Good day, everyone, and welcome to the VIAVI Solutions Fiscal Second Quarter 2025 Earnings Call. Just a reminder, this call is being recorded. I would now like to hand the call over to Ms. Vibhuti Nayar. Please go ahead, ma'am.

Thank you, Lisa. Good afternoon, everyone. Welcome to VIAVI Solutions fiscal second quarter 2025 earnings call. My name is Vibhuti Nayar, Head of Investor Relations for VIAVI Solutions. With me on the call today is Oleg Khaykin, our President and CEO, and Ilan Daskal, our CFO. Please note, this call will include forward-looking statements about the company's financial performance. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations and estimations. We encourage you to review our most recent annual report and SEC filings, particularly the risk factors described in those filings. The forward-looking statements, including guidance that we provide during this call, are valid only as of today. VIAVI undertakes no obligations to update these statements. Please also note that, unless we state otherwise, all results discussed on this call, except revenue, are non-GAAP. We reconcile these non-GAAP results to our preliminary GAAP financials and discuss their usefulness and limitations in today's earnings release. The release, as well as our supplemental earnings slides, which include historical financial tables, are available on VIAVI's website at www.investor.viavisolutions.com. Finally, we are recording today's call and will make the recording available on our website by 4:30 p.m. Pacific Time this evening. With that, I would now like to turn the call over to Ilan.

Thank you, Vibhuti. Good afternoon, everyone. Now I would like to review the results of the second quarter of fiscal year 2025. Net revenue for the quarter was $270.8 million, which is above the high end of our guidance range of $255 million to $265 million. Revenue was up 13.7% sequentially, and on a year-over-year basis was up 6.4%. Operating margin for the second fiscal quarter was 14.9%, significantly above the high end of our guidance range of 11.4% to 13.4%. Operating margin increased 490 basis points from the prior quarter, and on a year-over-year basis was up 170 basis points. EPS at $0.13 was also above the high end of our guidance range of $0.09 to $0.11 and was up $0.07 sequentially. On a year-over-year basis, EPS was up $0.02. Moving on to our Q2 results by business segment. NSE for the second fiscal quarter came in at $199.9 million, which was at the high end of our guidance range of $184 million to $192 million. This was mainly driven by strong order pace from service providers and NEMs for field instruments, in addition to the recovery across many of our product segments. On a year-over-year basis, NSE revenue was up 11.3%. NE revenue for the quarter was $179 million, which is up 15.1% year-over-year as a result of strong demand by service providers and NEMs for both lab and field instruments. SE revenue was $20.9 million and declined 13.3% from the same period last year, driven mainly by enterprise customers' conservative spend. NSE gross margin for the quarter was 64.8%, which is 140 basis points higher on a year-over-year basis. NE gross margin was 64.5%, which is an increase of 200 basis points from the same period last year as a result of higher volume and product mix. SE gross margin was 67.5%, which is a decrease of 140 basis points from the same period last year due to lower revenue. NSE's operating margin for the quarter was 8.7%, which is a 510 basis points increase on a year-over-year basis, and came in significantly above our guidance range of 3.8% to 5.8%, driven by higher gross margin fall through. OSP revenue for the second fiscal quarter came in at $70.9 million, which is slightly below the low end of our guidance range of $71 million to $73 million. On a year-over-year basis, revenue was down 5.3%, primarily due to weaker demand for 3D sensing products. OSP gross margin was 50.6%, down 150 basis points from the same period last year, and was primarily driven by lower volume and product mix. OSP's operating margin was 32.4%, which is a decrease of 400 basis points on a year-over-year basis as a result of low gross margin fall through. Moving on to the balance sheet and cash flow. Total cash and short-term investments at the end of Q2 was $512.8 million compared to $497.9 million in the first quarter of fiscal 2025. Cash flow from operating activities for the quarter was $44.7 million versus $20.4 million in the same period last year. CapEx for the quarter was $8.2 million versus $5.8 million in the same period last year. During the quarter, we did not purchase any shares of our stock as we prioritized our capital allocation towards M&A with the acquisition of Inertial Labs. Fully diluted share count for the quarter was 224.8 million shares, up from 223.5 million shares in the prior year and versus 224 million shares in our guidance for the second fiscal quarter. Moving on to our third fiscal quarter guidance. For NSE, we are expecting a stronger seasonality trend across most segments. For OSP, we expect softer demand for 3D sensing products. We anticipate demand for anti-counterfeiting products to start stabilizing as the end customers continue to work down their inventories. For the third fiscal quarter of 2025, we expect revenue in the range of $276 million and $288 million. Operating margin is expected to be about 14%, plus or minus 100 basis points, and EPS to be between $0.10 and $0.13. We expect NSE revenue to be approximately $207 million, plus or minus $5 million, with an operating margin of 7%, plus or minus 100 basis points. Our revenue guidance for NSE includes a high single digit million from Inertial Labs, which is in line with our previous communication of a $50 million annual revenue run rate. OSP revenue is expected to be approximately $75 million, plus or minus $1 million, with an operating margin of 33%, plus or minus 100 basis points. Our tax expenses for the third quarter are expected to be around $9 million, plus or minus $500,000 as a result of jurisdictional mix. We expect other income and expenses to reflect a higher net expense of approximately $4.2 million as a result of lower interest on cash on hand used for the Inertial Labs transaction. Lastly, the share count is expected to be around 226.1 million shares.

