Viavi Solutions Inc (VIAV) 2018 Q3 法說會逐字稿

Good afternoon. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Viavi Solutions Fiscal Third Quarter 2018 Financial Results Conference Call. (Operator Instructions)

Mr. Bill Ong, Head of Investor Relations, you may begin your conference.

Thank you, Jessica. Welcome to Viavi Solutions Third Quarter Fiscal Year 2018 Earnings Call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call are 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 current expectations. We encourage you to review our most recent SEC filings, particularly the risk factors described in those filings. 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 or 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. The release, plus our supplementary slides, which include historical financial tables, are available on our website. Finally, we are recording today's call, and we'll 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 Amar.

Thank you, Bill. We closed the acquisition of the AvComm and wireless businesses on March 15, hence Viavi's fiscal Q3 reported results include approximately 2 weeks of financials of the acquired businesses. Viavi's revenue, including the acquisition, was at $219.4 million, operating profit was at $33.2 million, with operating margin at 15.1% and non-GAAP EPS at $0.13. The acquired businesses, which were reported in the NE segment, contributed $12.3 million of revenue in our fiscal Q3 and an operating profit of $4.1 million. Please note, that the revenue from the acquired businesses was skewed toward the end of fiscal Q3, while the expenses were roughly linear within the quarter.

Now excluding the acquisition, Viavi's fiscal Q3 results for the core business exceeded the midpoint of guidance in revenue, non-GAAP operating profit and non-GAAP EPS. Revenue at $207.1 million exceeded our guidance midpoint of $200 million with NSE overachieving, while OSP was slightly above the midpoint of our revenue guidance. Revenue grew 5.7% year-on-year, driven by growth in our NSE business. Operating margin at 14.1% beat the 11.5% to 13.5% guidance range, with both NSE and OSP contributing to the upside. EPS at $0.11 exceeded our $0.08 to $0.10 guidance range and grew $0.02 from a year ago EPS of $0.09.

Now moving to our reported Q3 results by business segment. Starting with NSE. NSE revenue at $157.1 million, including $12.3 million from the acquired AvComm and wireless businesses, grew 18.9% year-on-year. Excluding the acquisition, NSE revenue at $144.8 million grew 9.6% year-on-year. This was driven by a 10.9% growth in NE revenue and 4.9% growth in our SE revenue. NE revenue growth, excluding the acquisition, was a result of strong performance in cable and fiber instruments, partially offset by weak lab and production product demand. SE revenue growth reflected strength and the business turnaround in the data center product line, partially offset by the expected declines in the mature assurance products. SE's growth products versus mature products in the quarter reflected 80:20 revenue mix.

NSE's reported gross margins at 64.7% was up 20 basis points year-on-year, NSE operating margin at 6.1%, which includes 2.3 percentage points benefit from the acquired business, was up 940 basis points year-on-year. NSE's book-to-bill ratio, excluding the acquisition was slightly below 1.

Now turning to OSP. Revenue of $62.3 million increased 29.3% sequentially, due to demand recovery for our anticounterfeiting products and sequential growth in our 3D sensing revenue. However, OSP revenue was down 2.5% year-on-year, as the growth in 3D sensing revenue was offset by declines in the anticounterfeiting pigment business, which benefited from a major banknote redesign a year ago. Based on a positive history of acceptance of 3D sensing filter shipments, we were able to recognize revenue upon shipment in fiscal Q3 and will now continue to do so going forward. OSP gross margins at 52.6% declined 480 basis points from a year ago, due to the lower volumes in the anti-counterfeiting business and unfavorable product mix with a ramp in 3D sensing revenue. The 560 basis points decline year-over-year in operating margin was a result of the gross margin decline.

Now turning to the balance sheet. Our total cash and short-term investments ending balance was $738 million, operating cash flow for the quarter was $13.6 million. In Q3, we repurchased $1.1 million of Viavi's stock at a cost basis of $8.78 per share, including commissions. Of the $200 million authorized share buyback, we have repurchased shares worth approximately $137.4 million as of the end of fiscal Q3.

