Ciena Corporation (NYSE:CIEN) Q4 2023 Earnings Call Transcript

Ciena Corporation (NYSE:CIEN) Q4 2023 Earnings Call Transcript December 7, 2023

Ciena Corporation beats earnings expectations. Reported EPS is $0.75, expectations were $0.69.

Operator: Good morning and welcome to Ciena’s Fiscal Fourth Quarter 2023 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Gregg Lampf: Thank you, Drew. Good morning and welcome to Ciena’s 2023 fiscal fourth quarter and year-end results conference call. On the call today is Gary Smith, President and CEO; and Jim Moylan, CFO. 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 and the 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 reconciliation of these non-GAAP measures to our GAAP results is included in today’s press release.

Before turning the call over to Gary, I’ll remind you that during this call will be making certain forward-looking statements. Such statements including our quarterly and annual guidance and our long-term financial outlook and discussion of market opportunities and strategy are based on current expectations, forecasts, and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. Assumptions relating to our outlook, whether mentioned on this call or included in the investor presentation that we’ll post shortly after are 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 which will be filed with the SEC by December 29th.

Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events, or otherwise. As always, we will allow for as much Q&A as possible today, though we’ll ask that you limit yourself to one question and one follow-up. With that, I’ll turn the call over to Gary.

Gary Smith: Thanks, Gregg, and good morning everyone. Today, we reported very strong fiscal fourth quarter results including revenue of $1.13 billion, and adjusted gross margin of 43.7%. Our team has been executing exceptionally well. And in Q4, we shipped more hardware across our portfolio than ever before. For the full fiscal year, we delivered revenue of $4.39 billion, a 21% increase over fiscal 2022, which as you can expect drove very strong market share gains. We also drove a 43% increase in adjusted annual EPS. Notably in FY’23 revenue for our routing and switching portfolio also increased 27% year-over-year. I think a strong demonstration of the momentum within this element of our expanded addressable market. Before I continue, I want to be absolutely clear that our Q4 performance, our commentary about market dynamics and the outlook we are providing today is very consistent with what we said last quarter and indeed as we moved through most of fiscal 2023.

There have been no major changes to industry dynamics, including that demands remains incredibly strong as evidenced by high levels of customer activity and engagement across all segments and regions. The single variable that remains uncertain today is the precise timing around the flow of new orders aligning with reduced lead times from our service provider customers, particularly those in North America. And as a reminder, supply chain constraints led to elongated lead times, which resulted in large advanced order volumes. In fiscal 2023, a faster than anticipated improvement in lead times is requiring some customers to digest the large amounts of equipment ordered in prior periods. I would also note that the cloud providers were really the first to experience this dynamic and are very clearly the first who have worked through it.

And in fact, orders from our cloud provider customers as well as our total orders were up once again in Q4. And we strongly believe that what we’re seeing with cloud providers is a leading indicator. And that service providers will similarly return to normal order patterns in the coming quarters. And that belief combined with strong fundamental demand, our leading innovation and customer relationships as well as our outsized backlog which we’re still carrying, we enter fiscal 2024 very confident in our ability to continue to grow faster than the market and to take share. So moving to some highlights across the portfolio. In Optical Networking, we continue to extend our leadership from both a market share and technology perspective. In fact, we increased our global market share in optical by more than five percentage points on a year-on-year basis, which in fact puts us in an even stronger position than our pre-pandemic market share.

Looking ahead, we will be first-to-market yet again with our next generation 1.6 terabit WaveLogic 6 in mid-2024. And we intend to press down on this technology advantage as competitors have launched only 1.2 terabit alternatives. In Q4 specifically for optical, it was a record quarter for both WaveLogic 5 Extreme and 6500 RLS driven by cloud provider network expansions. During the quarter, WaveLogic 5e surpassed 100,000 total modem shipped, making it the most widely deployed 800 gig solution in the market. And as WaveLogic 5 success continues, WaveLogic 6 is of course building momentum, including orders from a large subsea customer and a strategic win and adoption with a cloud provider in Q4. In routing and switching we continue to grow our share as a challenger in this market, ending the year with greater than $500 million in annual revenue.

We added 14 new routing and switching customers in Q4 alone, and now have more than 300 in total. During the quarter, we received initial orders for the WaveRouter, our industry-first converged metro platform, which became generally available in Q3. And as some of you may have seen we announced last week, we are partnering with Flex to add new US-based manufacturing capabilities for our unique NextGen pluggable optical line terminals OLTs, and our Optical Network Units ONUs as broadband access is a key part of our addressable market expansion strategy over time. We’re very excited to support the Department of Commerce’ broadband equity adoption and deployment the BEAD program, and to ensure our customers can meet the Build America, Buy America requirements of this program.

