Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Welcome to the TMT Conference. I have a great pleasure of hosting Ciena this morning, Q&A with Ciena. My name is Rod Hall. I'm the networking and hardware analyst here at Goldman Sachs. Got Jim Moylan, the CFO of Ciena with me. So welcome, Jim. Thanks for joining us, virtually anyway.

So I guess I'm going to kick right off into questions here. People should be aware, there is a Q&A interface. So if you do have questions for Jim that you'd like me to ask, go ahead and use that interface. You may want to familiarize yourself with that while we talk here at the beginning, and then we'll take some audience questions towards the end. So Jim, let me kick off with the spending environment. Nobody seems to know what's going to happen in 2021. I don't think either of us do either, but I know that you've got a lot more contact with companies and that people actually spending money than I do. So I just wanted to get an update from you. You guys have talked about near-term headwinds, slowdown in business velocity for the carriers. I just wonder if you could tell us what you're seeing in your different business segments, carrier, webscale, et cetera, different geographies? Any color you can give us on what's going on with the demand environment?

Sure. Well, the first thing I'd say is that there doesn't seem to be any slowdown with respect to demand for bandwidth. That's continuing apace. The flows have changed a bit. There are no longer massive flows going into enterprises. Their flows go into the edge and to our homes, so that the sort of way the network is being added to has changed a bit. That's affected us. But I'd say, overall, because we have for our top 40, 50 customers, we have a dedicated sales team, which has continuous conversations with our customers, we do have a good sense of what they're planning to do this year. And what we are hearing over and over again is there's going to be a bit of a slowish start to this year, and they'll come back in the second half. That's what we're hearing customer -- across the customer base. That's -- and when I say that I'm really talking about service providers, the GCNs are -- they're continuing their activity. So I don't -- we're not really seeing that behavior with respect to the GCNs, although we didn't see as much spend last year as they have spent in -- as much growth in spending as they have done in previous years. We think they were low- to mid-single digits, something like that. So it's the service providers and it's service providers globally for a lot of reasons. COVID is one of them. I think they have other spending needs. This whole auction -- the spectrum auction in the U.S. has affected AT&T and Verizon. And I think the movement to the edge and the access has changed some of their prioritization. So all of those things have affected us and caused us to say what we've had to say, but we're very confident in our position. We feel -- in terms of base market share and when I say base market share, I'm talking about the awards of the various applications across the networks, we are continuing to gain that share. It's not showing up in revenue. And so if you -- a technical calculation of market share, our revenue compared to the industries may or may not show that we're gaining share. But with respect to application share, we are gaining share across the customer base worldwide.

Okay. And when you -- you've talked about the tail end of the year and not getting better. What do you think the main drivers of that are? I know that we would expect 5G build-outs to drive that. Can you just walk us through some of the other things? Maybe also how you see 5G when you can see that deployments in the U.S. accelerating that kind of thing?

Yes. The fundamental driver for our business, as you know, Rod, is demand for bandwidth. And as long as demand for bandwidth continues to grow, then we're going to be just fine. We don't see any evidence that there's been a change in that phenomenon or a change in the growth rate. But we think that because of COVID, because of other CapEx needs that the big service providers, particularly in North America, are running their systems a little bit harder than they have, frankly, the amount of intelligence that we put into our year allows them to run it a little more -- at a little higher rate because we can move flows around the network and we have assurance and analytics on our Blue Planet side that allows them to see what's going on. So we've probably caused some of that ourselves. But as long as demand for bandwidth continues to grow, we're going to be just fine. With respect to 5G, we have -- first of all, we think we know that 5G is going to be important to our business. That is absolute truth. But we've always been a little cautious about the rate at which spending on 5G is going to happen because, number one, it's expensive. They have to build -- to put antennas farther out and more of them, and they have to connect those antennas with whatever that part of the network the antennas go into. And there's no real killer app yet for 5G. They know that -- yes, I guess, maybe people can watch videos with higher priority and with less interruption. But I don't think that's going to cause people to watch more videos. And -- so I think what we have to have is a killer app, which allows the service providers to monetize the massive amount of spend that it's going to take to really build out 5G. I mean there's a lot of marketing going on. Everybody's claiming 5G and all that stuff. There aren't really 5G devices out there yet. And there's no killer app. So we've been cautionary about the rate at which they're going to spend on 5G. And when I talk about 5G, I'm really talking about the rands, the antennas, all those things that connect into the network. Of course, we don't spend -- I mean, we don't actually sell any of that stuff. What we sell is the stuff that goes on the towers or next to the antennas that sends the stuff through fiber back into the network.