Thank you, Ilan. During the December quarter, our revenue and EPS came above the higher end of our guidance range. As we mentioned in prior calls, many of NSE traditional end markets have stabilized and are showing signs of gradual recovery as we enter calendar 2025. Now let's look at, in more detail, at each of our businesses starting with NSE. NSE revenue in fiscal Q2 grew year-over-year, driven by recovery and growth across many of our product segments. We expect this momentum to continue through the remainder of fiscal 2025. A bit more color on individual product segments. Fiber field saw solid demand from service providers and NEMs, particularly in fiber monitoring systems, in support of fiber network build-out. We expect this momentum to continue. As we mentioned in our prior call, we're also seeing signs of stabilization and green shoots in our wireless business, driven mostly by the resumption of 5G deployment in North America. We expect the gradual recovery to continue during the first half of calendar 2025. Fiber lab and production demand was up significantly in the December quarter, driven by growth in lab fiber and optical transport. We also shipped our first 1.6 terabit fiber product and saw continued demand for our 800 gig product, which should drive significant growth for the remainder of fiscal 2025. Our aerospace and defense business segment continued its robust year-on-year growth, driven by growth in our mission-critical products, including communications, avionics, and PNT, which stands for positioning, navigation, and timing. Earlier this week, we closed the acquisition of Inertial Labs, which strengthens VIAVI's position in the PNT space by complementing our industry-leading resilient timing technology with positioning and navigation solutions. Our expanded PNT portfolio positions us well in the high growth markets such as alternative navigation and autonomous air, land, and sea vehicles. Lastly, SE was down year-on-year, primarily driven by lower enterprise customer spend. Looking ahead for NSE, we expect a seasonally stronger Q3 across the broad base of our product portfolio, with continued recovery momentum for the remainder of fiscal 2025. Now turning to OSP. During the fiscal second quarter, OSP declined on a year-over-year basis, primarily due to lower demand for 3D sensing products. We expect fiscal Q3 to be roughly flat year-over-year, characterized by seasonally weaker 3D sensing. We continue to monitor inventory levels of anti-counterfeiting products, and we currently expect to reach demand-supply equilibrium within the next two quarters. To summarize our near-term outlook, we expect Q3 to be seasonally stronger and recovery momentum to continue through the rest of fiscal 2025. In conclusion, I would like to welcome employees of Inertial Labs to VIAVI and thank the VIAVI team for managing through the challenging environment over the past two years. Lastly, I would like to thank our customers and shareholders for their continued support. With that, I will now turn the call back to the operator for the Q&A.

We'll go first to Ruben Roy from Stifel.

Nice to see the turn, as you highlighted on the last call. I guess if we could drill down into some of the moving parts here, starting with the field demand for fiber monitoring. Can you talk a little bit about that? Is that still mostly telco service providers or are you starting to see some hyperscalers get involved with fiber monitoring?

