SPNUF - Spirent Communications plc (SPMYY) Q4 2022 Earnings Call Transcript

2023-03-08 12:22:05 ET

Spirent Communications plc (SPMYY)

Q4 2022 Results Conference Call

March 07, 2023 4:30 AM ET

Company Participants

Eric Updyke - CEO

Paula Bell - CFO

Conference Call Participants

Francois-Xavier Bouvignies - UBS

Janardan Menon - Jefferies

Kai Korschelt - Canaccord

John Karidis - Numis

Bharath Nagaraj - Berenberg

Presentation

Eric Updyke

Good morning. Welcome to Spirent's 2022 Full-Year Results Presentation. Please take a moment to review our safe harbor statement.

I'm excited about the opportunity to discuss our results with you. 2022 is another year of strong execution despite a more challenging macro environment. Paula will take you through the financials as usual. And then I'll walk you through how we're delivering on our strategy and how the opportunities we see over the medium to long term are well aligned with strong and diversified market drivers.

So first, let me set the context and summarize the environment we saw in the last quarter of the year, and then we'll get into more detail later. 2022 is another year of strong execution of our strategy. All of our enduring end markets remain intact, including 5G, but not only 5G. We're confident that customers remain fully committed to their 5G plans, and I'll be discussing why in more detail later.

We built a record order book during the year, laying a strong foundation for 2023 and beyond. And our strong financial platform and operational platform gives us the flexibility to invest, both organically and inorganically to address the attractive market opportunities we see. In Q4, we saw some delays in customers purchasing decision-making as they responded to the macroeconomic uncertainty by placing all procurement under greater scrutiny. This was particularly pronounced in our lab end markets, especially in the wireless device segment and in some CSPs. And we believe that the great majority of the delays we saw in customer projects were just that, delays, not cancellations because our opportunity pipeline remains strong.

After analyzing our own win-loss data for the period, we're confident we didn't lose market share and continue to win against the competition. I also want to emphasize, we continue to win key strategic deals throughout Q4 at our largest and most important customers; a Tier-1 service providers and MSOs in North America, leading global NIMs and government contractors for our positioning business. I'll be talking later about what we're hearing from our customers now that we're in Q1 of 2023 and how we're adapting our go-to-market to the current environment.

And now I'll hand you to our CFO, Paula Bell, to go over the numbers.

Paula Bell

Thanks, Eric. Good morning, all.

Right. So let me take you through our full-year results for 2022. We delivered a strong performance overall in the year, with a further 7% growth in our order book and revenue growth of 5%. Strong cost management meant we were able to give good growth in earnings, as you can see here, operating profit up 9%. And on the back of good tax management and bank interest income, EPS was up 14%.

We continue to focus on cash collections and optimizing customer payment terms on bids and free cash flow was strong once again. We proposed a 12% increase to the dividend. And for our UK investors, this represents a 24% increase in sterling, reflecting our confidence in our midterm outlook, which remains unchanged. It's worth mentioning, too, that we've been growing our ordinary dividend by double digits since 2018, creating good returns for our shareholders.

So, we've updated our performance trend data shown here. And as you can see, very strong progress since 2017. Average revenue growth of 6% over this timeframe has delivered some good operating leverage. As we expected, we did see a slight drop in gross margin resulting from increased component costs, but we easily made up for that with OpEx management, which I'll walk you through shortly.

We delivered a strong operating margin again, now over 21%. And taking a whole financial progress into account, the EPS growth over time averaged 20%. So, we set out a few years ago now to deliver sustained revenue growth. And to do that, we focus on a clear strategy to drive stickier business with our customers, supporting them with the key projects such as 5G rollouts. We do believe our portfolio does not contain anything like the technical cyclicality risk hampering progress pre-2016. And today, we are seeing some customers reassessing their '23 investment profiles due to macroeconomic pressures, whilst remaining committed to their important 5G plans.

So let's look at the figures in a little bit more detail here. The order book, which is orders received but not yet taken to revenue, I mean, some call it backlog, grew again in 2022 and even on the back of a huge increase in 2021, clearly driven by a strong comparator year for orders in the same year 2021. As order intake at $625 million, still larger than the annual revenue of $607.5 million, thus creating a book-to-bill ratio of 103.

Now, I've mentioned the slight gross margin reduction shown here, and this was offset with some great work on managing our costs effectively. As component price increases are slowing, the 72% represents a realistic estimate for the new financial year. Looking at operating costs here at $307 million, you can see they're flat compared to the previous year. We worked hard to mitigate cost inflation.

In late 2021, we commenced a plan to transfer some of our more costly US engineering resource to lower-cost regions. We set up a new facility in Romania and expanded our base in India. Operating profit reached $129.5 million, slightly up on market consensus and driving a good operating margin. Profit before tax at $114.6 million was also up 11% in the period. Tax came in slightly better due to benefits of our UK Patent Box. However, we note the UK tax rate increases to 25% occurring in this year in 2023, and our estimate of our tax rate at around 15% in the near term remains unchanged. Cash remains strong with good cash conversion and positions us well as we focus on acquisition opportunities as a priority.

So turning to the performance of our segments. Lifecycle Service Assurance, this segment was directly impacted by customer spending delays, as Eric mentioned earlier. We continue to invest to develop the much-needed assurance solutions our customers require for their 5G rollouts. So due to all the timing challenges, we were unable to drive the top line as much as we planned by the cutoff point, i.e., the end of the financial year. Both connected devices and Wi-Fi also making up this segment performed well. The acquisition of octoScope made in March 21 has been fully integrated, is performing to plan as the clear market leader in the Wi-Fi test space and growing nicely.

