Spirent Communications plc

Rachel Whiting - CFO Eric Hutchinson - CEO and Executive Director

Gareth Jenkins - UBS Owen Lamb - Liberum Capital Arun George - Canaccord Genuity Robert Lamb - Jefferies George O’Connor - Panmure Gordon Nick James - Numis Securities James Goodman - Barclays Rahul Chopra - Citigroup

Thank you very much. Good morning, everyone and thank you for joining the call.

We’ve given the trading update today on the first quarter’s performance. As we highlighted at the year-end results announcement, we expect to see a slow start to 2015 after the very strong finish in 2014.

New business was slightly down by $2.3 million against last year resulting $99.4 million. We saw growth in the wireless service experience and service assurance segments but weak demand for network and applications particularly during January and February more than offset this.

Although demand for network and applications came back strongly in March, it wasn’t sufficient to offset a slow start. Regionally, we did see good growth in North America up 13% but delays in demand patterns in Asia and Europe offset this.

We have a strong recovery with a key equipment manufacturer in the quarter, our participation in a large number of proof-of-concept trials for virtual technologies gives us confidence that we will see growth in major service providers during the remainder of 2015. Regionally, both Asia and Europe see improved prospects in the second quarter.

The impact on revenue for the first quarter was exacerbated in comparison with the first quarter of 2014as this period included $12 million for the shipment of handheld test tools. There is a further $16 million contract for these in 2015 but is not expected to ship until the second half year.

We have increased the resources working on new growth initiatives in the group, so our cost base is higher in 2015 when compared to 2014. As a result, we’ve incurred an operating loss of $3.6 million in the first quarter of this year.

Cash generation was much improved at $12.5 million compared to $2.9 million last year. Looking forward we see stronger order activity trends coming through in the second quarter and we anticipate improved growth rates in the second half year.

With the high operational gearing in the business, this has much greater benefit to operating profits. Hence we remain confident that further progress will be achieved during 2015 broadly in line with our expectations.

More importantly, the long-term value for Spirent continues to be enhanced. With that summary, I’ll open the call to questions.

And hand back to the operator. Thank you.

Good morning, Gareth.

Yes, good morning. I just wondered whether we could talk about the growth expectations into the back nine months of the year.

I think the outlook says broadly in line and I suspect that means that you’re expecting an acceleration and growth from here. But maybe you could just give us a bit more detail around that and maybe what gives you confidence in that, whether you’re seeing something in the pipeline that gives you confidence over and above the handheld test tool?

And then secondly just on gross margins, I wonder if you could give us some color around gross margins in the first quarter and how that trends through the year and maybe some of the acquired OpEx that you may have brought into the business? Thank you.

Okay, three-part question there. The growth rate that being expected or we talk about for the year, if I look at expectations out there, we’re high-single-digit growth on a full year basis, are clearly from here than the means we need to see stronger growth rates near term.

As I look into the second quarter prospect and pretty good start during April, we’d expect to be in double-digit growth rates through the second quarter. And awful lot of the new product introductions and some of the projects by service providers, which give us fairly meaningful software contracts are certainly being scheduled for Q2, Q3, Q4, hence the confidence we have what we should to able achieve is high-single-digit growth rates from full year basis.

And regarding the gross margin, we actually saw the gross margin firm up and improve during the first quarter compared to the first quarter of last year. So, we are ahead of last year.

Interestingly with low activity level, we normally expect the gross margin to be smooth a bit. But in fact we’ve seen an improvement.

And that’s without any significant changing the mix from software contracts. So, for that margins have been quite robust.

And regarding the acquired businesses perhaps Rachel, you want to take one?

Sure, that’s the gross margin we’re expecting steady improvement in that through the rest of the year to reduce our service a bit more benefit from software in the mix. So, that’s our, we’re still turning up in Q1 2014.

And in terms of OpEx expense, we saw some increase in the OpEx in Q1 as a result of the acquisitions coming in, so really our increase in OpEx in that quarter was driven by the acquisitions. And that will continue through for the rest of the year.

