Viavi Solutions Inc. (VIAV) Earnings Call Transcript & Summary

So I'm Samik Chatterjee. I cover the IT hardware and networking equipment at JPMorgan. For the next fireside chat here I have the privilege of hosting Viavi Solutions. We have with us Oleg Khaykin, CEO of Viavi; as well as Amar Maletira, who is the CFO of Viavi Solutions. Thank you both for attending our conference and participating here. Thanks for your time.

Let me just start off as we -- with most companies in the conference, just kind of the hot topic being COVID-19 and the impact you're seeing from that? Just maybe take us through your reported earnings recently as well, gave us an update, just take us through what you're seeing on the demand side, particularly as kind of service providers and also the NIMs kind of evaluate their plans, what are you seeing on the demand side relative to the disruption at this point?

Maybe I'll start and then Amar can chime in. Well, I mean, you got to look at the nature of our business. I would say if we look at different segments where we play, pretty much, I think, any segment that has a lead time more than 3 months, we have not seen any impact. And in particular, if we look at anything relating to the lab and production, if anything, last quarter was very strong and the strength continues into this quarter, driven mainly by very strong demand for fiber and 5G wireless equipment and the deployments there are underwriting a lot of those trends. The area where we did see disruption, and I wouldn't call it a demand disruption, I would call more demand push out is the area where we have -- effectively, it's a bookshop business. You book it within the quarter, you ship within the quarter. And that mainly impacts, I would say, field instruments. And the field instruments, the way it works. Usually, first of all, the start of March quarter is seasonally the weakest quarter. A lot of service providers come back. They decide on their budgets early in the year. By the end of February, they start releasing POS. And they take the delivery in the kind of second half of March. Well, if we see how this thing was going, it was going fine up until the Europe and North America really, it started in Asia and it was all kind of beginning of February, everybody said, well, it's really a China issue. It's not an issue for Europe and North America. Well, within the 6 weeks, we went from being no problem to a complete shutdown. And I think that's where a lot of the revenue headwinds came from. The POS did not get placed or the ones that get placed couldn't be received. There's been a lot of I would say chaos, sort of say, as everybody was deciding how they're going to shut downs, who it goes on, so on and so forth. So that's really, I would say, the piece of the business that got impacted. Everything else beyond it, like be it 3D sensing or anti-counterfeiting, that pretty much came in as was planned. And in case of a 3D sensing, we already saw visibility of reduced demand based on the January in China. And there was a bit more degradation, but not that much. So I would say really, aside from the field instruments, and I would emphasize feel the instruments on the edge, not the metro or the core, the edge, that's really, I'd say, the rest of the revenue came in pretty much as your MA.

Just to add, Oleg to this, our anti-counterfeiting business is quite resilient from that perspective, and we saw strength even in our -- in the March quarter, more than what we expected, and we will continue to see the strength in the short to midterm.

Yes. And we are seeing this. I mean our thesis that with all that stimulus out there, some of it is inevitably makes it into new cash. And we actually saw some of it in the March quarter, we're already seeing some elements with emerging in the June quarter. And I mean one thing to also remember, just like everybody else is working from home, so are the printing process. Everything that's being shipped, the notes come out of inventory. So when the printing facilities do reopen, there will be a lot of the inventory replacement that will need to take place. So that's one of the thoughts that we would like to share on our conference.

Let me just take a pause, remind investors who tuned in that they do have the option of sending in questions through the Q&A feature, and I will ask it on your behalf of Oleg and Amar. So let me just continue there. Oleg, maybe kind of as we start to look more maybe longer-term beyond this, we've heard of a lot of trends being sticky coming out of the pandemic in terms of work from home, higher bandwidth requirements. So how are you thinking for the core business? How are you thinking about kind of the long-term implications of this? We understand the short-term challenges or the near-term challenges. But longer term, how does it impact your business?

