Spirent Communications plc

LSE:SPT

Earnings Call Analysis

Spirent Recovers in Q2 with Strong Orderbook

Spirent Communications experienced a challenging first quarter in 2023, which led to a decline in revenue and operating profit. However, the second quarter saw a return of business momentum, with order intake matching the previous year's strong Q2, resulting in a solid orderbook exceeding $300 million. This improved visibility gives management confidence in their strategy and pipeline, expecting to capture significant customer opportunities in the second half. Gross margins have remained stable at 72%, supply chain issues are resolving, and costs are well-controlled, with proactive cost management and sustained investment in R&D as key priorities. These factors contribute to their positive full-year outlook.

Introduction to Spirent's 2023 First Half Performance

Spirent Communications' first half of 2023 presented both headwinds and opportunities. While the year kicked off slowly due to macroeconomic pressures and unforeseen challenges, such as the COVID-19 lockdowns in China disrupting customer spending, the company adapted and saw an improved order book and a strengthened balance sheet.

Financial Highlights and Challenges

Despite a sluggish start affecting revenue, the company maintained a healthy gross margin of 72% and managed to grow its order book by 7% year-over-year to over $300 million, showing resilience and operational leverage. An increase in the dividend by 5% signals management's confidence in overcoming short-term softness in trading. Yet, the reduced customer spending impacted the operating profit, reinforcing the impact of external economic factors on the company's performance.

Segment Performance and Future Prospects

Different segments of Spirent faced varying degrees of pressure. The Lifecycle Service Assurance segment felt the customer spending delays, affecting operating profit, while the Networks & Security segment showed growth prospects, especially in positioning products. Encouragingly, 60% of the order book is expected to reinforce revenue in the second half of 2023, suggesting a recovery underway.

Cost Management and Operational Efficiency

Spirent demonstrated strict cost discipline, managing to offset inflation impacts and maintain investments in key technologies. Actions included relocating high-cost R&D activities and rightsizing the workforce, contributing to slightly reduced operating expenses compared to the first half of 2022.

Cash Flow, Customer Base, and Market Diversification

Cash flow management focused on shareholder returns, with significant outflows for dividends and share buybacks. With a varied customer base and efforts to expand into non-telco markets like hyperscalers and financial services, Spirent seeks to diversify its revenue streams and reduce dependency on any single customer category, which is crucial for sustainability.

Strategic Response to Macroeconomic Changes

Spirent is agilely navigating the current uncertain macroeconomic environment, focusing on customer pain points and optimizing its go-to-market strategy. The company remains committed to sustainability, achieving carbon neutrality in 2022, and continues to invest in initiatives promoting diversity and inclusion. Importantly, there's positive momentum expected to carry forward into the second half, with opportunities arising from new sectors like Financial Services and continual engagement with Tier 1 customers.

Comparison with Peers and Investment Focus

Addressing revenue decline, Spirent emphasized that its product mix and regional exposures could explain performance variance compared to peers. Investments in future growth are unwavering, as evidenced by R&D alignment with medium and long-term growth drivers. The trajectory for operational expenses is expected to follow the growth in revenues, albeit with efforts to mitigate cost inflation.

Customer Engagement and Confidence in Full Year Targets

Customer engagement is on the rise, which is a crucial sign of improvement. Spirent observed customers overcoming internal budget restraints to renew spending with the company. While there were delays in deal closures, there's no indication of lost deals. The revived customer interactions add to the confidence in meeting full-year targets, despite the continued challenging macroeconomic climate.

Earnings Call Transcript 2023-Q2

[Eric Updyke, Chief Executive Officer]

Good morning, welcome to Spirent 2023 First Half Results Presentation. Please take a moment to review our safe harbor statement.

I'm delighted to take you through today's presentation. Our CFO, Paula Bell will walk you through the financials as usual, but I also want to take some time to step back and take you through how we're delivering our strategy and the opportunities we see, which remain robust over the medium and long-term.

We had a very slow Q1, which resulted in negative impact on revenue and operating profit for the first half. However, we're encouraged about the momentum we saw returning in Q2 as customer engagement and orders increased significantly. Order intake in the second quarter was broadly in line with last year's strong Q2 and our orderbook has grown to a record level of over $300 million improving our forward visibility.

