Earnings Call Transcript - VIAV Q4 2025

Operator, Operator

Good afternoon. My name is Bella, and I will be your conference operator today. I would like to welcome everyone to the Viavi Solutions Fiscal Fourth Quarter and Full Year 2025 Earnings Call. Today's conference is being recorded. At this time, I would like to welcome and turn the conference over to Vibhuti Nayar, Head of Investor Relations. Please go ahead.

Vibhuti Nayar, Head of Investor Relations

Thank you, Bella. Good afternoon, everyone, and welcome to Viavi Solutions Fourth Quarter and Fiscal 2025 Earnings Call. My name is Vibhuti Nayar, Head of Investor Relations for Viavi Solutions. And with me on today's call 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 the guidance that we provide during this call are valid only as of today. Viavi undertakes no obligation 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 supplementary 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. Now I would 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 fourth quarter of fiscal year 2025. Net revenue for the quarter was $290.5 million, which is at the high end of our guidance range of $278 million to $290 million. Revenue was up 2% sequentially and on a year-over-year basis, was up 15.3%. Operating margin for the fourth fiscal quarter was 14.4% at the high end of our guidance range of 12.5% to 14.5%. Operating margin decreased 230 basis points from the prior quarter and on a year-over-year basis was up 350 basis points. EPS at $0.13 was also at the high end of our guidance range of $0.10 to $0.13 and was down $0.02 sequentially. On a year-over-year basis, EPS was up $0.05. Moving on to our Q4 results by business segment. Given Viavi's revenue growth and recent acquisition, the service enablement revenue as a percent of total revenue is lower and led us to combine network enablement, NE and service enablement, SE into one reportable segment, Network and Service Enablement or NSE. The ongoing reportable two segments would be NSE and OSP. NSE revenue for the fourth fiscal quarter came in at $209.1 million which is above the midpoint of our guidance range of $203 million to $213 million. On a year-over-year basis, NSE revenue was up 14.8% as a result of strong demand for fiber lab and production products, mainly driven from the data center ecosystem as well as growth in aerospace and defense products, including the acquisition of Inertial Labs. NSE gross margin for the quarter was 62.2%, which is 10 basis points higher on a year-over-year basis. NSE's operating margin for the quarter was 4.7%, an increase of 290 basis points on a year-over-year basis. NSE operating margin was slightly lower than the midpoint of our guidance range of 4% to 6%, mainly as a result of fiscal year-end employee variable costs as well as higher R&D expenses. OSP revenue for the fourth fiscal quarter came in at $81.4 million, which is above the high end of our guidance range of $75 million to $77 million, and was up 16.6% on a year-over-year basis. The increase in revenue for the quarter was primarily a result of strength in anticounterfeiting and other products. OSP gross margin was 54.7%, up 170 basis points from the same period last year and was primarily driven by higher volume and favorable product mix. OSP margin was 39.4%, which is above our guidance range of 36% to 38% and is an increase of 460 basis points on a year-over-year basis as a result of a higher fall-through. Moving on to the full year results of fiscal year 2025. For the full fiscal year, revenue was $1.84 billion, which is up 8.4% on a year-over-year basis. The revenue growth was mainly driven by strong demand for lab and production and field products, primarily from the data centers ecosystem. This was partially offset by a decline in spend for wireless and cable products by NEMs and service providers. We also saw growth in our aerospace and defense products, including the acquisition of Inertial Labs. For OSP, we saw growth in our anticounterfeiting and other products as the industry's inventory levels normalized. Operating margin for the full year was 14.2%, up 270 basis points from fiscal year 2024 and was driven by higher revenue and favorable product mix, resulting in a higher fall-through. Full year EPS was $0.47, up $0.14 from the prior year. Moving on to the balance sheet and cash flow. Total cash and short-term investments at the end of Q4 were $429 million compared to $40.2 million in the third quarter of fiscal 2025. Cash flow from operating activities for the quarter was $23.8 million versus $26.2 million in the same period last year. During the quarter, we did not purchase any shares of our stock. For the full year, we purchased 2 million shares for about $16.4 million. We have almost $200 million remaining under our current authorized share repurchase program. In fiscal year 2025, we prioritized our capital allocation towards M&A with the acquisition of Inertial Labs and the pending acquisition of Spirent's high-speed Ethernet, network security and channel emulation business lines. The fully diluted share count for the quarter was 227 million shares, up from 224.2 million shares in the prior year and versus 227.4 million shares in our guidance for the fourth fiscal quarter. CapEx for the quarter was $5.5 million versus $3.8 million in the same period last year. CapEx for the full fiscal year was $27.8 million, versus $19.5 million in the prior year. Moving on to our first quarter guidance. Historically, Q1 is a softer quarter relative to Q4. However, we expect the first fiscal quarter revenue to be slightly up sequentially. For NSE, we expect first fiscal quarter revenue to be slightly up relative to the prior quarter, which reflects a seasonally strong quarter, driven mainly by data center ecosystem as well as aerospace and defense and offset by continued weakness in wireless. For OSP, we also expect quarter-over-quarter revenue to be slightly higher, driven by seasonally stronger 3D sensing products. For the first fiscal quarter of 2026, we expect revenue in the range of $290 million and $298 million. Operating margin is expected to be 15%, plus or minus 40 basis points and EPS to be between $0.13 and $0.14. We expect NSE revenue to be approximately $211 million, plus or minus $3 million with an operating margin of 5.8%, plus or minus 40 basis points. OSP revenue is expected to be approximately $83 million, plus or minus $1 million, with an operating margin of 38.3%, plus or minus 20 basis points. Our tax expenses for the first quarter are expected to be around $8.5 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 $5 million, and the share count is expected to be around 228.6 million shares. Our guidance does not include financial performance from our announced acquisition of certain Spirent's business lines, and we currently estimate the transaction to close by the end of September. During the fourth quarter, we successfully priced and allocated a $600 million Term Loan B, which will be used to fund the transaction at close as well as general corporate purposes. The Term Loan B will close concurrently with the transaction. Over the long term, we target a 4x gross leverage and below 3x net leverage. With that, I will turn the call over to Oleg.