Okay. You mentioned the auctions, the spectrum auctions before. I know that those have gone a lot better than many expected they would. Do you think that, that's going to have any impact on carrier spending, phasing of spending this year, amount of spending?

When you say better, are you talking about from the point of view...

The prices have been higher.

Yes. Yes. Yes. Yes, the prices have been higher. The government is making a lot of money here.

I mean better for the government, not necessarily for the carriers.

I guess I'd say that we haven't seen any indication in our conversations with our customers that this is going to affect what they've told us before about their spend. Now of course, it's kind of hard off the press, so we'll see that. I believe that because the demand on their networks is still growing, they're going to have to spend.

Right. Okay. When do you expect -- just on all of this, when would you expect to have a clearer picture? Or do you mean just kind of develops linearly through the year? Or do you expect them to come back to you in February and give you a budget? Or what's the timing of when they might give you an update on what their plans are?

Yes. Typically, at the beginning of the -- in the first calendar quarter is when budgets are distributed, and it varies across the customer base. But it will be February-ish that we'll have confirmation of what we think or refutation, whichever one. But I'd say this, it's not -- it's going to be linear. It's not going to be one big event. And there's nothing that we've heard from our customers so far that would indicate that anything they've told us in the past is different -- is going to be different. We'll see.

Okay. So you've guided for 0% to 3% revenue growth this year. What do you think long-term growth in optical looks like, 5G and so on and so on, all the different drivers? But what do you think the long-term growth ought to be in your market?

Well, if you look back at optical spending over the past 10 years, it has not been, per se, a rapidly growing business. And there are a couple of reasons for that. One is that the service providers' business models are not as good as they would like them to be. They haven't been able to monetize their networks to the degree that they would like to. And I know they're working hard to do that. So they have always been somewhat constrained in the CapEx. I should say, they've been careful about the CapEx. Constraint is too stronger word. The fundamental driver, of course, is bandwidth demand and that's growing at 25%, 30% a year. However, because of technology, the industry takes 25% or something or so out of the cost per bit of the stuff that we sell. So that equation in and of itself means that you're going to have a slow growth, not a very rapidly growing industry. Our view has been that this industry will -- for both of those reasons will remain a industry that grows in the low- to mid-single digits as it has for a long, long time. In that context, over the past 10 years, say '20, which was a COVID-affected year, we've grown 8% or 9%, depending upon whether you count the excess growth in '19 from the GCNs, but 8% without sort of a super good year. And we've grown our bottom line at an even faster rate. We haven't -- this year, as you know, we haven't given specific targets for the next 3 years as we have over the last 3 years, just given the uncertainty. But COVID will end. We'll have vaccines. You will have a real conference someday again. And when we get back to that world, I don't see any reason why the future should look any different from the past.

Yes. Never expected this conference will come into my living room here, but here we are. All right. So what about share gains? You've been gaining share the last few years. Your 400-gig technology drove a lot of that. Your technological advantage has been, I think, driving a lot of share gains. What do you think the main focus areas are now to gain share looking forward, maybe setting technology aside? We know you've got your 800-gig product out there. You might want to talk a little bit about when you think that really kicks in and starts driving share. But what other focus areas do you have as a business to increase your share, continue the share gains?