So, we’ll get the full year impact from the acquisitions coming through. Apart from that we do have a little bit of change in the OpEx where we’ve gone direct with some of our moving from channel to direct sales.

You see that moving from the gross margin into the OpEx margin.

And just to remind everyone, we stepped up the operating expenses in the business in 2014. Our plans are not to increase clearly, organic investment back in the business during 2015.

So, most of the effect that you’ll see in, in increased expenditure is the consolidation of the business that we acquired.

Thanks.

Hi there, just to go into more detail on the H2 weighting, I think Q1 profitability was a bit weaker than I had expected and for you to hit full-year numbers you need a very strong profitability weighting to the second half. Given, I suppose, the lack of visibility generally in this space, do you believe this is a bit of a risk?

Or do you believe you can still hit consensus roughly in the second half, with a very strong H2?

In terms of the weighting in the business, I think the guidance we’ve given is that the revenue would look something like 45% of revenue in the first half year, 55% in the second half year. We wouldn’t change that here based upon a slow start in Q1, we still expect to see tax rated ratio.

As our gross profit margin in nearly 70% then that change of the weighting for the second half drives the profit up considerably. And you’ve seen in past reporting periods for the company that we’ve had very significant increase and prosperity when we get past sort of change in activity levels.

You’re right in the sense that visibility in the industry is difficult quite short-term, but because we’re working closely with quite a number of major service providers and major equipment manufacturers, we can see that plans for new product introductions and launches, we cannot fairly see the trials that they’re running on new technology’s improvement concepts is stepping up. And we believe that we have solutions are very attractive so we’re getting very close to the feedback on customers.

So we believe although there is risk, although there is risk in any projection that we’re very well placed to achieve the consensus numbers as the gross bottom.

Okay. Thanks.

And just if I take a step back, given, do you still think Spirent should grow at high-single digit, given the changes and the structure of your end market? Is 8% or 9% still roughly the top-line growth we should expect for Spirent?

That’s right, by the time that’s certainly our intention being the more that we see the changes in our customers and technologies we believe 2016 actually should be a very attractive year for Spirent portfolio. Competition having very mixed experience and new sectors at the moment, there is a bit of sector consolidation going on which can reduce supplies at the time.

But on the other hand, I would believe looking at introducing more and more capabilities delivering data communications, we’ve got all of the challenges of security threats to operations. We’ve now got threats to satellite navigation signals and we’ve got the whole build-out of a new structure with new technologies.

And we’re very well placed to serve those needs. So we still remain confident that we should be growing business in what maybe a quite challenging in the market.

Okay. And then just one final question on consolidation, with consolidation in the network equipment manufacturer, Alcatel-Lucent and Nokia, does that change your view on what it is the test and measurement space would benefit from consolidation?

So, there is probably a consolidation seen across the industry and the test and measurement sector. I think as I said at the year-end, there are more independent pure-play test and measurement businesses out there which have been spun out of larger conglomerates or businesses are splitting themselves in two.

A lot of those things are happening in the public arena and that’s still being digested. So we’re definitely seeing that.

Consolidation activity level in test and measurement itself pick-up as yet I would anticipate that it will probably through this year.

Okay. Thank you very much.

Okay. Thank you.

Good morning. I just had one question.

In terms of the strong order growth in North America, the 7% growth that you put in the statement today, I was just trying to understand, I guess, what is behind it, because it stands in contrast to what your competitor JDSU talked about in their conference call on Thursday night. So is it to do with probably targeting different sort of pockets of growth?

Or are you gaining substantially market share? Thank you.

Okay. So, I think the previous questioner very good point as well, and certainly volatility in the sector.

The force behind our numbers is we’ve seen some good contract wins in the live networks monitoring, which is a competitive gain. We’ve also seen considerable growth with major equipment manufacturer in North America.

And that’s certainly gaining market share on our part. We get to see some of the major service providers spending coming back but we know that they booked budgets and management reorganizations settling down.

