Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Perfect. Good afternoon, everyone. My name is Amit Daryanani, the IT hardware and networking analyst here at Evercore, and I'm delighted to have with us Ciena for our next fireside chat over here. And more than thrilled to have from Ciena, Jim Moylan, the Chief Financial Officer; and Gregg Lampf and Patty from the IR team. We'll keep this fireside chat around 30, 35 minutes, which is how we've done the other ones. Michael and I will spend close to 20 minutes or so going through some of the questions we have prepared. We're happy to take questions from the audience post that. [Operator Instructions] So with that, thank you very much, Jim, for being -- spending some time with us. Really appreciate it.

I think before I get into the session and start asking all the questions, maybe it would be helpful if you want to spend a couple of minutes sort of recapping the April quarter results from last week, maybe touch on a couple of key points. And really, I think the big incremental stuff that folks would love to hear from a recap basis was really the back half of the year, fiscal year guide and sort of what you expect to see at that point. Maybe we'll start with that and then we'll get into the questions.

Sure. Yes. Just some context first. Remember, we're an October 31 fiscal year company. And so our year started November 1. We prepared our plan for the year back in August, September of last year when we were right in the middle of COVID, when our order flow was well below the order flows that have been in place for many quarters before that. But we've had a lot of experience with the service providers, and we know that demand on networks has continued to grow. So we felt that even though they were very concerned about their underlying business because their enterprise business had suffered some difficulty, we felt as long as demand on networks continue to grow, they were going to have to spend. And our sales force is out there talking to these customers every day, and they were telling us the same thing that they were going to be delayed, but they were going to start to spend as we move through our fiscal year. We built a plan based on a pretty low revenue number for Q1 and Q2 and a very big jump in Q3 and Q4 revenue, back to levels of spend that reflect what they need to do to keep their networks operating. That depended on our projections about their behavior being true. And in particular, it depended upon a big jump in orders in Q2. So we -- and that's exactly what we saw. We saw a big jump in orders in Q2. Now some of that we know was kind of catch-up because they really hadn't been spending. Some of it, we know, was because they are looking ahead to the fact that there is a shortage of semis, and they wanted us to be aware of their demand for the last half of the year. Pretty much all the orders call for delivery dates this year. So this is really not a '22 phenomenon. This is not a preview of 2022 is what I should say. But it does feel as though that what we predicted is happening. Our order flow continues to be strong. Our quarter was good. It matched our guide. The -- in terms of revenue, it was actually a little bit higher than the midpoint, but pretty much where we thought it might be. And the gross margin was extremely good. It was over 49%. And that combined with the 48-plus percent gross margin we had in Q1 means that our gross margin for the first half of the year is well over 48%. A lot of you will know that because of COVID, we haven't seen the deployment of many of the new wins that we have in some places. And typically, as this is the case, new deployments mean lower gross margins on that business and a corresponding reduction in our overall gross margin. And so we predicted that early in the year. We said we were going to enjoy a higher gross margin in the first half and a return to something more normal in the second half. That's the shape of what is happening. But I will say that we've been very pleased with our gross margins this year. We've had quite a bit of mix, and we're first in the market with the 800 gig, and so we're getting good pricing leverage on that. And we -- although I do think we're going to have to get some of our new wins in -- coming into deployment in the second half in order for us to get to our revenue numbers and we did call down margins, we -- our underlying margin for the back half of the year is going to be sort of 46-plus percent, 46%, 47%. So very pleased with our gross margins. There's a lot of contributing factors. We're not yet calling that level our run rate level because I'm not sure that it is, but very pleased with that. The guide for the back half of the year on revenue does show the kind of pickup that we talked about. And so we think that our business is kind of back to a normal point. I would say this that some people are taking what we're saying as happy days are here again and it's all upside from here. We don't think that, that's true. We want to emphasize that what's happened is exactly what had to happen for us to get to our 0% to 3% guide for the year. And so we're still sticking by that 0% to 3% guide on revenue. We think that's what's going to happen. We also know that there are supply chain issues out there that are going to constrain our ability to get above those kind of revenue numbers. We think that we're not going to be constrained from hitting them, but we're not going to exceed the numbers, we don't think. The other thing I'd say is that India is -- as people know, unfortunately, India has gone into another bout of COVID, and that's affected the country and of course, very damaging in emotional ways, but this affected our business as well. And so we have called down in our internal numbers, our India numbers. We're still going to grow in India this year. We're still going to going to have a good second half, but it's not going to be quite as good as we thought it was going to be. And we replaced that essentially with webscale business.

Perfect. That was a good overview there. I think one of the dynamics and you sort of touched on this and I fully appreciate the fact that we're not off to the races narrative quite yet, but one of the dynamics you talked about in the call, Jim, was spending is starting to get somewhat more normal on the telco side. I thought the commentary was the patterns looked a little bit more like what they did pre-pandemic. Maybe you can flush that out a little bit. From a geographic basis, where are you seeing things reverting back to more normal pre-pandemic life?

