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

Good day, and thank you for standing by. Welcome to the Viavi Solutions Fourth Quarter and Fiscal Year-End 2021 Earnings Call. [Operator Instructions] I would now like to hand the conference over to Bill Ong, Head of Investor Relations. Please go ahead.

Thank you, Ashley. Welcome to Viavi Solutions Fourth Quarter and Fiscal Year 2021 Earnings Call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call are Oleg Khaykin, President and CEO; and Henk Derksen, 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 and estimations. We encourage you to review our most recent annual report and SEC filings, particularly the risk factors described in those filings. The forward-looking statements, including guidance 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 supplemental earnings slides, which includes historical financial tables, are available on Viavi's 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 Henk.

Thank you, Bill. Fiscal Q4 2021 reflects a strong quarter with Viavi record revenue, non-GAAP profitability and operating cash flow for a given June quarter. Fourth quarter revenue came in at $310.9 million, which exceeded our guidance range of $290 million to $310 million. Revenues grew 16.6% from a year ago level and set an all-time Viavi Q4 record. Consistent with the prior quarter, the year-over-year performance continues to reflect robust recovery from last year's pandemic impact as well as continued strength in wireless and fiber and solar demand for our anti-counterfeiting products. Viavi's operating profit margin at 20.8% expanded 120 basis points year-over-year and 60 basis points sequentially and exceeded the guidance range of 19.5% to 20.5%. EPS at $0.22 per share exceeded the high end of the $0.18 to $0.20 guidance range and increased $0.04 from the year ago period. In addition to strong operating performance, we benefited from a lower-than-anticipated tax rate of 17%. The share count of 241.9 million shares includes the dilutive impact of the convertible notes of 10 million shares. Now moving to our reported Q4 results by business segment, starting with NSE. NSE revenue at $236.5 million increased 13.5% year-over-year, exceeding our guide range of $219 million to $235 million. Within NSE, NE revenue increased 17.6% from a year ago to an all-time record high of $212.7 million, reflecting strength for our fiber, wireless and cable products. SE revenue at $23.8 million decreased 13.5% year-over-year and increased 17.2% sequentially, a result of the lag in recovery for our assurance and data center products. NSE gross profit margin at 63.4% decreased 120 basis points year-over-year. Within NSE, NE gross profit margin at 63.1% decreased 60 basis points over last year, primarily due to unfavorable product mix. SE gross profit margin at 65.5% decreased 500 basis points year-over-year due to lower revenue. NSE's operating profit margin at 15.1% exceeded the high end of our guided range of 13.5% to 14.5%, primarily as a result of operating leverage on higher revenue. Year-over-year operating profit margins decreased 180 basis points, mainly a result of lower gross profit margins. Sequentially, operating profit margins improved by 520 basis points as a result of leverage on higher revenue. Now turning to OSP. Fourth quarter revenue at $74.4 million revenue, up 27.8% year-over-year was at the high end of our guided range of $71 million to $75 million. The strength was driven by robust anticounterfeiting demand offset by a modest seasonal decline in our 3D sensing products. Gross profit margin at 57.5% increased 650 basis points year-over-year, driven by higher volume and favorable product mix. Operating profit margin of 38.8% was within our guided range of 38% to 40% and increased 940 basis points from last year's levels as a result of the aforementioned higher gross profit margin. Now moving to our fiscal 2021 performance. While the COVID-19 pandemic impacted the start of fiscal 2021, Viavi experienced a sharp recovery beginning in late last calendar year with a strong finish to record revenue at $1.2 billion, up 5.5% from fiscal year 2020. OSP reached a record revenue of $361 million, up 25.8% year-over-year while NSE at $837.9 million saw a modest decline of 1.4% in revenue. Viavi's full year 2021 gross profit margin at 62.7% increased 70 basis points from a year ago level, reflecting leverage on volume, resulting in improved gross profit margins within our OSP segment. Operating profit margin at 21.1% expanded 250 basis points, reflecting gross profit margin expansion, combined with operating expense control. Operating profits at $253.5 million grew 20.2%, increasing $42.6 million year-over-year. EPS at $0.83 per share grew 13.7% or $0.10 from last year. Stronger volume in our Asia Pacific region resulted in a shift in jurisdictional mix of income contributing to an increased tax rate of 19.4% in fiscal 2021 compared to 17.5% in fiscal 2020. The share count used includes the dilution of the convertible notes and is calculated both on a full year basis and on a quarterly basis. Hence, the resulting full year EPS of $0.83 is $0.01 lower than the summation of the individual quarters. Now turning to the balance sheet. The ending balance of our total cash and short-term investments was $703.7 million, an increase of $25.6 million sequentially from the prior quarter and up $159.7 million compared to the prior fiscal year. Operating cash flow for the quarter was $63 million, a fourth quarter record, and an increase of $35.8 million compared to $27.2 million in the year ago period. We invested $25.4 million in capital expenditures during the quarter compared to $8.3 million in the prior year. The increased CapEx reflects a new production facility in support of increased future demand built in Arizona. On a full year basis, we generated record operating cash flow of $243.7 million, up 79.7% and reflecting an increase of $108.1 million compared to fiscal year 2020 at $135.6 million. On July 1, 2021, the 1% convertible notes due in 2024 with a face value of $460 million met the 130% pricing trigger, resulting in the notes becoming convertible at the option of holders until September 30, 2021. As a result, we have reclassified the $414.2 million book value of the notes to short-term debt and reported the difference in the book value and the face value of $45.8 million as temporary equity on the face of the balance sheet. This change has no impact to reported interest expense, EPS or the diluted shares calculation. In addition, we are not aware at this time of any note holders electing conversion. In Q4, we repurchased $10.9 million of Viavi stock at an average cost of $16.77 per share, including commissions. In total, as of the end of the fourth quarter, we repurchased $87.1 million out of the $200 million authorized under the share buyback plan announced in September 2019 at an average price of $12.98 per share. We will continue to be opportunistic in our share repurchases, and we continue to develop and intend to execute on our capital allocation and debt management strategy. Now on to our guidance. We expect fiscal first quarter 2022 revenue to be approximately $310 million, plus or minus $7 million. Operating profit margin is expected to be between 21.5% to 22.5% and earnings per share to be in the range of $0.20 to $0.22. We expect NSE revenue to be approximately $215 million plus or minus $5 million, with operating profit margin at 12.5% plus or minus 50 basis points. OSP revenue is expected to be approximately $95 million, plus or minus $2 million, with operating profit margin at 43.5%, plus or minus 100 basis points. Our tax expense rate is expected to be approximately 20%. We expect other income and expenses to reflect a net expense of approximately $3.5 million. The estimated fully diluted share count used in our calculation is 244 million shares. This includes an increase of approximately 12 million shares to reflect the estimated dilutive impact from the 2023 and 2024 convertible notes. The share count without the convert dilution is approximately 232 million shares. With that, I will now turn the call over to Oleg.

