Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Okay, folks. We are about to start our next session here. This is Simon Leopold, Raymond James' data infrastructure analyst here with Ciena. We've got Gary Smith, the CEO as well as from the Investor Relations team, Gregg Lampf and Erin Karney as well as my colleague, Mauricio Munoz. So fireside chat format, as you know. I've prepared some questions in advance that I'll go through and really try to set the stage of talking about some of the macro issues and then drilling down into Ciena to help folks in the audience learn more about the company.

So Gary, it's got to be tough to have to answer the same questions over and over again, but I promise I've really been listening to your answers. So I wanted to maybe start out taking an advantage of the fact that you are the likely most seasoned CEO in the sector, and I want to see if we can benefit from your experience. You joined Ciena in 1997, and you took the helm in 2001. So you've seen your fair share of cycle. So thinking about the phrase, those who fail to learn from history are doomed to repeat it. Would you maybe help folks understand what happened to Ciena during prior cycles? What you learned from the experience and how you're applying it to Ciena today?

Yes. No, I -- so I guess the 2 previous downturns, each of them have different dynamics. I think that's important to say, but -- with the telecom nuclear winter 2001 and then obviously, the global recession in 2008. I think the things that is important, and Ciena is in a very different position than we were in either of those downturns. But I think the thing to bear in mind is kind of 2 things. Focus on what you think you've got to get done to come out of this even stronger. Yes, you've got to navigate through the financial implications of the downturn, for sure. But really focus on what do you need to do to be stronger when you come out of it. And then the last 2 downturns, that's what we've been able to do with different things that we did, but basically, we invested in the downturn and others didn't, and we came out stronger because of that. It doesn't mean to say you get everything right around all those decisions. But generally speaking, I think that's the kind of lesson. And I think that works if you're in an industry that really does have good secular demand. Obviously, if that demand, you really think is going away or is going to be in a different form, then that's a different set of answers. But I don't think that's the case for our industry.

So as a sell-side analyst, I know investors cringe if I ever utter the following, but it's different this time. So cringes aside, can you help investors understand how Ciena has evolved versus the Ciena of prior cycles? What's different about the company?

Well, I think the quick summary, we're a grown-up company now. And I think the industry structure has matured. I mean, in 2001, we must have had 30 competitors; in 2008, 20; and now you've really got just 3 or 4. So the industry structure is much more rationalized than ever before. We're at a completely different scale than we were before and a much more diversified revenue base. Large parts of our revenue come from the content players. That wasn't the case before. And our geographic coverage is very strong. So I think you've got diversification scale, and we have a business model that's proven to be very robust and works. And I think the other element to it is you've got pretty much now 2 decades of proven technology leadership that we've executed on in the optical space. And we have a credibility there and a reputation and relationship with customers that's deep rooted.

And so maybe let's get to the near term. So your last earnings call was not met with a good stock reaction. But maybe for anybody who missed that, could you just remind us of maybe the snapshot of what you reported in your guidance the last earnings call?

Yes. We talked about it in the previous call, and we kind of saw some of those trends sort of amplified. We were cautious as we saw initially, as we go through the year, the COVID thing hit, the spike in demand, we had super strong orders in Q2. We knew that some of those will pull forwards of some sort, people looking for continuity of supply, et cetera, and security of supply. Sort of downtick in those orders in Q3, kind of expected, but we're seeing 2 kind of dynamics play out. One is generally a deprioritization of new business initiatives amongst the service providers. Meaning, building out new routes, taking on new architectures, et cetera. So we saw that as a dynamic come to play. And then I think that's been coupled with I describe it as sort of more economic caution by the carriers in terms of their budget spend. Not that they're slashing budgets or any of that, it's not that, it's a little subtle, but it's -- we're seeing it across the board. And that's what we reported in the quarter. We obviously had a fantastic quarter in Q3, but we took, based on that, the forecast down for Q4. And so as best we can tell, we think this is probably going to last for a couple of quarters here, as they digest some of their build-outs and inventory and run their networks harder.

And so I think the debate that's really circulated through the investment community since your earnings call is trying to discern what's macro related and what might be Ciena-specific. And I think when I listened to your conference call and your remarks, I felt that the vast majority was macro. Subsequently talking to other companies, listening to other conference calls, it seems as if there's maybe more of a balance than my first impression. And I think investors are struggling with this. So maybe with the benefit of hindsight, can you maybe help investors think about the macro versus Ciena-specific in terms of the current trends?