It's very broad based. But of course, our business is U.S., Europe, India and parts of Asia. We're not in Africa. And we -- our business in South America, although we have a good business, it's not a huge business. And I'd say that the comeback has been stronger on service providers because they were the most heavily affected by COVID. The data center guys were affected, but not as heavily as the service providers because they don't have to worry about their economic situation. But it's very, very strong in the U.S., and you've seen announcements from AT&T and Verizon about the need for spending. We're coming up to moving toward run rate levels with our new wins at companies like Lumen and Charter. Our business in the U.K. has always been strong, but BT is coming back to spend. Vodafone is spending. So it's very broad based across the places in the world where we actually have a good business. And it's service provider -- the difference between where they were spending and where they're spending now is bigger with the service providers than it is with the webscale.

Understood. And then, one of the themes that we keep hearing a lot about is service providers that, yes -- service providers not just in the U.S., but really on a global level, are pushing to add more and more fiber to their networks. So perhaps you discuss for a bit -- how does this benefit Ciena? And how long do you think this fiber deployment can be sustained? And what does that road map look like?

It's all about broadband demand or demand for data basically. And I would say, generally speaking, that in Europe, the spend has been constrained for a number of years. And I think that has something to do with fiber, but I think it more has to do with the overall economic environment in Europe. And it -- I think that they're going to have to add fiber across Europe in order to meet the demand. They're not really very far along on 5G in Europe. U.S. has started in parts of Asia. And that's going to have to happen because customers over there are going to demand that kind of service.

Fair enough. And then maybe you could spend a little bit just talking about your hyperscale business, your data center business over there. It's been one of the big drivers of the diversity. You're seen at CNN in the last 5 years, maybe a little bit longer. But talk about your positioning with the hyperscale companies. How do you see that market evolve over the next couple of years? And can you sustain the growth rates you've seen over there in the last few years?

There are 5 big hyperscaler spenders, Google, Amazon, Microsoft, Facebook and Apple. And then there are a couple of others that are somewhat behind them but growing, Oracle, IBM. Those are the 2 that come to mind. There might be a couple of others. In addition to that, there are literally hundreds of companies with a data center based sort of business model. Not all of those are at a stage where they can afford to have their own fiber and build out, but many of them are. So for example, we have now 100 or so, you tell me, Gregg, 100 or so Waveserver customers, and most of those are companies with a data center centric business model. But back to the top 5, we have a good business with 3 of the 5 and a burgeoning business with the fourth. It's all about their business model and their need for more capacity in their data centers. It started in the U.S. They're now building global data centers. There are parts of the world where they're not able regulatory-wise to connect their own data centers, so they get a service from a local service provider. But Western Europe, they're pretty much able to do what they want to do. U.S., of course. Parts of Asia, they're starting to get some traction and even parts of South America. Now our growth rate in that business has been -- I couldn't even give you a number. It's been enormous. We started from kind of a 0% share 5 or 6 years ago, maybe a little bit longer ago. Now we have something like a 50% share. So although their spending has been strong, the biggest part of our growth has been the gain in share that we've had. Our view going forward is that because we already have such a high market share with these customers, and they're always going to want choice that it's going to be hard for us to continue at the same kind of growth rate that we've had historically. But it's our full intent to gain share if we can, but certainly not to lose any share with those players and I feel good about our ability to do that. So if they're going to grow at something -- they're not going to grow that much this year. If they're going to be sort of mid-single digits, if they're going to get back to the high single digits numbers that they have been at, then I think we'll grow that business in high single digits.

Got it. That's fair. And then, you sort of touched on this, Jim, in your initial comments around -- to me, the big standout last quarter probably was the gross margin performance, right? And if memory serves me, I think we were looking at 46%. You came in at 49.2%. That's a nice 320 basis points outperformance. I guess my question to you really is, how much of that do you think is transient versus permanent because I thought -- and you talked about it, but a component of this was just better mix with software doing better than [ hardware ]. So just curious, how would you break out the transient versus permanent levers in the gross margin expansion?

Well, just some history on that, Amit. It's a question we're looking at closely. Our gross margin has improved a lot over the last couple of years. A couple of years ago, we were looking at low to mid-40s type of gross margins. And then we twice raised what we thought was our run rate margin. And again, our run rate margin includes new projects, which are going to have lower gross margins than our more mature type projects. But we've raised that low to mid-40s to sort of centered around 44%. And then we raised it again to center it around 45%. We've actually done very well the last 3 quarters. But if you could look inside our revenue stack, you would see that we sell to customers. We sell them different products. We've made the contracts at different times. And so there's not a -- we don't sell to any customer every application at the same gross margin. It all depends upon when the deal was struck. That means that mix plays a big role in how good our gross margin is. And so we had an extremely good mix within our revenue stack in the quarter. We didn't have a lot of new projects. One -- well, we did have one new project, and it turned out it was a better margin than we expected. So we had a lot of positive surprises in there. Software is a contributor and software will continue to be a contributor. But I -- as I sit here today, I think our run rate margin is -- once we get through this year, is probably more like the 45% we've been talking about. I don't -- I'm not ready to say that our run rate margin is higher than that. We'll see. See, as we move and get into the next year call, we'll see where we are and make a call then.