In Networks & Security, strong momentum continued through the second half of the year. We delivered 9% revenue growth as demand for high-speed Ethernet testing was strong on the back of customers moving their data centers to the cloud and generally heavier data traffic. Our global engineering site strategy to increase resource in lower-cost regions, as I mentioned, mainly benefited our high-speed Ethernet business. So good revenue growth, together with good effective cost management resulted in a material profit growth -- material growth and profit.

Our GNSS positioning business released some new products and made some good progress in the year also. As you can see here, corporate costs were similar to last year. A bit more color here on the makeup of our revenue. Diversification remains robust. Top 10 customers equate to 36% of revenue, broadly consistent with previous years. In addition to the usual financial metrics I have shared so far, we also carefully measure a number of focus areas representing KPIs that our strategy is working.

Selling it on the live network, up 15%. Live solutions mean more software, more attractive gross margin. Lab sales were the area affected by customer spending delays. Services grew 13% as we look to incorporate more of the support activities into our offerings. We previously explained our focus on hyperscalers. And although starting from a small base, revenue growth was delivered here also. Again, we win more multi-year deals, constantly feeding the order book with revenue that is beyond the current year.

So, I have updated the chart here on bigger deals, as we show how we move to our selling larger solutions that's really gained traction here. This analysis is for deals over $1 million. In 2017, we delivered 28 deals worth $67 million, and in 2022, that increased to 78 deals worth over $184 million. In this economic environment, as customers scrutinize their spend, we have implemented enhanced approvals. So now we have to adapt our value proposition to reinforce the financial benefits our solutions bring and, in some instances, go smaller in deal size to get faster traction.

We introduced the order book metric at our last full-year presentation, and I've updated it here. Order book continues to grow even from the half year point. In 2021, the order book grew 30% and a further 7% in 2022. We do now have a record order book. So how will the order book unwind? Around 30% is due for delivery beyond 2023, which is a greater proportion than we saw at the close of the previous year, which was 21%. We are building strength, visibility and resilience in our business mode.

Right. Let's take a look at costs. As you know, we keep a tight rein on all of our costs as we grow. We invest with a very targeted approach. In a world of increasing cost inflation, we are managing this very carefully. We continue to ensure our products remain relevant and first-to-market to take share where we can. We've been busy targeting release of important new products across the whole portfolio.

Product development costs reduced year-on-year due to our engineering global site strategy. We constantly look to drive optimal productivity where we can. We continue to invest in sales and marketing. It's important we reach maximum customer base with our technologies, and we continue to focus on key accounts. We've added 2 more in the year 2022.

Sales commissions were lower in the year as orders pushed out. Admin costs increased compared to the prior period. We are implementing new systems to standardize time recording and analysis across the group. The more we scale our business, the more important is to standardize processes. Other costs include insurance, fees, advisory fees for increasing compliance regulations. So overall, we start the new financial year with a well-managed cost base, which is mostly people-related.

Inflation assumption and pay rises were broadly 5% across the global workforce for '23, and we have initiatives planned to mitigate around half of that increase. We move to the next phase of our review of our organization, maximizing benefits from lower cost regions, reducing headcount from consolidating activities whilst we continue to focus on, importantly, leading edge product development.

I'll talk a few moments about pensions. We've actually done a really great job this year, 2022, removing material risk from our balance sheet. Our main pension scheme in the UK with nearly 1,400 members is reaching maturity. So, we took advantage of some favorable pricing in the market and have secured $166 million of pension liabilities as one of the leading pension insurance buy-in specialists, meaning funding contribution ceased and the risk to asset returns, interest and inflation has been removed. We do have a remaining very small UK pension scheme left, which we are also looking to insure. So, this is great news, a huge piece of work and implemented well.

Turning to cash. We maintain a strong balance sheet, closed the year with nearly $210 million of cash. Cash conversion, strong again, 91%. Working capital increased slightly stronger as collection more than offset increased inventory. We're managing the supply chain challenges, which appear to be easing. Pension contribution is much reduced as the scheme reaches self-sufficiency and shows a surplus.

Tax payments, as I explained at the half year point, in 2017, the US Senate agreed new rules, which came into effect a few months ago. R&D costs were allowed to be deferred over 5 years, and this has been removed, resulting in accelerated tax payments. This has the impact of an extra $12 million payment this financial year, no impact to the effective tax rate. The other item to note is our employee share ownership. Quite frankly, we took the opportunity to buy more shares for our long-term remuneration schemes. So to summarize, strong cash conversion, good balance sheet, strong cash balance and with regard to capital allocation, we remain committed to focusing on acquisitions.

Medium-term targets. There is no change to our mid-term targets as presented here. We just need to manage carefully the near-term challenges. We are navigating choppy waters right now in an uncertain environment. And although our customers have confirmed they remain committed to their strategic programs, they are reassessing their near-term spending profiles. And whilst this duration is difficult to predict, we estimate the next few quarters will be impacted.

So to summarize, we closed 2022 with a record order book. We will continue to focus on customer pain points and help them invest in their own products -- in our products, sorry, and solutions to help them drive improved savings in their own businesses. Our financial management remains strong. We respond to external challenges proactively taking cost actions and sustaining our focus on cash management as we always have.

Looking forward into 2023, i.e., the uncertain near term. As customers firm up their spending budgets much later in this calendar year, then we don't expect to see a spring back in demand for our Lifecycle Service Assurance products until the second half. And this timing will like restrict revenue this financial year. We anticipate both high-speed Ethernet and positioning, i.e., our Networks & Security segment will continue to be a stable contributor to growth at the market growth rates of low single digits.

So overall, the financial year '23, the first half will be very challenging and we anticipate slight revenue decline in the full year.

So with that, let me hand you back to Eric.

Eric Updyke

Thank you, Paula.

A strong set of results despite the environment. As I said at the outset, I now want to spend some time looking at how we're delivering on our strategy, discuss what we're hearing from our customers and providing more context for why we believe our strategy is robust and sustainable over the medium to long term.

