Ciena Corporation (CIEN) Earnings Call Transcript & Summary

I'm going to dive right into some Q&A. And obviously, if there are questions, please go ahead and send them through, and I'll try to get to them.

Scott, maybe one of the places to start. I mean, obviously, there's a lot of questions around sort of this post-COVID world, and it seems like you navigated that fairly well in the most recent quarter. But can you talk a little bit maybe about sort of on the supply side first if you're seeing challenges there, particularly with some of the newer products that you've recently launched. And then maybe we can move over to the demand side and just sort of talk about maybe what some of the changes you've seen as a result of the COVID situation and how that's changed your outlook.

Sure, John. Thanks, and thanks for having us this morning. And good morning to everybody. We were going into our quarter 2, our February to April quarter, and we sort of tried to provide a perspective on our Q1 earnings call, how we thought the quarter might unfold and the impacts of COVID from both the supply-related perspective and a project logistics perspective on our customer side. And we kind of size that in the $30 million range of an impact. And I would say, as the quarter went on, although maybe not exactly as we expected as the virus moved around the world, the impact came in, at the end of the day, it was just about exactly on that sort of order of magnitude. I think from our perspective, on the supply side, to your question, John, just to give people a context of a little bit of high-level architecture of our supply chain, we've worked very hard over the last couple of years to build a very diverse supply chain, dealing with Tier 1 contract manufacturers around the world and working hard with them on their business continuity plans. And we're -- on the components side, to have a very diverse multi-source component ecosystem and an inventory approach all up and down the supply chain. And that has served us incredibly well in terms of, I think, faring better than most in terms of being able to continue to service our customers. As -- obviously, China started off as the news item for supply challenges that sort of, as we went through the quarter, came back to close to normal in other parts of the world. Malaysia is probably the next one that was in the news. We weren't immune to those, but all of the work that we did in the past in terms of that diversity has put us in pretty good stead. From a manufacturing perspective, we weren't directly exposed to either of those hotspots, and our manufacturing facilities remained up and running at 100%, and it was really around component supply for us. And as I said, our component inventory and multi-sourcing approaches of the past has served us incredibly well. I think as we look forward, I think the supply side of it, assuming that we don't have some significant resurgence around the world, the supply side of it abates a little bit. And what it starts to be now is more our customers' ability to consume and the pace of that going forward.

Got it. And with the recent introduction of the new 800-gig products, how, I guess, has COVID impacted that? One of the questions that I get a fair bit of, Scott, is if we saw maybe some increased pull-in of 400-gig, let's say, over the last several months as a result of demand from -- particularly from your cloud customers, your webscale customers as a result of COVID, does that perhaps push out the expected sort of adoption of 800, right? If they added more 400 today, does that push out their need for 800 a little bit further? And I know we're still very early in that evaluation process of 800-gig, but could you comment at all maybe about how that has progressed and if you think that we do run this risk of perhaps of the pull-in of 400 pushing out demand for 800?

Yes. So maybe just for some of your audience that may not be as familiar with the Ciena portfolio, we introduced what -- our next-generation optical engine, which we call WaveLogic 5 Extreme that went commercially available in our Q2. And that is, for us, the next generation of technology, 7-nanometer DSPs, our new Ciena electro optics as a front-end to that. That basically allows us to make a significant step function in optical performance for all of our customers. And that is the vehicle that we would introduce 800-gig wavelengths on, but it's also the vehicle that allows people basically to half the cost per bit if you wanted to have a single -- a simple way of thinking of it. So if you had a 400-gig application that may be able to go -- maybe it won't carry those waves a couple of hundred kilometers or whatever today, we can double that. And that comes with a tremendous economic value to our customers. So it's not just about 800-gig. It's about doing everything in the optical network better, lower cost, lower power per bit performance. So with that in mind, our existing customers that have 6500 installed base or are familiar with Waveserver, it's an easy move for them to make. So from an incumbency perspective, anybody that has significant bandwidth demand increase, has some fiber constraints and they know the 6500 in the Waveserver platforms, that's an easy step forward. And I don't think that has any impact from a COVID perspective at all. Where I could see some impact, and it's not just about 800-gig, it's generally us in the marketplace, is where we are an attacker in trying to gain share, and those share gains have to come through technology trials, RFP cycles, et cetera. Those could be somewhat slowed to some degree. But if I come back to your original question, in terms of the ramp of WaveLogic 5, we'll fill our boots, basically, on people that have an immediate demand today that I don't think will be that impacted by COVID.

