Ciena : Q3 2023 Earnings Call Transcript

Ciena Corp (Q3 2023 Results)

August 31, 2023

Corporate Speakers

• Gary Smith; Ciena Corporation; Chief Executive Officer, President & Director
• Gregg Lampf; Ciena Corporation; Vice President of Investor Relations
• James Moylan; Ciena Corporation; Senior Vice President of Finance & Chief Financial Officer
• Scott McFeely; Ciena Corporation; Senior Vice President of Global Products & Services

Participants

• Alexander Henderson; Needham & Company, LLC; Senior Analyst
• David Vogt; UBS Investment Bank; Analyst
• George Notter; Jefferies LLC; Managing Director & Equity Research Analyst
• Dave Kang; B. Riley; Analyst
• Gregory Mesniaeff; WestPark Capital, Inc.; Research Analyst
• Meta Marshall; Morgan Stanley; Vice President of Research Division
• Michael Genovese; Rosenblatt Securities Inc.; Senior Comm and Cloud Infrastructure Analyst
• Samik Chatterjee; JPMorgan Chase & Co; Analyst
• Simon Leopold; Raymond James & Associates, Inc.; Research Analyst
• Timothy Long; Barclays Bank PLC; Managing Director and Senior Technology Hardware & Networking Analyst
• Timothy Savageaux; Northland Capital Markets; Managing Director & Senior Research Analyst

PRESENTATION

Operator^ Good morning, everyone, and welcome to Ciena's Fiscal Third Quarter 2023 Financial Results Conference Call.

(Operator Instructions) Please also note, today's event is being recorded.

And at this time, I'd like to turn the floor over to Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Gregg Lampf^ Thank you, [Jamie]. Good morning, and welcome to Ciena's 2023 Fiscal Third Quarter Results Conference Call. On the call today is Gary Smith, President and CEO and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, 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 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 or included in the investor presentation that we will post shortly after, are an important part of such forward-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 filing and in our upcoming 10-Q filing, which will be filed with the SEC by September 7. 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 will offer as much Q&A as possible today. (Operator Instructions) For those in the investment community who will be attending ECOC, Jim Moylan and I will be meeting with investors on October 2 and 3. Please reach out to us if you're interested.

With that, I'll call -- turn the call over to Gary.

Gary Smith^ Thanks, Gregg, and good morning, everyone. Today, we reported strong fiscal third quarter results, including quarterly revenue of $1.07 billion, an increase of 23% year-over-year. Our results included solid profitability metrics with quarterly adjusted operating margin of 12% and adjusted EPS of $0.59.

We are delivering a very strong year with 22% revenue growth year-to-date as we continue to capture market share. And in fact, we are confident as we look forward, particularly given that secular demand for bandwidth continues to increase. In fact, bandwidth growth has remained consistent for years, even through the recent period of supply chain constraints. And the underlying drivers of that strong growth are very durable over the long term. These include mobility, 5G cloud, automation and more recently, artificial intelligence applications as they move out towards the network.

These market dynamics in turn drive direct demand for our industry-leading technology and services, which we measure through 3 indicators: Number one is customer pipeline and forecasts; number two is orders; and number three, backlog intimately shipments, which collectively reflect demand in our business, not just a single element of these. So, I thought it might be helpful for me to provide some insights into what we're seeing across each of these indicators' demand.

Starting firstly with pipeline. We are very encouraged by the level of overall customer activity that we are seeing across all regions and segments. Most notably, we are seeing early signs of near-term requirements with our customers as they work to ensure their network readiness for machine learning and AI traffic coming out of the data center and into the WAN.

With respect to orders, the flow of new orders in recent quarters has been directly impacted by several factors. Specifically, customers ordering decisions in the prior supply-constrained environment resulted in both large order backlog and then higher than typical customer inventory levels. In addition, the recent rapid compression of our lead times has reduced the need for customers to place advanced orders. As a result, new order flow over the past couple of quarters has been meaningfully below revenue and we expect this to continue for another couple of quarters. Therefore, this order flow in isolation has not really been a good reflection of underlying demand.

Now, however, we are starting to see an uptick in new orders, led by cloud providers. Our orders were slightly up in Q3, and we expect higher orders in Q4. Importantly, we believe that this recent uptick in orders from customers is a leading indicator of a rebalancing of supply and demand, which we believe will begin to flow through to our service provider customers in the coming quarters.

And finally, backlog. We have had and continue to have an outsized backlog resulting from the previous period of supply constraints and the resulting elongation of lead times. I would remind everyone that our backlog is still larger in both absolute and relative terms than any of our competitors, which is testament to our increasing competitive advantage. And as we turn this backlog into revenue, it is translating into significant market share gains, which so far this year have been in approximately the mid-single digits.

We now expect that we will exit FY23 with backlog that is approximately $2.7 billion, even with our strong revenue year. And I think this is very encouraging on several levels. Fundamental demand drivers for our business are strong and improving. Customer activity is increasing and supply versus demand is gradually coming into alignment. Against this backdrop, Ciena has never been better positioned to deliver faster than market growth through trusted customer relationships and increasing technology leadership, new platform introductions and considerable market expansions over time.