So your Blue Planet software business just reported a record quarter, getting right about at $100 million annual revenue run rate. So just hoping it's going to be a big driver going forward, as you just mentioned on the gross margin and things of that nature. So wondering, can you give us an overview of the business and maybe how you think it can grow going forward?

What Blue Planet is all about is automating networks. If -- this business really started to be talked about 6, 7 years ago because the service providers needed help in terms of automating parts of their network functions like orchestration, they needed help in orchestrating, which is a way to build services. They needed help in doing network function virtualization. So we began a journey probably 6 years ago, 7 years ago organically. We saw Cyan in the market, and they were winning deals. They had the best orchestrator in the market. We acquired them. We got a nice hardware business along with it, but we acquired them basically for the software capability. The market has continued to evolve and now instead of just single-use cases, like orchestration and network function virtualization, what the operators really need is a way to automate the operations of their network across the piece. Now it's a huge task, and it's not something that they're going to do immediately. And there are companies that are already there. We're talking about the OSS system of the network. Amdocs and Netcracker are there, and they're tough competitors. They have a little different model than ours. Their model is heavy customization of a base software capability. So they have an enormous amount of service revenue. Our model is a very complete set of software functionality that's open. So the service provider can choose to modify it himself once it's inside the network or he can ask us to do it for if he wants us to do it, but the point is it's open. And that's very attractive to them. They're not as tied into us as they are to say an Amdocs or a Netcracker who have armies of people inside their networks. So that's the history. We've always felt that there was a nice opportunity for us. If you go back to the last time we gave 3 years of guide for that business, we said it was early 2020. Gregg?

Yes.

Yes, early 2020. We gave a 3-year guide that said by 2022, which would be in the third year of that period, we're going to be at sort of -- we expect to be at something like $120 million to $140 million in the Blue Planet business. Now I'd say that at the time, we weren't doing anywhere near that. And so it was as much hope as it was based on fact. But over the last 3 or 4 quarters, it appears to us that the service providers are starting to take decisions to automate their network. We've had lots of wins this past quarter. We had how many Tier 1 wins, Gregg, 4, 5?

This past year, yes, that's right. Yes.

And we had a strong revenue quarter starting in Q4 of last year and it continues to get better. So we're well on our way to that $120 million to $140 million. Michael, you mentioned that our run rate in this quarter was approaching $100 million. I think we're -- we've gotten enough traction to feel that Blue Planet is going to be a feature in our future and we're very happy with it. It makes us sticky with customers. They're not sort of tied to us forever. But once they have implemented the software, they're going to -- you're going to be in that network for a while because it's hard to replace. So that's just a good trend on Blue Planet. Certainly not ready to declare victory because we've got a lot of cards to play, but it's in good shape.

And we're working on the recurring revenue. It is at that run rate, but the recurring revenue combined, which is what we're working on is still something we're building up, so I just want to be clear on that.

Yes, great. And then the other, I guess, very popular topic among our clients right now is Huawei. And so I know we're still in the very early innings here, especially in Europe. But wondering if you can maybe give us any indication from customers that you're seeing kind of an uptick in wanting to use something other than Huawei for new projects.

Yes. You have to look at this from a global perspective to start. There are going to be places who are going to be very happy to use Huawei gear for a long time, and we're talking, of course, China, places in South America, places in Asia, Indonesia, Malaysia, Thailand. And so I -- we don't see that kind of push to move Huawei out of those networks that we see in places like, of course, the U.S., where they can't play and in Western Europe, where there's a great debate going on. The debate has sort of been settled, okay, is it -- Huawei gear. Nordic countries have sort of made up -- they're not going to. But the big battlefield is going to be in the big economies of Europe who have been pretty big Huawei users, Germany, France, Spain, Italy. I'd say that the pressure on Huawei has increased. There haven't been a lot of big infrastructure deals available and made in those economies that I just mentioned. We have talked about some wins in Deutsche Telekom, which were not -- they were under a slightly different situation. There was pressure on Huawei, but it was all internal to Deutsche Telekom because they were too -- they felt too heavily reliant upon Huawei as a vendor. So they wanted to diversify, and we did win some stuff there, but that was not at the level of sort of geopolitical pressure on Huawei that we see today. Our view is this, that -- I should also mention India. India has basically made the decision not to use Huawei any longer. And of the 3 big players there, 2 of the 3 were users of Huawei. So there's an opportunity there, which we have taken great advantage of. Now back to Europe, which is the big battleground. It's some number like $500 million to $1 billion, which is in play here on an annual basis. There's going to be a fight for it. It's going to be Nokia and Ciena. And it's not all going to happen at once. It's going to happen over a number of years. But I think that's going to be a good sort of tailwind for us. We'll have to compete against Nokia for it. And Infinera, we'll try to get some and other smaller players. But really, I would be surprised if the lion's share of that amount of money doesn't come to ourselves and Nokia.