With regards to our original $650 million 2033 convertible notes, that is puttable and callable in August 2018, we have repurchased a total of $221.5 million in notional amount to date as of the end of fiscal Q3. Specifically in Q3, we repurchased $22.5 million. Our remaining 2033 convertible note balance is $428.5 million. Our total outstanding debt of $888.5 million includes the $460 million 2024 note. We'll continue to be opportunistic in repurchasing our Viavi stock to offset earnings dilution from stock-based compensation.

Now to our guidance, which includes the acquired businesses. We expect fiscal fourth quarter 2018 revenue for Viavi to be in the range of $243 million to $267 million, operating margin at 11.7% plus or minus 1% and EPS to be $0.08 to $0.12. We expect NSE revenue to be at $205 million plus or minus $10 million, with operating margins at 7.5% plus or minus 1%. We expect OSP revenue to be at $50 million plus or minus $2 million, with operating margins at 28% plus or minus 1%. The OSP revenue guidance contains an immaterial amount of 3D sensing revenue. The lower operating margin guidance was as recent historical trends reflect the under absorption of manufacturing costs for 3D sensing filters, as customers transition to next year's product cycle. Since we have just in time manufacturing for 3D sensing filters, we have prudently idling production during Q4 to avoid building excess inventory. Our tax expense is expected to be approximately $4.5 million. We expect other income and expenses to reflect a net expense of approximately $1.5 million. Share count is approximately 230 million shares.

Lastly, I'd like to provide some guidance for the acquired AvComm and wireless businesses for fiscal year 2019. We expect these businesses to add about $205 million to $245 million of incremental revenue to core Viavi's business in fiscal year 2019. This includes deferred revenue write-down related to purchase price accounting. We expect the acquired businesses to have an operating margin of 14% to 16%, with gross margin in line with the corporate average of about 61%. The implied EPS equation is expected to be $0.11 to $0.14 in fiscal 2019. This includes anticipated synergies realized in the first year of integration, which would partially offset the profit impact from the deferred revenue write-down. We expect overall synergies of $15 million to $20 million over a 24 to 36 months period, with most of the synergies expected to occur within the first 24 months.

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

Thank you, Omar. In the fiscal third quarter, Viavi delivered a solid performance in its core businesses and successfully closed the recently announced acquisition of Cobham's AvComm and wireless businesses.

Looking at the individual business segments. Within NE, field instruments delivered strong results with all of its product lines growing year-on-year. Cable was the strongest driver of growth, followed by fiber instruments, held by fiber-to-the-home deployment and lastly, the Excess products which grow off a small base. NE's lab and production business while growing -- while showing a strong recovery from a trough Q2, was still meaningfully down from a year-ago levels, driven by a weak demand from our optical components customers. A bright spot was storage network test product line, that saw a strong sequential and year-on-year growth driven by gen 4 PCI Express products. The SE business saw a year-on-year growth, our data center product line was a particular bright spot with revenue more than doubling from a year-ago levels. We are pleased with its continued turnaround performance.

Looking ahead for the rest of calendar 2018, for our core NSE business. We expect the demand for fiber and natural products to continue to be strong, driven by fiber-to-the-home build outs. The cable product demand is expected to pull back some, following several quarters of strong demand driven by DOCSIS 3.1 deployment in North America. The Excess product line is expected to remain a laggard, as North American telecom service providers appear to be delaying the deployment of higher speed G.fast technology until late calendar 2018 or sometime in 2019. That said, we are seeing a more aggressive G.fast deployment regionally in Europe.

The outlook for lab and production appears to have stabilized, and we expect it to improve in the late calendar 2018 and early 2019, driven by 400 gigabit optical and 5G wireless adoption. And lastly, the SE business is expected to remain roughly flat with the growth in the data center product line partially offsetting the expected continued decline in the mature products.

