Good morning, everyone. Thank you for standing by, and welcome to the Ciena Fiscal Q2 twenty twenty one Financial Results Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer I would now like to hand the conference over to your speaker today, Greg Lamp. Thank you.
Please go ahead, sir.
Thank you, Casey. Good morning, and welcome to Ciena's 2021 fiscal 2nd 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 Q and 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 fiscal second quarter performance, our view on current market dynamics, as well as a discussion of our outlook for the Q3 and fiscal 2021. Today's discussion includes certain adjusted or non GAAP measures of Ciena's results of operations. A detailed 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 everyone that during this call, we'll be making certain forward looking statements. Such statements, including our quarterly and annual guidance, discussion of market opportunities and commentary about the impact of COVID-nineteen and supply chain constraints 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.
These statements should be viewed in the context of the risk factors detailed on our most recent 10 ks filing and in our upcoming 10 Q filing, which is required to be filed with the SEC by June 10. We expect to file by that date. Ciena's new has 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 allow for as much Q and A as possible today, though ask you limit yourself to one question and one follow-up. With that, I'll turn the call over to Gary.
Thanks, Greg, and good morning, everyone. This morning, we reported strong performance for our fiscal Q2, including $834,000,000 in revenue and a particularly strong gross margin that drove a 16% adjusted operating margin and a $0.62 adjusted earnings per share. These results reflect continued strength in the fundamental demand drivers of our business. They reflect our distinct competitive set of advantages as well as continued encouraging signs of improvement in the overall market environment. And I must first once again thank our people for their hard work and fortitude in these challenging times.
They continue to drive our business forward and build on our position as the industry leader. As you may recall from our commentary, as we entered fiscal 2021 and again last quarter, we laid out several key assumptions that form the basis of our outlook for the current year. 1st was an improvement of industry and economic conditions overall, which we are starting to see in many parts of the world where the effects of the COVID-nineteen are somewhat abating. Of course, fully recognizing that the current COVID status globally of each region and country varies tremendously. Secondly, we noted that service provider spend, which has been constrained since the second half of twenty twenty, needed to return to more typical pre pandemic levels.
I am pleased to report that during Q2, we began to see material amelioration of the operational and fiscal caution of key service provider customers around the world. And we believe that this is translating into a more normalized approach to network investments and operations, including more focus on new architecture builds and deployments. And lastly, really as a result of these two dynamics, we indicated the need for strong order flow and backlog growth, particularly in Q2, if we are to drive a stronger than typical uptick in second half performance in order to meet our outlook for the year. We absolutely achieved that as orders in Q2 were significantly greater than revenue and backlog grew both sequentially and year over year. So as we close out the first half of the year, the things we said we needed to happen in the market and our business are in fact materializing.
And this has yielded financial results in line with our expectations and overall business performance that continues to outpace the competition. Based on these dynamics, we continue to be confident in our ability to deliver on the financial guidance we provided for fiscal 2021. In fact, we now believe that we will exceed our profitability target for the year through better than expected gross margins, and Jim will cover that in more detail. Before I review some of the highlights from the quarter, I'll briefly comment on the shared industry concerns around semiconductor supply chain constraints that are impacting a broad range of technology market sectors. And while we have experienced some lengthening of component lead times, we have in place very strong mitigation strategies for supply chain disruptions, as we've proven over many years and most recently through the COVID-nineteen challenges.
We also benefit from scale and diversification of our supply chain and continued investments in inventory as well as a high degree of vertical integration. As a result, we are well positioned to navigate this dynamic. And as we sit here today, our perspective is that we can believe we can manage the current supply chain challenges with no material impact to our revenue expectations for fiscal 20 21. Moving to highlights from the quarter, our innovation and diversification continued to strengthen our competitive position. And with respect to innovation, our lead in 5th generation coherent technology with WaveLogic 5 is uncontested.
In Q2, we secured 16 new wins for WaveLogic 5 Extreme, bringing our total customer count to 95. And we shipped nearly 5,000 WaveLogic 5e modems in the quarter, bringing our total to date to roughly 11,500 WaveLogic 5e modems shipped to a wide range of customers around the world active in their networks. We also remain on track with our WaveLogic 5 Nano pluggables and expect to have GA product in time to intersect with customer demand, which will likely begin later this year. We have product in customer labs today with the solution performing extremely well, including best in class power performance, perhaps the single most important metric for a differentiated pluggable. I mentioned last quarter our increased strategic focus on IP technologies and our routing and switching portfolio and our growing customer engagements in this area, specifically around our adaptive IP solution and ability to address key use cases in areas like 5 gs, Internet of Things and Edge Cloud.
Our momentum for this portfolio continued in Q2 with roughly a dozen new wins ranging from global Tier 1 service providers to MSOs and enterprises. Q2 was also very strong again for Blue Planet, with the largest order quarter to date and 4 new portfolio wins with major service providers. Turning to customer segment and regional performance in the quarter. Our overall non telco business continues to be strong, comprising 43% of revenue in Q2. Direct to upscale contributed 24% of quarterly revenue as these customers have once again started building and expanding data centers.