Got it. Got it. And when you think about the introduction of 800, obviously, webscales -- or webscale customers have been the earlier adopters of the new higher-speed, higher-capability products. How do we think about either their demand for 400 in light of that or maybe the migration of 400 into the telco world as 800 moves a little bit more aggressively into the DCI market? Can you just sort of help us think through maybe how those 2 play off one another as we're looking out over the next 12 or 24 months?

Yes. So again, when you think about 800 gig on a wavelength, it could be multiple different options in terms of the services that are feeding it. So it could be N^100-gig or even N^10-gig services that are going on to that wavelength. And it's just the more cost-effective way to carry it wherever you're trying to carry in the network. That's one use case. The other use case would be 400-gig e-interfaces going on to that wavelength. From our perspective, the folks that will go first are the cross-section of significant bandwidth growth and some fiber constraint. If you want to think of the poster child for that intersection, it's probably some of the submarine networks around the world. The new fiber is extremely expensive and extremely long lead times, and they're seeing bandwidth demand growth from the over-the-top carriers, so they're trying to react to that. So the economic value proposition of an engine like the WaveLogic 5 is substantial. You mentioned the GCNs themselves are probably the -- in some of their application spaces would be up there as well. We've -- we were -- we basically have been commercially available now for a month. We've shipped over a dozen customers for commercial deployments in that month. And it's a smattering of the applications. Yes, it's some DCI. It's certainly some submarine, as I mentioned, but it's also -- there are Tier 1 service providers for their infrastructure now. It's in there as well. And you can kind of get a taste and the flavor for that by the 5-or-so public announcements that we've made around that. You'll see it's quite an array of the different application set.

Got it. Okay. And then as I think about how the telcos are looking at demand right now, how much do you think in terms of demand globally, Scott, is geared towards preparation for 5G and things along -- as opposed to just sort of normal maintenance work and normal upgrade that generally happens in the network? Are you seeing a real pull ahead of some of the 5G deployments that are expected later this year and certainly into '21 and '22?

So my -- I'll caveat my answer to this with a statement around, in our optical business, sometimes we sit, I'll just say, reasonably deep in the infrastructure part of the network. And it's sometimes difficult to discern exactly what is coming at us from a traffic perspective. We get better exposure to the access part of it in our packet business, and we can talk about that later, John, but I don't see the bandwidth demand that's coming at us right now as being significantly 5G-related. What I see is I look in the rearview mirror, and I see a pretty consistent bandwidth year-over-year increase in the, let's call it, the 30% year-on-year for as many seasons as you want to go back. And I think the world we live in right now in the last couple of months, it certainly has reinforced to us that -- a couple of things: number one is the network is important, starting to take its place right after air and water in terms of the importance of how we live our life; two, is the trends that we were seeing pre-COVID are reinforced and maybe, ultimately, once we get behind -- get through the uncertain times that COVID has triggered maybe is accelerated. So things like enterprise moving their workflows to the cloud. They'll be able to support a distributed workforce. Things like us using more collaboration tools and video as a way to live our lives and both our commercial and our social lives. Now those were trends that were there for the last number of years and has been driving this 30% year-over-year bandwidth increase. I think those trends continue going forward. And from an infrastructure-provider perspective, 5G is just a -- in a sense, is just a removal of one of the access constraints that will just allow that bandwidth increase to continue into the future. So I don't actually see it as -- for us, anyways, I don't see it as a 5G event. If I was a radio access network provider, that would be different. But for us, I don't necessarily see it as a 5G event.

