Perfect. Welcome everybody to Day 4 of TMT. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. I'm Meta Marshall. For those of you who don't know me, I cover the networking space here at Morgan Stanley. We're delighted to have Ciena here with us today. David Rothenstein, CSO of Ciena, our Chief Strategy Officer.
Good morning, Meta. Thank you for the coveted 8:00 A.M. slot on day 4.
Exactly. you know, a webcast is available at any time.
Fair enough.
All right. Maybe just kick off, given that you guys just reported on Monday, you had strong results with a nearly 10% beat and a guide up. Clearly a lot of this was from supply chain loosening, but you guys also expressed some kind of confidence in the second half of the year. Just what are those kind of demand signals that you're seeing that are giving you that confidence?
Yeah. I think when we're talking, Meta, about this year specifically, it's less about demand signals that give us confidence and more about, frankly, the size and durability of our backlog, right. I think, which has been well established by now. You know, we effectively grew the backlog over the past few years by about 3.5 times over 24 months, and that was largely a result of COVID-related dynamics as well as, of course, the supply chain issues that you were referring to. By virtue of those items, the backlog has grown to the point where historically one could think about backlog as representing about 35% of the forward year's demand. Two years ago it was 66%.
Coming into this year, the backlog actually represented almost 100% of the demand. By virtue of that, we have great visibility and line of sight for this year.
Mm-hmm.
You saw obviously your point in Q1, we were able to acquire more components than we thought we were going to, so we were able to overachieve our guidance for the quarter. In terms of second half, it's effectively, as you said, what we're counting on is the supply chain environment continuing to gradually improve, more components, more of those constrained power management integrated circuits becoming available, so we're able to actually service that demand and that's frankly why we were able to take the guidance up for the year by about 400 basis points.
Got it. There's obviously been a lot of discussion about backlog coming down and that kind of being in part the reason for the beat, but the book-to-bill was 0.9 in the quarter, kind of seasonally higher than it would've been. Just where is that kind of strength on seasonality? Why was it or why did you view it as higher than normal?
Yeah, I think, you know, in the current times, given dynamics that we're experiencing right now, macro and otherwise, I think seasonality and those types of trends kind of go out the window.
Mm-hmm.
You know, we have received some questions about, well, why isn't the Q2 guide seasonally higher given...
Mm-hmm
... its historical performance above Q1 and the reality is those types of dynamics really don't exist today, right? As I said, we were able to overachieve our guide in Q1 by about $100 million. We took the guide up for Q2 based upon the balanced view that we see at that particular point in time. In terms of the book-to-bill, honestly, it likely will for a few quarters this year be below one, and that's actually a good thing because the size of the backlog that we spoke of, which coming into this year was about $4.2 billion, you know, was at an unsustainably high level.
Right.
Yes, while it does provide a degree of visibility, as we talked about, it also doesn't provide a sufficient amount of equipment being provided to our customers who badly want and need the equipment as soon as we can provide it. A book-to-bill below one, given our overperformance on revenue, frankly doesn't bother us. That backlog that we talked about is going to come down. It has to come down. It needs to come down. When it does come down, it's a good thing.
Mm-hmm.
It's a good thing because it means supply chain conditions are improving. It's a good thing because it means we're actually delivering more to our customers. It's a good thing because we're finally able to convert the orders and backlog into revenue.
I mean, with a lot of backlog come concerns about pushouts. You know, given service provider ICP data points during the quarter, there's been a fair amount of concern around this. You know, just is there something that we can point to, you know, on the service provider side, like either their networks have been running too hot or performance is breaking down or we know that a certain city is being built out to kind of give confidence around the pacing of service provider orders?
Yeah. If you take the different customer segments, so you asked specifically about service providers...
Mm-hmm
... but the answer is different for the web scale.
Yep.
For service providers, you know, candidly, we are not seeing any significant slowdown in demand...