Well, actually, I'm optimistic about the long-term because I tell you one thing. I mean I haven't had so many outage of my cable network, as I've had in the last couple of weeks. And a lot of it is driven by the fact that most of the networks are designed to be a big fat pipe downstream and a narrow pipe upstream. What we've been seeing. And in fact, what we are doing right now is we're streaming video upstream, and that puts an ordinate amount of stress on the network, which are not designed to work that way. So that means you now have to -- if we're going to see the new normal, more people working from home and much richer content is being uploaded. You need to go to the permanent solution in terms of rearchitecting the network, which is providing a symmetric bandwidth for download and upload. And that means you've got to push fiber much further into the neighborhood, much closer to the home. And you got to reset how you manage the traffic both upstream and downstream. What's happening today is that a lot of the operators are opening up additional channels for the upstream traffic. They're typically, they would never use because they're very noisy. Well, that introduces a lot of noise and problems into the network, thus, you have to periodically have to reboot or reset the operations. So I think as the people get back to work and the operators bring their field service back to work. One of the things they're going to start addressing is how to better rebalance the network, and that includes upgrading the field nodes and pushing the bandwidth closer to the home because that's the only way you can create more bandwidth. Obviously, in some ways, some people believe it may accelerate things like 5G because that's how ultimately can give you more spectrum, more and more bandwidth on the edge. So I think from that perspective, the mere fact, there's a lot of issues with these new traffic patterns, it drives a lot of rearchitecture, reengineering and retooling of the network, which is all good for our core business.

Let me just follow-up. Let me just follow-up on that. Oleg, you mentioned kind of the field technicians coming back and slowly coming back as kind of telecom companies start to bring them back. How are you thinking about the recovery pace there? Particularly, is there a challenge there given kind of the social distancing and kind of working outdoors is a concern? And maybe if you can help us size that business exposure for the company.

Well, I think, listen, in the end, most of the technicians are working -- the more you get to the edge, the more technicians you have, right? So it's -- so today, our core and the most -- if you look at our typical operator, they are triaging their operations. They're making sure that their core is running and their distribution nodes are working. Anything that's happening to the edge of the network closer to your home, that's a secondary because that's ultimately where you need to do it. Well, these things do degrade. You have noise. You have problems. So a lot of these repairs are being pushed out. So I mean we're seeing already now a lot of operators. Clearly, March was a very tumultuous month. April, May, by now, most of them have found a new cadence. They've kind of settled down, everybody reconnected. We reconnected with our customers. Our customers reconnected among themselves. And things are starting -- they're now assessing the situation and they're starting to plan. So in that respect, we're actually seeing things already stabilizing, getting back to normal. In terms of the sales, I think of course, they got to figure out what they need. And I imagine in the second half of the year, the decisions will be made where to spend the money and where to prioritize the resources. I don't see any of the operators laying off thousands of technicians at this point in time. I think it's just a matter of time to figure out how to bring those people back safely and provide them with the necessary PPE equipment. But I mean, for example, if we have a better problem and it's something to do with your house, you are out of luck because they're not going to send anybody in your home. And unfortunately, those things will accumulate as time goes on because it's a nature of physical network point. It breaks down, things go bad and you need somebody to come in and fix it.

So if I could just add to that, when you look at our field edge business, the key driver there is the number of field technicians. And as Oleg mentioned, there -- no one is laying off any field technicians, we are not hearing that. In fact, we believe that with the 5G build-out, which also result in fiber build-out, there's a lack of field technician that's out there. So there's a huge sort of requirement for field technicians who can do the wireless 5G build out as well as the fiber build out. And so there's a lot of technicians are getting cross trained, and we are at the forefront in helping them getting cross trained. We have used that model in Europe and we've been very successful, and we'll do the same here in the U.S. So long term, I think, this is the field side, mainly wireless and fiber is quite promising.