Yes. Interesting, Rod, that the GCNs, in particular, webscale, whatever way you define them, have been the most focused and the most rapidly adopting of new technology because they are sort of relatively newcomers to the whole idea of owning their own networks, and they have massive needs, and they have, for the most part, relatively simple networks. They're connecting data centers. So for all those reasons, they've been early adopters and that has coincided with the fact that we've had a technology lead on our competitors. So those 2 things work together and that's what caused, frankly, the upsized revenue growth in '18 and '19. My own opinion is that it's going to be difficult for us to continue to gain share in that segment. We'll retain share. Maybe we'll gain a little bit of a share. But the issue there is that they all as do every -- all network operators want to have second sources. And we have well over 50% of global GCN share. And we don't do much of all -- much of anything in China, which means that our share in the U.S.-based webscale companies is -- I don't have the exact number, but it's 60% or some number like that. I think it's going to be hard for us to grow share there. They will probably continue to be the most rapidly growing segment. But that's not what we're going to gain share, I don't believe. I think that we're going to gain share in the international market. I'd point to India. India has been slow for the last couple of years. We had a good quarter in Q4, but it looks like they might be getting back into business. We won a lot of stuff in India. Some of that is because India is the most -- well, other than the U.S., the most aggressive country in terms of eliminating Huawei presence. And so there are share gain opportunities for us, which we've stepped into and won. In Europe, there is an opportunity with respect to Huawei. I'd say that the carriers there have gone back and forth on how rapidly they're going to move. But it just seems to me with all the noise in the -- particularly U.S. and China situation, all of the situations in which the Chinese service provider -- I'm sorry, the Chinese systems vendors have been cut off or threatened to be cut off from components that as the service providers in Europe upgrade their systems, I think it's going to be very difficult for Huawei to win, at least the amount that they've won in the past. And that's an opportunity. It seems to me that that's an opportunity for Nokia and Ciena. And we're going to -- we have the best gear, and I think we have the best service levels with respect to how we deal with the customer. So I think we'll win more than our share in Europe.

Have you got any test cases against Nokia in terms of how you're faring when you're [Technical Difficulty]?

It's a complicated question because I'd say this, and I think you and I've talked about this in the past. Nokia has been a very aggressive pricer in the market. They have not been able to lead with technology and so they have led with price. Now we know that there have been changes at Nokia. There's been changes in the entire management team. There's been a statement by the CEO about how they're going to move forward with respect to their various segments. And they say that each of the segments is going to have to stand on its own legs in terms of profitability. It's too early to know how that's going to play out. I think it's going to be a tough row to hoe for them because of the fact that they're behind on technology. And -- but I'd say that it's too early to know how that plays out. They've been an aggressive pricer.

Okay. I wanted to -- can you all say, by the way, Jim?

Yes. I can.

I wanted to ask you about the -- let's come back to the GCNs, and there's been talk that there's at least one major GCN we know who we're talking about has maybe made a move toward more white boxing or purchasing of components and combining those into their own systems. How do you see that trend developing? Do you see it developing? Or do you think this is just a technology TikTok thing going on? I'm curious what your thoughts are there.

Yes. I would start by saying that there is one of the webscale players -- well, by the way, I'd start off. Everyone of the webscale players want choice. They want to have a second source. And that particular webscale player has tried to -- has tried some of our competitors with respect to second sourcing. And because it has some rather unique needs, they have decided that they'll move away from any -- from other systems vendors and have their own sort of, call it, a white box second source. And we've seen that in the past. We've seen a couple of the other big GCNs do white boxes. It's more complicated than it seems to be. And so there hasn't been a lot of pickup in that. But having said that, the GCNs are very smart. They're a bunch of smart people, and they can do a lot of things. It's just that when you get into the white box situation, you have to do all kinds of things, like planning capacity needs. And on your supply chain, you have to do sparing, you have to do training. All those things are more complicated than they seem at first blush. We're -- we think our technology is as good as anybody's. And so what we'll have to do is compete very hard to keep that second source from being a significant piece of their "buy." We think that we factored that into our plan appropriately.

I -- one of the things -- it seems to me that there's no -- your 800-gig product is the highest capacity product in the market right now. But I wonder do you think any of this relates to the volume you're able to supply at 800 gig and as your...

No.

So it's nothing to do with that?

No.

Okay.