So we’d expect them to start spending from Q2 onwards. So I think our general background in the service provider market is being subdued.

And we’ve actually made some competitive wins.

All right. Thank you.

Good morning, Robert Lamb from Jefferies, thank you for taking my question. It was just on virtualization.

We’re now seeing reports of Verizon exploring SDN and NFC. And obviously, when AT&T have looked into this it’s led to a pause in the industry.

So how would you characterize the conversations you’re having with service providers globally on this and how developed the Spirent products to meet their needs in terms of functionality or possibly even the economics of selling such solutions?

Hi good morning, Robert, thank you for the question. It’s quite timely.

We’ve just announced a new virtual test solution which we’re calling cloud stress that was announced at the Interop exhibition last week. We’ve seen quite a number of proof-of-concept trials being run on NFC and SDN deployments.

And we’ve been participating in that. And just to report that of the trials we’ve seen, 93% of service providers run rate per concept trial are going to go ahead with deployments.

The issue with AT&T was in the third quarter last year as we reorganized their business they’ve changed the way that they were going to run testing and monitoring. And they put their lab businesses, lab-testing activities together with live monitoring, they put a new team in place and they’re setting, we said in the budgets.

And they clearly told everybody in the industry that they weren’t interested in pursuing new technology solutions that was a very considered policy on their part. I think that we’re seeing another service providers that a more incremental evolutionary approach so we’re not seeing the same disruptive impacts because they continue to invest in current technology whilst looking at the ways to deploy the new technologies.

So, certainly nowhere near us, a shock to the industry as we saw third quarter last year. In terms of our solution set, we continue to enhance our virtual test capabilities.

We need some quite considerable certain deployments at scale. So we’re now doing things like 500,000 tool tests and on tested in this formula of virtual machines.

And we have let’s say a whole new approach to stressing the cloud which is very applicable to NFC deployments. And we expect to do more of that in the second quarter, and setting our terms up for the rest of the year and next year.

Okay, great. Thanks very much, guys.

Yes, good morning Eric and Rachel, George here. I just wondered, what was the value of the orders that slipped in Q1?

Good morning George, I think we saw about $5 million of business really slipping out of networks and applications. That was really the sort of shortfall.

We expect to be pretty much on track again by the end of the second quarter and most of the networks and applications product lines.

Would you, I didn’t have a consensus number for Q1, but would the sort of 101 kind of number hit consensus?

Yes. There wasn’t really a meaningful consensus for Q1, George, there where we didn’t publish any Q1 consensus.

Okey-dokey. In terms of the rev-rec policy, was that due to something at the customer side?

Or was it due to new hurdles that Spirent has put in?

Revenue recognition, there is no change in.

There is no change in our policy there.

In policies or hurdles. It’s purely to do timing of…

Yes, are you referring to the order being received too late?

That’s right, yes.

Okay, so that was purely because the orders were coming in so late in the quarter that we couldn’t literally couldn’t shift from there.

There is a more prosaic reason there, George. We couldn’t actually make the starting time of the shipment.

Yes.

Right, okey dokey. I heard your comments.

I heard your comments on gross margin, but, sort of generally, how are pricing trends? How did they progress through the period?

Pricing continues to be quite challenging particularly in the wireless device test market. Everybody’s fighting for share in quite constrained market.

In terms of the infrastructure test, it’s pretty normal it’s no more intense than it was. And it really comes down to if you got a product to substitute and they’re going to have deep incumbencies and it’s going to be quite challenging.

Otherwise, it’s normal.

Okey-dokey. Good stuff.

Thank you very much.

Okay.

Yes.

Good morning. Just a couple of questions.

One on the pickup in network and applications at the end of the quarter. Was this in any particular region?

Or was it global? Or was it in any particular product lines which we kind of picked up at the end of the quarter?

And I guess the second one was just if you could help us understand a bit more on some of the new products coming out in H2, which you’re inspecting to drive the better revenue trends.

Okay. The pick-up in applications was primarily North America.

