Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Good afternoon, everybody, and thanks again for joining us here on day 2 of Stifel's Cross Sector Insight Conference. We're fortunate today to have Ciena with us. And with us is Scott McFeely, who's Senior Vice President of Global Products and Services. We also have Patti Trautwein who is new to the IR team at Ciena. And then, of course, Gregg Lampf, who many of you know as the man and head of IR here at Ciena. So what I'd like to do is start out first, Scott, with a few demand questions and then maybe transition a little bit into some of the new technologies, things like that and maybe spend a few minutes on competition.

But first, if you could, maybe just starting on the telecom side of things, if it's possible, maybe just sort of take us around the globe geographically. What you're seeing in North America? Obviously, a lot of focus there, particularly with the expected ramp in the second half of the year. Maybe what's happening in Europe, where it seems like things are starting to move a little bit there? Certainly India and some of the challenges. But if you could maybe just take us around the world a little bit and just sort of give us a sense of where that telecom demand is now with customers, I think that would be helpful.

Sure, John, absolutely, will do that. Before I do, though, let me just say thanks for hosting us today. Thanks for you and your client group for your continued interest in Ciena. So if I take a look at the telecom demand that we're seeing here now, probably the context that you have to have is what have we been seeing in the last year or so. And I'll get into the sort of regional variations on this, but in general, the theme, if I rewind the clock back a year ago as people hit with sort of, obviously, a real shakeup of the system and sort of going into the early times of the pandemic, the reaction of the key network owners around the world that we talk to had some level of consistency in the themes, they all had spike up in terms of capacity demands, particularly on their broadband access as we all went to our homes and kind of communicated. In general, the bandwidth demand on the overall network at an aggregate level was pretty much a year's worth of demand that hit them in a very short period of time -- demand growth that hit them in a very short period of time, and then the network kind of stabilized. The reaction to that to various degrees was one of implementing policy in their network and essentially running their infrastructure in the network hotter than they normally would have. And how that varied depending from customer to customer in terms of what the state of their network was when they went into it. I think the other kind of dynamics that we saw that was pretty consistent around the world was anybody that was subject and exposed or overweighted towards success-based business that was driven by enterprise and particularly small and medium businesses, took a bit of a pause on that part of their business for sure. And then the other thing that was maybe a little bit more unique to Ciena or certainly had a bigger impact to Ciena is, folks that were driving implementations in various stages of projects that I would just categorize as moving their network forward in terms of next-generation architecture bills that we've been the benefit of winning a number of those, those went to the back burner while they prioritized basically just keeping the lights on. And that had the effect that we celebrated in past quarter calls on our business for a period of time. And we sort of predicted that would last for a few quarters, and we'd start to see that come back in various degrees as we entered in our second half, and that's what we were trying to tell the world basically with our earnings call last week, is we have seen the signs of that coming back. Now to your point around the world, what do I see? The -- certainly, the North American service providers as a whole, we're starting to see spend come back. And I think it has some aspects of catch-up. I think it has some aspects of getting back onto those new projects and has probably some aspects of security of supply in it, given all the dynamics that -- or all the press around supply chains and whatnot. It's difficult for us to put a mathematical formula to which parts of those ingredients are which. I would say this though. We don't -- I don't see in the order book or the backlog a significant difference in terms of the lead time to customer request dates, which suggests there's not a huge amount of security of supply, toilet paper effect going on there. It's more catch up, if you like, to having run their networks hot around. And those themes are actually pretty consistent in the service provider space around the world, and it depends what sort of state that your network was in before you went into COVID as to how much of the dynamic is shifting in. You saw -- if I look at Europe on the service provider space, you saw our first half business up on the order -- on the service provider side, probably 14%, Gregg, will keep me honest here, first half to first half. So quite significant increase in EMEA, partially due to that pent-up demand, partially due to, I think, the competitive dynamics. A great quarter in AT&T. I think that won't continue on the AT&T front for the second half of the year, but we do expect to see strength in the North American service providers balanced by a few of the other logos in the second half of the year. So that's the service provider space. The one space that I probably would be remiss if I don't talk about is India. Because we had India up year-on-year first half to first half. And certainly, our plan for the year had it being up reasonably nicely for the whole year. We still think it will be up year -- for the whole year, year-on-year. But we have taken our expectations for the second half in India down a bit. Fortunately, we have enough robustness in North America service providers, EMEA service providers and the webscale to make up for that little hole in the plan that India had caused.