800 gig is stepping up faster than 400 gig, overall. I mean we've seen every generation of technology. The take-up faster than the previous one, and that's no exception with 5G or with 800 gig.

Right. So could you talk a little bit about that 800-gig platform? I know you're not the Teligus. So I don't want to force you to go too deep here, but what are the...

Thank you.

What are the -- what would you say are the main advantages that platform has relative to -- we've got Acacia with their AC1200, the second revision of that out there, 600-gig product and, of course, all the other competitors, too. So maybe just spend a moment talking about what you're seeing in field tests and how your product is performing against some of the others out there in the market.

Yes. For the benefit of some of your listeners, we brand that product as an 800-gig product. But there's a direct correlation between the amount of information which goes down the line and how much -- how far you can send a signal without regeneration. And so when we say 800 gig, it can also be used at 700 gigs and 600 gigs and 400 and 200 and 100. And the key point of differentiation here is how far each one of those signals can be sent across that axis. We believe that our capability is unmatched. Just maybe not at every point along the line, but it's just about every point along the line enough that we give it a significant advantage to people who need that. And of course, we have the only capability to send an 800 signal down a single driver. So those are the big advantages. Now the one thing I'd say and this is important that GCNs, because they have had such massive needs and massively growing needs between their data centers, are the most focused on that capability. As I said earlier, it's they who have been the early adopters and the early rapid adopters. Service providers -- that kind of capability is important to them, but just as important to them is the reliability, the customer service levels, the relationships, all those kinds of things. And so technology is very important, and we're going to continue to invest and be the leader. But we're also focusing on things that are important to the service providers beyond technology, which is service levels, basically. Shortly stated, the service.

Got it. Okay. When you think about the service providers versus the GCNs, do you -- if you look out 5 to 10 years, strategically, do you think that GCN just keep getting bigger as a proportion of your customer base? Or how do you see your customer base looking vis-à-vis those 2 groups in the medium-to-long term?

It's a great question. And we're not sure. What we are seeing, for several different reasons, is movement to the edge and access part of the network. It has to do with the fact that people aren't going to work and their buildings anymore. They're working from home. There, it has to do with the fact that 5G requires more endpoints out there that fiber deep, which is the corollary on those cable side requires more endpoints. And it also is caused by the fact that everyone is thinking about edge compute, meaning moving data centers closer to the customer. So for all these reasons, things are moving to the edge. Now there's still a vast need for movement between data centers. There's still a vast need for movements around metros and all that sort of thing. But what I think happens, I don't know what's going to happen between who's going to do what with respect to the service providers and the GCNs, but that's going to be the most important sort of phenomenon and driver of who are our customers going forward. And actually, you're seeing GCNs and service providers working together to deal with this edge compute thing. We've got a Verizon, and I think it was Amazon tie-up and -- not tie-up, but a cooperative agreement. And then some other things with Microsoft is doing. So that's going to determine who our -- what our customer base is going to look like. Now I always -- I think that there will always be a need for the service providers to provide the last point of connection to the customer, whether that's through a phone or through a cell tower or a Internet service. I think they will always be the one -- well, always is a long time. But for a long, long time, they're going to be the person who provides that final service. But from that point back, no telling how it all shakes out.

Well, that's what I see. It seems -- I don't -- I'd be curious to know what you think. But it seems like the GCNs have moved faster with automating these core networks, probably because they built them from scratch mainly. And if I was a service provider, I think I would be thinking seriously about leveraging all that capacity and automation somewhere else, I don't see why a service provider. I know a lot of them think they need to run their own networks. But just from a pure economic point of view, it seems like it makes sense to leverage that, and then like you say, provide that access myself. I don't...

We'll see the thing that's always been an advantage for the GCNs and a bit of a disadvantage for service providers is that the GCNs don't really have legacy. They don't have 30 years or 20 years of equipment in their systems and 20 or 30 years of services being provided to a vast array of customers so that the complexity of their networks is just as significantly higher than that of the GCNs, and they've got this mix of equipment and services. That's why this whole automation thing is difficult for them. And I understand that. They're smart people and they'll figure it out. But I think it's possible that they will leverage some GCNs with respect to making their services more efficient.