Let me begin with a quick reminder of our strategy, which we've aligned with the opportunities available to us and which allows us to take full advantage of them. On the left-hand side is the Spirent Yesterday. We sold products and mostly hardware. Our customer base was mainly network equipment manufacturers and service providers who use our products in their test labs to validate technologies prior to commercial deployment.

But Spirent Today is a very different company. We're selling more solutions, services and software to a more diverse range of customers, addressing their larger, most critical business problems. While we remain leaders in lab testing, we're also pushing further into the live networks and adding value across the customer lifecycle. All this makes us a closer and more strategic partner to our customers, while helping us to reduce cyclicality and improve visibility in our business.

The market drivers I discussed with you during our first-half results announcement remain in place. 5G remains our #1 growth driver and it's still early days for 5G globally. I'll talk more about where we are in the 5G journey in a moment. However, with our diverse portfolio of solutions and services, the drivers of the markets we address extend well beyond 5G. The worldwide shift to work from anywhere is now an irreversible trend. And so the performance and security of fixed, mobile and satellite broadband, including Wi-Fi, remain as important as ever.

The emergence of the metaverse, the idea of a shared decentralized and digital space that exists beyond the real world, continues driving, among many other things, the need to test and assure augmented and virtual reality devices and platforms, as well as the latency performance of 5G networks. Despite some widely publicized layoffs, hyperscalers remain huge industry players with a growing focus on the telco space, aiming to take share in 5G core networks, edge computing, Open RAN and private networks, while needing to expand their own data centers with higher speed Ethernet, including 800G.

And finally, location awareness is a key enabler in innovation in devices, drones, transportation, many other applications, which rely not only on satellite systems to determine location but increasingly make use of other sensors such as inertial as well.

So what customer impacts are we seeing and how are we responding? We maintain very close relations with our customers, and we continue to seek their input. We just completed an independent customer survey, which indicated, not surprisingly, that their current priorities are mainly centered around customer experience, churn reduction and cost efficiency. While customer budgets remain largely intact, there's no doubt that spending is being scrutinized much more heavily.

The business cases associated with each investment is subject to greater scrutiny at more senior levels, which has been delaying some purchasing approvals. With the intense focus on time to revenue, customer projects are getting shorter, so investments must generate a high level of ROI and address their most critical pain points. There's also greater demand for creative buying approaches to address near-term needs and stretch their budgets.

We also validated that Spirent remains a trusted partner. Our customers appreciate our innovative products and solutions and rely on us as an agnostic evaluator of diverse technologies. In response to this feedback, we're decisively adapting our go-to-market approach to the 2023 budget realities, ensuring that our products and solutions have the strongest value propositions, that we have commercial models to fit today's environment and that our customer-facing organization is able to clearly demonstrate and deliver strong customer ROI.

We always mention the importance of the 5G market driver to Spirent. So let's remind you of where we are in the 5G journey. We're basically transitioning from the early 5G phase, known as non-standalone 5G, where deployment of 5G radios has provided subscribers with faster access speeds. We're now moving into the maturing 5G phase, where the true value of 5G with its potential for higher revenue use cases and applications is unleashed.

The key element of this is 5G Standalone or 5G SA, which uses a new 5G core network. This brings with it the challenges of deploying and managing a disaggregated virtualized and cloud native network with more intelligence moved to the edge to provide much better latency performance for new 5G use cases, all of which provides opportunities for Spirent to help our customers along their journey. The number of commercial 5G standalone deployments is forecasted to more than double in 2023. This is also a year where we expect to see Open RAN, or O-RAN, take a significant share of the radio access market and more on this in just a moment.

We see 5G as an enduring driver since industry standards will continue to evolve throughout this decade and beyond to support new use cases and new economies, while networks pursue the goal of full autonomy through automation, AI and ML. So while we have seen many investment delays in recent months -- while we may have seen some investment delays in recent months, 5G spend really is non-discretionary since operators have committed and continue to commit to very large investments in 5G spectrum and network infrastructure. For a relatively minor incremental investment, 5G standalone enables the exciting revenue potential and cost savings opportunities for operators.

There are opportunities for Spirent across the 5G lifecycle. We've already been addressing our customers' challenges as they deploy and validate 5G technologies in the lab. As I mentioned earlier, 5G and particularly 5G standalone brings with it the challenges of deploying, orchestrating and developing a disaggregated and virtualized network requiring new operating models and processes. With our comprehensive portfolio of solutions and services, we've been able to help customers globally along that journey.

Monetizing 5G requires agility in the development and deployment of new services and enhanced network capabilities that provide an excellent customer experience and help minimize customer churn. This new agile model makes use of continuous integration, continuous delivery and continuous test, which we support and enable. Addressing more live network opportunities has meant evolving our own go-to-market to reflect the change in customer buying centers through the technology lifecycle as technologies move from lab to pre-deployment, deployment and finally into operation.

Let's pivot to some of our big win stories from 2022, which provide excellent proof points of our ability to support customers across the globe in their technology journey. First, a top-tier Indian network provider committed itself to deploying the nation's first 5G standalone network. They turned to Spirent with its Test-as-a-Service capabilities and unique testing tools to provide a managed solution that delivers and automates the customers' test requirements for its 5G core network, cloud infrastructure and security, and that can be rapidly delivered and scaled as required.

In Japan, NTT Docomo developed a testbed for its 5G Open RAN ecosystem to promote the interoperability and commercialization of O-RAN solutions. Docomo reached out to Spirent for its world-leading emulation capabilities, which are now at the heart of the testbed, enabling interoperability and performance testing and providing confidence that the commercial O-RAN deployments will perform as expected.