Also in Q4, Blue Planet had a good quarter with $20 million in revenue. And as some of you also may have seen we’ve just recently announced a new collaboration with BT Group, which is using Blue Planet solutions to automate the orchestration and delivery of network services. And lastly, our Global Services segment had a record quarter in Q4, with revenue of $150 million, an increase of 20%. And interestingly, obviously driven by installation and deployment services, which again is a positive leading indicator of service provider’s ability to consume product. Taking a perspective around customer segments, clearly we had a record quarter with cloud providers, as they continue to invest in data center interconnect for their traditional business and begin to provision their networks for AI-related traffic.

Indeed our WaveLogic leadership continues to be particularly highly valued by this critical customer segment. And as I mentioned, orders from cloud providers were up once again over the prior quarter. Significantly for the first time our two 10% customers in Q4 were both cloud customers. Also in the quarter, Direct Cloud Provider revenue accounted for 35% of total revenue, the highest percentage ever. And for the fiscal year, Direct Cloud Provider revenue grew 57% reaching $1.2 billion or 27% of total revenue. So importantly, as we reflect on all of this, the fundamental demand drivers for our business remain incredibly strong. Over the past 20 years, the 30% plus annual growth in bandwidth demand has been driven by many mega-trends, like the monetization of the internet, the move to the cloud, mobile, the digital transformation to name a few.

And we have been the leader in servicing that demand for bandwidth with our leading technology. It is becoming increasingly clear that over the next several years AI will be a catalyst for continued strong bandwidth growth. And we are incredibly well-positioned to address these opportunities across our portfolio and from our customer relationship perspective. We have industry-leading optical technology to high speed delivery at the edge to network automation. We will continue executing on our strategy to be the best-in-class innovator in optical bringing to market leading innovation like WaveLogic 6, while expanding our market opportunities in routing and switching. Specifically in that, we will continue investing in our portfolio to address higher growth areas in converged metro core, PON, and virtual routing, where we are already winning deals and taking market share.

So in summary, we delivered an outstanding year in fiscal 2023, gaining significant market share and further advancing our leadership position. Obviously, we are well-positioned to continue to grow faster than the market driven by our leading innovation, and the diversity and strength of our customer relationships. With that, I’ll turn it over to Jim who will provide more details on our results as well as our business outlook. Jim?

James Moylan: Thanks, Gary. Good morning, everyone. Ciena delivered very strong Q4 results. Revenue came in at $1.129 billion and adjusted gross margin was strong at 43.7%, reflecting a favorable product mix as well as improvements in component costs in the quarter. Q4 adjusted operating expense was $338 million. With respect to profitability measures, in Q4, we delivered adjusted operating margin of 13.8%, adjusted net income of $111 million and adjusted EPS of $0.75. In addition, in Q4 adjusted EBITDA was $179 million. Cash from operations was $196 million and free cash flow was $173 million, driven by $140 million reduction in inventory. We repurchased approximately 4.2 million shares for $189 million completing the $250 million repurchased targeted for the year.

With respect to performance for the full fiscal year, annual revenue was $4.39 billion. We drove adjusted gross margin of 43.5% for the year. And adjusted OpEx for fiscal year ’23 totaled $1.33 billion, precisely as we planned. Moving to profitability. Adjusted operating margin in fiscal 2023 was 13.1% and adjusted EPS was $2.72. Free cash flow for fiscal 2023 was $62 million. Strength of our balance sheet is a significant differentiator, particularly in this uncertain environment, and we ended the year with approximately $1.25 billion in cash and investments. Inventory ended at $1.05 billion, down roughly $140 million from Q3, but somewhat higher than we expected due to a shift in product mix delivered to customers. We expect inventory to come down by $250 million to $300 million by the end of the year.

Now turning to guidance. We will be giving new three-year revenue targets today. To start, however, I want to compare and contrast the targets we gave last year at this point in time to the new three-year targets for fiscal ’24 through fiscal ’26. You’ll recall that last year we provided a three-year revenue compound annual growth rate of 10% to 12% through fiscal year ’25. We made it clear then that 10% to 12% revenue growth is not our long-term sustainable rate of growth. However, we provided that target knowing that fiscal year ’23 would be a year of outsized growth and that we would return thereafter to our long-term trend of 6% to 8% annual growth. Fiscal year ’23 followed three years of low annual revenue growth due to the unprecedented set of dynamics that resulted from the global pandemic and the subsequent supply chain challenges.