We're seeing increasing customer engagement across the portfolio as well as improving pipeline and we're maintaining a high win rate. Our efforts to diversify our customer base are paying off. You'll hear more in a moment about the strong first half performance of our positioning business, which has highly diversified end markets many of which are outside the telco ecosystem. And as you may have read in our press release we believe a breakthrough in the financial services space will open more doors into this new customer segment.

We're seeing significant customer opportunities in second half that make us confident in our full year outlook and even more excited about 2024. Our strategy and portfolio are well-aligned to capture those opportunities.

I hand it over to Paula to walk through the numbers before we talk more about our strategy. Paula?

[Paula Bell, Chief Financial Officer]

Thanks Eric. Good morning all. So let me take you through those first half results for 2023. Okay, so looking at some of our key metrics the first half trading was very much affected by the slow start at the beginning of the year. The macroenvironment impacted the timing of customers spending then the added challenge in China where recent COVID-19 lockdowns halted lab spending plans.

By the second quarter, we saw momentum returning and indeed we managed to grow the orderbook to over $300 million as you can see here, up 7% since June last year and 5% since December.

Now we enjoy the benefit of operating leverage as we grow the business over a well-managed cost base. However, given the adverse impact of customer spend on our revenue this first half, we can see the negative impact on operating profit. We continue to exercise good cash discipline and preserve a strong balance sheet, and at the end of June we were halfway through the planned $70 million share buyback program. So we're proposing a 5% increase to the dividend and reflecting our confidence that the softness in the current trading is indeed short-term.

So, turning to the financial summary here. And as we predicted, I mean, it was almost a half of two very different quarters. The order book some call it backlog, grew resulting in a book-to-bill of 107. Order intake in the half at $239 million was well-below HI 2022. However, as Eric mentioned orders in the second quarter were in line with the same quarter last year and I've got some more details on the quarterly trend in just a moment.

The slow start meant there was a direct impact to revenue in the period. Gross Margin at 72% is holding very well. Supply chain lead times are improving and cost increases are slowing, which is also good news. We fully mitigated cost inflation in the first half and benefited from a number of actions, so operating costs were $149.4 million, down on H1 2022.

So as you can see here operating profit close to just over $11 million compared to a very strong comparator in the previous half. Taxes in line with our predictions and the outlook is unchanged at around 15%. EPS as we can see here reflects the fall in the profit in the period.

So turning to the performance of our segments I'll start with Lifecycle Service Assurance. This segment was directly impacted by the customer spending delays, but we continued to invest in much needed assurance solutions that our customers require for their 5G rollouts. So due to order timing challenges, operating profit was directly impacted. We enjoyed multiple O-RAN wins pipeline is building for our assurance solutions, including a major lab and test automation deal opportunity.

In Networks & Security, we saw good growth in our orders for our positioning products and solutions, which are for delivery in the second half and beyond. The recent COVID-19 lockdown in China meant orders for our high-speed Ethernet were impacted and expected to return in the second half. New product releases continue underpinning our 800 gig high-speed Ethernet leadership. And as you can see here corporate costs were similar to last time.

So I just want to share some information to set up the quarterly trend in orders here. And we can see here in the second quarter versus the previous two years. And on the life-hand side, you can see we really struggled in the first quarter this year. Then if you look at the second quarter comparisons, you can see a few things. The pickup in Q2 versus Q1 in absolute size is material. This is the gray bar. Q2 was also very similar to the two prior years.

Other key information which is providing assurance along with a growing orderbook is the gradual increase in pipeline and the conversion rate of those prospects into actual orders. So the recent improvement is feeding into our orderbook build as you can see here and for the first time we're actually over $300 million. So how will the orderbook unwind? And at the end of June, 60% of the orderbook underpins the second half revenue for 2023 and 40% for future years. So we continue to build strength, visibility and resilience in the business model.

So turning to cost management. I mean, the discipline in cost management is critical. And whilst we maintain our investment in key leading technologies, we also look to drive cost efficiency from across the business. Now cost inflation was around 5% in terms of the average salary rise which we managed to mitigate as you can see here. Product development costs reduced. We moved high-cost R&D activities in North America to India and Romania partway through last year.