Well, it's a combination. Clearly, on a broad base, it's the telcos because as they build out their fiber networks, it's just really the volumes game, right? Because there's so many telcos and so many of them are building out fiber, but also there are cable providers who are also building out fiber. So clearly that's driving. But the new segment emerging is really the hyperscalers who are not your traditional data center operators. They're actually putting very sophisticated fiber monitoring interfaces onto their data centers to monitor all the fiber going in and going out of their network. And part of it is really protecting the billions of dollars they're putting into those data centers and making sure that the connectivity, latency, and performance of their fiber interconnect is on par with the performance inside the data center. And that is a new phenomenon because traditionally data center operators really didn't care. They just took whatever connections they got. And today, I would say the hyperscalers have gotten extremely well-educated on the performance and strengths and weaknesses of the traditional fiber connections they've been getting. And they're taking matters into their own hands and actually paying to deploy these systems so they can hold any of their service providers accountable for the service level agreements that they are signing with them.

On the lab side, congrats on the 1.6T shipment. But if we look at 800 gig, can you talk about your visibility there? Clearly, you're talking about momentum through the end of fiscal 2025. But how are you thinking about that business, the 800 gig shipments throughout the rest of the calendar year? And can you give us a little bit of an idea of how big you think that could get as part of the NE business?

The reason I say fiscal is because we generally don't like to go beyond one, at most two quarters. Clearly, 800 gig is the workhorse that everybody is buying today, and the volume is growing pretty rapidly. 1.6 terabit is really what is entering the R&D labs at semis, NEMs, and module developers. And that's probably going to be hitting production maybe towards the end of the calendar year. We think the 800 gig will be the volume driver for this year, calendar year, and the 1.6 starting to maybe gain momentum towards the end. And there's still 400 gig shipping as well. And that's across the board about, say, traditional semis, module developers, and NEMs. On top of it, we are seeing very strong demand from module builders, the factories production testing in Asia that is largely in support of the kind of, say, 400 and 800 gig, predominantly actually growing 800 gig module demand to support the 3AI data center infrastructure.

If I could just sneak one in for Ilan on the comment around capital allocation and the M&A with the Inertial acquisition and successful closure. Maybe you can just give us an update on what your appetite for further M&A might be going forward. Is there still room for additional M&A as you look out into calendar 2025, or how are you thinking about capital allocation here?

Obviously, M&A continues to be part of our overall capital allocation model. We believe that we have more bandwidth to raise additional funding if we find the right opportunity for us. We are very focused in terms of our EPS growth for the short, mid, and long term. And that's a major driver for us in our decision-making process. And it's less about the funding, more about the specific opportunity and the EPS specifically.

I'd say if we look at our M&A potential target funnel, nobody's in there that is a bunch of PowerPoint presentations. All of the deals that we are considering and evaluating are highly profitable with a margin profile that is accretive to our overall business. Clearly, in the end, the price has to be right because one thing we are very cognizant of is we have multiple options on how to deploy our cash, and we believe in paying the right price for the right deal.

Next up is Andrew Spinola, UBS.

I was wondering if we could talk about the upside in the quarter and wondering if, when you look at it, how much of it came from your cyclical uptick in your SE business, and I'm talking specifically about NSE, versus maybe how much of the contribution came from your secular growth drivers in some of the other businesses?

I would say probably a third to a half came in from the tide that rises all boats. The service providers started to come back, crossing the T's, dotting the I's, and the fiber spend. We actually saw very interesting trends, the green shoot in wireless, with buying wireless field instruments, which indicate that somebody is planning to start doing major 5G deployment restart in the next two quarters. So that is what I would call a gradual recovery and continued recovery. The rest came really from our diversification efforts into fiber lab and production, aerospace, and defense segments where we've seen really good revenue growth and substantial margin expansion driven by volume in both of those segments.

A follow on to that. Obviously, the AI demand is driving some pretty substantial growth rates in some of the end markets that you serve. I'm trying to correlate that with your fiber lab business to try to understand what's the potential upside in that business. How much of that 50% of your growth in this quarter that came from secular came from fiber lab and just anything you can do to help me understand how big that business is that's exposed to 30%, 40% growth rate, and how big can it get?