Yes. One thing I'd be curious to know is, do you think that, that would be -- I have my own thoughts and I'll share them with you if you want. But I -- would that be good or bad news for your business if service provider traffic started picking up and moving over to GCNs? I think it would be good, but I'm curious what do you think.

Well, we have a 50% global share with the GCNs, and we have a much lower share with the service providers. So my feeling is it would be good because it would be very much focused on technology and that's where we really are the best.

I think you could also end up rebuilding some capacity that's already sitting at the service provider that can't be picked up and moved, so it's going to have to be rebuilt, the GCNs and...

I think as fast -- yes, yes.

Okay. Let's go back to Huawei a little bit. One of the things that we have a problem with -- we know what Huawei sold over the years, but we don't have a good way to think about how to quantify how big Huawei might be next year or the year after. It's one of those things that, as you say that, the European service providers, where they have a lot of footprint, seem to come and go in terms of the seat with which they want to transition, although they all -- I think they all eventually will, like you say, transition. But I am curious at how do you think about sizing that as you look out the next couple of years?

Yes, yes, and just to be clear on the whole Huawei issue, the -- there are going to be places in the world where they are always going to be big. And it's just a question of, they offer more as a country than just technology. They offer roads and dams and bridges and electrical systems and all those kinds of things. And so the less developed parts of the world, particularly Africa, some parts of Asia, are just going to continue down that path. There are parts of Asia, which have sort of natural enmity and that's been the places where we've been successful, India, particularly, Japan, Korea, Australia. But a lot of places. You think about the big countries, Malaysia, India, Indonesia. Those are Huawei bases. And I think they are probably going to stay there. We have attacked and I'm seeing a lot of success. Europe is the battleground. Because Europe is the place that, as you said, Huawei has got a big footprint. And that's going to be the battle between us and Nokia for the share that Huawei is going to lose. It's been sized at $500 million to $1 billion and I think that's reasonable in terms of the estimate. It's not something that changes overnight. Well, when we're in COVID, the easy button for service providers globally is to stay with incumbents. And so they're not going to move away from Huawei and they're not going to rip and replace Huawei. No, at best, it is not going to happen. The Huawei gear will stay in their networks. But what will happen? Over the next x years, service providers are going to look to upgrade their system. They're going to go to next gen, all of the things that have to do with next gen. And they're going to have to work on this axis, thing that we were talking about earlier. And I believe that it's going to be really, really difficult for Huawei to win that -- the kind of share that they've had in the past. So I just -- I think it's difficult. That's an opportunity for us. But I think people -- some people have said out, it's an immediate opportunity. We don't believe that to be the case. We think it happens over the next several years.

Okay. Can we talk a little bit about the pluggables products? You said you plan to have them out later in the fiscal year. How does that affect your webscale business? Or what do think that means for that business? Is it accelerated? Is it just to replace other systems you're selling?

There has always been a pluggables market, and there have been pluggable optics in systems for a long time. In fact, our packet switching has pluggables in it. We bought pluggables and use them there. The difference is that 400ZR means that we will have a coherent capability in a pluggable, meaning that it can be -- the length over which a single can be sent will be higher. It's still not going to be hundreds of kilometers. It's going to be 100 kilometers, maybe a little more. So that with this technology, it will be important for, are those applications which have relatively short reach. And that market will occur. We've said for a long time that it will occur. We've also said that one of the reasons we went into the components business is that we wanted to develop a plug and attack that market as well. Our view, and this has been a consistent view for a couple of years, is this is a $300 million to $500 million market for the next at least several years. Now maybe as technology develops, maybe the coherent plugs can become longer in reach and maybe it displaces a significant -- a more significant piece of the market, but that's not in the near term. And my own view is we'll have as good a plug as anybody, better than most. And so we'll get our share. The one thing that people should always keep in mind here is that the cost per unit of bandwidth goes down inevitably by technology. That's just the way it happens. Plug is just the latest sort of instantiation of that fact. Like, for example, we developed the Waveserver now. How many years ago? 4, 5 years ago. And that's a much simpler box than 6,500, which is our top-of-the-line service provider box. The cost -- the difference in price to the buyer is very significant. And people had a lot of concern about that. They said, "Oh my gosh, you're going to be selling -- your ASP is going to go down so far, you're not going to get your growth rate." We haven't seen that at all. And I don't think that's going to be the case when we're selling pluggables either. Yes, our price per unit is going to go down. But I don't think that significantly affects our revenue trajectory.