Mm-hmm
... or ordering. I think, Meta, it's a really important point to make given the current environment that one cannot conflate demand and the fundamental demand drivers for our industry with shorter-term ordering and backlog dynamics because the two are not necessarily correlated. The reality is demand is and has been and will continue to be driven by annualized bandwidth growth.
Mm-hmm
... which has grown roughly about 30% year-over-year for the past 25 years. That is the fundamental driver for demand in our space. With respect to service providers, they have been running their networks hot for the past few years. They know they have to continue to invest in their networks to reduce latency, increase operational efficiency, and frankly drive more modernization of their assets and monetization of their assets at the network edge. That's true of cloud adoption, 5G, AI, automation, whatever it might be. Even though a particular provider may be looking at a change in their aggregate CapEx year-over-year. In many cases, that's correlated with, you know, wireless or wireless spectrum decisions and far less about the fundamental demand and buying patterns in the space that we care about.
Got it. Maybe turning that same question to the ICP side.
Mm-hmm.
You know, just what are you seeing there in terms of kind of everything we've heard with CapEx volatility on their side and just their need to kind of continue to invest in their networks from an optical side?
Yeah, that is, you know, one of the questions we've been getting quite a bit...
Yeah
... this cycle as you'd expect. What I'd say about the cloud providers is, those demand drivers that I spoke of are equally applicable to them, but in a slightly different context.
Mm-hmm.
Where the service providers have to, you know, really focus on the efficiency of their decentralized distributed networks, the cloud providers, it's all about transforming the networks at massive scale.
Mm.
You know, the proliferation of the need to continue to host a wide range of cloud applications and cloud services, connecting cloud to cloud, is and only gonna continue to proliferate. What we are seeing with the cloud providers is that as they are looking at managing their budgets a little more tightly, there's a lot of ink spilled about some of the recent layoffs and other budgetary decisions at some of the cloud providers. They are reprofiling some of their order book...
Mm
...out a quarter or two to manage their budgets a bit more closely in that regard. However, it is not in any way a negative indicator about those demand drivers. That demand is still there, and the reality is, budgetary issues aside, they would take all the equipment tomorrow...
Mm-hmm
... if we could deliver it and they could take it operationally. Overall, the demand function is great for them. Actually, we had a fantastic quarter with the cloud providers. They represented about 24% of aggregate revenue. One of them was a 10% customer. What we've said for the segment this year is we expect record revenue out of the cloud providers and a growth rate that is likely going to be above the corporate average.
Got it. India was another source of strength during the quarter. That business has, you know, ebbed and flowed over the years. Just what is kind of helping or what is driving kind of the strength that we're seeing today, and just how long is this cycle expected to be there?
Yeah. Generally, you know, I do kind of bristle at the word cyclical...
Yeah.
...'cause I think in many cases those are overstated. In this case, I think it's actually quite applicable.
Mm-hmm.
If, you know, you take back to 2018, 2019, Ciena had a couple of years of significant outsized growth. Part of that was because of the cloud provider increase in their CapEx spend, but part of it was, India building out its then 4G infrastructure. There was a pause or a slowdown or a digestion or whatever you wanna call it during COVID and the, and the supply chain issues over the past period of time. I think we're at the beginning stage of a new significant 5G infrastructure upgrade cycle in India. You know, what's interesting is, you know, whereas 10, 12 years ago, there was over a dozen providers, there's really only three-.
Mm-hmm
... today, right? Jio, Bharti Airtel, and Vodafone Idea. Each of them, in their own ways, has talked quite openly about the desire and frankly, the need to drive broadband across the entirety of the rural population in...
Mm-hmm
... in the country. I think Jio has even talked about spending $25 billion over the next few years to do exactly that. We do see that they're at the beginning of a pretty significant investment cycle, and we believe that we're incredibly well-positioned to capitalize. We currently have the number one market share in optical in India. The goal for us is to continue to maintain and hopefully even grow that share.
Mm.
We're well-positioned with Jio and Bharti for their NLD, their National Long Distance infrastructures, and for Vodafone Idea in terms of some of their metro regional build-outs.
