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

Hi. Good morning. I'm Samik Chatterjee, the IT hardware and networking equipment analyst at JPMorgan. The next company we are hosting is Viavi. We have the pleasure of hosting Oleg Khaykin, who's the President and CEO of Viavi Solutions. We also have with us Bill Ong, Senior Director of Investor Relations. I do -- I will start with a bunch of questions for Oleg and Bill, but I do encourage investors to send in their questions over chat as well. Keep in mind, though, that companies are generally in quite period. So they'll be a bit limited in kind of commenting on specifics on the quarter, but please feel free to send any questions, and we want to make it as interactive as possible.

Oleg, Bill, thanks for the time today. I did want to kind of start you off with a question just on the consumer side of the business. And obviously, there's been -- everybody's focused on what's happening with Apple and iPhone [indiscernible]. But on the 3D sensing business, how should investors think about the content opportunity for Viavi on the latest generation of iPhones, particularly the ones with the LiDAR scanner on the back? And what have you heard in terms of feedback related to the success of these latest product launches from the key customer?

Well, I mean, clearly, as you can imagine, the key customer doesn't really share these kind of things with us, but purely looking at the order flow and demand, I think it's clearly been a very successful product. And I think, just the mere fact, the -- a lot of the Android ecosystem is showing a lot of interest in the world-facing cameras, I think, once again, they're looking to be fast followers. And I think if it was not a feature that consumers really enjoyed or demanded, probably we would not see as much interest. So I think, overall, it's -- our thesis has been all along that -- we expect to see more and more 3D sensing-type applications entering mobile devices, both world-facing as well as the rear-facing. Rear-facing, obviously, it's professional recognition security; world-facing is for camera and augmented reality applications. And I mean, for us, it's a nice added opportunity. It may not be as big on the filter side as the rear-facing because world-facing cameras use smaller filters, lower resolution filters. So as a result, there is a smaller filter. So for us, it's all a matter of filter area, but it's obviously still a very nice opportunity. But on the other hand, also, it gives us an opportunity to sell our diffusers into it as well because it's a time-of-flight technology. So our available tempered per module is both the filter as well as the diffuser. And it's roughly the same ASP as for the filter on the world-facing -- on the rear-facing cam.

Got it. Moving to -- you brought up Android. I mean you're seeing interest from them. One of the other topics that has come up is, even on the facial recognition, Apple might be looking to get a downsize the notch real estate on the front face. So when you're looking at interest from Android, are you seeing that specifically for world-facing? Or are you seeing that across both facial recognition and world-facing? And is the content opportunity relatively similar to what you have with Apple when you're in discussions with some of these Android OEMs?

Well, I think the only company that really have -- I think, had wherewithal to figure out how to do the facial recognition was Huawei. They were kind of the only Android player for adopting the technology. But due to the sanctions and component restrictions, a lot of their high-end phones that were using this technology have been shelved. So as a result, I think Android is -- I mean, I think that miscalculated how difficult their facial recognition technology. So in many ways, they're kind of far behind and they're looking for face-saving way to kind of do similar things, that maybe doable cameras or whatever. But net-net, they really kind of missed the boat on a facial recognition. So as far as we see, the Android is very much focused on the world-facing cameras. In fact, some handset manufacturers had already these modules designed into the models that they launched in the fall. Last minute, they held back because they weren't sure if they can get the money’s worth for that incremental bill of material, and they wanted to see how the market innovator will do. And clearly, it's been a success. So I imagine we may see as early as June quarter, people are reintroducing upgrades to their models by including the world-facing camera. And definitely, I expect higher in force to have world-facing camera in the second half of the calendar year. I think it's becoming a checkmark that you got to have.

Okay. Okay. That's interesting. Moving on to kind of outside of the smartphone industry here, and I'm sure you've seen as well, there's certainly been a lot of interest in kind of the opportunity for both optical lasers as well as filters on LiDAR for the automotive use cases. And obviously, maybe triggered by something totally unrelated, but we are getting a ton of questions on that front over the last couple of weeks. So just wanted to kind of see how you are thinking about that opportunity for optical filters when you think about LiDARs being used for autonomous driving and automotive use cases?