And in this half, we closed out our R&D center in Berlin and transferred those activities to China, as part of our overarching focus driving efficiency in the global footprint. And recognizing a tougher ahead of us, at the start of the year we also took out around 40 heads to help drive cost base improvements. So in summary, operating costs were $149.4 million in the half and compared to $152.6 million in the previous half.

All right. So let's look at cash. And as you can see from the chart here, the main cash flow outflow is to our shareholders, $31 million being the final dividend and $35 million for shares purchased and canceled. And looking forward, we expect to conclude the remainder of our share buyback program i.e. another $35 million in the second half. So in the half, we can see here the top customer represented 7% of revenue and the top 10 is around 35%, so a good diverse base with no one customer being too overweight.

Customer category diversity is also important too and as we look to build hyperscalers and now financial services. Telco end markets have been of course challenging in recent months and order placement timing uncertain, but we saw good order growth in our Positioning business and it's a great example of progress being made in the other end markets.

So pulling together a number of strands here, the management team is working in an agile way to respond to macroeconomic environment challenges. We're driving new customer segments with non-telco end market and it plays to our portfolio benefits and drives opportunity for new revenue streams. We'll continue to focus on our customer pain points selling our products and solutions to help them achieve cost savings. We have developed our go-to-market materials accordingly and we're clear what benefits we can bring to our customers' cost models.

So as said supply chain lead times are easing and cost increases slowing and we can see here how that protects the gross margin. Costs are well managed as I explained and new opportunities include reduction of our office space, as we settle down into an increase in remote work working and opportunities for more organization design benefits. So we are navigating really choppy orders right now in an uncertain environment. Our customers have confirmed, they remain committed to their strategic programs and therefore there is no change to our midterm targets. We just need to manage carefully these near-term challenges.

So we remain confident in the growth trends across our markets. Our financial management remains very strong as we respond to the external challenges, proactively taking cost actions and sustaining our investment into our leading R&D programs.

Now recognizing we're entering the second half of 2023 with a strong order book returning business momentum, we've got a very robust gross margin and a well-managed cost base this gives us confidence for the full year outlook.

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

[Eric Updyke, Chief Executive Officer]

Thank you, Paula. As I said at the outset, I now want to spend some time looking at how we're delivering on our strategy. The key market drivers of our business that I've discussed previously remain strong, even as they continue to evolve. Despite experiencing some well-publicized rollout delays, 5G remains our number one driver and it's still early in its life cycle especially for 5G standalone.

As one of the innovations powering 5G, Open Radio Access Network or O-RAN technology is also gaining momentum and I'll talk about both in a moment. Relentless cloud growth continues with hyperscalers focusing on the telco space. They're also addressing the ever-increasing need to expand the capacity of their data centers by using higher speed Ethernet including 800G.

A Q1 survey of our customers' buying behavior highlighted their strong preference for funding projects able to demonstrate clear efficiency improvements and ROI. This aligns well with our everything as-a-service offerings and our value-based selling approach. Extended reality is driving a wave of innovation in devices and expanding the need to test and assure those devices as well as the performance of 5G networks.

And finally, we continue to see the location awareness as a key enabler for innovation in devices, drones, automotive and many other applications. Next-generation positioning navigation and timing systems, including those enabled by Low Earth Orbit satellites, are evolving to address this critical need with Spirent playing a leading role.

We consistently mentioned the importance of 5G to Spirent, but it's also important to remember that we're still in the very early days of true 5G deployment. To-date around 25% of operators globally have commercially deployed any kind of 5G network, which in the vast majority of cases has meant overlaying a 5G radio access network onto an existing 4G core network.

A far smaller percentage around 3%, have commercially deployed 5G standalone. This uses the true 5G core network without which it's impossible to realize the technology's real potential. For operators standalone is the key to monetizing 5G. It enables the agile deployment of new services along with much more efficient network operations and scalability through extensive automation.

Consumers and enterprises benefit from 5G standalone with even faster speeds and much lower latency transforming use cases such as mobile gaming and enhanced reality. And network slicing makes 5G private networks a practical reality for manufacturing, healthcare and other sectors.