Got it. When you look out beyond sort of this near term, right, because I think there's a little bit of concern out there that, as you mentioned, there's some pent-up demand that's actually maybe fueling some of this near-term growth, is as those networks are coming off running hotter and they're trying to catch up a little bit to maybe what their plans have been. You've got 800 gig sort of rolling -- beginning to roll on top of that. I think there's a little bit of a concern that even as we get through the second half of the year, maybe we see that ramp, but then maybe '22 isn't as strong. And I know that you haven't given '22 guidance and I'm not asking for that here. But given, I guess, where we are with some of the newer technologies coming to market along with sort of where you see these carrier networks being, should investors be concerned, I guess, that as pent-up demand rolls off, then we go back to a lower growth rate than maybe where many are expecting you to be at?

I look at it a little bit differently than that, John. I sort of see that we're going to continue to see balanced demand growth in these infrastructure network side, is double digits, 20% to 30% year-on-year. Unfortunately, the market doesn't grow that fast because it's offset by price erosion. But I think those dynamics continue. And I think what you saw over the last 3 or 4 quarters was sort of a blip in time where you saw a bit of a spike a year ago and sort of took a bit of a pause. And now you're seeing us back on that normal curve of 20% to 30% bandwidth demand year-on-year. That's sort of how I look at it. And on your comment on 800 gig, any sort of next-generation optical technology typically has 2 drivers to it. One is, everybody trying to eke out the right economic model where lowest cost per bit because in a world where the bandwidth is growing 20% to 30% per year, obviously, our customers' ARPU isn't anywhere near that, unfortunately. So they're looking for innovation to drive cost of ownership reduction. And that's the key driver for any generation. So in our case, if you look at WaveLogic 5 versus the previous generation, WaveLogic Ai, your mileage may vary. But the simple statement is, it's twice as effective from a cost per bit perspective, so people are going to move to that as the best way to serve the demand that they have. So I don't see that as a demand cycle so much on that dimension, as I do as a competitive differentiator, which is it's the lowest cost to serve the demand that is there. We don't drive the demand, and we're serving the demand. The second dimension of it, though, is where the client service rate is changing. So in the world, we went from 1 gig to 10 gig as a dominant service client for the business that we play in. The last number of years, 10 gig became supplanted by 100 gig or in by 100 gig. I think we're going to go through a period now where 400 gig E starts to be a bigger proportion of the services that need to get served, in which case, that will favor folks that can carry that 400 gig seamlessly end-to-end where the service needs to go, which you need the generation of technology that WaveLogic 5 is in order to do that. But that's still in front of us.

Right. Okay. Okay. That's helpful. And you mentioned, obviously, webscale being a bit stronger for you here in helping offset some of that weaker India outlook. Can you talk at all about in terms of what they're deploying now? Obviously, similar to a lot of other networks, they paused a bit last year and moved a bit more tactically rather than strategically. When you look at that strength now, is it pent-up demand? Is it getting back to network expansion in terms of just geographic or regional build-outs? Is it 800 gig adoption that had been evaluated, but then was put on pause? Just -- we know that Microsoft is a new customer now. Just curious what were some of your -- what sort of demand drivers are for that renewed push out of the webscale customers?

Yes. I'll talk, I guess, generically, and I'll talk without naming the customer, some individual anecdotes or what's going on at Ciena specific. Generically, I think they continue to drive geographical expansion and capacity expansion driven by the applications in each one. We talk about them as one ubiquitous segment, but they're not. They each have their own drivers. But in general, they are growing bandwidth demands faster than the rest of the industry. And you see that not only in the direct business that we do with them, but they become a bigger and bigger player, actor among the industry where there's wholesale bandwidth being consumed as well, either through the service provider business that we do or a large actor in the submarine place as well. For those on the audience side that maybe don't -- aren't as close to us, I mean, we service the webscale folks. And we connect basically their data centers together, either their compute or their content together, in 3 kind of distinct use cases. One is a campus and/or metro kind of use case where essentially it's all one virtual location. They own the fiber for the most part, and it's fairly short-reach optics. National backbone networks, where they've built out some very sophisticated optical networks that have photonic line systems, ROADMs, amplifiers as well as wavelength terminals. And then very active, as I mentioned, in the submarine space. So what technology and exactly what we saw varies by those 3 use cases and varies by customers. I mean, I think everybody has -- probably has a perception, which is a bit misplaced, that the webscale guys are always -- every Monday morning, they're at the bleeding edge of the technology. And 5 years ago, there may have been some truth to that. But they're running very large networks and spent significant energy and integrating into their back end "their software stack and back office systems". So they don't -- they aren't quite as fleet a foot as people's perception is. So they're running various different generations of our technology in that business. The other thing you should take from that, though, is our relationship with them has become much more strategic and much stickier over the years as we integrate into their back office as we do services for them, as we partner with them outside of their North American space with service providers that we have incumbency with, et cetera, to serve them. So that's another dynamic. I go to the individual ones. You mentioned new win in Microsoft. That is starting to materialize in terms of real revenue for us now. So that's part of that numbers that you would have seen, and we think it will grow over time. You heard us talk publicly without naming the customer, a very, very large one, if you look in the rearview mirror last year, that was sort of on a digestion phase and didn't spend anywhere near what they spent with us the year before. They had a very, very strong first half of 2021 and expect -- we expect them to be strong for the rest of the year. And as I said, we're in most of those applications. The other one that is interesting for us in terms of an upside potential, there's one of them. And you guys probably guessed who it is, that for that use case around campus or metro DCI, it doesn't use any coherent technology today. So we don't have a solution to address that. They will be moving to coherent over the next short while here, and that's an opportunity for us to expand the relationship there too for -- we've got to go in, of course, but that's an opportunity .

