RBBN - NASDAQ

Greetings, and welcome to the Ribbon Communications Second Quarter 2025 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Fahad Najam, Senior Vice President, Investor Relations. Please go ahead.

Good afternoon, and welcome to Ribbon's Second Quarter 2025 Financial Results Conference Call. I am Fahad Najam, SVP, Corporate Strategy and Investor Relations at Ribbon Communications. Also on the call today are Bruce McClelland, Ribbon's CEO; and John Townsend, Ribbon's CFO. Today's call is being webcast live and will be archived on the Investor Relations section of our website at rbbn.com, where both our press release and supplemental slides are currently available. Certain matters we will be discussing today, including the business outlook and financial projections for the third quarter of 2025 and beyond are forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those contained in these forward-looking statements. These risks and uncertainties are discussed in our documents filed with the SEC, including our most recent Form 10-K. I refer you to our safe harbor statement included in the supplemental financial information posted on our website. In addition, we will also present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measures are included in the earnings press release we issued earlier today as well as in the supplemental financial information we prepared for this call, which again, are both available on the Investor Relations section of our website. And now I'd like to turn the call over to Bruce. Bruce?

Great. Thanks, Fahad, and welcome to the Ribbon team. Good afternoon, everyone, and thanks for joining us today to discuss our Q2 results and outlook for the rest of the year. I'm very pleased with our strong financial performance in the second quarter with revenue reaching a new all-time high for the quarter. We're tracking well in the first half of the year against the growth objectives we set with revenue year-to-date increasing 8% year-over-year and adjusted EBITDA growth year-to-date of 13% year-over-year. Demand in the North American market is very strong across both service provider and enterprise market verticals, including U.S. federal agencies as we continue to win some of the largest and most challenging voice transformation opportunities in the industry, resulting in significant growth year-over-year in our Cloud & Edge business. Our portfolio is the broadest in the market and supports an extensive number of use cases with a particular focus on elimination of legacy copper networks with modern cloud-centric unified communication systems that can be deployed either on-premise or in the cloud. Ribbon's innovation in cloud-native voice and edge routing solutions is winning customers and gaining momentum. Building on the first quarter activity, we continue to see strong investment in next-generation fiber broadband networks, resulting in very good growth in Asia Pac and North American markets. Excluding sales to Eastern Europe, our IP optical business grew by 25% year-over-year in the first quarter, and we continued that momentum with sales increasing another 14% sequentially in the second quarter. In particular, Tier 1 operators in India, such as Bharti Airtel, continue to invest in transforming their IP services network with new advanced routing platforms and adding fiber capacity to support their growing mobile networks. And in North America, we continue to expand our IP networking footprint with expanded deployments with regional service providers and critical infrastructure networks such as AEP. So the demand picture remains strong, and we continue to expect good growth this year. In the second quarter, we delivered revenue and earnings at the high end of our expectations. Revenue was up 15% year-over-year and 22% sequentially, above the high end of our guidance. Sales to service providers increased 18% year-over-year and 17% sequentially, driven by a record quarter with Verizon and strong sales to Bharti in India as well as a new logo win with a Tier 1 telecommunications operator in Southeast Asia. Enterprise revenue also increased 7% year-over-year and 34% sequentially as a result of strong sales to U.S. federal agencies and new critical infrastructure wins, including several deals that were delayed from the first quarter. Adjusted EBITDA increased 47% year-over-year, an increase of $26 million sequentially, right at the high end of our guidance. These results align with the plan we laid out at the beginning of the year. Our visibility into the second half of the year is solid with book-to-bill in the second quarter above 1.0x, similar to the last several quarters. As we anticipated, gross margin improved substantially in the quarter with a stronger mix of software and better regional profile. This was modestly below our guidance range with additional hardware shipments and professional services in the quarter. Now a little more detail on each of our operating segments. We had a great quarter in our Cloud & Edge business with sales growing 24% year-over-year and 27% sequentially. Excluding maintenance revenue, product and service sales increased 48% year-over-year. The strong growth in sales resulted in a 43% increase in adjusted EBITDA. The increased revenue in the quarter was primarily a result of higher sales to global service providers, increasing 28% year-over-year, highlighting the broad base of interest that we have in network modernization and improving efficiency. This includes our multiyear voice transformation program with Verizon, which continues to progress very well and is focused on replacing hundreds of legacy central office switches. In addition, we're working with Verizon to virtualize their existing wireline voice softswitch cores. Our solution includes our virtual C20 call controller and our Neptune router for IP traffic aggregation, resulting in significant cost savings as compared to traditional architectures. Cloud & Edge sales to enterprise customers also increased in the second quarter by 13% year-over-year and 32% sequentially, driven by strong sales to several U.S. federal agencies, including a deal that was delayed from the first quarter. As expected, Cloud & Edge gross margins declined year-over-year and were down 60 basis points sequentially due to the higher mix of professional services and hardware shipments. This included a significant number of media gateways to support the replacement of legacy TDM switches and a higher demand for enterprise edge gateways. We expect an improvement in gross margin in the second half to the more typical mid-60s for the segment with a higher mix of software and continued improved service margins. In our IP Optical segment, we had a number of notable wins in the second quarter, which drove sales up 13% sequentially and up 2% year-over-year. Excluding Eastern Europe, IP Optical sales to all other customers increased 5% year-over-year. Our footprint and presence in India continues to grow with sales up more than 40% year-over-year in this region in the second quarter. In addition to expanding the footprint of our IP routing solutions at Bharti, Tata and Vodafone Idea, we have a new win supporting the deployment of broadband Internet access in rural India. Sales in Southeast Asia were also strong with multiple new projects across the region, including a new win with a Tier 1 service provider that validates the competitiveness of our optical portfolio. We continue to see new opportunities across the region, partially due to vendor consolidation as well as the need to build networks that have no Chinese OEM equipment. IP Optical sales in North America were also a standout this quarter, growing over 45% year-over-year. We're supporting a number of market segments and use cases, including regional and rural broadband Internet expansion, critical infrastructure private secure networks for utility companies such as AEP and TDM voice network modernization and IP traffic aggregation with telecom service providers. Sales in the EMEA region were solid, up 42% sequentially and essentially flat year-over-year, mostly offsetting the loss of sales from Eastern Europe. As expected, gross margins for the IP Optical segment improved significantly in the second quarter, increasing over 700 basis points sequentially. The improvement was tied to several factors, including higher North American sales, improved product mix and margins in Asia Pac and better fixed cost absorption related to higher volume. With that, I'll turn it over to John to provide additional financial details on our second quarter results and then come back on to discuss outlook for the second half of the year. John?