The other element is there's been fundamental stuff of any kind of construction. So I mean the fiber still needs to be laid. I mean for you to deploy 5G network, or people think the 5G network, but its reality is the biggest winner, one of the biggest winners is fiber. Because as you go through all these smaller cells, smaller coverage areas, that means you got to run fiber all the way to every one of these small cells. Well, until somebody builds all that fiber or connects all that fiber, you cannot connect any of those 5G cells. So I think one of the big drop-offs right now has been the pretty much complete stop to the doing build out until a lot of those same technicians get back to work. And it's already starting to happen. Little by little, things are starting to open up and people get back to work.

Kind of one of the concerns that we've seen from investors is nobody's really sure how, given that we're in a very weak macro backdrop, how the different customers will respond to it. And maybe you're not as much aligned to their CapEx plans, but they can only spend on technicians and technicians can only do their job once they deploy the CapEx and buy the equipment, right? So how generally, you've seen other cycles as well in previous cycles? What's your experience of how a telco versus a broadband cable customer might respond to this kind of overall macro backdrop?

So again, that's a very good question. Actually, if you think about it, it's also common sense. When things get tight, the first thing we try to do is, can I do more with what I've got. So when things are really good and you need more bandwidth, people just throw more equipment, more capital. When things are getting tighter, everybody says, you know what, I'm not as efficient with my existing assets as I could be. So in the past, whenever we're in a recessionary environment, actually, our field business has done really well. Because that's when everybody steps back, say, you know what, I have all these assets, I got to figure out how to sweat them on. And that's actually the word they're using. How can I sweat my assets more, which means you've got to go and optimize it? You've got to start figuring out how can you open more channels? How can you get more bandwidth? How can you improve the uptime or reliability of your existing equipment? And that's ultimately goes back to a lot of what we do in terms of the increasing the assurance of your network, be it with our software solution or with our hardware solutions. So I think I don't -- I mean, clearly, nobody is going to stop their plans on deploying the 5G the technology because I think that's really new and they've already committed. They may do it at a slower pace, but a lot of the existing plant will need to be shored up or improved in terms of the performance.

And the example, Oleg, of BT, stopping the dividend to go reinvest in building out the fiber network is a good case in point.

And we're very well familiar with it. I mean, in fact, there is -- in U.K., there is a national mandate to connect pretty much every home within the next couple of years to the fiber network. And it’s independent on whether you're thinking of 5G or the wireline. In the end, you need 5 -- if you have a fiber network going into community, you can deploy either wireless or wireline services that work, but if you don't have the fiber plant deep into the community, you are limited to how much brand that you can bring. But it's also part of their national policy. And we've seen similar trends moving around other European countries because everybody is now, especially now given a whole new wind with these work from home, having bandwidth becomes a lifeline. If you don't have the bandwidth, you cannot work.

Let me move to the Cobham Group and the outlook there. I mean you -- since the acquisition, it's had a great track record, you've raised the revenue guide at one point for your expectations from that group. Just help us kind of think about the addressable revenue opportunity there? And which innings are you in, in realizing that to maybe, to some extent, address, when you look at the 5G opportunity with Cobham, which innings are you in realizing that?

Well, I mean, listen, we started with the truly, I would say, leading technology for the 5G infrastructure test. That's what Cobham brought in. Since then, we have -- not only we don't -- growth came from 2 factors. One is we've further penetrated and captured the market. In fact, we are now at the point we are pretty much exclusive supplier for infrastructure, testing the major names. But we also have expanded our portfolio. So it's not only start with the lab where you do infrastructure test for development, then you do a test for the production. So once you start ramping up production, you need test to test all the systems that are going up. Then you expand the product portfolio. We've introduced products that do load testing, which is effectively a virtualized solution that sits on the server and generates massive amount of traffic that you can test your network, both in the lab as well as in the field to see higher response to different types of traffic to different types of loads. Now the next thing is happening. You now have a strong demand from the service providers that everything they buy be interoperable. This whole ORAN. Well, our solution is the leading portfolio of products that enable compliance testing with ORAN. We're introducing a whole suite of applications and products that enable you to test compliance of different parts of the network, whether they work with one or another. So we're not only did we just capture the share -- more share in our traditional solution, we have been expanding the addressable market that we're going after. And then on top of it, last but not the least, is developing a whole portfolio of the field instruments to enable the deployment of 5G services, ranging from the antenna alignment to fiber testing to the beam forming, beam switching, all the elements that assure that your 5G network is working. So I mean all of that came from our acquisition of Cobham, which the knowledge that we gained from that has been helpful.