Relative to all the capital investment that's gone into 5G radio access networks, the incremental cost of deploying a 5G core is relatively modest at around 10% of the RAN investment. So why haven't far more operators already moved forward with 5G standalone?

Their hesitancy has certainly created some headwinds for our LSA business over the past several quarters. It turns out standalone deployment is not a trivial task. Let's look at some of the key challenges that have been holding up rollouts around the world.

Standalone networks have much greater technical complexity about 50 times greater than 4G, especially around new cloud-native architectures. And operator teams have significant gaps in their internal skill sets, especially when it comes to cloud and virtualization.

Since the key advantage of standalone is the agility to quickly roll out new services and network upgrades, operators need overall their processes to deal with multi-vendor environments and rapid release cycles. And until recently there are very few handsets and other devices could support standalone though that is changing.

But these challenges for operators represent opportunity for Spirent. Given our global leadership in testing and assurance of 5G core networks, we're uniquely equipped to help them with their standalone challenges. We're already helping more than 50 operators and cloud providers and expect to help many more.

Our vendor-neutral solutions help them accelerate their deployment, enhance efficiency via automation, and assure performance, while overcoming skill set shortages with our managed solutions offerings. And legacy passive assurance and monitoring solutions are no longer fit for purpose in this cloud-native environment.

Next-generation assurance needs to be a proactive automated form of continuous testing and monitoring, opening the door to exciting new opportunities for our active assurance portfolio.

A quick refresher on how we've aligned our strategy to take full advantage of the opportunities available to us. Over the last few years, we've fundamentally changed our company. Spirent used to sell mostly products and hardware to primarily service providers and network equipment makers, mainly for lab testing.

Our strategy remains intact and has built a strong resilient foundation that's carried us through the recent tough macroeconomic environment. We're selling more solutions, services, and software to a wider range of customers. And while we're still leaders in the lab, we're pushing further into the live network.

Let's pivot to some of our big win stories from the first half. These provide solid proof points that our strategy of diversifying our customer base and growing services is working.

I mentioned O-RAN earlier, we had an important win with Japan's largest operator NTT DoCoMo who chose Spirent to test O-RAN multivendor interoperability and performance. We had other strategic O-RAN ecosystem wins during the period and are excited about the opportunities the technology offers.

Benchmarking the performance of 5G networks has been an important element of our services growth strategy. And in the first half we were successful in adding another North American Tier 1 to our benchmarking wins.

We see good potential in the rapidly expanding Low Earth Orbit or LEO satellite space. LEO satellites are supporting next-generation position navigation and timing systems to augment GPS.

Our Positioning business is playing a key role in these initiatives with several strategic wins and partnerships in the first half highlighting the diversified end markets for this business.

In our 2022 results announcement, I mentioned the release of a major new platform for our security solutions business and this led to growing customer engagement and expanded pipeline and initial wins including a major Q2 win at a global security solutions vendor.

We've been making quite a bit of noise about our new opportunity in the financial services vertical as we're very excited about it. So, you may be wondering why Spirent is now working with financial services institutions. These banks are running large and complex networks which enable their many customers to access sensitive personal information. There's an important job to be done to verify the performance, reliability, and security of these networks.

Let's talk about some of the challenges they face and how we're helping to address them. These institutions have a major compliance challenge needing to ensure that tens of thousands or even hundreds of thousands of devices on their global networks are working as intended. They need to deal with an ever-increasing velocity of releases and end-of-life issues in their networks, while working to minimize disruptive and costly outages.

Today this is a fragmented, manual, and highly inefficient task. Testing has frequently farmed out to vendors, but this doesn't provide enough confidence in end-to-end performance and it can incur significant cost.

With a strong desire on the part of these institutions to dramatically improve efficiency and reduce OpEx, there's an exciting opportunity for Spirent to help address their challenges.

Our solution is delivered as an outcome-based service that evaluates the current state to make key recommendations for re-architecting their labs and processes. The implementation phase includes automation using our Lab-as-a-Service platform and our interactive test development environment.

The anticipated outcomes from this project for the banks can be dramatic, an efficiency gain of around 90 times going from weeks to hours, annual savings in multiple millions of dollars, reduction in costly and disruptive outages with vastly improved end-to-end testing, and 24/7 by 365 access to their automated labs by their organizations around the globe. Clearly, this is an exciting opportunity in a new segment for Spirent that we're strategically well aligned to help our customers solve.