Thank you, Henk. I'm pleased with Viavi's performance in our fiscal second half with both Q3 and Q4 achieving record revenue and profitability. The NE segment achieved new revenue highs, benefiting from the continued service providers' business recovery and upgrades to the fiber and wireless networks. The demand for 5G wireless equipment reached a record high with strength across all geographical regions. 5G field deployment remains on track for the balance of calendar 2021. The fiber revenues were driven by fiber-to-the-home deployment, 400G network and data center upgrades and early 800G adoption. NSE bookings came in at record levels resulting in record backlog and providing us with greater near-term demand visibility. One challenge for our NE segment is the continued shortage of advanced semiconductor devices, dampening our ability to meet an otherwise very strong customer demand. These supply chain constraints have been factored into our fiscal Q1 guidance. Should these supply constraints resolve in near term, we would expect to see some revenue upside in the NE business segment. The SE business segment continues to recover with revenue increasing 17.2% sequentially as we rebuild the customer business funnel. We expect SE to continue to improve as enterprise customers reevaluate their IT project needs and 5G assurance opportunities start to materialize later in calendar 2022. Now turning to OSP. The OSP business segment delivered a record June quarter revenue and profitability, led by strong demand for anticounterfeiting products. Anticounterfeiting demand continues to be driven by a combination of global fiscal stimulus, inventory replenishment and bank note redesigns. 3D sensing finished strong in fiscal year 2021, up 18% from last year's levels, driven by broader technology adoption and new applications. Despite strong pandemic-driven headwinds early in the fiscal year, we successfully recovered and managed a very strong finish, hitting multiple financial performance records, including record non-GAAP EPS and cash flow from operations. Record OSP fiscal year revenue, non-GAAP gross margins and operating profits, all up double-digit percentages year-on-year and the record NE revenue in Q4 driven by strong wireless and fiber demand. As we look ahead into fiscal year 2022, it is off to a strong start with improved NSE demand visibility driven by 5G wireless and new fiber deployment. We expect strong demand for our anticounterfeiting products to continue driven by global monetary policies and banknote redesigns. In 3D sensing, while we expect a relatively flat demand in fiscal year 2022, we continue to see it as a major growth driver longer term. Overall, we expect our principal growth drivers, 5G, fiber and 3D sensing to continue driving growth and profitability for Viavi in fiscal year 2022. In conclusion, I'd like to express my appreciation to the Viavi team for its continued strong execution in delivering another record quarter and record fiscal year. I wish all our employees, supply chain partners, customers and our shareholders to remain safe and healthy. I will now turn the call over to Bill.

