Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Hi. Good morning, everybody. Thanks very much for joining us. This is the third day of our conference, and I'm very pleased to host this morning Ciena, which we have been supporting for a while. Today, with us, we have a Jim Moylan, SVP and CFO; and Gregg Lampf, VP of Investor Relations. And I prepared -- as always, I prepared a list of questions to take them through what we're seeing -- what they're seeing in the market, opportunities and challenges. And also, as you know, there is a panel system, the Veracast system, where you can ask questions. If you have an interest, please text me the questions, and I'll be very happy to ask them.

So with no further ado, I will just start with the first question. And if you need to do any kind of safe harbor statements, this is the time. I want to talk about the short term. You were cautious before, and we'll talk about the numbers in a second. This quarter, you sounded both cautious and optimistic. And I want to ask about the trends you're seeing in the market, what makes you optimistic and what makes you cautious basically. What are the positive trends and maybe -- or negative trends that you're seeing in the market? And I'm talking about spending trends, projects, et cetera.

It goes without saying that the safe harbor provisions apply here, so I won't say it. But I will say, Tal, that one of the issues with working with you for so long is that you know us too well. And so you actually read our body language in our calls extremely well. And so here's what I'd say. We started this fiscal year and prepared our plan back in August, September, that time period, a time period in which orders were quite low. We were right in the depths of COVID. We were getting signals from our sales force that spend was coming, but it was not going to come immediately. And our experience is that the -- first of all, we knew that the service providers had seen a very tough couple of quarters in their enterprise business and that we were very cautious about what was going to happen. But we felt that they would have to start spending because demand for bandwidth has not slowed. It's increased, if anything. Based on that set of signals, we made a plan for this year. And the plan called for 2 relatively low orders of revenue and a bounce back -- a bigger bounce back in the second half than is typically the case. One thing it depended upon was those projections being true, that what the sales guys were saying was true and what our belief system was that the customer behavior was true, and it depended in large part on the order flow in the second quarter. We saw a big order flow in the second quarter. It was a bit -- it was beyond our expectations. Now there's a couple of caveats to that. One is, some of it, as we've come through this question about semi availability, is an attempt by some of our customers to give us visibility into their demand for the year. Some of it may be some catch-up because maybe they are running harder than they need to. But with all those caveats, it was a very, very strong orders quarter and gives us confidence that we can hit the targets that we've set out. We -- it's not an assumption anymore. I wouldn't say the year is done because we still like to get some orders in order to make the year, but we're in good shape to hit our numbers for the year. So that's the confidence part. The -- you might have heard some caution and I guess what I'd say is this. We're -- I think there's a tendency on the part of some people in the investment community, when things turn, to assume that the pendulum is going to swing a long way beyond the center point and believe that our numbers are going to be significantly higher than the numbers we put out there. And that we were cautionary about. We don't think that people should do that. This order flow in Q2 was exactly directionally what we thought it was going to be. Yes, a little higher than normal, but there are reasons why, and we don't want people to run. And by the way, the supply chain is such that I don't think we could -- I knew it would be difficult for us to exceed the top end of our range. I'm not going to say impossible. But it's going to be difficult for us to do that.

So just to put it in perspective, in the last quarter, your revenues declined 9% year-over-year, and you're guiding for minus almost 8%, 7.7% to the midpoint. What regions and trends drive the weakness? If you can relate to types of customers, maybe service providers versus cloud, if you can relate to types of product. I'm trying to understand where the weakness is and where the recovery is going to be.

When you say the Q3 side is sequentially up 16% or something like that, are you talking about year over last year?

Yes, year-over-year.

Yes. Okay. Honestly, you've looked at it in a way that we haven't looked at it. We put the -- we've looked at it as sort of low first half, high second half. And we think of the second half as being a very strong period of time. It's -- when COVID hit, what we saw was the service providers contracted their spend in a very significant way. The data center guys slowed slightly. They don't have the same business model as the service providers. And so their business was not as impacted by COVID, but they did slow their spend. This orders pickup that we saw in Q2 is very broad, very wide across our customer base. But the amplitude of the change from Q2 to Q -- I'm sorry, from Q1 to Q2 is much higher on the part of the service providers than it is on the webscale. I would just, though, say that just about every region, just about every vertical had very good order flow. The one area that we highlighted that we are not doing as well as in Japan. And that's a situation in which NTP has sort of returned to its roots and begun spend more with indigenous Japanese providers. And -- but other than that if you go from Europe to North America to India, parts of Asia, strong orders quarter across the board.