Okay. We've got a couple of audience questions. So I want to make sure we fit those in before we end here. One question going back, since this is your most recent -- one referring to your recent comment on Huawei here that it's $500 million to $1 billion, I assume that's per year that you're talking about.

Yes. Yes.

The question is what makes it -- it's kind of a wide range, so what makes it -- what would make it $500 million and what would make it $1 billion?

More rapid action on the part of the service providers would get it to $1 billion. So it would be -- it's a timing issue. I mean -- and by the way, we're not certain as to what the number is anyway. So -- but that's what I'd say is more rapid decisions on the part of service providers would move it to the top end.

So if people...

And by the way, the European service providers recently have not moved very rapidly as we've seen.

Right. Is that, you mean, due to COVID or just generally?

Just generally. I mean they haven't spend than a lot of spend in Europe for a while.

Yes. It's been pretty slow. The other question that came in is the webscale customer we were talking about that's experimenting with white box, what are the unique needs that customer has that -- you mentioned unique needs, what are those unique needs that have driven this move?

It's a good question, but I'd prefer not to answer it. I just -- I don't want to get into the way they operate their network.

Okay. All right. Fair enough. I've got one more. We're running down to the last couple of minutes. I've got one more for you. And by the way, audience if your list -- you're out there and you've got a question, please put it in. We're happy to ask, Jim. We've got a couple more minutes here. But you talked about R&D investments or you have in certain areas such as packet to boost your IP capabilities. Can you talk about your future strategies in -- with respect to technology and where you think you can develop further to serve 5G or any of these other technological network developments you and I discussed?

Sure. Big driver is what we talked about before, Rod. The edge and access is -- for a lot of different reasons is going to be the place where there's going to be the most change, architectural, sort of reconsideration and design and product design. So that's where we want to position ourselves to take maximum advantage. We have some great strengths as that change occurs. We have the best optical in the world. We have a very, very strong packet product. The one area that we want to do is we want to develop an IP capability. We're not going to build a router per se, a traditional router or certainly not a core router. But because of this emphasis on the edge and because not all flows need to go back to the core, some can stay in a relatively -- particularly if you have edge compute, some can stay in that area. So the -- what the kind of routing capabilities we're developing is the ability for the machine to compute what the next best pop is. And that's the capability that we'll have in market this year. That's why we've stepped up our spend with respect to R&D a little bit. And the other thing is this is a -- it's a little more complicated sale than an optical sale. It's switching and routing and our routing capability. And that has to be positioned appropriately. So we have -- we're changing our sales force -- doing some training, but also bringing in people with that sales capability.

Do you think that routing capability -- will we actually see that deployed out in market? I know that you do have -- I think you're going to see quite a bit of edge business as 5G, these 5G base stations deployed, particularly in the U.S. Will those also include routing capability? Is that something that's a little further down the road?

I don't have a crisp answer to that. The one thing I'd say is that this is not going to be a sort of a stair step, wake up, turn the light switch on, all of a sudden this changes, mainly because we, as we've said, are a little bit cautious about the whole 5G move. But the fact is that in order to make 5G more economic, we don't think it's possible to put a router at each antenna or anywhere near the antennas. That's just not possible. But you can possibly put that routing capability in the software form at the edge. So my own view is that when 5G spending really picks up, then that's when you'll see a more active -- we'll see -- we'll be selling wave routers, is my guess.

Great. All right, Jim, I'm going to let that be the last word. We're out of time here. So thank you very much for coming along virtually. Really appreciate you, good to see your face. And thanks, everyone, for attending.

Great to see you, Rod. Same here.