Ciena Corporation (NYSE:CIEN) Q4 2022 Earnings Call Transcript

Ciena Corporation (NYSE:CIEN) Q4 2022 Earnings Call Transcript December 8, 2022

Ciena Corporation beats earnings expectations. Reported EPS is $0.61, expectations were $0.08.

Operator: Good day and thank you for standing by. Welcome to the Ciena Fiscal Fourth Quarter and Year End 2022 Results. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Gregg Lampf: Thank you, Katherine. Good morning and welcome to Ciena’s 2022 fiscal fourth quarter and year end review. 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 well as certain highlighted items from the previous €“ from the quarter and the fiscal year. 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 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 will remind you that during this call we will be making certain forward-looking statements. Such statements, including our quarterly and annual guidance and long-term financial outlook, discussion of market opportunities and strategy and commentary about impacts of supply chain constraints on our business and results are based on current expectations, forecasts and assumptions regarding the company and its markets, which include certain 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-Q filing and in our upcoming 10-K filing. Our 10-K is required to be filed with the SEC by December 28 and we expect to file by that date. Ciena assumes no obligations 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&A as possible today. I will ask that you limit yourselves to one question and one follow-up. With that, I will turn the call over to Gary.

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Gary Smith: Thanks, Gregg and good morning everyone. Today, we reported strong fiscal fourth quarter results, including higher than expected revenue of $971 million and adjusted gross margin of 45.2%. This performance reflects the benefit of some favorable supply chain dynamics that occurred in the second half of the quarter, including that we received more integrated circuits than expected from certain suppliers and that we were also able to procure more parts in the open market than originally projected. These developments enabled us to ship more products to customers in the quarter, especially modems, which also had a positive impact on both revenue and margin. For the full fiscal year, we delivered revenue of $3.63 billion, essentially flat with fiscal 2021 due entirely to the challenging supply chain conditions that we encountered during the year.

Despite the difficult supply environment in fiscal €˜22, we saw robust demand from customers across our segments, regions and applications, as evidenced by annual order growth of 26% and a backlog of greater than $4 billion as we exited the year. Our results across FY €˜22, including the strong finish in Q4, demonstrate the continued volatility and unpredictable nature of the current supply dynamics. With respect to supply, overall, we are seeing ongoing signs of gradual improvement. The majority of our suppliers are delivering to their current committed lead times and volumes are slowly increasing. And we also expect continued improvements in these areas as we move through fiscal 2023. We are also starting to benefit from the various mitigation steps that we have taken over the last year or so.

As a reminder, these include product engineering redesigns and qualification of alternative components designed to minimize the impact of supply chain challenges on our customers. At the same time, the unpredictable performance of specific vendors for a relatively small number of components, even if they are low cost, low value, can negatively and disproportionately impact our revenue and significantly shift our product mix, which is what happened in Q3 of last year. Conversely, our Q4 results, particularly on revenue and margin, illustrate how these same supply dynamics can have an unexpected and disproportionate impact in a favorable direction. So to be clear, the volatility can obviously manifest as both headwinds and tailwinds, but generally, we believe them to be moving in the positive direction.

With respect to demand, we remain very positive that the fundamental drivers, including 5G, cloud and automation are durable over the long-term. Based on these drivers for network investment, we continue to see a strong demand environment in the coming quarters and the next several years. Importantly, we are confident that our leading technology as well as our strategy to expand our addressable market in key areas, are closely aligned with these drivers and the areas of investment for our customers. As we look to FY €˜23, specifically the combination of continued signs of gradual supply improvement and our significant backlog gives us confidence that we will deliver outsized year-on-year revenue growth and gain market share. Jim will expand upon this shortly with more specifics on our outlook and how we are thinking about our business over the longer term within these demand and supply conditions.

Before he does that, I want to share a few highlights from the fourth quarter and fiscal year. Of particular note is the growth in our routing and switching portfolio, for which quarterly revenue was up nearly 40% year-over-year in Q4 as we benefited from the addition of the Viada Solutions and organic portfolio enhancements. In fact, during Q4, we reached a milestone of more than 200 Adaptive IP customers, fueled by momentum in coherent routing, metro aggregation, PON and high-speed business services. And we continue to invest in our next-gen metro and edge strategy, particularly in our routing and switching portfolio. As you saw, we recently closed the acquisition of Benu Networks and announced that we are acquiring Tibit Communications, which we expect to close in Q1 €˜23.

These acquisitions will enable us to build upon our existing strategic investments in fiber broadband access and pursue a larger set of opportunities in this market segment. Specifically, the addition of advanced subscriber management and next-generation PON technologies will advance our ability to address fast-growing applications, including residential broadband, enterprise business services and fixed wireless access. This also represents a significant addressable market expansion for Ciena, something we have been talking to you about for some time within our routing and switching segment and is expected to be a considerable investment area for many customers. In optical, we added 15 new customers for WaveLogic 5e in Q4, bringing our total global customer count to more than 200 with more than 50,000 WaveLogic 5e modems shipped to-date.