Oleg Khaykin, President and CEO

Thank you, Ilan. Fiscal '25 ended on a strong note with Viavi revenue and EPS coming at the high end of our guidance. NSE revenue in fiscal Q4 grew approximately 15% year-over-year, primarily driven by strong demand from the data center ecosystem and aerospace and defense customers. More specifically, Fiber level production saw another strong quarter driven by continued strong and growing demand from the data center ecosystem. We further extended our leadership in this segment with the launch of the second-generation 1.6-terabit test solution. We expect the strong demand from the data center ecosystem to continue well into calendar '26. Our Aerospace and Defense business saw another strong quarter of growth, driven by high demand for our positioning, navigation and timing products. We expect this trend to continue throughout fiscal '26. Field instruments business continued on its gradual recovery trajectory, driven by leading service providers' fiber deployment and growing demand from the data center ecosystem. Furthermore, we expect the gradual recovery to accelerate during this fiscal year, driven by anticipated stronger fiber CapEx spend by leading North American service providers. Wireless business continues to remain a mixed bag. While we have seen healthy demand for wireless field instruments, the recovery in the infrastructure test continues to get pushed out due to the business weakness at leading wireless NEMs. We expect the infrastructure test demand to remain sluggish in the medium term. And lastly, service enablement results were in line with our expectations. Looking ahead, we expect NSE revenue to be slightly up quarter-on-quarter, driven by continued strong demand from the data center ecosystem and aerospace and defense customers. This is stronger than the traditional seasonality in the first quarter. Our diversification and growth in the data center ecosystem and aerospace and defense businesses is offsetting and mitigating the traditional revenue seasonality driven by service provider demand dynamics. Now turning on to OSP. OSP saw strong year-on-year growth driven by recovery in anticounterfeiting and other products. We expect fiscal Q1 to be slightly up quarter-on-quarter mostly driven by seasonally stronger demand for 3D sensing products. During the fourth quarter, some of our revenue was subject to newly imposed tariffs. However, we were able to largely mitigate our initial concerns over the tariffs and are comfortable in our ability to continue to manage the ongoing impact of tariffs. After 2 years of decline, fiscal '25 was a growth year for Viavi. Our diversification strategy into the data center ecosystem and aerospace and defense, combined with the stabilization and beginning of recovery in our traditional businesses drove the growth. We expect the strategy to continue driving our growth in fiscal '26. In conclusion, I would like to thank the Viavi team for their strong execution and successfully navigating the volatile macroeconomic environment during this past quarter. Additionally, I would also like to thank our customers and shareholders for their continued support. With that, I will now turn it back over to the operator for questions and answers.