Oleg, this is a -- and if you look at the chart, you may have to turn off your -- automatically just the mic because it sometimes it amplifies your voice.

Really?

Yes. It comes -- it increases and it goes down. So some suggestion on…

I think maybe Zoom needs to buy some of our solutions to improve their assurance of their network.

Let me ask the question. And if you need me to repeat, let me know while you're doing that or maybe what I'll do is I'll just kind of move to something more for Amar at this point while Oleg is fixing that. Amar, at the Investor Day last year, you talked about we are guiding to roughly $1.255 billion of revenues, operating margins 19% to 21% fiscal '22. How realistic are those targets now, given kind of what we're seeing in terms of the disruption and kind of a weaker macro backdrop?

Yes. I think, listen, Samik, there's something that's about more than 2 years out, correct? And at this point in time, the visibility is limited to the next -- even not limited to the next 6 months. So it's hard to predict what will happen in the next 6 months. Having said that, we do have a model in place that we are executing against. Yes, we have taken a detour right now given the COVID-19 situation. We have, as you said, it will be driven by 2 drivers, a decent top line growth. But also more importantly, continuously reducing our cost and driving OpEx efficiencies. So we have a funnel of opportunities that we'll continue to work on. So on the cost side, that -- COVID-19 is not impacting the execution on the OpEx efficiency. In fact, one of the biggest driver of our OpEx efficiency was getting on to a new ERP system. We reimplemented and upgraded our ERP system, and we've been working on this for more than a year. And even under the COVID-19 situation working from home, we were able to successfully transition from the old system to the new system, right? Now having done that, now we are now able to go integrate the back-end system for our -- for the acquisitions from Cobham that we've been talking about. So we have multiple systems there. We'll go and consolidate into our parent system. We'll reduce cost there in terms of need multiple IT teams supporting it and you don't need multiple licenses. And so there's a lot of efficiencies to go drive there. Similarly, we've got a funnel of opportunity. So long story short, I think we do believe that some of this demand that we are not seeing, and we are just into the second or third month of the COVID-19 impact. Some of the demand. The demand is getting pushed out. So at some point in time, there will be a pent-up demand that will come out because corporators will have to start building out their networks, upgrading their networks, which will go drive the revenue on the edge of the network. We are continuing to see lab and production being strong. Our anti-counterfeiting business is quite resilient. In fact, we might be -- we know that the design pipeline, the redesign pipeline is strong at this point in time. So all those things are lining up to a situation where we're saying, once we get out of this, whatever the U-shape recovery is, we should get back on track to go and hit the fiscal '21 number. Now whether it's going to be at the low end, midpoint, high end, I don't know where we will be, but there's a good opportunity for us to go do that as we continue to accelerate some of the OpEx efficiencies that we have.

Let me go back to Oleg and kind of follow-up on the Cobham business. Oleg, is there a difference when we look at in the U.S., particularly sub 6 versus millimeter wave infrastructure deployment, is there a content difference for Viavi, test and measurement equipment? And we were hosting one of your competitors, national instruments yesterday. And they did mention seeing some push out of millimeter wave infrastructure deployments relative to sub-6. So anything you're seeing on that front?