Now, I'd like to turn to our operating divisions to highlight some of the key accomplishments in the first half despite the challenging environment. Let's start with our Lifecycle Service Assurance business.

As I mentioned earlier, we had multiple O-RAN wins in the first half, underlining the opportunities in this growing ecosystem and the results of our focus on it. And our second half pipeline looks strong.

In the live network space although, delays in 5G standalone deployment impacted the ramp-up of our Vantage solution, we continue to see success for VisionWorks in the live networks of Tier 1s, with significant new North American business won in the first half and a positive outlook for H2.

Our leading test and lab automation capabilities and the ability to offer more of our expertise as-a-service, aligned well with our customers' focus on efficiency and ROI and we see expanding opportunities in those areas.

I described our excitement around the opportunities to expand in the financial services vertical earlier, with initial opportunities mapping to our LSA business. And we maintained our Wi-Fi test leadership building on our successful octoScope acquisition in 2021, as we engage with our customers around their next big driver for the technology, Wi-Fi 7.

In our Networks & Security segment our Positioning business benefited from its diverse customer base, much of it outside Telco, seeing good orders growth in its government and hyperscaler markets as well as leading chipset and automotive players. As discussed previously, the business also saw strategic wins in the LEO Satellite ecosystem, representing an important new growth opportunity.

Despite market headwinds especially at major Chinese network equipment vendors, as the country emerged from the impacts of the pandemic, our core Ethernet testing business maintained its 800G leadership, with strategic wins at leading chipset vendors and hyperscalers.

We also saw returning momentum in our Security Solutions business with good engagement and significant initial deals, for the new security testing platform, we introduced in 2022.

Underpinning our business is our robust operating model which continues to evolve. This model is built resilience, driven by our returning momentum despite the macroeconomic environment we operate in.

As I've already highlighted a few times we continue to diversify into new customers and new segments, including entry into financial services sector. This strengthens our business against headwinds in any one particular market or region.

Our Solutions and Services are addressing broader customer needs, enabling us to act as strategic partners to our customers across their entire life cycle. While it's been a less critical issue this year than in the recent past, I'm also proud of how we've diligently managed our supply chain continuing to deliver for our customers.

We maintained strong cost discipline as well, keeping costs broadly flat, despite global inflation. In addition, sustainability remains a key element of our operating model. I'm proud to report we achieved carbon neutral certification in 2022. We continue to invest in our green efforts as well as diversity and inclusion at Spirent.

Our products are also helping our customers achieve their sustainability goals by reducing their carbon footprint. In summary, we're encouraged by the positive momentum that we're now carrying forward into the second half. There's a lot of activity happening below the surface that gives us confidence.

On the left-side of this chart you'll see, the activity you would normally expect us to report this time of year. VisionWorks Tier 1 wins Ethernet hyperscaler wins opportunities in positioning and in security.

To the right however additional reasons we think the second half of the year are will yield the necessary results, to meet our full year targets. Some of these reasons are new, like the new Financial Services sector opportunity and early wins with our new O-RAN product suite.

And some are reasons signs of recovery, such as the fact that our Tier 1 customers are once again entertaining conversations around big, multimillion-dollar deals and the return to health of the China market. All these elements give us confidence in our predictions that the targets we've set for the full year are achievable.

Overall, we're managing through the macroeconomic environment well. After the tough first quarter we saw a significant improvement, positive signs of returning momentum in the business in Q2.

We continue to focus our investment in the future growth of Spirent. I'm proud of the discipline we've taken to managing costs, while sustaining our investment in the right R&D, aligned to our medium and long-term growth drivers.

While the macroeconomic environment remains challenging our full year outlook remains unchanged, with a heavier than usual weighting to the second half, with our strong orderbook growth and returning momentum giving us that confidence. Thank you.

And with that we'll take questions from the analysts who are here in-person and then we'll 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 on the line in due course. For those who wish to listen please remain on the webcast. And please note, the event is being recorded and it will be available in the Spirent Investor Relations website. Kai?

