to vrv solutions second quarter fiscal 2022 earnings call all lines have been placed on mute to prevent any background noise after the speaker's remarks there will be a question and answer session if you would like to ask a question during this time simply press star followed by the number one on your telephone keypad if you would like to withdraw your question again press star one thank you bill ong head of investor relations you may begin your conference thank

Thank you, Josh. Welcome to VRV Solutions Second Quarter Fiscal Year 2022 Earnings Call. My name is Bill Ong, Head of Investor Relations. Joining me on today's call are Olik Heiken, President and CEO, and Hank Thurksen, CFO. Please note this call will include forward-looking statements about the company's financial performance. These statements are subject to risk and uncertainty second quarter's 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. VRV 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 slide, which include historical financial tables are available on VRV'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 Hank. Thank you Bill. Fiscal Q2 was VRV's second highest quarter for revenue and a quarterly record for non-GAAP profitability. Second quarter revenue came in at $314.8 million dollars up five percent year-over-year exceeding a guidance range of 296 to 310 million dollars the strength was driven by record revenue in our nse business segment offsetting anticipated temporary weakness in our osp segment viavi's record operating profit margin at 23.3 percent expanded 100 basis points year-over-year and 60 basis points sequentially and exceeded the guidance range of 20 to 21 percent, a function of operating leverage on higher revenue volume, favorable product mix, and disciplined OPEX control. EPS at 24 cents tied a quarterly record high and increased a penny or up 4.3% year-over-year and exceeded the $0.18 to $0.20 guidance range. The share count of 242.3 million shares is consistent with our expectations and includes the dilutive impact of the remaining convertible nodes of approximately 4 million shares. Now moving to our reported Q2 results by business segment, starting with NSE. NSE achieved a new quarterly revenue record at $244.2 million, up 18.1% year-over-year, and exceeded a guidance range of $230 to $240 million. Within NSE, an e-revenue increased 18.5% from a year ago to $214.4 million, reflecting strength in our fiber and wireless products. SE revenue came in at $29.8 million, increased 15.5% year-over-year, driven by strength in our assurance and data center products. NSE gross profit margin at 65.3%, increased 200 basis points year over year. Within NSE, an E gross profit margin at 64.4% increased 180 basis points from last year, primarily a result of leverage on higher revenue volume. SE gross profit margin at 71.8% increased 360 basis points year over year, reflecting both higher revenue and favorable product mix. This is the record operating profit margin at 18.7% exceeded a guide range of 15.7 to 16.7% primarily result of operating leverage on higher revenue and disciplined OPEX control. Operating profit dollars more than doubled as margins increased 800 basis points from a year ago now turning to osp second quarter revenue at 70.6 million dollars was down 24.2 percent from a year ago revenue was slightly ahead of the high end of our guidance range of 66 to 17 million dollars as demand for our 3d sensing products improved during the quarter gross profit margin at 56.2% decreased 650 basis points year-over-year due to lower revenue volume. Operating profit margin at 39.2% decreased 870 basis points from a year ago as a result of the aforementioned, exceeding the high end of the guidance range of 34.5% to 36.5%, primarily due to better-than-expected expense control. Turning to the balance sheet. The ending balance of our total cash and short-term investments was $738.5 million, up $89.7 million compared to a year ago, primarily a function of pre-cash flow generation over the last 12 months. Operating cash flow for the quarter was $22.2 million, a decrease of $46.5 million compared to $68.7 million in the year-ago period. The reduction is a result of non-recurring tax payments during the quarter mainly related to a restructuring project executed during Fiscal Q4 of 2021, as well as a temporary increase in inventory levels in anticipation of increased future demand. In addition, we invested $18.4 million in capital expenditures during the quarter, compared to $10.5 million in the prior year. The increased capex reflects the new Arizona production facility. As you may recall, in early September, we completed a transaction to redeem approximately 40% of our 2023 and 2024 convertible nodes from the original $685 million in principle to a remaining outstanding balance of $410 million at the end of Fiscal Q1. During Fiscal Q2, we redeemed an additional $45.6 million in convertible nodes, which further reduces the principal value of our combined convertible nodes outstanding to $364.4 million at the end of the second quarter, or 53% of the original principal value. Also in early September, we settled the combined retirement of $275 million in principal value in convertible notes, in part in cash, for an amount of $197 million, dollars as well as by issuing 10.6 million shares in viavi common stock subsequently the board authorized the repurchase of up to 190 million dollars of these shares which commenced at the start of the second quarter we are pleased to report that as of yesterday february 2nd we We repurchased 10.9 million shares at an average price of $16.30 per share, including commissions, for a total of $176.4 million, an intent to complete the $119 million purchase program before the end of the third quarter. We plan to continue to improve our capital structure and provide the financial flexibility to allow us to execute our growth objectives. Now on to our guidance. We expect the fiscal third quarter 2022 revenue to be approximately $308 million, plus or minus $7 million. Operating profit margin is expected to be 21%, plus or minus 50 basis points, and EPS to be in the range of 20 to 22 cents. We expect NSE revenue to be approximately $234 million, plus or minus $5 million, with operating profit margin at 15.5%, plus or minus 50 basis points. OSP revenue is expected to be approximately $74 million, plus or minus $2 million, with operating profit margin at 38.5%, plus or minus 100 basis points. Our tax rate is expected to be approximately 16%. We expect under income and expenses to reflect a net expense of approximately $6 million. At the current stock price levels, and as we complete the aforementioned share-y purchase program, the estimated fully diluted share count used in our calculation is 239 million shares for the third quarter. We also expect the fully diluted share account to reduce to approximately 237 million by the end of the fourth quarter with that i will

