Ciena Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Siena Fisco Q1 2021 Financial Results Conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to Mr. Greg Lamp.

Thank you, Sharon. Good morning and welcome to TNR's 2021 Fiscal First Board of Results conference call. On the call today is Gary Smith, President and CEO, and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, is also with us for Q&A. In addition to this call and the press release, we have posted to the investor 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 recent performance, our view on current market dynamics and drive of our business, as well as a discussion of our financial outlook. Today's discussion includes certain adjusted or non-GAAP measures as soon as results of operations. A detailed reconciliation of these non-gap measures to our gap results is included in today's press release. Before turning the call over to Gary, I'll remind you that during this call, we'll be making certain forward voting statements. Such statements, including our quarterly and annual guidance, discussion of market opportunities, and commentary about the impact of COVID-19 on our business and our end results, 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 too early from the statements discussed today. These statements should be viewed in the context of the risk factors detailed in our most recent 10-K filing and in our upcoming 10-Q filing, which is required to be filed at the SEC by March 11th. We expect to file by that date. CN 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, so ask that you limit yourselves 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 solid revenue and strong profitability for our fiscal first quarter, including adjusted operating margin of nearly 15%. This quarterly performance once again demonstrates the strength and durability of our business model, which enabled us to perform well in Q1 despite continued challenging conditions due to COVID-19. With these results, our fiscal 2021 is starting off essentially as we'd anticipated. including, as we indicated during our Q320 earnings call in September, that pandemic-related challenges would likely persist for a few quarters. Specifically, we see continued operational caution and business velocity challenges, and really affecting prioritization by our service provider customers of new architectures and deployments. And more generally, Tier 1 service providers, primarily in North America, remain financially cautious. However, we are seeing some early encouraging signs of improvement. In fact, orders in Q1 slightly exceeded revenue for the first time since the first half of 2020. These indications are providing us increased confidence in a strong second half performance this year. Achieving our annual revenue target requires that our performance in the second half of fiscal 2021 be stronger than our typical first half versus second half growth. Obviously, the precise trajectory of this second half improvement is dependent upon the ongoing recovery in industry and economic conditions, specifically enabling continued growing order flow and building backlog as we move through the year. We remain very confident in our competitive position, and we continue to take share, winning more than our fair share of new business around the world. Turning now to highlights from the first quarter, our WaveLogic technology continues to lead the market, with the only generally available 800-gig capable platform in the market. We secured 14 new customers in Q1, bringing our total WaveLogic 5 Extreme customer count to 79. In just over nine months of commercial availability, we've shipped WaveLogic 5e coherent modems to more than 75 customers around the globe, all of whom are actively deploying the technology in their networks. In fact, the adoption rate of WaveLogic 5 Extreme is impressive. Based on available data, it has been faster than the combined ramp of all competitive 600G solutions that are in the market today. Moving to packet networking, we've recently renamed this portfolio Routing and Switching. This change we think better aligns to the language used in the industry and by our customers, and also reflects an increased strategic focus on IP technologies in our portfolio. We continue to grow our customer engagements in this area, particularly given the unique advantages we bring with our adaptive IP solution and ability to address key use cases in areas like 5G, the Internet of Things, and Edge Cloud. In fact, in Q1, we secured our first private 5G network win using our 5164 router for in-building XOR aggregation. Revenue for our Blue Planet automation software and services portfolio increased 10% year-over-year in Q1, and we now count more than 200 customers worldwide. With customer engagements continuing to expand, it is very clear that Blue Planet can disrupt the status quo and deliver a software-driven approach to digital transformation and service management and delivery. Our fiscal first quarter was also strong with respect to diversification across customer segments and geographies. Of particular note is the strength of our non-Telco business, which comprised nearly 40% of revenues in Q1. This was led by our continued market leadership in web scale. And in fact, direct web scale revenue increased 25% year over year and represented more than 20% of total revenue in Q1. And at this point, most of our large web scale customers are now deploying WaveLogic 5 Extreme in addition to prior generations of WaveLogic. Geographically, EMEA performed well in Q1, increasing 20% year-over-year, and we continued to see encouraging signs of recovery from India. Finally, our subsea business was also strong in the quarter at 9% of revenue and five new wins in the quarter, including the Southern Cross Next cable, as well as upgrades on two large international cable systems. Turning to the broader environment, Our fundamental drivers remain strong as demand for connectivity continues and the move towards cloud architectures has in fact accelerated. Our strategy is well aligned to these market dynamics and we continue to invest in our portfolio to address these key opportunities. The specific dynamics related to COVID-19 have accelerated bandwidth consumption in core networks. And while many customers are running these networks hotter right now, they ultimately will need to be augmented with additional capacity to maintain performance. And we are extremely well positioned to meet this demand, given our market leadership in high-performance optical platforms and systems, including pluggables that support the connection of content to content and users to content, particularly in DCI, submarine, and long-haul and regional networks. COVID-19 dynamics have also driven a focus on network operator investments in next-generation metro edge and access networks, due to the distributed nature of how connectivity is now being consumed. As this presents an opportunity for addressable market expansion, we are making investments to expand our IP and automation capabilities as well as our talent area for this particular opportunity. Digital transformation has also grown in importance for our largest customers. From 5G to content delivery to cloud applications, customers are directing CapEx towards automating and streamlining how they deliver new services to reduce operational inefficiency in their back office operations. Accordingly, we continue to invest in our Blue Planet business to build a market leadership position and deliver a software-driven approach to digital transformation. With these investments in focus, we believe we are well positioned to take advantage of the current market opportunities and intersect longer-term trends and transitions. In doing that, we believe that we will continue to drive strong financial performance over the long term. With that, I'll turn it over to Jim.