We continue to retain a very strong leadership position in segment as our relationships with these key customers become increasingly broader and more strategic. And I think the introduction of our WaveLogic 5 pluggables further enables us to address a wide range of our webscale customers' needs. Activity with our Tier 1 service provider customers, especially in North America, is increasing as they can no longer put off adding capacity to their networks, and they are now better able to navigate logistical COVID related challenges. EMEA also performed well in the quarter, with revenues increasing 10% year over year, as service providers in the region invest to address their own traffic growth needs, as well as to support increasing traffic flows and bandwidth requirements of the webscale players. And finally, on India, with the recent wave of COVID across the country, we've expanded support and resources for our local team, and we continue to be incredibly impressed by their resilience and optimism amidst a very challenging situation.
With respect to the business in India, this new wave of the pandemic is obviously slowing the expected recovery. However, revenue from the country for Ciena still grew sequentially and year over year. And I would also say that wins and order activity continue to be strong, with the impact to date largely related to deployment schedules. We continue to expect India to grow year over year in fiscal 20 21 with any near term challenges mitigated by our general geographic diversification. Overall, there remains strong underlying secular demand for bandwidth and automation that drives our business.
Our strong performance in Q2 is a reflection of that demand, and it gives us greater visibility as we sit here today. These results together with encouraging signals in the market environment and the continued execution of our strategy gives us confidence in a strong second half and our ability to achieve our financial targets as we move through the year. Jim?
Thanks, Gary. Good morning, everyone. We performed well in Q2 with revenue in the quarter totaling $834,000,000 Adjusted gross margin in the quarter was again strong at 49.2 percent driven by a favorable customer and product mix, including strong software contribution and a high concentration of capacity adds versus new builds. Adjusted operating expense in the quarter was $279,000,000 With respect to profitability measures, in Q2, we delivered adjusted operating margin of 16%, adjusted net income of $98,000,000 It's worth noting that GAAP net income in Q2 was higher than non GAAP as a result of $40,000,000 we received from the Canadian emergency wage subsidy during the quarter. This figure flows through our GAAP P and L at each line where wages are incurred, primarily in OpEx.
We have excluded this effect in getting to our adjusted numbers. And finally, on profitability, we reported net income of $0.62 per share. In addition, cash from operations was $225,000,000 in Q2. Free cash flow was $194,000,000 Adjusted EBITDA was $156,000,000 We ended the quarter with approximately $1,400,000,000 in cash and investments. Also in Q2, we repurchased approximately 483,000 shares for $26,000,000 We continue to expect to repurchase approximately $150,000,000 of shares in fiscal 2021.
Turning now to our guidance. As Gary mentioned, encouraging signals in market conditions and improvements in customer spending as well as our strong first half performance give us confidence in our ability to deliver on our fiscal year 'twenty one targets. Specifically, we continue to expect to grow our annual revenue in fiscal year 'twenty one in a range of 0% to 3%. As we've said previously, as conditions improve and revenue begins to reflect a more typical mix of existing and new business, we do expect gross margins to moderate somewhat. However, we do expect a somewhat higher gross margin in the second half than previously, as we expect that our favorable mix of strong software contribution and we expect that that will continue.
Additionally, we expect OpEx for the second half to be higher than we generated in the first half. OpEx for the first half was a bit lower than the average quarterly OpEx call for the year, so there is some movement of OpEx from first half to second half. Also, the weak dollar continues to put pressure on our OpEx. With this guidance combined with our adjusted gross margin results in the first half, we now expect adjusted operating margin for the fiscal year to be in a range of 16% to 17%, 100 basis points higher than previously anticipated. For Q3 specifically, we expect to deliver revenue in a range of $950,000,000 to $980,000,000 adjusted gross margin in the 46% to 47% range and adjusted operating expense of approximately $285,000,000 to $290,000,000 In closing, we delivered a great performance in Q2.
2nd quarter order flow indicates a return to spending by our service provider customers and gives us great visibility into the rest of this year. We are confident in our ability to deliver a strong second half and significant profitability for fiscal year 'twenty one. Before moving to Q and A, I want to once again thank the entire Ciena team for their continued focus and dedication during a very difficult period. In particular, our team in India has demonstrated tremendous resilience in recent weeks in the face of another COVID-nineteen wave. Also, our employees have also been incredibly active in their communities, safely gathering with each other as well as with our With that Casey, we'll now take questions from the sell side analysts.
Before we start
the Q and A, we are aware of some webcast technical difficulties. For those who have tried to access through the webcast as well, please re register and you should have access. Casey, we're ready for questions.
Certainly. Thank you. Key. Thank you. Your first question here comes from Meta Marshall from Morgan Stanley.
Please go ahead. Your line is now open.