Thanks, Bruce, and good afternoon, everyone. Let's begin with Q2 financial results at the consolidated level. We had an exceptional quarter, generating revenues of $221 million, an increase of 15% from the prior year and above the top end of the guidance we gave during our Q1 earnings call. Our financials clearly reflecting the operational momentum that we have built within the business. Second quarter non-GAAP gross margin was 52.1%, marginally lower than we guided due to the mix of services and higher hardware in cloud and edge and the very strong performance once again from our India team, where margins are usually a little lower. Non-GAAP operating expenses were $87 million in the quarter, reflecting the seasonality in expenses such as sales commissions and variable employee compensation, which we expect to increase in the second half. Second quarter adjusted EBITDA was $32 million, again at the top end of our guidance and an increase of $10 million or 47% year- over-year. Our non-GAAP tax rate for the quarter was 34%, and our interest expense was $11 million, including amortization of debt issuance costs. Both of these were in line with our expectations. Quarterly non-GAAP net income was $10 million compared to $9 million in the prior year. This generated a non-GAAP diluted earnings per share of $0.05, which was the same as the prior year. Our basic share count was 177 million shares, and our fully diluted share count was 180 million shares for the quarter. Now let's look at the results of our two business segments. Our Cloud & Edge business continued to deliver impressive growth in the second quarter as we executed strongly with our service provider and U.S. federal agency customers, maintaining the network transformation momentum that we've created. We generated revenues of $137 million, an increase of 24% year-over-year and up $29 million from Q1. Non-GAAP gross profit of $85 million was up 16% year-over-year, although the higher proportion of both hardware and professional services resulted in non-GAAP gross margin of 61.9%, which is down from the prior year. Adjusted EBITDA for the segment was $37 million or 27% of revenue in the quarter, a 43% improvement year-over-year. Now on to our IP Optical Networks results. We recorded second quarter revenue of $84 million, a 2% increase versus the prior year. Second quarter non-GAAP gross margin for IP Optical was within our normal range at 35.9%, up 760 basis points sequentially, but down approximately 300 basis points from the prior year, reflecting the hardware and geographical mix between those quarters. Notably, we had another excellent quarter in both India and North America. IP Optical Networks adjusted EBITDA was a loss of $5 million versus a $4 million loss in the prior year. Moving on to cash and capital expenditure. Cash from operations was a usage of $1 million in the quarter with a closing cash balance of $62 million, down $12 million from the first quarter. This was principally driven by higher working capital resulting from the sequential increase in sales and the capital expenditure and share repurchases, which I will cover momentarily. We closed the quarter with a net debt leverage ratio of 2.3x. Whilst we still need to complete our evaluation, we expect a near-term cash benefit from recent tax bill passed by Congress. The bill enables companies to return to expensing U.S. R&D tax costs as they are incurred rather than depreciating them over time, and it also permits catch-up on deferred deductions from prior periods. This will result in an estimated cash tax savings of approximately $15 million to $20 million for 2025 compared to our projections coming into the year. Total CapEx in the quarter was $6 million, including a final $2 million expenditure in relation to the new R&D facility in Israel that we mentioned last quarter. We expect normal capital expenditure for the year to be approximately $12 million to $15 million in addition to the $8 million relating to our new Israel facility. In the second quarter, we announced a new stock repurchase program to use a portion of the company's free cash flow over the next several years to repurchase up to $50 million of the company's common stock. During the quarter, we repurchased 573,000 shares under the program for a total consideration of $2.3 million. The underlying trends in our business continuing to improve, and we continue to look at ways to accelerate shareholder value creation. With that, I'll turn the call back to Bruce.