Well, so there's two segments to the business. One is we sell advanced test equipment to the developers. So if you are developing next-generation chipsets or processors, the 400, 800 gig, 1.6 terabit bandwidth, you need those tools to aid you in the development and debugging. If you're developing modules, you need that equipment. And if you're developing systems, you need that equipment. And then there is a whole other market. So I'd say this one is growing. I wouldn't be surprised if it doubles or triples over the next three to four years because what's different here is when the telecoms were driving migration node to node, it would be about six years, six to eight years between going, let's say, from 100 gig to 400 gig, and then 400 gig to 800 gig. Now today, the evolution of technology nodes is not driven by telecom; it's driven by datacom. So as a result, you're seeing every two to three years there's a new technology node. So your product cycles are just as big, and they're happening much faster. So seeing that business doubling or tripling is fairly realistic. There is a whole other part, which is the production piece. So again, when you're doing telecom, you only deployed so many modules. Well, when you're putting fiber optic modules in the data centers, you have orders of magnitude more modules. So the demand for spectrum analyzers, power meters, and fiber inspection, all these things, that is purely a function of how many units need to be shipped. And what was interesting is when it was a 400 gig, we did not see much demand because much of it was bought or even installed by telecom service providers. When their business tanked about two years ago, all of that capacity shifted to hyperscalers. As you know, bringing out 800 gig and then just over the horizon 1.6 terabits, it’s the data center operators who are driving the deployment of that production capacity, happening at a much faster turnover pace instead of like a six-year horizon over two to three-year horizon. Again, we are very positive on that business. And then the third element here, traditionally we played in layer one, layer zero, and now we're going to layer two to layer seven. So we're also expanding the market that we're addressing within all of these applications. We feel that business unit will be a major growth driver for us in years to come.

The next question is from Ryan Koontz, Needham & Company.

I wanted to drill down on wireless if we could. This is a pretty quick rebound here. And we've heard recently some pretty optimistic signals from Ericsson and Nokia as well that are pretty aligned. But if you drill down there, do you think in terms of the operators, is this driven by capacity additions, be it small cells or rebanding of spectrum, or is it new services around the 5G core? Anything you can share there on the wireless front?

That correlates very well with what you heard from Ericsson and others. But before you get maybe orders or indications that there is going to be a restart of 5G deployment, what we saw is the placement for field instruments. And that's usually the first thing you do because you've got to equip all of your techs with equipment before you kick off a campaign. And what I believe is happening, it's really all about cost, cost, cost. And it's really accelerating conversion of 4G spectrum to 5G spectrum because it's our understanding you're seeing anywhere between an 80% to 90% drop in cost per bit when you convert the spectrum. If you want to grow the available bandwidth for your customer base, one of the cheapest things to do is just accelerate the conversion of 4G into 5G. The instruments that we are seeing, and if I look at the software downloads and codes and use cases that we provision with those instruments, it indicates to me that it’s a lot more about reclassifying spectrum from 4G to 5G. It also feeds our belief that millimeter wave is pretty challenging to execute on a mass scale. The easiest way to create bandwidth is really repurposing your 0 to 7 gigahertz spectrum. And that’s just our view on this matter. By the way, this is a North American phenomenon only. I believe Europeans will jump on it as well because they have the exact same problem: they're under massive cost pressure. That is one of the easiest ways to lower the cost of your bandwidth.

Just a quick follow up I could around your acquisition of Inertial Labs. How do you see that product fitting into your portfolio? Is it very much a standalone business unit? Is there much adjacency or synergy with the rest of your commercial activities? You've had a couple of weeks at the helm there and what's been the feedback?

Well, we just closed this deal two days ago, but we've been obviously working with them for a while. So this has been a conscious diversification for us to be less reliant on the highly volatile telecom service provider market. If I look at our core competencies, it's really communications engineering, algorithms, and truly advanced system design. When we looked at our skill set and said, well, where is there richer opportunities using this know-how? It’s aerospace and defense. The technology we have is actually generations ahead of what the traditional players are servicing the market with today. We think we can leapfrog pretty much everybody in that space. We’ve shown it with our resilient timing technology. These products are, unlike the traditional book-and-ship business in test and measurement, a very attractive margin business, you have to every quarter a significant chunk of which is a book-and-ship business. What we're talking about here in aerospace and defense, PNT, it's a design win-driven business. Once you win a module, subsystem, or product inside a larger system with tier 1 OEMs, you're done. When they go into production, they just pull all the business. That leads to much lower costs of growing revenue and profitability from a go-to-market standpoint. So you're still leveraging your engineering know-how and competence, but at a much lower go-to-market cost. I think longer term, that gives us a very nice operating margin expansion and gross margin expansion. When we acquired Jackson Labs a couple of years ago, we acquired the T in PNT. With the acquisition of Inertial Labs, we added P and T positioning, which stands for positioning and navigation. Now we can effectively deliver the whole alternative navigation modular system to any system integrator out there. The high growth in drones and the demand for alternative navigation solutions are where we are playing into.