So I think it's really a matter of 3 horizons that you got to think about it. If you're thinking really within the next kind of 2-year period, it's really handsets, handsets and handsets, right? That's really where the volumes and the money is. Within the -- but also within these 2 years, we are seeing already kind of the adoption of these technologies happening more on the industrial side, like machine vision robotics. We're doing a lot of work with robotics and drones and machine vision security. But even as attractive it is, it's got very nice ASPS, the volumes are 2 order -- like an order or 2 orders of magnitude, smaller than handset [ sales ], right? And on the automotive side, today, the early adoption is really in-cabin monitoring, which is really targeting high end cars. Again, volumes are not very high. And so when we talk about the autonomous driving, I view it as a more of a third horizon kind of like, maybe 2 to 4 years for the market ramp. Because I mean, the way we pursue that, look at this market is we engage with every LiDAR player out there. And I don't know how many of them will be around 3 years down the road. I imagined significantly smaller number. There's going to be a lot of consolidation shakeout. But our view is we don't care who is going to win. We are trying to be in every single design. And I think the activity is very robust. There's a lot of R&D. And I mean, I do believe longer term, it's a very nice, very attractive market, but it is not in any kind of meaningful way within the next 2 to 4 years. I'd say maybe year 3 -- with 2 to 4 years, you will start seeing take off, but really 4 years is kind of before it becomes many.

Got it. Just curious, and before I move away from this topic on the automotive side, obviously, like the LiDAR space is very nascent at this point, but does it make a difference, whether it's a mechanical LiDAR or it's a solid-state LiDAR? Does that change anything in terms of content? Just curious if you've looked at those.

Well, clearly, I mean, mechanical is more expensive. But even solid states are still very expensive. So I think by the time the commercial product is launched, either one of those is going to have to cost reduce and shrink. So I mean from that perspective, I mean, we really don't care. We play -- we work with both sides. But my bet is whatever technology gives you the lowest cost is ultimately going to win. And I do believe solid-state like ours, the future in the industry.

Got it. And does RPC Photonics have -- the diffuser have a position when you're thinking about the LiDAR opportunity?

Sure. We're obviously working with [ oil and gas ] for diffusers as well. I mean, it all really depends how people architect and how they monitor their thing. But it's -- I mean, in some cases, they use other tricks, but I mean there is diffuser opportunities.

Okay. Let me just again remind investors, you can send in questions over chat, and we'll be happy to kind of take it up here. Moving, Oleg, to the next kind of product area. And if I think about the kind of currency print business that you have, we have seen kind of a quarter with very strong momentum for you. But if I start thinking about kind of the pace of activity and if that's at all related to kind of what's going on related to COVID, how are you thinking about the refresh activity on the currency side or the pace of activity once we start to hit a more normal environment post-COVID?

Well, I think as I mentioned in the prior calls, we started talking in the summer, we actually see a super cyber -- cycle coming to us in terms of the -- in the counterfeiting. And I mean, clearly, COVID just accentuated even more. I mean overall, if you think about the totally, what drives the market, it's a number of printing nuts. And that number continues to increase globally year-over-year in a low single-digit rate. The second thing that kind of drives that is the penetration rate and adoption of advanced anti-counterfeiting features using our technology on the spec [ NOLs ]. And that's actually accelerating and increasing, there's a lot of new redesigns have been in the pipeline. And so when you take this thing together, that was going to be kind of the driver of growth. Then on top of it, you overlay COVID with all the various stimulus that's out there, and that actually creates an even greater demand because inevitably, chunk of every stimulus is actually putting more cash in population hands. And last but not the least, what happened with the shutdowns, a lot of the print works have been shut down for a long time, and if governments have exhausted the inventory for finished nodes. And they've exhausted whatever the pipeline of materials were in their inventory. So now you have the natural growth of the market, combined with the new redesigned currencies being launched, combined with the stimulus and the shortage of material and inventory, I expect we're going to see a significantly higher level of demand for our anti-counterfeiting profits for multiple quarters to come.

