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spk08: Good morning, everyone. Thank you for standing by and welcome to the CNF fiscal Q2 2021 financial results conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question in the intersession. To ask a question during the session, you would need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Greg Lance. Thank you. Please go ahead, sir.
spk04: Thank you, Casey. Good morning, and welcome to Ciena's 2021 Fiscal Second Quarter Results Conference Call. On the call today is Gary Smith, President and CEO, and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, is also with us 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 fiscal second quarter performance, our view on current market dynamics, as well as a discussion of our outlook for the third quarter and fiscal 2021. Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today's press release. Before turning the call over to Gary, I'll remind everyone that during this call, we'll be making certain forward-looking statements. Such statements, including our quarterly and annual guidance, opportunities, and commentary about the impact of COVID-19 and supply chain constraints are based on current expectations, forecasts, and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed on our most recent 10-K filing and in our upcoming 10-Q filing, which is required to be filed by the SEC by June 10th. We expect to file by that date. CNS knows 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 ask you to limit yourselves to one question and one follow-up. With that, I'll turn the call over to Gary.
spk12: Thanks, Greg, and good morning, everyone. This morning we reported strong performance for our fiscal second quarter, including $834 million in revenue and a particularly strong gross margin that drove a 16% adjusted operating margin and a $0.62 adjusted earnings per share. These results reflect continued strength in the fundamental demand drivers of our business. They reflect our distinct competitive set of advantages, as well as continued encouraging signs of improvement in the overall market environment. And I must first once again thank our people for their hard work and fortitude in these challenging times. They continue to drive our business forward and build on our position as the industry leader. As you may recall from our commentary, as we entered fiscal 2021, and again last quarter, we laid out several key assumptions that formed the basis of our outlook for the current year. First was an improvement of industry and economic conditions overall, which we are starting to see in many parts of the world, where the effects of the COVID-19 are somewhat abating. Of course, fully recognizing that the current COVID status globally of each region and country varies tremendously. Secondly, we noted that service provider spend, which has been constrained since the second half of 2020, needed to return to more typical pre-pandemic levels. I am pleased to report that during Q2, we began to see material amelioration of the operational and fiscal caution of key service provider customers around the world. And we believe that this is translating into a more normalized approach to network investments and operations, including more focus on new architecture builds and deployments. And lastly, really as a result of these two dynamics, we indicated the need for strong order flow and backlog growth, particularly in Q2, if we are to drive a stronger than typical uptick in second half performance in order to meet our outlook for the year. We absolutely achieved that, as orders in Q2 were significantly greater than revenue, and backlog grew both sequentially and year over year. So as we close out the first half of the year, the things we said we needed to happen in the market and our business are in fact materializing. And this has yielded financial results in line with our expectations and overall business performance that continues to outpace the competition. Based on these dynamics, we continue to be confident in our ability to deliver on the financial guidance we provided for fiscal 2021. In fact, we now believe that we will exceed our profitability target for the year through better than expected gross margins. And Jim will cover that in more detail. Before I review some of the highlights from the quarter, I'll briefly comment on the shared industry concerns around semiconductor supply chain constraints that are impacting a broad range of technology market sectors. and while we have experienced some lengthening of component lead times we have in place very strong mitigation strategies for supply chain disruptions as we've proven over many years and most recently through the covid 19 challenges we also benefit scale and diversification of our supply chain and continued investments in inventory as well as a high degree of vertical integration as a result We are well positioned to navigate this dynamic. And as we sit here today, our perspective is that we can believe we can manage the current supply chain challenges with no material impact to our revenue expectations for fiscal 2021. Moving to highlights from the quarter, our innovation and diversification continue to strengthen our competitive position. And with respect to