Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Good morning. My name is Fahad Najam. I'm the senior analyst covering networking and comm equipment here at MKM. And today, it's my pleasure to have Scott McFeely, Senior Vice President of Products and Services at Ciena; and Gregg Lampf, Vice President of Investor Relations, to join us. Gentlemen, it's a pleasure to have you here. Gregg, I'm going to hand it over to you for a quick rundown of your disclaimers.

Sure. Thank you. Thanks, Fahad. We -- we're looking forward to the conversation today and speaking with folks during the day. As many of you may know, we did have our financial results call just last week on Thursday. So for those who have not taken a look, please do so. We have the earnings presentation on there as well as, of course, the transcript, press release, everything else that you would expect from us. As we have our discussion today, just as we did last week, please keep in mind that the topics that we're talking about and the way we're thinking about the future really is embedded in what our thoughts are today, and those things can change. As you look at our risk factors in our most recent 10-Q, those are important to keep in mind. We also will be filing the 10-K shortly. You should take a look at that as well for, of course, a full look of the year as well as the risk factors associated with the business then. So with that, I will pass it over to Scott for a bit of an opening, and then we'll get going with the fireside chat.

All right. Well, good morning, everybody. Fahad, first of all, thank you very much for hosting us today and letting us talk to your community. It's a pleasure. I know you have lots of topics that you want to take us to, so I'll keep my introductory remarks pretty short. As Gregg said, we're coming off of our year-end -- our fourth quarter and year-end earnings announcement. I'd summarize it as although there are a few headwinds in the short term around the COVID world, as a company, we feel like we've never been in a stronger position. And whether that is looked at through the lens of the technology and portfolio as witnessed by our recent next-generation coherent optical technology introduction with WaveLogic 5; whether that be with our market share position which, looking in the rearview mirror, we've been consistently growing global market share; or whether that be on financial strength, P&L, profitability, probably not matched in our segment and strength of balance sheet, we're very happy with, I'll just say, how our business model has held up through diversity and resilience in some challenging periods here and as witnessed by our year profitability. Although we haven't been able to net this out yet on top line growth, we have some significant, I'll call them, design wins that will show up as the macro environment improves a little bit here and show up both in terms of P&L and market share. And we -- our perspective of that is that starts to happen in the second half of our fiscal '21 as some of the COVID environment gets to be behind us. If I look through sort of the short term, we're very confident in terms of the overall secular demand for what we do. The year-over-year demand increases. And bandwidth on our customers' network has grown, for as long as I've been at this probably but certainly over the last decade, 20% to 30% bandwidth growth a year. Now obviously that's balanced by some price erosion, some markets not growing that fast. But that bandwidth growth, we sort of look through the short-term piece, we see as continuing into the foreseeable future with the same dynamics that have driven it in the past continuing. The -- and we continue -- even though there are some short-term headwinds here, we're very determined to continue to invest to come through this even stronger than the position that we're in right now. And we'll do that, though, while we maintain profitability. Maintaining profitability, it may be not necessarily top of mind for this community here but important to us. We'll also do it while we take the good -- the health and well-being of our employees into account, first and foremost in our mind, and also contribute -- do good in our communities as you've seen us do with partnership with some of our customers through things like digital inclusion, et cetera. So we're feeling very, very strong in terms of the position we sit in with some short-term headwinds that you saw in the last half of our year in terms of our financial, but we do believe those are short term. So that's sort of maybe a lead into where we want to take the fireside chat, Fahad. I'll turn it over to you to direct us where you want to go.

Okay. Thank you, Scott. And I just want to remind investors that I have plenty of questions to ask. I can probably go on for half a day, but this is your time. And so if you would like to ask questions, please enter your question in the chat session then I'll ask them on your behalf. So Scott, I think as a former network engineer myself, having spent over a decade-plus in the industry myself, I view the world is shifting from electrons to protons just driven by the nature of demand consumption increasing and the capabilities of traditional electric- or semiconductor-based ecosystem would keep up where demand is just not going to last long. So I have a very positive outlook for the optical communications market because I do think that coherent technology just becomes very pervasive not just in metro and long haul, but eventually in access and in data center. And so notwithstanding the near-term headwinds, but I just do want to -- since a significant portion of the investment community is so laser focused on the near term, can you help us understand what you are seeing in terms of the impact from COVID-19 on your customer demand trends? Why are the AT&Ts and the Verizons pulling back on CapEx when the demand for bandwidth is just increasing with everyone working from home and Zooming like we are right now? Why shouldn't they be spending more on their metro and long haul infrastructure right now?

