Spirent Communications plc

Eric G. Hutchinson - Chief Executive Officer and Executive Director Rachel Whiting - Chief Financial Officer and Director

Eoin Lambe - Liberum Capital Limited, Research Division Rahul Chopra - Citigroup Inc, Research Division George O'Connor - Panmure Gordon & Co. plc, Research Division

Thank you very much, indeed. Good morning, everyone.

I hope you're all fit and well and feeling good after an invigorating evening last night, for any of those who attended the techMARK Awards Dinner. So we're bright and early on a Thursday morning.

You'll see that we released our formal Q3 IMS statement today, and we reiterated in the trading update the impact that we've highlighted at the beginning of October, the slowdown in demand, principally in the United States, really driven by the curtailment of activities by primarily AT&T, who have been cutting back on spending, and they've made some recent announcements about that in the last few days. And that's really impacted activity levels through the whole of that ecosystem in the United States.

There was also a hiatus of demand in China during the third quarter, which slowed activities over there a bit. These effects were really felt in our Networks & Applications division primarily.

And as a result of that reduced activity level, we restated our guidance for the fourth quarter and -- for revenue in the range of $120 million to $125 million. You've also seen the statement that, as part of our budgeting and planning process for 2015, we're reviewing our spending plans, with a huge containing overheads going into next year.

But we're doing that in such a way that it doesn't act to the detriment of the achievements of our strategic objectives. And the other thing to note from the release is that we continue to innovate.

We're releasing radically new approaches to testing interoperability of wireless devices, and we've added service provider, software-defined networking capabilities to Spirent test center. And we've also released products through our virtual probes to give visibility into Ethernet traffic to name but a few.

So with that, I'll ask Rachel to comment.

Thank you, Eric. Good morning, everyone.

So I'm just going to comment primarily on the acquisitions that we've made in the first quarter and our cash position. So we completed 3 more exciting acquisitions in Q3.

At the end of July, we completed the acquisition of Radvision TBU, which is based in Tel Aviv, Israel. Radvision provides development solutions to mobile chipsets and devices, communications infrastructure and mobile operators.

Then in September, we completed the acquisition of Mobilethink, which is based in Aarhus, Denmark. And Mobilethink provides mobile device management device analytics and intelligence solutions to mobile operators.

Also in September, we made a very small acquisition of IP from NetGend, based in Texas, which provides performance testing platform that runs in the cloud. So total cost of these acquisitions in the quarter was $47 million.

And together with the interim dividend that we paid in the third quarter of $9.9 million, that leaves us with a cash balance at the end of the quarter of $104.9 million. All those acquisitions, and together with the ones that we made earlier in the year, are -- that they're performing according to our plan.

So I'll hand you back to Eric now, for...

Thank you, Rachel. I think just -- something I'd just like to emphasize, as you look into the numbers, that Spirent's revenue for the first 3 quarters of the year, we've got growth of 11%, of which just under 8% is organic growth in the business.

And the gross margins are running at 69%, just slightly off the 69.8% last year. So the underlying health of the business is actually quite robust.

And really the comments in the trading update are really referring to some short-term impact from the business. The direction of Spirent is pretty well set.

And sometimes, I think that gets lost in some of the comments on our news play. Okay.

So with that, I'll hand over to the operator to take Q&A.

It's Eoin. A few different ones.

First, on the outlook into next year. Is 6% to 7% revenue growth still the right ballpark?

Or have we seen a further slowdown given AT&T's cut in CapEx for next year?

I think, Eoin, that we're currently going through our detailed budgeting plan, so it would be wrong to say we've got a definitive number. I think the market expectation out there that we can see is around about 6% revenue growth.

Certainly, from the preliminary roll ups of our planning, that doesn't sound to be wrong. I think the other thing that's happening is we've just also seen some comments on net neutrality, which again is creating a level of uncertainty in North America.

We've seen some major statements by AT&T overnight saying that they're going to stop the buildout of fiber-optic. And again, that may be a near-term dent in us.

But I don't think it deviates from our view because if I look at my activity levels with customers, we're down on these major accounts in the United States, but we're up on everybody else around the globe. So I think there is sufficient momentum there to carry us through next year.

Okay, perfect. And then just the kind of more higher level strategic question.

There's quite a bit of corporate activity in M&A in the space. I think JDSU is spinning off and NetScout's buying Danaher.

I was wondering what your view is, what this sector benefit from further consolidation and how would Spirent play within that?

Well, that's a big question. I think what we've seen actually is a whole series of better [ph] management business has now become pure play.

So you've seen key sites spinning out of Agilent [ph], so [indiscernible]. You've seen JDSU splitting optics in test and measurement.

So it's almost as though we've got -- we don't have new entrants, but we've got more pure play. I would expect the management teams of these various entities to start looking at rollup scenarios for consolidation in [indiscernible] a lot of sense there's been consolidation and [ph] service providers need consolidation in the equipment manufacturing market, logically where you can see complementary businesses.

It makes sense for these consolidation in test measurements. I'm not sure how quickly that's going to move.

Certainly, each and every one of these pure play companies probably would accept that NetScout, Danaher because that's [indiscernible] but it potentially [indiscernible] and present to your target as well. So until you start seeing those dominate [indiscernible], I'm not quite sure how it plays out.