Well, we don't see a push out of millimeter wave infrastructure deployment. It really comes down to what were you expecting. As we said all along, we don't really see anything in a major way being deployed until the end of this year or early next year because I think it's naive to think because we look at it, things don't happen magically. We all know that you need to have fiber at the edge before you can deploy the millimeter wave equivalent. So I mean we actually looked at a very different time scale as to how that takes how long it takes to physically deploy the infrastructure. So I would say, I think our assessment of how things are being deployed are exactly within the time frame we've been budgeting on, and we've been aligning our internal investment to support it. That said, clearly, the more you are to the edge, the bigger the opportunity because that means -- just to give you an idea, you can service the entire core of the network with about 1,000 technicians. The edge of the network, you need about 40,000 to 50,000 technicians. So it just tells you how big of a market is the smaller you make the cells, the more bandwidth you want to provide in the neighborhood, that means the more physical labor, you need to expand the trucks, the forklifts, the bucket tracks to make all these connections. Clearly, but also, that's how you get the huge bandwidth. If you do the intermediate waves spectrum, well, the problem you have there is the amount of bandwidth you can offer by putting on an existing set of towers is not as great. So if you really want to deliver a huge bandwidth, you need to push it much further to the edge and deploy a lot of the small sets. So from the short answer to your question is, I think the way it's happening is pretty much the way we have been forecasting and planning for it, which is really nothing in the near term, but more towards the beginning and end of the year and into next calendar year.

Just thinking kind of about one of the questions that I get from investors quite a bit is because of the positioning in the R&D equipment stage. A lot of investors think of the opportunity being a bit more cyclical in that as you go deeper into the 5G investment phase, the demand moves closer to field equipment, and hence, the R&D kind of the growth in the R&D equipment stage starts to moderate. Just help us think about kind of how do you see the demand profile here? Is it more cyclical? Is it more secular? How should investors view it?

Well, it's actually not true. I mean the reality is the in terms of the development, because remember, there's always new releases coming out of standards. And then, of course, the whole ORAN environment that everybody insists on, right? So yes, you may have developed the basic core. But remember, we don't test the physical signal like the radio interface. Most of the stuff we do is modeling and testing traffic in the system line. So every time you make a change to your system, you got to make sure that it's still compliant with the older protocols and things like that. So from our perspective, as you go more towards the deployment in the edge, yes, there may be going to be a reduction at the core -- of the core equipment, but you're going to be developing a lot of services that will need to go on a 5G network. You've got to be developing a lot more of the what I call private 5G networks. And all of those things still need to -- what we test is the services and applications. We're not testing in the 5G networks, the layer 1, layer 2 of the network. That's really the strength of some of our other competitors. We're testing really starting with the layer 3 and ever -- so once the networks get deployed, you're going to be introducing new services, new applications, all of those things need to be still testing. And in fact, at that point, we will be able to sell our equipment to companies that are selling applications, not just the equipment themselves.

And I think just to add, in 5G, the application ecosystem is just going to explode compared to 4G or LTE, right? That's the whole basic driver of 5G, and which means, to Alex’s point, there'll be IoT testing, there's private 5G this is -- and similarly, we saw 4G wave actually continued for a long time. It was not…

It's still selling very well.

Right? So there is also demand for 4G and LTE. A lot of networks are not still in the 2G, 3G stages, right? So we’re still upgrading into 4G and LTE.

Let me move to the topic of 3D sensing, just being cognizant of time here. What are you seeing in terms of -- we understand the demand outlook on smartphones is obviously lower at this point. What are you seeing in terms of more design wins on 3D sensing, more OEMs willing to put up kind of the 3D sensing modules on their phones, particularly in the backdrop of them being concerned about consumer spending, wanting to keep ASPs low on their phones. How are you -- what are you seeing on that front?