Operator, Operator

Your first question comes from the line of Ruben Roy with Stifel.

Ruben Roy, Analyst

Oleg, I appreciate the results and guidance. My first question is about the guidance. Regarding the recently reported quarter, there were some tariff impacts. I wanted to inquire about the revenue side of these impacts, particularly concerning the purchase orders that were returned. How did that situation develop? Is some of this reflected in the guidance for September, considering the strength you're observing in data center and aerospace and defense? Could you clarify that for us?

Oleg Khaykin, President and CEO

Sure. Well, I mean, first of all, the impact is mostly on the North American sales, but we also have some impact from Chinese tariffs when we send some material to some of our factories in China. Overall, I mean, the whole tariff impact is around $1.5 million, which we have more than mitigated. And at this point in time, the tariffs are fully built into our pricing and also the supply chain realignment to minimize the tariffs. So I think at this point, provided nothing has changed in the last 24 hours. I mean, really, if we take Europe, Thailand and China tariffs are somewhat fixed at this point in time, we feel we are fairly comfortable we've got it all mitigated.

Ruben Roy, Analyst

Great. And then I guess, a little bit of a longer-term question just on the data center strength and 1.6T test. It sounded like from your prepared remarks that this is something that you've got some visibility into continuing well into next year. Maybe you can just talk about the competitive dynamics that you're seeing at this point and sort of customer conversations relative to 1.6T. I mean it seems like that's something that's still on the come as we think about next year and even the year after. So just wondering if you could talk about.

Oleg Khaykin, President and CEO

1.6 trillion is what you initially focus on; that's our cutting-edge products involved in advanced development. The majority of our revenue currently comes from 800 gig and 400 gig, which are in production and shipping significantly. However, I believe that 1.6 trillion is essential for entry and securing follow-on activities as the business grows. The demand remains exceptionally high, which is why we reference the data center ecosystem that includes top semiconductor vendors, leading optical module developers, and equipment manufacturers. Furthermore, the worldwide production capacity in China, Thailand, and Vietnam is geared toward creating these optical modules, switches, and products. This involvement spans the entire value chain, and you typically gain a strong foothold by achieving high performance at the leading edge. We have just launched our second-generation 1.6 terabits in the June quarter while much of our competition has only recently introduced their first generation, which gives us confidence in our position. We will continue to invest heavily and expand our reach. Additionally, the data center ecosystem is not just about lab and production test equipment; it is evolving into what I call smart buyers. They have shifted from viewing network management as an afterthought to recognizing the criticality of fiber to their performance, demanding active management. We're witnessing data centers becoming major customers for our field instrumentation or fiber monitoring equipment, a market typically served to carriers and service providers. This proportion has been increasing each quarter, which is encouraging as they see network performance as integral to their business model. They are not looking to save money by compromising quality; they are committed to investing in enhancing and optimizing network performance. We are optimistic about this trend, which is why I will increasingly refer to the data center ecosystem as it captures a rapidly growing segment for us. I wouldn't be surprised if, in a few years, this market surpasses the traditional service provider business.

Operator, Operator

Your next question comes from the line of Ryan Koontz with Needham.

Ryan Koontz, Analyst

Congrats on the quarter. I guess within NSC, could you unpack a little bit about what's going on in the end markets there across broadband, optical and wireless in the quarter? And then how you're thinking about that going into FY '26?

Oleg Khaykin, President and CEO

I would say it's primarily focused on fiber. Within NSE, we have a data center ecosystem that is driving volume today, including products like 400 gig, 800 gig, and advanced developments at 1.6 terabits. For service providers, cable is likely being delayed by one to two quarters due to various upgrade dynamics. Fiber remains a key focus, and we're noticing many specialty fiber companies concentrating on data center interconnect, along with emerging hyperscale data center operators. Major fiber interconnect and service providers in North America and Europe are steadily deploying their networks. Additionally, some North American fiber companies are making aggressive investment promises, which are starting to influence supply chain management and operations. We have several customers anticipating significant order growth in the next one to two quarters. This gives us confidence that traditional network carriers deploying fiber to homes and specialists optimizing for hyperscale and AI data center interconnect are looking quite promising. Cable deployments may see some activity in December and the March quarter, but delays are expected due to financial considerations of these operators. Wireless seems to be lagging in our portfolio, but I am optimistic about a pickup in field instruments in the December quarter as expansion continues. So far, efforts have focused more on network optimization rather than new deployments, leading to a somewhat slow demand for our infrastructure testing products among major NEMs. I expected growth to accelerate in the June quarter, but it hasn't yet, and I anticipate a couple more quarters of sluggishness before we see a turnaround. Hope that helps.