Got it. Growth margins clearly are a little bit depressed right now just because of supply chain challenges, but also because you're in the early stages of a lot of larger deployments that you've kind of won over the past few years. Just what, maybe taking supply chain out of the equation, just how do we think about some of these new deals ramping and time from kind of that initial chassis deployment to more growth margin upside from kind of the line cards piece of the business coming in or just the piece of the business coming in?
Yeah. I'll speak directionally. Obviously, every operator is a bit different.
Yeah
... in terms of their, deployment cycles. Some have very significant OSS/BSS integration time frames and things like that. Directionally, you're right. I mean, what we did see was at the beginning of the pandemic and maybe the first 12- 18 months of the pandemic, we were still out there winning business and accumulating some significant design wins. Typically, they would have, you know, started deploying quite a bit earlier. You had COVID-
Mm-hmm
... where the reality is no one was deploying and building, you know, greenfield or even significant overlays on their existing networks. You actually saw that in our margin profile. For the 2021 time frame, there was about four or five quarters where we were in the high 40s.
Yeah.
That was entirely a result of mix. We were just not putting any new deployments, any line systems out there. It was all the higher margin, capacity adds. Now what you're seeing is, as the pandemic is not gone, but it's certainly some of those dynamics are abating. As supply chain is gradually improving, you're starting to see some of those previous design wins actually start going into deployment, right?
Mm-hmm.
It's gradual. It'll be lumpy. It's not gonna all happen at once. You know, the real question I think we were going is, what's the potential upside there on margin as network traffic growth starts to increase on those new builds? Then you can start adding the capacity. It's dependent. I mean, you said it earlier, I think a lot of operators were running the networks hot.
Yeah
... during the pandemic. For now, the way we see it, at least for this year, is that because of that mixture with an increased amount of line systems going out right now, which is a good thing, on track is a good thing, we do see some headwinds on margin, which was why we've retained our guidance of 42%-44% for this year. Now the other dynamic you said to exclude supply chain, but I've got to mention it.
Yep.
Which is we are still experiencing higher than typical, what we call exception costs. Effectively, the premium that we pay to brokers to procure ultimate components on the open market. Those are still elevated relative to historical. They're down from what they were last year. Last year, I think we dimensioned it at about 400 basis points of margin impact. It'll be less this year, but it is still an impact. Both of those dynamics are what are kind of conspiring to keep margins where they are right now. We absolutely see, one, those exception costs continuing to come down, and two, that fuel mixture changing over the course of time. That's why we've said we absolutely see a line of sight over the next few years to get back to our target margin of the mid-40s.
Got it. Another kind of conversation we often have with investors is just kind of the dominant share that you have with the ICPs and a lot of that gained in the 400 gig cycle. Just how has supply chain maybe impacted that share position? Just do you see that changing going forward, just given kind of the supply chain challenges that yourselves and everybody else had?
First of all, Meta, as a former lawyer, I would never say dominant. You know.
Leading.
Significant.
Significant. There we go.
No, you're right. I mean, we have and you're talking about direct web scale data center interconnect-.
Mm-hmm
... opportunities, you know, single span switch to switch interconnect, between data centers for the cloud providers. You're right. We have and continue to have a significant, market share, number 1 leading market share in the space, and we've had that for quite some time. You know, the reality is supply chain issue notwithstanding, you know, I think every provider is looking at some point in time to ensure there's sufficient diversification-
Mm-hmm
... in their supply chain, for a lot of different reasons. You add into what's transpired over the past 18 months, I think that has caused a lot of providers to really think twice about making sure that there is a viable second or dual source for a lot of their key components, their key network equipment. I do not necessarily think that means that, you know, all of a sudden you're going to see a market share shift or even a share shift within a particular provider to 50/50 or some type of equanimity like that. You could have a dual source at 10% of the, of the overall spend just to keep the primary, you know, honest, but also, frankly, to keep the supply chain lines open in case there are issues.