In mid-March, we successfully closed a recently announced acquisition of Cobham's AvComm and wireless businesses. The AvComm business delivers RF test and calibration products and solutions to military, public safety and avionics customers. The wireless business provides advanced test and measurement products and solutions to wireless, infrastructure OEMs and mobile network operators. Both businesses have positive near-term outlook, driven by 5G deployment on the wireless side and increasing spend in military public safety and avionics on the AvComm side. As we move forward with the integration, we expect to realize meaningful cost and revenue synergies.

Moving on to OSP. OSP revenues saw a strong recovery to about $62 million in Q3 from about $48 million during the December quarter, driven by strong demand for both anti-counterfeiting and 3D sensing products. We expect the anti-counterfeiting business to continue its positive recovery momentum into the Q4 and the second half of calendar 2018. The outlook for 3D sensing products is a different story. The 3D sensing revenue in the June quarter is expected to be immaterial as our customers undergo a model year transition and consume existing inventory. To avoid building excess inventories, we are choosing to idle our factory capacity during the June quarter and run only minimum production to maintain training and yield improvement efforts. The net effect of these options will be a short-term operational margin headwinds in the OSP business segments, while we expect operating margins to dip into the high 20s from the 38% in Q3. We expect the 3D sensing to snap back to full volume production in the September quarter, as we ramp production volumes to support multiple new customers and product models. We also expect the second half of calendar 2018 and for the overall calendar fiscal 2019, to have increased 3D sensing demand and to be significantly above the fiscal year 2018 volumes and revenue. Correspondingly, we expect a continuous recovery in OSP operating margins in the September and December quarters.

Next, short-term volatility notwithstanding, we remain bullish on the 3D sensing market and growth potential. We see strong interest in our 3D sensing technology across multiple industries and applications in a positive on its long-term potential for Viavi.

In conclusion, I would like to thank the Viavi team for delivering a strong quarter and to welcome aboard the AvComm and wireless employees. Finally, I want to express my appreciation to our customers and our shareholders for their support.

I will now turn the call over to Bill.

Thank you, Oleg. This quarter, we will be participating at the UBS Investor Conference on May 24th taking place in our San Jose Corporate Office. We will also be presenting at the Stifel Investor Conference on June 11th in Boston and William Blair Investor Conference on June 12th in Chicago. Jessica, let's begin the question-and-answer session. We ask everyone to limit the discussion to one question and one follow-up. Jessica?

(Operator Instructions) Your first question comes from the line of Dmitry Netis from William Blair.

I wanted to touch on couple of items. Let's maybe touch the housekeeping items first as far as the guidance goes. So in your June quarters guidance of $50 million for OSP, it sounds like you are not assuming any 3D sensing revenue or de minimis 3D sensing revenue, which kind of goes back to the question of your original guidance for the 3D sensing side of things of $25 million for fiscal '18. Where does that shake out now with there being no revenue in June quarter?

Yes, so thanks, Demetri. So if you recall, we said, no, we will be roughly at $25 million for the entire fiscal year '18, that was our estimate last quarter. And we are maintaining that estimate because that's exactly -- we already factored in the steep decline in shipment in our March as well as June quarter in that number. So when you look at the revenue that was recognized in our fiscal Q3, which was the March quarter, it included the shipment that we did in the December quarter plus the shipment that we did in the March quarter. The shipment that we did in the December quarter was roughly about 50%-plus of the total shipment of filters for fiscal '18, and the shipment that we did in March quarter was roughly about 5%. So that's how much of revenue that we recognized in Q3. So that was in line with what we were expecting. It was a little bit higher because we had not expected that we were able to recognize the filters that we shipped in March quarter -- in March quarter, but since we got the revenue recognition ruling, we were able to do that. So to answer your question, to summarize it, we are still in line with that $25 million, but most of the shipment happened in the September quarter and December quarter, and because of the lag in the revenue recognition, you saw a lot of revenue being recognized in the March quarter.