Thank you, Oleg. This quarter, we'll be participating at the Jefferies 2021 Semiconductor IT Hardware and Communications Infrastructure Investor Summit on August 31. Ashley, let's begin the question-and-answer session. [Operator Instructions]

[Operator Instructions] Your first question comes from the line of Samik Chatterjee with JPMorgan.

Oleg, I think previously, you've mentioned that between the 2 drivers being fiber and 5G deployment, you think fiber is the more kind of near-term upside or visibility and then 5G deployments a bit later. Can you just kind of share your updated thoughts on that? Is still -- is that how you're still thinking about it? You mentioned increased visibility for any -- what is contributing to that or a bit more color there will help. And I have a follow-up.

Sure. Well, I think fiber is still very much the biggest driver. And it's across every segment. It's not only field instruments, but it's also data center, it's lab. It's also fiber applications for the wireless networks because before you can provision 5G or other wireless services, you've got to run the fiber to the tower or the antenna. So fiber continues to be extremely strong, and we are seeing significant government infrastructure drive in Europe and now also increasingly in North America in getting fiber deeper into the Tier 2, Tier 3 cities and into the rural customer base. So in that respect, I mean, it's a very, very strong demand. It's far outpacing our ability to supply all the needs that there are out there today due to the severe semiconductor shortage. And as -- when I say it's improved, we have -- improved visibility, it means you have a growing backlog that you cannot meet in the short term, so it rolls over into the future quarters, which on one hand, it's the best of times because now you have visibility of a big backlog, but it's also the worst of times because you cannot get all the product that you need when you need it. We continue to manage, but I think it's fair to say there's a meaningful chunk of revenue that we could have realized in this quarter that we push out into the future quarters. And we're only seeing that trend accelerating and continuing to get stronger as various European countries embark on running fiber to practically every home. And we see more and more programs being rolled out and increasing number of requests coming in. So fiber continues to be very strong. That said, we're also starting to see a lot more activity around 5G wireless deployment as plans are starting to come to fruition and major operators starting to move -- to start doing initial deployment. It's clearly still not as big as we expect it to be within the next 6 months. It's the early stage, but we are seeing the progress being made in that area as well.

Okay. That's great. And Oleg, if I can follow up, if you can you give us an update on where the process is with EXFO related to the different actions you've taken there. What do you think are the next steps? And as a side note, like you have been building cash, you're generating quite a substantial amount of cash now on a yearly basis, outside of EXFO, what else is kind of in the thought processes or alternatives that you can explore to use the cash that you're generating?

Well, I mean, the cash is not burning hole in our pockets. I mean we remain very disciplined. I mean in the case of EXFO, the valuation put forward by the Chairman and Founder of the company was a no-brainer for us. And we knew full ahead that, fundamentally, there is no deal unless Germain Lamonde decides to sell. But we felt it was compelling and necessary for us to put a strong offer on the table to signal the value of the business because, effectively, it's our business as well and the bullishness with which we view that environment. And we'll see. Tomorrow, I think, is the day when their shareholders get to vote. If they vote to -- majority of the minority shareholders vote to decline the offer, then maybe there will be further discussions. If they vote to accept it, then they get what they deserve, which is selling their shares sub par. So I mean there's really not much more to it. In the end, it's really very much up to the Chairman and Founder, what he wants to do with the company. But we felt we owed it to our shareholders to signal that we are not afraid to be aggressive and put an offer on table. And there are other targets potentially out there. And in due time, we'll bring them up to the forefront as well.

Your next question comes from the line of Alex Henderson with Needham.

I was hoping you could talk a little bit about the magnitude of the impact from the supply chain challenges. To what degree your order rate is above 1.0, and how much of that you might have been able to ship had you had the product? And any granularity around which particular products were the most impacted?