Yes. And I get this. I think the real answer to that is, time will tell, right, as we go through the next few quarters in Europe. But try and get out ahead of that. I mean, I think what we're seeing is -- and that's all we can talk about, really is what we're seeing. What we're seeing is certain customers are going through absorption and running their networks harder. Certain markets that we have exposure to, probably in India, is one that comes to mind, which has really kind of closed down. So we're not seeing any activity there. And that -- these kind of things manifest themselves in different ways to different companies depending on your exposure. So we can only really talk about us. But I think the company has done really well in terms of its diversification and scale over the many years now. And some of these events with particular customers or markets, frankly, on their own, we've been able to drive through and continue the growth trajectory of the company. And I think what we're seeing particularly right now is you always have those ebbs and flows of certain customers in certain markets, but we're not able to cover that. And I think as we go to the other service providers around the world, they're all sort of incrementally more cautious. And so our ability to cover that was not there. Now would you conclude from that, that some things are specific to Ciena? I mean, yes, of course. But I would also say in conversations with executives at all of these carriers, they're all -- we're seeing a familiar trend to it. And I think what's really happened, Simon, is initially, they wanted to make sure that their networks were getting the access points to all of the domestic areas, and they deprioritized the new business stuff on that, and that's kind of to be expected. They're running their networks harder. I think what we've seen more recently is an economic caution creeping to some of the service providers around their budgets. None of them are slashing their budgets, none of them are canceling projects. They're all just being incrementally more cautious. And I think that is driven by, in my conversations with them, their exposure to some of the enterprise markets where they're obviously being very impacted by the pandemic, things like hospitality, restaurants, travel, et cetera. And they are exposed to them. And I think that's what's really, I think, triggering some of the economic caution. And I think that's kind of widespread.

Yes. No, I guess, one of the aspects of this is, it sounds like it's a laundry list of factors. So it's maybe not one but many. And the last one you're mentioning here, the lower enterprise spending is not shocking. And I think if we go back to Cisco's earnings report, its commercial vertical, which is meaningful and maybe corresponds to more of the SMB, their orders were down 23% year-over-year. So Ciena's forecast is not the first we've heard about these challenges. But I guess what I'm sort of struggling with is, if that's really the case, why shouldn't this chain reaction, right, the enterprise, the law, the accounting firm not buying capacity from the operator, therefore, not buying capacity from Ciena, why shouldn't companies that also have high service provider exposure be seeing the same thing?

I think they will in various ways, but how it manifests to them would be -- and I think it's quite subtle, but it's just an increased caution around their budgets. And this may be slightly different if you're in the access market or you're in a different part of that, that might be different or if you're a smaller player in optical. It may well be different. We can only say as we find at this stage. I think I'd also say that our reporting structure, we tend to be out a quarter ahead of everybody else. We have a slightly different fiscal quarter. And it wouldn't be the first time that we've been out on our own with that kind of a commentary. And we like to be very transparent around what we see and sort of thoughtful about that. And that's why we're articulating it in this way, and time will tell how that plays out. I mean, there are clearly things that are probably directly readable on Ciena, like large India market, et cetera. But normally, we're able to blast some power through that. But I think the overall thing that we're seeing should be a general impact on folks. I mean, we're not really directly, as you say, exposed to the enterprise market, but Tier 1 carriers are. And so the knock-on economic effect of that is probably just beginning to show up.

So maybe kind of drilling down on the service provider vertical. One of the aspects we've gotten this pushback is, well, Ciena's issues are once again AT&T and Verizon. So we know from your disclosures, those are your 2 largest service provider customers. They have each at times been over 10% of revenue. In the most recent quarter, we were able to discern from your disclosures, Verizon was, my recollection, 7%, 8%; AT&T might have been 12%. But in the past, these 2 customers were probably 30%, 35% of revenue. So how do you respond to that criticism that the current issues are, your AT&T and Verizon concentration? Because it's still high relative to many other companies' exposure because they can be 10% customers.

I think that comment would be sort of pertinent 4 or 5 years ago. I think, listen, they're still very big and important customers to it. But as you say, they ebb and flow between high single-digit and double digit, as do a number of others, content players, too. So we've got a cadre of Tier 1 carriers and content players that come into that 10% thing depending on the quarter. So we've actually got good diversification for it. And frankly, you've always got 1 or 2 of them in digestion mode or going through some ebb. That's pretty normal for us. So I don't see any really different behavior that we're seeing out of any of those carriers, particularly. They're sort of normal dynamics that we would expect of the Tier 1 service providers. I mean, there's no magic to it. You just got to get a lot of these large customers, so that when one ying in, the other ones can yang. And listen, I think we've proven over the last 5, 6, 7 years that we've been able to do that. And we've been able to basically power through those kinds of events. And so I think the difference right now is that as we look into other parts of our business, it's doing okay, but nothing can cover all of the ebbs and flows that you're seeing is another way of describing that. But we've got a lot of very large Tier 1 carriers that get awfully close to those 10% threshold, including Comcast.

