Ciena : Q1 2024 Earnings Call Transcript

Ciena Corp (Q1 2024 Results)

March 7, 2024

Corporate Speakers:

• Gregg Lampf; Ciena Corporation; Vice President Investor Relations
• Gary Smith; Ciena Corporation; President, Chief Executive Officer
• James Moylan; Ciena Corporation; Chief Financial Officer
• Scott McFeely; Ciena Corporation; Executive Adviser

Participants:

• Samik Chatterjee; JPMorgan; Analyst
• Amit Daryanani; Evercore; Analyst
• Tal Liani; BofA; Analyst
• Jeffrey Koche; Raymond James; Analyst
• Meta Marshall; Morgan Stanley; Analyst
• George Notter; Jefferies; Analyst
• Michael Genovese; Rosenblatt Securities; Analyst
• Alex Henderson; Needham; Analyst
• David Vogt; UBS; Analyst
• Ruben Roy; Stifel; Analyst

PRESENTATION

Operator^ Good day. And welcome to the Ciena's Fiscal First Quarter 2024 Financial Results Conference Call. (Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Gregg Lampf^ Thank you, Dave. Good morning. And welcome to Ciena's 2024 Fiscal First Quarter Conference Call. On the call today is Gary Smith, President and CEO; and James Moylan, CFO. Scott McFeely, Executive Adviser, is also with us for Q&A.

In addition to this call and the press release, we have posted to the Investors section of our website, an accompanying investor presentation that reflects this discussion as well as certain highlighted items from the quarter.

Our comments today speak to our recent performance, our view on current market dynamics and drivers of our business as well as a discussion of our financial outlook.

Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations.

A reconciliation of these non-GAAP measures to our GAAP results is included in today's press release.

Before turning the call over to Gary, I'll remind you that during this call, we'll be making certain forward-looking statements.

Such statements, including our quarterly and annual guidance and our long-term financial outlook and discussion of market opportunities and strategy are based on current expectations, forecasts and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today.

Assumptions relating to our outlook, whether mentioned on this call are included in the investor presentation that we will post shortly after are an important part of such for looking statements, and we encourage you to consider them.

Our forward-looking statements should also be viewed in the context of the risk factors detailed in our most recent 10-K and our 10-Q, which will be filed with the SEC today.

Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events or otherwise.

As always, we'll allow for as much Q&A as possible today. Though I ask that you limit yourselves to one question and one follow-up.

As a reminder, we will be hosting Investor Group Meetings for the sell side at OFC later this month. We look forward to seeing many of you in San Diego.

With that, I'll turn it over to Gary.

Gary Smith^ Thanks, Gregg. And good morning, everyone. As you've seen from the press release today, we reported strong fiscal first quarter results, including revenue of $1.04 billion and adjusted gross margin of 45.7%. Our Q1 performance also included very strong profitability metrics, with quarterly adjusted operating margin of 13.2% and adjusted EPS of $0.66. Additionally, we generated $250 million in free cash flow within the quarter. The drivers of bandwidth demand remain strong, and we believe very durable, and network traffic is increasing as a result.

And we remain incredibly focused on growing our business and capturing additional market share. Specifically, we are taking advantage of bandwidth growth and cloud adoption trends, to extend our leadership in Optical and to expand our addressable market, particularly in metro routing and broadband access.

Fundamental to these growth ambitions is the expansion of our relationship with cloud providers as they rapidly grow their global networks. Reflecting these expanded

relationships in Q1, non-telco revenue accounted for over 54% of our total revenues. And of that, direct cloud provider revenue was $346 million in the quarter, up 38% year-over- year, and both of our 10% customers in the quarter were, in fact, cloud providers.

Orders from cloud providers were also up year-over-year in Q1 and we continue to secure new deals with all of the major players in this segment. In Q1, for example, we had a significant design win for our 400G ZR+ pluggables with a very large cloud provider, which we plan to begin shipping and taking revenue on later this year. We were also recently selected by a major cloud provider as their primary vendor for its future global architecture based on our RLS platform.

So, it is very clear that we've been broadening our engagement with cloud providers, including discussion around how we can leverage our leading innovation, as AI becomes a growing driver of traffic and a great opportunity for us. In fact, with about 50% plus market share in data center interconnect, we are incredibly well positioned to benefit as more data centers are built and when AI traffic flows begin to come out of those data centers.

