Earnings Call Transcript - VIAV Q1 2025

Operator, Operator

Hello everyone. My name is Tamika and welcome to Viavi Solutions Fiscal First Quarter 2025 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. I will now turn the conference over to Vibhuti Nayar, Viavi Solutions Head of Investor Relations. Please go ahead.

Vibhuti Nayar, Head of Investor Relations

Thank you, Tamika. Good afternoon, everyone. Welcome to Viavi Solutions fiscal first 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 PM Pacific Time this evening. With that, I would now like to turn the call over to Ilan.

Ilan Daskal, CFO

Thank you Vibhuti. Good afternoon, everyone. Now I would like to review the Results of the first quarter of fiscal year 2025. Net revenue for the quarter was $238.2 million, which is slightly below the midpoint of our guidance range of $235 million to $245 million. Revenue was down 5.5% sequentially and, on a year-over-year basis was down 3.9%. Operating margin for the first fiscal quarter was 10%, at the low end of our guidance range of 9.9% to 11.7%. Operating margin decreased 90 basis points from the prior quarter and on a year-over-year basis was down 240 basis points. EPS at $0.06 at the midpoint of our guidance range of $0.05 to $0.07 and was down $0.02 sequentially. On a year-over-year basis, EPS was down $0.03. Moving on to our Q1 results by business segment, NSE revenue for the first fiscal quarter came in at $159.4 million which is around the low end of our guidance range of $160 million to $168 million. This was mainly driven by a slower order pace from service providers for field instruments. On a year-over-year basis, NSE revenue was down 6.5%. NE revenue for the quarter was $141.6 million, which is a 5.6% year-over-year decline as a result of continued conservative spend by service providers and NEMs. SE revenue was $17.8 million and declined 12.7% from the same period last year, driven mainly by conservative spend by enterprise customers. NSE gross margin for the quarter was 60.9%, which is 270 basis points lower on a year-over-year basis. NE gross margin was 60.9%, which is a decrease of 220 basis points from the same period last year due to lower volume and product mix. SE gross margin was 60.7%, which is a decrease of 650 basis points from the same period last year as a result of lower revenue. NSE's operating margin for the quarter was negative 4.6%, which is a 550 basis point decline on a year-over-year basis. NSE operating margin was below our guidance range due to lower revenue and gross margin fall-through. OSP revenue for the first fiscal quarter came in at $78.8 million, which was above the high end of our guidance range of $75 million to $77 million, primarily driven by anticounterfeiting and 3D sensing. On a year-over-year basis, revenue was up 1.7%, driven by strength across all products. OSP gross margin was 55.3%, up 280 basis points from the same period last year and was primarily driven by higher volume. OSP's operating margin was 39.6%, which is an increase of 180 basis points on a year-over-year basis as a result of the higher gross margin fall-through. OSP operating margin exceeded the high end of our guidance range of 33% to 35%. Moving on to the balance sheet and cash flow. Total cash and short-term investments at the end of Q1 was $497.9 million compared to $496.2 million in the fourth quarter of fiscal 2024. Cash flow from operating activities for the quarter was $13.5 million versus $50.3 million in the same period last year. During the quarter, we purchased two million shares of our stock for about $16.4 million. The fully diluted share count for the quarter was 224 million shares, down from 224.2 million shares in the prior year end versus 224.2 million shares in our guidance for the first fiscal quarter. CapEx for the quarter was $7.3 million versus $6.7 million in the same period last year. Moving on to our guidance. For NSE, we are seeing signs of recovery and normalization of the seasonality trend and expect a stronger second fiscal quarter. For OSP, we expect a seasonally weaker second fiscal quarter, mainly driven by softer demand in anticounterfeiting products. We expect the near-term demand for anticounterfeiting products to be on the softer side as the end customers work down their inventories. For the second fiscal quarter of 2025, we expect revenue in the range of $255 million and $265 million. Operating margin is expected to be 12.4%, plus or minus 100 basis points and EPS to be between $0.09 and $0.11. We expect NSE revenue to be approximately $188 million, plus or minus $4 million with an operating margin of 4.8%, plus or minus 100 basis points. OSP revenue is expected to be approximately $72 million, plus or minus $1 million, with an operating margin of 32.3%, plus or minus 100 basis points. Our tax expenses for the second quarter are expected to be around $7 million, plus or minus $500,000 as a result of jurisdictional mix. We expect other income and expenses to reflect a net expense of approximately $3.5 million and the share count is expected to be around 224 million shares. With that, I will turn the call over to Oleg.

