Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Gary, I think you are the longest tenured CEO in the space actually right now, which I -- given that I've been covering you for most of that time, I consider that a badge of honor. And Gregg Lampf, I think. And then I think most of you likely have met, but if you hadn't, Patti Trautwein has joined the team over the course of the last couple of quarters. So I am happy to have a few moments with you, Gary. And I think, actually, these are the first few moments at a conference that you and I have ever had despite our tenure in the industry.

I think that's probably right. I think that's probably right.

No, our conference schedule and your quiet period haven't really jagged for most of my tenure, which is a little bit longer than yours, actually, as CEO. So that's saying something. Okay.

So we've got a bunch of topics to cover and not nearly long enough to cover it. So why don't I begin talking about demand. And both on your call last week and some of the earlier sessions today, demand is -- you kept saying demand is strong. I feel like during your call last week a little off track and sidetrack by supply issues and I really want to get back to. But can you tell us a little bit about like what is driving the pickup in demand? And then secondarily, like how durable you think that it is?

Yes. So listen, I appreciate the opportunity to chat with you, Jeff. I didn't realize it was our first intersection at a conference...

Maybe I've forgotten, but...

It's the benefits of the virtual world now, we can get to communicate. So listen, I mean I think the dynamics that we're seeing are multifaceted. I think it's -- we've gone through this pandemic period. Unfortunately, we're still going through it. But I think as we first went into the pandemic, you had certain large carriers kind of did some forward orders and just made sure they had continuity of supply. So you saw that as soon as the kind of wave came. And then sort of soon after that, I think the dynamics that we observed when it settled down a little bit was this period for quite a few quarters, maybe sort of about 3 or 4 where you saw caution on behalf of the carriers, both in terms of caution on the operationally, sort of don't touch the network. We're not going to put any capacity on. We're going to run it harder. We're not going to continue modernizing our network at the pace that we were at. And also, I think coupled with that, there's some fiscal caution. Because if you go back sort of 15 months, it was really -- it's hazy now, but it was really very, very foggy then. I mean none of us knew what was going to happen. And I think that sort of situation played along for about 12 months or so. And as we entered this fiscal year, have hypothesis, if you will, our theory, and I hope, was that, that would begin to ameliorate and you can't run the networks that hot for that long. And also, we develop these coping mechanisms of, if that's the right expression, around the whole COVID environment. And that has largely played out. That's what we've seen. And it started in our Q2. We saw a significant uptick in orders. And again, I think that's driven really, Jeff, by: A, a catch-up on capacity into the network; two, the modernization of their network. And then I think the third dynamic that's come along is really the step function in capacity traffic. And I think we've all seen this around increased use of the cloud, both personally in our virtual home offices and then also from an enterprise point of view. And I think they're dealing -- and I'm talking about carriers very generically here, they're dealing with all 3 of those things. So that's -- when I talk about the demand characteristics, those are the threads that we see blended. We saw a very strong order flow in Q3. And I think we're going to have a good order flow in Q4 built on the back of those. And so the second part of your question, if I may, was the durability of that.

Yes.

I think that is pretty durable. I mean, because I think 2 things. One, this industry generally has grown in the mid-single digits, and it's not done so for a couple of years. So very simplistically, how I look at it is we've got some catch-up to do. Secondly, the actual secular demand characteristics around the industry, I think, are very strong, meaning the demand for traffic. Put aside the catch-up for a minute. Just the dynamics about traffic increases, all of the things we're seeing around 5G, Internet of Things, the cloud, edge compute. All that basically, Jeff, is driving greater capacity closer to the customer, which is great for us. So my feeling is that we're in for a period here that might be of good durable growth. Now we haven't, of course, quantified that yet because we haven't finished the year that we're in. But as we begin to turn the year in Q4, it is likely that we will obviously give some more granularity around what we think around that kind of growth dynamic.

Well, you all on your call last week said strong growth. Or I forgot exactly, word strong came up like 4 or 5x to talk about 2022. So those of us on this side are trying to parse it as, is it strong versus fiscal '21? Is it strong versus that 6% to 8% target? Is it strong versus the market? Is that...

Well, externally, here's 1 way of answering your question, it's certainly strong relative to the last 2 years that we've seen, right, where it's been flat or low single-digit kind of growth. It's definitely strong relative to those, I feel, all things being equal in the world, which is probably a big thing to say, given everything that's going on. But we seem to have seen, in my view, a more normalized approach in the carrier space, coupled with the catch-up.

All right. We'll see what we can do with that. Okay. I guess you didn't mention Huawei, Gary, in that sort of durable demand discussion. So I would imagine that's additive to the topics that we just discussed.