Before turning it over to Jim, I'll run through some quick highlights from the quarter. Optical revenue was 27% up year-over-year. As expected, much of the growth in the quarter was in our optical line systems. Specifically, Q3 was a record quarter in revenue and shipments for our 6500 reconfigurable line systems, RLS, driven by cloud and content provider network expansions. RLS is, in fact, the only next-gen line system in the industry that is shipping at scale and serves as a strong indicator of future revenue growth and margin expansion opportunity.

We added 18 new customers in Q3 for WaveLogic 5 Extreme, bringing our total customer count to 246. And we also received our first order for WaveLogic 6 in the quarter, well before it is even generally available. Routing and Switching revenue was also up 27% year-over-year, with the addition of more than 30 new customers for the portfolio in the quarter, a clear example of our technology leadership and a growing pipeline. The increase in Q3 was primarily driven by sales of our access and aggregation platforms.

We also continue to advance our TAM expansion efforts in this general technology area, and particularly around coherent routing, broadband access and PON opportunities. We also secured our first customer for the WAVE router platform this quarter.

Notably, our Platform Software and Services revenue was up 24% year-over-year. This reflects strong growth in software maintenance services, primarily related to our domain controller MCP. And as we know, MCP is the industry's leading multilayer domain controller now with nearly 800 customers worldwide and more than 1/4 of those customers leverage the advanced apps on the platform. In fact, in Q3, we added 18 customers for these advanced apps.

Shifting to customers. We had one 10% customer in the quarter, which is a cloud provider. Overall, direct cloud provider revenue increased 39% year-to-date, well above our overall revenue growth in the same period.

Panning out a little further. Total non-telco revenue was 46% year-over-year in the quarter to $487 million, a record high. Further, subsea revenue was up 21% year-over- year in the quarter to $76 million. Revenue from service provider customers was up 9% year-over-year, which included one Tier 1 customer that came in just under 10% threshold in Q3, and we continue to win with this important segment. By way of example, we have recently secured a multiyear strategic expansion of our relationship with a major U.S. Tier 1 service provider for our full portfolio, including routing and switching as they continue to enhance their network, another example of growing customer activity and pipeline.

And finally, with respect to geographic regions, Asia Pacific was again a solid contributor at nearly 16% of total revenue in Q3, up more than 30% year-over-year. And in that region, India remains very strong. with year-to-year revenue in FY23 of just over $200 million compared to just under $170 million for all of last fiscal year, and we expect this growth to continue. Here also we continued to perform well. Importantly, as our pipeline grows, we secured several new design wins across the region in Q3, which we expect to begin taking revenue on in FY24.

So in summary, we believe we are executing well and are confident as we look forward. We are benefiting from strong secular demand and growing our pipeline with increased customer activity. We are increasing our competitive advantage, bringing new platforms to market and expanding our TAM, and we are converting backlog to revenue and gaining market share.

With that, I will turn it over to Jim to speak more about all of these elements and provide additional detail on the Q3 financial results. Jim?

James Moylan^ Thanks, Gary. Good morning, everyone. We delivered outstanding fiscal third quarter financial results. Total revenue in Q3 was $1.07 billion at the high end of our expectations, up 23% over Q3 of 2022. Adjusted gross margin in the quarter was 42.7%, reflecting the product mix shift towards design systems that we expected, and Q3 adjusted operating expense was $328 million.

With respect to profitability measures, in Q3, we delivered adjusted operating margin of 12%, adjusted net income of $89.1 million and adjusted EPS of $0.59. In addition, we generated $9 million in cash from operations and adjusted EBITDA of $151.3 million.

Finally, we ended the third quarter with approximately $1.3 billion in cash and investments. Inventory levels in Q3 went up $94 million from last quarter. As a result of changes in the mix of products delivered to customers from that which we expected, we also saw an increase in deferred cost of sales on product delivered to customers but not yet taken to revenue.

We expect total inventory to be down in Q4. And at the end of this fiscal year, we expect it to be roughly equal to that of Q4 of '22. We repurchased approximately 1.4 million shares for $61 million during the fiscal third quarter. Since the end of Q3, we have repurchased an additional $40 million in shares, bringing our year-to-date total to approximately $100 million in value. We continue to expect that we will repurchase an aggregate of approximately $250 million in shares during this fiscal year.

Turning now to guidance. As a reminder, the outlook I'm about to provide reflects all the key assumptions that we detail in our earnings presentation. Our expectations for Q4 are consistent with the fiscal full year guidance that we provided on the last earnings call.

Specifically, for the fiscal fourth quarter, we expect to deliver revenue in a range of $1.06 billion to $1.14 billion, adjusted gross margin in the low to mid-40s range and adjusted operating expense of approximately $335 million.

With respect to fiscal year 2024, as is our normal practice, we will provide a detailed view of our expectations for next year when we report our Q4 results in December. But it's important to remember the context we provided when we laid out our three-year targets last December. Specifically, we said that revenue compound annual growth rate over the 3-year period from fiscal year '22 to fiscal year '25 would be 10% to 12% and would not be linear, particularly given our expectations for outsized revenue growth in fiscal '23, which we will deliver. We are still comfortable with those projections for that 3-year period. Specifically, we expect fiscal '24 to be a growth year. We also expect to grow faster than the market and to take market share.

Before we close out the call, I want to highlight our recent announcement of science- based environmental targets, which support and strengthen our sustainability