One of Europe's leading service providers needed to move its own 5G core network cloud platform to accelerate its 5G standalone evolution, while swapping out much of its existing infrastructure hardware with solutions from new suppliers. To address these needs, Spirent helped deploy a Test-as-a-Service solution that leverage the provider's existing Spirent test assets, along with our VisionWorks solution for preproduction infrastructure validation and active assurance testing, which provided us with an important live network win in Europe. And our focus on closing larger multi-year deals in our core market also continues to bear fruit.

A leading global equipment manufacturer customer, we worked over a long period of time to earn trusted adviser status. This, coupled with our 800G Ethernet market leadership helped secure almost 100% of the customer's 800G and other high-speed Ethernet test spend through 2023. As part of this multimillion-dollar bundle deal, our evolving and compelling cloud and security story helped us secure Spirent's first major security solution win in the account as well.

At a time when budgets are under increasing pressure, O-RAN's objectives are great for the industry to increase the competition and innovation while lowering costs with its open, standardized interfaces and software-defined radio access network architectures. The success of O-RAN will be highly dependent on whether it can perform at least as well as traditional radio, close feature gaps and achieve simple plug-and-play interoperability. It's creating new and complex dynamics and testing compared with traditional RAN approaches with the need to integrate multi-vendor systems, placing a greater testing burden on network operators and providing new opportunities for Spirent across the lifecycle and ecosystem.

From a very low base, O-RAN growth started to take off in 2022 and is expected to accelerate in 2023, with O-RAN forecasted to capture up to 10% of the global RAN spend this year. Beginning in the second half of 2022, Spirent introduced a complete suite of integrated and automated O-RAN test solutions, helping vendors and their network operator customers accelerate deployment, development and deployment of O-RAN systems with a higher level of confidence in the performance and robustness.

I'd now like to turn to the results of our operating division, starting with Lifecycle Service Assurance. Our strategy of focusing on live network opportunities was validated by double-digit growth in our live network services and assurance solutions. We saw softness in Q4, mainly in lab and especially in the devices segment, mainly as a result of order delays. As reported during our half-year presentation, we released Vantage to broaden our addressable live market beyond top-tier service providers targeted by our existing VisionWorks service assurance solution.

We also introduced solutions that I described earlier to address the emerging O-RAN market opportunity. And we saw multiple wins for our "as-a-service offerings in 2022", helping to increase our average deal size and significantly expanding our services footprint outside North America. Our leadership in Ethernet test has been a key pillar for Spirent for more than 2 decades, and that business made a significant contribution with strong growth on the back of early 800G wins, acceleration of 400G as we released a new test platform and robust demand for lower port speeds, such as 100G, driven by backbone network upgrades as data growth continued.

We released new application performance in cybersecurity solutions, including the industry's fastest application testing platform, which drove order growth in the second half, as well as a strong opportunity pipeline for 2023. And our positioning business saw expanded success in the space, automotive chipset and device segments.

A reminder that our services strategy is all about adding unique value around our products, where our products remain our key differentiator. Successful execution of this strategy was shown by double-digit growth across our services portfolio and larger average deal sizes. Services also provided us with an excellent opportunity to address customer demand for OpEx efficiencies.

We focused on alignment of our organization and optimizing our tools and processes to enable us to scale services globally from proposal all the way through delivery. And our services key wins were not only in North America, we saw multiple strategic wins in EMEA and the APAC regions as we help service providers with their 5G journey.

We're committed to the highest standards of environmental management, social practices and corporate governance in our business and supply chain to help our customers tackle important global sustainability challenges and the focus of that commitment is our FuturePositive program. I'm proud to announce some important progress in 2022. We achieved our goal of achieving carbon-neutral status certification for Scope 1, Scope 2 and some Scope 3 emissions. We continue to source 100% of our electricity from renewable sources, and we conducted a detailed energy efficiency audit of all our labs during the year to support our long-term carbon and energy reduction targets.

We're continuing our policy of site consolidation wherever possible to help reduce our overall carbon footprint. And our automation solutions and services are helping our customers achieve their sustainability goals, as we help them automate and consolidate energy-intensive labs and accelerate the adoption of new energy-efficient technologies in their networks.

At Spirent, we value, invest in and empower our employees. I'm proud of the progress we've made in our diversity, equity and inclusion program. Our employees completed over 1,500 hours of diversity, equity and inclusion training, helping to raise awareness across the business, and we launched a set of clear DE&I metrics to measure the impact of the initiatives we've put in place.

With a strong employee value proposition, we were able to perform significantly better than industry benchmarks in terms of talent retention. We further developed our go-to-market capabilities, adding carefully selected key accounts, enhancing our solutions and services, selling bench strength and strengthening our inside sales organization globally to expand our customer base. We continue to improve our organizational structure to better enable solution selling and focus on innovation around leading-edge technologies.

Moving into 2023, we plan to further enhance the leadership team, including the appointment of a Chief Information Officer to spearhead the standardization of processes and systems to enable us to scale while supporting our cost efficiency agenda. And we'll continue to evaluate all areas to ensure our operating costs are optimized as market conditions evolve.

To wrap up, we continued to deliver on our strategy. We saw another year of revenue and profit growth and order book build despite decision-making delays at some customers. Our medium- and long-term market drivers remain very attractive with 5G first amongst them, but also with our many diversified drivers beyond 5G. Our strategy of pushing into live networks is delivering results as we saw growth in the live network solutions and services and brought important new solutions such as Vantage to market.

Our efficient operating structure and strong balance sheet affords us a high degree of flexibility in growing our business, allowing us to continue to innovate, invest in R&D and go-to-market channels while focusing on select inorganic opportunities that position us for continued growth. We expect a challenging first half likely will lead to a slight revenue decline in the fiscal year. The medium-term prospects remain strong.