turn the call over to oleg thank you hank i'm pleased with the obvious performance in the fiscal first half of 2022 during which we achieved record revenue and non-gap profitability our fiscal first half revenue came in at 641.6 million dollars and non-gap eps was 48 cents which is a new VIAVI record. The NE segment demand strength was driven by fiber and wireless, a double-digit percentage growth from the same period last year. Our fiber field products achieved a new revenue record as service providers, both in America and in Europe, continue to upgrade and expand their networks with fiber. Customers started to adopt our 5G field instruments in late calendar 2021, 2021, and we expect this deployment momentum to continue throughout 2022. Our 5G lab equipment demand continues to be robust with initial field deployment of ORAN technology expected this calendar year. The cable product demand moderated as our cable customers prioritized fiber deployment over the traditional coax upgrades. That said, we expect the industry to launch a new COAX upgrade cycle with DAXES 4.0 sometime in 2023. Longer term, we expect most cable networks to move to fiber and wireless technology. The 400 gigi optical transport demand continues to be strong with many leading customers starting to make initial investments in the next generation 800 gigi technology. As many of you are aware, our industry has been experiencing component shortages of advanced semiconductor devices. That said, we have been successful in securing critical components and meeting our customers' demand. Our ability to execute has resulted in market share gains and enabled us to drive upsides to our revenue guidance. At this time, we are starting to see the supply starting to catch up, and we expect to see a much more favorable supply chain situation by mid-calendar 2022. The SE business segment came in just under $30 million in revenue, reaching a quarterly revenue level last seen in calendar 2018. The SE turnaround is a result of our restructuring of the business segment in early calendar 2017 and subsequent launch of Common Nitro platform for the assurance and data center market segments. We expect a strong SE performance in this calendar year driven by growth in the base business and anticipated strong market demand for 5G assurance. We expect the quarterly revenue run rate during this calendar year to be in the high 20 to low $30 million range. Now turning to OSP. The OSP business segment delivered better than expected revenue and profitability. Our Q2 anti-counterfeiting products revenue decreased sequentially. as central banks globally moderated their demand to reflect reduced print volumes following more than a year of elevated pandemic-driven demand strength. That said, we expect during the calendar 2022, the core OSP revenue to remain above the pre-pandemic levels at the high $20 million quarterly run rate, $50 million, $50 million quarterly run rate. We expect 3D sensing in in fiscal Q3 to be seasonally stronger than in the past years, reflecting stronger customer demand to make up for component supply constraints in late 2021. Further, we expect the supply and demand seasonality for 3D sensing modules to normalize by June quarter and expect seasonally strong demand in the second half of calendar 2022. In conclusion, I would like to express my appreciation to the VIAVI team for its continued strong execution in delivering another record quarter and the record first half. I wish all our employees, supply chain partners, customers, and our stakeholders to remain safe and healthy. I will now turn the call over to Bill.

Thank you, Oleg. We will be participating at the Ciskehanna Technology Investor Conference virtually on March 4th and the Morgan Stanley TMT Investor Conference in San Francisco. on March 10th, 2022. Josh, let's begin the question and answer session. We ask everyone to limit discussion to one question and one follow-up.