Great. Thanks, John. As we look forward to the second half of the year, the demand picture remains robust. We anticipate a seasonally stronger second half with revenue increasing 15% to 20% as compared to our first half results, similar to FY '24. We continue to project revenue in line with our full year guidance of $870 million to $890 million. Visibility to this target remains good following a first half year-to-date revenue growth of 8% and higher backlog for the rest of the year as compared to the same point last year. Similar to last year, we expect the fourth quarter to be the strongest quarter of the year given the timing of enterprise deals and service provider projects. Longer term, we're in an up cycle and gaining momentum. We're in a multiyear investment period to modernize communication networks across service providers and enterprise verticals and are in a great position to win a large share of this opportunity as we continue to innovate to leverage our entire voice and IP networking portfolio to differentiate our offering against larger entrenched competitors. And as our first half performance highlights, we continue to secure new wins with our IP optical portfolio as customers invest aggressively to keep up with the growth in traffic driven by mobile broadband, fiber network expansion and explosive data center growth. From a profitability perspective, the higher year-over-year sales support continued growth in the bottom line, although there is some potential pressure on OpEx and gross margin in the second half of the year due to the weakening U.S. dollar. On a full year basis, both gross margin and EBITDA are trending towards the lower end of our guidance range. Focusing specifically on the third quarter, we're projecting the business to look very similar to our exceptionally strong second quarter. In our Cloud & Edge segment, we're projecting revenue consistent with last year and in a similar range to the second quarter of this year. We expect higher sales to a variety of enterprise and U.S. federal customers, offsetting lower shipments this quarter to U.S. Tier 1 service providers. Verizon deployments are expected to continue at a very strong pace with strong professional service revenue, but lower equipment and software revenue this quarter. We're still early in the initial phase of this multiyear program with significant opportunity for multiple years beyond this as well as a large potential opportunity as Verizon completes their acquisition of Frontier. In the IP Optical segment, we're projecting 5% to 10% year-over-year growth in the third quarter. The key trends in this business include the following areas. In North America, we're continuing to build momentum with both critical infrastructure and regional service providers tied to the growth in fiber networks. We're also effectively leveraging our IP routing portfolio to further differentiate our voice core platform, creating opportunities to land and expand inside major service provider networks. The latest product in our innovation pipeline is our new modular Neptune 2714 router that was recently introduced. We expect to achieve general availability this quarter and have a healthy sales funnel and trials underway and have secured our first win. We expect continued momentum in Asia Pac with strong sales in India and Southeast Asia, similar to the last several quarters. Bharti, Vodafone Idea, Tata and others continue to expand network capacity, and we see additional opportunities related to expansion of rural Internet access and data center interconnect in India. And we have a lot of activity in Europe and the Middle East with both critical infrastructure and defense agency projects expanding secure command and control networks, which should contribute higher gross margins. We continue to make solid progress towards our goal of achieving a profitable contribution from our IP Optical segment, overcoming the loss of revenue from Eastern Europe, and we remain committed to achieving profitability in the near term. Overall, for the company, we expect continued improvement in gross margin in the third quarter. While there remains a lot of uncertainty over where U.S. tariffs will settle and any reciprocal trade barriers that may be implemented, at the current time, we're not projecting a material impact on our business. So based on the foregoing, for the third quarter, we're projecting revenue in a range of $213 million to $227 million and non-GAAP adjusted EBITDA in a range of $28 million to $34 million. As I mentioned earlier, the overall demand picture remains robust. And similar to last year, we expect the fourth quarter to be the strongest quarter of the year given the timing of enterprise deals and service provider projects. We are well positioned to benefit from the growing investment in fiber networks to meet the exponential increase in data consumption. And we expect the growth in our voice communications business to continue with investment across a wide range of service provider and enterprise customers. Operator, that concludes our prepared remarks, and we can now take a few questions.

