Ciena Corporation (CIEN) Earnings Call Transcript & Summary

Your building footprint and your tax rate to that footprint, it's an open line systems, I understand, right, but the attach rate and the advantages of deploying...

Why wouldn't you put our modems on it when you get -- you got the best technology and the most effective use of it, you put our modem technology on it, which typically they do.

Yes. That's great. On the demand side, you guys had some pretty impressive book-to-bill run here. What factors do you attribute to this run here on strong bookings that you guys reported?

Well, I mean, I think there's 2 or 3 things that play here. One is if you look at that service provider business, which has gone through quite a tumultuous whiplash. First of all, they had COVID. When they didn't want to invest in the network and just wanted egress and ingress points on Zoom and don't mess with the network. Then you have this whole supply chain chaos and have now absorption, which they're largely through. And so I think it's an artifact really of that, that we're now seeing that get into balance, and they're beginning to invest in a normal way again from the service provider. I'm just sort of generalizing that, and we had our first positive book-to-revenue ratio was on that last quarter, and that looks like continuing. So I think that's got back into balance, as I would say it, Ryan. The other thing that's coming on top of that, of course, is the growth of cloud. And as we talked, it's just continuing to grow. Some of that is fueled by the AI traffic. Some of it fueled by machine-to-machine AI traffic. And we're seeing that expansion. And we're also beginning to get into new markets that we don't really have revenue from like the campus. We're beginning to get pluggables into the campus. And that's not an area that we've got revenue from before. So you put all of those things together, and that's why, from an order point of view, we're beginning to get some very strong order quarters together. And our backlog actually grew last quarter even though we had a good revenue. So I think I think we're in for a fairly strong dynamic around the market here for the foreseeable future.

Yes. Super exciting. Are there any specific initiatives? We've talked about AI, or anything else you'd point to in terms of programs that are driving your outlook?

Yes, Ryan, you talked about the campus. I mean we really get no revenues from the campus. And these campuses are now getting very large, as we know. The speeds that are required and the amount of capacity that's required now is get to a point where some of our technology, our coherent technology is a good fit, and we're beginning to see that. And then I think the piece that we're heavily invested in is the opportunity to intersect that same dynamic inside the data center, which has really been a direct connect market kind of technology forever. But it's get the physics to getting to a point, where these GPU clusters is all much traffic coming out from them. The architecture requires that they put some -- in some cases, some optical switches in there. And once you start to do that, you're introducing noise. And so you then need to manage that transportation in a way and coherent is the perfect technology for that. So we're super excited about that. We're in market with product at the end of the year -- by the end of this year, inside the data center. I think it will take a while. We think the next 1 to 3 years, there will be an intersect point where that technology homes into that space. And again, this is about growing our addressable market, basically taking the same technology, let's just call it, WaveLogic and taking essentially the same technology into the systems market, the optical system market that we're known for in the various applications. And then taking that same technology generally in component or pluggable form into the campus and the data center, which is a whole new market for us.

Yes. And those distances are kind of in this 10 kilometer reach for these massive campuses, massive data centers that we're talking about those kind of distances?

Yes. And I was talking to somebody here today on the fiber side, they're saying they're shipping more fiber into the data centers than they are outside of the data centers, which kind of gives you -- I don't know how true that is. But it does give you a -- it's a shocking perspective, the amount of fiber that's going into these data centers, when you think about the compute ramp that they're having and they're getting massive, both in terms of distance and the wraparound of the fibers around there. The distance is getting quite long.

Yes. As they scale, they have nowhere to go but out, right?

That's it, or up. Some of them are actually building, with the deal that we won the day that was 3 stories. They're just building on top. But the constraint is, as you and everybody knows is on this call, it's power. And I was talking with one of the executives from one of the big cloud players here today, is that the constraint is not capitals. It's absolutely power. We would be building more, if we could. It's power and being able to get the right kind of location. But even the location, if they can get the power and the cooling and the rest of it, they can figure the network out. It's easier to figure the networking out than it is the power, which makes sense.

We hear all this stuff about nuclear, micronuclear and they've been building data centers next to power plants for like the last decade, I think, and...

Yes. Yes. Yes. No, I mean the good news is that all that investment in GPUs and compute and the rest of it and all the data centers that are coming online towards the end of this year, if they're going to monetize all of this investment, it's got to be on the network. How do you get to inference and the users, if you got to put it on the network. So -- and no one knows how that will model out, but logic says, it's going to be a pretty big uptick in traffic.

But power needs of the new Blackwell chip and everything. I mean, it's only going up.

Yes. No, that's the good news. It's a good place to be in.