At this time, I would like to remind everyone in order to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from Alex Henderson with Needham. Your line is open.

Thank you very much. First off, congratulations on a good quarter in a tough environment. I was hoping you could talk a little bit about the OSP business, what you're thinking in terms of the degree to which the Tinson security products stay at this lower run rate that you're talking about, or whether there's some indications of any change in the demand structure there. And then the second piece, if you could talk a little bit about where we are in terms of 5G adoption of 5G cores versus 4G cores. Thanks.

Sure. Thank you, Alex. So, first, the anti-counterfeiting. Well, I think, as I've mentioned, for about five quarters, we were in significantly higher volumes. And then I'd say late last year, we've seen a decrease in demand as everybody continues to digest what they bought. We expect most of that digestion have taken place last quarter and maybe this quarter. And this business gradually starts creeping up to a little bit better volumes. But we don't think it's going to get to the kind of level we saw during the pandemic. We think high 50s run rate is kind of going, for core business, going to be kind of the new normal. If you remember a few years back, it was low 50s, then we kind of got it to mid 50s, then it got to the low 60s. And we think, you know, kind of a higher 50 range is the good assumption for the foreseeable future. Now, it doesn't mean that there won't be any quarters where we'll pop over 60, maybe for a quarter, but I don't think it's going to last as long as a year. And that usually would happen when a major economy launches a new redesigned currency. So I'd say as a good kind of way to think long-term, at least an intermediate term, assume like high 50 run rate as the norm for core business. In terms of the, you didn't ask about 3D sensing. 3D sensing is going to moderate. You know, as I said, you know, our elite customer had challenged getting supply, so they really took a hard step to rebalance and it just confluence of events we saw both anti counterfeiting and 3d sensing drop last quarter we expected to meaningfully kind of start bouncing back this quarter and continue into the fourth quarter but you know I think as a result of the kind of lower 3d sensing first half we'll probably see seasonally stronger second half of things kind of level out and we expect a very strong second half of a year as majority of the new models are going to be coming out regarding the 5g we see you know we see a very interesting demand developing we're seeing increased interest in our products so I think it's you know we have the first data points we clearly saw demand for our products increase in the fourth quarter and you know and you know but also it's not only wireless product RF products it's also the 5g I mean the fiber products because actually a lot of these 5g deployment is also pulling the fiber instruments as well for field instrumentation so it's becoming a bit of a double whammy for us which is in a positive way so we do see 5g starting to pick up there was obviously concerns around the FAA and the safety of radio altimeters and 5G frequency I think there's a lot of testing going on we are obviously providing good advice and technology offering to both sides to make sure that there is no this a danger or impact on the commercial aviation.

Great. Thank you very much.

Thanks. Your next question comes from Medhi Hassini with Susquehanna International. Your line is open.

Yes. I just want to go back to the impact of the supply chain disruption. Oleg, can you help us understand what your December and March quarter upside would be if you didn't have any challenges with procuring components?

Well, you know, I mean, let's put this away, there's two, two upsides. The first one is we would have significantly lower COGS. So we'd probably pick up one to two percentage points in the gross margin if we did not have to pay through the nose, surcharges and expedite fees and things like that to make sure we get the components. And the second one, I'd say on the top line revenue, we probably would be able to ship five to $10 million. And the reason for that is it's, you know, if you get components in the quarter, but get it let's say after the 10th of the third month it's very difficult to build and ship the product so that's generally you know uh where we see the challenge getting all the components by the end of the second month so we can finalize and ship the product uh into third month so that's generally how we see and then it just kind of just keeps rolling over into the next quarter okay great

And just looking beyond the March quarter, it has been a while since you last updated us on your target, especially for top line and operating margin. Is this an occasion where you can give us an insight how we should think about the second half, especially that some of the revenue are pushed into the second half of calendar year and how we should be thinking about opportunities looking into the next fiscal year?