Given that our revenue performance in fiscal year ’23 was outsized, as expected, and with confidence in our ability to continue leveraging our market and technology leadership going forward, we believe that we remain on track to be in that 10% to 12% revenue CAGR for the three years ending in fiscal year ’25. With that, as we look ahead, we believe it’s valuable to look at a period that excludes the outsized growth in fiscal year ’23 in order to provide a more accurate reflection of our anticipated average growth rate going forward. Accordingly, today we are providing a new set of long-term targets for the three year period encompassing fiscal years ’24, ’25, and ’26. We believe that we are well-positioned to deliver strong top-line growth and profitability for the long-term.

With that, we expect average annual revenue growth of approximately 6% to 8% for the next three years, which is consistent with the growth rates we have delivered over the long-term whether the past three, five, ten or even longer years. All of this reflects our confidence in the fundamental demand drivers for our business. We expect to leverage those opportunities by continuing to lead in optical, while expanding our addressable market in routing and switching. Additionally, with respect to operating margin, we continue to focus on driving leverage from our operating model. Accordingly, we are targeting to achieve adjusted operating margin of 15% to 17% for fiscal year ’26. As we think about fiscal year ’24 specifically, I want to reinforce a few points.

As Gary stated, the fundamental demand drivers for our industry, including the growth in bandwidth demand remained strong. As expected, we enter 2024 with $2.6 billion in backlog, which is still outsized both on a relative and an absolute basis over twice our historical levels in absolute dollars. And we have begun to see both increased spend and plans for a strong 2024 CapEx by our cloud provider customers. We believe that the recent increase in orders from cloud customers is a leading indicator that service providers’ order patterns will improve in the coming quarters. However, as Gary stated earlier, current service provider order flow is low, particularly in North America, as these customers continue to work through relatively high levels of inventory.

While we expect service provider order patterns to improve as we move through 2024, the timing and volume of that improvement remains uncertain. Taking these factors into consideration, we will guide to a slightly wider than typical range of revenue in fiscal year ’24. Accordingly, we expect our revenue growth in fiscal year ’24 to be in a range of 1% to 4%. Within this environment, optical industry growth estimates for 2024 are currently being updated by industry analysts. Based on what we’ve seen from those sources and our own assessment, we believe the prevailing expectation is for largely flat market revenue in 2024. Given our diversification, leading position and differentiation, we expect to take share and to grow revenue faster than the market.

With respect to gross margin for fiscal year ’24, we expect it to be in the mid 40% range with some variability by quarter, but generally reflecting the positive impacts of improving supply chain conditions. For operating expense in fiscal year ’24, we intend to continue investing strategically, both to advance our leadership position in our core markets and to expand our addressable market in key growth areas, including converged metro core and broadband access. Therefore, we expect adjusted operating expense to average $355 million per quarter in fiscal ’24. This number may vary by quarter, and we expect OpEx to start slightly lower and increase through the year. Finally, as we improve our net working capital by reducing inventory levels throughout the year, we expect to generate significant cash in fiscal ’24.

We believe that we will generate free cash flow of at least $400 million during the year. We also plan to repurchase another $250 million in Ciena shares under our $1 billion board approved plan. Finally, with respect to Q1’24, we expect to deliver revenue in a range of $980 million to $1.06 billion, adjusted gross margin in the mid-40s percentage range, and adjusted operating expense of approximately $350 million. In conclusion, our strong Q4 and fiscal year results underscore our industry leadership driven by our technology advancements across our portfolio and a diverse customer base. Looking ahead, we anticipate a return to normalized order patterns as we go through 2024, and foresee AI as a growing driver of bandwidth growth. And we are confident in our ability to seize market opportunities and to deliver profitable growth as we combine our leadership in optical with our continued investments to expand capabilities to address new markets in routing and switching.

With that, I’ll turn the call over to Q&A with questions from our analysts. Drew?

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Samik Chatterjee with JPMorgan. Please go ahead.

Samik Chatterjee: Hi. Thank you for taking my questions. I guess just given the information that you shared and particularly around the guidance. And thanks for all that color, a lot of details on the call today. When we think about the 1% to 4% growth rate that you’re guiding to for next year, how should I think about what you’re embedding in it? Clearly cloud, you have a lot more confidence in the growth, but when I think about the other verticals, telco, cable, can you just share your thoughts about particularly, if you’re assuming telco sort of is in decline in terms of revenue next year or any other — any color on the other customer verticals would be helpful. And I have a follow-up. Thank you.