Great. Thanks. I appreciate the question. Maybe just on in terms of one, what you're seeing as far as the ramp of kind of the 800 gig product versus maybe the 400 gig and how that's trending versus your expectation? And then just on the pacing of the Tier 1s, certainly you sound better.
But I guess just in terms of is it orders? Is it new projects? Just maybe some more context for what you're seeing on the Tier 1s in North America that leaves you encouraged? Thanks.
Yes. Thanks, Meta. It's Scott. I'll take the first one on the 800 gig. So just to repeat the sort of ramp numbers that we talked about or Gary talked about, to date and we're just a little shy of a year, I guess, into commercial shipments, we've got about 11,500 total units of our WaveLogic 5 Extreme shipped 5,000 in the last quarter.
So you can see that that's absolutely accelerating. And if I sort of compare it to previous generation, what you referred to as a 400 giga, call it WaveLogic AI from a brand perspective, that's an accelerated pace of ramp from the previous generation. And it's across all customer segments as well, I should point out.
And Meta, on the this is Gary. On the Tier 1s, and I'm generalizing sort of globally here. But I think the main issue that we've seen with them in the second half of '20 and the first half of 'twenty one was just really describe it as an operational caution both operationally and fiscally on the networks. They ran it hot. And I think we are seeing encouraging signs of that ameliorating, both in terms of their operational plans.
And I think it's manifesting right now in terms of a bit of catch up around capacity, which was helpful to our margin in Q2, but we're also getting good indications of the new business deploying in the second half. And I think they're getting a little more comfortable from a a fiscal point of view as well in terms of their budget spend. So that definite improvement in the second half across the board in most service providers around the world.
Great. Thank you.
Thank you, Meta.
Your next question comes from the line of Paul Silverstein from Cowen. Please go ahead. Your line is now open.
Thanks, guys. Appreciate the question. Gary, on the competitive landscape, one with respect to traditional competitors, in particular Infinera and Nokia, both of whom are talking a very good game. And then more broadly, I know you did a whole seminar on ZRS did Infinera in terms of downplaying the threat. But can you update us in terms of what you're seeing real time with respect to customers' planned deployments in terms of empirical data that would speak to that threat?
Well, I think the best set of empirical data is the numbers that just went through in terms of our shipments. Real customers, we've got 95 customers now for WaveLogic 5e. And I mean real customers where we're actually deploying, so pretty much most of the primary landing slots on 800 gig are already taken with the head start that we've had. And I think that's the best set of metrics kind of talks to itself, frankly.
And Paul, to your second point on the ZR dynamics in the marketplace, I mean, you referenced an investor chalk talk that we did probably about a month ago. So for those on the call that hadn't had an opportunity to see that, we spend quite a bit of time giving you our perspective and belief system of the application space and how various different flavors of coherent technology play in those application space. So that's accessible on our IR events page. So I'd encourage you to go look at that if you're interested in more details. I would summarize it as this, Paul.
The first early moving application, I think, for this technology will be in the campus Metro Data Center Interconnect. We've talked in the past around the timing and the market size of that. Our perspective hasn't changed on that. I think you'll start to see some early deployments this year, later this year and moving to more significant deployments in 2022. As you know, our technology that addresses that is our WaveLogic 5 Nano.
We've said we were targeting midyear for GA. We're on track for that. We're extremely pleased with the optical performance that we're seeing on that. And we get more and more confident that we have best in class not only optical performance, but best in class power numbers. And that product and technology is now actively in certification in a number of customer labs around the world.
Guys, you can't share with us what your backlog is on the WaveLogic 5 modems relative to those 95 customers, can you?
No. I tried. The
numbers I'll say though that Paul, the numbers that we quoted in terms of port numbers, those are shipped. That's not backlog. That's shipped.
Yes. Understood. Understood. All
right. Thank you.
Thanks, Paul.
Your next question comes from the line of Rod Hall from Goldman Sachs. Please go ahead. Your line is now open.
Yes, good morning. Thanks for the question. I guess I wanted to focus in on the software line that is substantially higher than what we were forecasting. And you guys have grown that now year over year. It's accelerating on non EV comps last year, admittedly off a low level, but still the growth is pretty high.
And yet it seems to me that you're indicating, Jim, that gross margin drops off next quarter. So I've got, I guess, 2 questions. 1 is big picture for Gary, and that is what do you see happening there? Can you do you have any intention to give us some kind of targets on where that revenue line could go? Because obviously, it's a huge margin driver and I think a pretty positive sign for you.
And then Jim, next quarter, what are you implying to us when you give us the lower margin guidance? Are you saying that, that revenue drops off next quarter? Can you kind of tell us what you think is happening with that software line in the fiscal Q3? Thanks.
So, Rod, let me take the first part of that. And I'd broadly say, I'd split the sort of we've got a lot of embedded software, which we also get value to, but the pieces that we pulled out and report on are really this network layer, the automation of the network layer. And then secondly, we've obviously got Blue Planet, which is really around the service layer. And I think what we're seeing is increased focus on automation in both of those areas, very encouraged by what we're seeing. I think Blue Planet has tremendous amount of momentum.