innovation, Our lead in fifth-generation coherent technology with WaveLogic 5 is uncontested. In Q2, we secured 16 new wins for WaveLogic 5 Extreme, bringing our total customer count to 95. And we shipped nearly 5,000 WaveLogic 5e modems in the quarter. bringing our total to date to roughly 11,500 WaveLogic 5e modems shipped to a wide range of customers around the world active in their networks. We also remain on track with our WaveLogic 5 nano-pluggables and expect to have GA product in time to intersect with customer demand, which will likely begin later this year. We have product in customer labs today with the solution performing extremely well, including best-in-class power performance, perhaps the single most important metric for a differentiated pluggable. I mentioned last quarter our increased strategic focus on IP technologies in our routing and switching portfolio and our growing customer engagements in this area. specifically around our adaptive IP solution and ability to address key use cases in areas like 5G, Internet of Things, and Edge Cloud. Our momentum for this portfolio continued in Q2, with roughly a dozen new wins ranging from global Tier 1 service providers to MSOs and enterprises. Q2 was also a very strong again for Blue Planet. with the largest order quarter to date and four new portfolio wins with major service providers. Turning to customer segment and regional performance in the quarter, our overall non-telco business continues to be strong, comprising 43% of revenue in Q2. Direct web scale contributed 24% of quarterly revenue as these customers have once again started building and expanding data centers. We continue to retain a very strong leadership position in this segment as our relationships with these key customers become increasingly broader and more strategic. And I think the introduction of our WaveLogic 5 pluggables further enables us to address a wide range of our web-scale customers' needs. Activity with our Tier 1 service provider customers, especially in North America, is increasing. as they can no longer put off adding capacity to their networks, and they are now better able to navigate logistical COVID-related challenges. EMEA also performed well in the quarter, with revenues increasing 10% year over year, as service providers in the region invest to address their own traffic growth needs, as well as to support increasing traffic flows and bandwidth requirements of the web-scale players. And finally, on India, With the recent wave of COVID across the country, we've expanded support and resources for our local team, and we continue to be incredibly impressed by their resilience and optimism amidst a very challenging situation. With respect to the business in India, this new wave of the pandemic is obviously slowing the expected recovery. However, revenue from the country for Sienna still grew sequentially and year over year. And I would also say that winds and order activity continue to be strong, with the impact to date largely related to deployment schedules. We continue to expect India to grow year over year in fiscal 2021, with any near-term challenges mitigated by our general geographic location. Overall, there remains strong underlying secular demand for bandwidth and automation that drives our business. Our strong performance in Q2 is a reflection of that demand, and it gives us greater visibility as we sit here today. These results, together with encouraging signals in the market environment and the continued execution of our strategy, gives us confidence in a strong second half and our ability to achieve our financial targets as we move through the year. Jim. Thanks, Gary.
spk14: Good morning, everyone. We performed well in Q2, with revenue in the quarter totaling $834 million. Adjusted gross margin in the quarter was again strong at 49.2%. driven by a favorable customer and product mix, including strong software contribution and a high concentration of capacity ads versus new bills. Adjusted operating expense in the quarter was $279 million. With respect to profitability measures, in Q2 we delivered adjusted operating margin of 16%, adjusted net income of $98 million. It's worth noting that GAAP net income in Q2 was higher than non-GAAP as a result of $40 million we received from the Canadian Abundancy Wage Subsidy during the quarter. This figure flows through our GAAP P&L at each line where wages are incurred, primarily in OPEX. We have excluded this effect in getting to our adjusted numbers. And finally, on profitability, we reported net income of 62 cents per share. In addition, cash from operations was $225 million in Q2. Free cash flow was $194 million. Adjusted EBITDA was $156 million. The quarter was approximately $1.4 billion in cash and investments. Also in Q2, we repurchased approximately 483,000 shares for $26 million. we continue to expect to repurchase approximately $150 million of shares in fiscal 2021. Turning now to our guidance. As Gary mentioned, encouraging signals in market conditions and improvements in customer spending, as well as our strong first half performance, give us confidence in our ability to deliver on our fiscal year 21 targets. Specifically, We continue to expect to grow our annual revenue in fiscal year 21 in a range of 0 to 3%. As we've said