Got it. Got it. And then maybe, Scott, if we could just spend a couple of minutes on some of the share gain opportunity that's still left out there. You gained quite a bit of share, particularly in the webscale market with really being the only provider at 400-gig commercial coherent. How do we think about that market over, say, the longer term as you shift to 800 given how much you've already won there? I don't know if there are differences, geographically you can speak to or if there's still an opportunity to gain share in that DCI market or should investors look at that as more of just an upgrade opportunity?

Yes. Maybe it's a good -- we'll walk around the world here and try to give you a flavor for both from a geographic segment and actually also from a portfolio perspective where we see the growth opportunities. So you mentioned the DCI market, and we have exposure to that market through a number of different use cases or applications. We sit in their metro DCI. We sit in their infrastructure builds, and we sit in their submarine networks. We are in a position right now where, depending on what analysts you read, we have north of 50% share of that data center interconnect across those use cases. It would be hard for me to put an argument in front of you that says, in the short term, we can substantially take a step function increase in that share. But I do feel very confident in both our incumbency. And that incumbency is back office integration. It's -- we're tied into the deploying services for them. We are sort of a partner with them when they go internationally and where they can't own infrastructure. And we have incumbency in the service providers and countries that they're trying to go through like India. There's a comfort factor that they have the same technology solution there. So although I don't see it as a step function gain in share, I don't see it as a threat either. Our expectations is we'll maintain our share in that segment. We think that segment grows faster than the overall optical market and therefore, is a bit of a rising tide for us in that SaaS segment. We have a great position in North America from a service provider perspective. Some of the logo wins that we've had in recent seasons haven't actually 100% materialized yet in terms of its impact on the P&L. So there's probably some moderate share gain that we will continue to see in the service providers in North America. And that's also true from an MSO perspective globally, not just in North America. Our recent logo wins that haven't translated necessarily into the P&L yet, you could see some share gains from. If I think of our optical market, though, the biggest opportunity for us over the long term for share gain growth is outside of North America, where our share position is not as strong as it is in North America. If I go to the packet portfolio, what you see in our packet numbers today is very dominated by a North American position and very dominated by North American wireless backhaul and North American Ethernet business services. We have significantly enhanced the portfolio. We have historically focused on Ethernet. And that has, from a historical perspective, kept us out of the wireless infrastructure business outside of North America, where the 3G decisions of many years ago went down the IP MPLS path. We didn't have portfolio to address that. We now have a significantly expanded, I believe, addressable market. As those architectural decisions come up as people look at non -- sorry, stand-alone architectures for 5G, we think we'll have a better and stronger seat at the table to try to take some share there outside of North America. So that was a long question -- a long answer, John, but try to give you a bit of a walk around the globe.

No. That was great. I appreciate that, Scott. That's actually very, very helpful. A couple of other, I guess, product areas that I wanted to touch on, and one is sort of there on the telco side. You've talked a little bit about some of that new routing opportunity or -- for new equipment that essentially is going to be placed at the base of these base stations as 5G is rolled out. I'm just curious in terms of some of either the early discussions with service providers, what do you think of the timing for some of that as a contributor to Ciena's revenue? And is that really a greenfield market in your mind? Or is it replacing, say, older edge routing equipment or something along those lines as we look out over the next several years?

Yes. It's a good question, John. Again, it goes back against where our incumbency is, and we would look at North America and, to some degree, our India position in our packet portfolio as trying to evolve that installed base into the next generation as they look at how do they actually deal with migrating their 4G traffic into a 5G world. And our solution sets around our IP portfolio allow for that migration from our existing installed base to that 5G world. Other places in the -- outside of those 2 domains, we're largely the attacker, so it's a new business opportunity for us. I really think those opportunities are probably in '21 and beyond in terms of growing that addressable market and installed base. We're introducing -- we've been building, basically, a next-generation [ I POS ] from a software capability perspective that can be deployed either as a disaggregated stand-alone software solution or it can be deployed in conjunction with our product set, our packet product set. The first set of products that are coming to market as a newly designed set of hardware that instantiates that software, we announced back in the beginning of Q2, and it was a set of portfolios, a set of routers that is optimized for 5G, front haul, backhaul, mid-haul and interface densities of a 5G infrastructure. And those will be commercially available for us in the summer, this summer. And we're quite bullish about the opportunity for us to go after some increased addressable market, both on that IP software stack but on those product specifics as well. Now I do believe some of the COVID dynamics in the short term will push some of those engagements a little bit to the right. So -- but long term, 5G is a topic that's going to be in this industry for a decade or more, and we're just starting the journey.