Okay. So maybe more specifically, how do you -- what are -- I'm trying to understand the drivers. For those of us or those -- or the investors that don't know Ciena that much, can we talk about what is driving the order growth? Meaning, what kind of projects? Is it related to 5G? Or is it related to 800-gig deployment? Or are these general infrastructure projects? I'm trying to see the underlying trend from a product point of view.

Okay. Yes. Well, I'd say that it sort of varies by vertical. And on the service provider side, I do think that there is some catch-up to fill in of capacity adds in order to kind of cool down the system and get the utilization of their system -- networks down a little bit. On the -- and it's -- I think that's the -- a large part of it, not the largest part, but it is a large part of it. With respect to other service providers, including some in Europe and some in the U.S., it's real infrastructure type stuff. On the part of 800-gig, remember that the data centers are going to be the fastest -- they're going to be the fastest on the take-up of 800-gig. So that's a lot of data center interconnections. And that one is -- we're going to build a line system in most cases, and we're going to install Waveservers. So that's the kind of projects that we're seeing there. I think the underlying thing, as we've always said, the underlying demand factor for us is the growth in broadband, whether it's 5G or infrastructure or whatever else. And we're not always sure exactly whether it's 5G that's driving it. We know that 5G is being implemented, parts of Asia, parts of the United States, not so much in Europe. And we're not always clear if what we're selling to these companies is for 5G or not, but it has to be in part.

Got it. Cloud revenues increased 25% year-over-year. It is now 20% of your business. Can you discuss the growth drivers? And even close to the historical perspective of cloud revenue.

Yes. There are probably hundreds of companies with a data center-centric or web-centric business model, maybe thousands, and a lot of them build out their own connections. But there are 5 that are the biggest. It's Amazon, Google, Facebook and Microsoft and Apple. We have business, concentrated business, with 3 of those 5 and a growing business with the fourth of the 5 with whom we do business. Behind that, there are companies like Oracle and IBM, Equinix who are big customers, but not anywhere near the scale of the 4 -- the 3 and going to be the 4 that we serve. The business is data center interconnection. Now they are -- they have -- and of course, I'll make the obvious statement, their business model is not owning and leasing network capacity. Their business model is something else. And so they're building network connections strictly because that -- they want their underlying business to be the best it can be. They're very, very focused on quality of service. Just about all of them have a combination of long hauls, regional, metro, and in some cases, campus connections. We have served all of those connections with a combination of 6500 and Waveserver. It's all about what's going on in their base business, growth in advertising, growth in cloud services, growth in whatever, searches, all of those things that demand data center utilizations, and they need to build data centers and connect them. Now we'll probably talk about this in more detail later on. But one of the things that's happening is that they are moving data centers closer and closer to the edge because they want better quality of service. And there are massive flows out there at the edge, so they want to have as low, low latency as they can have. What that means is that there will be architectural shifts as we move through time, and we can talk about that later on after we sort of plumb the depths of the webscale guys. I'd say that our business with the data center players is -- 6, 7 years ago, it was nothing. They were just starting the journey of connecting their own data centers. Today, it's a big part of our revenue. It's the fastest-growing part of our revenue. And in addition to the 4 that I've talked about earlier, we have as many as 90 to 100 Waveserver customers. So those are not all data center-centric companies, but most of them are. Our expectation is that they're going to be growing in this year, I think, in mid-single digits. I think they might return to a little higher growth rate as we move forward. We gained massive share with them. We have the largest share with the data center group. We have -- I don't have the exact number, Tal, but we have over 50%. The last time I saw these numbers a couple of months ago, we had over 50% global share with data center companies and we have very little in China, which is -- that's a big data center-centric business area. And so we believe that we have a very high, well over 50% share with data centers guys. They love our technology. They're all about quality of service, and our technology provides a great quality of service. Some of their networks are getting a little more complicated. They're not just data center connections anymore. They -- some -- a couple have meshed their network. They have special features and functionality that some of them need. And so it's not just a transactional business with them as it was perhaps when it started. It's much deeper. We're engaged in their strategy. Networking is becoming a more important part of their business model. Again, their business model is not selling network capacity. But in large part, it's cloud services, which are -- the quality of the connections between the enterprises and cloud are just very important and significant, and they look to us for that reason.