What about additive. I mean I think our view on this has been pretty consistent. I mean -- It's got a lot of exposure because of the geopolitical stuff in the last couple of years, but we've seen this dynamic for a little while, sort of 2 to 3 years that, I guess, it's been going on, pre-COVID. And basically, it's a lot of the European carriers because that's really the market talking about, where they've got a very large installed base. Get concerned around their level of concentration, frankly, around a single vendor. And then on top of that, you had layered the geopolitical concerns. And you, I think, are seeing a move to migrate away from that dependency of Huawei over time. And I choose that word carefully. It's migrate. It's not a rip and replace necessarily. And it's also, I would say, prioritized around the mobile 5G rollout or -- and the 4G. And I think that's the dynamic you've seen in Europe. And we've seen carriers and we've won business around moving -- wished to moving away from Huawei and to migrate their traffic over time. The cautionary piece that I always add with this is this is a multiyear event. It takes a long time to operationalize and to cap and grow or even remove the network. And that money has to come from somewhere. And so that also is a factor in this. And the operational disruption required to that is nontrivial. So the carriers are prioritizing mobile first and then the transport. It's definitely happening. We're winning business. We're seeing that roll out over time, and we think that's got another 1 to 3 years in front of it. And so that's the dynamic in Europe. India is a little bit different, and I think they're taking a slightly more aggressive stance there and actually looking to rip and replace the installed base of Huawei there, particularly on the transport side. And we are seeing that, and we've won more than our fair share of that business. And I think that will begin to deploy over the course of the next year or 2.

Where are we in the India recovery story? It's just been very checkered for years maybe now.

Yes. No, I mean you've gone through the massive overbuild and then all the petition issues, if you remember, that was very specific to the carriers and then the whole economy blew up. And then, of course, we had the waves of COVID, which were particularly impacted, too. So yes, it's been a very challenging, frankly, 3 or 4 years there. We do see good signs of growth now in India. We think the situation is stabilizing. We're seeing good uptick year-on-year for us, albeit from very low numbers last year given all of the challenges. But we're very encouraged by what we're seeing. We're seeing, I think, the start of an investment cycle there. The ability as well to get out and install the equipment, we think that is beginning to ease and they're finding ways to get that done. And so I think we are in for a pretty good flow here. It's still the fastest-growing Internet market in the world. And you've still got -- when you look at the numbers, they're still relatively underserved in terms of the penetration of mobile phones or Internet or fiber close to the premise. So I'm very enthusiastic about that space. It's taken a while. But I think that market is beginning to move now.

Not to put you too much on the spot with the numbers, but I feel like I recall, India was never a 10% market for you, but close to 10% at its peak. And then more recently, it might have been a low single digits, 3% or so. Is that right? Okay.

Yes, that's about right. I mean, fortunately, now we're kind of large enough to be able to kind of take that in our stride, the ebbs and flows in that kind of a market. But yes, it's been close to single -- double digits in terms of our total revenue.

Well, I've told you this offline elsewhere, Gary, but I feel like one of the great store lines in my time in telecom has been watching you get away from vagaries of visual carriers from quarter-to-quarter.

I appreciate that. It didn't happen overnight. A lot of people put a lot of effort into that, and there's no great science to it. You just need a lot of customers. That's also that you're not dependent on 1 or 2. That's easily said and quite difficult to execute on, apparently.

Well, let's talk about some of those other folks that are in the market, and I think we talk about Huawei a ton, but that means that we don't really talk about what Nokia is up to or what Cisco might be up to. I know that they came up on your call, I think last time, maybe in June. I think conventional wisdom has been that Nokia might be less stable than it was, given some executive departures. But on the other hand, it doesn't seem as though the company is backing away, and yet -- and then also, Cisco arguably is putting a little bit more focus on the market than they might have a couple of years ago.

Yes. I mean listen, we're #1 in the world, Huawei is #2. Then you've got Nokia #3. I don't think they're going away anytime soon. They're not as focused on the optical space as we are. They've got a lot of other things to focus on, RAN and other businesses. But they're a strong competitor, very respectful of them. Cisco, I think a large part of their motivation, I suspect, around the Acacia acquisition was really to get security of supply and technology so that they could address the top of switch integrated plug technology, and that's a large part of their focus. We see them in certain accounts. We don't see them in a lot of accounts. And I think they're -- they've come in and out of the carrier space a few times in my tenure. So they're a tough competitor, obviously. But I don't think they want to be an optical component vendor than I think they want to be an enterprise software player with subscription revenues. I think that's where their heart really lies.

Well, we'll see more next week at their analyst day.

I suspect, yes.

Okay. So then let's talk about some areas where you're on offense a little bit, and that is the switching and routing space that you put some wood behind. This week's been a lot of news, only the most recent. But you've been talking about 5G as a driver and metro switching and routing a little bit. Like, why is now the time to do that, Gary? And like are there like entrenched folks that have done that historically? So like how do you lever, say, Cisco's ASR 5000 out of there, or the old Tellabs TITAN, whatever, I forgot, 600?