Thanks, Gary. Good morning, everyone. We performed as expected in Q1, marking a good start to fiscal 2021. Total Q1 revenue was $757 million. Adjusted gross margin in the quarter was again strong at 48%. Adjusted operating expense in the quarter was $253 million, lower than expected, as certain projects and spend shifted out into future quarters. With respect to profitability measures, in Q1, we delivered adjusted operating margin of 14.6%, adjusted net income of $81.3 million, and adjusted EPS of 52 cents. In addition, in Q1, cash used in operations was $7 million, consistent with our first fiscal quarter typically being a seasonally soft quarter for cash. Adjusted EBITDA in Q1 was $134 million. We ended the quarter with approximately $1.3 billion in cash and investments. Our balance sheet continues to be a differentiator. that speaks to our long-term strength and viability, particularly in the current environment. It also offers us the flexibility to continue investing in our business for the long term, as Gary described, while returning capital to stockholders. To that point, as we reinstituted our share buyback plans during the quarter, we repurchased approximately 250,000 shares for $13 million in Q1. And since the program began, we have repurchased 6.1 million shares for a total of $242 million. Turning now to our guidance. As Gary mentioned, our business has performed largely as we expected within the current market conditions. and we are seeing the initial encouraging signs we were anticipating by this time. We are benefiting from the unique advantages of our deliberate strategy to drive innovation, diversification, and global scale across our business. From our 800-gig leadership to our growing software business to the agility of our supply chain, we are well positioned to continue successfully navigating challenging times. Therefore, we continue to expect to grow our annual revenue in fiscal year 21 in a range of 0 to 3%. This level of growth is predicated upon the same variables that we talked about last quarter, including continued improvement in economic conditions, as well as spend by service providers returning to more typical levels. Achieving our annual revenue target also requires that our performance in the second half of fiscal 2021 be stronger than our typical first half versus second half growth. As Gary touched on earlier, that is dependent upon a continued improvement in order flow, our ability to build backlog through the year, as well as successful supply chain execution against the orders necessary to achieve our second half plan. With respect to OPEX, as I said earlier, our Q1 OPEX came in much lighter than expected. Certain IT infrastructure and R&D projects we expected in Q1 shifted into future quarters of the fiscal year. While we have not changed our OpEx plan for the year, we are also seeing some pressure on OpEx from the weaker U.S. dollar. As a result of these two factors, we expect our OpEx for the remaining three quarters of the year to average between $280 and $285 million. With respect to adjusted operating margin for the fiscal year, we continue to expect it to be in a range of 15% to 16%. Turning to our second quarter 2021 performance, we expect to deliver revenue in a range of 810 to 840 million dollars adjusted gross margin in the 45 to 47 percent range and adjusted operating expense of approximately 280 to 285 million dollars before we close out our prepared remarks i want to take a moment to again thank the entire sienna team for their continued passion and commitment during a challenging period. It is because of our people and their resilience that we continue to perform well and to meet our customers' needs. I also want to highlight progress on our digital inclusion commitment, which promotes digital inclusion through greater connectivity, access to technology, and digital skilling. with the goal of expanding opportunities for 100,000 underserved students in our global communities. We've recently launched a number of innovative new programs with customers, including Verizon, Spark New Zealand, and Bar-T, and we're excited about other digital inclusion initiatives on the horizon. In closing, The fundamental demand drivers of our business are strong. We are very confident in our competitive position, and we continue to perform well, delivering strong profitability and returning capital to shareholders. We are encouraged by the initial signs of improvement in market conditions and are increasingly confident in our ability to deliver a strong second-half performance this year. With that, Sharon, we'll now take questions from the sell-side analysts.