[Operator Instructions] Our first question today is coming from Michael Genovese from Rosenblatt Securities.

I guess I really liked everything I heard on the conference call that you just said. So I just need a couple of things explained to me, which are, first of all, the gross margins being a little bit below expectations for the second quarter. What happened there?

Mike, so that was primarily just a shift towards a little more hardware in the Cloud & Edge segment, the shipments there. It was part of the reason we ended up at the higher end of the guidance range or above the guidance range. And so that just -- obviously just has a bit of an effect on the overall gross margin. That was the primary reason. Second, we had a little more professional services in the quarter as well associated with some of the modernization programs. So both of those have a little less overall gross margin relative to selling software, obviously.

Okay. That makes sense. And similarly, I mean, understanding you beat the second quarter on revenues and the third quarter guided a little bit below consensus, but the year basically doesn't change. But just -- I mean, I know you went through all this, but there was so much information. The idea that revenues could be sequentially down in the third quarter before obviously coming back strongly in the fourth, what's going on in the third quarter?

Yes. So if I just kind of compare it year-over-year first, so second quarter is up 15% versus second quarter last year. And then I think if you look at the midpoint of our guidance for third quarter, we'd be up about 5% relative to third quarter last year. So if you look at our full year guidance, up about 5.5% versus 2024, we're kind of off to a good start. First half of the year is up 8%. We got Q3 guided up about 5% -- and then if we have obviously a solid Q4 like we did last year, I think we're in really good shape. So that sequential kind of flatness Q2 to Q3, primarily because Q3 ended up ahead of the curve really.

Got it. And then finally, I'll just ask, obviously, the Cloud & Edge business outlook has gotten much better the last several quarters than it was previously. And it also seems like optical is doing pretty well. I just want to kind of take your temperature on the idea that Ribbon has these two kind of separate businesses and how you're feeling about that? Or if you would prefer to focus more on one business, if you could get rid of the other one. Any comments on that would be helpful.