Oleg Khaykin, President and CEO

Thank you, Ilan. During the September quarter, our revenue came in at the lower end of our guidance range with stronger OSP demand partially offsetting weaker NSE demand. The EPS was at the midpoint of our guidance range. On the positive side, we are seeing many of the NSE's traditional end markets showing signs of stabilization. We believe it marks the beginning of NSE recovery and expect it will continue into the second half of fiscal '25. Now let's look in more detail at each of our businesses, starting with NSE. The NSE revenue in fiscal Q1 declined on a year-over-year basis, driven by softer demand for field instruments and wireless products. Lower September quarter demand, notwithstanding, we are seeing positive signs around order stabilization, which imply the beginning of recovery in Q2 and continuing into the second half of fiscal '25. A bit more color on the individual product segments. A decline in field instruments was driven by lower demand from North American cable and service providers. At the same time, there are signs of stabilization and improved momentum, leading to demand recovery starting in the December quarter and continuing into the second half of fiscal '25. In addition, we're also seeing stabilization in our wireless business and expect it to start recovering in the second half of fiscal '25, which is earlier than previously anticipated. Fiber level production demand was slightly down. September quarter notwithstanding, we expect to see significant growth in this business for the remainder of fiscal '25, driven by high demand for our 800 gig and recently launched 1.6 terabit fiber and high-speed Ethernet products. Our Mil/Aero business continued its robust year-on-year growth, driven by growth in mission-critical products, including communication, Avionics and P&T. Lastly, SCO was down year-on-year, primarily driven by lower enterprise customer spend. Looking ahead for NSE, we expect a seasonally stronger Q2 across all product segments with continued gradual recovery momentum in the second half of fiscal '25. Now turning to OSP. During the fiscal first quarter, OSP grew on a year-over-year basis driven by higher demand for anticounterfeiting and 3D sensing products. Overall, OSP results exceeded the higher end of our guidance. For OSP, we expect a seasonally weaker second fiscal quarter, mainly driven by softer demand for anti-counterfeiting products. We expect the near-term demand for anti-counterfeiting products to be on the softer side as the end customers work down their inventories. In summary, Q1 notwithstanding, we expect Q2 rebound to be the beginning of gradual recovery. Despite the challenging environment over the last two years, Viavi has continued to invest in advanced products and technologies to maintain our industry leadership. With that in mind, I would like to recognize the Viavi team for achieving two major milestones during the September quarter. The first milestone is the launch of the Valor Lab in Chandler, Arizona, which will provide test as a service for the open rent ecosystem. The second milestone is the release of the industry's first 1.6 terabits per second high-speed Ethernet testing for AI workloads. These two achievements position Viavi well for the leadership in wireless, data center and high-performance computing market segments. Lastly, I would like to thank our customers and shareholders for their continued support. With that, I will now turn it back to the operator for the Q&A.

Operator, Operator

Thank you. Your first question is from Ruben Roy with Stifel.

Ruben Roy, Analyst

Thank you for taking my questions. Hi Oleg and Ilan. Oleg, I appreciate the details you provided on the segments and the order momentum. Could you elaborate on the linearity throughout the quarter? Were the bookings consistent, or did they increase as the quarter progressed? I also have two quick follow-up questions. Thank you.