We are also developing solutions for inside the data center, a whole new market for us. And this is based on our next-generation pluggables family, as existing technologies are unlikely to satisfy the rapidly increasing requirements for this critical application space. This momentum really exemplifies the strong confidence we have in our position with cloud providers and our belief that we will have a very strong 2024 with them as we continue to expand these important long-term relationships.

However, at the same time, the normalization of order volumes from our service provider segment is not materializing as we expected. We were very clear in our commentary last quarter that our fiscal 2024 financial performance would be largely determined by the timing and magnitude of order flow, from our Service Provider customers, particularly those in North America.

More specifically, we expected to see orders from these customers begin to increase significantly in Q2. And as we sit here today, it is taking longer than we and many in the industry anticipated, for these customers to absorb their high levels of inventory. This is in part due to difficulties installing and deploying equipment, including site readiness and access to fiber, which is limiting their placement of new orders and the absorption of existing inventories.

In addition, in other parts of the world, we are seeing some caution driven largely by macroeconomic concerns that are contributing to lower-than-expected order volumes from service providers in certain international geographies, almost entirely and predominantly being Europe. Our current view based on our discussions with customers is that we now expect a recovery in order patterns from service providers to occur more gradually over the next few quarters.

And Jim will speak shortly about how we expect this to impact our business outlook but I want to emphasize that we and our customers view these dynamics as temporary. And to be clear, we are confident in the durability of the underlying demand drivers in the industry and our ability to continue to take share and grow over the mid- to longer term. In fact, there are several key highlights from our Q1 performance that really illustrate the strength of these fundamental demand drivers. In Optical, we continue to take share and remain the undisputed leader across virtually every domain, including metro, DWM, DCI, submarine and long haul.

During Q1, we added 11 new customers for WaveLogic five Extreme, bringing our total customer count to 270.

And to date, we've shipped more than 115,000 WaveLogic 5e modems. WaveServer had a record quarter as well in Q1 with more than $250 million in revenue, reflecting a 34% growth year-over-year. Quarterly revenue doubled year-over-year for our reconfigurable line system or RLS platform, with eight new customers in the quarter, bringing the total to nearly 70.

And for our WaveLogic five Nano, 400ZR and ZR+ pluggables, we gained 19 new customers in the quarter and now have a total of 86 total customers. Looking ahead in Optical, we're already taking orders for WaveLogic six Extreme, the industry's first and only 1.6 terabit solution, which will become generally available this summer.

In fact, we've already announced two of these wins, Southern Cross and Vocus. Further, WaveLogic six Nano, our next-generation pluggables family, will feature products such as H100 gig ZR, in the latter half of calendar 2024. In Routing & Switching, where we've been making both organic and inorganic investments, we continue to execute our strategy to expand our TAM into faster-growing markets. And in Q1, we had double-digit revenue growth year-over-year for the combination of our 3,000 and 5,000 series platforms. Our AT100 continues to gain traction as we scale our metro and coherent routing capabilities.

And we now have more than 50 customers around the globe for this platform. We continue to build momentum with this portfolio, including our wave router platform, of which we are building additional form factors to address a wider range of applications over time. Other portfolio highlights for Q1 include, notably another very good quarter for Platform Software and Services, with 22% revenue growth year-over-year and 9% sequentially.

We also saw 13% revenue growth year-over-year in our Global Services business, and this is most notable because it was driven by another strong quarter for installation and deployment, which really illustrates our role and visibility in helping our service provider customers work through some of their near-term absorption challenges. In summary, we delivered a strong performance in our fiscal first quarter.

Our technology leadership position has never been better and will continue to improve. Our customer engagements remain focused on helping them meet the growing demand

for bandwidth, digitally transform their operations and monetize their networks faster. And more recently, positioning them for the rise of AI and what it means to network infrastructure and operations.

We remain very confident in the opportunities ahead and in the execution of our long- term strategy. With that, I'll turn it over to Jim, who will provide details on the quarter's results, as well as our business outlook, particularly in the context of the current service provider order dynamics, that I referenced earlier.

Thank you, Jim.