Yes. Thanks, Mike. Well, obviously, I think we're feeling pretty good about the different elements. And you -- I know we covered a lot of material, but we mentioned that at Verizon, the voice core upgrades that we're doing, the modernization there moving to a virtual platform now includes our IP router to do the IP traffic aggregation as part of that upgrade. So it's a perfect example of how we're able to leverage the technologies between the two different businesses and really differentiate us. I don't think anybody else is doing that today. So yes, I think all things move in the right direction there.

Our next question today is coming from Ryan Koontz from Needham & Company.

Bruce, can you give us any more color on this Class 5 replacement opportunity as it applies to other large wins in the pipeline? Do you think there's international opportunities? And then what do you correlate kind of these opportunities with? Is it -- do you directly correlate it with fiber deployments and they're looking to kind of just radically reduce OpEx in a particular region? That would be helpful.

Yes. Thanks, Ryan. Yes, there's definitely a correlation between the fiber upgrade and the Class 5 upgrade, not so much because the technologies plug into each other. But typically, what we'll see is a telco continuing to push fiber deeper and deeper, moving traditional copper lines to a voice over IP, voice over fiber capability. And then for the long tail, if you will, of remaining lines, it makes a lot of sense to modernize that Class 5 switch. So they don't have to wait until the entire fiber penetration is at 100%. They're able to capture some pretty significant cost savings by basically doing the switch modernization in parallel with the fiber deployment. And as you mentioned, right, that kind of approach applies really to any wireline operator, particularly in North America, where there's a traditional Class 4, Class 5 switch architecture that's been put in place 35 years ago. As you go to Europe, the network architectures look a little bit different. You see more convergence between mobile and fixed lines through an IMS architecture, and we participate in some of those programs as well, more focused on a cloud-native implementation of our voice core, our SBC, our policy server, et cetera. So similar idea, just probably a little different architecture and implementation.

Helpful. And what's the general tone on CapEx these days, Bruce? I mean we've been hearing some relatively positive commentary around accelerated depreciation maybe starts to open up a little more CapEx in the coming quarters. Any commentary there you've heard from customers in the U.S.

Yes. It's so fresh right now, a few weeks old, and I'm not sure how many people have read the 1,000 pages of the bill yet. But clearly, that's a tailwind for the industry. As John mentioned, it benefits us being able to normally expense the R&D investments that we're making and other capital investments but even more significantly for our customers where they're able to fully expense the capital investments that they're making in the U.S. That's a huge deal. I think across the industry, billions of dollars of additional cash flow. But again, as I say, it's early, I'm not sure I've heard a lot of direct dialogue on it other than, obviously, Mr. Stankey was pretty vocal on that on his call today.

Yes, exactly. Great. And then on the -- maybe last question, and I'll pass it on. But commentary on private networks. I know you guys are pretty strong in Europe and some U.S. government projects. Any kind of broad commentary on what's the spending environment like around voice and even optical and routing in the enterprise?

Yes, great question. So we -- in North America, kind of have two different initiatives, one focused on voice modernization with many of the large DoD agencies and have a really great pipeline and a series of programs going there. And we are fairly early, but now starting to see a number of key wins in the U.S. for critical infrastructure, energy companies, transportation, those sorts of areas. And we think that's a big opportunity for us because we haven't done a lot in that space historically. In Europe...

By channel, Bruce? Sorry to interrupt.

Yes. No, good question. Certainly, the -- any of the government-related programs are through channels. Typically, you're going through a series of large system integrators and kind of specialty providers. There has been kind of obviously a renewed focus in that space around making sure every dollar that's spent is being very efficiently used and trying to reduce the amount of overhead and getting technology into the hands of the agencies and kind of streamlining that whole sales process. In the short term, that kind of, I think, delays decisions a little bit. But in the longer term, I think it really plays to the strength of the technology OEMs and makes our products more cost effective and achieves the goals that the government is trying to focus on here. So I think in Europe, obviously, there's a large step-up in spending around defense spending across Europe today. Countries like Germany and several others are going to spend and invest a lot more around defense than they have in the past. We've got a series of customers in that region that are really strong businesses for us in Israel and Switzerland and Finland. And we're really looking to expand our presence there in both data transport as well as in voice modernization. So I think we'll invest more there and try and replicate some of the success we've had here in the U.S.