So, we saw a big slow efficiency in the last few days in North America, we had been to see the pick really in the other regions particularly. We’ve seen that starting to come through in April, again North America is much stronger in April.

In terms of new products but we have the new network functional virtualization trial stress products coming through, deliverable software tools in the second half. We’ve got a new and half version of our by-channel tech solution which should be coming in the second quarter to drive second half revenues.

And we have also dropped a new virtual enhanced second core tech solution which we will be demonstrating during the second quarter and now come through in the second half year. And we have a new virtual price so we’re launching in our large motion business, which happens again into NSP deploying deployments.

Great. Thank you very much.

Good morning, thanks. A couple of clarifications from me please.

So I think the consolidation in the wireline market was mentioned, but more in terms of the general trend there. I was wondering, in terms of Nokia and Alcatel, to what extent have you factored in the weakness from those vendors?

I seem to remember they’re both top 10 vendors historically, but is that out of date and perhaps they’re far less now? And then maybe I’ll come back with a couple of clarifications.

Okay. The consolidation of Nokia and firing Alcatel Lucent, they are both in our top 10 on a combined basis, they ran about 6% of revenue with these sell, somewhat different solutions to both of them.

So, there is an achievement of overlap. The risk on that type of consolidation is that obviously exactly migration that happens that reduces the number of different initiatives.

But certainly the feed factor you’re getting in the areas that we serve that there is a good degree of confidence from both. Being realistic we’re all are seeing, we have seen is that when the consolidation happens that can cause a 3 to 4 month buy increase whilst everybody work they’re going to be doing.

So there is a short-term impact. And over time we’d expect to see degradation in the total business from a 6% on a combined basis for doing 4.5% to 5%, that’s the type of effect we’ve seen in the past.

So yes, we’ve factored in do we believe this material to start, probably not.

Okay, that’s very clear. Thanks.

So just the, just clarifications on the phasing of the service assurance deal, is that equally split Q3/Q4? And I was just curious also on the condensed reporting for the quarter.

Is there a rationale as to why you’ve taken that step now?

So, on your first point on the handheld, we’ve got that in Q3, although, obviously some go into Q2 and Q4 but we’re expecting it in Q3. As far as the condensed reporting is concerned is really following the change in reporting requirements and so, following practice of other people and reducing the level of precaution that we’re giving.

I think there’s been a steer being given; getting too hung up on quarterly results is not particularly helpful to anyone. So we’re following the trend in the industry in this sector.

Sure. Okay.

Thank you.

Hello, thank you. Just a couple of questions from my side, first is in terms of the cost base.

You had $71 million cost in Q1. So in terms of, so how should we expect the cost to move ahead for the remainder of the year?

Should we expect the same cost on the run-rate basis? Or are there any opportunities for cost reduction going forward?

Secondly, in terms of can you split out the Q1 performance by product vertical, please? Thank you.

Okay, in terms of the cost base, as I said year-on-year on organic basis we’re probably pretty flat. And we’ve put the acquired businesses in.

We’re managing the cost according to the activity levels, so we’re not seeking to expand significantly. Having said that, we do continue to invest in expanding business, so, we are spending more money go-to-market as marketing channels.

You’d probably see that coming through during the second half year but hopefully not with the expense with operating margin. So, overall I wouldn’t expect to see a cost reduction unless we feel that we’re not going to get top-line growth.

Okay.

Second question, supplementary question.

Sorry, could you repeat the second question Rahul, sorry.

Yes, pleas, it was can you split out the Q1 performance by product vertical, please?

By product vertical?

Yes.

No, we haven’t given that degree of detail in the announcement. I think doing it on the fly is probably not appropriate.

Okay, fair enough. Thank you so much.

Thank you.

Okay. Thank you very much, operator.

And thank you everybody for joining the call. I hope you found that useful.

And I look forward to keeping in touch with you over the remaining time of the second quarter, over the remaining time of the second quarter and we’ll see what progress we make there. But certainly we’re feeling actually quite confident by having, have a slow start to the year.

Thank you very much. Goodbye.