Yes. Power is up puts more demand on the network as they have to move to new grids.

Yes.

Maybe shifting back to the income statement a little bit. You've set a target of 15% to 16% by [ 15% ] '27 for op margin. What are your strategies to achieve that, a mix of growth and some OpEx expansion, walk us through that?

Well, it's more about growth and operating leverage because some of those markets we -- another way of putting it is kind of growing into our body. We've been investing during all the chaos in the last 3, 4 years, we continued to invest, for example, in WaveLogic into the data center into the pluggables, et cetera, because we felt passionately that, that market would open up for us. So we've been investing. And we do not need another massive step function in investment to get where we think we want to go. We'll continue to make sure it's -- we're investing at the right levels for sure. But basically, it's a matter of them getting growth. And you saw our growth span between 8% to 11%. So it's higher than we would normally be and it should be because that's what we've been spending into that and investing into it. So we grow into our body. We'll expand our OpEx, but it won't be a big step function expansion. We'll get operating leverage as we go forward on our OpEx because of the investments that we've already made. And sort of 15%, 16%, we think, is a reasonable approach that we think we can get to. I would kind of remind folks that pre-COVID in the decade prior to that, we expanded our operating margin pretty successfully, and we were, I think, at 18% by the time COVID came along. So it's not without precedent. I think we'll see how far we can get to. But 15%, 16% should be a reasonable target for us that we can get through basically operating leverage.

Sure. And the gross margin line, you said you've got some mix issues going on in the front half, maybe normalized in the second half, and you see opportunity to continue to tweak that up with new fulfillment models, how should invest...

Yes. I mean I think it's really for us about mix as we go through. We should see an improvement in the second half. And as we start to talk about year 2 and year 3, I think you get to that 15% operating, 16% operating margin, you've got to get to a gross margin in the mid-40s for that to really kick in. And that's certainly absolutely doable. We think we can get there. We've got some ramping to do on the pluggables to get that scale. We've got some ramping to do on WaveLogic 6, but we know how to do that. So I think we can get the margin into the mid-40s as we go forward. And then we'll we see where we go from there. We're entering the opportunities into these new markets in the campus and in the data center with our components. That will help scale when you think about -- you're taking the component, you're putting it into the data center and you're shipping it to systems the velocity of that should yield some pretty interesting economic benefits for us.

Yes. Great scale, great scaling opportunity. In terms of your kind of technology suite there, WaveLogic Extreme really set the bar. It seems like you've got a pretty big lead there. Can you kind of walk us through your competitive position specifically where you guys feel like you are on the high end?

We probably think we're about 18 months to 2 years ahead, everyone else. And we're continuing, as we talk here, we've actually got the Nano in-house, and we're working on that. But the variance of that, which will be the 800-gig plug, and then the inside the data center piece. So we're continuing to invest. We're not standing still on any of that. We have a very aggressive program on all the WaveLogic stuff to further compound our competitive advantage. So lots of different variants of it that are optimized around power and space and distant submarine cables variant for it. So we feel very, very confident around our technology leader. And people always talk about us in terms of the modem technology leadership, but also you look at things like line systems, which are -- have become critical in the densification of fiber around all of these huts, et cetera, I'm unable to do that. And the intelligence that's going to be required in these line systems. We probably have about a 2-year lead on that, too. And pretty much all of the major hyperscalers have adopted RLS, and that gives us a tremendous advantage. So you think about that. And then in addition to that, here, we've got our Navigator software, which is the only microservices-based platform to manage and the whole domain around that. That was a massive investment for us that took us more years than we care to mention and more costs too than we care to mention, it was a painful journey, but we're finally at a point now, where we can pile basically all different kinds of applications on top of it and a micro services platform. It's the only one of its kind out there by any kind of systems player. And so you think about the optical situation to answer your question, we've got the technology leadership on the modems, the line systems and on all the management software enabling around all the domain management of that as well. So we're in a super strong position. There's no doubt about it. And we're leveraging that both in the service provider world and obviously in the cloud.

Yes. And you talked about several variants on ZR. Are you starting to see interest in the ZR -- using ZR in the ZR+ model, where you have definitely you mentioned subsea and different applications where you might see use of pluggables and other applications?

The answer to your question is yes. I think the main deployments of these is going to be in the short reach interfaces. Because you start talking about the submarine cables or even the long distance, they don't want to mess with pluggables. They really don't. They just want to lock into the system piece and now on the metro side, where we didn't have a large market share, I absolutely think that the pluggable piece is -- and we are seeing it, it's blank. And it makes a lot of sense. And then as you get into 800, I think we had the first win of anybody on the 800 ZR. So I think that's a fantastic market for us. I don't see it really apart from a couple of corner cases really extending into the long haul. I don't. There are a couple of applications that I think makes sense to it. But -- the great news for us is it really gives us the opportunity and the shorter reach on the metro side, where we didn't have a large market share. So that's working out well for us.

