Hello, everyone. My name is Rob. Welcome to Viavi Solutions Second Quarter Fiscal Year 2024 Earnings Call [Operator Instructions]. I will now turn the line over to Ilan Daskal, Viavi Solutions’ CFO. Please go ahead..

Thank you, operator. Good afternoon, everyone. And welcome to Viavi Solutions' second quarter fiscal year 2024 earnings call. My name is Ilan Daskal, Viavi Solutions’ CFO. And with me on today's call is Oleg Khaykin, our President and CEO. 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 that 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 discussed on this call 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 as well as our supplemental earnings slides, which include historical financial tables, are available on Viavi’s website at www.investor.viavisolutions.com.

Finally, we are recording today's call and will make the recording available on our Web site by 4:30 p.m. Pacific Time this evening. Now I would like to review the results of the second quarter of fiscal year 2024. Net revenue for the quarter was $254.5 million, which was above the midpoint of our guidance range of $240 million to $260 million.

Revenue was up sequentially by 2.7% and on a year-over-year basis was down 10.5%. Operating margin for the second fiscal quarter was 13.2% and exceeded the high end of our guidance range of 9.6% to 12.8%. Operating margin increased 80 basis points from the prior quarter and on a year-over-year basis was down 300 basis points.

EPS at $0.11 exceeded the high end of our guidance range of $0.06 to $0.10 and was up $0.02 sequentially, and on a year-over-year basis was down $0.03. Moving on to our Q2 results by business segment. NSC revenue for the second fiscal quarter came in at $179.6 million, which is above the midpoint of our guidance range of $169 million to $185 million.

On a year-over-year basis, revenue was down 13.3%, primarily due to lower CapEx spent by NEMs and weaker spend by service providers. NE revenue for the quarter was $155.5 million, which is a 15.2% year-over-year decline. SE revenue was $24.1 million and grew 1.3% from the same period last year.

NSC gross margin for the quarter was 63.4%, which is 100 basis points lower on a year-over-year basis. NE gross margin was 62.5%, which is a decrease of 190 basis points from the same period last year, and was primarily due to a combination of product mix and lower volume.

SE gross margin was 68.9%, which is an increase of 460 basis points from the same period last year and benefited from higher margin product mix. NSC’s operating margin was 3.6%, which is an increase of 270 basis points sequentially and the decrease of 530 basis points on a year-over-year basis.

NSC operating margin was above the midpoint of our guidance range of 0% to 4%. OSP revenue for the second fiscal quarter came in at $74.9 million, which was at the high end of our guidance range of $71 million to $75 million and was down 3.2% on a year-over-year basis.

OSP gross margin was 52.1%, which is a decrease of 20 basis points from the same period last year, and was primarily due to lower volume and unfavorable product mix. OSP operating margin was 36.4%, which is 140 basis points lower sequentially and increased 90 basis points on a year-over-year basis.

OSP operating margin exceeded the high end of our guidance range of 32.5% to 34.5%. Moving on to the balance sheet and cash flow. Total cash and short term investments at the end of Q2 was $571.8 million compared to $489.7 million in the same period last year.

Cash flow from operating activities for the quarter was $20.4 million versus $46.2 million in the same period last year. We have not purchased any shares of our stock in the second quarter as we plan to retire the outstanding balance of our March 2024 convertible notes in the amount of $96.4 million.

The fully diluted share count for the quarter was 223.5 million shares, down from 227.1 million shares in the prior quarter and was -- versus 222 million shares in our guidance for the second quarter.

CapEx for the quarter was $5.8 million, which is $12.3 million lower versus the same period last year when we were completing the construction of our new facility in Chandler. Moving on to our guidance. For the third fiscal quarter of 2024, we expect revenue in the range of $245 million and $253 million.

Operating margin is expected to be 10.4% plus or minus 160 basis points and EPS to be between $0.05 and $0.09. We expect NSE revenue to be approximately $176 million plus or minus $3 million with an operating margin of 1.5% plus or minus 150 basis points.

OSP revenue is expected to be approximately $73 million plus or minus $1 million with an operating margin of 31.8% plus or minus 200 basis points. Our tax expenses for the third quarter are expected to be around $8 million as a result of jurisdictional mix. We expect other income and expenses to reflect a net expense of approximately $3 million.

And the share count is expected to be around 224.7 million shares. With that, I will turn the call over to Oleg.

Oleg?.