Got it. It sounds like there is no competition in the cloud, what we saw in Cisco [ working on ] that integrated solutions. We're seeing that Juniper and, I think, all the others, they are trying to expand because they have an issue -- sometimes an issue with their routing, they are trying to expand the definition of what is a router. And an optical is the only way to add value basically. So do you see great competition coming in the future? Are you concerned about the trend? How do you view the cloud business shaping up and also the service providers business shaping up in the next few years?

Well, this has always been a very competitive business. I think generally, the consolidation of market share in the business has -- it certainly has not worsened the competitive dynamics. It's probably improved them a bit because you really have ourselves and Nokia as the big players. Now what I would say is this. I talked a little bit about architectural changes. And with all of the flows, with all of the quantity of flows and the edge of the network and an aim for massive number of endpoints and interconnections, the ability to install a router at all of those endpoints is very difficult because routers are expensive. And so what is developing, and this is the architectural point I was alluding to earlier, what is developing is the need for converged platforms, which have very good optical and a routing functionality which allows for segment routing. For example, the ability for the box to detect what the next optimal pop is out there at the edge. So you don't -- not every flow is going to go back to the core or even back to the metro. It's going to stay in a relatively smaller region. So that's the need, is for this optimized converged box. And to be honest with you, it does put us in more direct competition with Cisco than we have in the past. They have Acacia. They're going to have a good optical capability and have the legacy in their routing ability. But we're going to have the necessary routing capability that we need in order to meet that need, and we're going to have the best -- as we do today, the best optical in the business. So -- and the only other player, I think, that's going to be out there seriously is Nokia because Nokia has strong routing and they have a good optical. Juniper is going to come out there, but they're going to have to integrate somebody else's optics, and you know that that's always complicated. So I think it's the 3 of us that are going to fight for this new business out there. And we're not going to get all of it, but I like our chances. Some of it is incremental business because it's routing replacement.

Got it. I want to go back to visibility. You -- in order to hit the annual guidance, you have to grow 25% second half versus first half. How much -- and I think you guided for -- and again, I'm -- from memory, 16% sequentially. So it means that it needs further acceleration in the following quarter. How much of it is in the -- in your orders or backlog? How much of it is based on customers? I'm just trying to understand the visibility because you provided the guidance earlier in the year when you did have this kind of visibility.

Yes. That's right. As I laid out earlier, we didn't have backlog visibility. And what we had was an educated view based on what customers were saying and what are our experiences with the service providers and a knowledge that demand for bandwidth continues to grow. Q2, I'm not going to say that Q2 locked our year-end because that would not be for a -- but I would say that we're in very good shape. We've got very strong visibility out to the end of this year. I would say that we're going to have to get some amount of additional orders in Q3 and Q4 and turn that -- those orders to revenues, what we call book to revenue type orders. But none of that has to do with new wins. We don't have to -- at the edges, I'm sure there are some new wins. But all of that BTR, it's kind of getting late in the year for us to win something and then start converting it to revenue. So I guess I'm feeling confident based on the backlog, based on what our sales guys are saying about demand on their end customers, that we're in good shape for this year. Now next year, we'll see. It's -- one of the important things to note is that the question that might have been asked is the big upflow in orders that you had in Q2 related to 2022, is this advanced demand? And the answer to that is not really. Most of it is '21 demand. We have been given some advanced visibility into Q4 demand. But very little of it relates to '22. So we're going to have to have strong orders in Q3 and Q4 to build -- keep our backlog to go into 2022. But feeling good about this [indiscernible], Tal.

I was going to say a backdrop to this as well is we've got, as was mentioned earlier, WaveLogic 5, our next-generation coherent offering, the 800-gig that people referred to. And we have talked about the fact that during COVID, there were some delays in rolling that out. You were seeing an acceleration now as we're starting to get through COVID of those deployments. And that's not incremental to what we're saying, but this is part of what gives us confidence to the year.