Do you have anything else on that...

I'm sorry, I didn't hear the question.

Yes. I was just curious if the dynamics of Huawei will affect the pricing environment at all, do you think?

Well, it should. They've been a price aggressor. But I would say this that Nokia has been very much a price aggressor for several years in the market, and so we'll see. You think that with the lack of the presence of a big player like Huawei, you should see some improvement over time. But I don't think this is a near-term phenomenon.

From the audience that are listening to the webcast, one, it's not related to this topic, which is, do you think -- do you see Nokia perhaps also becoming more price rationale under a new management team or is this a little too early?

Too early to say. But certainly, the statement by the new CEO, the reorganization of the company into the 4 segments, a statement that he is going to demand that each of those segments get to profitability goals that he has set, it would lead you to think that they're going to need to moderate the pricing behavior. But it's too early to say that, that's happening. We'll see it when the infrastructure, Huawei replacement deals come forward. That's when we'll see what the pricing environment looks like for that.

Fair enough. And then the second one that was here from the audience was, if you had -- if you had no supply chain issues, what would the guide look like? I guess maybe the realm is -- is the guide you provide curtailed by a capacity or something else?

Here's what I'd say about that. Not to a great extent as we sit here today, yes. If we were to get a continuation in Q3 of the kind of order trends that we saw in Q2, then it is -- and it's a very hypothetical answer. And we had no supply constraints, yes, I think that maybe we could look at something bigger. But that's -- those are 2 very big ifs. And kind of hard to see that we get the same kind of orders in Q3 that we guided in Q2.

This is a question I got a fair bit -- last year when you reported actually. So I figure who better to ask this question with you, which is -- Ciena's been doing this $3.5 billion in revenues, give or take, for the last 3 years in a row now. And everything -- management said everything, you said everything. Things are normalizing and there seems to be pent-up demand. So the question I guess become, should we think about the company doing something better than the 6% to 8% long-term growth you've had in the past as we get into fiscal '22 and beyond?

Well, that sounds suspiciously like guidance, Amit. And I'm not going to get into a guide. But I wouldn't say this, that the market is already anticipating a bigger than 6% to 8% growth rate there. I think the market today is something like 8.6%, which looks kind of steep to me right now.

Question that opened up today -- end of my time, I have to squeeze this one in. I asked this question to Gary on my call back, and he said I should ask this to you, by the way, which is -- you're sitting on a good amount of cash. So it's like -- actually, I should preface this -- the question is coming from your boss, not from me. You're sitting on a healthy amount of cash. I know you've been doing buybacks, but how do you think about capital allocation priorities beyond buybacks? And where does dividends or as you said, the D word fit into the narrative?

Did he faint when you asked him the question?

I think he punted it to you. So that was probably...

Well, first, I'd say this, that yes, we're building up a big cash stockpile and it's higher than what our goals are. Our goals are sort of have 800 -- maybe a little higher liquidity, given we've gone through a COVID event, which scared the heck out of everybody. But we're above those levels today. We have a lot of cash. We have hoped that there would be an M&A opportunity that would consume some of that cash and we've looked at a lot of them. We haven't found something that works for us yet. But that's -- if I had my choice, that would be my first choice of capital allocation because that would bring value to current shareholders. And you're right, we have started to repurchase stock. A dividend is a big decision for a company because it's just -- it's very inflexible. If things were to change, if we were going to go into a huge downturn, then taking away a dividend is a massive trauma to the world, whereas a reduction in a stock buyback thing is -- no, people don't like it. But at least they understand that -- they seem to understand that better than they understand removing a dividend. So we're going to be very cautious about approaching that question. I would say we've talked about it. But I wouldn't say that it's in our near-term future.

Well, maybe I'll pause here. I want to thank you for your time, which has been extremely helpful for me to learn about. I want to turn this back to you because we touched a fair amount of things. But if there's something, Jim, I haven't touched on, we haven't covered that you think investors should be aware about or cognizant about, please do let us know through the virtual line. Back to you.

You have covered the waterfront, Amit. I don't know that we've -- we got anything left. I got nothing.

I'd be as great -- but I need this then. Thank you for your time.

All right. Thanks, everybody. Thank you.

Thanks. Thank you.