Oleg Khaykin, President and CEO

Sure. As we begin a new quarter, we have some backlogged orders along with anticipated new ones that should come in during the quarter. Generally, the linearity of orders was in line with our expectations; however, several major service providers indicated they would prefer to begin taking products in the second fiscal quarter, which pushed some revenue in NSE to the next period. It’s also clear that engagement in orders for Q2, Q3, and even Q4 has significantly increased, coming not just from NIMs and semiconductor vendors but also from service providers. We've observed some interesting developments recently. For the last year and a half, I mentioned what seemed like a stalemate among operators, as they all communicated reluctance to invest and spend. However, this quarter, several significant changes occurred. For example, AT&T has become very vocal and aggressive about their upcoming fiber deployment in 2025. Verizon reentered the fiber market by acquiring Frontier, which they had divested their fiber assets from around eight years ago. With major telecom players pushing into fiber, this has prompted cable providers to expedite their network upgrades to stay competitive. As a result, we’ve shifted from mere discussions to a flurry of activity related to auctions and order placements, marking a significant change in operators' behavior. Also noteworthy is that wireless operators have seemingly emerged from inactivity, beginning to discuss faster 5G densification and placing orders for field testing equipment, which usually indicates network expansion. Therefore, we expect demand from wireless NIMs in the second half of the fiscal year to be stronger than we initially thought. Last quarter, we believed recovery would happen in the middle of next calendar year, but we are now more optimistic and think it may occur in the second half of this fiscal year, which aligns with the first half of next calendar year. This pattern is also present in EMEA and other markets, and it seems that the interest rate cut in September may have been a key factor in releasing funds for network upgrades and maintenance.

Ruben Roy, Analyst

That's great. Thanks for all that detail, Oleg. And you hit on sort of my follow-up. But I guess just to make sure I understand on the wireless side and sort of the sooner-than-expected modest recovery. I was going to ask if that was sort of project-based. Obviously, we're hearing about AT&T and ORAN, but it sounds like it's broader than that. And I guess if we're thinking through that earlier-than-expected recovery as we look ahead, to the second half of your fiscal year, would you say, and maybe Ilan you could chime in, that we should think about seasonality any differently as we think about the second half? And that's all I have. Thank you.

Oleg Khaykin, President and CEO

Well, I mean, as you know, generally for us, the first fiscal quarter and third are the weaker ones. Clearly, to the extent a lot of these indications materialize in the March quarter. NSE may be a little bit stronger seasonally than it would be otherwise because we do see some of the orders, I mean, believe it or not, with this rapid auto placement, as much as there is inventory in the channel, it's never the perfect inventory in the channel and for some of the more specialized parts, we actually have lead times longer than eight to ten weeks. So that kind of puts these orders more into the March quarter rather than being able to execute them in the December quarter. So, I think it's a bit early to say, but there's definitely an opportunity for NSE to be stronger in the March quarter than normally would be.

Ilan Daskal, CFO

And Ruben, I would add that we continue, obviously, to monitor the macro environment, I mean, post-election and the kind of interest rates dynamics. I mean, Oleg mentioned earlier, the first Fed move, I mean, probably was the inflection point. But we have to see how it continues from here, and that will be another factor. So generally thinking, generally speaking, we are thinking about momentum continuing, but we have to continue to monitor the macroeconomic.

Ruben Roy, Analyst

Thank you.

Ryan Koontz, Analyst

Thank you for the question. It's promising to see carriers launching cable, fiber, and even wireless services, which is quite unexpected. Could you elaborate on your comments regarding Europe? It seems there is some progress there. Additionally, I'd like to ask about your 1.6 opportunity with data centers and AI developments. Could you explain those a bit more for us? Thank you.

Oleg Khaykin, President and CEO

Sure. Let's break it down into two parts, Ryan. There are no freebies, but feel free to ask anything. Regarding EMEA, it was never as challenging as North America, but we do observe that the fiber rollout remained stable due to significant government support in Europe. However, the wireless sector faced substantial difficulties in Europe. On the positive side, fiber continues to perform reasonably well in Europe, and we see improvements in North America. It's noticeable that European carriers often emulate what is happening in North America; when the U.S. sees a decline, Europe tends to follow suit, and vice versa. This reflects a bit of a herd mentality. As for the 1.6 terabit systems, this growth is predominantly fueled by AI and the needs of data centers. Interestingly, up until 400 gigabits per second, telecom operators drove demand, with a typical transition from one technology to the next taking about four to six years, such as moving from 100 gig to 400 gig. However, we are now observing that with data centers, this transition accelerates to about two to four years. The ramp-up is quick, especially with 800 gig, and there is considerable design activity pushing us to start sampling the 1.6 terabits. While telecoms were the primary drivers for 400-gig deployment, the current push for 800 gig and 1.6 terabits is driven entirely by chip vendors, module vendors, and system vendors responding to data center operators focusing on AI. In fact, we've already made some sales this quarter of the 1.6 terabit systems to leading equipment and semiconductor companies. I anticipate this momentum will continue to grow into next year, with 800 gig now entering high-volume production.