Okay. Well so just to simply kind of put the numbers behind this, if this $25 million kind of standing here and you did kind of mid-single digit kind of revenue in the December quarter, that sort of -- and assuming you have no revenue in the June quarter, you'll be probably at the $17 million, $18 million level, give or take, in March. Is that a fair assumption?

Oh, yes. So listen, I think the best way to estimate this is, I said plus roughly about 55% of the overall $25 million was recognized. 55% to 60% was recognized in the March quarter. So you are in the $13 million to $15 million ballpark range.

Thanks, Amar. Appreciate it. And then moving on to Cobham, thank you for giving us the guidance there and talking kind of about the synergies. My understanding is you won't be including that there is some kind of an offsetting impact as far as the deferred revenue recognition goes into fiscal '19 time frame. But given sort of the 24-month period, you'd mentioned, all that synergy number, $15 million to $20 million should start rolling into the model by the fiscal 2020. Is that correct? And if so, what are you assuming all else being equal, that will translate as far as the EPS number goes?

So Dmitry, I think you said it well, our guidance already includes the deferred revenue write-down that we have to take because of purchase accounting, so that is already part of our guidance.

We already backed it out.

We've backed it out, right? Now there is a profit impact because of this deferred revenue write-down in the first year, which is fiscal year '19, that is getting offset by the cost synergies that we are driving in fiscal '19. Now going into fiscal '20, you will see the costs synergies that we've realized in fiscal '19 plus the costs synergies that we realized in fiscal '20. So I think there is lot of earnings power here on this particular business, assuming that the revenue remains stable, which we believe there is a likelihood that it will happen. I think there is a strong earnings power from these 2 acquired businesses in fiscal '20.

Okay. And then maybe last one, if I may, and I'll jump off the line. And again, that sort of goes to Cobham as well. Your revenue number is roughly $220 million sort of at the midpoint of the guidance for fiscal '19, I think the biggest driver growth here that investors might be focusing on is 5G wireless opportunity. So there has been a lot of interesting data points with the -- your -- specific your collaboration with China Mobile, for example, as it comes to the 5G side of things and your relationship with -- well, sorry, the Nokia deal that was mentioned with China Mobile as well and your relationship there on the Cobham side, I presume, yourself -- your TM 500 there as well for the emulation side of things. All that included, given that people are sort of raising the bar -- the network manufacturers are starting to raise the bar in 5G and noting their service provider partnerships. The 4 operators even here in the U.S. are starting to talk about the trial activity, right, in the second half of '18, all related to 5G, and it seems like it's a rising tide. So I'd love to hear from you where -- when -- what the timing is, what your expectation is, as it relates to Cobham and maybe core test and measurement business unit? And the timing relative of the ramp in 5G as well? Any of that you could address that would be helpful. And then give us sort of the sense of where that Cobham business may end up 2, 3, 4 years from now?

Sure. So I think, thank you, Dmitry. So if we look at it where we are today, I mean, what they have in the wireless business unit, there is a mix of, clearly, 5G and 4G and even some of the 3G extensions. And the 5G really just kind of started ramping in the past, I'd say, 12 months and clearly, early on, a lot of it is -- if we look at where they are engaged, our wireless business unit is pretty much engaged deeply and has a significant market share across the entire supply chain -- the value chain. So there's -- starting with the chips, the processors, the infrastructure ICs, to the NAMs, where the equipment manufacturers all the way to the service providers and various trials. So clearly, the single biggest bucket where we're seeing the business today is on the NAMs side, as they are preparing their systems for launch. And it's mainly on the engineering point at this point in time, where they are proving their systems and making sure that they're working. But also we're increasingly starting to see service providers wanting to acquire the systems to integrate into their trials. So obviously, as the production starts ramping then we will be seeing also a lot of these products migrating to production tests. So if I were to say, where we are today, it's kind of, I'd say it's probably not quite in the midpoint, but in the first third of the rollout, heavily focused on the technology developers and now starting to see the service providers coming into the picture. I'd say towards the end of the year, we'll be heavily at the kind of equipment NAMs as well as the service providers and from there on, as it goes into high-volume production, it will be, obviously, production testing.