Yes. So it's a good question, Fahad. So let me give you a sense of the conversations I have had with the executives that run these networks around the world. You said AT&T and Verizon, but the themes are pretty consistent around the world with different varyings of degree depending on where the individual's network is at, where the individual's business exposure is at. But the themes that -- were pretty consistent. One was you talk to them and every one of them will tell you that they sort of saw peak time traffic demand spikes in their network going back into the late March, early April time frame, which equates to when we all reverted into our houses and started to behave differently in terms of society. And they would put a magnitude on that spike that -- it was probably best articulated to me was they saw this 20% to 30% increase in bandwidth in their network year-on-year and they had that budgeted for this year. They saw that increase in demand happened in a 3- to 4-week window. So it went up, and then it's been relatively stable since then. What did they do to survive that demand? One is where they had spare capacity, they [ manned their network hotter ]. Two is where they had inventory, they did deploy some emergency capacity. Three is policy changes in their network in terms of how they route traffic and et cetera and even policy changes in terms of how they dealt with the applications. Favorite example is when -- a time of day when you download upgrades to your favorite game into the network. So all those things allowed them to basically survive, and it has. The networks have largely survived. They were running a little hotter and they can do that for a period of time. So that's one dynamic. Second dynamic that we saw that varies from customer to customer but pretty much every one of them did some form of, I'll just say, business continuity, which if you remember back to the March time frame, there was all kinds of press and discussion around how will global supply chains survive in the COVID world. So a number of people, pretty much every major corporation, went into business continuity mode. And in our case, we saw a lot of pull forward in terms of demand orders. People spending their budget, if you like, in order to secure supply or committing their budget in order to secure supply. How that showed up in vendors' revenue and P&L, really dependent on how their supply chain performed. If your supply chain was resilient and performing, it showed up earlier. If you had some struggles, it would show up later. But for sure, there was some commitment to spend front-end loaded in terms of the capital. The third dynamic that is difficult for us to put a number on but I think if you think about how we live our lives, a lot of the traffic has gone to -- onto the residential broadband wireline network away from the wireless network. And if there was emergency use of CapEx, it was probably to give relief in terms of those access networks. And they could run the core a little bit hotter. That can't last forever, as you know as an engineer. At some point in time, you're going to have to add -- if you're bringing more app traffic onto the network, that traffic has got to go someplace at some point in time. You got to let out the [ capacities pick up ]. The last one I would say is a little -- there's a couple of dynamics that are very specific to certain customers. If they had a customer that was very overweighted in terms of their revenue on their business-to-business, particularly the small and medium business practice, there's obviously uncertainty in that particular segment and there's a bit of a pause, I think. And those that have exposure to that, you can see that in their behaviors. The other one is very specific and don't ever admit it, but I do think with spectrum auctions coming up in the U.S., capital allocations are being scrutinized quite tightly in a couple of key accounts right now. Put all that together, has a bit of a headwind for us in the short term. But to your point earlier, there's secular demand and that demand gets served at the photonic layer, I believe, more and more. Longer term, we see through this, and I think it bodes well for folks like ourselves.

All right. That's very helpful. So looking forward, calendar '21 is shaping up to be maybe, hopefully, fingers crossed, a normal year or a return to normal year. Do you think -- and in terms of -- within your webscale segment, it was very understandable that a lot of hyperscalers are going to open new data centers, build out new data centers and those probably would have subdued demand for new chassis. But webscale has just been growing for you guys. Do you see that webscale segment really increasing even more in calendar '21? Because with everybody returning back to some kind of a normalization, data center build-outs returning, new data center footprints being added, do you think that business adds more, your webscale business increases more?