Ryan Koontz, Analyst

Are these at the 1.6, are they new customers to you or customers you've always had? They are just taking a bigger slice of the pie.

Oleg Khaykin, President and CEO

It's a mix. So, it's clearly on semiconductor and NEM. These are the same customers. But what we are increasingly seeing is all the dozens of fiber optic module vendors in Asia.

Ryan Koontz, Analyst

Is that just for production then mostly from them with their module makers?

Oleg Khaykin, President and CEO

Initially, the first 1.6 is, of course, for development. And as then we'll transition into the production. I'd say probably late next calendar year. I think most of '25 will be driven by R&D CapEx for 1.6 with maybe initial production orders for 1.6 towards the end of the calendar year.

Ryan Koontz, Analyst

Got it. Super helpful. Thanks Oleg. You briefly mentioned the enterprise world, and it seems that it's still quite soft. Is that mainly related to WiFi testing? How has that environment been?

Oleg Khaykin, President and CEO

Our enterprise service assurance is primarily software. Most of our customers in this area are large financial services and healthcare institutions. We have noticed a much more cautious environment regarding enterprise software spending, especially for our core products. Even with large orders, just one or two delays can lead to significant volatility.

Ryan Koontz, Analyst

Got it. Great. That's really helpful. That's all I have for now. I'll get back in the queue if I need something.

Michael Genovese, Analyst

Great, thanks. Can you talk all about cable? How do use your exposure to cable now? And are you seeing a pickup in those orders for the next quarter and beyond?

Oleg Khaykin, President and CEO

Hi Mike, sure. Cable is moving forward with upgrades, although they've experienced some delays due to architectural, system-level, and software issues with their network vendors. It seems the process is finally gaining momentum as we saw initial sales in the September quarter, with more expected now and in the future. However, cable is becoming less significant for us as more of their orders are shifting to fiber. They are increasingly integrating into our fiber customer base, but I believe there’s likely one more cycle where we’ll still see coax testers. All our coax testers are currently hybrid fiber and copper. From what I see, many cable vendors are starting to act more like service providers, investing significantly in assurance to enhance their network performance. They are also investing more in fiber and are even outpacing some traditional fiber providers by implementing advanced optical monitoring systems, which greatly improve the availability and reliability of their fiber optic networks. Overall, we're observing cable operators elevating their game in high-performance networking. I wouldn’t be surprised if, within a year, while we’ll still refer to them as cable companies due to their origins, they become more aligned with firms like Zayo, Frontier, and other fiber operators.

Michael Genovese, Analyst

Great. Very helpful. And I also want to echo that it's great as the service provider in the U.S., certainly moving in the right direction here. That being said, 3D sensing these days gets very little attention and maybe because it's kind of boring. But let me just ask you for any update, anything we should be thinking about in re-sensing what's going on in the market there. Thanks a lot.

Oleg Khaykin, President and CEO

Sure, they remain our key customer and are performing well. However, the market is quite saturated for us. Our growth is tied to their growth. We are starting to see early adoption of 3D sensing by Android manufacturers in China, particularly in high-end models. If this technology expands into midrange and lower-end devices, it could become an exciting opportunity for us. That said, it's still too early to make any definitive statements about it.

Michael Genovese, Analyst

Appreciate it. Thank you.

Operator, Operator

Your next question is from the line of Meta Marshall with Morgan Stanley.

Meta Marshall, Analyst

Great thanks. Maybe a couple of questions. So, first question, just on, is there any changes on how we should think about kind of the run rate of the OSP business? Any changes to kind of volumes of reprints or how we think about that business? And on the second question, just on, I understand kind of enterprise commentary, but just kind of what are some of the green shoots you're seeing on the SE side of the business. Thanks.