Thank you, Ilan, and welcome to your first earnings call with Viavi. The fiscal second quarter 2024 came in stronger than expected. Revenue was slightly above the midpoint of our guidance, helped by stronger demand for 400 gig and 800 gig fiber, middle ARO and SE products.

EPS came in above the high end of our guidance, driven by richer margin revenue mix and lower OpEx. In the near term, we expect stronger demand in the above product areas to help offset continued weakness in the service provider spend. Starting with NSC, the second fiscal quarter NSC revenue came in above the midpoint of our guidance range.

Although, the NSC revenue declined on year-over-year basis, driven by a slowdown in 5G and fiber build outs by major service providers, there was a number of bright spots. Fiber 11 production has continued to recover, driven by strong 800 gig demand, offsetting weakness in computing and storage.

Aerospace and defense products saw robust growth driven by strong demand for avionics and PNT or positioning navigation and timing products. And the new SE products continue to perform well, resulting in a slight year-over-year growth despite the decline in service provider spend.

Looking ahead, we expect continued demand recovery and growth in our Fiber 11 production, aerospace and defense and SE products, compensating for the continued near term weakness in the service provider spend. Now turning to OSP. OSP declined on a year-over-year basis, primarily driven by lower demand for anti-counterfeiting products.

This decline was partially offset by strong 3D sensing demand. Overall, OSP results came in at higher end of our guidance range. In the March quarter, we expect OSP to be slightly down from the December quarter with a stronger demand for anti-counterfeiting products offsetting the seasonal decline in 3D sensing.

Looking ahead to calendar ‘24, we expect telecom service provider spend to continue to be soft with a notable exception of the North American cable operators. We expect cable spend to ramp in the middle or second half of calendar year 2024.

That said, our strategy in the past six years to diversify outside the service providers into 11 production and aerospace and defense makes it easier to ride out the telecom cycle downturn. 11 production spend is seeing a faster recovery versus service providers, driven by the demand for the new technologies such as 800 gig and Open RAN.

Recently Viavi was awarded a $21.7 million grant by NTIA to create an advanced test lab to empower and accelerate the development of Open RAN technologies and components. This award reflects Viavi’s technology leadership in 5G, upcoming 6G and ORAN.

Our aerospace and defense products are seeing strong demand and growth, driven by the next gen avionics and the need to protect critical infrastructure and assets against jamming, spoofing and cyber warfare.

In conclusion, I'd like to thank my Viavi team for managing in this challenging environment and express my appreciation to our employees, customers and shareholders for their support. With that, I will now turn back to the operator and Q&A..

[Operator Instructions] And your first question comes from the line of Michael Genovese from Rosenblatt..

Oleg, first question is just on the service provider market, just to understand, make sure I heard the comments right. It sounds like you're saying all of ‘24 calendar expects to be weak there, cable getting better at the end of the year.

First of all, did I hear that right? And secondly did your expectations change in the last three months, has the carrier stuff, telecom stuff gotten more pushed out or was that consistent with three months ago?.

So let me just say, look, the reality is I don't know what the second half is going to look like from service providers. We know the demand will be somewhat stronger in the June quarter. It's always stronger. Beyond that, I just think -- I mean, clearly, it's not getting any worse, it's getting a little better.

But I would still prefer to think of it as a flat to slightly recovering as the kind of modus operandi, because I think they're still pretty weak. But the point is we are seeing -- it's coming in but it's not as dramatic as I would've liked to see. Now the area that is stronger is the cable.

In fact, we were expecting cable to start spending and coming in, in the first half of calendar year. But as you probably know, there were some delays, driven by technology readiness in deploying the DAA architecture by some of the vendors, and aside to the ramp is being pushed by one or two quarters.

So we know it's coming, we're already seeing some orders. But the spike that we were expecting in the March quarter got pushed out, that's why we are guiding March quarter flat to slightly down. It was going to be slightly up in the absence of that slow down.

I mean, let's put it this way, I feel a lot better about the environment in which we are operating than we were even a quarter or two quarters ago. I just don't want to get ahead of our skis on service provider recovery, because when I see it, I'll believe it.

I mean -- so I think they still got a lot of balance sheet issues they need to address before they really start spending significantly. So just take it as abundance of caution. I mean, do I feel better about what's going on? The answer is yes. Am I seeing big dollars coming in? The answer is no.

And now one thing what we did see interesting is we are seeing pretty good traction on our service enablement products with the new architecture AI op, which drive OpEx reduction and things -- capital avoidance. So there we are seeing a pretty good traction.

