Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Good morning, everyone.

Good morning. This is Jim Suva from Citi Investment Research. I want to welcome you here to day 2 of Citi's Global Technology Conference. My name is Jim Suva. I'm the IT hardware and tech supply chain as well as telecom equipment analyst here at Citigroup Investment Research. I'm very pleased today to have Ciena joining us. I do want to reference you to please refer to the safe harbor statements that are posted on Sienna's website. They contain a lot of the risk and the factors that you can please read. We also do note there are disclosures with this. Media and press are not invited to this. So if you are media or press, you are expected to drop off immediately, and we will be going through to make sure if there's any media or press, we will exclude you from this meeting. This is for Citigroup institutional investors only. We also do note that the company does on its website have lots of things, including their recent results and outlook. And joining me on the line are both Gregg and Jim. So maybe if I can kick things off and say good morning to both of you. Can you maybe just give us a brief overview? You just very, very recently gave an updated results. And if my memory is correct, the results were much stronger than expected, but the outlook had some various things that we should factor into and be very keenly aware of, whether they be coronavirus or government shutdowns or government making it more difficult to do business. But Jim or Gregg, could you maybe update us on the recent results and the outlook so people can get their arms around what you just recently posted?

Of course, Jim. Thank you, and good morning, again, to everyone here in the Western Hemisphere. Good afternoon even to those of you in the Eastern Hemisphere. I'm very glad to be here with you and tell you a little bit about Ciena. We did announce our earnings last Thursday. We had a great quarter. We exceeded expectations on just about every financial statement metric, continuing a string of quarters which we've had and a string of great growth in taking share. In fact, we believe, based on what the analysts -- industry analysts say that we gained another point of share in the first half. However, if you are following us and have been following us for a while, you know that when we announced our second quarter, we gave a little bit of a cautionary view to the rest of the year. We've pulled in our estimates for the year at that time, although to a -- not to the level that we pulled them in this time. What has happened is that the cautionary things that we saw when we announced Q2 have continued and, in fact, have intensified. As we came through our third quarter, which ended in July, we had a significant slowdown in orders. And most of you know that our quarters are back-end loaded, so that's when we saw the biggest brunt of the reduction. It is broadly based for us. And we're assuming and we know that this is true for some of our customers with whom we've talked that the slowdown is directly or indirectly related to coronavirus. Recall that when the virus first hit, there were a lot of countries shut down and activity in the country was severely restricted. That did make it difficult in many cases for us to get to sites to implement equipment, that sort of thing. It made it impossible for us to engage personally with customers, and it started to have an effect on our business even then. Whereas a lot of countries have opened up to some extent, some more than others so that the ability to get to sites is not quite as difficult. It's still not easy to get to customers because companies have put restrictions on behavior of their employees, and many people just don't want to be in a live meeting. So that has continued. What we've seen most recently, though, is that our customers are looking at their businesses, knowing that they have dependencies upon the consumer and upon the enterprises and have proceeded very cautiously with respect to their CapEx. This is broad spread. I'd say that the one question that we've had more than any other is that other people in our business, our competitors and our peers are not seeing this slowdown. I would say that you have seen a bit, Cisco when they announced their earnings for Q3 did talk about weakness, although they are more of an enterprise and commercial supplier than they are a service provider customer. They did note the weakness in their orders. And you've seen hints of it in other places. But generally, we haven't seen a lot of corroboration among our peers and competitors with respect to what we're seeing in the market. And on reflection, we think that's because our profile of revenue is quite different from most others. We have a heavy dependence upon U.S. service providers. We have a big business with the webscale companies. In fact, we're the biggest with the webscale companies. And then we have a concentration in India. Whereas we have business in EMEA, it's not a large part of our business. And so that profile is just different from others. I will say one other thing. With respect to the webscale companies, we knew going into this year that one of our customers was going to reduce its spend because of the way they're operating their system, and we had that factored into our results. We also expected that we would gain share with others, other webscale players. All of that has played out pretty much as we expected. Industry analysts, though, are calling in the webscale spend slightly. They had them from 7% to 10% growth this year. Now they're calling low to mid-single digits. So they are pulling their projection in as we speak. They're also pulling their overall market call down to flattish, which means that if the webscalers are growing at low to mid-single digits, then the service providers are shrinking this year. So that's what I'd say. I'd also say that we're very confident that demand for bandwidth continues to grow. We've seen no indication that, that has stopped. We know that our competitive position is still the strongest in the industry. We're not losing share in any account or any significant account that we're aware of. And so we think that this is a temporary slowdown. And we think that with those 2 conditions that the service providers are going to have to spend to meet the demands on their system, they can let their systems run hot for a quarter or 2 or maybe 3, but they're going to have to spend to keep up with demand. And that's why we think that this weakness in orders that we're seeing is a short-term phenomenon. That's where I would say -- open it for questions, Jim.