Sure. So I will start and I'll turn it over to Hank. So, you know, remember, we are going to have our analyst day in September, and that's what we'll provide a longer term model. But clearly, our current model is already running ahead of what our three year projection was. We expect so first calendar quarter generally has a lot of statutory costs that we accrue for the year. So generally, there's some headwinds on OPEX and gross margins. but even with that we are you know looking to be in 20 plus cents EPS in terms of the operating margin I'd say we're probably looking at a low to low 20 already even we could normally consider a March quarter to be one of our weaker quarters so in that respect already there and I do think as NSC continues to gain momentum and if that momentum sustains we could see our gross margins start moving up uh to maybe towards closer to mid 60s um and obviously as osp business

recovers it'll make it that much easier um hank anything so yeah we will we'll be presenting to you a very granular plan uh upcoming september investor day like we did three years ago we'll give you a three-year outlook uh for revenue growth uh margins on a consolidated basis and by segment and as Oleg said very pleased with our performance so far we're ahead of our plan we average 23% of the first half and and with a little bit of statutory cost we think we think we will post solid performance for the back half

your next question comes from the line of Sammy Chatterjee with JP Morgan your

line is open great thanks thanks for taking my question I guess if I can just start with one for Hank first. Hank, just a bit surprised after the record margin or operating margin that you had this quarter. I'm a bit surprised with the guidance for the March quarter. It does look like you're expecting a sequential moderation and a material sequential moderation in March, despite almost like similar or maybe a slight moderation in the revenue, but OSP is going up in terms of mix as well. So I'm just, if you can unpack that a bit because i'm i'm surprised with the magnitude of the moderation sequentially in

terms of operating margins yeah so our margin outlook as you said in the high end the revenues are consistent uh with what we just posted but we do have to factor in the typical increase in statutory costs which is about four to five million so that's about a percent or a half and then we anticipated maybe a little bit normalized mix in our guidance is typically prudent so that's the rationale here on the tax rate we posted the 12 and a half percent tax rate for the second quarter in our guidance and that's 16% tax rate for the March quarter okay and just for my follow-up

then, Oleg, you've been more recently focused on investing and growing the SE business. This is obviously higher on rate in terms of quarterly revenue for SE, but based on how the portfolio looks today, what the capabilities are, what's the sort of opportunity set for What can be the ceiling in terms of quarterly revenue? What does that portfolio allow you to do before you have to sort of acquire to add more

capabilities? Well, I think, listen, we think organically, we could probably, well, I probably should get ahead of myself. We think we can grow that business at a much higher rate than overall via AVI if everything goes as planned and, you know, at least double the rate, you know, we want to target and obviously uh with the new platform a new a new a new uh product it's coming in at meaningfully higher gross margin than the rest of the other but it's really a function of scale obviously for uh to make a many meaningful impact but we think um you know at the very least we should grow it double the rate of um nsc business overall thank you thanks for taking my

questions. Sure. You're welcome. Your next question comes from the line of Tim Savasho with Northland Capital. Your line is open. Well, good afternoon. Congrats on the quarter. And

that's good timing because that sort of begs the question, what is the overall NSE growth rate? If SE is going to grow double that. And that's really going to be the focus of my question. And, you know, like you talked about double digit growth in fiber and wireless in the quarter, You've got some easy comps here, but you appear to be guiding to something around a 10% growth in NE here going forward. And so, you know, my question is, given the trends you see in the market here, which look pretty positive, you know, is double-digit growth achievable in the network-enabled business or sustainable as you look into next year? Well, yeah.

You know, one thing I learned, 10% growth year over year becomes increasingly more and more difficult. So the comparables, you know, easy comparables don't last that long. And 10% on 100 million is one thing, 10% on 800 million is a different number, right? And so I think, listen, I mean, when we talked originally, we were talking more like 5% type growth. We think, you know, for the overall NFC business, maybe moving into the higher single digits is a reasonable number. I remember we do have some, I expect some of the segments like DSL and cable decline over time. Things like fiber and wireless increase over time. So overall, you know, clearly the growth segments will grow meaningfully in the double digits. but you also got to assume some of the legacy segments will decline. So net net, we're kind of thinking, you know, our goal is to get from mid single digits to maybe higher single digits for that segment.

Great. Thanks very much. Sure. Thanks. Your next question comes from the line of Richard Shannon with Craig Hallam Capital. Your line is open.

First one is on 5G and the field instruments.

Sounds like you're showing some signs of early progress there. I would love to get a sense of how far out you could see kind of these share gains starting to manifest themselves and any way that you can characterize the kind of the dollar opportunity here relative to the base that you have in 5G today. If any way you can help us think of that, that would be great, please.