Next question is coming from Dave Kang from B. Riley Securities.

First question is, did you guys have any FX impact?

Yes. Dave, John can probably comment a little more. Yes, we definitely see the weakening U.S. dollar as a headwind from an OpEx perspective. And, John, what was the impact in second quarter?

So in the second quarter, David, it wasn't huge. Most of the sort of weakening of the dollar occurred during the second quarter. So probably on OpEx, it was about $1 million in the second quarter. But clearly, as you look forward for the rest of the year, then if everything stays as it is, and all of this is relative to the -- our expectations at the start of the year and the guidance we set there. We do see headwinds roughly around $2 million a quarter. And that really depends if the current exchange rates hold. And the current we're seeing the pressure from the shekel, the euro and the Canadian dollar in particular. So obviously, the one thing I can say is the exchange rates won't stay where they are, but it's just -- but if they do, then that's the likely impact.

Got it. And then regarding gross margins, it sounds like you're guiding third quarter gross margin to increase 150 to maybe 200 bps sequentially. Just if you can go over the dynamics behind that?

Yes, that's about right. I think it's really across both of the businesses, the mix that we're seeing in the third quarter in our IP optical business should result in quarter-over-quarter improvement in that segment. And then in Cloud & Edge, as I commented, we expect less hardware shipments in the quarter and less media gateways and more of a software mix in the third quarter, which kind of moves us back to more maybe more a traditional gross margin mix is for the business. As you know, when we were awarded the Verizon contract last year, we did expect that the overall gross margin would come down as a result. Obviously, super accretive on the bottom line, but the additional services and hardware just carry a lower gross margin than software.

Got it. And my last question is, I'm just wondering if you had any order pull-ins during the quarter.

No, I think it was a pretty middle of the road, I guess, I would say, quarter for second quarter. As we look into the second half of the year, we've got obviously a strong funnel and projecting got really strong growth versus the first half. Getting the exact timing between Q3 and Q4 is always tricky, but we're pretty optimistic about the second half here, obviously.

Next question today is coming from Tim Savageaux from Northland Capital Markets.

I want to -- I think you mentioned a record quarter at Verizon. I wonder if you can be a bit more specific on that. It looks like that might take them up around 20% of revenue. I just wonder if you could talk to us in more detail on where Verizon ended up and also what the dynamics were across the rest of the service provider space, which is to say if they grew as much as it appears they did, it looks like you might have seen some growth in the rest of the service provider world. But anyway, I'll follow up from there.

Yes. Thanks, Tim. Yes, so your number is almost bang on, and you'll see it in the Q as we publish our 10% plus customers. So Verizon was, I think, a little over 20% of total sales in the second quarter. The last time we had a quarter that strong was not that long ago. Our fourth quarter was obviously very strong with them as well, but this was a little bit above that level. If you go back to kind of my commentary last quarter, we projected that. We knew we had a lot of activity, a lot of work to do in the second quarter with Verizon. And I'd say we're extremely pleased, and I think they're very pleased with how the upgrade and the modernization programs are progressing and the velocity at which we're getting after capturing the cost savings for them across their network. So going very well. As I think you've already backed into the math accurately, the other parts of our service provider business also increased in the quarter. I don't have the exact number, obviously, not as large as Verizon, but all of the other service providers increased as well in the quarter year-over-year. The one I did comment on was obviously India. We had a very strong quarter in India with the Tier 1 service providers there as well.