If you would like to ask a question at this time, please press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. First question comes from Rod Hall with Goldman Sachs.

Yeah, hi. Thanks for the question. I wanted to start off with a question on the guidance. Just the fact that the margin guide is down a little bit, maybe you guys could dig into that, help us understand, you know, why that's happening, and then I've got a follow-up.

Yes, Rod, we think that this is sort of good news because we are starting to see the rollout of some of the deals that we want. So it's really a little faster on some of the deals that we've had in the hopper for a while that have not been able to roll out for various reasons.

Is that any regional color you could give on that, Jim? Is it India or, you know, what types of projects are you seeing roll out now?

It's really generally. I mean, it's Europe, it's India, it's U.S. It's around the world.

Okay. Thanks for that. And then on my follow-up, I wanted to just ask competitively, I know that Infonera has talked about a couple of 800-gig wins. You guys obviously have a whole lot more. I wonder, are you seeing them in the market with 800-gig? Can you just talk a little bit about the 800-gig gap? competitive environment as it stands right now.

Yeah, Rod, good morning. As we said in the press release, we're up to, I think it was at the end of the quarter, 78, 79 customer wins. Since the end of the quarter, that's actually increased. By the way, 18, I think, of those 79 were brand-new logos to Sienna, so a lot of momentum there. Last I checked a few weeks ago, that equated to something like 7,500 units shipped to customers. So as far as I know, we are the only commercially available 800-gig solution in the marketplace, and you can see it in those statistics.

Do you guys think that these are just lab deployments then that these guys are talking about?

75 million units, a lot of labs. Oh, the other competitors? I don't know. You'd have to ask them. I'm probably not the right one to comment on that.

Okay. All right. Great. Thank you.

Next question comes from George Notter. Please go ahead.

Hi, guys. Thanks very much. I guess I wanted to ask about the supply chain dynamics. Obviously, it's been – you know, uh, more of an issue for many companies, I think, uh, over the last few quarters, are you guys having issues with supply chain? And, uh, you know, is that factored into your guidance for Q2 or the full year, you know, any kind of color you could give us would be great. Thanks.

Yeah. I'm wearing George, um, So, first of all, you know, as I think everybody probably knows, George is referring to specifically the subset of the supply chain that is related to the semiconductor supply chain and ecosystem. And, you know, the dynamics that we're seeing in there is very similar to, you know, the dynamics we would have seen in other challenges and not too distant past on the supply chain. And whether you look at components that had high concentration in areas that were hit hard by the early days of COVID or not too far before that, capacitors and resistors and pumps and power supplies, et cetera. And for somebody that sits in the sort of system vendor part of the ecosystem like us, what's really important to be able to navigate those challenges as they come up is the design of the supply chain uh and the dimensions of that but also uh the willingness and ability to invest in it and you know from from our perspective and we were very deliberate in terms of investing in resiliency on a bunch of different dimensions geographical multi-component supply strategies inventory strategies throughout the supply chain including component levels and distribution partner networks and the confidence in our business and the scale and financial strength to invest in that ecosystem and network. And that served us incredibly well in the past challenges, particularly recently through the COVID challenges. And you didn't see us uh back off from our service level agreements to our customers or have to talk about it being you know a significant headwind to us delivering to our financial plans so your to your specific question with that context we had no impact in our queue on results to supply chain execution and we expect no to little impact in the immediate quarters in the future um if you know that situation persists for a long period of time obviously we're not immune to it uh it's a multi-industry challenge. But given the design, given our continued investment in it, and given how it's served us in the past, I'm extremely confident that in our segment, we'll be best of class in terms of our ability to continue to serve our customers. Great.

Thanks a lot, guys.

Thank you.

Next question comes from Simon Leopold with Raymond James.

Thank you very much. Two things. First one is I just wanted to see if you could help us understand what you're assuming in your outlook as it regards to the Tier 1 international carriers, particularly those in Japan, India, and Germany. And then I've got a follow-up.

Yeah, and I think it does differ between those. In Japan, the working assumption that, you know, from a Siena point of view, is that continues to be sluggish from our perspective. I think, you know, for the remainder of the year, that's our working assumption. In India, we are seeing increased activity, you know, both in terms of, you know, beginning deployments that were held up because of COVID. That's beginning. And also the award of new business there, you know, primarily, I would say, driven by the desire to replace Huawei. We are seeing that being expedited in India. And we've won a number of those awards, so we're seeing good activity in India. We're also seeing strength in EMEA service providers. And to some extent, in North America, what we're seeing is a bit of an amelioration of the caution around operational deployments, as Jim noted. you know, it's a little perverse statistic, but we expect our gross margins to go down slightly because they're beginning to deploy the things that we've won, you know, in the last 18 months. So, you know, those are all actually, you know, encouraging signs. And then in Germany, and particularly, you know, in Europe, we've had a number of wins that we are beginning to deploy. Again, as I said, that's both with Tier 1, you know, mainly with Tier 1 service providers But also in Europe, there's a dynamic around a lot of the wholesale players providing capacity for the web scale folks as well, including Germany.