Yes. I guess our perspective on the webscale piece -- so first of all, maybe your -- just for your audience that may not know us as well as some, our exposure to the webscale is both direct [ in terms of ] we sell transport solutions to them directly largely across 3 applications: their campus metro data center interconnect, their backbone terrestrial networks and in their submarine networks. And if you look across the global spend in that space, we have a very significant share position there, north of 50% depending on what industry analyst you keep score by. It's difficult for me to give you a hypothesis on the direct spend that we're going to have a radical step-up in that market share. But we do believe from a competitive position perspective, we're in a very strong position to at least maintain share as that spend grows. So that's our perspective on that. The other place we have exposure to them is indirect. And as you know, in many countries, these webscalers can't own their communications infrastructure. They have to buy it as a service from a service provider. Take India for example. And they're becoming a more important actor in -- even in the service provider spend space because they're chasing them as customers. We have a great position in the sense of having these global relationships with the service providers, having the same product that the webscalers buy from us direct certified in the service providers so that when they show up in a country and want to buy our service, they're very comfortable on the technology solution. And we benefited from that as well.

Scott, if you can just remind us, what is your total direct and indirect? What's the total net exposure by your estimates?

Yes. So from a percentage perspective, if I want to look at Q4, the direct piece of the revenue was in the low 20% of our revenue, so call it 22%. Gregg, do you want to keep me honest here?

That's right. Exactly.

And that -- it varies a little bit quarter-to-quarter, but that's been pretty consistent. If I look at full year '19, it was in the same range, maybe a little bit lower. But it's been around that range. Go back a few years, it was obviously smaller as they grew. But that's the direct piece. It's very -- and I'm not trying to dodge the indirect question. It's just very difficult for us to count it because obviously, take an example and this is a bit contrived, but imagine they go into in India and they buy service from somebody like a [ Geo ] and we're providing [ Geo ] the same product solution for their core network as we are for their managed service to a webscaler. It's very difficult for us to discern exactly the split. But no question, they're becoming a more and more important actor across the piece.

I think in the question, you would ask what do we -- what's the growth rate there. We expect the market to grow about mid-single digits. And as Scott said, we expect to about maintain our share there. So that's about what you can expect in that particular customer segment. Again, the context of our overall revenue growth for our fiscal year is flat to 3% growth.

That comment, Gregg, was on the [ direct ] piece.

Yes.

Okay. Well, this kind of plugs into the next question I had was revenue diversification. And I think fiscal 4Q '20 was a milestone in that sense that you had no 10% customer in a long period of time and still have very impressive upside on gross margins and EPS upside. In terms of going forward, how do you think about your revenue mix, both product mix and then customer segment mix evolving? And I think that's certainly a very significant improvement over the last 3 years, for those who have been following Ciena...

It's a good question, and thanks for recognizing that actually because it's actually something that we've been actually working very hard on. The -- and that's not to say in our traditional spaces we don't want to or expect to continue to grow, but we expect to be able to grow outside of sort of our traditional spaces faster. And if I look at the dimensions of that, you can slice it a couple of different ways, and I think that's where you were going with your question. If I look at non-telco now makes up approximately 40% of our revenue, sort of that's a global statement. And if -- you've known us for a long time. So if you look back in the rearview mirror, that number would have been very, very small. So we're quite happy with that. And that comes at us from the content providers we talked about. It comes at us from government business. It comes at us from some enterprise direct business. So that's one dimension. The second dimension would be sort of geographical, if you like, and we've got -- you just look at the market share position, an extremely strong position in North America. We believe our growth opportunities continue to be strength in North America, yes, but growing share in EMEA, some parts of Asia Pac including India. And when I say some parts of Asia Pac, the ones that tend to not have a China, Inc. bias to them. If I look at it from a portfolio perspective, which is, I think, part of your question as well. If I look at the optical piece of that, we have exceptional share in submarine, in DCI and in long-haul WDM. And again, it would be difficult for me to give you an hypothesis that says we're going to double digit grow our share there, but we at least expect to maintain our share in those pieces. We have a strong and growing share in metro. We would expect to be able to overrate grow in metro WDM. And then if you look at our packet portfolio, although it was down a bit from a comparator perspective in Q4, we do believe we've significantly increased the addressable market there and would expect to gain share there. And then the third piece would be in software. Though fairly small and embryonic right now, we do see it as an opportunity for growth and actually an opportunity for actually margin expansion as well.