Gary Smith: Yes, Samik, if I sort of answer by sort of, what we feel is going to be strong and we have visibility to good visibility, I think is cloud, submarine, India are three large elements that I would say we feel you know very positive about both in terms of what we’ve got as backlog and on pipeline and activity. I think, you know, service providers generally are beginning or working through their inventory, they’re all at various stages of progress to that. I think the uncertain one on precise timing is really the larger North American Tier 1 service providers. And again, you know we talk about them collectively, and they’re all at different stages with different progress around the absorption of all of this, some are actually in very good shape.

Our view on timing for you know the convert to a normal book-to-revenue and order flow, our assumption is that it would be in mid-year, which I think is consistent with what you’ve probably heard from a number of other different companies around the industry. You know there’s a lot of absorption they took in 2023, there is some clean-up there we think in the first part of ’24. But generally, if you look through that their underlying demand is strong, I mean capacity growth and traffic growth continues to be very robust in for the service providers. Certainly not an issue of budget frankly either, it’s really just some of these larger ones just absorbing and being able to get deployments of the stuff that we’ve shipped to them.

Samik Chatterjee: Okay. Got it. And if I from a follow-up, a bit more longer-term question, I mean, you issued the guide for 6% to 8%, which is really consistent with what you’ve done historically and what your guide has been, one of the key investor concerns I hear around that long-term growth trajectory is really the acceleration of the pluggables market or the impression there of that pluggables market is accelerating and Ciena doesn’t really replicate the share it has on systems when it comes to pluggables. When you think about sort of where share against have come from particularly as you highlighted robust share gains like how do you think about that 6% to 8% growth impact of pluggables there? And are there any sort of offsets there where your’re gaining more share than you have historically to provide offsets. Any color there. Thank you.

Gary Smith: Yeah, I mean, I would just comment on sort of pluggable piece, we’ve sort of, I guess been having this sort of conversation about over the last three or four years, it’s taken a lot longer for pluggables, you know, the 400 ZR and you’ve still got a lot of inventory of the stuff that’s already been shipped. So that’s really not impacting the market right now. If I think about, you know, when pluggables will happen, and I think we’re very well placed for that both with the customer relationships and with leading technology, so we see that more as a — as we’ve talked about as an opportunity than a threat. Even 400 ZR will obviously be in market with WaveLogic 6 variant onto the 800 ZR as well. So we will take more than our fair share of that market we believe.

You know, and I think about it in the context of this sort of 6% to 8%, Samik. I think we will continue overall to take market share in optical. I think there’s no question about that. But obviously, we’re getting to a point where we’ve got a large market share, and it’s a bit of the sort of lure of large numbers, you’re not going to take five percentage points each year. But we’re augmenting that growth with our TAM expansion in the key areas around routing and switching, which gives us even greater confidence and diversity about our ability to grow going forward.

Samik Chatterjee: Thank you. Thanks for taking my questions.

Gary Smith: Thanks, Samik.

James Moylan: Thanks, Samik.

Operator: The next question comes from Amit Daryanani with Evercore. Please go ahead.

Amit Daryanani: Good morning, everyone. Thanks for taking my question. I have one and a follow-up as well. So, I guess, first one I would love to understand on the cloud side up, you folks are talking about a fairly good bit of strength in the quarter, it was really strong and then expected to continue next year. Can you just talk about specifically based on the product portfolio set what is driving the strength in cloud? And if you actually see any signs of AI-centric infrastructure tailwinds benefiting your business already.

Gary Smith: We are seeing in the cloud players, growth around there, all dimensions of the business and we have quite a broad relationship with them. So we’re seeing it in sort of data center interconnect into the metro, into their long haul with things like Waveserver. We’re also seeing it in submarine where they’re investing significantly around the globe, and also in their country expansions, we’re working closely with them in a number of markets where they don’t necessarily take the fiber themselves, but they partner with the local carrier. We’re seeing a lot of those opportunities, and of course we’re incredibly well-placed to participate in that. I would single out places like India for that, where you know it’s the fastest growing internet market in the world and you’ve got the cloud providers all being very aggressive in investing in there.

So you think about it in overall terms for the year they’re up over 50% for us in revenue. We’re also seeing an improved order flow from them. And again, the point I would make is it’s across multifaceted applications and product applications with the cloud players.