Great. And if I could maybe extend that commentary into Q3. I mean it sounds like high level, a little bit of the flattish guide might be a little stronger Verizon in Q2 and a little weaker in Q3. Is that a reasonable way to look at it? Is that kind of pullback material for Verizon? And then I would anticipate, given your expectations for the year that you would expect kind of a new record with them in Q4, maybe not percentage-wise, but maybe absolute dollar-wise. Just interested in your thoughts on that.

Yes. I think the Q3 commentary is accurate. I mean we have a ton of projects obviously going with them. And so we'll have a strong Q3, but we're not anticipating shipping the same amount of product that we did as we did in the second quarter. We're spending time now getting it all deployed, obviously. But we do see the diversification we have in the business, the strong enterprise set of customers, whether it's financial institutions, transportation or defense, all of those, we expect more growth in the third quarter. So we see part of the business increasing, part of it coming down. The net-net is a fairly consistent Q3 to what we just did in Q2, but up obviously, year-over-year from last year.

Great. And I think you mentioned you've got a router in there in that deployment. I think you've at least talking about the same kind of situation at AT&T last year or maybe even prior to that, sort of inserting your routing solution into the overall IP voice solution. I mean, I guess, can you give us an update there? And is that indeed the case? And I think it brings to mind the question, can you extend that into the other elements of the routing product line or the transport product line, on the optical side proper as you think about those two big U.S. carriers?

Yes. So we have, I'd say, two primary use cases where we're using the routing platform as part of our voice modernization. One is that router becomes an aggregation router basically to aggregate all of the voice core traffic, and that's a key part of that system upgrade and the reliability, the performance and everything are really crucial to make sure that 911 carrier-grade traffic continues to flow properly. So that's the first use case. The second use case is using it as an edge aggregation device, in particular, around doing circuit emulation for traditional TDM networks, TDM links. And we're seeing really a broad set of telecom customers looking at that use case or using our platform basically to help them eliminate TDM infrastructure across their metro network, move everything to an IP backbone, if you will, and where they have to continue to provide TDM interfaces, just do it at the edge. So we see really good interest or uptake around that. And as I kind of said in the commentary, I think of that as a land-and-expand strategy. And once we're deployed in a couple of different use cases, we really want to get deployed much more broadly into a broader set of edge aggregation use cases. And it's just kind of part of the longer-term strategy here to expand our market share in that space.

Our next question today is coming from Christian Schwab from Craig-Hallum Capital Group.

Bruce, this is a meaning of clarity. We talked about currency headwinds on OpEx, but I thought I heard in your prepared comments that you expected to be at the lower end of your gross margin and EBITDA range for calendar 2025 due to currency. Did I hear that correct?

Yes, exactly, Christian. So we -- as John said, there's -- if things kind of continue at the level they're at today, and of course, they'll change, we just don't know which way. But if they continue where they are today, it's about a $5 million headwind on overall earnings relative to the original guidance that we set at the beginning of the year. That's in, I'll call it, in OpEx. Obviously, we have some fixed costs also in the COGS line that goes into gross margin. So it's put some pressure on the gross margin line. That's not as significant as the OpEx impact, but definitely contributes a little bit. So overall, as we look at the rest of the year and try and project where we end, I think on earnings, we're thinking we're lower in that range than where we would normally be without that headwind.

Great. And then as it relates to Verizon strength this year, I mean, can you elaborate on your visibility or bookings or backlog outlook, however you'd like to do that with that customer for calendar 2026? Or is that too early?

Yes. No, we think next year looks like a strong year. As we had indicated last year, the original -- the initial phase of this program is a 3-year program. So we're kind of 1 year into implementation. And I know we got a ton of work to do just on what was part of the original defined program. That only does a partial portion of their network. And assuming everything is going well and no other kind of macro changes, we would certainly expect to see that continue well beyond that. You then layer in the opportunity around Frontier as that business gets integrated into the Verizon processes, we would expect very likely that they would want to implement something similar there to go after the cost infrastructure in that business. So we feel really good about the outlook going into next year with Verizon.

Our next question today is coming from Greg Mesniaeff from Kingswood Capital Partners.