And as we have in the past looked at giving some long term targets for that. Obviously, when COVID came, that kind of all got disrupted. But as we come out of the year, when things begin to stabilize, I would expect for us to articulate some longer term goals for Blue Planet, and we'll talk a little bit more about that. As it continues to grow, it will probably exceed both orders and revenue for this year that we set. And also on the network side of things, on the automation piece, we've got a lot more applications being rolled out certainly as we turn the year and I think that will help drive the overall gross margin and software adoption.
Jim? Yes, Gary. On gross margin, Rod, remember that we've said all year that because of the mix of new projects in our revenue stream being lower in the first half than it is in the second half, we expected margins to come down from Q I'm sorry, half 1 to half 2. And that's the way the world has sort of modeled their consensus numbers. What we're seeing though is a very good mix, including software, but also just generally product and customer mix.
And we expect that mix to continue in the second half. So yes, we do expect gross margins will come in a little bit as we move into the second half. But we also expect that gross margins in the second half are going to be up sort of 100 basis points from where we had expected them to be. We're now calling margins in the second half to average 46% to 47%, which is what we call for Q3. And yes, we'll have a good software mix.
But remember, when we enter new projects, typically we experience lower gross margin and that's going to be a higher percentage of our revenue than it has been in the first half. Overall, we're very pleased with our gross margin performance.
So Jim, is it fair to say then on that, that it's not a software mix necessarily reduction thing going on in Q3. It's much more to do with new projects spin up and that dragging the margins back down as
we would expect it to.
Totally. That's totally right. We don't expect credit software to come in.
Yes. Another bit, Ravi, it's just the relative size. I think we'll continue to do well on software, but as a standalone piece, it's still relatively small to the rest of the business. And that's why we pull it out separately for people to see the progress. Okay.
All right. Great. Thanks, guys.
Thanks, Rod.
Your next question comes from the line of George Notter from Jefferies. Please go ahead. Your line is now open.
Hi, guys. Thanks very much. I guess I wanted to ask about the Huawei market share capture opportunity. Obviously, it's been an ongoing narrative, I think, for some time. At some point, you guess that there'd be some forcing function as Huawei runs out of inventory on the component side.
But tell us what you're seeing in the marketplace regarding Huawei right now? Thank you.
George, I would say that the dynamic hasn't really changed with one probably notable exception. I think the main area is the main region to date has been Europe, where you're seeing a slow migration or reduction in dependency upon Huawei, largely being run initially out of the RAM business where they're seeing it first and then getting to the core infrastructure. So that's taking time and that's a dynamic that I think is well understood and talked about. And it's definitely a tailwind for us over a period of time. I do think one notable change as I think about this year has been India, which I think is going much more aggressively to reduce their dependency.
And we have seen not yet deployed mainly because of some of the challenges in the with COVID in India, but we've seen a lot of activity around the major carriers there wishing to decrease their dependency on Huawei, gone out to RFP. We've won more than our fair share of those deals and they are being I think probably more aggressive than we're seeing in other parts of the world. So that would be the sort of exception I would call out. But that's not yet on the scorecard because it hasn't been deployed, but definitely planning to reduce their dependency.
Huawei dynamic is positive for us for the long term, but we have always been cautionary about how fast it happens, because in Europe, it's just going to take a while for them to replace, well, I shouldn't say replace, I should say move away from Huawei. They're not going to rip and replace in Europe. That's not going to happen. But as new infrastructure projects begin to come into play, then it's going to be difficult for Huawei to win and I think that helps us. Great.
Thank you.
Thanks, George.
Your next question comes from the line of John Marchetti from Stifel. Please go ahead. Your line is now open.
Thanks very much. Gary, I wonder if
you could just spend an additional minute on the India market. Maybe just talk about how maybe the last 2 or 3 months have gone and maybe as you're looking into 3Q and into even further into the second half of the year? As you're looking into 3Q and into even further into the second half of the year?
Yes. I think it's had a couple of prior to the COVID piece, I think it had this sort of situation. Just to remind everybody, as you say, John, it had these challenges around, A, had a very big build out and was digesting that. 2nd of all, the economy and then some regulatory issues. So it's been a challenging 2 or 3 years on that side for India.
But the underlying dynamics and demand, I think, are strong. We were just starting to see that move again when, of course, COVID hit. They had a very big lockdown and very little got deployed. We began to see activity, I would say, at the beginning of this year, and we won some new deals then, and they were beginning to be deployed. And then, of course, what's happened in the last few months has really slowed all of that down.
We would say from the experience that we're seeing currently is it seems to be stabilizing and in fact improving. I would say that from talking with our team in India generally, still got a long way to go, but I think it sounds like they're heading in the right direction. I would say that our view on the second half was obviously we've kind of derisked that view in the second half given what we were seeing. And so but I still think that India will be up for Ciena year on year. It won't be as high as we had anticipated.