James Moylan^ Thanks, Gary. Good morning, everyone. As Gary stated, we delivered very strong fiscal first quarter financial results. Total revenue in Q1 was $1.04 billion. Adjusted gross margin was 45.7%, reflecting a favorable product mix.

Q1 adjusted operating expense was $337 million, a bit lower due to delays in certain internal projects and lower sales incentive compensation. With respect to profitability measures, in Q1, we delivered strong results, including adjusted operating margin of 13.2%, adjusted net income of $97 million and adjusted EPS of $0.66. In addition, we generated $266 million in cash from operations. Adjusted EBITDA in Q1 was $160 million. Finally, we ended the quarter with approximately $1.5 billion in cash and investments.

Inventory levels came down $66 million from Q4 and we repurchased approximately 690,000 shares for $32 million during the quarter. We are continuing to target the repurchase of $250 million total during the year. As we turn to guidance, I want to reinforce a few points. Most importantly, the fundamental demand drivers of our business, including growth in bandwidth demand remain very strong. Bandwidth demand has grown at 25% to 30% per year for decades and with AI applications imminent, shows no signs of slowing.

We continue to grow our business and gain share with cloud providers in connection with their network expansion and data center infrastructure build-outs. And our deep relationships and engagements with service provider customers continue to position us well in opportunities across both Optical and Routing and Switching domains.

However, we remain in a period of uncertainty, which has come about as a result of the whiplash effects on industry supply chains, caused by shortages of key components, elongated lead times, huge orders by customers in response and inventory builds of networking gear by our customers. They are working down this inventory and things are getting better. However, it is taking longer than we and many in the industry anticipated for Tier one service providers in North America to work through these high levels of inventory, and this is impacting their placement of new orders.

Additionally, we are seeing increased caution from certain European service providers related to macro concerns. All of this is largely consistent with what our customers,

competitors and suppliers have been reporting in recent weeks and months. We continue to believe that these dynamics are temporary and currently expect to see orders improvement over the next few quarters.

Taking all of these factors into consideration, we are adjusting certain elements of our annual guidance for fiscal 2024. We now expect revenue for fiscal 2024 to be in a range of $4.0 billion, to $4.3 billion, down from our previous expectations of 1% to 4% growth over fiscal 2023.

With respect to adjusted gross margins in fiscal '24, we continue to expect it to be in the mid-40s range with some variability by quarter. For adjusted operating expense, we intend to continue investing strategically both to advance our leadership position in our key markets and to expand our addressable market in key growth areas.

However, taking into account our current revenue outlook for the year, we are now planning for operating expense to average $340 million to $345 million per quarter in fiscal year '24, down from our previous guidance of $355 million per quarter. With respect to Q2, we expect to deliver revenue in a range of $850 million to $930 million, adjusted gross margin in the low 40 percentage range, given expected product mix and lower volumes in the quarter and adjusted operating expense of approximately $340 million to $345 million. Finally, we are updating our 3-year financial targets.

As a reminder, given the severity and duration of the rebalancing of supply and consumption, our fiscal 2023 was a year of outsized revenue growth, over 20% and well above our historical growth rate of 6% to 8%. Our outlook today is that for the same reasons, our fiscal 2024 revenue growth rate will be substantially lower than the historical rate.

Given this revised view, using our updated fiscal year revenue outlook of $4 billion to $4.3 billion, as a baseline year, we believe that 6% to 8% CAGR best represents our long-term growth rate. And in a market growing low to single -- low to mid-single digits percentage, Ciena's expected revenue growth rate will ensure continued market share gains. In summary, the industry is experiencing some near-term headwinds as our customers recover from the supply chain challenges that they've seen in recent years.

Bandwidth demand though continues to grow at, at least the historical 25% to 30% annual rate. Underlying demand drivers of that, which now include AI, ensure that this will continue well into the future. Our leading technology and focus on growing our portfolio to address new markets as well as our deep relationships with both service providers and cloud providers position us extremely well to address the evolving network priorities of our customers. We expect to continue growing our market share and to deliver profitable growth over the long term. Dave, let's turn the call now over to analysts for Q&A.

QUESTIONS AND ANSWERS

Operator^ (Operator Instructions) The first question comes from Samik Chatterjee with JPMorgan.