What we have seen, you know, is given the supply chain constraints, given our extended lead times, we have seen certain competitors rifle shot priority of equipment into certain customers to, you know, take a piece of business, a small route or a small opportunity. We've not lost a single customer, and we still maintain meaningful and significant market share in the space. Frankly, given the numbers I talked about with you, we expect to do that. We did over $1 billion, well over $1 billion in orders from web scale providers last year.
Mm-hmm.
As I said, we're gonna be above the corporate average of growth rate this year. At the end of the day, customers vote with their wallets.
Got it. Your 1.6 Tb WaveLogic 6 was announced kind of before expectations. I mean, everybody needs an OFC headline, but I think this was one that was kind of well ahead of expectations. You know, just when can this be a contributor to revenue? You know, how does that impact kind of how you look at what your data center positioning can be?
You're right, and thank you for asking it. We have announced our next generation of the coherent optical technology, which is the sixth generation WaveLogic 6. Much like WaveLogic 5, it'll be initially available in two different form factors. There's the WaveLogic 6 Extreme, which is for longer reach metro regional applications, where the focus is on capacity and programmability and spectral efficiency. There's the WaveLogic 6 Nano, which is the footprint and power optimized version, the plug for that data center interconnect application that we spoke about for the cloud providers. What we have said is, it is for everyone's specs, it's a 200 GBd, 3 nm CMOS-based DSP. You know, it will, you know, once again leapfrog the competition in terms of its performance specs.
In terms of when it'll be available for revenue, what we've said is the first instantiation for general availability will be in the first half of 2024. We would expect a similar ramp to production volume as WaveLogic 5. Then over the course of time, we will roll out additional variants and additional form factors to, you know, additional contributors in that regard. In terms of what it could do for us in terms of the data center.
Yeah
... you know, what you will see in WaveLogic 5 Nano for the first time is a very specific variant for the campus data center use case. Think 1-20 km. You may be hearing it called Coherent Lite inside the data center. We think there's a really interesting opportunity for us in that regard, I would caution that's not in the next three years. That's in 2025 and beyond revenue opportunity for us, We do think it's a very interesting one for us.
Got it. We've spent a lot of time at this conference, and with OpenAI here today, there'll be more of that conversation around kind of AI workloads and the increasing networking needs with AI workloads. Can DCI see some of this too, or is that largely in data center traffic? Just what are ways for you to kind of capture a piece of that opportunity?
Yeah, I mean, there's no shortage of talk even before OFC, but especially at OFC this week, about the impact of AI and automation on networking connectivity. I think you're right. I think initially you'll start seeing that most inside the data center, you know, because our estimate right now is that only about 20% of enterprise workflows are in the cloud.
Okay.
Which is, you know, if you think about that's a significant-.
Yeah
... amount of workflows that have to still be transitioned into the cloud. That compute power is gonna need to continue to increase in the data center to support that increased workflow. You are gonna see it, I think, initially inside the data center. However, the power requirements to support that increased, you know, compute power in the data center are not going to be sustainable, which means it's gonna have to be distributed out into the network, and that's where we come in. At the end of the day, more compute, more storage, means the need for more capacity and more bandwidth. We absolutely see over the course of time, you know, a meaningful opportunity for us to leverage the benefit of AI.
What's really interesting, and it's way too early for us to dimension it, but you know, I mentioned that annualized 30% bandwidth growth-
Mm-hmm
...just, you know, reliably for a long time. Does that dynamic with respect to increased workflows in the cloud increase that annual bandwidth growth? Don't yet know.
Yeah.
It's certainly something that we see as a potential tailwind.
Got it. You have a 400ZR, but maybe versus kind of some of your competitors out there, you've been just a little bit more muted on the opportunity beyond kind of a couple of hyperscaler customers. Just maybe how do you see the 400ZR opportunity, and just how is that maybe where are you in difference with some of your competitors?
Yeah, I mean, I think there's certainly room to agree to disagree on certain areas, and this is one of them. I think we've been really quite consistent about our view about the ZR opportunity.