But I think the order activity and RFP activity continues to be strong as they do their plans, and we're winning more than our fair share of that. So one's hopeful as we turn the year that we'll see a good step function in India, albeit a delayed one from the second half.
Got it. And then just maybe shifting gears to overall order growth. You talked about that being up significantly higher than revenue. I'm just curious if you can comment at all about whether that's more heavily weighted towards Tier 1s. You obviously had a very good sequential quarter in webscale.
Just as we're looking into that second half, is it a function of those networks that you talked about running hotter? You're starting to see that ease out and those orders now are coming in for second half deployments? Is it a function of now having time to evaluate 800 and doing those Just curious if you can give us any color there on some of that order growth that you saw. Thank you.
Yes. No, I would say generally, it's across the board. We're seeing it with I think the dynamic is obviously very different as you go to each of the webscale players. But I would say generally, they have been constrained in their ability to roll out and connect new data centers. Just like the carriers have been constrained in terms of their ability to deploy, 1st of all, both logistically, but more latterly out of caution and run their networks hot.
So slightly different dynamic obviously between the 2, but we're generally seeing most of them now. And I would describe it to some extent as being catch up on their capacity build outs, which I think has been largely they've been running it hotter the last sort of 9 months or so. And I think that's what we're seeing is I described it as sort of catch up and then a return to a more normalized approach to the development of their networks. So, as Jim sort of talked about, a lot of the new business that we've won, we actually think we'll end up now deploying in the second half, which is what we kind of hoped and expected. So that's good news, coupled with this catch up.
And I think we were expecting a big step function in our second half. And I think we're now much more we've got real confidence around that in terms of what the activity that we're seeing and the backlog that we've got as well. So I would say, really, John, it's across the board. It's Tier 1s in North America, Tier 1s in Europe. We talked about India.
I would say, Japan is still a challenge for us. That's more specific to us because of what's going on with DOCOMO and NTT. But generally, across the board, we're seeing a catch up on capacity and we're seeing increased leaning in on the deployment of new architectures and new builds.
COVID affected everyone's spend really across the board in terms of customers, but it had a much more severe effect on the service providers than it did on the web scale. So we did expect and hoped for a big improvement in service provider spend as we came into our Q2 and we have seen that. But I would say, as Gary said, this is across the board. I think that everyone is seeing the need for network. The network is more important than it ever has been, and we expect that trend to continue for us.
Thanks,
John. Thank you.
Your next question comes from the line of Simon Leopold from Raymond James. Please go ahead. Your line is now open.
Thank you for taking my question. This is Mauricio in for Simon. Just wanted to go back to the question on the European opportunity on the back of the Huawei backlash. Maybe you could talk about what you're seeing in terms of the pricing dynamics as some of the Huawei footprint starts to gradually become available and competitors look to gain a piece of that footprint? And then I have a follow-up.
Maurice, I would say this dynamic has been going on for a while. I don't see any particular change in the pricing dynamics. I would say, as Jim talked about earlier, I think the main priority of the Europeans is to derisk themselves around their RAN business, and that's where they're focusing their attention and dollars right now. Underlying to that, as they look at changing their network infrastructure and transport architecture, they are looking to decrease their dependency on Huawei. And so those are the entry points, if you will.
And that takes time, both in terms of the evaluation, the decision and the actual deployment. And it's a big deal for these carriers because they're all integrated into their back office, their systems, their support, and that doesn't happen quickly. And this has been going on for a couple of years. We've a number of those and we're now kind of deploying and that is sort of an ongoing tailwind for us. But we're not seeing any particular change in the dynamics there.
It obviously benefits us and other competitors that are not Huawei, But it's a very long term play. And really, I would stress again, it's the RAN vendors that are really seeing a significant probably uptick in the shorter term from it.
Yes. And any time there's been major piece of infrastructure that's competitively contested, it's always a very competitive and tough pricing environment and that hasn't changed. And the fact that the trigger happens
to be a
move away from Huawei, I don't think is going to change that either.
Thanks. And then for my follow-up question, Jim, this is the 2nd consecutive quarter that we're seeing a sequential increase and actually another record high on Sienna inventory levels. So I'm just wondering if this concentration is related to getting you ready for the sort of demand that you anticipated in the second half of the year? Or perhaps it's a combination of that as well as an effort to build some inventory buffer that will help you navigate the supply chain limitations we're seeing in the industry. So maybe if you could offer some color around that and how we should think about inventory for the remainder of the year?
Thank you.
Yes, I'll start and Scott can continue. It's all of the above, frankly. We do expect and our guidance would lead you to think that we're going to have a big uptick in the second half and we had to build inventory for that. The other thing though is that with supply chain, we have always been very proactive in terms of making sure that we had good inventory levels as we moved into shortages in some areas. This year is no exception.