Well, I mean, clearly, there's 2 things you look at. There's the TAM, the total addressable market and there are -- every reports says there's going to be fewer smartphones sold this year than last year. And then there's also, you look at the penetration of the 3D sensing into the mobile phones. And so it's adoption and penetration. So we have seen initial adoption in Android happening last year, mainly driven by the Chinese smartphone vendors. So clearly, that they will be impacted by change in sales in China. But we're also now seeing the other -- maybe for the facial recognition, the technologies proved to be a lot more complicated than many have thought. But now that we are seeing world-facing cameras being adopted. We actually think Android, we'll see more of those being adopted sooner rather than later because they act in conjunction with the camera. And on top of it, of course, the layer in the 3D sensing going to be -- is also going to be introducing world-facing camera. So in that respect, we -- for us, I guess, you got to do the math, how much the market will shrink versus offsetting into greater penetration and greater adoption. I think net-net, we think at the very least, it should be flat because the greater content perform and adoption of world-facing cameras should be at least as much, if not more to offset the shrink in the market. But it's -- your guess is as good as mine as to how the consumers are going to behave. I mean so far, we are seeing pretty healthy demand, even with all the issues there. They’re clearly not as good as we were hoping it to be, but it's not as bad as many thought.

Oleg, Let me take one of the questions that came in on chat here, content growth in 3D sensing. And maybe this gives me an opportunity to also ask you on an update on RPC photonics that you acquired what are you seeing in content opportunities in 3D sensing? And maybe as a follow-up, kind of outside of smartphone, where are you seeing opportunities?

Well, so I mean, think about content. So there's the -- we started off with the low angle shift filter for the IR, for the facial recognition. Now you need the same thing for the world facing so you now have additional sockets there. And in case of the RPC acquisition, it's a diffuser. So if you think about the laser going from VCSEL, and into the sensor, you need a diffuser to diffuse it and filter to on the receiver side. So now having both of these things I mean, ultimately, we see opportunities to get greater content on both the -- especially as world adopts more time-of-flight cameras, our engineered diffusers play very well into that market. So I would say, today, we have more addressable sockets between having both diffusers and the filters. And then there's other things. I mean now we're also developing other technologies. We do direct application to a wafer where you take existing wafer and do wafer-level optics for a lot of filters and things just putting in directly on the silicon. So there's many other things. And of course, there's other elements, the same technology we're using here. When you talk about the BOLED below the OLED display sensors, we have technology and filters and coatings that go into those products.

Got it. Let me take the other question and kind of maybe you've addressed this to some extent already, how much of the core business is lab use versus field, and I guess this is more just trying to quantify what you've just gone through. So anything on that front?

So I can take that. So it is when you look at our business, NSC, we have an N business, which is the instrumentation business, and we have C business, which is mainly assurance and network performance business, mainly software business. On the instrumentation side, more than 40% of our business is in lab and production across fiber as well as wireless.

Okay. Just as we get kind of close to wrapping up here, I think one topic that we definitely wanted to hit on is you've been successful in scaling the NE business and driving significant operating leverage. How are you thinking about kind of the headroom on continuing with that strategy, particularly, when we saw you draw down on a revolver recently, I really didn't see any cash flow concerns, other than kind of getting dry powder here for M&A. So just help us think about kind of the headroom on that strategy, which kind of part of the portfolio has that headroom?

Do you want to start, Oleg?

I think the first thing is, I mean, no, we did not draw down the revolver. We just put it in place. We don't need cash. We have plenty of cash. But it's just more of a part of an insurance, but also we do believe there are going to be opportunities for consolidation. I think -- I don't think the timing is quite there. I think people need to get used to the new normal, the new normal means new valuations. And our view is we're not looking to go and blow our money on -- I mean the cash is not burning hole in our pocket puts. Our view is, I think the time will come and we will be -- there'll be a lot of attractive opportunities. And we are looking at both. We're looking both at the continued consolidation on the instrumentation side. And obviously, and we're looking at the opportunities for consolidation and growth also on our software side.

Okay. Great. We're getting close to end time here. So I would like to thank you both for attending the conference and participating and making kind of the -- letting us conduct this virtual conference. So thank you, both, and thanks to everyone who tuned in as well.

Thanks.

Thanks, Sami. All the best.

Thank you.