Samik Chatterjee^ Maybe for the first one, if I can just ask for a bit more color on the order patterns you're seeing, both on the telco and the web scale side. I mean, any color on the sequential order trends there? Because from the commentary of the Q2 guide at least, it does appear like telco orders probably were a lot worse than you were expecting. But any more color there, in terms of the magnitude of the sequential order trends between those two verticals that you're seeing? And I have a follow-up.

James Moylan^ Yes. Just Samik, let me try to describe the dynamics here. We've just gone through Q1, which is historically a relatively low order quarter for us. But they came in about where we expected and are slowly improving. But the premise for our guide for this year was our view based on everything we had heard at the time that Tier one service providers would be working through their inventory at a faster rate and would begin to normalize their ordering patterns by Q2.

That was our premise for our plan and for our guide. What's happening is that it is taking them longer to work through their inventories. There are all sorts of issues, too, with respect to fiber, with respect to site readiness, with respect to labor and all of this is causing them to take longer to work through the inventory that they have accumulated over the last 1.5 years. Let me make it clear though that they are working down the inventory and things are getting better. We do expect higher orders in Q2 but we do not think now that they're going to be at the level that would enable us to reach our Q2 guide and our full year guide.

So that's what's happening. In Europe, it's really at the edges but clearly, the macro situation in Europe is not strong, and we're just seeing lower orders and expect to see lower orders from them for the year.

Gary Smith^ Samik, to your point on the cloud, that sort of contrast with the cloud, which you saw the numbers in Q1, we were up 38% year-over-year. We expect to see that continue to be strong throughout and good order flows throughout the year. Obviously, we've grown tremendously there in 50-odd percent growth last year. We're not going to see that kind of growth but we're going to have a very solid year in the web scale.

Samik Chatterjee^ Okay. Got it. And for my follow-up, if I can just clarify, Jim, your comments about the long-term growth guide prior quarter. I think the previous guide was for fiscal '24 to '26 to be 6% to 8%, I didn't exactly -- it seemed like you were sort of reiterating that guide but I didn't exactly capture what you're trying to imply in the updated long-term guide that you provided?

James Moylan^ Yes. If you think about what we said at the beginning of the year, we said 6% to 8% over three years, and that was starting off with a lower growth rate in '24, which implied perhaps a slightly higher growth rate in the later years. We're now saying

that you should -- if you're doing a 3-year forecast for us, you should take fiscal '24 as your base and assume a growth rate of 6% to 8%. Now that sounds like a guide. We're not trying to guide for '25 right now.

We could well be better than that. We hope it will be. But we think for modeling purpose, it's as good a guess as any.

Operator^ The next question comes from Amit Daryanani with Evercore.

Amit Daryanani^ I guess maybe to start with the updated guide at this point sort of implies that you have a very steep ramp in the back half of the year for Q3 and Q4, I think almost implying like mid-teens sequential growth for the back half. Can you just talk about what gives you the confidence?

And you can get that kind of growth given the downtick you just offered to the telco customers? And then maybe an extension of this, if the orders from these telco customers don't materialize the way you expect, is the risk more than you are at the low end of the guide? Or how do I think of that dynamic as well?

Gary Smith^ Yes. Amit, yes, it's clearly a step function into the second half that we actually thought we'd start in Q2. We are seeing the orders as Jim said. This is not a sort of binary event. We are seeing progress in the absorption, inventory going down, and we are seeing a gradual increase in the service provider orders.

That sort of gives us confidence. And obviously, we have deep partnerships with these guys, and we're installing some of the equipment as well. So we -- particularly in North America, where we have insight into it. I think the other dynamic that we're in a better position now is people have released their budgets and their budgets really haven't changed. As I think most people have seen, CapEx is not changed at all, amongst most of the major carriers for this year and their intent is absolutely there.

But what we've got greater insight into now is the planning and timing of those installations. As we've turned the year, the budgets have been released, we're now sitting in early March, we do have a better visibility into it than we did, and it's not as much of a step function, if you will, Amit as we had anticipated before. And that's where we've best reflected the change in the guide.

Amit Daryanani^ Got it. That's really helpful. And then if I could just follow up, cloud continues to perform extremely well for you folks. I wonder if there's an element of some of the AI demand that has come into your numbers right now? Or do you think the AI opportunity is still much more of a future narrative but it's not impacting numbers right now.

