. The question is what was the mix in the quarter between legacy and growth products?

Yes. So SE growth in this quarter was roughly 67%, 66%-67%, and the balance was SE mature, so about 33% to 34%. So just as a recap, when we exited fiscal 2016 the ratio was 60%, roughly 60% SE growth and 40% SE mature.

Okay, okay, thanks. And then moving on to OSP, specifically on 3-D sensing, a two-part question.

First, what is the better environment that you are seeing now versus maybe three months ago? I believe, on your analyst day you guys touched on how proprietary your technology is and that Viavi was the only game in town for solutions in the consumer electronics segment.

Wondering if you are seeing competitors emerge in the environment right now, as the space looks promising. That's the first part of the question.

The second part of the question -- I understand you cannot share that many details, but wondering if you can give us a high-level perspective of how big the opportunity is, either in content per unit or in dollar terms as a market. And that's all for me, guys. Thank you.

Well, there's always competitors. There's many different ways to implement a filter. However, there are better ways and not-so-good ways.

We have been working with customers in that space for a number of years and we are very comfortable about our leadership in that area. Also we have a very strong IP portfolio that covers probably the most effective way of doing 3-D sensing.

And clearly, as a number of people announce their products, we certainly hope they are not violating our IP because we will defend it vigorously and very aggressively.

So clearly, there's always going to be competitors. As I said, there are better ways of doing it and not-so-good ways. We believe we have one of the best ways, and that has been confirmed by most of the major customers with whom we engaged. And we are far along in the design cycle.

In terms of opportunity, I would prefer not to speculate. At this point in time there is no firm launch date yet confirmed by our customers. And there are still a number of thinking all of them have different view of how many cameras and how many sensors to use per handset.

So as we get closer to the launch point, though, clearly we will provide a greater degree of resolution.

Fair enough, thanks a lot. I'll step out of line now.

Rod Hall, JPMorgan.

I wanted to zero in on the NE numbers again and NSE, I guess, in total as well. The guidance is weak, as we would have probably expected, given how weak your CapEx is here at the end of the year. I just wonder, Oleg, could you comment on when you think the earliest recovery for that business might be?

Is it possible to think that March gets better or do you think we have to wait until the middle of next year for things potentially to stabilize a little bit more? And then I've got a follow-up to that.

Well, I think it's always good to disaggregate. I'm actually pretty happy with the EMEA and Asia-Pacific. It's doing pretty well. North America, particularly just by contrast from a year ago -- a year ago it was all vectors pointing in the same direction and all major service providers spending aggressively on access and metro infrastructure. And this year, it seems like the switch was largely turned off.

And as we saw numerous M&A announcements come out from the major providers, it's literally within a week a lot of the discretionary CapEx spend discussions came to an abrupt end.

So clearly, while a lot of instruments that we sell, the field test instruments, are not what I would say mission-critical for these providers -- they can go on for a while with what they've got -- I would say it's analogous to your home maintenance. If you don't do anything like fixing your roof and painting your house, in the end you will have to spend more to catch up.

So I don't know if March will be a catch-up quarter. It's too early to tell. But we know that at least this quarter we are not seeing anybody announcing any end-of-year budget flush or anything like that. But we do also see some capital being released. And obviously, then, if you have the product on the shelf you grab the orders.

I certainly do hope that sooner or later they return back to managing networks rather than chasing M&A. And we will see recovery in the order pattern. But as I said, that whole phenomenon is very much in North America and we are not seeing -- we are seeing fairly good business climate in EMEA, Asia-Pacific and actually even in Latin America.

Okay, and then my quick follow-up -- I didn't hear you guys comment on the Lumentum share position. Could you just give us an update on the position as it stands now, any activity during the quarter and what your current plans are with respect to liquidation of that position?

So we have 3.4 million shares of Lumentum that's remaining out of the 11.7 million shares that we had. We did liquidate a good chunk during the quarter, in Q1. And we would like to be opportunistic about this position and how we liquidate it and monetize it, in the next couple of quarters.

So we will be very opportunistic about it and we have been, in the last couple of quarters. So 3.4 million shares currently valued at $141 million. But this was as of last year, fiscal Q1, and since then Lumentum shares have actually gone down.

And has that liquidation been more recent or can you give us any idea on the timing of that?

The timing of when we are going to monetize?

Well, no. When you sold shares this quarter, when you are talking about.

You mean when we bought the shares in fiscal Q1?

No, no. I think that you guys had been selling some shares in the quarter just reported and maybe beyond that as well, so I'm just curious if you can give us some idea of timing.

We sold shares about a couple of months ago, and then we had to lock down because we were doing it under Form 144, and that limits how much we can actually monetize. And I think that restriction is lifted now, and so we will be more opportunistic.

I think I know where you're heading. To answer your question were we responsible for a recent selloff that drove down the stock it is absolutely not.

Not.

We are big believers in Lumentum and I think they've got a great business ahead of them.

Great. Thanks, guys.

Dmitry Netis, William Blair.

I wanted to delve a little more in on the SE. I think you said 40% from mature products.

So is that -- it was a little bit above consensus, by about $4 million. So I'm just curious, was that the mature products that actually outdo or outperform expectations here? And then also, if you can comment in that same vein on the enterprise side of the business. I think you mentioned it was lower than expected or slowed down this past quarter. So any comments what's going on there and when the rebound is expected.

So I got the enterprise question but I didn't follow the first one because you had -- the audio was not -- so do you want to know the mix of SE?

No. We got the mix; I think you said it was 40% from mature. So I was just wondering if the outperformance in SE by about $4 million versus consensus came from the mature side of the business.