Got it. And maybe shifting gears to the other newer product that I think has a lot of interest amongst investors on 400ZR. You guys have talked about having your own product for that market, but can you talk a little bit about where you see that playing in the ecosystem? Do we worry at all that, that, if it's successful, displaces more valuable Waveserver-type sales for Ciena? And I guess as a result of COVID as well, do you see the ZR evaluations or the time line for ZR being pushed to the right or into '21, just given the lack of ability perhaps to run some different trials right now?

Yes. Okay. So a couple of things. So first of all, ZR, for the audience that doesn't necessarily follow the optical lingos closely, ZR is a standard that was targeted at interoperability book-ending solutions where, historically, in the optical worlds, the 2 ends of a pipe typically came from a single vendor, so you didn't worry too much about interoperability. So interoperability is one aspect of it. The second aspect of it is -- it was targeted at being a very low-power, low-footprint solution, so miniaturization of coherent optics. And the combination of those things basically has said, it is an application set that will allow you to do 400-gig on a wavelength but a very restricted reach, so let's call it 80 kilometers; and a very restricted set of sophistication -- lack of sophistication, if you like, a very simple optical network between those 2 endpoints because you just don't have the optical performance to traverse complex networks. So if you take that as the spec, what part of the application set does it really apply to? And it really applies to, very specifically, that campus portion of the data center interconnect market. It doesn't apply to the backbone infrastructure. It doesn't apply to submarine. It's the campus portion. Our perspective on the market size of that, and there's others that have sort of come up with similar sorts of numbers, say that in the fullness of time, that's probably a $500 million [ area ] of market on a backdrop of an overall optical market, that's depending on who you listen to, is $13 million or $14 billion. So it's a relatively specific targeted application. I do believe, COVID aside, that the real time frame for that, from a get-started market perspective is 2021, both from the commercial availability of the optics technology but also, it needs a next generation of data center switches in order to take advantage of that technology. So now the data center have to deploy the 400-gig data path switches in order to be able to take advantage of that technology. They're in the process of doing that, but it takes time. So I think it will be an event that starts in 2021, and it goes from there and in the fullness of time becomes about a $500 million market. We will have product with that. It will be off the backs of our WaveLogic 5 Nano technology node platform. And for us, that will be available commercially at the end of this calendar year. So right on time with the market. Now to your question of will it "cannibalize" some of the Waveserver sales, we size -- so it has that -- certainly, it has that potential to be the next step in the technology evolution for part of the Waveserver applications, and we sort of size about 1/3 of our Waveserver revenues in that potential application set. We will -- the other thing, though, just -- you didn't ask this, John, but just on the back of that, the same trend of miniaturizing coherent technology also opens up a different market space for the coherent technology that typically hadn't been available [ to coherent ] in the past, and that is basically in the service provider access network or the MSO access network. So when you -- when people start talking about 5G in terms of the infrastructure backhaul, it starts to -- the coherent optics start to be an important aspect of that, or when people talk about fiber deep on the MSO side, coherent optics, for the first time, start to be an important aspect of that. So the overall addressable market for coherent technology I see as increasing even though the very specific campus DCI piece may be in transition or part of it may be in transition to the ZR technology.