Okay. Okay. That's helpful. Let me move -- transition here to the kind of core communication business. And you obviously are aligned to a lot of different technology adoptions by your customers. But if you think about just calendar 2021 and what would you kind of highlight to investors being the most relevant technology drivers and for Viavi's communication testing equipment for 2021? And what are these technologies that customers are trying to adopt?

Well, I think for the -- our NSE business, I think fiber and wireless are very big drivers. And in many cases, they're not mutually exclusive. If we are seeing today, we're seeing very strong demand from players who are both fiber network operators as well as wireless operators because just ahead of the deploying their 5G, many of them have to upgrade their fronthaul and backhaul optical fiber. And we are seeing, as a precursor to that, they are investing heavily in the fiber tools and things like that to upgrade the network. At the same time, we do expect in the second half of the year, the 5G deployment is starting to pick up steam. And there will be demand for the wireless tools. What we are doing is it's kind of, in many ways, unique to the [ heavy ] is we are introducing tools with fiber and RF in the same device. Because in the way different from 2G and 3 G, we believe fiber will be an important element of the RF deployment because every time -- because today, fiber runs all the way to the antenna. So simultaneously, when you're doing base station installation and calibration, you need to check the latency, you need to check the timing and you need to check the fiber connectivity as well as check out all of you our wireless instruments. So we do believe that gives us a unique differentiation vis-à-vis traditional RF players. And as you know, we are the newcomer to this market, and we believe today, we actually have the best field instrumentation portfolio for RF instruments.

Got it. Got it. Before we go into specifically the wireless opportunity on field instrumentation, if I just stick to kind of your existing field equipment business, particularly related to fiber. We've seen a couple of quarters of low activity on the field side, given kind of the challenges around COVID. So what are the latest trends there? If you can just dive into that. What are you seeing in terms of lab demand, which has been relatively strong versus field, which was soft for a couple of quarters? And are customers still kind of sounding like they're willing to push out or delay some of the field activity? Or is that getting to a point where they might kind of make some decisions on this?

Well, when we think about field instruments, there's 2 things that drive demand [indiscernible]. There is a traditional kind of maintenance retrofit upgrade demand. That's kind of steady state demand when people buy equipment and they just cycle through it and so on. And then there is the network build-out or the new technology standard introduction. So generally, the base of the demand is really the maintenance and retrofits. Anytime you also have a build-out or new technology transition like we saw with the DOCSIS 3.1, that puts a whole extra layer of demand for [indiscernible]. So today, while we are not seeing much in the new build out a new technology adoption, what we've been seeing is when the COVID hit, everybody kind of crawled into their holes, and there was -- everything was got frozen. And then throughout the summer and into September quarter, we start thinking things picking up. And that trend continued to pick up and accelerate in the December quarter, and we're actually seeing this continuing into this year because I think people have realized that there's a new normal, they figured out how to work with the new normal. And there is a massive customer demand for improved connectivity and bandwidth as people now work from home. It's no longer a luxury, it's now a necessity to have a reliable network. And from what we are seeing is that trend has been actually very good. And it's not only for cable that's been pretty strong or fiber. We've been seeing DSL coming back. There's a lot of demand for DSL too. So we've pretty much given up on that segment for all practical reasons. And what's even more interesting to me is even the regions they get hit really hard economically like South America, they are actually prioritizing spend on field instrumentation because they also want to upgrade their field network.

Okay. Interesting. Okay. Just focusing on some of the infrastructure initiatives here, particularly one that's driving a lot of enthusiasm here is the RDOF initiative where just the Phase 1 auctions were concluded recently. There's a $20 million budget, obviously, and we saw the Phase 1 come in quite a bit below what the first phase budget was for. But when you start to think about kind of the tailwinds for the industry or for network equipment companies, including yourselves relative to some spending happening on that front, how are you thinking about it relative to like CAF I or CAF II? And how realistic are these kind of numbers when we see like a $9 billion auction, how realistic are those to be kind of a tailwind for the industry?