Thank you. And with that, we'll take questions from the analysts who are here in person and then move to those that have dialed in on the conference bridge. The conference call will be run by an operator, who will provide instructions on how to ask a question for those who are on the line in due course. For all those who wish to listen, please remain on the webcast. And please note the event is being recorded and will be available on the Spirent Investor Relations website.

Question-and-Answer Session

A - Eric Updyke

Francois, go ahead.

Francois-Xavier Bouvignies

I have a couple of questions. The first one is on the visibility that you have. I mean, we are aware that H1 is going to be challenging and it's something consistent with peers what they are seeing as well. So what visibility do you have on the recovery in the second half of the year? And maybe do you have any cancellation rate? Or what's the cancellation behavior in your order book as well since end of last year, the delays of spending? That's my first question.

Eric Updyke

Yes. Good. Well -- so I think our visibility starts with a strong order book as we reflected. And that foundation coming into 2023 is better than it was because it grew over the course of last year. So that's a great asset, and it is a product of an intentional strategy that we've adopted over the last few years, right? It's not the effective supply chain constraints or something else. It's longer-term deals and better visibility that we've built. I think the other thing then that we -- it is a bit of an uncertain world at the moment. But the thing that I think is super important in this environment is that we stay very close to our customers. And this customer survey that we conducted very recently, we engaged a third-party. We wanted to get feedback absolutely as quickly as practical to make sure that we weren't missing something and we got the benefit of those insights.

One of the really encouraging things about that exercise is they reflected -- they've never seen an organization move as quickly to organize themselves to get the customers prepared and ready. And it reflected on the depth and the strength of our relations the customers were willing to engage in the survey on really very, very short notice. So we got a pretty broad-based input in a very short period of time. We've, of course, taken all that input. I reflected some of the key themes. The customers are very focused, of course, on ROI. We're really going to sharpen up our value propositions.

We've already been on a course to sell value and business outcomes. I think that does differentiate us in the way we go to market from some of our competitors. But we're going to build even more robust playbooks to really tune into those themes that are so important to our customers. We had a great week last week at Mobile World Congress. We had well over 100 customer meetings over the course of three days.

So all of this is what gives us some confidence in sort of the direction of travel with our customers and the visibility as it relates to their ongoing commitment to us and the question around order cancellations. Our order book, nothing has been canceled out of our order book. Anything that we've booked and we've had there remains. So I think that's another sign of confidence that anything we've won customers are counting on us, and they're sticking with us and we're executing well on their behalf.

Francois-Xavier Bouvignies

Great. Maybe if we move to the wins that you described in your presentation and you have a few examples that was helpful. And since we know that, again, your competitors are seeing as well an uncertain outlook. Can you maybe give us some numbers or describe your market share conscious about these wins?

I mean, how your market share is trading because your competitors are also talking about wins and strategic wins, etcetera. So how do you see your market share evolving in this kind of downward market? And maybe what would be interesting as well is to remind us your recurring revenues today versus a couple of years ago? And if you have any insight on -- versus your competitors as well would be helpful.

Eric Updyke

Yeah. So maybe I'll tackle kind of the just the market share kind of question and then Paula, maybe you can comment on recurring revenues and so forth. But yeah, look, we're really proud of these wins. I think it shows some diversity and strength across the portfolio. You see a theme of a couple of very significant Test-as-a-Service wins in the period. And this is an area where we think we've got a very unique value proposition relative to our competition. So not only we're leveraging the strength of our products, but we're really partnering with our customers and engaging with them to take a broader kind of responsibility and accountability to deliver value and business outcomes for them in that process.

The O-RAN win that we highlighted, we see O-RAN as being a significant growth driver and a great new opportunity for us to participate in. The O-RAN offering that we built, we think, is the only real end-to-end comprehensive O-RAN Test solution in the market. And we've got a single user interface to really manage that end-to-end testing process. It's sort of impossible at this stage to measure market share around that because it's so new and it's so nascent, but we think we've got a great product that we're really going to push into this year. And then around the other win that reflects strength in 800G and our Security Solutions.

We feel like we're winning very important strategic high ground around 800G. You saw the strength of our Network and Security segment in total. The high-speed Ethernet testing portion of that performed very nicely last year. And it was across many vectors, winning key deals and important footholds around 800G, some pickup in volume in 400G, continued strength in the kind of legacy port speeds of 100G and even 10G as more applications are moving to the edge of networks as well. So it is a little difficult to measure market share in each of these segments, and it -- and we compete in a variety of different end markets, of course.

The thing that gives us confidence is when we look at win-loss rates we still enjoy a very high win rate. The thing that as I reflected on, I guess, concerns us the most, given the macroeconomic environment is customers just delaying decisions. And so there, it goes back to sharpening our focus on value propositions, in some case, providing flexible commercial models that fit within budget envelopes and in rightsizing our deal offerings.

Even as we've gone on a path very intentionally of trying to sell bigger, longer-term multiyear deals, I think we're going to need to accept in some instances, getting a smaller initial deal but just getting the win, adding customer value and then landing and expanding from there. So that's very much the mindset that we've adopted and the approach that we're going to take in engaging with our customers. Paula, do you want to talk just about kind of recurring revenue?

Paula Bell

Yeah, sure. A very important question. We don't have -- if we think of recurring revenue is pure subscription and not a lot of our business is pure subscription. So what's the best next alternative? We're looking for longer-term stickier business with our customers. So we had to go away and think about well, how do we achieve that? We've had a very clear strategy focusing on live assurance, focusing on software and focusing on services, which have all grown in the year.