Bruce, you mentioned when you talked about book-to-bill in the second quarter, you kind of gave us a general statement of greater than 1. When you look at your deferred revenues, it's a pretty interesting bump up from -- at the end of Q1 to end of this current quarter. You went from basically $23.5 million at the end of Q1 to $31.7 million at the end of this quarter, which is a much bigger pickup than from Q4 of last year, year-end of last year, $20.9 million up to $23.5 at the end of the first quarter. So obviously, deferred revenue is starting to accelerate, I guess, you could say. Is that really kind of the setup for the fourth quarter or some of that beyond? Can you just kind of give us some color on that trend?

Yes. Thanks, Greg. I think there's kind of two key aspects to our deferred revenue pipeline, if you want to think of it that way. The largest portion is associated with our maintenance and support contracts. And a large portion of those bookings tend to happen in Q4, so you see a big buildup and then that kind of bleeds off as the year progresses. But that can change depending on the timing of when we -- when those kind of contracts get renewed or implemented. The other part is associated with product and services deferred revenue. And particularly in the Cloud & Edge business, we can have larger programs that are implemented over multiple quarters, and that can definitely influence our deferred revenue number. And yes, it's definitely an indicator of obviously kind of future revenue. So an important element to look at. And as you commented on book-to-bill, again, kind of above 1x again in the quarter. I think that's the third or fourth quarter in a row we've had that, and it's particularly good to have that when we have a quarter where we beat the revenue number. So both the numerator and the denominator increased in that case.

And just a quick follow-up. You had guided to a fairly conservative gross margin trend for the third quarter, all things considered. But you also did say that the percentage of hardware sales in the second quarter was up significantly. Shouldn't we assume that at some point, you get the whole razorblade effect versus the razor, and that should give us kind of a delayed pickup in margins?

Yes. We certainly saw a little bit of that in Q2 in the IP Optical business, where our gross margins were up almost 800 basis points sequentially in Q2 with a much improved mix, particularly in Asia Pac and part of it is the razor-razorblade analogy that you've used. So if I think about the third quarter and your comment on that, there's two comparisons to think about. One is the sequential gross margin, and we expect that to improve Q2 to Q3, kind of continued improvement in gross margin given the higher mix of software and less hardware. But if you compare it year-over-year, we're still lower from a gross margin perspective year-over-year, primarily due to the increased professional services that we're doing in the business with some of these modernization programs. So a couple of different factors to think about there.

Next question today is coming from Rustam Kanga from Citizens.

One point of clarification on the comment regarding the FX headwinds in relation to the EBITDA and gross margins. the assumption there is that those rates would hold, and that's the reason for the call out. Is that fair?

Yes, that's right. Clearly, what we've seen is, as I referenced, the exchange rates moved fairly substantially during the second quarter. But so just trying to predict the rest of the year is clearly quite challenging. But they do hold, those are the rates.

Rustam, we have kind of three or four foreign currencies where we have OpEx exposure as John mentioned, India is probably the largest, Israel, India, those types of Canada, and the euro. So as we look today, what that current exchange rate is relative to when we set guidance earlier in the year, there's been a fairly material shift. It could all shift back. We just don't know.

Very clear. I appreciate it. And then secondarily, in regards to the call out or the optimism around the European defense opportunity, to what extent is that largely driven by the recently increased NATO defense budget?

So today, I would say almost none. We're exposed to other investments that are being made there that really haven't been affected by the increased NATO investment. The area that I think I'm most interested in trying to capture is really around their voice modernization, the similar programs that we're doing here with the different defense agencies. There's a similar need for those types of upgrades in Europe, and I don't think they've really started with Earnest yet. I don't know what the timing is yet, but we've certainly increased our focus there.

We reached the end of our question-and-answer session. I'd like to turn the floor back over to Bruce for any further or closing comments.

Yes. Well, thanks, operator, and thanks again for being on the call and your interest in Ribbon. We really look forward to speaking with many of you at the upcoming investor conferences that we're at and updating you on our progress. So with that, operator, thanks, and that concludes our call.