So I mean, listen, I mean, from our perspective, when that money actually gets spent, I think we're going to do really well on it because one area that is grossly underserved today is the kind of areas outside of the Tier 1 [indiscernible] and Tier 2 cities, right? There is a dart of fiber and a lack of bandwidth to deliver a lot of the services. So -- and a lot of operators who operate in these areas really don't have the money or the capital to do what's necessary. So without government subsidies, they cannot do that. And they would love to buy all the things that the major metropolitan area operators have when they can. So clearly, when that money gets spent, it's going to be a boon to our cable, our fiber business and our public safety outcome business as well. Now that said, let's also remember, it's government, right? So that money has to be approved. The tenders have to be done. And so I just don't think that [ money ] is going to get spent this year. So I think it will probably be at least next year until we see the first dime of that money being disbursed and spent. And we look at it as one of those super cycles, kind of like 5G, it will gradually roll out over a 10-year period. So yes, if it -- maybe at like $10 million, $20 million, $30 million a year, that's great. But I mean -- so for us, we view it as purely as the upside to whatever plan we put out there. And we don't include in any of our forecasts. So anything -- if and when it comes, it will be just an upside to our results.

In terms of magnitude, are we thinking about it correctly that related to kind of some of the earlier plans, this one being more aligned to kind of favor fiber deployment to these areas and Viavi being a leader in fiber testing can have an outsized impact?

Yes. I think -- because remember, a lot of these rural areas, they still have cable network connectivity, right? So -- but what they do is they don't -- the cable is still old cable. So they probably will run fiber much deeper into neighborhoods and they bring more fiber connectivity to the area. So I think fiber will benefit together with cable, but I also think the fixed wireless will be a good product because in both density without 5G, you can actually deliver high bandwidth much cheaper through the air to a lot of the low-density population areas than that. But you need to bring in the fiber. And then I'd say a combination of fiber and 5G and fiber and cable is what's going to drive resets in that area.

Got it. Got it. Again, if anyone on the line has any questions, please feel free to put them in the chat, and we'll ask it only on behalf here. Oleg, let me move to the 5G wireless discussion. And you mentioned you are on the field instrumentation in 5G wireless, you're one of the newer players. Can you -- I don't know if it's possible to quantify what that revenue looks like today, but more so kind of what makes you confident that you will be able to get, say, displacing some of the incumbents? Can you also give us a bit background on who you're competing within that business?

So I mean, we think the field instrumentation business for the wireless is around $300 million business a year. And obviously, 5G will take several years to build up to that. And we think, for us, capturing anywhere between 1/4 to 1/3 of the market is very reasonable because, listen, I think we bring in, clearly, I think, given how long it took for 5G to finally rollout, even though we always were telling everybody that it will take a lot longer, it gave us significant amount of time to really develop our RF technologies. And because we have been working with all the leading [ NEMs ] on their infrastructure development, we've taken a lot of the lessons as to what is the mass cap features and critical functionality in the field instrumentation to make 5G infrastructure work in the field. So we actually had a seat at the table on the front lines for the last 2 years to really optimize our devices and our products. So with that, I think our rep performance of our devices is on par or better than the incumbents. At the same time, what we're also bringing is the whole idea of the workforce automation. If you look at today, how fiber, DSL and cable gets implied -- deployed, you rely on a relatively low scale technicians and very smart instrumentation to do the deployment, right? And it de-risks it, make sure that it's all done right and it qualifies and certifies the installation. In RF, traditionally, you relied on the highly skilled technicians and relatively unsophisticated instruments. We are bringing the same thing. And if you really want to deploy a significant amount of base station with the -- you're going to have to dip into a lesser skilled technician pool to do the installation. And we believe our instruments actually improve the productivity and lower the cost of the deployment. And so there's a very good operational map that comes together with our equipment. And last but not the least, we've been working for the last 2 years with all the leading NEMs and service providers to certify and qualify and write-up into their installation manuals our products. So now we are focusing -- shifting our focus onto the contractors and construction crews to create awareness and educate them about this [indiscernible]. So if we've done everything right, I think we should be able to capture meaningful share in that margin.