Ryan Koontz, Analyst

Great. Yes. That's really helpful and good to hear. As a follow-up on that, as you mentioned in your prepared remarks and given guidance, 1Q is going to be off from typical seasonality. How should we think about the rest of the year compared to regular seasonal be?

Oleg Khaykin, President and CEO

Well, three quarters does not establish a trend, although we noticed a much stronger March quarter. Traditionally, the September and March quarters have been weaker because service providers typically allocate their budgets at the end of February, which then carries through the rest of the year. Some service providers conclude their fiscal year in June while others in December, leading to generally stronger quarters in June and December. Interestingly, in the data center ecosystem, demand seems to be stronger in March and September, as deliveries are digested in June and December. This dynamic offsets the usual trends. Additionally, as the data center now purchases field instruments, this further mitigates the situation. The main cyclical pattern I observe is in our optical business, which follows the cycles of 3D sensing for consumers and fluctuates with anti-counterfeiting demand, which varies throughout the year. So, I wouldn't say our cyclicality is over; I just think it will be less pronounced and more balanced. In aerospace and defense, this is driven by design wins, and once a platform is secured and production begins, the orders tend to be fairly predictable for major programs. I believe the new businesses we have are growing, and we should experience less quarter-to-quarter volatility than in the past when we were heavily reliant on service providers.

Operator, Operator

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

Meta A. Marshall, Analyst

Congrats, Oleg. Just a couple of questions. Just can we just get like a rough size of the data center business in Q4 would be helpful. And then just kind of the contribution of Inertial Labs to kind of the Q1 guide would be helpful.

Oleg Khaykin, President and CEO

Let’s discuss the NSE specifically, excluding OSP for now. Currently, approximately 50% of our revenue comes from service providers, which is a significant drop from nearly 90% when I first joined the company. About 30% of our revenue comes from the data center ecosystem, which includes semiconductors, modules, equipment vendors, and data center operators, as well as some enterprise customers. The aerospace and defense sector represents around 20%. A year ago, the service provider share was likely closer to 60%, while the other segments were around 20% or less for aerospace and defense. All segments have experienced growth. The service provider segment is showing a gradual recovery and we anticipate this will accelerate in the upcoming quarters due to several large fiber deployments in the pipeline. Notably, the data center and aerospace sectors have seen substantial growth, particularly with the acquisition of Inertial Labs, which has rapidly boosted that segment. As of the end of the June quarter, the distribution was 50-30-20. Looking ahead a year from now, I expect the service provider share may decrease slightly below 50%, while the other segments will grow larger due to their faster expansion compared to the service provider sector.

Ilan Daskal, CFO

Sorry. Regarding your question, Inertial Labs, if you recall, when we announced the transaction, we mentioned around $50 million run rate a year. It's tracking above this number. However, both the fourth quarter and the number that we baked into the first quarter is also kind of including some growth from the base aerospace and defense business. It's not all about Inertial Labs.

Operator, Operator

Your next question comes from the line of Andrew Spinola with UBS.

Andrew Carl Spinola, Analyst

I wanted to ask a similar question for Q1. If we consider that the typical seasonal dip would have been around 5% from Q4 to Q1, how would you describe the factors contributing to the upside? Which segment, data center or aerospace and defense, had a bigger impact on that increase? Can you provide details on how significant each contribution was?

Oleg Khaykin, President and CEO

No, I think it's kind of getting into the segmentation that we don't disclose. So I mean, they were both very strong.

Andrew Carl Spinola, Analyst

Okay. I wanted to ask a question about margins on NSE. You're currently at low to mid-single digits for Q1. What do you think the margin can reach for NSE? What revenue would be necessary to achieve that? What are your long-term thoughts on the potential for increasing that margin?

Oleg Khaykin, President and CEO

So on NSE, as that business recovers, if you look at it, just prior to the telecom meltdown in September 2022, we approached a 20% operating margin on the NSE business unit. This was before it had significant exposure to data centers and aerospace defense. Data center margins are somewhat higher than those for field instrumentation, whereas aerospace defense margins are a bit lower, which balances each other out. Overall, NSE will likely maintain a gross margin in the low 60s. I would say that's the margin profile. As we consider our recent acquisitions and continue to grow in the data center and military sectors, along with a recovering service provider market, our initial goal is to comfortably reach mid- to high teens margins and then aim for the 20s in the longer term.