Next up is Meta Marshall, Morgan Stanley.

Congrats on the quarter. Maybe just as a first question, you had been more optimistic about seeing some of this demand kind of return in fiscal Q3 or calendar Q1. So was this, did you just start to see some of those orders earlier than expected or starting to see it stronger than you anticipated? The second question is just kind of the recovery path that you see for the SE business and some of that business returning.

I was really looking and kind of measuring temperature of, well, even starting in the summer and really September quarter, just the tone of the likes of AT&T, Verizon, T-Mobile and all the other operators has been shifting towards, hey, we're going to increase build-outs of our fiber. And what we saw is the run for the hills has kind of converted to a market share grab mindset within those operators. That was the first inkling that, hey, we're going to start seeing things finally turning around after two years. These dialogues started in the September quarter and accelerated into the December quarter. It’s really a competitive play where nobody wants to be left behind. You saw T-Mobile getting into fiber, Verizon getting back into fiber, and AT&T accelerating fiber builds. MSOs, the cable operators are looking at it and saying, hey, wait a second, they're coming after my bread and butter, which is broadband. They are now being forced to start doing something at least in the interim before DOCSIS 4.0 shows up. By doing all of that, the wireless segment wasn't far behind. When we saw the change in all these dynamics happening, we inferred that this is the beginning of a change in the mindset we’re seeing with service providers. But we didn't see the money materializing until fiscal Q2, which is the December quarter, where we saw people putting money where their mouth was. It’s continuing into Q3, which normally is a weaker quarter because everybody doesn’t set their budgets until the end of February. But that trend is continuing into this quarter. The mere fact that we're not seeing the seasonal dip in the service provider is clearly telling us it's not a one-time fluke. One last thing to highlight is we were kind of doom and gloom up until about September on the wireless space. We didn't think much was going to happen until the middle of next year. The indication that people are starting to place significant orders for wireless field instruments indicates that they are one to two quarters away from mass deployment or restarting their 5G initiatives. We also know the kinds of software downloads you have in those instruments, and that gives us a clear indication of what kind of work people are planning to do. To emphasize, all of this pertains to North America; we’re not yet talking about Europe. I’m feeling much more optimistic on the North American landscape. Traditionally, Europeans were about three to six months behind. I do believe it will spread to Europe probably by mid-year, providing a second wave of recovery.

And next up is Tim Savageaux, Northland Capital Markets.

Congrats on the results from me as well. You touched on some of this, but I'll maybe see if I can fill in some blanks here. In terms of the carrier strength, and I know your North America revenue is quite strong sequentially in the quarter and you kind of touched on it. the strength there in fiber monitoring and carriers being principally US based, just want to confirm that. And also, whether that's really concentrated with the real big guys, the AT&Ts and Verizons of the world, or if you're seeing any broader base to that strength in the US in fiber access and fiber fields.

The fiber monitoring, ironically, it's the countries outside of the US that are the big users of fiber monitoring. They always believed in monitoring their fiber network. In North America, we are now seeing some, I would say, tier 1 players are starting to consider rolling it out in several markets. If that trend catches on, it will result in significant growth in that business. However, it's really the hyperscalers in North America. The who's who in big social media and AI are viewing fiber monitoring as an integral part of their data center build-out. If you're going to spend hundreds of billions of dollars building out data centers, you should spend at least $100 million to ensure that they are connected to something that works. They’re finding that the weak link is the interconnect between the data centers. There is already a significant bifurcation between those who can and those who can’t. There are some really next-generation fiber service providers who are putting in state-of-the-art fiber links where you monitor even dark fiber. This enables them to turn it on at a moment's notice and provide the SLA agreement needed. Of course, it is self-serving; we believe they should be doing it, but it is also making significant investments in quality of service and performance that the networks deliver. Thus, we view it as the smart money and the smart engineers deploying it. In North America, the fiber monitoring is in the early stages, and it’s typically used in a more handheld manner when building out networks, but we believe you should use it both when building and managing because it enables automation and reduces the cost of managing the network.