Appreciate that. And then just as a follow-up, you did reference North America. I'm assuming you did not have 10% customers in the quarter, but that you expect some improvement in your April quarter from your historic top customers. And maybe the reason for the caution is Is it at all related to spectrum auctions and what they're paying, or are there other issues at play here? Thank you.

You know, the honest answer is it's difficult to truly discern, Simon, but I think it's a combination of those things. You know, the amount of capital required to that, just the general caution of the COVID environment financially and operationally. But we are seeing a little thawing out of that. There are some signs to that. Now, that needs to continue for us to achieve our plan in the second half. But, you know, we are expecting a much better second half. And part of that is, you know, Tier 1 service providers in North America, you know, beginning to deploy some of their plans, frankly. I'd express it like that. Another way of saying this is, you know, generally across our business, we expect Q1 to be the low point for the year, obviously.

Thank you. And I would also add that it would not be surprising if we ended up the year with, you know, one or possibly 10% customers, because we do expect to come back in big tier one service providers.

Thank you. Thanks, Tom.

Next question comes from Mayta Marshall with Morgan Stanley.

Great. Thanks. I just wanted to spend a second on the hyperscale customers. You know, given that you're at early days of those deployments, You know, is there any better visibility just because, you know, they're just trying to get their hands on kind of new generation of product? And then just maybe second question, you noted the private LTE product. Are you partnering with anybody on those deployments? Thanks.

Yeah, just on the web scale generally, obviously we've got, you know, number one market share. We've got a massive installed base with the web scale players and all of the four major players are now customers. I think, as we said at the end of last year, you know, the fourth one we've now secured. So we've got, you know, the large market share there. You can see the strength of Q1. It was 20% directly of our business and a considerable amount indirectly through other carriers around the world. They're all now deploying WaveLogic 5 Extreme in addition to the prior generations of WaveLogic. And we think we're extremely well positioned to grow with that market. Tough for us to really increase market share there, given the size of our share. But we're very confident of growing with that market, which we think will be in the mid-single digits in 2021, I think. There was some challenges, I think, certainly last year and bleeding into this year in terms of their ability to deploy data centers and build around the world. They're very focused, I think, on ramping that up as best they can. And so we do expect to see some growth this year with the web scale folks.

Scott, do you want to? Yeah, just maybe add a color in that one. When we talk about the web scale customers and the big ones and all of them, I think, and we're certainly in multiple applications. So I think of submarine core networks, their metro deployments, and even managed services to them through the service providers. So to Gary's point, they are deploying multiple generations of technology as they may turn on new generations in one of those applications or a couple to get started. So that's why you see us with a large installed base and multiple generations of technology in there. To your question on the X-Hall win in that particular one, that was an open X-Hall, so that was a direct sale by us to the customer. There was obviously some work on integration and interoperability, but that was a direct sale by us.

Great, thanks.

Thank you.

Next question comes from Paul Silverstein with Cohen. Thanks.

Guys, the streets have been worrying about the impact of plugables, ZR and ZR Plus, for a while. Any insight you can share on your thoughts, more specifically on what you're seeing? Obviously, that's been pushed back somewhat, but it's coming. And, Jim, what are you seeing in terms of the pricing environment? It sort of arises that Nokia, I would think, would moderate and Huawei is obviously in desperate shape. Are you seeing any improvement in pricing?

Good morning, Paul. Let me try the pluggables XR question first. So what we said last time was we expect to see some potential early deployments of that application and that technology later in 2021, which was quite a push later in time from when people probably would have perceived it was going to be 12 months or so ago. Our perspective hasn't changed on that. So I think potentially some early get started deployments, but really material deployments starting in 2021. For our play in there, we're basing our product offer off of our WaveLogic 5 nanotechnology. And again, no change from what we said last time there. We expect to have generally available product in the first half at 21, and the program is executing well on that path. I'll ask maybe to pass it to Jim on the pricing environment.

Hey, Scott. Paul, we're not really seeing any appreciable change in the pricing environment as of yet. Now, we've seen announcements by Nokia that they're they're changing their segments. They're going to look at the profitability of each of their segments. And we think that's a positive sign, but it's really too early for that to be, you know, sort of in the market yet. No real change.