But what are the true financial metrics that help us decide that we're actually building some form of recurring revenue? Well, indeed, those financial metrics are around the order book and the content. So the order book growth, the multiyear content within the order book feeding much future work beyond 2023 is a [indiscernible] indicator. And the other slide that we introduce is deal size. Again larger, longer deals is a good metric to try and give credibility to our [net] recurring revenue. So we don't have a pure subscription, but that's the metrics that we focus on to get heavy, sticky, longer business here.

Francois-Xavier Bouvignies

Great. And last one, if I may. Sneak one on the cost side. I mean, obviously, we have inflation like you described Paula and the 5% impact and half of that is going to be mitigated -- maybe can you elaborate a bit more where -- what's your flexibility here? I mean, what kind of work you are doing on the cost side? And is there any room for maneuver, I mean can you go a bit more deeper and what's your flexibility there?

Paula Bell

Yeah. Eric and I review the cost base almost on a surgical basis to understand exactly where we add the next dollar and where we take the next dollar from in terms of maintaining as a priority, our leading position on R&D is always at the forefront of our minds. However, there is always opportunity to drive for improvement. We are implementing time recording, standardized process and systems across the group, which we mentioned, and we'll look to get some interesting data and information about in terms of how we can collaborate more effectively across the group, where we have duplicate engineering activities where we can consolidate and take cost savings. We will continue to expand our lower-cost regional model.

As I mentioned, Romania and India is lower cost than some parts of our North American operations, which gives us opportunity as well. So we have quite a proactive agile management team always looking for ideas and being open-minded how to drive that. But at the same time, the R&D focus is clear. Key account management is something we've invested in, in recent years, and it's paying dividend with our -- with our customers forming deep relationships. So we tend to protect that as well. So there's no stone that's left and turned in a cost inflation environment, but we did a lot of the heavy lifting in 2022, where we maintained our cost base to be flat on '21. So we start the year in quite a positive position. We've always got some ideas.

Eric Updyke

Any other questions in the room? Janardan at the back.

Janardan Menon

Yes, I just want to go into the O-RAN part because you seem quite excited by that opportunity. But when we look from the outside, O-RAN still seems to be a bit of a niche technology adopted by a few sort of niche operators like DISH and Rakuten, etcetera. So from a customer point of view, where are you seeing the opportunities?

Is it that a lot of operators are doing trials on O-RAN in small geographies like villages, etcetera, and they need your equipment to test that or is it from equipment vendors? I just want to understand what is the potential size of this market? And how do you see that evolve over the next couple of years? And also, is this a solution where you're partnering with Anritsu and in which case, how is it being divided, the value getting out of it between yourselves and Anritsu?

Eric Updyke

Yeah, sure. No, we are excited about O-RAN. I'm glad you picked up on that. I would say, a little over a year ago, we felt we absolutely needed to make some bets, some investments around O-RAN. At that point in time, I think we were less certain about sort of how we thought the market might evolve. Fast forward a year, I think we have a lot more confidence that this is going to be a meaningful part of the overall O-RAN market. The RAN market globally is huge, right, as you well know. We're projecting O-RAN to maybe command about 10% of the global RAN market spend. So I think there were definitely innovators, disruptors out there early, like as you reflected, like Rakuten, like DISH.

But I think this is going to move and it is moving much more mainstream. We have many more engagements with large galaxies, some of the large galaxies around the world, some of the big established service providers who, in the same way that the strength and benefit from the core network being opened up with 5G standalone, it's the same kind of thing of this is -- historically a proprietary part of the architecture that as we open those interfaces, it's going to bring more innovation, more new competitors flowing in and lots of benefits around innovation that then out of our crew and hopefully, even cost reduction. It does make things more complex, which is why it's good news for companies like ours.

The thing that we've done with our O-RAN solution that we think is unique and different is we truly have an end-to-end testing offering. So it goes back to our strength in the core network with our Landslide solution is part of this. Some of our legacy connected devices components. And we have -- we've got some important partnerships out on the radio access side of things. So Anritsu in particular, is offering us RF conformance, which is, I'd say, in the whole scheme of things, I mean, it's an important part. We've seen it in different RFPs. It's an important part of the overall equation. We believe our solution we're going to still capture within Spirent a good amount of the end-to-end value. And whereas some others have kind of just cobbled together a set of disparate sort of testing solutions, we've got an integrated user interface and an end-to-end approach that we think will give us some good differentiation here.

Janardan Menon

Understood. And just going back to the sort of second half recovery. So just wondering from your confidence point of view, where do you think that recovery is more likely to come in terms of products? I mean, is it a question of some of the discussions on Vantage, for instance, haven't converted into orders as yet which you might have expected towards Q4, and you would expect those discussions to progress or expand to other customers, and that will start coming in, in second half or is it that the 5G core testing has weakened last quarter and that would come first or is it new products like O-RAN? I'm just wondering where does your confidence lie the most in terms of where you would see those signs of recovery or acceleration coming through in the second half of the year?

Eric Updyke

Yeah. I think it's some of each of those things, actually, Janardan. So when we look at how we ended 2022 and the outlook for 2023, it is a dynamic environment, as we all know. The Networks & Security segment, when we look inside there, first, the Positioning business, it's got some different end markets that we serve that are a little uncorrelated to some of the rest of the company, actually. And that's a beneficial thing. And so we think that could be a nice pillar of stability for us in 2023 as well. We have some confidence that we work through a proxy company in the U.S. as we support the classified programs for the Department of Defense in the U.S.

Defense budgets got set at a high level, and we think that sets a good foundation for us to do well with our proxy company partners. Around high-speed Ethernet testing, again, our outlook there and with the launch of our new security solutions products that we think are best-in-class in terms of their performance, price performance as well give us an opportunity to -- we don't expect that to grow fast, but at least be in sort of low single-digit growth is sort of the expectation we have on that part of the business. So Networks & Security, we think is pretty nicely intact with our traditional expectations.