Your next question comes from the line of James Kisner from Loop Capital Markets.

So just a quick housekeeping. I don't think -- I dropped off for a second, so sorry, if you've answered this, but did you give the -- what you expected for the Q4 contribution from Cobham, I know you give the year? And then also with the deferred revenue impact, do you have an idea of what that besides that whole is for this year?

No, I think -- so we have, which, James you didn't miss anything, we didn't give any color, we plan not to breakout those 2 businesses because they will be very tightly integrated into our NSE business. But since this is the first time, let me give you a little additional color. But going forward, I think this will all roll into our T&M business. So what we're expecting -- when you look at our midpoint of our NSE guidance, which is $205 million, in that we are expecting our core NSE business to actually grow year-on-year about 7% to 9%. So sequentially, when you think about our business, our core instrument business, which is what we call as NE should grow anywhere between say 9% to 11%, and our SE business should be flattish to say decline slightly. So that's how-- that's -- you can back into those numbers and come up with what the outcome in wireless business will look like in fiscal year, I'm sorry, in Q4 of '18. Also keep in mind, within this number of Q4 '18, that we're guiding for AvComm and wireless, there is also a deferred revenue haircut that we are taking, okay? So don't use that and extrapolate it to what the revenue number should look like for fiscal '19.

Again is there -- I mean, is there any revenue impact that over $20 million or over $10 million, if you can help us understand that...

Say it again.

The deferred revenue impact. How -- can you help us understand how big that's going to be? I mean just (inaudible) all the deferred revenue on (inaudible) balance sheet kind of disappears, right. What's the...

Well, not all. Not all will disappear. And I won't start getting into the details here. But it's -- there the deferred revenue is sitting on the -- there are 2 pieces of business, there's more deferred revenue sitting on the wireless piece of business because of the nature of the business there. And there's less of that on the AvComm side of the business. So typically, give or take, in this kind of purchase accounting, you take a haircut from anywhere from 70% to 30%, right?

All right, that helps. So I just -- I'm going to just turn to the recently announced T-Mobile deal. Obviously, more interesting for you, with the acquisition of Cobham I think. But I'm just wondering if you could give us kind of your exposure historically to those 2 carriers, just really roughly, is it below 5% for each of them or does your exposure increase for Cobham? And do you -- I mean, would you anticipate perhaps any disruption that you normally see before and after the deal, I know it was just announced, but any thoughts would be helpful.

Yes, for us, they're pretty minor customers. I mean, there's -- it's nowhere near the percentages you are assuming. It's a fairly -- we have fairly small revenue with each. But I actually see it more as an opportunity because anytime you merge 2 networks, you've got to integrate them, you've got to rationalize them. That's where you get some need for instrumentation. So I don't really see it as any kind of revenue threat. It may actually be an opportunity, but at this point, it's too early to tell.

Okay. And just last one, do you have any visibility to any changes to the competitive environment in filters? Any update there at all?

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Well as far as I can see, I mean, we still have all the products we had and we picked up a whole bunch more. So in the particular space where we play, I know there is number of people who've been talking about it. But frankly, I haven't seen anybody having any major success.

Your next question comes from the line of Michael Genovese from MKM Partners.

So given what you said about the 3D sensing in fiscal '18 before, I just want to check, I'm calculating based on those assumptions for core OSP that your revenues were up about 14% sequentially or something in that ballpark. Is that correct?

Well, I think, yes it is up double-digits.

Okay. And then on the -- can you give us any help in the 2019 outlook for the $25 million in 3D sensing ballpark, the kind of growth that you saw...

Well, so as I said on the -- so you heard our guidance on 2018, we said about $25 million. What do we expect in 2019 is significantly more than that as we go into production with multiple models and multiple customers. I mean, today, our business is highly volatile linked to one product. As the technology proliferates deeper and broader in the industry, the volatility will decrease, and we will add a number of new models as well as new customers, which will smooth out the -- somewhat, but also will significantly increase our run rate, and we're actually adding capacity going into the September quarter.