I mean, clearly, we would see ourselves as a potential consolidator if we have the capital firepower to do it.

Okay. And just one final brief follow-up.

On the cost base, I know it's early, but could you give us some feel on your strategic review, how much -- is costs flat next year? Is it up marginally?

Just a -- kind of a rough feel for it at this stage.

Rachel?

Yes. Good morning, Eoin.

So we're looking at the cost base being flat on an organic basis, but we'll have some increased in OpEx as a result of the full year from the impact from the acquisition, so it will be up a bit from this year.

Rahul from Citigroup. A quick question in terms of the overall demand outlook in terms of what you're getting from AT&T and how comfortable are you with the fact that it's slowing in China?

Do you expect to achieve this with probably 6% to 7% consensus growth for this year? And in terms of -- also I want to check in terms of the book-to-bill.

The book-to-bill was 95 this time. And in H2, you had 104, that's on like-to-like book-to-bill.

So can you just tell me what does the book on like-to-like [indiscernible] for the 12 million additional revenues you had from services business last year?

Sorry, Rahul, what was your first point again?

The first question was in AT&T in China, yes.

Okay. So AT&T are clearly refocusing their priorities onto virtualization, software-defined networking, and they're really pushing their domain 2.0 initiatives.

The good news is that we are participating in that. We're on dialogue on that, and we're working through some key projects with them.

I think the reduction in activity levels on existing technologies is the one area where we see some majors holding back, and that's what we've baked into our guidance for Q4, and it's surely underpinning our thinking for a lower rate of growth than we're originally anticipating for 2015. So that's in our thinking on that 5% to 7% next year is that it's going to be subdued.

Regarding China, there was a hiatus in Q3. The good news is that we went over in September and last week and met major customers there.

And they're clearly looking to invest. And activity levels actually picked up.

So I'm quite comfortable that China is looking more resilient than it was. So that helps underpin a bit of confidence in the fourth quarter.

And looking at next year, the projected activity levels for major customers in China is still very robust. There will be considerable buildout on additional infrastructure and wireless technologies, and we're in a very good position.

So the dialogue I'm having with Chinese customers is they're looking to get more [indiscernible] from Spirent, not less. So that's a good backdrop.

Yes, just the second point.

You asked about book-to-bill as well. So as you know, coming into this year, we had $12 million -- in particular, we have $12 million backlog in service assurance, which flows through this year.

I don't think that we will be -- it depends on what happens in the fourth quarter. There may be some further input into service assurance in Q4 this year.

So at the end of the year, we certainly hope to be around 100, but it really depends on whether we've got some big orders coming in during Q4 that gets shipped next year.

So we're negotiating on those prospects, and there is a definite need for that equipment and there's a very strong return on investment by the customer for those devices. So whether we can book an order this year or whether we book it at the beginning of next year, it feels as though that contract would repeat again most likely in 2015.

In terms of the book-to-bill ratio in Q3, clearly, we shipped out of order backlog in Networks & Applications, which is the main reason why we put out the trading update because normally, we want to see that replenished in the quarter, and that didn't happen.

If you don't mind, a couple of quickies from me. One, can you comment on the pricing environment at all?

Secondly, on the phasing of orders through the quarter, and then sort of expectations for Q4 in terms of budget flush and the phasing of orders through Q4 as well, please.

Okay. Well, the pricing environment, George, has not deteriorated any further.

It's not got particularly better. It's definitely highly competitive with the major equipment manufacturers.

And I think they're feeling the squeeze, so they're trying to play us against competition as hard as they can in the United States on pricing. The good news is, while we're introducing new technologies and new solutions, pricing is not the same dynamic because the need is for the functionality.

So overall, actually, gross margins in the third quarter were reasonably robust, partly because we saw a bit more [indiscernible] in the mix. So I think we did about 70 [indiscernible] 70.4% gross margin against 70.1% in Q3 last year.

So better performance in Q3 on gross margin than we've seen in the past 6 months. So I think as we look at our budget planning for 2015, that gross margin won't be effective, and we feel it's under pressure.

In terms of phasing of activity, July was actually pretty good. August was thin, but then it's usually thin.

But the second half of August has really disappeared down very quickly, which is really a result of AT&T holding back. And then they made an announcement of the reorganization of their test.

18th of September.

18th of September. I really want to test [ph] the reorganization and [indiscernible] test and monitoring activities.

So we saw more business in September but nowhere near at the same sort of momentum that we'd normally expect to see. October, the patent was pretty normal, reasonable, not robust, but reasonable, and November is always thin because you've got Thanksgiving in the U.S.

and everything, it looks like it's going to happen between December 26 and December 31. In terms of budget flush, I think we have very modest expectations that we will see any budget flush.

I don't think we'll see anything significant.

When will you make more acquisitions do you think, by the way?

We have -- well, we're always looking, and we haven't got anything at this moment.

I think nothing material.

And we've got to digest the ones that we've made this year.

Yes, you said -- does consensus for Q1 reflect your current thinking, by the way?

Q1, we don't -- I don't think we've got a specific consensus for Q1. We've only got one for the year.

Thank you very much. Well, if there are no more questions, thank you for joining the call and no doubt, there'll be opportunities to talk to you one-on-one over the next few days.

And thank you very much. With that, I'll end the call.

Thank you.

Thank you.