Sure. Sure. And Scott, that's, I think, an interesting transition point, obviously, into some of the fears around 400ZR, right? And what that means, not just from a demand perspective, but also from a margin profile and things of that nature? I think a lot of investors still equate 400ZR with a more commodity type product, right, in terms of the -- it's going to be a standardized, pluggable form factor and things of that nature. So when you think, particularly about when you broke the network into sort of the 3 areas that you serve into those thirds and you think about that metro, campus sort of environment, where I think ZR is particularly well suited here at least early on. I guess, how should investors think about that opportunity and/or risk for ZR relative to Ciena? I mean is each one of those sales at the expense of a Waveserver? And what does that mean from, I guess, a margin profile perspective?

Yes. So let me take -- there was a few really good ones in there, John. I'll try to take them one at a time. So let's talk first about the margin profile perspective and the pricing environment. And the perception is, yes, so this is a commodity item, and you'll be able to buy it at 7-Eleven, so therefore, the pricing environment is going to be really challenging. I'll tell you this. I think OFC probably 3 years ago, you would have thought 20-some people would have had ZRs in the marketplace 1.5 years ago. I'd say it's not going to be as widely available in a functioning form factor as people thought then, for sure. And there's still water to be -- under the bridge. So in terms of the folks that actually control -- yes, there may be value-added resellers of the technology, but in terms of the folks that actually have control of their own destiny and most of the costs of the ZR plug, there's actually not that many of them, and you can draw your map of the ecosystem and figure out who they are. We certainly count ourselves in -- amongst the list of the folks that have it. So I don't actually -- I don't think it meets my classic definition of the commodity. But that is what I'm trying to say, that I like to look at specifically at the pricing. We sort of talked about -- we've lived for the last probably 15 years in this space where bandwidth demand has been 20% to 30% year-on-year, and yet you wake up and you look in the rearview mirror, and the market only grew 2% to 5% year-on-year. And you scratch your head and you go, what happened there. And you go, the answer is it's price erosion. And the price erosion has been on that pace for as long as I can remember. And the folks that have actually been able to survive and maybe even thrive in that environment are the folks that have invested in innovation and owning their own technology. And I look at the prices that are out there being proposed in early RFIs and RFPs and the ZR and I go, it's just a continuation of that curve. And if you aren't somebody that is fairly vertically integrated, isn't going to get the volumes and doesn't control your own technology, you're not long for that game. But that's why we think we have a hand to play there.

And can you talk a little bit -- you had a pluggable talk a few weeks ago. And you mentioned sort of being able to do some variance off that 5 nano chipset that allows you to maybe differentiate there a little bit. Is that within that cloud or that webscale market overall? Or is that to address maybe ZR+ or whatever is next and different areas of the overall market as that ZR technology matures?

Yes. Yes, you're right. So for those who don't know what we're referencing, John, we did do an investor chalk talk that's available on our investors web event page, I think, Gregg and Patti can be honest it's -- on that front. So if you want to spend an hour or so listening to pluggables, I'll point you over there. But John, your -- one of the things I didn't mention on the answer to your last question was sort of the market size and opportunity. Specifically on the ZR piece, we've sort of sized in the fullness of time that we think that will be about a $500 million market for the ZR metro campus DCI use case. It will take a couple of seasons to get to that, but that's sort of the sizing against an overall optical market of $13 billion. So yes, in some accounts, where we are using Waveserver for that metro DCI, it would be substitutive. In other accounts, where it's not coherent today but will move to coherent with those ZR plugs, it's a new opportunity. We have, in the past, talked about the proportion of our Waveserver revenue that fits into that use case. It's -- Gregg, you're going to have to keep me honest here in terms of the past, but it's less than half of the overall Waveserver revenue that fits into that sort of substitutive category. Other applications use Waveservers as well, of course. So I just wanted to -- I just didn't answer your question on the market size. Yes. So you're right. Within the same technology node, both the DSPs and the electrooptics, we have designed it to provide a broader market applicability than the ZR spec as it does itself. And it comes in 2 flavors: One is even within the ZR spec, driving, we believe, best-in-class power performance versus what we've seen from others out there. So even in that metro campus, we think, yes, price will matter, but there are ways to differentiate yourself. One is power, and one is -- if you're -- the specs has basically single span, so think of it as 60 to 80 kilometers. If you're able to drive within that spec and that power footprint up 140 kilometers and there may be some webscale folks that haven't stamped out their architecture that says that metro campus DCI is restricted to e-commerce, that if you want to get 100% of the use case, you have to go a bit more than that, that matters. So that's one area, sticking with the ZR spec, but doing it better, just doing a better implementation job, if you like. The second area, though, is going beyond that into other modes that would be more proprietary than in the same footprint or at least in other options for pluggable footprints. We can drive substantially more performance, and that starts to become applicable more into infrastructure metro networks, for example. And we think there are lots of reasons for pluggables. They've always existed by the way. It's not a new topic. Typically, in the infrastructure business, pluggables are there for modularity so you don't have to -- if you have a 12-port card, you don't have to pay for all 12 -- 12x whatever the data rate is at day 1, you can fill it as you need to go. So pluggables have always been there. And we think having a pluggable that has got fantastic optical performance is going to advantage our system business.