You did see a bit of an uptick in Europe, at least sequentially in the quarter as well. You've indicated you really haven't seen the carriers come back and I guess that's both fiber field and wireless. So should we assume that's network equipment manufacturers driving that or any other factors?

Clearly, Europe is pretty strong for us with NEMs, although a big chunk of it is wireless NEMs and they have not been that strong. We hope that the recovery in the field, wireless, maybe in one or two quarters, as they start shipping equipment into the networks, the infrastructure test equipment will also pick up. And of course, the fiber NEMs in Europe are quite strong. In Europe, there's a run rate demand that is fairly consistent. We know that, generally, Europe is about one to two quarters behind the US. When the US went into a downturn in September of 2022, Europe probably took about one or two quarters behind as well. We think that by the middle of the year, Europe should start picking up too. Fiber deployment and 5G advancements in Europe could be a second win to our field instrumentation telecom business.

Last one for me. In terms of the discussion about seasonality, and I think what you're saying is you're seeing better than seasonal. So backing out Inertial, it looks like your NE segment would be flattish to maybe down a very little bit where you might normally see, I don't know what, maybe a mid-single digit, low to mid-single digit seasonal decline typically. And you're not seeing that this year given the recovery and demand. Is that basically right?

Yeah, that's basically right. Although I wouldn't even say decline; I think it's flat to maybe even single-digit growth. And then on top of it, you have the Inertial Labs acquisition. The mix changes within that revenue. Even though the top line is flat to maybe slightly even up, the margins are a little weaker because of the mix. In some segments there is a lower margin profile than what we did in December. I would also say that first quarter is when we accrue most of our statutory expenses for the year, which is clearly the biggest drag. Some of the mix will be different though. Volume-wise, we feel NSE is going to see pretty strong—I would say a seasonally strong Q3. Generally, we drop anywhere between 5% to even sometimes 10% from Q2 to Q3. Here, we are flat to slightly even up.

We'll take the next question from Mehdi Hosseini, Susquehanna.

Oleg, it seems that the 3D sensing performance has declined this quarter, but it typically improves in the second half. Can you share your insights regarding pricing and market dynamics? Also, how does this relate to your operating segment profit guidance of $75 million for the third quarter of 2025?

Usually, if you look at the 3D sensing, the September and December quarters are bigger, and March and June are smaller. So I would say when we say seasonally weaker, we had more demand in the September quarter and some of it might have been pulled in from the December quarter. Plus, there is also some annual ASP reduction that kind of lowered the revenue, but the volumes were pretty healthy. In the second half of the fiscal year, it is pretty much in line with seasonality in 3D sensing. There are fundamentally fewer units built in the second half than in the first half. I think on the $75 million projection, we always break up core business and the 3D sensing. I think we have a pretty healthy anti-counterfeiting and industrial business, which more than offsets the decline in 3D sensing. Also, we are taking proactive measures to lower our internal inventories. We are shipping anti-counterfeiting demand from our inventories. Even though the volumes go up, we are not running the factories at full capacity, so we are not picking up the extra absorption. As a result, we'll end up with lower inventories, but we'll free up more cash. But we are not picking up maybe another 1, 2, or 3 percentage points of operating profit that we would otherwise. This is a conscious measure to really accelerate demand-supply balancing because we are seeing channel inventories are declining, and we want by the middle of the year to achieve supply-demand balance, which will make forecasting and planning our production much easier after that.

The inventory balance is a slight headwind to margin, but we consciously took that approach.

Cash is cash.

Everyone, at this time, there are no further questions, but I'd like to have him call back to Mrs. Vibhuti Nayar for any additional or closing remarks.

Thank you, Lisa. This concludes our earnings call for today. Thank you for joining everyone. Have a good afternoon.

Once again, everyone, that does conclude today's conference. Thank you for your participation. You may now disconnect.