Where we've seen the weakness, it is more isolated around some of the 5G lab testing. We did well in the live side last year and even ahead of Vantage catching hold. So I think with the launch of new offerings like O-RAN, like Vantage and the fact that when we just think about the sort of the broader economics around 5G, there have been tens of billions of dollars spent on spectrum. There have been billions of dollars spent on deploying radios, and there's this sort of thimble full of incremental expense to upgrade a core network to go get all the revenue, interesting and exciting revenue opportunities out of all that investment.

It's just nonsensical. Even if it's got some complexity and there's work to do that we're happy to -- very happy to help with, it's a necessary step that needs to happen and will happen. And so as with a lot of big transitions, I think sometimes they come a little later than we all hope and expect, but in the end, maybe they end up being bigger than we expected. So that's where a lot of the focus is. We've got this great customer engagement. We've got a great foundation of incumbency. And we're really going to hone our value propositions, as we talked about, to really make sure we're meeting customers exactly where they are to try and navigate through these choppy waters.

Janardan Menon

Understood. And just one last question, perhaps for Paula. Your Network & Security business did extremely well, both in terms of growth and margin last year, and you got to that 25% minus 3% or something operating margin. Why would that not continue through '23 and '24? I mean barring a big fall in revenue as long as your revenue is sort of in positive growth territory as Eric was suggesting it will be. What would prevent the margin from staying at around 25%? Is there any investments or anything that you plan, which could change that equation or growth?

Paula Bell

Yeah. It's a great outcome last year, 25%. We're thrilled with the progress of this business over recent years, driven by in the main, the site strategy and really getting the R&D cost in this business to really be really effective. And we'd love to do more of that going forward. So I think this has a great benchmark, and we'll certainly challenge the team to take that on board as we step forward. So there's no particular reason why we can't sustain that level. It will be quite -- I think one of the key assumptions that we have to also make in 2023 is that component price increases have to be passed on to the customers. And that would be the risk around that, if you will, that we're working hard to make sure that customers understand that in this environment, that's what we need to do.

Eric Updyke

Should we see if there's any questions on the phone? Alright, if not, oh, there are, there are, there are.

Operator

[Operator Instructions] Our first question is from Kai Korschelt from Canaccord.

Kai Korschelt

I just had a couple -- so one really more from a top-down perspective, if I can play sort of devil's advocate a bit, particularly looking beyond 2023, if you look at the CapEx guidance in the U.S., your largest customer group, I think, is sort of peak last year and down 10% to 20%. I appreciate a lot of that goes into RAN equipment and other parts of the network and then also China, a similar picture. So I'm just wondering what gives you the confidence that beyond the short-term cyclical macro-driven impact that we're not seeing a potentially secular shift down was potentially in generally 5G activity because some of these sort of CapEx numbers, they did coincide with your own revenue trajectory.

So I'm just kind of curious if you have had any thoughts on that. The second question was around two other sort of I guess product areas. I'm not sure I joined late, apologies for that if you mentioned them, but particularly Wi-Fi and then also the sort of up-and-coming activity around extraterrestrial sort of 5G, Low Earth Orbit, R&D. So I'm just wondering kind of what if anything you are seeing in those two areas?

Eric Updyke

Yeah, sure. Well, look, as it relates to sort of the longer-term outlook and our continued confidence in 5G, I think it goes back to a little bit of what I said previously is there's been a mountain of investment made. And there's a need for service providers to basically still go and earn that return. And there's a lot of work left to do to go do that. It starts, I believe, with in a large way around the upgrade to the 5G standalone which we're very well-positioned to assist with.

As they go through that step, it enables a cloud-based and software-based virtualized core network that then lends itself needed to be managed by Active Assurance, where we saw excellent growth last year, but we think it's just sort of the beginning phase of networks getting better -- more fully utilized and some of the interesting new applications, particularly enterprise applications that are going to have tight performance conditions attached to them that need to be measured and managed giving rise to the need for more and more Active Assurance.

We see O-RAN is another evolution of the standards where more industry participants are getting on board. And so we just launched our O-RAN offering and highlighted a nice win with DOCOMO. We had tremendous engagement with customers at Mobile World Congress around this. So yeah, I think we do remain optimistic that there's a lot left to come in that regard. And some of the other pillars of our business are still chugging along at pace. So as it relates to Wi-Fi, Wi-Fi performed nicely for us. It grew at a double-digit rate last year.

We see good growth potential for Wi-Fi testing with the evolution from Wi-Fi 6, 6E to 7. So we think we're very well0positioned there, and that's going to be a nice small but nice growth engine for us. And then the evolution of Low Earth Orbit satellites and its participation in 5G, we certainly have engagement principally with the players, the LEO players with our positioning group. It's a unique capability that we have around GNSS simulation and capabilities that really our competitors don't have. And so as that evolves, we think we're going to be nicely positioned to continue to work and drive some of that exciting opportunity.

Operator

Our next question is from John Karidis from Numis.

John Karidis

Eric, I had a heart attack when you said there are no questions from the bridge. I was trying to ask a few. So firstly, a relatively easy one. When management teams talk about sharpening their offer, the first thing that brings to mind is a price decrease. So can you talk about this, please? And also, when you talk about more imaginative commercial structure to meet budget does that mean that you're going to consume working capital?

Eric Updyke

Yeah. No, I think I can give you some assurance on both those fronts. So when we look at sort of what we've heard from customers, and I think this is a really valuable exercise that we went through and we blitzed through quickly to get the feedback. And we've got a tiger team that's running with the recommendations and the actions. Sharpening our value propositions is to really make sure we are more clear and we really equip our sales team with playbooks so they can clearly articulate return on investment and the value of our propositions. Every customer, we heard those big themes around customer experience, churn reduction, OpEx impact.