previously, as conditions improve and revenue begins to reflect a more typical mix of existing and new business, we do expect gross margins to moderate somewhat. However, we do expect a somewhat higher gross margin in the second half than previously. as we expect that our favorable mix of strong software contribution and we expect that that will continue. Additionally, we expect OPEX for the second half to be higher than we generated in the first half. OPEX for the first half was a bit lower than the average quarterly OPEX call for the year. So there is some movement of OPEX from first half to second half. Also, the weak dollar continues to put pressure on our OPEX. With this guidance, combined with our adjusted gross margin results in the first half, we now expect adjusted operating margin for the fiscal year to be in a range of 16 to 17 percent, 100 basis points higher than previously anticipated. For Q3 specifically, we expect to deliver revenue in a range of $950 to $980 million, adjusted gross margin in the 46 to 47 percent range, and adjusted operating expense of approximately $285 to $290 million. In closing, we delivered a great performance in Q2. Second quarter order flow indicates a return to spend service provider customers and gives us great visibility into the rest of this year. We are confident in our ability to deliver a strong second half and significant profitability for fiscal year 21. Before moving to Q&A, I want to once again thank the entire Siena team for their continued focus and dedication during a very difficult period. In particular, our team in India has demonstrated tremendous resilience in recent weeks in the face of another COVID-19 wave. Also, our employees have also been incredibly active in their communities, safely gathering with each other as well as with our customers to give back through a wide range of service activities. We are extremely proud of the Siena team. With that, Casey, we'll now take questions from the sell-side analysts.
spk04: Before we start the Q&A, we are aware of some webcast technical difficulties. For those who have tried to access through the webcast as well, please re-register, and you should have access. Casey, we're ready for questions.
spk08: certainly thank you uh as a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound or hash key also once again in the interest of time please limit yourself to one question and one follow-up thank you your first question here comes from nata marshall from morgan stanley please go ahead your line is now open
spk07: Great. Thanks. I appreciate the question. You know, maybe just on in terms of, you know, one, what you're seeing as far as the ramp of kind of the 800 gig product versus maybe the 400 gig and how that's trending versus, you know, your expectation. And then just on the pacing of the tier ones, you know, certainly you sound better, but I guess just in terms of, you know, is it orders? Is it new decks? Just maybe some more context for what you're seeing on the tier ones in North America that leaves you encouraged to think.
spk13: Yeah, thanks, Matt. Scott, I'll take the first one on the 800 gig. So just to repeat the sort of ramp numbers that we talked about or Gary talked about. To date, and we're just a little shy of a year, I guess, into commercial shipments, we've got about 11,500 total units of our WaveLogic 5 extreme shipped. 5 000 in the last quarter so you can see that you know that's absolutely accelerating and if i sort of compare it to previous generation what you refer to as a 400 giga call it wave logic ai from a brand perspective that's that's an accelerated pace of ramp from from the previous generation and it's across all customer segments as well i should point out i met her on the uh says gary on the on on the tier ones and you know i'm generalizing sort of globally here but uh
spk12: I think the main issue that we've seen with them in the second half of 20 and the first half of 21 was just really described as an operational caution both operationally and fiscally on the networks they ran. And I think we are seeing encouraging signs of that ameliorating both in terms of their operational plans You know, and I think it's manifesting right now in terms of a bit of catch-up around capacity, you know, which was helpful to our margin in Q2. But we're also getting good indications of the new business deploying in the second half, and I think they're getting a little more comfortable from a fiscal point of view as well in terms of their budget spend. So, you know, definite improvement in the second half across the board in most service providers around the world.
spk04: Great. Thank you.
spk12: Thank you, Nathan.
spk08: Your next question comes from the line of Paul Silverstein from Cohen. Please go ahead. Your line is now open.
spk03: Thanks, guys. Appreciate the question. Gary, on the competitive landscape, one, with respect to traditional competitors, in particular Infinera and Nokia, both of whom are talking a very good game. And then more broadly, I know you did a whole seminar on ZRS and Infinera in terms of downplaying the threat. But can you update us in terms of what you're seeing real time with respect to customers' planned deployments in terms of empirical data that would speak to that threat?