[Kai Korschelt, Canaccord]

Thanks. Good morning. Kai Korschelt, Canaccord. I'm going to be greedy and ask three questions.

[Eric Updyke, Chief Executive Officer]

I better move over and write them down then Kai.

[Kai Korschelt, Canaccord]

I can do two first and then a third. The first one was around the revenue performance in the first half, down 20%. If I look at some of your peers like Keysight or – I think they are down mid-single digits. If I look some of these smaller service assurance peers some of them have been growing revenues.

I'm just wondering kind of do you think it's like your product mix, it is perhaps regional exposure. Just wondering if there's any more color that you might be able to provide on that? The second is around the 5G standalone, some great numbers and color on sort of that it's been going slower than expected.

Outside of the Landslide solution which I think is more of a lower ticket software sale as I understand. What other products do you think will benefit from that ramping up? And then maybe I'll just do the third as I see your writing taking notes. OpEx was down a couple of percent in the first half year-on-year. Assuming revenues grow again in the second half, roughly what trajectory should we assume for costs? Thank you.

[Eric Updyke, Chief Executive Officer]

Maybe I'll try and tackle one and two and let Paula handle number three. Yes. I mean the revenue being down relative to peers. I mean I think particularly a company like Keysight, that's nine times our size, they've got a much more diversified business and diversified end markets. And I think their EIS group held up better in the recent past than the communication services group, right? So there's that sort of distinction. And then even within CSG kind of where the old Ixia mapped in, I think you see a very similar sort of pain, right relative to where the exposure, particularly the telecom market was where I think most of the softness has been. So it was most acute for us as we talked about in Q4 of last year and in Q1 of this year.

I think we said it many times in the presentation, we're pretty encouraged by the direction of travel, the increased engagement, the actual order activity, the improved close rate, conversion rate deals that came through in Q2 and the pipeline and the outlook for the remainder of the year. But Q1 was a difficult quarter and dug a bit of a hole for us fundamentally.

Around 5G standalone, yes, I mean Landslide, I've said it many times, I'll say it again. I'm not going to miss an opportunity. It's the best core network test and emulation solution in the world. And so it's a really critical tool to help service providers manage this journey ultimately from a 4G core to a 5G core, that is much more feature-rich and much more capable but is quite complex.

Because of all that complexity, the other things that we ought to benefit with as more carriers get on the road to 5G standalone is certainly our approach to managed solutions around our products, where we put our automation framework in place with our test-as-a-service engagements, has given us broader insight and more opportunities, once we've got in and help them manage that overall testing process. And we also think it's just the beginning of managing that customer journey from the lab and the validation of the technology into the preproduction environment and managing the change control process and then ultimately into active assurance.

And so we really are delighted we developed Vantage, is a next-generation active assurance solution, cloud native, lightweight. The market isn't quite ready for it just yet because of this slow pace to 5G standalone. The Vantage is ultimately going to be a beneficiary. And as I said, where we see immediate opportunities where the market is just more ripe, and more mature it needs more help and managing the customer experience is back to the North American Tier 1s, where of course we have a lot of incumbency and really strong relationships. So that's an immediate term where we're really going to put most of our focus. Paula?

[Paula Bell, Chief Financial Officer]

Yeah. So dealing with OpEx, down in H1, as moving to H2, H2 is by nature slightly bigger than H1 in a normal year. Well, why is that? Things like sales commissions are linked to the weighting of the order profile, so we'll be heavier in H2 versus H1. But when we give our outlook for this financial year and some time ago, we said that what we were trying to achieve is mitigate 50% of the cost inflation. And that's exactly where we're going to end up this year. So 5% increase in pay which is most of our cost base mitigate half of that. So we're absolutely bang on track for what we said and we're delivering that nicely.

[Eric Updyke, Chief Executive Officer]

John?

[John Karidis, Numis]

Thanks very much. John Karidis from Numis. I guess three as well, if I may. I'm actually after sort of specific anecdotes to explain why your customers are coming back now. At the risk of sort of answering my own question is it because their networks are creaking or somebody's breaking ranks or whatever? But I am interested in specific anecdotes, if you have any please. Secondly, can you talk about how advanced you are in engaging with other retail banks other than the one you're about to sign a contract with?