The idea of sort of discretionary spend isn't happening really in the same way in this environment. So we need to tap into the mandatory spend and make sure that -- and it's not discounting. I mean, the idea here is not to discount. It may be to rightsize our offering and have a smaller package initially, but to not give away all the value either -- to rightsize that offering to be very clear around the value that we're bringing, to tap into those customer pain points and the playbooks are really going to be designed to give the rules of the road to give kind of clear step by steps for in a given customer situation, this is what we sell. These are the value points that we want to stress and accentuate.

And around commercial flexibility, no, I mean, you know how vigilant Paula is about cash collection and the like. But look, if customers want -- if they're more comfortable with offerings that are more OpEx related; if it's more pay as you go, we are quite happy to be as flexible as we need to be around meeting the customers where they are in terms of what their budget realities are. And so it doesn't necessarily mean -- and in fact, it doesn't mean we're going to lend our balance sheet to our much larger customers. But it is just different commercial approaches. If they don't want a traditional license model, they want a different approach, we're happy to accommodate as required.

John Karidis

Okay. And then secondly, I need to drill down more on what was said or what I think was said in January and what is being said today. So I think today, you basically said it's LSA, its lab, and it's mainly devices. And I think in January, what I heard was that as far as the network operators are concerned, the second tier guys have finished the lab, and they are waiting or taking their sweet time to go to the deploy stage and devices weren't mentioned at all. So can you help me bridge this? And clearly, I must have misheard but please help me -- give me quite a bit more detail, please.

Eric Updyke

Yeah, sure. No, it is mainly LSA and it is mainly lab, where we're seeing the slowness. And I think as we reflect our expectations around the Networks & Security segment, I think it reflects that. And we had continued strength and good growth in the live part of the portfolio. I think it is true that in a way, we're frustrated that the pace of adoption of 5G standalone hasn't been faster, right? I think it's a necessary step the industry is going to take and has to take and will take, but it's been a little bit slow to evolve and slower than we maybe hoped or expected.

So that's an important driver for us. And there was some weakness amongst some of the large device makers. I think we've got the right set of actions, again, to tap into these themes and to really unlock spending. O-RAN, the O-RAN offering that we talked about contains within it some of our traditional connected devices products. And so we expect that to give kind of a nice lift there and not just to be selling in sort of a standalone way in the way that we would have in the past. And around 5G and Landslide, which is -- continues to be the very best core network test and emulation engine in the world.

It's at the heart of some of these as-a-service wins that we highlighted last year as well. And we're going to do some very targeted outreach to the customer base that we have because the nice thing about that part of the business as well is we have a very big existing customer base. And so we're going to do very targeted campaigns into that customer base for those that haven't yet upgraded to 5G licenses and so forth to try and stimulate that activity into 2023 as well.

John Karidis

And as far as the devices are concerned, did I mishear you saying today that it's more devices rather than network operators or is it more network operators versus devices? And if it's more devices, presumably the -- what was said about the move to standalone 5G doesn't apply to these guys, they can wait longer.

Eric Updyke

It's sum of both, John. It really is sum of both.

Operator

Our next question is from Bharath Nagaraj from Berenberg.

Bharath Nagaraj

Just have one quick question. Could you take us through an example timeline of, let's say, if there are new orders for chips for making Ethernet switches at, let's say, a chip maker, let's say, Broadcom, for example, who announced some like a few days ago, how does that come to ultimately benefit Spirent in terms of new testing orders? Can you take us through the timeline? That's all right.

Eric Updyke

I didn't quite -- I'm sorry, I missed I think the essence of the question.

Bharath Nagaraj

Yeah. So just to repeat the question, I was wondering if you can take us through the timeline of how -- if there are new orders for chips, let's say, at -- for making Ethernet switches, let's say, for Broadcom, which announced some of these orders like a few days ago, how does that come to benefit Spirent in terms of new orders in the future, new testing orders in the future?

Eric Updyke

Okay. Yeah. No, we've -- we felt we really won some important high ground in 2022 around 800G. It wasn't the biggest of volume driver yet. But where it starts, the chipset makers, of course, influence a lot of the downstream ecosystem. And so it's important to win with the chipset makers around 800G and high-speed Ethernet in general. And we did have significant wins with multiple chipset makers that set, I think, a very good foundation for us around our prospects for 800G. Does that help?

Bharath Nagaraj

Sorry, yeah. Just a follow-on then. In terms of like testing out the network after Ethernet, which is effectively used to building out the network, what's the timeline that we are looking at from the time the chipset makers make these orders right down to where you get the benefit for testing the network or how much time are we talking about there?

Eric Updyke

Yes, got it. Well, I mean we get immediate benefit, of course, from the orders that we make to the chipset. That part of the business, there's a pretty quick translation from order to revenue. One of the really big wins that we reflected in high-speed Ethernet last year was with a large network equipment maker and a lot of that's around 800G. We do believe the way the market is going to evolve is the hyperscalers ultimately with the amount of data that is moving to the cloud and between their data centers, maybe ahead of traditional service providers in pushing to 800G.

We see markets like China going to higher data rates and port speeds as well. So it'll -- yeah, it flows kind of through the ecosystem, network equipment makers and then service providers ultimately. And it will be initially some select service providers that are really driving the highest bandwidth across kind of backbone networks or data networks that would be early adopters of 800G we would expect.

Operator

We currently have no further questions. I would like to hand back to the CEO, Eric Updyke, for final remarks. Please go ahead.

Eric Updyke

All right. Thank you very much. I hope we've reiterated that we have a lot of confidence in the ongoing prospects and certainly into the midterm in navigating these choppy waters in Spirent and I want to thank everybody for joining us today. Thanks very much.

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Spirent Communications plc (SPMYY) Q4 2022 Earnings Call Transcript