We've also had some MDs of certain products and we had to get last time buys. So it's all of those things combined. We do think that inventory levels will come down over time. We'll have to watch and see what happens as a result of this semi issue and whether there might be last time buyers associated with that as we move through the year. But over time, we do expect our turns to get back to something approaching our more normal levels.
Jim, you covered it. In fact, the question kind of was bang on in terms of the dynamics is really primarily to, we've talked in the past of our supply chain resilience and the strategy that we've built in, not only how we architect it, but how we invest to service our customers. And I let I'm convinced our customers reward us for that by the way. So that's one driver of it and it's certainly served us extremely well as we've now staring at the semi challenges of the industry. The second piece is, as we've noted a couple of times in the call here is, we built a plan and an expectation that we were going to have a substantially bigger second half than first half, and we bet on success.
So we were getting ready for that second half.
Thanks, Mauricio.
Your next question comes from the line of Jeff Gual from Wolfe Research. Please go ahead. Your line is now open.
Yes. Thanks very much. And I've got a question for you, Jim. And let me ask it the most direct way, but I can ask it another way if you prefer. And that is the margin structure that you've given us for the second half is really I mean, it's noticeably better than where you've been historically.
Do you think that that is sort of a new baseline for Sienna? Or do you think that over time you'll get back to that mid-40s range in the out year?
Well, here's what I'd say about that, Jeff. We have been experiencing very good gross margins. We have taken a lot of cost out of our product and we have great technology. All that has contributed to our improvement in gross margins. We have called up our gross margins a few times over the past year or so, but it's a very dynamic environment in which we find ourselves now.
The dynamic that we've said that new projects will cause margins to get back more toward the mid-40s is still there. We're just not because of our underlying performance in gross margin expecting it to be as significant as we expected for the second half of this year. As we move through time, we'll address this issue of gross margin more fully, but we do like our performance so far.
Okay. So new wins turning back on is part of the guidance for the second half
of the fiscal year then?
Absolutely, yes.
Okay, great, great. And then let me follow that up by asking, is it possible that one day that you'll get back to talking about that 6% to
8% long term sales growth? We're going to revisit the issue of long term guidance as we turn the year. We've been through an incredibly dynamic period in our market with all sorts of behavioral changes on the part of our customers and with good reason of course. And that caused us to suspend our 3 year guide. Although I would say this, remember, we just we did talk about the future as we began this year.
We said that we still expected the market to grow in the low to mid single digits overall, and we expected to take share in that context. We just didn't continue that thought to give a number in terms of our revenue growth. I won't say that we're going to as we come into the 1st part of next year, but it's certainly what we're thinking about as we sit here today.
Okay. Thank you very much.
Your next question comes from the line of Amit Dabriyanani from Evercore ISI. Please go ahead. Your line is now open.
Yes. I guess the first one I had was on the webscale business. I was hoping if you could just maybe touch on what's happening over there. I think the business was down on a year over year basis, a lot of sequential. Understand kind of what's happening in webscale.
And then as you think about the back half narrative, how do you think the webscale business performs versus the back half guide that you provided?
Amit, I would say that, you see ebbs and flows to the webscale players, and obviously they all have very different business models and we talk about them generically. I would say a couple of things to it. 1, we continue to perform very well with them. They've also been constrained around their connectivity and ability to ability to deploy new data centers and connect them. I think that is getting better.
And the fact that year to date, we're at about 4% up as we get to the half year is about what we thought. We think we'll see growth for the year in about the mid sort of single digits and we will absolutely tough for us to take even more share than we already have, but we're absolutely confident of maintaining the share that we've got. And we do think that the second half will improve on the first half in terms of revenues. Absolutely, we'll see an uptick along with the rest of our business on that. So I think we're pretty optimistic around that space.
They seem to be getting back into the swing of being able to build out these data centers around the world. And I would say that's a key point. It is around the world where we're partnering with them. It's not just in North America. And that has been particularly constrained for them outside of the U.
S. For obvious reasons. And that seems to be getting better. So we're pretty optimistic about the second half for us, Amit.
Right. Perfect. And then if
I could just kind of
hear you talk a bit more about free cash flow expectations in the back half of the year. Q2, I think, was exceptionally strong. So I don't know if you would call up on those one off there. But how do we think about H2 free cash flow? Because historically, that's been the stronger half of free cash flow.
Is that the same that happens this time despite the ramps that you're expecting?
I would expect that we'll have better free cash flow in the second half we had in the first half. Although I would say that we had a particularly strong Q2. But we're going to we've said in the past, and I don't think we've guided to this recently, but in the past we've said that our free cash flow is going to be 60% or some 70% of our EBIT and that's the kind of number that we kind of expect.
Your next question comes from the line of Alex Henderson from Needham and Co. Please go ahead. Your line is now open.
Thank you very much. So you've addressed the issue associated with Huawei, but I was wondering if you were to look at the broader environment, whether there's been any change in pricing, 1, as a result of Huawei receiving from the market 2, because Nokia is saying that they're going to try to drive to profitability? And 3, to the extent that you have such an advantage with the 800 gig, is that causing better pricing environment for Ciena as a whole? Can you talk a little bit about what's going on in the pricing realm?