And then there's certainly geographical diversification, right? I mean ex North America, your revenue is also lumpy but generally trending upwards. The question I got just from the investors just now was can you remind us how big India was in your fiscal fourth quarter.

How big the revenue was? Sorry. Was that...

India. How big India was.

Oh, India. I don't know if we were public with that, Gregg, but it...

It was about mid-single digit for the quarter.

Okay. So certainly, the Indian market is recovering and turning a corner from a few quarters ago. The recent Supreme Court hearing has been -- potentially been positive developments there in the Indian market. Do you think India market turns a corner in terms of sequential growth from here on? It's been a while since the Indian telcos [ haven't ] really invested given the lawsuit [indiscernible].

It's a great question. As you point out, like Gregg said, it was mid-single digits from a revenue perspective for us in Q4, which was up quarter-on-quarter and up year-over-year Q4-to-Q4. To answer your question, I'm going to go back a little bit in terms of the dynamics that happened in India. We had massive capacity built up in India in, let's just say, 2018, sort of the [ Geo ] and the response from the other providers. I think going through '19 -- prior to '19, there was a bit of a digestion effect there. A lot of the service providers had some balance sheet challenges. They've since cleaned up their balance sheets a bit. We were coming into 2020 thinking with the Supreme Court ruling, the tax ruling that you're referring to, sort of behind us that 2020 would see a bit of an uplift in India, going to be the year that we start to see it come back on the upswing. That really didn't happen for the full year, and the reason is COVID. If there was probably a market in the world that I would say was on the extreme end of just being mired in the dynamics of COVID, it's probably India just in terms of movement of goods and people, et cetera. I think there's some hope that, that really starts to alleviate in 2021. The other dynamic, I would say, is the service providers have been incredibly active in terms of RFP activities. And I think it's driven by 3 dynamics. One is there've been a pause in the spend, and you can only live running your network not for so long and they've got to come back and start to build capacity. Two is if there's one place in the world that seems to be aggressively taking action on the Huawei dynamic, it's actually India. So they are awarding business to migrate away from Huawei capacity in their optical backbones, and we have benefited from design wins there. We haven't benefited from necessarily taking that to revenue yet. And the third area actually is the webscale folks are all very active in India and starting to look for capacity on these networks. So exactly when we start to see the benefits of that, that's a great question. We're sort of starting to model it coming back in the second half of '21, that we think that India year-over-year will be up modestly in '21, but a good trajectory coming out of '21.

Okay. I have 3 big topics that I want to quickly go over, and we have only 7 minutes left. So one, the Huawei cutback opportunity. I think on the earnings call, Gregg, correct me if I'm mistaken, but Gary said it was a $500 million to $1 billion revenue opportunity for Ciena and you've already gotten some wins. Can you help us understand how big this one bit is? I understand it will take a long time. But to the investors, can you share some data points that speak to your early share wins in that cutback opportunity and maybe help us understand when you think those will become materially -- material to your revenue?

Yes. Gregg, I'll take a crack at it. And respectful of your 7 minutes, I'll try to do it quick. The 500 to 700 -- the $500 million to $1 billion, and I actually think we were a little tighter than that but we'll use those numbers, was actually, we think, the total addressable -- the total share that's addressable in the industry. Love to think 100% of it would come to Ciena, but that's probably not realistic, but that's what's available. And I think in some small cases, you're seeing some of that happen now, where there's dual sources in an account and maybe they're dialing the share of wallet piece. I don't think you're seeing a significant impact in the industry whole scale procurement changes, and I think that will take time. I think you're seeing India making decisions but not necessarily implementing them yet. I think you see a lot of Europe talking about it but not making decisions yet. And I think you want to get a time scale. It will be measured in years. And if you want to sort of make external reference to sort of back that up, look what the British government is saying. They're giving the service providers 5 to 7 years to do what they need to do. And I believe the prioritization, just because of the hype that's in the press on it, will actually be on the radio access network first as opposed to necessarily on the core optical infrastructure. But it will come, but it will take longer than we all think and all wish, but it'll come.