Operator, Operator

Your next question comes from the line of Mehdi Hosseini.

Mehdi Hosseini, Analyst

Yes, my follow-up questions. Oleg, it's great that you have the fiber and helps you with a better than seasonal churn into the new fiscal year. But I'm a little bit cautious as to what happens to the March quarter when cloud service providers close the calendar year. Should we see the typical seasonality that happens in September or Q1 fiscal year for you happens in the March quarter?

Oleg Khaykin, President and CEO

I fully expect that if I consider the service provider without any significant programs they want to fund, there will always be some cyclicality. Typically, service providers tend to purchase slightly less in September and March. However, if you look at the enterprise and data center segments, March and September are actually stronger quarters for them. So, while it’s difficult to eliminate any seasonality completely, I think it will become less pronounced over time. In a down quarter, you might see a slight dip or flatness in some areas. However, I believe that the growth from our new businesses will likely offset most of the seasonal variations. Additionally, if I take into account the aggressive spending plans from fiber operators and others, I would anticipate some strength in their spending that may carry over into the March quarter. Although it might be somewhat muted, it’s still too early to say definitively, as I don't have visibility into March yet. I do have a clear view for December, and it appears to be very healthy in that regard.

Mehdi Hosseini, Analyst

Got it. Okay. On OSP, it seems there's still some pressure on the ASP, especially regarding 3D sensing. I'm also looking at the margin profile for the first fiscal quarter. Am I correct in thinking this way? What measures are you taking to address this? Additionally, considering that overall OS smartphone unit shipments have been in the low single digits for the past few years, could we be nearing the bottom for 3D sensing opportunities? If there is any increase in OS unit shipments, could that help relieve the ASP pressure?

Oleg Khaykin, President and CEO

When considering the pressure on average selling prices in the 3D sensing consumer business, we've effectively managed to reduce costs. Our margins in this area have been stable, although the main challenge we face is in volume. We have a strong presence in this market segment, but it is now quite saturated. While we've been able to maintain margins by cutting costs in response to the decline in ASP, the real issue is that volume growth has stalled. This can be seen as a mixed situation; while we have established relationships with customers, if they are not experiencing significant year-over-year volume growth, then we aren't seeing increases in our business either. A more significant impact on margins comes from the mix of our anti-counterfeiting products, which oscillates between older pigment technologies and newer offerings. Depending on the time of year or our major customers, we may be producing a product mix that results in either lower or higher margins, which significantly affects gross margins from quarter to quarter. I believe that ASP has now stabilized, and our OSP revenue stream is currently around $300 million, with a slight upward trend. We are branching out into new segments and have several promising applications in development that should start generating meaningful revenue within the next two to three years, leading to growth in this segment. Thus, I see this fiscal year as one of stabilization and gradual growth, with potential for faster increases as new segments become viable for our business.

Ilan Daskal, CFO

And maybe, just to echo what Oleg said, I mean, OSP generally is a high fall-through business. And it's all volume-based. I mean the ASP is not a factor and not in our projection right now. It's all about...

Oleg Khaykin, President and CEO

And that's where we have our biggest fixed cost. I mean if you see with those factories that's a lot of iron sitting on the floor.

Mehdi Hosseini, Analyst

But Oleg, just as a quick follow-up. You're not experiencing any impact from a change in form factor, whether it's a telephone or a foldable. If you're not taking that into account, maybe there is no change in 3D sensing or you're just being conservative?

Oleg Khaykin, President and CEO

Yes. Well, I mean, we are talking about today. I mean, clearly, there's a road map. We have new products on a road map. I don't want to get into the specifics, but there is a lot of new engineering, which will probably result in some of the ASP appreciation as we implement these new form factors and some of these new opportunities because it's basically new products that need to be developed and I don't want to go into specifics on that. So right now, we're talking about mainly what we are shipping in production, not what's on the road map.

Operator, Operator

That concludes our Q&A session. I will now turn the call back over to Vibhuti Nayar.

Vibhuti Nayar, Head of Investor Relations

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

Operator, Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect. Everyone, have a great night.