Yes. That's a good question. I mean -- but this is not a new thing for us. I mean we identified this space quite a while ago around we think that sort of broadly the metro edge is where you're going to see a convergence of IP, optical and software. And if you look at the portfolio we've invest in, clearly, we've got best in the world optical systems. I think that's clear. Combining that and leveraging that with an architecture that is, we call, Adaptive IP, which combines our automation software, together with our IP and packet software, and we've been developing that for a number of years ever since the Packet's acquisition. And so we've slowly grown our share in the access part of that market and the Ethernet on-ramp. And we're the largest provider of mobile backhaul in the United States and North America. And so we've got a good footprint now in which to go leverage that. And we really see a real opportunity there. And to your point around things like 5G, edge compute, et cetera, these are all kind of entry points for us where it's an opportunity for us to insert ourselves in that market that has been full of really the very traditional router players. And our architecture is much differentiated. It's much simplified. It's lower maintenance. It's a much cleaner, simpler architecture built on lower levels of routing, as you'd expect. So it's routing light with a lot of automation software and bringing our optical stuff to bear. And we think that that's a great opportunity for us really in the coming years to expand our total available market because we think there's going to be a lot of IP optical convergence in the edge and metro parts of the network. When you think about all the things that are happening, really, it's all just about getting higher capacity closer to the customer, and that includes the convergence of IP. And things like wireless backhaul, 5G backhaul, that's an obvious place to start. And we're pretty well equipped there now. And I think the acquisition of Vyatta is really basically continues down that path. Gives us more resource, gives us great talent pool coming on board that have built really the virtual router for AT&T. And we're going to take that team and that technology and integrate that and use that to speed up our time to market into that space.

Okay. So there have been -- you've been doing a lot of the optical and maybe some of the switching work for our backhaul, but then the routing would be provided by, I don't know, Cisco or somebody else. And now is your opportunity to take a bit of that routing slot?

Yes. We've increased our routing capability significantly that we've invested in organically over the last few years. So we've also grown our own iOS, which is our source software, which permeates throughout all of our platform. And so really integrating...

I heard that before, iOS, somewhere.

Yes, yes, I've heard that. Yes. Yes. so we're pretty well placed around the IP capability of that, particularly in sort of virtual routing. I mean the beauty of it is we've got nothing to lose, we've got no installed base. And so we can be the challenger in this space. And we've got nothing to lose with it, and we've got a very differentiated, we think, solution. And there's plenty of insertion points along the way, and -- given the dynamics and disruption that's going on in that space. And we are securing some really good footprints at some really Tier 1 carriers around the world. So still small relative to the last of our business, but that is a big investment area for Ciena.

Let's use that to talk about pluggables for a second, and then we'll get to supply chain. But I guess, one of the pluggables' monster has been -- I know it was something that folks have wondered about for you all, really since the open standards got momentum a couple of years ago. What do you think the pluggables market looks like kind of now as we're on the cusp of actually getting commercial shipments of it? And how has it changed from what we might have thought it would have been when we started?

First of all, it's about years later than a lot of people predicted, right, would happen. I think -- it might even be 5 because it feels like we've been talking this for forever. So that's the first observation I would have. Secondly, you're talking certainly for the foreseeable future, a few customers, and we all know who they are, right? I mean it's the content players are going to be the early adopters of this, and not just the early adopters, I think, the main adopters for a while. We see a very good opportunity there because in terms of their architecture, makes a lot of sense for them, and the way they've constructed their networks. So I do think you'll see that adoption. I think you'll see it start in earnest during the course of probably the next year, 2022. Having said that, I go back to my previous point, it always takes longer than we all think about this. But I do think we're actually in grave danger of actually deploying some of this stuff in '22. It will be small relative to the size of the market. And I think you'll see it go up from there because I do think it's a good application. It gives us an opportunity to get into some spaces that we're not already in. So it opens it up a little bit for us. We think we're very well placed. I mean we've now gone GA with our WaveLogic 5 Nano, and we're being certified by all the kind of names that you can suspect, and it's a fairly small set, right? We also feel that we have a differentiated offering there, too. Being the leaders in coherent technology, we focused on really the value proposition that we think is most important to that application, which is power. And we have got, we believe, the lowest power-consuming plug in the market today, and we think that will be validated as we go through the next year.

One of the things that came out of the session that Gregg and Patti put together earlier was that even in the pluggables market, there are a lot of trade-offs that you need to make.

Yes, absolutely.

And that means that one solution does not, in fact, fit all. You have speed and power and distance are all different characteristics that have different use cases and therefore, different pluggables. And so it's...

Totally. I mean there's a specification for the pluggable, a standards, whatever you want to call it. And then within that, you can have different functionality.