And just to be clear, you've already won some footprint. I mean Deutsche Telekom and [indiscernible].

Yes. Whether or not you think that's from geopolitical or just good procurement practices, diversity of suppliers is left to one's interpretation.

And we think much of this will occur through the natural process of as they go to upgrade their networks, the RFP process, we think that really helped. And that's why, in part, why it will take a while.

All right. My next 2 questions are on the 800-gig upgrade cycle and industry cadence. Obviously, you've highlighted 5,000 modems shipped in the last quarter, 65 customers. It seems like the ramp in 800 gig is bigger and stronger than previous generation. You can correct me if I'm mistaken there. And also, I think the -- Acacia is kind of, I suspect, going to come out with a 1.2 Terabit AC4800 module based on 120-gigabyte solution. I suspect you're going to announce something to compete against that offering fairly soon. So where do you think the industry cadence is? Is it accelerating?

Yes. So I guess there was a couple of questions in there, so let me see if I can take it. So first of all, the typical cycle for us over multiple generations as coherent technology is obviously development phase, introduction ramp phase, the phase where it is the bulk of our port shipments to a phase where it has a long tail of still being a very positive business contributor but not necessarily being the majority of our port shipment. If I go back to WaveLogic 3, as an example, that we sort of started shipping 7 or 8 years ago, it's in that last phase. I think our last generation of WaveLogic AI, it's in that -- the majority of the port shipment. And we recently announced, which you referred to, our WaveLogic 5 Extreme, which we went commercially available with in the spring time frame, early spring. And we're sort of 7 or 8 months into its life, and it's started its ramp. The number of customer wins is probably about twice the rate of the previous generation. The number -- the net capacity is also quite a bit higher, but the number of ports shipped is lower. I think the number of ports shipped being lower, I think, is a COVID effect. The reason why the ramp on new wins is faster, I believe, is the last generation, if you remember, the technology had a dependency on people upgrading their photonic line to flexible grid; in other words, not being constrained to the fixed ITU grid in -- on the photonic line. Most of those upgrades, every photonic line that's been put in the ground in the last 5 years is all flex grid. So you don't have that as a barrier to introduction anymore. So that's why I think this generation of technology will get adapted faster. In terms of the second part, I guess you're basically -- the second part of your question was, "What are you guys going to do next?" Obviously, I think as you can imagine, I'm not going to do a product announcement today, but for sure you'd be very disappointed in us if we weren't well down the path of the next development cycle. You can imagine that in order for us to have a value proposition, it's going to expand on the following dimensions: spectral efficiency, in other words, how much can you put on an individual fiber; optical performance in terms of how far you can transmit a given bandwidth in distance; the power footprint, how much power do you have to consume in order to get that performance. All 3 of those things wrapped together basically add up to a significantly lower cost per bit for our customers. And the fourth -- the last piece of it is what client interfaces can you support onto it. For sure, the next-generation that we do will expand on all of those dimensions. In order to do that, we need to invest in the latest and greatest CMOS technology nodes because you need the compute power on the digital side with a lot more sophisticated math algorithms. You need to invest on the analog side, which talks -- you talked about higher baud rates on the analog side. And you need to invest actually -- and a very, very important part that a lot of people forget, you've got to be able to get from the analog world to the digital world and back to that analog world at very, very high speeds and very, very high fidelity. Otherwise, you lose your optical performance. The folks that control the innovation on all those key components I just talked about, I think, will continue to be winners. And I would suggest that we won't be necessarily alone, but I think we've proven that we do control our destiny and the innovation of all those key components. And although we obviously have to execute, I think our past performance gives us pretty good feeling that, that we'll be there when the time comes with leadership in the next generation. It's interesting to talk about the next generation when we're the only one shaping the current generation, but that's the state of our industry.

Well, thank you, Scott and Gregg. Really appreciate it. We are out of time, and I want to thank you again for your answers. And I wish everyone a good rest of the week. Thank you.

Thank you. Thanks, everybody.

Thank you very much for having us, Fahad.