I'd love to just understand what's driving the cloud trend and if AI -- if you have time to see some AI benefit already?

Gary Smith^ I would say we're not really seeing the -- now there is some AI traffic with the various offerings, Gemini, et cetera, GPT, that's out there. So that is generating some traffic but obviously not an appreciable step function. I think our understanding with these guys is that's all to come really about how they monetize the broader dimensions of AI. They're investing massively right now as we all know in compute. And figuring out how to then release that for monetization, which will then flow into the network.

So what we're seeing is just basically business as usual cloud growth. I think you are seeing an acceleration of that. You've seen the SaaS companies do well as another sort of gauge of that. And I think we're seeing very robust. You saw it last year, we were up massively in network deployments with these guys and that was really cloud.

I don't think you're seeing virtually any of the AI step function that we're all anticipating in those numbers yet.

Operator^ The next question comes from Tal Liani with Bank of America.

Tal Liani^ How do we know that what we're seeing here in service providers is not structural, that it's your -- in your comments, you're talking about cyclical downturn that will recover absorption of inventory. When you talk to the carriers, they talk about a permanent decline in spending, their desire to spend less. Are there any parts of their spending that could be more structurally down that could be replaced by something else? Or do you have really confidence that this is just cyclical?

Gary Smith^ Yes. Tal, this is a good question and obviously one that we're super focused on.

I would separate it out.

I would say in North America, I do not believe there's a structural sort of issue to it. It's really about absorption.

Their CapEx, what they want -- their intent is actually to spend more and absorb more. And I think with all the major service provider, that is their intent. They want to catch up with their network builds. I do think that there is a reticence around 5G. Obviously, it's not been the monetization event for many carriers around the world that was anticipated.

And I do think that there's a curtailing of that spend in, which my own personal belief, I think is structural. I do not think that will have a major impact on the transmission and infrastructure build. I mean they're very focused on access and the build-out there in North America. So I think in total to it, I do not think there's a structural issue, notwithstanding my comments about 5G. Europe, I would think a little bit differently on.

I think they have some inherent structural challenges there. You have 180 carriers in Europe. You have some tiny jurisdictions with multiple carriers, makes no economic sense. And I do think that, a, you're seeing a bit of a downturn in the economy in certain

key countries like Germany, which is hugely influential in Europe. And I think they are more receptive to those kinds of challenges than the North American model where the economy continues to do well.

So I think there are, Tal, some structural issues associated with the European piece and that's not new news. But they are more sensitive to the economic challenges.

James Moylan^ In India, we think, is still going up and to the right. They're going to continue to build out their networks. We had a big year within India last year. We're going to be sort of flattish with them this year but India is going to be a great place for us for a long time.

Gary Smith^ And we're not seeing any of that in Asia Pacific, either that sort of uncertainty.

James Moylan^ The one thing I would say, Tal, is the driver for our business is demand for bandwidth. And that has grown and continues to grow at very rapid rates. Now the people who are building networks, to manage that demand really, the structure has somewhat changed toward the cloud providers. If you go back, ten years ago, they weren't buying any network gear. They're buying a significant part of it today.

It's very possible that, that could expand over time. If there is any shift, that would be the shift from service provider to cloud providers.

Gary Smith^ Certainly in the long haul.

James Moylan^ Yes. Yes.

Operator^ Next question comes from Simon Leopold with Raymond James.

Jeffrey Koche^ This is Jeff Koche in for Simon. So I was just hoping you can maybe hash out the strength in Europe this quarter, maybe how that reconciles with your comments on the weeks, maybe the weakening macro-outlook there? And as well as like Huawei swaps or displacement opportunities? It sounds like it's going really well in India.

James Moylan^ Yes. I'll deal with the first part. Our regional report reflects the region into which we deliver equipment. It doesn't necessarily reflect the type of customer. So the -- the big jump in deliveries into Europe were driven by cloud providers, not the service providers in Europe. The Huawei thing, there's still an opportunity ahead for us.

Now the whole supply chain and COVID situation was actually a benefit to Huawei because they had gear. And service providers really wanted to stick with the status quo. They didn't necessarily want to build out stuff. And so for a combination of those two reasons, Huawei did pretty well over the last two years. The desire of Western economies