And Gregg, maybe just a follow-up, or Jim. WaveLogic, is it addressing -- or 800-gig, let's talk about 800-gig. Is it mostly addressing cloud? Or are you going to see also application in the service provider space?

Well, we'll definitely see service provider applications. We'll definitely see submarine applications, which is initially -- not mostly. It's a mix of service providers and cloud. But the biggest early take-up is the cloud guys. And that's really because they're -- they have just -- even though their networks are getting more complicated, it's a simpler connection. They don't have to do all the kind of testing of services, et cetera, that the wave -- the service providers do. But I'd say how many customers do we have now for 800 -- WaveLogic 5? 95 or something?

95, yes.

Yes. So it's not just the webscale guys. They are the volume buyers at this point.

On the call, you also highlighted upside for the new routers. Can you discuss the IP area for you? Maybe a little bit of the background, what drove you to enter the routing market? And then what's the current driver -- what are the current trends that you see in the market?

Yes. To be clear, we're not going to have a stand-alone router. At least that's not in our view right now. What we're going to produce is a -- then what we have in a couple of customers already is a converged box, which combines optical, packet switching and routing functionality, which allows the integration of those various technologies, not just at edge, but including the metro. And basically, it's a much more economic solution, as I said, than putting a router everywhere. We started this journey a long time ago. Remember, we acquired World Wide Packets 10 years ago to put us into the packet switching business. And we -- because we have very close relationships with service providers all over the world, we know what they're thinking about. We know what their problems are, and we know how we can solve them. And I'd say about the 3 years ago maybe, maybe 4, we saw that this change in architecture was going to occur. And they were going to need these converged platforms and we're down the path of building those. Now as I say, we have early-stage products in a few customers. By the end of this year, we'll have a pretty full suite of these converged boxes. And as I said, we're going to be -- we, Cisco and Nokia are going to be fighting for a market where edge routing is going to converge with optical. And by it, I don't mean that every edge router is going away. That's not true. It's never black and white, but there are going to be a lot of applications where this converged box is the best solution. And that's incremental business for us.

And this is an area that allows us to address some of the direct flagship spenders, not the actual fronthaul, midhaul, global edge commute -- or compute. Of course, the capacity that's required with 5G are fundamental to our business, but this is sort of an extension.

Right. As far as I understand, in fact, it's -- the main application for the router is actually to aggregate 5G base stations because of the change of technology there. But now it's done by IP and not by ethernet basically.

Absolutely. You're right.

And last question on the IP, just because you highlighted it last quarter. Is the opportunity mostly U.S.? Or is the opportunity also Europe?

It's all over the world. And surprisingly, India, the India operators are very interested in this. And it's all over the world. Brazilian operators are interested in it. I'd say that Europe is just beginning, but we're very confident that the architecture is such that it's going to be attractive to just about every service provider that has a complicated network. So -- but I'd say the early moves are in India, Brazil, U.S. It's where it's going right now.

We always talk about cloud, and we talk about service providers. We don't talk a lot about cable operators. How important are they to your business?

Well, let's see, they were -- how much, Gregg, 7% or 8%?

That's right.

Some number like that. They're very important to our business. And some people think of them as sort of like the service providers. Their networks are different in that they have sort of asymmetric flows. There's a lot more data and stuff going out than there is coming back to them. But their networks are, in terms of architecture, very similar to that of the service providers. And with the rise in video, with the rise and the fact that they're all selling business services now, they're all seeing a similar increase in demand on their systems. So we don't talk about them a lot. We probably should talk about them more. We have a very nicely growing business with them. Comcast has been our biggest customer for a long time. I'll say one other thing about the cable companies or MSOs. They have networks that have long haul, regional, metro and edge type applications. So again, architecture looks very similar. And this whole trend about more endpoints or more -- I shouldn't say more endpoints. I should say more, higher flows at their endpoints is going on with them. And so they have a similar technology. It's not quite similar but a corollary technology to 5G, which is called fiber deep. And it's called different things, fiber densification, whatever. They have different names for it but it's developed the same thing, which is about flows at the edge. And our stuff is -- fits very well with them. We've gained a lot more share in that business over the past several years. We now have business with just about all of the big cable companies. We won -- I think people know we won a pretty big deal with Charter a year or so ago. It's beginning to roll out in a big way. I'm very proud of that. And hopefully, that relationship is going to continue to grow. Other big, but not as big, cable providers are in our stable. We have the 2 or 3 big ones in Canada, Liberty Global in the U.S. It's interesting when you go outside of the U.S., the cable offer, the television or movies or whatever, tends to be offered through service providers. It's not always the case. But often, we're going to sell to the service provider, and they'll fit their -- whether they're delivering business services, video, whatever. It's just a little different. But the big business for us with respect to MSOs is U.S., Europe and Canada. A bit in Europe, yes, but not in -- I was going to say Central Europe. [indiscernible] is a lot of U.K. So...