Sure. I mean, well, 5G is a little tricky, right? So we have a 5G system task, which is a significant business for us today already. for infrastructure tests, primarily targeting network equipment manufacturers, but also the service provider labs and some of these new players like Rakuten and others who are coming in and the ORANs, right? So that's more infrastructure kind of big iron, you know, big software type products. And then there is a field instrumentation business where we are a newcomer And there we are, you know, viewing the market maybe about $300 million run rate per year when it's fully converted to 5G. And we're targeting, you know, 25 to 33 percent market share. So we think this year we probably should be, you know, when all's said and done, as things start ramping up, we should be comfortably maybe in the 20s, maybe hit 30, and then continue growing into next year as Europe and other regions start adopting 5G and as the 5G starts rolling out into private networks.

Okay, great. That's a great perspective. My follow-on question is on gross margins. I may have misheard you in the prepared remarks, Oleg, but I thought I heard you say about gross margins go higher as you grow here. And I guess with 5G-filled instruments, I guess my understanding was those would be slightly lower gross margins since they're generally a higher volume kind of a product. So I just want to make sure that level sets together.

well so let me give you a little perspective um if you take like fiber cable dsl a kind of wireline instrumentation and you'll take wireless instrumentation um the wireless market generally carries higher margins so even um let's say um the same things you have a handheld for cable you have a handheld for wireless uh there is a significantly higher uh gross margin on the wireless instrument than there is on the cable and part of it is you know that you don't need as many you just don't sell as many wireless instruments but they generally come at a higher margin so I guess you need to have that in order to recoup your investment right so for example you'd be selling tens of thousands of units in cable space and you may be selling you know 10 to 20 thousand uh in the wireless space uh once also now so as we get more wireless content in our instrumentation uh we we expect the average asp to go up and the average margins to go up actually

as well okay that that's very helpful uh thanks for all that so much your next question comes

from the line of meet up marshall with morgan stanley your line is open great thanks uh maybe

The first question for me, you know, Oleg, you mentioned that you were seeing some share gains right now on any business just from ability to, you know, not having as many supply chain issues. Just wondering, you know, as supply chain reverts or loosens, you know, how do you hold on to some of those share gains that you've seen? And then second, maybe kind of building upon Tim's question of just, you know, clearly fiber is going to be a growth market for years. but, you know, just, you know, do you see digestion periods over time? Do you see labor or supply chain kind of being a gating item to how fast that business can grow in the near term?

Sure. So I think the – I see your first question was for much on that. The maintained share. So, you know, so in many deployments, generally when they do it, they kind of try to do 80-20. ideally they want to have a hundred percent but but they want to keep everybody honest first to squeeze your own price they bring a second I call a price rabbit for you know to for 20% well a lot of these price rabbits often cannot execute right and as is the case right now and what we are doing is we're taking 100% share and as you're doing all these deployments it's kind of like possession is 80 percent of the law once your equipment is in and everybody's practiced at certain point you know when things do get back to normal you continue to have that natural momentum because people are used to using a certain type of equipment they're trained you create a whole new barrier for switching costs and things like that also at the same time when we're doing that we are introducing a lot more software content and the kind of the software like a cloud applications where all these instruments upload data into the cloud and the generates reporting and visibility well you know as you get more and more via the instruments and you use via the software to optimize your network operations and monitor your network it just becomes really yeah somebody can offer you much lower price but it's you're gonna be penny wise and pound foolish since you cannot use that instrument for a lot of other things so we obviously do our best to make these barriers permanent obviously there's gonna be some of the share may go back just you know for them to keep us honest I guess but generally once you gain share it's it becomes like a new new normal okay now regarding the constraints listen labor is a big constraint and in North America they are rolling out fiber and it is a huge challenge because the same people who are building your fiber you need those people to build your wireless network right so to the extent we fuse the two together and we introduce a lot of automation and a lot of the solutions that can run in the background and your network and reduce the truck rolls and reduce you know improve the productivity of your you know constrained assets that gives us tremendous opportunities and we actually seeing that a lot in fiber I mean we we view the whole build out of wireless and 5G networks and fiber networks will present us with significant opportunities for this whole field of fiber monitoring where it's not just instruments you actually sell a lot of big products and a lot of software that resides in the network and actively and passively monitoring your network operations and triggers alarms when there is a problem so we actually like the more constrained you are on resources the more our value proposition resonates with you perfect thanks so much sure

There are no further questions at this time.

I'll turn the call back to Bill Ong for closing remarks.

Thank you, Josh. This concludes our earnings call for today. Thank you, everyone.

This concludes the call. You may now disconnect.