Hey, Scott, with respect to your comments, putting aside timelines, in terms of magnitude of the impact, magnitude of prospective threat, Again, any insight you can share on what you're hearing from customers, both web scale and traditional communication service providers,

The short answer is no. A little bit of colour on it. If I look at the ZR application in particular as it applies to potential DCI metro and campus, we have said in the past that in the fullness of time that might be a total market opportunity of $500 million on an annual basis. Our perspective on that hasn't changed. By the way, you articulated it as a threat. I think it's also an opportunity because there are some non-coherent technologies that serve that market today. So that moving into coherent is an opportunity for those that lead in coherent. And I would say the same thing on the server provider side as an opportunity on the access side, not necessarily ZR, but other pluggable technologies becoming coherent is an opportunity.

For sure. Thank you.

Thanks, Paul.

Next question comes from John Marchetti with Siebel.

Thanks very much. Gary, I was just wondering, with the renaming of the packet networking business and seeing some of the focus now on the edge of the network, just, you know, with some of the investments you're talking about making there, can you talk about, particularly in Europe, where that's been a focus, what you're seeing, you know, as you're looking through the rest of this year and maybe a little further out, and if you feel like you need some significant, you know, additional efforts there in that portfolio and maybe even, you know, the possibility of some M&A focus there?

Let me try and then Gary can add some color. So first of all, what we believe is the winning hand in that part of the network is a combination of what we've called adaptive IP, sort of a next generation. I think of it as a thin IP not necessarily burdened by the applications or protocols of the router that was built for the internet 15 plus years ago, combined with the convergence of best-in-class optics, an intelligent photonic layer, and the software automation tools that go along with that convergence in order to be able to operationalize that in the network. We think that is the architecture of the future, and it's a long game. And we've been investing on that for a period of time now, and you're starting to see the products come to fruition from those investments, both in our routing and switching portfolio, but also in our software assets, Blue Planet, yes, but also in our domain controllers, MCP.

So, John, just to reemphasize that, this is not sort of, obviously, as Scott said, sort of an epiphany to us. I think, you know, we've been talking around this kind of convergence, you know, actually probably for decades in the industry. You know, I really do think that opportunity is presenting itself as the metro edge particularly evolves. And we've been investing heavily in I think basically we've doubled the amount of technical talent that we've had on this area, you know, in the last couple of years and also, you know, invested heavily on the go-to-market side. We think we're very well placed. We have an architecture that we think delivers a much more simplified and operationally better economic solution. We think it's very compelling. We think we have all the elements to that to be successful. Obviously wouldn't, you know, wouldn't rule out additional scale and technology in that space, you know, of course. But, you know, right now we think we have a, you know, a good path with the architecture and the investments that we've made.

Thanks very much.

Next question comes from Taliani with Bank of America.

Hi, guys. I have two questions. First one probably I'm going to ask you for the next 25 years is if you can give us an update on Huawei share replacement, share gain. And the second one, both of you cautioned us enough about second half guidance that I want to ask about the specifics of your guidance, meaning what are the projects with what type of customers maybe not customer names but types of customers and types of projects that need to materialize in order for you to hit your second half guidance what is assumed um categorically what is assumed in the guidance okay let me let me take the first part of that and then i'll hand off to to jim so the the question that you're going to ask me for the next 25 years um

Same kind of answer, I think. I think I'd describe, you know, the major opportunity with Huawei is really in Europe. And that's, you know, again, you know, to your point about 25 years, it's probably not that long. But, you know, we're in the infrastructure business. This takes time, both time for decisions, time to operationalize, you know, and to get all the back office done. And that, you know, is a multi-year program. You know, whilst this has had a lot of focus, you know, for all the reasons that we know in the last sort of 18 months to two years, we saw signs of this before basically just – and I would describe it more around reducing dependency. Such a large market share in Europe in all facets of infrastructure. And I think the carriers began to realize that, frankly, you know, about three years ago. When you look at some of the wins we've had, you know, with Deutsche Telekom, with Vodafone, etc., you know, those wins, I think, were centered a long time ago in this dynamic. I expect that to continue. I would also comment with this on the EMEA side. Whilst we've seen that, and that opportunity, you know, is very much a, you know, a tailwind for us, I think their priority right now is on the RAND side, because I think that's the one that's got the, you know, the particular geopolitical focus. But, you know, and that's why I think this will be a multi-year element, and we are winning more than our fair share of that. I would, as I mentioned sort of earlier... India, I think, is moving faster in all dimensions of that change-out, I think, because of the relationships between the two countries. And we are seeing that being expedited and beginning to be awarded and, you know, will begin to roll out. And that reflects... To your second point, Carl, some of the assumptions around our second half uptick, basically I think we're very confident that the second half is going to be a significant uptick to the first half. There are certain assumptions to meet our target, you know, that have obviously got to continue, and one is, you know, India continues to recover, and I think we're pretty confident around that. Second element overall, I would say, is that the Tier 1 service providers, most notably in North America... begin to deploy some of their plans that they've cautiously not deployed. And we are beginning to see that. So I would say, you know, combination of service provider tier ones in North America, Europe continues as it is, and that we see this uptick in India. Web scale, I think they've got pretty good visibility to that. I think they're going to have a good year. You heard my comments around mid-single-digit growth in web scale, and we will grow at least with the market there. Jim, any other comments on the specifics?