Okay. Got it. And who should we be watching in terms of companies that you're competing with, who should we be watching to kind of figure out what...

I think, Anritsu is the market incumbent. And you have smaller share in the market for more specialized players like Keysight and Rohde & Schwarz of that kind of higher...

Okay. Moving to another technology discussion that we're seeing drive a lot of conversations is O-RAN, and we've kind of heard debates on both sides where certain kind of companies are very excited about it. Some kind of continue to think that this technology is not mature yet. What are you seeing? What are your thoughts and implications for Viavi O-RAN does kind of get adopted well in the industry?

Well, I think our view is that, I mean, your view of this technology really depends whether you're an incumbent or you're a newcomer, right? So if you are a traditional now, you prefer a closed network, I mean, because it gives you stickiness and gives you a better market advantage. If you are a newcomer, I mean you prefer the open network. We are indifferent. We work with both. But we do see O-RAN as a significant market expansion opportunity for Viavi. And we are one of the leading players. In fact, we are the leader in setting the standard bodies and working with the 5G standards in terms of defining and working on how to test it and verify. And we see O-RAN as the next wave of growth in our infrastructure test of traffic generation. And it is not only the new comers. I mean, the incumbents are also aggressively developing products for O-RAN. And the reason O-RAN is so much more interesting to us is when you test a proprietary system, you only test ingress and egress. Well, the moment you make it an O-RAN, you now have half a dozen interfaces that you need to make sure you are compliant with. And that just means significantly more test, but it also creates more customers because now we have specialized players coming in who only want to sell a particular portion of the network. So companies like Mavenir, Altis, Rakuten and so on. So I think in that respect, it expands our market and it expands the number of customers. And for us, I see it as a big growth -- continued growth opportunity for our infrastructure test beyond the original 5G development.

But it sounds like you're thinking the timing is at least 2 to 3 years? Or am I characterizing that...

Actually, now, there's O-RAN happening today. I mean -- and I think that the momentum is gaining -- is going to -- again, I think initially, I think service providers want to make sure that network works, they go with improving existing solution from leading [ OEMs ]. But many of them are working very aggressively, much so than in 3G and 4G to unbundle it and bring in other players. And you actually see some operators from the get-go going out with the open architecture, so -- which we didn't have before.

Got it. Let me finish up with a couple of questions. Firstly, on M&A, it's been relatively quiet since the Cobham acquisition. You had the strategy that you had laid out, which you've successfully executed on with scaling the NE business. So how much more room there is on that strategy? What kind of more areas or capabilities are you interested in using to scale NE?

Well, I think the M&A is still always part of our strategy. It just needs to have the right deal at the right price. And the areas we look is clearly continued -- in NSE, it's really a consolidation play. With a targeted -- with the point technology acquisition where we need to strengthen our portfolio. In OSP, we are looking at the broader optical space to continue invest and expand in that area. And I would say also in NSE, we are looking at some of the more -- on the security side and the firewall testing, the traffic generation, that technology. So we are -- on an NSE, we're looking to consolidate and go deeper into the infrastructure and lab cast. And on the OSP is really broadening our optical landscape.

Got it. Helpful. Last question in the last minute we have here. Any update on the CFO search at this time?

We're making good progress, and I hope that we should have a CFO candidate identified starting probably before the fourth quarter.

Okay. Okay. Great.

So March, April time frame.

Yes, yes, yes. Great. Oleg, thanks a lot for the time. Bill, thanks as well for the time today. Thank you for attending the conference. Quite an interesting discussion. Thank you.

Thank you for having us. Happy New Year.

Thank you all.

Happy New Year.

Bye.