I want to ask you one more product question before we go to the numbers. Blue Planet [indiscernible] last quarter again. Can you discuss, first of all, for those that don't know exactly what the product is, what is Blue Planet and what kind of trends are you seeing? What drives the growth?

Yes. Blue Planet is a stand-alone software product that's multi-vendor and can be used to orchestrate networks and automate networks. Now what does all that mean? We started an organic attempt to build this product -- set of products about 6 or 7 years ago. We saw that there was a need on the part of the service providers to automate certain functions of their network. They have tended to be extremely manual in the way they establish services. And that has resulted in the fact that it takes them a long time to set up services, to actually put them in place or design and construct new services. It's very difficult and complicated for them. We saw that need. Others saw it as well. But we began organically to build this capability. We saw Cyan in the marketplace was -- with a great orchestrator. And we acquired them. We got a nice hardware business as well, but we essentially acquired them for the software capability. We've watched the way this market has developed. And we now see that there is a significant demand for a network automation set of solutions. And that means things like being able to monitor what's going on in the network to issue sort of warnings about what needs to be done, where capacity needs to be moved around. It's an ability to actually put services into operation automatically and ability to know exactly what's in their network and inventory function. We've addressed all of those capabilities through acquisition of smaller companies. Over the past couple of years, we've integrated those capabilities, and we now have a set of strong solutions. I think we have the best set of solutions in the business. In the meantime, all of that has been happening, and we've been working very hard to gain customers with service providers. And really, it's been a slow trek. And I think it's because it's a very complicated choice on the part of the service providers. This is a massive change for them. They know that they need to do something. They know that they've got to get away from the manual establishment of services and manual monitoring of their networks. But it's hard. Starting third quarter of last year, we started to see traction in Blue Planet. We got -- we started winning customers. They started actually coming to us and saying -- well, they started giving us orders. So we had a good orders quarter in Q3. We've had good orders quarters for the last 3, Q4 of last year, which has continued this year. It's our view that we were right about this need that -- and we're not alone in that. But everybody is seeing the service providers start to move and actually putting POs on us. For the most part, they're buying perpetual licenses so far. We think that the move will be ultimately toward a subscription type of business. But right now, it's mostly perpetual license type business. We won, I think, 5 or 6 service -- Tier 1 service providers in this past quarter. We think Blue Planet is well on its way to becoming an important business for us. I mean this year, it's going to be $65 million, $75 million, something like that. But our aspirations [ last year ], a couple of years ago, were $120 million to $140 million, and we think that's certainly in the ballpark of what we'd like to do. One other thing I'll say about it, think of the competitors. Cisco has an offering. Nokia has an offering. But we're all really aiming to hive off some of the business from the legacy providers, companies like Amdocs and Netcracker, who have a different model. They have some software but it's heavily customized and heavily services-led. So they have armies of people inside the service providers providing this capability. Our idea is give a heavy -- heavily capable software set of solutions that's open. If the customer wants to change it himself, he can. If he wants us to do it for him over time, we can do that, too. And it's an attractive offer. We are doing quite well.

Great. Unfortunately, we ran out of time. I wanted to ask you about the margin. But I'll summarize it on my end saying margins are good, and that's it. We just ran out of time. I want to thank you, Jim. I want to thank you, Gregg. Thank you very much for joining us this morning. If we get any questions from the investors, I'll sure send them your way. Thank you.

Great. Thank you, everybody.

Thank you.

Take care.