Okay, great. And then finally, I don't think you have much exposure to China, and I think it's through the lab part of the NE business. But could you publicly here talk about what your exposure to China is?

Well, I think you probably -- I mean, you were like China, you're probably thinking ZTE sanctions and things like that, is that right?

Well, just in general, not...

China economy in general.

...ZTE, but just... yes, exactly.

Our China exposure is not that big. It's in single digits and the particular accounts at risk, it's low single-digits.

Your next question comes from the line of Dave Kang from B. Riley.

This is Lee Krowl filling in for Dave Kang. Two questions. First, I guess, on the 3D sensing, you guys mentioned multiple customers. Just out of curiosity from a revenue timing standpoint, do you expect a similar revenue recognition dynamic that you had with your first customer where you shipped ahead of revenue?

No, I don't believe that to be the case, and I think we have now established a good track record here. In fact, the -- it was -- when you look at the product quality, et cetera, it was a very positive trend we saw the last 3 quarters. So no, I think we will be able to recognize revenue as we ship, because it is the same type of 3D sensing technology that we'll ship to other customers.

Okay. And then on the NE business, or excuse me, NSE business, you guys mentioned the book-to-bill below 1. Just kind of curious if you could provide a little bit more color on the dynamics driving the book-to-bill below 1?

Well, I think it's -- in this industry, clearly, December quarter was a very strong booking quarter, it's the end of calendar year. The first quarter is seasonally the weakest quarter. In fact, I think this is the first March quarter in many years that JDS or Viavi actually did not miss its guidance, which is, in itself tells you how unpredictable the first quarter generally is. And a lot of the telecom and service providers, they're trying to get their budgets figured out and what's going to be. So as a result, the releases in bookings are generally weaker in the March quarter. So I would say, there is really nothing specific beyond just seasonality that I can point out to you.

Your last question comes from the line of Jun Zhang from Rosenblatt Securities.

So my first question is that, could you comment on the volume of (inaudible) some Android camp? And also non-small segment, like gaming or automotive in the second half -- the calendar second half of this year? And also is the gross margin of future product related to the volume of (inaudible) shipments?

Sure. So it's predominantly, obviously, our guidance on fiscal '19 is heavily driven by the mobile phones, right? And clearly, the Android camp is coming in, but fairly unevenly. I mean, I guess, this 3D sensing technology is proving to be a lot more challenging than many people are estimating. So some of them, do you have it working? Some of them are still trying to get it to work and some are deferring it by several months behind. But net-net, they will all be coming in during the fiscal '19, whether it will be in the fall or in the spring, I mean it really depends on the particular model and particular OEM. We expect majority of our volume in 3D sensing to be with the leader in 3D sensing. In terms of the gross margins, we don't comment on gross margins, but we did comment that the operating profitability or -- and you can then assume the gross margins are significantly lower than our usual OSP operating margins such as anti-counterfeiting. But they are meaningfully above the overall company operating margin.

Okay, great. And also could you share with us that the current market share you have in the 5G testing market. And how should we think about -- how big a market of 5G testing could grow over the next few quarters?

Well, I think, we play in a very early adopter, so it's kind of lab. And there we are in the, I'll say, in the 80s, in terms of the gross margin -- not gross margin, the market share. And traditionally, the wireless business unit always plays at the bleeding edge and early adopter and they always maintain very high share for all the new technologies and new product calls introduction and so on and so forth. Where they normally don't play is as technology becomes more mature and migrates into field instruments, they don't play in that market, but guess what, that's what Viavi is very strong at. So we are actually hoping to parlay our leadership in the lab and production space with our 5G technologies and bring out a family of field products to follow through and enable the same customers who are deploying these systems into that. So that's part of our market expansion and market share growth strategy for the wireless business. Viavi today has very little in the wireless space.

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

Thank you, Jessica. That concludes our earnings call today. Thank you, everyone.

This concludes today's conference call. You may now disconnect.