So thank you, Alex. Well, I mean, the order rate in the fourth quarter was significantly above 1.0. I mean -- by significant, I mean, by a big margin, right, a big margin, which we always caution people about book-to-bill ratio. Because remember, a lot of our products are shipped within the same quarter. So clearly, when you have a very big book-to-bill index, it just basically tells you have a pretty good start in the first month of the next quarter. And usually, especially in NSE, most of our products, in NE in particular, are shipped within 3 to 4 months. So it's all kind of shipped -- a big chunk of it is book shipped. The shortages that we see, I mean, whereas we are able to pretty much manage most things pretty well. Increasingly, the area of the most acute shortages is the advanced ICs in the 14- to 28-nanometer range. So it's really -- you can make your own deductions what it is. It's the more complex-type ASICs and processor type products that is at the core of our devices. And even though we are fairly good at getting all the other auxiliary parts and be able to put the kits together, that is the area that remains very short. I think we've done really good call in the fall of last year to load up on the parts. Unfortunately, now that inventory is running pretty low and now we are also starting to see some of the shortages. So we continue to manage. But I mean it's not a very small number, but it's also obviously not a very big number. But let's put it this way, it will be meaningful enough to drive a significant EPS growth had we been able to meet our demand for this quarter.

If you look at it from the cost side of the equation, how much of your costs are being impacted by expediting higher air freight, higher container costs and the like that are the side effects of all of this?

Well, I'd tell you, I think the freight costs are up significantly. The components costs are up. I mean on the extreme -- on these parts that are in the extreme shortage, we are seeing brokers charging 30x, and I mean 3-0 x premium on the normal price. So it's a complete sellers' market out there in some of these things, right? So it's -- those are individual escalated devices. But unfortunately, without that last piece, you cannot build and ship a multi-thousand dollar product. So that said, we did have some pressure to our gross margins. But fortunately, for us, we are in a very kind of high-end products where even higher cost for some devices, expedite fees, logistics fees, we are able to absorb it. And with a higher volume, the better absorption of manufacturing overhead offsets some of the higher costs. At the same time, we are proactively going out there and increasing prices on our products as well. So we are not -- we are passing some of those increases to our end customers, and we're being selective about where we are doing it and where we are not. But I can see down the road, you're going to see some of the ASP appreciation across the board on all the products. And we are seeing the same. I think our competitors are facing even more severe shortage and higher cost. So that's an opportunity to actually to provide some ASP appreciation.

So can you quantify the impact or no?

I'm not -- it's not material. It's within a couple of percentage points.

Your next question comes from John Marchetti with Stifel.

Oleg, maybe just following on with that on the supply chain side for a moment. Can you just talk about maybe over the last quarter or last several months, how that's trended? Are things relatively stable? Do you still feel like it's getting worse? And kind of where your outlook is, I guess, in terms of how you think this plays out over the next quarter or 2?

So I mean -- I think you really -- it's a really bimodal distribution. I mean on the basic parts, like the discretes, the passives, boards, plastics, I mean, while there is some challenges here and there, it's fairly manageable and you can handle with expedites. The area that where the situation, I think, is getting worse, and I think the December quarter is going to be probably more acute than even September quarter is, as I said, in that kind of high-performance 14- to 28-nanometer advanced ICs. So it's microcontrollers, FPGAs, ASICs, you name it, because that's kind of the sweet spot for high-volume production products that are out there today. Since we don't use anything in the 7- or 5-nanometer range, I'm not privy to shortages there. But I think in the kind of mainstream 14 to 28 is really where we're seeing the biggest shortages. And it's not only silicon, there is also obviously challenges with some of the substrates from what we understand from our vendors. But silicon is, by far, the biggest.

Perfect. Okay. And if I move just to some of the geographic commentary in the quarter. Asia Pac had a couple of strong quarters here in a row. I'm just curious if that's skewed towards either the anticounterfeiting or anything going on there and how maybe we think about what's going on, I guess, from a geographic basis as we're looking out over the next several quarters.

Well, it's a combination. I mean, clearly, anticounterfeiting is one thing, but we don't comment on specific countries. But also 5G wireless. I mean our wireless business has been doing very well in Asia, has a lot of vendors and operators around 5G. And we're also seeing some -- continue to see healthy demand for fiber products.

Your next question comes from Tim Savageaux with Northland Capital.

Great. Sorry about that. I am going to go back on the supply side a little bit here before asking a higher-level question. But to the extent that you're talking about strong bookings, it looks like that's continuing into the current quarter across the network enablement business, and I guess, across all 3 pieces, if you will, fiber, wireless and cable. Should we assume that given that you had the potential to grow or at least keep any flat sequentially absent any supply constraints? And then I'll follow up.

Yes. Absent of the supply constraints, we probably would have had an all-time record quarter in September. So I mean the answer is yes to your question about growth.

Fantastic. And then zooming a little higher level here. Last quarter, you mentioned the kind of super cycle dynamic underway across your various communications test businesses. It sounds like that continues to develop favorably, but I just wonder if you might provide us with an update on whether any particular piece of that equation has accelerated or changed in a meaningful way since the last quarter?