As reported by the news portal BestStocks.com Viavi Solutions Inc. (NGS: VIAV) in fiscal 4Q20 grew non-GAAP EPS year-over-year despite a negative top-line comp, reflecting operating cost efficiencies as well as an uncommonly large contribution from the high-margin OSP business.
The Network Enablement (NE) business, which provides testing solutions for wireline and wireless networks, continues to navigate a COVID-19-impacted demand environment. As more and more 5G networks go live, we look for the field-test equipment portion of this business to strengthen, although that process will be measured rather than abrupt. The service enablement business, which has at times struggled for traction, was positive in the quarter.
Optical Security & Performance Products (OSP) had an exceptional quarter, with both anti-counterfeiting and 3D-sensing outperforming expectations. Demand was strong from the company’s large North American handset customer (Apple), potentially signaling a strong launch to the iPhone 12 cycle. This business may not get much of a lift from Android devices, at least in the next few quarters.
While the company will likely post a negative top-line comp in 2Q21, we look for annual revenue growth to resume in the back quarters of the fiscal year. We look for further top- and bottom-line acceleration once the field-test business gets back to growth.
As it deals with challenging end markets, Viavi believes it can pull operating levers to drive margins in fiscal 2023. According to Finscreener, these include 5G becoming a mass-market phenomenon; access-networking test & measurement recovering as the fiber buildout recovers; and more normal demand conditions for the two major businesses in OSP.
Management late in October revised its top-line guidance to $282-$284 million from an initial $258-$282 million. The preannouncement consensus of $271 million was just above the original $270 million guidance midpoint. Non-GAAP earnings totaled $0.21 per diluted share. Non-GAAP EPS exceeded management’s revised guidance of $0.18-$0.19, up from its original guidance of $0.14-$0.16.
At the time of the guidance revision on 10/21/20, Viavi announced that CFO Amar Maletira would step down from that role effective 11/20/20. Global controller Pam Avent will become interim CFO as the board conducts a search for a permanent CFO. Later in November, Amar Maletira will become President and CFO of Rackspace Technologies.
In his final call with Viavi, CFO Maletira attributed the above-guidance sequential revenue growth to stabilization in NSE (network service & enablement) and seasonal strength in Optical Security & Performance Products (OSP). Given the heavy contribution from the high-margin OSP business, Viavi posted a 21.3% non-GAAP operating margin, up 370 basis points from the prior year and a record for the fiscal first quarter.
For 1Q21, NSE revenue of $184 million (64% of total) declined 19% annually and 12% sequentially. In the summer quarter as in the spring, network test faced a tough annual comparison within a normally seasonally strong period hampered by pandemic-related shutdowns. Additionally, wireless networks are in early-phase transition to 5G and away from 3G/4G, resulting in muted demand for field-test equipment even in areas where the pandemic is not inhibiting on-premises work.
Within NSE, network enablement revenue of $162 million (57% of total revenue) dropped 19% annually. While NE demand remains sound in the areas of laboratory testing and production, field instrumentation continues to be impacted by pandemic-related access issues and the slow pace of 5G rollouts.
In 1Q21, the wireless lab equipment business was down modestly on a sequential basis after delivering a record revenue quarter in fiscal 4Q20. According to CEO Oleg Khaykin, service provider demand for wireless lab equipment is expected to strengthen sequentially in fiscal 2Q21, as carriers prepare for broad 5G deployments.
In an encouraging sign, Viavi saw orders for wireless network field-test instruments begin to stabilize and recover later in fiscal 1Q21. Demand recovery has continued in the current quarter as service providers resume field operations.
In optical access, one area of strength has been 400 Gigabit Ethernet. Optical equipment leaders including CommScope and Corning are driving accelerated adoption of 800 GigE to support the next wave of network and data center traffic. Over the next several quarters, optical infrastructure put in place by these companies should translate into demand for testing services.
Viavi sees the field-test market coming back slowly, rather than all at once. Both wireless lab test and optical access may show more than seasonal strength as the weather cools and network providers make up for pandemic-related impediments in earlier quarters. Altogether, CEO Khaykin expects NSE revenue to be up significantly, reflecting continued demand recovery in field instruments and seasonal strength in lab and production equipment.
Although economic uncertainty remains, Viavi expects 5G wireless and fiber access to lead the recovery early in calendar 2023.
Optical Security & Performance Products (OSP) revenue was way ahead of initial and even revised expectations, as this business delivered its first-ever $100 million-plus revenue quarter. OSP revenue of $101 million (36% of total) was up 27% annually and 74% sequentially.
Demand exceeded expectations across the three main areas of anti-counterfeiting, 3D-sensing, and aerospace-defense. The 3D-sensing business has grown from a single filter delivered to one application, to filters and optical diffusers going to multiple customers and applications. The key customer remains Apple, and we believe the successful iPhone 12 launch is driving OSP upside. Even though Viavi is not looking for meaningful Android revenue in the near term, management now expects 3D-sensing revenue to rise 10%-20% in FY21; three months ago, this business was guided flat for the fiscal year.
Anti-counterfeiting demand is expected to remain robust, driven by fiscal stimulus planning and banknote redesign. Aerospace-defense-related product demand is expected to remain strong for the remainder of the fiscal year.
Overall, Viavi is expected to benefit from participation in markets with secular growth, including 5G wireless test, fiber test, 3D-sensing and anti-counterfeiting. These markets bring a mixture of growth and/or higher margins that should drive EPS acceleration going forward.
Earnings & Growth Analysis
Management late in October revised its top-line guidance to $282-$284 million from $258-$282 million. The preannouncement consensus of $271 million was just above the original $270 million guidance midpoint.
Non-GAAP EPS exceeded management’s revised guidance of $0.18-$0.19, up from its original forecast of $0.14-$0.16.
Reflecting the outsized contribution from OSP, the non-GAAP gross margin widened to 62.8% from 61.7% in 4Q20 and from 61.3% a year earlier.
For fiscal 2Q21, Viavi forecast revenue of $290 million, +/- $10 million. Viavi looks for sequential growth in NSE, offset by sequentially lower OSP, which is coming off record levels.
Financial Strength & Dividend
During fiscal 3Q20, Viavi entered into a $300 million revolving credit facility to further strengthen its liquidity during an uncertain time.
Management & Risks
Global controller Pam Avent will become interim CFO as the board conducts a search for a permanent CFO. We do not expect this transition to be disruptive, given that Viavi appears to be aligned behind the strong leadership of CEO Oleg Khaykin.
VIAV is trading at 18.1-times our FY21.
Peer-indicated value is above current prices in the $14-$15 range.