Yes. Jim, that was a great overview and recap. So if I heard you correctly, and again, I know it's early in the morning, did you mention that you think that they're going to return, but it may be 1 or 2 or 3 quarters? And in your past history, has it been kind of consistent with that time frame of 1, 2 or 3 quarters or sometimes has it gone much longer? I mean I've been covering stocks through the global financial crisis and all these other recessionaries upwards and down cycles. I'm just kind of curious, is the 1 to 2 to 3 quarters in line with that? Is it longer, shorter? Just kind of trying to think about the recovery that you see versus past historical ones.

Great. One thing I'd say, I said 1 to 2 to 3 quarters, our official view is a few quarters. I didn't mean to imply that we've changed our outlook on that. I know people can take words and assume things. But our official view in our opinion is that this is a few quarters. And so I mean what we've told people that we've spoken to is we think the first half of next year is going to keep reflecting this, and hopefully, by the second half, we'll see a recovery. And that is, yes, consistent with what we've seen. In the global financial crisis of 2008, what we saw was a massive reduction in CapEx. That was a very significant global capital markets retraction. And the accompanying recession certainly caused service providers to pull in their CapEx. We saw a drop of 30% or something in our revenue from peak to the bottom. But it was 3 quarters or so, as I recall, that they were back on because demand for bandwidth continued throughout that downturn.

I have a quick question for you. I believe during your earnings call, you mentioned some countries were maybe a little more constraining with your relationships or more cautious given coronavirus, I think, whether that be India or something like that. Can you kind of update us or clarify a little bit on there? Is it just simply they're a little bit more, I don't want to say, difficult, but a little more conservative to allowing you to be going in and shipping and getting your people on the ground? Or help us understand that. Or is it like new orders that you're referring to?

Yes, very much varies by country, but there were certain countries which basically shut down. India, on whom we have a pretty significant dependency, shut down the country in, I don't recall the exact month, but March or so, March or April or so. India is a particular case in point. We've had a nice run in India. We think we're going to continue to have a good business in India. But India started the year with a couple of secular trends. One was the operators there, the big ones, Bharti and Jio, with whom we have a big business, were a little capital constrained in digesting the big spend they've had in the last few years. Secondly, there was a tax decree put on the operators in India, which caused them some consternation. Both of those secular issues were resolved around the end of last year or early this year. Both Jio and Bharti recapitalized to a significant extent. And the tax regulation was ameliorated, allowing for a payment over time. But about that same time, corona hit, and India was essentially shut down. People were not allowed to leave their houses except for 1 day a week to acquire food. So India has continued to be shut down from a telecom point of view, but they recently reopened the country for the population to move around, but the telecoms are not active in terms of spending. We -- during this period of time, they've been quite active in RFP, and we've actually won 2 or 3 pretty significant deals with those big operators, but nothing has been built to this point. The other places that were shut down were Korea and Japan. With them, we have a smaller business, but an important part of our business, and that certainly has affected us. It really varied from country to country, though. Australia and New Zealand, for example, were opened pretty quickly and remain opened to a significant extent, and we're doing okay in those countries.

And Jim, has the pandemic changed at all the demands, whether it be on data centers or the connections or even, say, for example, your lead times? Have your lead times and the demand changed at all? I know demand and lead times are different. But maybe if you can talk about has the pandemic changed in any of the way we do business?

On the supply chain, just to deal with that, I know that people would have questions about that, we did see, in the very early days of the pandemic, in fact, before it hit the West, to be honest, we did see constraints in China because China was shut down, many of the places that make technology gear and optical gear, in particular, were shut down. We did see an effect in our first quarter. We have moved our supply chain around a bit, and we're not seeing a significant supply chain restraint right now. Our lead times are good. In fact, it's funny. When we look at the metrics in our supply chain, you would say, what pandemic? So our supply chain is operating very well. I'd say that there's -- there are a couple of parts that we're having difficulty getting because of continued demand and under capacity or high capacity utilization on those particular parts, but that's not a significant part of this. With respect to demand, what has happened is that as people have changed where they work, data flows are no longer going into enterprises. They're going into residences, basically, and that's pretty much around the world. Data flows are going into residences and then out into the core. So the flows have changed. We did see on the part of many of our customers, a spend out closer to the access points of the network toward the residents to make sure that they could accommodate that demand. And so we've seen that change. But I'd say that the demand continues high and has not been affected by virus. Now when I say demand, I'm saying demand for data, demand for bandwidth. I'm not saying orders on the part of our customers. We've already commented on that.