Yes. when the first thing i'd say is that we've now gone through one quarter of the year and things are developing as we expected we feel very confident about the second half of the year but what we didn't want to impart to anybody is that uh every all of the spending is at the levels that they need to be at in order to get to our numbers for the year that was that was why we repeated the variables that we put out at the beginning of the year and it's still the case With respect to how we get to those, we do a lot of forecasting, and it's all bottoms up from our sales force. And so that set of numbers we're talking to comes from sales force indications of what customers are saying they're going to spend for the rest of the year. As Gary said, it's tier one service providers around the world. But I'd also say this, as I said before, our backlog is still not where it needs to be to get to those numbers. It will be, we think, as our orders start coming in at stronger rates. But we just wanted everyone to know that things have to continue as they have started to begin.

So, Jim, I have just a follow-up. If the carriers get frequencies in December, that's 100 gig in December, and they deploy radios, assuming they're going to deploy the equipment, that's what Erickson is saying, they're going to start before the time, not after they're getting the frequencies. Where is your portion of the network in terms of timing, meaning Is it before you put radios or is it after you put radios? Do you prepare the backbone optical before or after and all your routers portfolios? So can you just give us kind of the understanding of a typical deployment where you are timing-wise, where you are in the process?

Tell them the answer to your question is yes to all of the above. You know, and I'm not being cute there. I mean, you know, and I think about it in some of the real world examples we've had of that. We've had carriers that build out in advance of that spectrum. Because they're building out converged metro particularly, they're very mindful around putting capacity and the ability to go support that when they put it out there. We've got others. that are very hand-to-mouth with their perspectives around getting capacity into that spectrum as they deploy. And so you've got all shades around that. Obviously, there's a correlation, and it's good news for us, basically. The more they deploy out there, the faster they're going to require fiber-fed capabilities. So generally, it's a big positive. But we are seeing signs... I would say it's not particularly, from our perspective, spectrum-led at this stage. They had a number of plans to build out that got slowed down, but we're now seeing them, and these are wins that we've had, design wins that we've had, that they're now beginning to deploy. Now, you know, there's some correlation to Spectrum coming on and, you know, them leveraging that investment, but it's not, you know, it's not as simple as a direct line into all of that. Got it. Thank you. Thanks, Tom.

Next question comes from Alex Henderson with Needham.

Thank you very much. I was hoping you could talk a little bit about an issue around – the timing and the cadence of inventory purchases. Obviously, there's some constraints around some supplies, but on the other side of the coin, your inventory increased sequentially quite a bit, and I was wondering if you're planning on bringing the inventory down or whether you see the constraints that you're struggling with persisting and therefore anticipating continuing to build inventory. Can you just talk about the direction of that?

Good morning, Alex. So really primarily two things driving the inventory dynamics that you pointed out. One is it goes back to the second half of the year ramp that we talked about. We have... significant bigger second half than first half, and we are working for success and sort of priming the pump if you'd like to be able to deliver to the customers on that ramp. So that's number one, and that is by far the bigger of the two dynamics. The second one is, I'll just say, our own security of supply. So I talked about having the confidence in our business and having the ability to invest in that supply chain. that's what you're seeing happen there in terms of the security of supply. And it's not just the most recent semiconductor piece, but it's also, you know, the activities that we've done to protect ourselves from the COVID dynamics that we've talked about in the past.

We do expect that our turns will improve as we move through the year.

Yeah. Is it a function of, you know, more chassis and less line card, and therefore, you know, because of the footprint build? And then the second question I wanted to ask really was around the mix on the revenue guide sequentially. It looks to me like you probably would have a recovery in service sequentially, and therefore the majority of the pressure on the quarter is really on the product side. Can you talk a little bit about the cadence between those two as we go into the April quarter? Thanks.

On the first question, the mixed dynamic isn't really what's driving it at all. It's more just prepping the pump for a big uptick in the second half and the security supply dynamics that we talked about. On the second one, Gary.