In Blue Planet, we won several new logos during the year while expanding our presence at a number of Tier 1 service providers. Additionally, our strategic win at DISH has now gone live with both our inventory and our service order orchestration solutions. And our network transformation services grew 50% year-over-year. I think this really reflects the increased demand from customers to move from legacy to next-generation networks. And lastly, with respect to diversification, our non-telco revenue was approximately 40% for the year. And within that, 4 of our top 10 customers were major web-scalers. And like last year, we had more than $1 billion in orders from web-scale customers in FY €˜22, once again demonstrating continued strong demand from this key customer segment.

With that, I will now hand over to Jim to take us through the results in a little more detail and provide our outlook. Jim?

Jim Moylan: Thanks, Gary. Good morning, everyone. As Gary mentioned, we delivered a very strong Q4 performance. Revenue came in at $971 million, well above the midpoint of our guide. This revenue result speaks to the durability of demand and the clear need by our customers for more equipment faster. Importantly, it illustrates what can happen when we get more of the components that have been in the shorter supply and which have most severely gated our deliveries to customers. Additionally, it reflects some benefit of additional production capacity brought on with our investments, which helped us to deliver our largest shipments month in history in October. Q4 adjusted gross margin was strong at 45.2%, reflecting a favorable product mix as well as lower-than-expected incremental supply and logistics costs in the quarter.

Adjusted gross margin in the quarter benefited from the greater-than-expected supply of key components allowing us to deliver more modems. Clearly, availability of components and the performance of our vendors play a disproportionate role in our quarterly mix of deliveries. Q4 adjusted operating expense was as expected at $313 million. With respect to profitability measures, in Q4, we delivered adjusted operating margin of 13%, adjusted net income of $91 million and adjusted EPS of $0.61 per share. In addition, in Q4, our adjusted EBITDA was $154 million. Cash used in operations was $14 million. We continue to build inventory of certain components in Q4 while we wait for delivery of those components that are the most constrained. We also experienced a back-end loaded quarter, which caused accounts receivable to increase.

With respect to our performance for the full fiscal year, annual revenue was $3.63 billion. As Gary mentioned, we ended the year with $4.2 billion in backlog, slightly below where we ended in Q3, but still nearly double our backlog as we entered fiscal 2022. We have obviously seen periods of record order volumes and significant backlog growth in fiscal year €˜22. That said, as supply chain conditions gradually improved, we expect order growth relative to revenue and backlog to moderate over time even in a strong demand environment. Adjusted gross margin for the year was 43.6%, a good result and in line with expectations and adjusted OpEx for the year totaled $1.17 billion. Given our large order intake throughout the year, we paid higher sales commissions than we had planned.

However, with lower-than-expected revenue and operating income, we will pay a much lower corporate incentive bonus than originally planned. If normalized for these two items, adjusted OpEx would have been just over $1.2 billion, which was what we expected and guided for the year. Moving to profitability. Adjusted operating margin in fiscal year €˜22 was 11.2% and adjusted EPS was $1.90. Free cash flow for fiscal €˜22 was negative $259 million. This reflects the increase in inventory caused by lack of availability of a few key components. Finally, our balance sheet remains strong as we ended the year with approximately $1.2 billion in cash and investments. Just as a reminder, we also met our goal of repurchasing $500 million in shares in the year and plan to repurchase shares in fiscal €˜23 in the range of $250 million.

Turning to guidance. In the last few years, our revenue has been relatively flat as a result of the unique market conditions that stemmed from a global pandemic, which led to the supply chain crisis. Looking forward, we see signs of continued gradual supply improvement, which, when combined with our significant backlog, sets us up well for outsized growth in fiscal €˜23. Accordingly, we expect to grow our revenue in the year in the range of 16% to 18%. To be clear, this outlook includes key assumptions that are particularly important in a still uncertain environment. First, with respect to macroeconomic conditions and geopolitical dynamics, due to the size of our backlog, we believe our fiscal €˜23 outlook is somewhat less dependent on the macro environment than in a typical year.

That said, to be clear, our guide assumes that the global economy does not significantly worsen and more importantly that there are no material adverse effects on our business. Second, with respect to component availability and general supply conditions, as Gary mentioned, we continue to see and we expect volatility, but we have seen overall improvement. Our forecast assumes that supply chain dynamics do not worsen. With respect to gross margin for fiscal 2023, our outlook reflects the expectation that supply and logistics costs will ease somewhat, but will remain elevated. And that as supply improves we will take more revenue on the new wins we have secured over the last several years €“ 2 years. Accordingly, we believe that our gross margin for the full year 2023 will be in the range of 42% to 44%.

Our operating expense, intend to continue investing strategically on our business in order to expand our addressable market and to advance our position in key growth areas. Therefore, we expect adjusted operating expense to average $325 million per quarter in fiscal €˜23. I will point out that we are using an as adjusted tax rate of 22% in our fiscal €˜23 outlook. The 1.8% rate increase from last year’s 20.2% rate takes into consideration our best estimate of having increased taxable income and higher tax rate locations during the fiscal year. In the more immediate term for Q1 2023, we expect to deliver revenue in a range of $910 million to $990 million, adjusted gross margin in the low-40s range and adjusted operating expense between $320 million and $325 million.