But on the instrumentation, particularly with fiber deployment, I think there is a pause that may at least last six months. Maybe towards the second half of the year, things will get better. But at this point, I think my crystal ball is telling me I'm not seeing anything dramatic changing..

Next question. This 800G fiber lab in production sounds very interesting, and I think you've probably had either two or three quarters of sort of measurable revenues there. So I assume that that is increasing, and any color you can give us on that? And not sure whether you would answer this question.

But sort of how much of any that represents either now or what it could be in the future would be very helpful?.

So I mean, our 11 production business, I would say on any -- let's see, if I think about the -- we have a network enablement and the SE, so network enablement is about 87%. I'd say our 11 production is, I think -- but it also includes wireless, it's about 40%.

And of that, I'd say fiber lab and kind of high performance computing is roughly half of that. So maybe 20%. Now with the storage building slowdown, we saw the computing and storage was weaker. I mean, all of that business really kind of bottomed out around the June quarter.

But what's really been driving the recovery of that business is the fiber production and the fiber lab demand, and it is driven by 400 and 800 gig products. So I think -- so what I'd say is it's now -- it's a recovered. First of all, it's recovered and continue to grow.

I think the same players who are building telecom modules are now more recently, these AI enter data center modules are buying the equipment. I've been trying to ascertain like for so many million ports how much equipment is being bought.

I think we're probably not there in terms of truly understanding how the cap expand is linked to that, because it's still early in the game. But exactly same equipment that they use on the coherent telecom module line, they're using it also on building the data center modules for the AI applications..

Yes, sounds like going forward that'll be interesting to figure that out, that relationship, I can't wait to get an update on that. Last question for me, sorry to take so much time.

But I'd like to ask a broader question, which is, can you just help me understand -- because the revenues were pretty good for the quarter, the earnings were good, the revenue guidance is good. I'm just still not seeing the reason why the EPS guidance is lower.

So could you explain that to me?.

So as you know third fiscal quarter from a seasonality perspective is usually kind of slower than the second quarter. So if you think about it on a consecutive basis, then also when you have kind of the beginning of the calendar year, there's some incremental cost associated with employee related and that kind of drives kind of in terms of the OpEx.

But again, as Oleg mentioned earlier, the traditional seasonality, when you think about it, is kind of building up really nicely when you think about the rest of the year, including the fourth quarter..

So there's a lot of statutory cost accrual that happens in the first quarter of the calendar year. And on the OSP, you notice there's a lower margin because it's cyclicality of a 3D sensing. The second half of a fiscal year is a much lower utilization, so there is more underabsorption in that respect.

Now that said, the anti-counterfeiting is coming back, so it's offset some of it but not all of it. And last quarter, the 3D sensing was quite strong..

Your next question comes from the line of Tim Savageaux from Northland Capital..

Oleg, can you remind us of your lead times in service provider fiber test?.

Generally, if we get an order, I'd say within two months, we can turn it around. So it's all within a quarter, more or less. Now except for some things like, if it's a -- some products are very quick, like for example, fiber scope and things like that.

Other products, like where you are buying a whole bench where you have MEMS, switches and things like that, if we have them in inventory, we can turn it around within, I'd say, two to three months..

And where would you assess your service provider customer inventories to be with your product?.

Zero. I mean, it's all just in time..

And I guess the reason I ask it is that throughout the early part of reports here from both some of your bigger peers, Corning, Nokia, as well as some of the bigger service providers, we have seen some early indications of project based kind of increases in plans for ‘24.

And I'm just trying to reconcile what's been a pretty consistent drum beat here with what we're hearing from you. And I think there could be -- typically, you lead these things.

But I don't know, might you lag at this point because of the lead times, I wonder? And are you seeing some of the same things?.

No, I don't think so. I don't think we're looking and once they decide. So when they tell these guys they're going to do a project, they may tell it to them before they tell us, because once they're ready to start building, they just place an order and within two months they get their equipment. It's pretty quick..

Your next question comes from a line of Alex Henderson from Needham & Company..

Could you give us a little bit more granularity on the size of the 3D sensing in the quarter and the expectations for the 3D sensing in the March quarter?.

So generally, Alex, 3D sensing, half of the annual demand comes in in the September and December quarter -- two thirds comes in in the September and December quarter, and one third comes in the March and the June quarter. So I would say we ran right around $20 million, $25 million in the quarter..

And so in the upcoming quarter, you're looking at what $10 million or so?.

This quarter, I think maybe a little more than $10 million, but let me see. Yes, it's about it -- it is around -- it's $10 million plus minus $1.5 million..