Got it. Got it. Maybe just using that as a bridge to a competition question here because I know we're getting close to running out of time. There's a lot been made, obviously, at the 800-gig level with Huawei not being invited into networks, there's really only 2 of you now announced with 800 that's available to customers. There was a couple of announcements this week out of OFC. I think ADVA even earlier -- or at some point yesterday made an 800-gig announcement. But how do you look at the competitive landscape? And does it vary, I guess, for telecom customers versus what you're seeing for those webscale customers?

I think it's pretty -- where it's consistent is where customers have significant growth in bandwidth demand and some constraint on their fiber. They're always going to gravitate over time, I think, to somebody that has the best optical performance. And we've certainly benefited from that in terms of market share gains since Coherent became the sweet spot, and we would expect to continue to do that in generations, and you're seeing that now with WaveLogic Ai -- sorry, WaveLogic 5. We've shipped 11,500 units of it in less than a year. And other people are talking about that generation of technology being available sometime in the near future. I'd say this -- and by the way, the shipments are accelerating quarter-on-quarter. And our customers make these decisions in full knowledge of everybody's road maps. Everybody talks to them about road maps. So are we going to be alone in that generation of technology? Of course, not. At some point in time, there will be others that are doing it. But there are other dimensions of choosing a relationship with us or with us or others like us, that has to do with things broader than just that piece of technology. And incumbency, ability to serve, supply chain strength, ability to invest in things like inventory, trust and relationship is important as well. And I think all those things have served us extremely well in both the webscale and the Tier 1 service provider relationships around the world. I think they continue -- they will continue to going forward. I don't see a point in time, and it's going to sound a little bit arrogant, that anybody is going to out coherent optics us. And I mean that not only from a performance perspective, but also who controls their own destiny from controlling the bill of materials. I mean you mentioned ADVA and -- they're an interesting competitor that's -- don't know for who they are, not throwing them under the bus, but they own none of this stuff. They're a value-added reseller and historically allocation. It's a really tough position to be in when the market price erosion is what it is.

Right. Right. Maybe one last question. When -- obviously, a lot of opportunity ascribed to what's going on with Huawei. And you all have talked about that for a while now. With the first half, particularly in Europe being up as nicely as it has been, are we starting to see some movement on that Huawei opportunity side, particularly in Europe, where we're I -- obviously, India was moving that way a little bit quicker, but we all know what's going on kind of in India now. But how do we think about that maybe from a time frame and size perspective as we look at that Huawei opportunity?

Yes. I think -- so first of all, from a size perspective, we did a little bit of work for ourselves, obviously, because we keep getting this question around how do we think the role unfolds and what's really the overall market size over a period of time. And you sort of triaged the world into those that are really going to have a bias against Huawei or China, if you want to call it that, if somebody chose to [indiscernible] Huawei if they were in a doomsday scenario where they couldn't supply or ones that really won't care. And you can go around the world and pick the countries that will be biased one way or the other. Our view of it is the ones that will be biased against continue to have a significant portion of their spend with Huawei, in our space, adds up to $0.75 billion to $1 billion worth of market share over time. How much of that we can get at, that's in front of us. The one thing that we consistently say though and caution people is the timing piece. I do not believe that this will be, I'm going to wake up Monday morning, and I'm going to rip my optical network from Huawei. I think it will be in the short-term shifts of share of wallet, and that will benefit incumbents. And then I think in the longer term, as we look at still having a multi-vendor environment, they go back out for an infrastructure RFP for a new vendor, that takes time. And I like our opportunity over the longer term, but it's going to take time.

Great. Well, unfortunately, we are out of time. Scott, I really appreciate you covering out some minutes to spend with us here today. Best of luck with everything. And I'm sure we'll catch up again too.

Always a pleasure. Thanks, John. Thanks, everybody.

Thank you.