Yes, Alex, this is Gary. I don't think it's really, really changed. The Huawei dynamic has been around for a long time. So no real change to that. I think where we're getting increased margin, I think is a reflection on the scale of the business, the technology that we have and the vertical integration that we have and the innovation that we're bringing into the market and that's helping drive our gross margin.
I think the pricing environment generally has not changed. We haven't seen any appreciable change in behavior from any of the main competitors.
It's a competitive market,
Alex. And as Scott said, whenever there's been an opportunity for market share gains as a result of something like a Huawei or anything else, It is a competitive battle to get that market share and we're going to expect to see that as we move through the next couple of years trying to get Huawei's market share.
One way you asked that question related to 800 gig pricing, Alex. One way I would think about it, in most of the competitive engagements, it comes down to a total cost of ownership conversation. And within that, it's what's the cost per bit, not necessarily explicitly what's the cost for an 800 gig capable, but what's the cost per bit that they're trying to achieve. What the 800 gig WaveLogic 5 technology allows us to do is to participate in that market pricing, but at a much more competitive cost basis. And that is actually partially a partial factor in our margin dynamic as well.
Great. Thanks for that answer. The second question I had for you is you addressed the component supply constraints and basically saying that it was not impacting your outlook for the back half of the year. It wasn't constraining your expectations. But I wanted to ask a little bit more subtle question of whether that actually might negatively impact your ability to exceed the forecast.
Is that a governor on the growth rate within the band in the back half as a result of the inability to produce more if you had orders in excess of what you thought going into the period?
Well, what I'd say is that we expect to be able to meet our current call for the second half based on our current view of the supply chain conditions. Lead times have lengthened and so to achieve a significant upside to the numbers that we've called would be difficult. I wouldn't say it's impossible, but I would say it would be difficult.
That's very helpful. Thank you very much.
Thanks, Al. Your next question comes from Samik Chatterjee from JPMorgan. Please go ahead. Your line is now open.
Hi. Thanks for taking the question. I have a couple. Just wanted to start off with seeing if I can get a bit more visibility on what you're seeing with the North American Tier 1 service provider customers. Clearly, you indicated you're seeing either strong orders or revenues from them.
But how much of this is attributable to, you think, like return to normal levels of spending relative to or greater to just spending more tied to some of their wireless equipment deployments that are going to happen in the back half here relative to C band and having to invest to support that wireless equipment deployment? Just trying to get any insights you have of what is the driver here in their returning to a higher level of spending? And I have a follow-up, please.
Yes, Sumit. I think largely it's to do with them playing catch up on their capacity. Security, I. E, services to app, to security, services to our homes basically. And they didn't want any disruption on the network operationally and they were very cautious around doing anything on the network and so they ran it hard.
I think what we're seeing is more a function of a bit of a catch up of that and then a return to a more normalized approach of the development of their network, I. E, their new architectures, new business, new deployments. So I think you've got a combination of those two things going on. And I think there might be a little bit around ran priority earlier on, last year, etcetera. But I think it's more about this dynamic of caution on the network, operational caution and also fiscal caution.
I think people are generally in the economy feeling a lot more confident now, and that includes the carriers. And I think you're seeing that in some of their various comments around generally in CapEx. So I think it's more to do with those dynamics than it is prioritizing RAN versus transport, etcetera, because the RAN won't work without the transport. So they're pretty closely aligned really.
Got it.
And a quick follow-up. I know in the press release, you mentioned you have a 1 10% customer, which is accounting for 15%, I think. We saw move sequential move up significantly on DCI, but just wanted to get some color. I know you can't probably won't name it, but was it a service provider or was it a more of a DCI webscale customer?
We'll tell you it's AT and T. It's the biggest customer that we've had historically and continues to be a very strong customer for us.
Great. Thank you. Thanks for taking the questions. Thank you.
Your next question comes from the line of Fahad Nirjan from MKM Partners. Please go ahead. Your line is now open.
Thank you for taking my question. I wanted to revisit Jeff's question, but I'll ask it in a more nuanced way. If you look at the broader macro environment, probably the best time I can recall for the comm equipment sector in my memory, and I've been in this business for 20 plus years. You have 5 gs build outs. You have yesterday, we heard Facebook talk about 75% year over year growth in their network consumption.
We've got stimulus is coming from Biden's administration's infrastructure bill of $100,000,000,000 on top of that $20,000,000,000 for RDOF, various stimulus spending plans from various governments across the globe as they try to recover from the global pandemic. And you're still talking about a 0% to 3% year on year growth outlook for the second half and not kind of giving us more forward looking outlook on top of the fact that you already have the market leader in 800 gig, your largest competitor Huawei in a case. So why hold back on giving us a more forward looking outlook? What are you concerned about?