And then thirdly, you understand there's a sort of perception that your full year guidance is at the very top of the range of possibilities that you see for Spirent for this year. Maybe you can tell us where it is from your perspective given that you know what's happening under the hood? And also perhaps what a worst-case scenario outcome would be for the full year, again based on what you know and what you see happening under the hood? Thank you.

[Eric Updyke, Chief Executive Officer]

Yeah, anecdotes as to why customers are coming back and it is sort of just anecdotal. But I mean, we definitely have instances -- what's happened in a lot of customer organizations is they've been more -- as they've managed their own budgets and put scrutiny on their budgets, they've put some speed bumps in place, higher level approvals, have really restricted I'd say discretionary spending. A lot of the stakeholders that we work with are frustrated that they don't have the tools to do their jobs. And so, in many instances, they're helping us navigate their internal processes so that they can buy from us to get their jobs done, right? So we talked before in recent quarters that we weren't seeing deals being lost, but we were just seeing things continuing to shift to the right and not close in a timely fashion. So we have seen that conversion rate pick up. It's not exactly where we want it yet, but it's absolutely moving in the right direction. But I guess that's the kind of anecdotal evidence coming along with it in terms of just that customer behavior and people fundamentally believe in and understanding they need our tools and our services to effectively do their jobs.

As it relates to our progress with other banks, I mean you could imagine given how much we're talking about it now that we're really excited about the opportunity. I mean, what I described we think is a very common issue across the industry, complex networks many legacy systems, compliance requirements they can't keep up with, fragmented processes too many labs. It's not unique to the initial bank that we're working with. I think the biggest challenge for us to get after this at pace is it's not a sector where we have deep long-standing senior relationships. So that's what we need to fast track.

And part of how we'll do that is we'll work with some partners. There's some large systems integrators that have good existing relationships to many of these financial institutions at the right levels. But we do have a really good pipeline of more opportunities and we're getting after them just as quickly as we can because we see -- it's a really compelling economic financial proposition we think for these banks. And then the ones that we're already working with we're only working in the tower regarding to their networking sort of challenges. We believe they've got similar challenges around compute and around storage. So I think even with the first bank, there's a lot more that we can help them with. You want to -- all right. Paula wants the last one around guidance and feasibility and such.

[Paula Bell, Chief Financial Officer]

Yeah. So look when we sit here in August and we have to look at our crystal ball for the full year then quite frankly we're in no different position than we are in any other financial year. But some of the key metrics that we look at to give us confidence, very much center around lead indicators. So, just to run down what those are. Orderbook largest ever; pipeline growing; conversion rate getting better; Q2 order intake momentum. Now, you know that, because we've just been through that. But when we look at the full year outlook, our view is to try and cut what I say a centered view.

So there are opportunities to make the numbers better. There are risks to make the numbers lower. When you think about those risks right, I'm pretty confident that what we're doing with our pricing on supply chain cost inflation is working and we're holding our gross margin really well okay? When I look at the cost base, we've already got actions in trains that are delivering the cost savings and evidence of the numbers. So we're not necessarily too concerned about what sits beneath the revenue line. It becomes just a revenue conversation as opposed to many aspects right?

So and when we look at the revenue then the revenue was simply built up by two LEGO bricks. One is, what's in the orderbook that, we've already got in the bag. Now, we know what that is that's a 60% coverage for this financial year. And then we really study hard the pipeline. And as Eric said, there's a nice chunky stuff in there. There's a nice base load of smaller deals that we have to bring in and there's some nice chunky stuff that we've got there. So our job is to evaluate that pipeline and take a view on that. And quite frankly, it's no -- and when I look at all those statistics bottom up a top down they are no different from any other year sitting here at this time of the year. So that's how we arrive at that level of confidence.

[John Karidis, Numis]

Thank you. Is there anything to be said about -- a little bit more about the conversion rates and the confidence that you're getting from that particular metric?

[Eric Updyke, Chief Executive Officer]

I don't know that, I can give a heck of a lot more color other than that it really fell down significantly. I mean, it was a reliable metric in the past that really allowed us to predict with some pretty good accuracy of what was going to close in sort of the next 30 days. And we looked at what was in committed most likely in upside the different categories within our funnel, with a close date within the next 30 days, and we could predict with pretty good precision then how much is going to fall through. That fell down pretty significantly in Q4 and in Q1. It's come back not to historical levels, right? That we expect it to be at but it's moved very significantly in the right direction. I guess is, you know –

[John Karidis, Numis]

That's good to me. Thank you very much, both.