Oleg Khaykin, President and CEO

In OSP, we view the run rate as driven primarily by our base business, which includes anti-counterfeiting and the industrial Mil/Aero segment, along with 3D sensing. I've shared insights on 3D sensing previously, and it closely follows the trends of our lead customer in that area. I don't expect significant changes going forward. Typically, we see stronger performance in the first half of the fiscal year, with some weakness in the second half, though it's not as uneven as it once was, now more like a 55-45 or 60-40 split. Regarding anti-counterfeiting, we may see some lower demand in the near term due to currency redesigns in major economies, where they prefer to deplete existing inventory before making new orders. Additionally, sanctions have affected several markets that previously generated about $7 million to $8 million annually for us. Consequently, we anticipate that spending on anti-counterfeiting will be more conservative, particularly in the first half of next calendar year. However, we expect to see new designs and products emerge once older inventory is cycled out, which should lead to a rebound to our traditional run rate. On the SC side, it's a mixed picture. The enterprise segment offers a strong margin opportunity, but we have noticed delays in customer acceptances, which has slowed spending. Conversely, there is notable momentum in telecom, especially within private networks, where we are witnessing strong business development and order activity that will convert to revenue in the second half of our fiscal year and beyond. AI ops is generating significant interest in our products, and we anticipate reaching a quarterly run rate comfortably in the 20s next year, with further growth as more customers begin to adopt the AI Ops product. Initial acceptances are expected in calendar '25, followed by geographic expansion and a wider range of domain products that we offer.

Meta Marshall, Analyst

Great. Thanks so much.

Operator, Operator

Your next question is from the line of Tim Savageaux.

Timothy Savageaux, Analyst

Okay, good afternoon. Hopefully, I don't get bounced off again here before I say congratulations on the outlook, in particular, took a while, but you do seem to be syncing up with this overall positive environment, especially around fiber spend, but more broadly as well. I mean as you look at that and what's setting up to be a strong finish to the year for most of the big carriers you might want to historically call that a budget flush, although you seem to be characterizing it as more sustained than that with visibility over multiple quarters I wonder if you could provide some color on that in terms of what you're seeing in terms of the carriers finishing the year strong, but also extending that recovery? And what kind of visibility you have there?

Oleg Khaykin, President and CEO

I believe that what we are witnessing is more of a pent-up demand rather than just a budget flush, as companies haven’t been active for two years. When they start to engage again, it may feel like a budget flush because everyone suddenly claims they need it right away, despite previously indicating no interest. However, they are quickly realizing there are lead times involved. While I wouldn’t say there’s a shortage of components, if you haven’t placed orders for a long time, you might find that you can obtain about 95% of what you need, but there will always be something that has a longer lead time. To me, this reflects a return to fundamental business operations. If they expand their networks and undertake more build-out, it’s a positive development that enhances the base business of Viavi. This, in turn, boosts our faster-growing segments, such as Avionics, Aerospace, military, and fiber lab and production businesses, which are becoming increasingly interesting. We are also starting to see customers engaging with 6G discussions for advanced development, which is promising. Additionally, the conversation around 5G densification is finally gaining momentum. Overall, we feel optimistic about NSE making significant progress.

Timothy Savageaux, Analyst

Got it. Good to hear. If I could follow up on lead times, I imagine they vary across your business. The larger machines and lab and production tests likely take a bit longer. Could you discuss the differences between field and lab lead times and provide insight into where your lead times currently stand? I assume they have been historically short on the fiber field side; is that changing, or is it primarily a logistical issue with getting the machine back in operation?

Oleg Khaykin, President and CEO

The lead times for more mainstream field products are not extensive due to the large inventory of semiconductor devices and connectors available. However, we do experience significant lead times with cutting-edge products, such as 1.6 terabit and 800 gigabit, where specific components like Serdes are in high demand. For these, lead times can range from three to six months. We advise customers interested in bleeding-edge products to place orders as soon as possible to avoid longer lead times. For leading node products, such as three nanometer and more advanced, you can expect similar lead times of about three to six months. Conversely, for products at 400 gig and below, turnaround times are relatively quick.

Operator, Operator

At this time, there are no further questions. Presenters, I'll hand the call back over to you for any closing remarks.

Vibhuti Nayar, Head of Investor Relations

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

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.