So maybe let's pivot this a little bit to the duration. So I know you haven't given us a forecast beyond 1 quarter, and we haven't talked explicitly about '21. I think the commentary you've offered was a few quarters, which maybe 2, maybe 3. I get that. But let's look at this in terms of analysts who are trying to think about modeling. When you think about these kinds of cycles, you talk about networks running hotter, how long can they run hotter? We also think about budget cycles. So we enter a new budget cycle, while it -- they are on calendar years, they typically don't release budget until maybe the end of January, beginning of February. So for the outside observers, what should we be thinking about and looking for as maybe the mile markers for your recovery in business?

I think, obviously, we're not talking about next year. We haven't finished this year yet. But -- and there's probably more uncertainty than we've seen for a while, generally in the economic world. I would say that I'd expect next year, as we go through it, normal seasonality. Q1's always a challenge for us for exactly the reasons you said. And we kind of straddle the December, January piece. So that's always quiet in the service provider world. I'd expect the normal seasonality for that. And it's tough to predict how long they can keep running their networks hard and absorb that inventory. I think rule #1 that I've learned from the previous downturns is they can run them hotter for longer than we all think, rule #1. Rule #2, they can't do it forever. And we talk about sort of cycles and really, the capacity demand growth has been very steady. If you map out the last 20 years, it grows at 20% to 30% a year. And that's continuing to do that. And probably this year, it may even be higher given what's happened with COVID. So -- and that really plays itself through over time. And I don't think that's going to -- the second -- another way of saying it, secular demand is very strong. It's very consistent. It's 20% to 30% a year. And this too shall come to pass. So that's our best view right now is a couple of quarters, first half of next year is probably a little challenging. But at the end of the day, we're in an industry where the demand characteristics are still very positive secularly. I don't see anything impacting that. We're all going to continue to use bandwidth and getting it faster and closer to everybody's experience. That's very good. And our leadership in this space has probably never been stronger, both in terms of the technology that's out there and what we've got coming along. And the relationships have never been stronger. So we think we're in a very good position.

So maybe let's pivot to the other interesting, exciting vertical, that's the hyperscale webscale operators. So that's now neighborhood of 25% of sales. 20 years ago, it didn't even exist. 10 years ago, it was tiny. So when we think about that, I think you have disclosed, Facebook was a 10% customer in fiscal '19. And I think you've talked about others being material, another win. But that market is a little bit different. Maybe help us understand how this group of customers is affecting Ciena, both near term and long term?

Yes. I mean, they -- this group of customers, we generally call them the content players, obviously. And I think -- and we all fall into this, talking about them homogeneously, and they're not. They're very different business models and different network architectures, et cetera. But that being said, we've got a very strong relationship now with all of the -- all of those players. We've just secured last quarter the 1 large content player that we didn't really have. So that was a great design win that we'll see start to roll through next year. So the content play has different set of dynamics, obviously, from an enterprise exposure point of view. And I think they're not as exposed in the same way as some of the service providers are to some of the challenges of the SMB market. And generally, I think they're going to have a decent year. I don't -- I think the growth that we expected going into the year was probably about 7% to 10%. I think that's probably going to be single-digit now. They're also -- one of them is actually also running the network, probably a little bit hotter. We kind of knew that. We've actually done very well with all of the other content players. So overall, that's going to be a pretty reasonable year. I do think that, talking in terms of the pandemic impact, we are aware they're having some challenges in terms of the velocity of their data center build-out, particularly internationally, has been a challenge, it slowed. So that is probably impacting the overall growth of that space. But overall, it's been -- it's going to have a pretty reasonable year. And I would expect next year to have a reasonable year, too, and get back to certainly mid-single-digit-type growth probably in that space. That's speculating a year out. But I think they're going to have a reasonable year next year.

So if you think about that group, I understand the construction issue. If there's COVID, you maybe can't build that new data center. The other aspect that we've been asked about is was there pull forward. Did they pull forward demand into the first half of the year for whatever reason, perhaps somehow linked to COVID that is sapping the second half growth?

Yes. I think you saw some of that. I think that's -- and you're spot on with that, Simon. I think that's right. You've also saw it with the major Tier 1 carriers. So you saw some of that with them, too, because they were concerned about continuity of supply because you remember then at that time we were very concerned about the supply chains. And they've just been hit with all these capacity demands, right? Because we all went back to our homes and lit up our Internet devices. And so those 2 dynamics, I think, did cause them to -- and we had a fabulous order intake in Q2 from both the GCNs and the large -- some of the large service providers. So I think as we look at it -- back at it now, I think you can clearly see that.

So I want to maybe pivot the discussion away from verticals towards technology and products, but maybe let's just step back. If you kind of look longer term, let's get past COVID, how do you think about the sustainable growth for Ciena as well as the trends towards market consolidation? The patterns we've seen over the last several years, what do you see over the next several years?