Yeah, Alex, you know, I think about, you know, the rest of the year. I'd make my commentary around the rest of the year. And I think the overall trend that we're seeing is, you know, the deployment essentially starting of the winds that we've had over the last year or even 18 months. And as Jim said, you know, that will, you know, weigh on our gross margins, which is kind of a good news thing perversely in that, you know, that will get deployed and will. Our gross margins have improved overall, you know, in our baseline, as we've said, but this fluctuation has really been about, you know, not deploying the new business, which we're now seeing. In terms of the mix between services and product, You know, generally speaking, you know, the services for installation are lower margin, which go with the investment in the product side. Early days, you could express it to chassis and cards, but, you know, it's getting a little fuzzier than that, but lower margin at the start of it. And some of that is increased installation services as well. which we expect to see through the year. But that's all, you know, contained within our guidance on the gross margins.

Only other thing I'd say, Alex, is when you look at our services revenue, a very big chunk, over 50% is maintenance. And so the deployment is not a big number for many of our customers. We don't do deployment. It's the submarine customers. It's many of our non-U.S. customers. and including in Europe. So it's, you know, the sequence is not terribly telling, except deployment is going to come in at lower gross margins than maintenance or most of our products as well.

Thank you. Thanks, Alex.

Thanks, Alex.

Next question comes from Emmet Darienani with Evercore.

Thank you for taking my question. As you said, questions really are on the web-scale business, which did really well this quarter. I think it was up 20%. I'd love to understand, you know, how do you feel the web-scale business today for fiscal 21 in the context of the aggregate growth being 0 to 3%? And then secondly, you know, what do you mean for the competitive environment here today, especially with Cisco, a case that you've formally done? How does it alter the environment with CNF?

Hi, Amit. In terms of web scale, yeah, we had a very, very good quarter. And we expect to have a good year overall on web scale. You know, I think they've had some challenges deploying and standing up data centers around the world and the velocity that they generally would have liked, you know, during the last 12 or 18 months. So, you know, based on the plans that we're seeing right now, we would expect, you know, growth in the mid single digits in that space for the for the year we've got a very high market share there probably not going to grow that share but we're certainly going to maintain it you know we've got all of them now taking wave logic 5 extreme in addition to their prior generations and we're engaged in a lot of the planning around the expansions you know both in all of their applications in terms of submarine dci connectivity and in their metros as well so Very, very strong engagement on the web scale, and we think they're going to have a good year. I think there's even the potential for some of them to be a top 10 customer during the year. That's a possibility of one or two of them. We'll see how that goes. But I think generally we expect a good year in web scale.

And then with respect to the second question about Cisco and Acacia, I'd remind everybody that we've been competing against Cisco in various parts of the network really for a long, long time, and they have been using Acacia technology for a while. So this is not a change in and of itself. I would say that the excitement in our space is the fact that all of the architectural turmoil that's going on in the metro and in the edge and all of those things are opportunities for us. And we think that, as Scott said earlier, and I'm sure he'll want to add something to this, we think that we have a winning hand in there with the best optics in the business and increasing IP capabilities.

The other thing I would add, Jim, is these architectures play out in our customers' network. Another important dimension is actually going to be the software capabilities to operationalize this, and we think we've been investing for a while, both organically and inorganically, on that path, and that's going to be a really important part of the winning hand, as you said.

Thank you very much for all the clarity. Thanks a bit.

Next question comes from Sameek Chatterjee with JPMorgan. Sameek, your line is open. Next question comes from Jim Souza with Citi Research.

Thank you very much, Gary and Jim, and I'll ask both my questions at the same time. The first question is, when you alluded to or specifically called out the OpEx, kind of some push-out. You know, sometimes that happens because R&D for some of your key customers, they've asked you to change some of the specs on it, or sometimes it's just internally at the company. Like, Sienna, maybe you're deploying an ERP upgrade or system upgrade, and you just decided to do it later, or with COVID. Can you help us understand about why the OpEx got pushed out? Was it customer-driven? or was it more Sienna-driven? And then my second question is, you definitely laid out the risks of the second half ramp. When you look at the orders, bookings, and discussions with customers, you know, is it aligning to that ramp looking, you know, pretty probable, or is it aligning to that ramp having incremental risks that you kind of identified today? Thank you.

Hey, Jim, I'll deal with the OPEX question, and then Gary, I think, will deal with the second half. With respect to our OPEX, there were no customer push-outs or really any intentional push-out by us. Our OPEX does have projects in it, and the timing of those projects and the timing at which we can complete them and record them just moves around a little bit. And so I don't think you should read anything into that shift out, except that it is shifted out, and we are going to spend that money. As I said, we haven't changed our OPEX plan for the year. We will spend the exact amount of time and hours and money, except that, I'm sorry, for the full year, except that we will be a little higher because of the weakness of the U.S. dollar.