No, it was not. So let me just give you -- so first of all, let me make sure that you have the right numbers. In Q1 of 2017 the SE mature was 33% and SE growth was 67%. That's the mix, 67% growth versus 33% mature. Right?

The 60/40 was in fiscal 2016. So we exceeded the 60/40. We are at 67/33.

Now, the outperformance in SE versus consensus was mainly because we drove acceptance of a key solution in one of our big customer; and we actually accelerated the acceptance of the solution by about a quarter and so we basically brought it forward. And that helped us, to some extent, in outperforming or overperforming the SE revenue.

Okay, so that's the growth side. Okay, and then on my second question as far as the enterprise?

On the enterprise side, we have seen enterprise bottom out in Q4 of 2016 and then it is starting to slowly recover in Q1. And we expect the sequential improvement to continue in Q2.

Now, when you do a year-on-year compare, there are a couple of things that you have to keep in mind. One is last year, the same period, we did have a large number of deals which were $1 million and above. And we did not see that kind of volumes in Q1 this year. That is number one.

Number two is we had some leadership changes. We brought in a new leadership team a couple of quarters ago, and they have hit the ground running. And now we have started seeing the improvements that they are driving. And so we expect the sequential improvement to continue into Q2.

And then I have one more question for Oleg. And this has to do with the timing when you took over the business, and I think you put the SE on let's call it a probation period, for the lack of a better term. I think you've given six months for the leaders in that group to turn the business around. We are probably coming in this December off of that six-month period.

So my question is next time we will talk to you, maybe it will be the end of January/early February. So the question is, do we have to wait for you to make the decision of what is going to be done with SE, continuing on the path, to take another scenario (multiple speakers) --

Yes, thank you. (Multiple speakers) So, at the analyst day I think we already made some of our directional intentions clear by saying we are going to be focusing on driving much more NE. And we will scale back SE accordingly.

Just stepping back and looking at our SE business, the more I learn about it and the more I spend time with our management team, it's a good news/bad news. On the one hand we have a phenomenal technology. It's very good. But on the other hand I also look at our scale and what it takes to bring these products to market and, more importantly, implement them in market and roll them out and the amount of investment and cost that is going to evolve.

And I just do not see a path for us in the foreseeable future that we will make it as a positive contribution business over the next several years.

As such, we decided to scale back the SE business and really focus only on the components of it that are very tightly linked to our instrumentation base and then seek either partners or transition out of these segments, which require substantial investments and substantial commitment over a very long period of time to continue trying to win the market share and convert customers to our solution. So I think, in that respect, my conclusion has already been made as to where we need to go with that business.

And just one last one -- in terms of investment into SE, I think that the other thing that you mentioned, with the burn rate had been (multiple speakers) -- what do you do when you scale that? Or is there anything quantitative that you can provide as far as how much investment have you taken out of that business and where you think you will end up, let's say, in a quarter or two or three.

So let me just get started here and I'm sure Oleg will jump in. So the burn rate we talked about during the analyst day was roughly $40 million. That's what we --

The net burn rate.

The net burn rate, yes, that's right. Now, as we work through our plans, it will take some time to basically unwind some of those contracts, etc. So we are working through a plan on how do we take down the OpEx, as well as the other cost. And that's about at least 12 to 18 months type of process.

Now, in some cases we will be able to accelerate it. But in some cases, depending on how the strategic alternatives pan out, it will all depend on that.

But if that thing is ahead of us, it is not in the numbers that you see today that we have posted. And it's something that is futuristic.

And what Amar commented on is that would be what our organic path forward would look like. At the same time, we are also looking for opportunities to accelerate it. And the key components for us is assuring continued support for customers.

So we had a number of interested parties approach us who are interested in picking up the business and move it forward. To the extent we see that the value is compelling and our customers will be taken care of, we may accelerate the (inaudible) forward by partnering with other parties to pick up this business and move it forward.

Very well. I appreciate it. Thanks, gentlemen.

Meta Marshall, Morgan Stanley.

Couple of questions for you -- first, if you could just give some tone as to what the salesforce reception was, some of the changes that came out of the analyst day. And then the secondary -- I know you commented the DOCSIS 3.1 was kind of positive or you were encouraged by that, and that there was some general CapEx slowdown causing the NSE slowdown for Q2. But is there anything more specific about particular categories? Like is DOCSIS 3.1 in North America slow or copper slow? Just some more granularity there would be helpful.

Clearly, in the access category the world is moving to our new standard. In the cable side, it's DOCSIS 3.1. On the telco side it's G.fast.

So we have seen fairly slow progress towards migration. Most customers are not in a hurry to replace their installed equipment. But we are now finally seeing, in Europe, DOCSIS 3.1 being adopted and we are seeing also seeing same intents -- intentions being communicated by our customers in North America. We don't think it's going to be a step function; we think it's going to be, rather, a gradual swap of the existing equipment with the newer equipment as they rotate their installed customer premise equipment.

On G.fast, we are now starting to see some deployment happening in Europe. Usually this means they buy the central office equipment, the data center equipment. And once that is installed, they start rolling out the customer premise equipment. And that's when we start seeing demand for our instruments.

So that's why we said, we think later in the fiscal 2017 we will start seeing G.fast demand for the access equipment.

In terms of the reaction of ourselves, clearly there is a concern among especially salespeople, who are primarily solution-driven, as to what their future is. And, clearly, we are working through it. But also we are not completely getting out of the service assurance business, we are just focusing on the service assurance that is much closer to our core strength in the instrumentation field.

So I think we will be focusing much more on the lower-level's layers of the protocol stack, rather than the segments that are far removed from our core market presence.

Thank you.

And I am showing no further questions at this time. I'd like to turn the call back to Mr. Ong for closing remarks.

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

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.