Mm-hmm.
I think part of the challenge, Meta, is that it is easy to conflate ZR and ZR+ with the broader plugs or pluggable market, and they're not synonymous.
Yeah.
The, you know, the reality is we have been selling plugs into other switch vendors for a long period of time.
Mm-hmm.
ZR is for a very narrow use case, right? It is short reach data center interconnect, right? We've been clear. We dimension that as roughly a $500 million market. Nothing to sneeze at, but also not earth-shattering in terms of relative size of the overall addressable market for us and for the industry. We are there. Obviously, WaveLogic 5 Nano, you know, and the 400 ZR plug are there. We think it is as good, if not better than anything else out there in terms of performance specs, specifically in terms of power consumption and energy consumption, which is vital with that particular application because the footprint and power needed at the very edge in the data center interconnect are really quite important to them.
You know, we've been clear about the ZR market, you know, we frankly don't think it's changed. The other dynamic, I think, in terms of why it hasn't shown up more quickly, I mean, we were frankly talking, Meta, about ZR back in 2017, 2018, is because, you know, people sometimes forget this, every plug needs a host. It needs a socket to go into it. The reality is, the vast majority of networks, even with cloud providers, are still running on 100 and 200 gig. Until you upgrade your switch fabric to 400 gig or above, you're not gonna get the economic value.
Mm-hmm
... on a 400 ZR plug. Unless and until that happens, it's just gonna take some more time. Whether it's a pause or a delay or just a more gradual ramp than anybody anticipated, I think that's what's transpiring, and that's what's confusing a lot of people about that market.
Got it. You've talked a lot about the routing market opportunity, and most recent acquisitions have kind of helped with this product set. Just where do you see the most attractive opportunity kind of within the greater routing market, and just how can you gain positioning here?
Yeah. You know, we have been in routing and switching for a long time. You know, we were doing layer 2 access and aggregation 15 years ago. The reality is it's a different market for us. In optical, you know, I don't think I'm going overboard here, you know, we are the innovation in technology and market share and mind share leader. In routing and switching, you know, we're the hunter. We're looking to disrupt, we're looking to challenge, and that's across a number of different dimensions. I think we've been, you know, early on, pretty successful there. I do think we can, you know, differentiate ourselves competitively for a lot of different reasons, not the least of which is that we're leading with the coherent optics.
Mm-hmm.
You know, which is now everyone recognizes an integral part of convergence, right? Which is a big, scary word. You know, effectively, you're looking at collapsing service edge routing with metro DWDM.
Mm-hmm.
We, you know, are and will be in that space. We have not announced publicly, but we do intend to have purpose-built portfolio products for IP/Optical convergence, and we absolutely see an opportunity there. There are other areas as well, and kind of we call it more broadly and colloquially, next generation metro and edge. So think plugs and routers, Ethernet data services, cell site routing and cross-haul, as you backhaul the traffic out of the air into the optical IP fiber core. As well, you know, more recently, you mentioned a couple of acquisitions in terms of the broadband access space.
Mm-hmm.
We see each of those in varying degrees together really driving our TAM increase over the next several years. We've dimensioned it around going from $14 billion- $22 billion over the next several years, and that's driven largely by our inroads organically and inorganically in that space.
You've had a conversation where I guess the traction that you've actually had there is maybe better than people realize, and part of that was kind of Tibit. I guess if you could just kind of lay out for people the traction that you're already seeing in that market, I think It's impressive.
Sure. I mean, you know, we'll take broadband access, for example, right? You know, we didn't just get into broadband access two months ago. As I said, we have purpose-built cell site routers, ethernet switches that sit at the switching center or the central office. We have ONUs and ONTs at the customer premise.
Yeah.
We have a disaggregated network operating system. We've been partnering with them for several years. We were their largest shareholder. It brought the MicroPlug that plugs into the ethernet switch or the optical line terminal at the switching center. We also acquired Benu Networks, which is a virtual Broadband Network Gateway, which really is, think about it as advanced subscriber management, allowing the carrier to do all things with respect to their enterprise and residential end users, whether it be service authentication, creation, activation, deactivation, whatever it might be. The combination of those products and technologies gave us really an integrated broadband access solution. We have demonstrable proof points in the market, even before we acquired the companies, but now certainly since.