Gary? Yeah, on the forecast for the second half, I'd say sort of contextually this. You know, we've been running our business for the last few years, you know, going into each quarter with quite a large backlog, quite a large relative backlog each quarter. And so, you know, our ability to forecast, you know, over the last few years has been, you know, has been pretty accurate, you know, and a large part of that is you've got the backlog and you've got the pretty accurate forecast of when things are going to happen. I think with COVID, that has been disrupted for the reasons that we've talked about. And I think we're in the process, we think of building that back up again. And so it is a little more challenging for us, which we've expressed last year and as we came into this year. But as Jim also said, things are beginning to roll out as we'd anticipated. When you think about it at a high level, there's more capacity demands going into these networks. They're running the networks hotter. We've had a period of time where there's been a general caution around not wanting to operationalize any additional capacity or changes to architecture. and also some caution around, you know, financial spend. No one's taken their budgets down. No one's, you know, stopped projects, but they're not spending at the velocity that they'd kind of planned. And that's the period that I think we're beginning to come out of. But, you know, that adds to the uncertainty. But so far, so good, you know, in terms of what we're seeing for the year. I think we're very confident about predicting a substantial uptick in the second half of the year. Our ability to be completely precise about that is really dependent on, you know, that momentum continuing and us building up our orders and backlog. We have a very sophisticated system. forecast process that's well tested. And it combines, as you'd imagine, you know, backlog, detailed order forecasting by customers, many of which are long-term partners of ours, and we have very good visibility into, you know, and the project plans of things like submarine and some of these new metro architecture. So that all gets taken into account to it. But I think, you know, while we're sort of focusing this is really because we're not operating with a large amount of backlog that we're normally used to. But we're seeing the activity pick up, and we've been very explicit, I think, around the assumptions that we think are the headwinds and the tailwinds for us to hit our plan. And I don't think there are many companies, you know, actually giving guidance for the full year, but we think that we've got some visibility that we can share that with you, hence our guidance.

Thank you so much for the details and the clarifications. Thank you.

Thank you.

Next question comes from with MKM.

Thank you. Good morning. My first question for Jim. Jim, if I look at your last three-year trend, your overall full-year operating margin tends to be on average two percentage points higher than your first quarter reported operating margin. Do you expect that trend to continue this year? If not, why not? And do you expect that trend, moreover, to continue over the next three years? If not, why not? And then I have a follow-up for Gary or Scott.

Thanks, Vahad. Here's what I'd say. It is absolutely true that our Q1 operating margin tends to be the lowest operating margin for the year. That is mainly because the Q1 revenue has tended to be lower than that of other revenues. And our OPEX has generally been sort of flattish through the year. I know there's some movement, and there is. But that's the basic reason. OPEX as a percent of revenue in Q1 has tended to be a bigger number than the other quarters. As we move through the year, first of all, I'd say that we do expect for the year to average 15% to 16%. So we think that we will show higher operating margins in the later quarters. But I'd also say that sort of offsetting that point is that, as we've said, we expect that gross margin will move down from high 40s to the mid 40s as we move through the year. If you just run the math on that, I don't think that, you know, we're going to do 3% better for the year. I think we're going to do 15% to 16% for the year. Thank you.

For Gary or Scott, you know, I think you guys alluded to the fact that you are increasingly investing in your IP routing or IP SPAC capabilities. But do you think or are you comfortable that you have sufficient capabilities today to address the majority of the edge and 5G use cases, or do you think you need more heavy lifting to kind of get to that majority of the opportunities that are out there?

Yeah, I'll take that far ahead. First of all, the focus of the investment, as you said, was on the metro and the edge. The use cases that we're pursuing, I would say, is combined aggregation networks, 5G, IoT, enterprise connectivity use cases. If we were building to a legacy architecture, We would certainly have a steeper hill to climb in terms of capability sets, but we're actually built into what we believe that our customers are telling us is the architecture of the future, which is, as I go back, a thinner layer of IP where a lot of the application capabilities are no longer embedded in a router. They're getting disaggregated onto general compute capabilities, and it really becomes, again, back to the winning hand. adaptive IP layer, world's best optics, a programmable photonic layer, and the software automation systems to allow you to drive that converged architecture. That's the lowest cost per bit. That's the most flexible network for our customers, and that's what's going to win in the future. With that definition, we're feeling pretty good about our capability set. Gary's comments earlier, you know, if there was an opportunity to do something inorganically that added to scale, we would look at that. But we're pretty comfortable on the capability sets we have today. And you can see that in the product portfolio that we've released in the last six to nine months on that part of the portfolio.

Thanks, Bob. With that, we will close the call. And we thank everybody for joining us today. We look forward to seeing everyone on the road virtually over the next few weeks and hopefully in person in not too long. Everyone stay well and thank you again. This concludes today's conference call. You may now disconnect.