And can you give us an update on the plant in Phoenix? It's now fully operational. All of the benefits of the cost improvement are in the mechanics of the counterfeiting business at this point.

Is that correct?.

So what we are seeing now -- so that's when you know where people are running out of inventory. So you start seeing a lot of unforecasted spot orders popping up, like hurry up and ship as soon as you can. So we are starting to see more and more of these type of things popping up.

They're not big orders but it's telling us the inventory is starting to deplete itself in the channel. So in the March quarter, we are expecting a little bit stronger demand from what we were thinking maybe even three months ago. So that's actually helping us to offset some of the 3D sensing decline quarter-on-quarter..

Generally, it's fully operational and we still have more capacity for additional growth there. So it's not in terms of full utilization, it's not yet there in terms of the availability that we can get..

Fully operational but not fully -- not full capacity….

Alex, let me give you a correction. Actually, 3D sensing is going to be closer about $16 million in this quarter. I was thinking the end of year..

So going back to this split on the 800 gig product, just to be clear. So the ratio of ports to equipment is quite low, right? I mean, we're talking about double digit port per kind of ratio there. I assume that this is predominantly going into the production side of it. It's not going into the field deployment.

And you're talking about how many products can go through a test and measurement process in any given period, but that's a sampling process.

So the ratio is very high relative to the total number of ports that go across that equipment, right?.

I mean -- and it varies. So when you start production you tend to do a lot more tests. So you have a lower number of ports per, let's say, a million dollars of equipment. As you get with experience curve, you start -- and you feel comfortable, you start de-contenting the test, so you spend less time on a tester.

So yes, the equipment predominantly goes into the production line. I mean, you have all these factories in China and other places that are building these modules. So when they start, they generally use more intensive testing.

And then as they get more comfortable, they start reducing and doing more of a sample testing or less extensive testing per module. So that's why it's continuously moving target. So I mean, in one case we've kind of did a one project and we have gauged, it came out to about $0.40 per module of CapEx, per module of capacity.

So if you're doing a port, you need about $0.40 investment per port on the capacity line. So you build, let's say, 1.5 million units a week line so you probably -- I mean, I think it works out to about $0.40, about $300,000 for that capacity that you got to invest. But it's only one data point and other people do it differently so they spend more.

So it's still very early to tell..

So we've already seen very significant ramp in productions of both the NVLink and InfiniBand products going into the AI clusters. And from what I can tell, you really haven't seen any meaningful contribution from that at this point.

So should we then think that as we move into the second and third phase of production ramping that the sampling rates actually go up and therefore, we shouldn't be looking at the rate of growth in AI as the primary driver of the overall demand curve as opposed to the sampling percentage?.

Well, I wouldn't go that far, because remember what the first thing they did is they redeployed the same lines that were building telecom coherent business that dropped quite significantly. So they redeployed those assets to the AI data centers.

And just when you also think about it, if you're just doing alignment on like, say InfiniBand, you're putting photonic integrated circuit aligning with the processor that is really more semiconductor packaging.

When you are actually building the actual module with lasers and everything else, that's where you tend to use more of our optical test equipment..

Just going back to the telecom piece for a second. There's obviously a very large inventory glut out there of telecom equipment that has to be absorbed.

Has there been any build in inventory in your product areas or is that just something that didn't happen because they weren't constrained as much on those type of products?.

So we have no inventory in the channel. I mean, pretty much the orders kind of got turned off, I'd say, December quarter of calendar 2022. So if anything, a lot of the inventory in the field is getting long in the tooth, and we know that there is a lot of wear and tear and there needs to be a replacement coming up.

So we actually are already seeing signs that people saying, hey, I will need to replace, I mean, what would be the terms, what would be the lead times. So in that respect, people will kind of sweat the assets, they will swap the assets, they will cannibalize and then they'll have to do a wholesaler replacement.

So when I say kind of flattish 2024 or like -- I just think -- I just don't think -- I know they need to do it, I just don't know if they can afford a massive replacement. But there could be a good chance that in the second half we'll see more and more of these type of things popping up. But I don't have that kind of visibility beyond six months..

Your next question comes from a line of Meta Marshall from Morgan Stanley..

Oleg, you mentioned kind of you were more encouraged about cable spending kind of earlier in the year.

Just wanted to get a sense is that DOCSIS 4.0, is that just their networks are running hotter, just given some of the comments you just said to Alex? Just kind of what is the trigger to that investment? And then on the flip side, since you kind of think that wireless may take a little bit longer, just what do you think should be kind of the early signs of wireless resuming?.