Great. Thanks so much, Jim. When we think looking ahead, there's an 800-gig cycle coming. Can you talk to us a little bit about traction or discussions or deployments you have? And when should that kind of start to really materialize per 800 gig?

Yes. Yes. We've brought 800 gig into market early in this year. And so far, the uptake in terms of the number of customers that have purchased it is faster than any preceding generation. We have 50 customers who have purchased or ordered 800 gig -- not purchased because we'll not recognize all revenue, but ordered 50 gig -- or 800 gig, excuse me. But the take-up in terms of volume is slower than it was for 400 gig. So that -- I think that's a function of the fact that everybody is being -- many, many companies, I can't say everybody, many companies are being cautious about their spend levels. We expect that once they have a look at what their business is going to look like, once they understand what the effect of this whole recession and coronavirus is on their enterprise and consumers, customers, then they're going to start spending again, and we'll see a great uptick in 800 gig. You know, Jim, we're the only company with an 800-gig product end market. And the earliest that we'll see one is from Infinera at the end of this year or early next year, and we'll see.

Jim, there's been a lot of talk in the news and media about security. And security is really nothing new to what you do as well as national security for governments and such. But there's also been a lot about the U.S.-China tensions and also the U.S. government creating some entity lists that prohibit some companies from doing business in North America or some U.S. suppliers shipping to those, specifically the U.S. government has called out Huawei. Can you talk to us a little bit about the competitive position? It seems like that there might be a market share opportunity for you there, but I may be misspoken on that. Not necessarily here in North America, but maybe perhaps other parts of the year -- other parts of the world where Huawei maybe a more competitive offering in some of the bidding process with some of your customers or go-to-market strategies.

Yes. Yes. This U.S. administration has been particularly aggressive in its actions toward China and Huawei, in particular. And what I would say, first of all, is that we've seen on the part of mainly European, but some South American and other Asian service providers, a feeling that they were overly dependent on Huawei. This was even before the U.S. administration has become quite aggressive with Huawei. And so what we've seen is action on the part of many -- mainly European and Brazilian operators to diversify their spend away from Huawei, and we've been a beneficiary of that. Most recently, this very aggressive behavior on the part of our administration does present an opportunity for us. Now what we've seen in the series of steps that the administration has taken, they typically have stated a very aggressive policy toward Huawei, in particular, or ZTE, if you recall, a couple of years ago, and then a settlement is reached or the administration -- there are loopholes in what the administration's rules are or some other way that has allowed Huawei or ZTE to continue operating. And of course, they really can't operate in the U.S. as most -- everyone knows. But this most recent action by the administration, which states that as of September 15, Huawei will no longer be able to buy any technology or components from U.S. companies is quite telling for Huawei, and essentially, doesn't allow them to operate as an optical vendor. Now we have no idea what is actually going to come of this rule. Maybe it gets stayed, maybe it gets delayed, maybe there's a new administration when we have an election and this policy changes somewhat. But no matter what happens, we do believe that Huawei's competitive position, particularly in Europe and to some extent, in other countries, has been irretrievably damaged. I think that a big service provider is going to have to think very hard about whether or not they're willing to entrust their network to Huawei just because of the uncertainty about their ability to provide gear to them for the long term. And that is a great opportunity for us. There's a lot of people who think this is a sudden opportunity. And on September 15, all of a sudden, there's going to be this great market share available to us. We don't believe that. We know that Huawei has been stockpiling parts, and so they're going to continue to be able to operate for a while. We also know that they have a huge embedded base all over the world, and there's just no way that these service providers are going to be able to rip Huawei out of their network and replace that gear with someone else's here. That's -- it's too much money. They can't afford it. What we do see over time is a gradual availability of Huawei's market share to us and Nokia for the most part. Now we're going to have to compete for that. And Nokia has been extremely aggressive on price over the past few months, and we're going to be disciplined in the way we approach this. But we think that there's as much as somewhere between $500 million and $1 billion of Huawei market share in Europe, in particular, that is available to us. And as I say, we're not going to walk in and name our price, we're going to compete for it. But we think there's an opportunity for us over time, and we're going to take advantage of it.

And Jim, what was that number again? You think that you said [indiscernible] the potential?