Looking beyond next year, we remain confident in the positive secular demand drivers, including continued growth in bandwidth demand, which over a long period of time has been unaffected by macroeconomic conditions. We believe our customers will be compelled to prioritize network CapEx to address this demand over the coming quarters and years. And as we continue investing in our long-term strategy to expand our addressable market, we will be in a strong position to intersect those customer network investments. All of that, in combination with more normalized supply chain conditions, positions us well to deliver strong revenue growth over the next several years. More specifically, we expect the industry to grow in approximately the mid single-digits percentages during this time period and we intend you to gain footprint and take market share as we have over the last decade.

That said our revenue growth over the next 3 years will not be linear, particularly given our expectations for outsized revenue growth in fiscal €˜23 predominantly driven by improvement in supply. Our revenue growth expectations for fiscal €˜24 and fiscal €˜25 are based on an assumption of more normal business conditions, which are by definition more dependent upon the macro environment. Nevertheless, we are confident in continued strong demand dynamics and our leading market position. For that reason, we currently expect to deliver a 3-year annual revenue growth rate in the 10% to 12% range throughout fiscal 2025. That does take into account the 16% to 18% next year. Furthermore, we expect over the next several years that adjusted gross margin will improve to the mid-40s range and that we will increase profitability.

In closing, while €˜22 has been a challenging year for Ciena because of supply chain conditions, our market position has never been better and we expect that it will continue to improve. Demand for bandwidth is growing at rates of 30% plus. Demand for capacity from customers is sturdy and Ciena has the best technology and customer relationships in the industry. We believe that our supply chain will continue to improve as we move through €˜23, which will enable us to better service the strong demand from customers. And we believe that our financial results will reflect this. With that, Katherine, we will now take questions from the sell-side analysts.

Operator:

Gregg Lampf: We’re also aware of a technical issue with the Q&A line. We’re resending a link to the cell setters for you to be able to access that way.

Q&A Session

Operator: Our first question comes from Meta Marshall with Morgan Stanley. Your line is open.

Unidentified Analyst: Hi, this is on from Morgan Stanley. Congratulations on the results. And I guess just first question being, as you’ve seen supply chain loosen up a bit in the second half of the quarter, have you seen any changes to maybe customer conversations, maybe with conversations with customers that have moved to other vendors or maybe just generally at a high level, any incremental hesitation around macro and maybe any purchasing patterns?

Gary Smith: So why don’t I take the second part of that? The answer to your question is no, we haven’t. We continue to see, as we talked about in the earlier comments, very strong demand characteristics across the board, across geographies, across applications, across different customer segments. And that’s evidenced from a demand point of view in the outsized order that we €“ orders that we received in the year. When you think about it, we’ve got 26% order growth in the year. And that’s a very strong indicator around demand. And a lot of our customers still want the equipment faster than we can get it to them for all the secular demand dynamics that we’re aware of. So not seeing any change right now across the customer piece in terms of demand. Scott, do you want to comment on any of the supply chain stuff specifically?

Scott McFeely: In the supply chain stuff side, Gary mentioned it, we got more supply of components than we were expecting in the second half of the quarter. And that was across the board, but particularly important was those constrained components also we saw more supply. We also have more success in procuring those in the open broker market as well. And given the investments that we’ve talked about in the past around building up a bigger manufacturing capacity so we can turn those components into finished goods faster, that came into play significantly in our month of October. And I think Jim mentioned our biggest shipment month ever.

Unidentified Analyst: Got it. Okay. That’s very helpful. And then just a quick follow-up on maybe just quantifying or just any idea on how much of a benefit in the quarter the price increases was? And maybe how should we expect that to trend sequentially to Q1? Anything we should expect, an uptick sequentially? Or how we should think about that?

Jim Moylan: Still not seeing a ton of effect of that price increase in Q4. We did not see it. As we look into our backlog, it is there. It’s fully encompassed in our guide. And without giving a number, I’ll just say that it’s in the single-digit percentages ranges.

Unidentified Analyst: Okay. Thank you.

Gary Smith: Thank you.

Operator: Thank you. Our next question comes from Paul Silverstein with Cowen. Your line is open.

Paul Silverstein: Thanks. Gary, Jim, I did hear your responses to the previous question during the call, but I’m still going to ask you two related questions. One, one of your competitors have made comments about competitive gains. They clearly were referring to you, and I trust you listened to the Infinera call about competitive gains due to inability €“ your inability to deliver because of the supply constraints. The question obviously being to what extent that has been an issue. But from your comments, it doesn’t sound like it’s a big issue. The other related question, again, from your comments, it sounds like a non-issue, but given Corning, CommScope’s commentary, a lot of which seem to be specific to AT&T, but perhaps other Tier 1s as well, it doesn’t sound like you’re seeing weakness, but I want to ask you the question.