All right. Let's talk about the supply chain for a moment. I mean I guess you all had been preparing for this for a little bit, and you've built a decent amount of inventory on your balance sheet through the, I don't know, 3 or 4 quarters subsequent to this one. So well played in that sense. In this particular quarter, we did note that your inventory was down sequentially. And so that gives us a little bit of a sense that this was the quarter where finally the supply chain constraints really did put a pretty serious crimp on the revenue picture. Is that kind of an accurate read? And if so, what does that tell us about the next couple of quarters here?

Yes. I mean I think at a high level, I'm keeping it very simplistic, this is not a generalization, but I think it will. We obviously have a pretty robust supply chain, and it's certainly, I think, the best in the industry by far. We had a lot of inventory in hand. What we've seen with certain components, and it's the same components every other industry is suffering from, it's the generic chips. And we basically got through a lot of that inventory and it wasn't being replenished in the way that it was normally supposed to be replenished. Not a surprise. But over time, that happened pretty fast. And so that's why the actual inventory number is down. It's not through lack of effort trying to build that back up, another way of saying it. We're not immune to this. I think we're in a better position than anybody else, certainly in our industry, but -- and that didn't really impact us in Q3. You saw us overperform basically on the quarter from a revenue point of view by about $20-odd million. But we do think looking at it now that, that will impact Q4. And again, I think it's in the low tens of millions, $20-odd million again. So maybe it's the $20 million overperformance less what we did in Q4. But we think we can navigate through that, but it is a challenge, like everybody. And it's the same generic chips, Jeff. And it's kind of -- and the bad news is it's in all of our stuff. It's not just in a particular -- and it's the same as everybody else. I mean, these chips are in pretty much everything electronics that we all use in our daily life. And that's the change. On the optical side, we're in a pretty good place there. We're very vertically integrated. We have a very sophisticated supply chain around that, and we've got scale. So we're able to mitigate most of that. So some challenges. But that's not really -- it's really these generic chips that are causing the problem. And our best view on that is, hopefully, it will begin to ease, but it's certainly going to be around for the next couple of quarters, we think. I don't know the impact on that yet. But we'll have to see as we go through this in real time. But we are not short of demand, back to your earlier question. That's not going to be the issue. It is demand, it's going to be the ability to be able to supply in a timely way, and customer satisfaction.

Well, I guess one of the interesting things is that changes a little bit about how you communicate the outlook for us because it's not as much demand driven as much as it is supply driven when sort of the limiting factor is on...

We've never had to worry about that before, right? I mean, to the conversation we're having earlier, it's always been about we've been able to predict demand pretty accurately up to the pandemic piece. I mean, probably we've got a run here of about a decade. We've been pretty consistent growing the business, taking more than our fair share, growing our market and getting to a great business model. And listen, I think we've proven, even during the pandemic, we've got a great business model. I mean we just turned in 19%. Now I don't think that's particularly sustainable. But we're in that kind of a range. We're generating cash. We're very strong financially. And the other point that I'd really make is that we're able to invest in the things we want to invest in. The optical leadership, we're going to continue to press down on that. The routing and switching, same, but from a challenger point of view. And then, of course, all the software, both Blue Planet and MCP, we're investing heavily into and getting good traction.

All right. I guess, a prudent analyst then probably wouldn't want to put -- bake more into your next couple of quarters of outlook than what you have suggested just to be -- just to sort of connect the dots on that. Upside is hard to come by because it depends on supply availability.

I think that's absolutely right. I mean, we've been able to -- not always, but overperform a little bit on the margin we have. I think our ability, our flexibility to do that is really very, very limited now. It's just not there to be able to do that, certainly for the next quarter, Q4.

Well, the nice thing about that is that it gives you a nice pipeline of revenues well into fiscal '22 where that's a place where Ciena -- the numbers are always there at the end of the year, but they tended to be up and down a little bit more than we all would have liked.

Just I mean notwithstanding the pandemic, just judge us on the half years, and you can see the good performance there. And listen, we think we're in a very good place, notwithstanding all the stuff that's going on externally with COVID or may go on, on the economics, but secular demand, we feel very good about on our position in this space.

Well, it must be nice to be there after a long time of climbing your way to the top of the hill, you finally made it happen here. And so congratulations to you and to everybody at the Ciena team who I've known for a long time.

It's a team effort, for sure.

On that rosy note, why don't we hold it. And if anybody has any further questions, then let me know, and I'll sort of work that back to Gregg and Patti and the team, and we'll see what we can come up with. But with that, why don't I just thank the 3 of you for spending an afternoon with us here at Wolfe.

Thanks, Jeff. Appreciate it, as always, and thanks for everybody's interest.

The pleasure is mine. Thanks, everyone.

Thank you, everyone. Thank you.

Thanks, Jeff.