All the things that you mentioned with respect to the conditions in our market are true. But nothing ever moves quite as fast as we might expect it to sometimes. And there are constraint there are natural constraints on the service provider's ability to spend quickly. It's a great time to be in the networking business and we're the best at least at the optical layer. And so we're going to benefit for a long period of time from all the trends that you talked about.
I just think that as we look into the second half of the year, that's what we expect. And we did mention that the supply chain is going to make it difficult for us to exceed these numbers. And we'll talk about as we enter the next year, what we think about the next several years. I'm not promising we'll give numbers, but I will say that we will talk about it. We like where we are as a company.
The other thing I'd just add to that, Fahad, by way of sort of context is, depending on your sort of numbers, but rough out onto the guidance consensus, whatever, you're talking about a massive uptick in the second half. You're talking about a 16% increase in the second half versus the first half or in the order of magnitude around that, which is a significant uptick from where we'd normally be. And I think we're all dealing with a period of great turmoil around the COVID for the last couple of years. I would also say the other thing is, I don't know many companies that actually gave annual guidance for this year, which we gave, clearly predicated on a set of assumptions, which fortunately seems to be playing out. But as Jim said, there's also some headwinds to this thing.
We've got some supply constraints. We're not immune to that. We navigate through better than anybody else in the industry, but we're not immune to it. We have India is not going to be as strong as we thought. We derisk that.
So there's lots of sort of puts and takes on a global basis. But I totally agree with the underlying secular demand is super positive. And as we saw prior to COVID, it was extremely strong. And I'm very confident that we will return to that kind of an environment once we get through this.
Appreciate it. I have a follow-up on your routing and switching. You had a major win with Openreach in the UK. How big can this product line be? It seems like you're increasingly winning a far greater share of wins than is appreciated by the investment community.
Just help us understand what's where in which segments of use cases are you winning? Are you beginning to actually kind of take share away from the Juniper's and even potentially Cisco's and Orestas of the world? Can you just help us a little bit understand what's happening in the routing and switching?
Yes. So from a numbers perspective, I mean, I'd revert back to Jim's comment. We're going to take a look at giving you a longer term perspective of how we think that portfolio will grow as we get into the year. I will say this though, the growth rates are going to exceed the overall Ciena average growth rates. We've invested very substantially and it's not just a recent phenomenon for the last couple of years in terms of increasing the addressable market of that portfolio, particularly in terms of its IP capability, its next generation IPOS capability.
And that opens up new market opportunities for us around the metro and edge deployments, which as you know are undergoing a lot of significant architecture changes that is opportunity for non incumbents. So we're pretty bullish about the opportunities there. It'll show up in applications around the edge, wireless x hall, cell site routers, connectivity from users to content in various different flavors and Openreach was one example of that.
Your next question comes from the line of Tim Long from Barclays. Please go ahead. Your line is now open.
Thank you. Two quick ones if I could. First, Gary, you talked about the U. S. Tier 1s looking pretty strong.
I think someone mentioned government stimulus and rural broadband. Can you just give us your perspective on how you think that will impact Ciena over the next few years as the smaller and more regional telcos get potentially more funding and more optical reach into the networks? And then second, if you could just give us an update on the Subsea segment. I think it's a little bit smaller business, but seems to be there's some good dynamics there as well. Thank you.
Yes. Tim, on the rural piece, really talks to this thing that I think a number of the questions sort of got to the strong sort of underlying secular demand. I think really it's all about getting greater bandwidth closer to the customer, be it 5 gs, Internet of Things, a lot of rural broadband initiatives. Obviously, the one that we're focused on is I'm talking about is the U. S, but you've got those in different parts of the world too.
You've got them in multiple countries. I think people are recognizing, particularly during COVID, that the any inequalities that exist need to be addressed in the various countries' population. And you've seen a number of those initiatives kick off. I'd just caution that it is well, first of all, it's government at the end of the day. 2nd of all, it's infrastructure, and these things always take a little bit of time to work their way through.
But as we come out of the year and look to the next few years, this is a very positive underlying dynamic basically. If you couple that with 5 gs and just basically as we view it getting high speed closer to the customer, which is really about fiber. So we feel very positive around those dynamics. Similarly, kind of subsea, you look at things like webscale and as they look to expand into various countries, they're basically the largest owners, I think, now of subsea capacity in the world are the webscale players. It's no longer the PTT carrier consortia that control all of those cables, which was the case 10 years ago.
And I think that's a very positive dynamic for the future overall and that subsea market, as you look at higher speeds of connectivity out to the terrestrial networks, we're seeing a continued momentum in the need for new cables basically. And I think you're seeing a bit of a cycle going from adding capacity to existing cables. You're still going to see that, but I think we're into a big cycle of new cable build outs. And there'll be a bit of a lag effect to us on that because you've got to get the cable in first and then we'll come on top of it. But I think that looks pretty positive over the next few years.
Okay. Thank you.
Thanks, Jeff.
Thanks, Tim. Thanks, Tim.
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