We've got, I think, well over 35 or 40 customers for the PON solution. We've actually, since we've acquired the companies, we've actually won a few, pieces of business with the integrated solutions.
Mm-hmm.
We're really excited about it. We see, I think there's, you know, certainly no shortage of collateral out there in terms of the fiber being deployed over the next several years. We see that as a huge opportunity for us to make inroads and take meaningful market share, which we really don't have much today.
Got it. Another question that we often get from investors is just contextualizing the Huawei opportunity. you know, how do you see this developing and, you know, you've had great success with it in India. You know, EMEA would seem to be kind of the biggest battleground. Just how do you see getting inroads into that market?
We've been talking about, you know, and it's often talked about in terms of Huawei displacement or Huawei rip and replace, and I think one needs to parse those two out. Directionally, you're right. It has been over the past few years and will continue to be a tailwind...
Mm-hmm
...for Ciena. There's no doubt about that. That said, I think in some cases, the timing and volume of that is a bit overstated. A lot of the activity to date with respect to Huawei has been in the RAN, right? Where it's just far easier and frankly, more politically expedient to be swapping out a wireless base station or a remote radio head for non-Huawei equipment. That said, there is activity in the optical IP fiber core. To the extent it exists, it's primarily overbuilds or new builds. There's not a great deal of rip-and-replace of the existing infrastructure. In the U.S., there is some of that. There was funding in bill a few years ago for that, and that's happening very gradually. Over time, I think you're absolutely right.
I think the battleground really is going to be Western Europe.
Mm-hmm.
I think U.S. has kind of picked their choices here. India is another country that has been fairly aggressive in terms of excluding Huawei in the core going forward. Western Europe still has a lot of work to do in that regard, where kind of Nokia and Huawei are the two, you know, very significant market share leaders in the space. We do see it as an opportunity. We have won our fair share-
Mm-hmm
...of those opportunities where Huawei is no longer being considered. Nokia and some of the other competitors are certainly not unaware of these dynamics as well and are competing with us for that business. It's something that we think, you know, will continue to be over the next several years, a meaningful upside opportunity for us.
Got it. Any questions from the audience? All right, maybe last question for me. You know, we've talked about bandwidth kind of being a long-term tailwind, but there's a lot of money being invested in laying a lot of fiber in the ground. I think sometimes the question we get is just what opportunity does that create for you? Is it, is it kind of the broadband access that is kind of what you view as most lucrative? Just what do you view as the opportunity to kind of take advantage and timing to take advantage of just all this fiber that's going into the ground?
Yeah, I mean, I think, you know, in the U.S. alone, we estimate that more fiber will be deployed in the next five years than the past 15 years combined. Yes, we do see, as I talked about, broadband access being, you know, a key contributor and a benefit to that. You know, long haul metro regional as well will benefit.
Mm-hmm.
More fiber means the need for more capacity and more bandwidth, given those fundamental demand drivers that we talked about. You know, overall, we feel very good about where those demand drivers are going with respect to fiber being laid. As well, you know, there's a lot of talk about the government subsidy funding for, you know, the digital divide and rural broadband. You know, a lot has been written and talked about in the U.S. That's always going to take far longer than anyone anticipates. I mean, they haven't even fully allocated the rip-and-replace funding, let alone the $65 billion in BEAD funding. It's not just in the U.S.
Yeah.
There's Project Gigabit in the U.K., France Très Haut Débit in France, plenty of other jurisdictions around the world where the same dynamics are occurring. Again, it's built into our three-year guide, but you know, we do see the, you know, meaningful opportunity over the longer term as well.
Got it. All right. Well, David, thanks so much. That takes us to time. Pleasure having you.
My pleasure. Thank you very much for having me.