Yes. Great way and great progress. I think we talked about you guys approaching near 15% market share in ZR exiting the year, it's really impressive.

From where we were, it doesn't sound like a big number. We certainly have aspirations a lot higher than that. But from where we were because we kind of deliberately did not go through the first phase of this, when they first started out. And so we will have laid entrants to it. And we -- that was a trade-off that we consciously made on WaveLogic. But we thought the intercept point would always be round about now on the far and where it really starts to ramp up. And I think we got fortunate or whatever the expression is, that timing seems to be about right.

Perfect. Yes, that hats off -- it's been great to see. Maybe shifting gears to routing a little bit and your approach to coherent routing, which I understand it's kind of IP over WDM type model. Can you walk us through where you're seeing service providers start to embrace that idea?

Yes. Probably the best example of that is probably Verizon, a much public one of it, where they have a converged metro view. That's where we think the convergence is, is on the metro side. People have talked about this for years, right? IP and optical coming together, ever since I've been in the industry. And I think it is sort of finally happening, and there are some examples of that. Verizon being one of them. And it basically leverages what I would sort of crudely call an IP light type architecture, which basically simplifies the metro, converges it into a single network, which it isn't right now. Converges it and basically simplifies the operation and deployment of it. And you route when you have to and switch, when you can is the old saying. And that's a bit of a simplification of it. But basically, it's a very optical convergent bias, which suits us. But IP, where you need it out at the edge. And then also, we've looked at -- we do think there will be sort of cause for some of the waiver router type architectures, which are the biggest switches. Now that, I think, is a bit further out, but you've seen us invest in that. And players like Verizon and others will obviously go down that architecture. It's not for everybody around the service providers, but we're increasingly being interested in that kind of coherent routing because it simplifies the operations.

Yes. Historically, they've always had issues with 2 organizations and 2 fully different structures and management systems and eventually, costs in TCO might went out, and we start to see some progress there and that...

Well, I think you've seen that from the service provider world generally now. It's stuff that we've talked about for a while. It's taken way longer than we all would have thought. But there are at a point on a lot of these architectures and also sort of their automation and back office, where they're at a point where they -- if they're going to take their costs down and the rest of it and compete then that's become an absolute imperative because also a lot of the older software that they're running in their back office is actually becoming obsolete. And we've seen this on Blue Planet, too. It's a very small -- in a very small way, but you've seen the fortunes of Blue Planet come back very strongly. And that's largely because it's a micro services next-gen architecture. And a lot of the stuff that's out there in things like inventory is becoming obsolete.

Yes. Absolutely. Back to the competitive landscape, the big combination going on with your competitors, [indiscernible] and Infinera coming together, you are seeing impacts there? What do you -- how do you see that impacting your business over the next couple of years?

We're not seeing anything different. Certainly, in the last few months, we see them -- we've competed with them very well for the last few years. So we feel pretty good around our technology hand and our ability to compete with them. And I would say, it's always tough when you put 2 portfolios together, you have to make some choices. I know we went through it when we did the Nortel One at a big scale. And it's challenging. So they've yet to make those -- I'm sure they've already made them, but they've got to make some choices around what they're going to discontinue and the rest of it. And frankly, that's sort of an opportunity for us while they're going through that transition.

Yes, definitely. Well, we're just about out of time, Gary, I could talk to you for hours, but anything you want to say in closing up I think investors are missing about Ciena story? It's great to see the support and the stock price, certainly moving in a great trajectory here. But anything you'd say to kind of wrap up to summarize your opportunity ahead?

Yes. I mean I think the company where it sits right now as an enormous opportunity. It's known as an optical systems company, and it clearly won that market. It's the #1 player in all the things we just talked about. The opportunity is now to go into a whole new market for us, of which we already have relationships with the customers. So it's really then taking that same technology and increasing the velocity of it in its component or pluggable form into the data center and into the campus. And we're already seeing as a proxy for that, the orders for the campus pluggables. So this is an opportunity to, I think, rethink about the company. We're the best in the world at high-speed optics outside the data center. The opportunity is to be -- take that technology and leadership inside the campus and the data center. That's the opportunity for us.

Incredible. I'm excited to see it happen, Gary.

Thank you, Ryan. Appreciate it. Good to chat as always.

Thanks for joining. Thank you.

Thank you.