So if I look at -- so cable, first, I think, we know it is going to be happening. It was actually we were expecting some of the orders start popping up in the March quarter and then accelerating into June.

From what we've heard, and I'm not going to name any names, but there's been a delay in some of the core technology development by leading infrastructure providers. So I think that is being pushed by one to two quarters in terms of getting the software ready and everything needs to be working. So I think that's where we are with cable.

But I do see actually cable happening this year.

What was your second part of your question?.

Just on the wireless side..

So the wireless, we all know, you've seen the Ericsson, Nokia, Samsung, and all the deployments with T-Mobile, Verizon, AT&T. So that has slowed down. So the area where we are seeing less is on kind of the field equipment and a lot of the people sales related to deployment. Where we continue to see CapEx being spent is on product development.

So we have not seen significant decline in the R&D CapEx for 5G, and now we seeing some of the elements of 6G popping up. It’s just, generally, I think the wireless infrastructure is a bit more muted in terms of aggressiveness, I would say, in Europe and North America. Now that said, India is doing pretty well.

But it's obviously -- I wish the margins were better in India, but I think, clearly demand is -- right now, India is one of the few bright spots for infrastructure deployment..

Your next question comes from a line Ruben Roy from Stifel..

Oleg, I just had a couple of quick questions, really follow-ups. I think you talked about a little bit of this in answers to the prior questions, but just in terms of service provider. It sounded to me like you're saying that you are having conversations, right? So last quarter, I think, you've talked about not seeing any de-commits.

I would imagine that that's still the case. But also -- and some of the service providers still figuring out their budgets for this year.

Is that giving you a little bit of, I wouldn't call it hope, but sort of visibility I guess into thinking that you can still turn out to what should be sort of a normal seasonal year, meaning June up and then September a little bit down like usual.

Is that driving that or any other detail in those conversations?.

So I think this year, I mean, I don't want to jump too far ahead.

But actually September may actually be stronger this year than normal because the cable is maybe happening in September as it gets pushed, right? But generally, I'd say what we see from service providers, there's a very healthy insurance business, things go bad and just replacements and things like that.

What generally drives like another, like I'd say 20% more, which makes a big difference, is whenever they're doing build outs or upgrades to their networks. And right now what I don't see -- I mean, at least this time in terms of the insurance business, it's like orders coming in and they get released and there's no problem.

So the ongoing business is going pretty well. People maintaining their network, they're just keeping things running. What I'm not seeing yet is people doing big step functions and expanding capacity or upgrading the network or extending the network.

Some of these projects are a little bit more -- I mean, we know they are being planned, I know there's plans for that. I just don't know when they're going to decide to pull the ripcord and launch it.

And I just -- kind of looking at the general environment in the telecom sector, I think, they prefer -- if every quarter they don't do it, they just bank more cash and retire more debt.

So I think if I were kind of just looking at from competitive approach as cable guys start upgrading their networks, I think some of the service providers will see need to get back to extending their networks.

So I think I just don't -- I don't want to be a killjoy, but I just don't see cash burning hole in service provider's pocket that they need to go and start digging and laying new fiber or aggressively starting deployment.

The area where we do see fairly good momentum, but it's on a much smaller, like an order of magnitude, smaller scale, are these tier two, tier three primarily private equity funded fiber operators who are laying fiber in anticipation of data centers coming to the area or service providers extending 5G networks to the area or they finally needing a fiber to extend their network into some of these rural communities.

So that is one piece that is ongoing. But it's an order of magnitude smaller amount of volume than somebody like AT&T, Verizon or British Telecom or Deutche Telecom would spend on an annualized basis..

And then just a quick follow up for Ilan. I might have missed this on the balance sheet discussion. Are you where you need to be then on leveraging and do you expect to come back into the markets to repurchase in the near term? I might have missed that..

So probably for the next quarter or two, we'll be focused more obviously on the retiring of the convert. And you know it continues -- the overall, continues to be part of our capital allocation model, right? I mean, we are not deviating from the overall strategy.

But probably on the buyback for the next one to two quarters we'll be more muted about it..

Just decided to bank some cash, so we can retire the whole convert. In the way it's a synthetic share buyback, because you are avoiding a dilution down the road..

There are no further questions at this time. I will now turn the call back over to Ilan Daskal for some final closing remarks..

Great. Thank you. Operator. Please concludes our earnings call for today. And thank you everyone, for joining today's call..

This concludes today's conference call. Thank you for your participation. You may now disconnect..