[Eric Updyke, Chief Executive Officer]

Yeah. Francois?

[Francois-Xavier Bouvignies, UBS]

Francois-Xavier Bouvignies from UBS. Seems like the new rule is three questions. So I'm going to take my chance here. I have many follow-ups to what has already been answered. So first one is on H2 you covered it well. You have a nice slide showing your H2 drivers. Could you quantify a bit more on what is the main drivers of this H2 is like from a product or end market point of view? It's like telco's positioning, Open RAN, all of these things together what are the main drivers of this H2 strong recovery? That would be helpful.

The second question is the gross margin. Indeed, Paula you said, it's a very strong performance with the top line. How should we think into H2? The gross margin development from a mix perspective pricing all of that together how should we forecast the gross margin going forward?

And then the third one is hyperscalers and Open RAN both of them. Can you talk about the revenue contribution? How much is hyperscalers today? Is it growing declining? And Open RAN you've been talking a lot about that in the last few quarters with nice deals. How big is it now Open RAN for you? And yes and the outlook for that would be great. Thank you.

[Eric Updyke, Chief Executive Officer]

How about you take one and two and I'll take three?

[Paula Bell, Chief Financial Officer]

Yes. Let's do that. Okay. So in terms of H2, it's across the portfolio is the increase if you will proportionate to the size of those businesses. So it's not just one area. I think in the pipeline when we looked at that. Each of the areas of business order book had improved in all areas, number one. And the pipeline supports the outlook there. So we're relying on across the portfolio doing more in H2. It's not depending on just one area.

In terms of the gross margin, outlook unchanged, the half year is very representative of the full year. So that would be pretty much straight line I would say. And number three to you.

[Eric Updyke, Chief Executive Officer]

Yes. So, hyperscalers and O-RAN, I mean hyperscalers too slowed down in Q4 and in Q1 as did telco. I mean the well-chronicled I think layoffs with some of the hyperscalers in that time frame. They scrutinized constrained their budgets and we saw that. That's really come back to some good health as well as I think in line with some of the rest that we're reflecting here in terms of improved conversion rate and deal activity and so forth. So we're encouraged by the direction of travel there with hyperscalers.

And around O-RAN, I think that the important thing O-RAN started, and just to remind the room, we really didn't have historically a radio testing capability and business. And so, a lot of the spend around radio network rollouts in the past we weren't the beneficiary of it so much. And so, the O-RAN opportunity is a really new and exciting space for us, because it's the first significant way in which we are participating in this new trend around what's going on with the evolution of the radio access network architecture.

And we think about it not just in the context of, I'll say, open RAN, but there's other sort of variants that are talked about virtual RAN and cloud RAN. So in the context of next-generation Radio Access Networks, there's a fundamental need to test the end-to-end performance, because there are different components that are being handled now by different vendors, more interfaces that used to be proprietary and part of a closed ecosystem that need to be tested.

And so the offering that we've come with which leverages our expertise from the core out to the edge of the network is one where we can measure end-to-end performance. And we can do it from a single user interface, which we think is a unique proposition. We launched the offering only in fourth quarter last year. We've got very good traction in terms of real wins with market leaders in this space. And it's exciting, because there's going to be many new players that weren't RAN players in the past that now have an opportunity to go after some of this business.

So it started from zero effectively. We're winning meaningful deals. I think over time it becomes a noticeable contributor. But we just have to kind of recognize that the starting point was actually zero to winning a couple of significant deals and significant not -- these are not a couple of hundred thousand dollar deals they're bigger than that, right? But long way to go I guess, because we've got the first few in the bag but a really good pipeline of incremental opportunity.

If there's no more questions in the room, let me check with the operator. Daisy, any questions on the line?

[Operator]

We do not have any questions on the conference side.

[Eric Updyke, Chief Executive Officer]

All right. If there's nothing else, thank you very much for coming braving the rain, and see you again soon. Thank you.