Got it. And then maybe shifting gears here because we only have a couple of minutes left, Scott. A lot of speculation, obviously, about what's going on or in the future, I guess, of Huawei's competitiveness, given some of the actions that the administration is involved in right now in trying to limit their access to some of the 5G technology. While you don't maybe compete against them directly, obviously, with 5G, they are one of the leaders alongside you in optical networking. How do you think about -- or has the tone of discussions with global operators on the service provider side changed as a result of this sort of constant pressure on Huawei over the last 12, 18 months? So do you see that changing customer behavior at all relative to perhaps choosing Huawei as a vendor in the networks?

Yes. I think -- so a couple of things. One is there's a couple of dynamics on the go, one that's been there for a while, one that's sort of emerging with, as you said, the East versus West and the U.S. government actions along that. The one that's been there for a while is -- for a number of years, Huawei did a great job in terms of gaining market share, particularly in places like Europe. You have some major customers that wake up, and they had a disproportional share of their CapEx dollars sitting in one equipment manufacturer's hands, and that was probably just an unhealthy procurement policy. And as people start to look at their next-generation network decisions, I think diversity of supply, regardless of whether or not the East or West thing was coming up, was starting to be a dialogue that you could see starting to happen. I think the U.S. government actions in the East versus West kind of divide has probably accelerated some thinking in people's minds. Although I think I -- and we've talked about this before, John, these are major infrastructure decisions that don't happen overnight, and they'll happen -- as they naturally come up, I think that dimension will have a heavier weight on the procurement decisions. I don't expect and we haven't seen a flash overnight demand to rip a bunch of Huawei gear out of my network and replace it with some Western providers' gears. That doesn't seem to be the dynamic, but you can see that filter in some of the procurement conversations around strategic next-generation infrastructure. It will just take longer than I think people think.

Got it. And then I guess, lastly here, just while we have a minute or 2, I do want to touch on margins. You put up a very strong margin this last quarter, and you talked about some fundamental, I guess, changes going forward and increased the forward-looking outlook by almost 100 basis points. Just curious if you can spend a little bit of time on whether that is more the shift towards WaveLogic 5 and a better mix as a result of that, if it's got to do with some different cost actions that are now sustainably built into the model. Just as we think about the profitability of Ciena improving over the longer term, if you can just help unpack some of the pieces within that gross margin, that would be helpful.

Yes. It's a good question. So just, I guess, the facts, we printed Q2 results and gross margins that were just above 47%. That's against the backdrop of a model that we were articulating to the outside world of our margins running in the range of 42% to 44%. And as you said, John, we did, looking at our track record over the last number of quarters, get to the point where we're comfortable of saying 100 basis points improvements is a sustainable go-forward perspective. So the new normal for us is in that 43% to 45%. What -- and what drove that is many seasons of hard rowing on cost reduction. Scale and volume helps for sure. And as you mentioned earlier in the call, we've been on a good track record of increasing our market share. Up until '17, it was sort of a point per year pretty consistently; '17 to '18, it was 2 points per year, '18 to '19, it ended up being 3 points per year. So there is more scale in the business, and that helps. But also some systemic changes in terms of how we deliver services, more automation, et cetera, has helped us improve our services margins as well and all on the mix, we feel comfortable about that 100 basis point improvement as being sustainable. Now you ask the question, okay, well, that gets me partway there to what you posted in Q2, what's the other delta. And the other delta really touches on what I mentioned earlier. We have a bunch of, I'll just say, new logo wins that are in the rearview mirror that we would have expected to take to revenue faster than has happened in 2020. And that is really a pause effect of COVID in my mind. Also, when you look in the back part of the year, we did have in our plan, I'll just say, a more aggressive perspective of how we were going to gain share. And I think in accounts where we haven't won, that new product introduction process and the engagement process has gotten a bit in the way, so that means that more of our revenue is dominated by the non-new wins. And the new wins tend to be, in the short term, a drag on the margin. So that didn't happen. That drag wasn't there. And that sort of explains the deltas between the new normal for us and what you actually saw in Q2. And we do expect some of that benefit throughout the rest of the year as well.

Got it. Well, thank you, Scott. Unfortunately, we are out of time, but I really appreciate your time this morning, and best of luck as you continue to move forward. Thank you again.

Thanks, John. Thanks for your interest. Take care.