spk12: Well, I think the best set of empirical data is, you know, the numbers that Scott just went through in terms of our shipments, you know, of real customers. We've got 95 customers now for WaveLogic 5E. And I mean, real customers where we're actually deploying, you know, so pretty much most of the primary landing slots on 800 gig are already taken, you know, with the head start that we've had. And I think that's the best set of metrics, you know, kind of talks to itself, frankly.
spk13: And, Paul, to your second point on the ZR dynamics in the marketplace, I mean, you referenced an investor chalk talk that we did probably about a month ago. So for those on the call that hadn't had an opportunity to see that, we spent quite a bit of time giving you our perspective and belief system of the application space and how various different flavors of coherent technology play in those application space. So that's accessible on our IR events page, so I'd encourage you to go look at that if you're interested in more details. I would summarize it as this, Paul. The first early moving application, I think, for this technology will be in the campus metro data center interconnect. We've talked in the past around the timing and the market size of that. Our perspective hasn't changed on that. I think you'll start to see some early deployments this year, later this year, and moving to more significant deployments in 2022. As you know, our technology that addresses that is our WaveLogic 5 Nano. We've said we were targeting mid-year for GA. We're on track for that. We're extremely pleased with the optical performance that we're seeing on that and, you know, get more and more confident that we have best-in-class, not only optical performance, but best-in-class power numbers. And that product and technology is now actively in certification in a number of customer labs around the world.
spk03: Guys, you can't share with us what your backlog is on the WebLogic 5 modems relative to those 95 customers, can you? No.
spk13: I tried. I'll say, though, that all the numbers that we quoted in terms of port numbers, those are shipped. That's not backlog. That's shipped.
spk04: Understood. Understood. All right. Thank you. Thanks, Paul.
spk08: Your next question comes from the line of Rod Hall from Goldman Sachs. Please go ahead. Your line is now open.
spk02: Yeah, good morning. Thanks for the question. I guess I wanted to focus in on the software online that is substantially higher than what we were forecasting. And you guys have grown that now year over year. It's accelerating on not EV comps last year, admittedly off a low level, but still the growth is pretty high. And And yet it seems to me that you're indicating, Jim, that gross margin drops off next quarter. So I've got, I guess, two questions. One is big picture for Gary, and that is what do you see happening there? Do you have any intention to give it some kind of targets on where that revenue line could go? Because obviously it's a huge margin driver and I think a pretty positive sign for you. And then, Jim? Next quarter, what are you implying to us when you give us the lower margin guidance? Are you saying that that revenue drops off next quarter? Can you kind of tell us what you think is happening with that software line in the fiscal Q3? Thanks.
spk12: So let me take the first part of that. And I'd broadly say, you know, I'd split the sort of – we've got a lot of embedded software, which we also get value to. But the pieces that we pulled out and report on are really this network layer, the automation of the network layer. And then secondly, we've obviously got Blue Planet, which is really around the service layer. And I think what we're seeing is, you know, increased focus on automation, you know, in both of those areas, very encouraged by what we're seeing. I think, you know, Blue Planet has tremendous amount of momentum. And as we, you know, we have in the past looked at, you know, given some long-term targets for that. Obviously, when COVID came, it kind of all got disrupted. But as we come out of the year, you know, when things begin to stabilize, you know, I would expect for us to articulate some longer-term goals for Blue Planet. And, you know, we'll talk a little bit more about that. You know, as it continues to grow, it'll probably exceed, you know, both orders and revenue for this year that we set. And also on the network side of things, on the automation piece, we've got a lot more applications being rolled out. certainly as we turn the year. And I think that will help drive the overall, you know, gross margin and software adoption. Jim?
spk14: Yes, Gary. On gross margin, Rod, remember that we've said all year that because of the mix of new projects in our revenue stream being lower in the first half than it is in the second half, we expected margins to come down from Q, I'm sorry, half one to half two. And that's the way the world has sort of modeled their consensus numbers. What we're seeing, though, is a very good mix including software, but also just generally product and customer mix. And we expect that mix to continue in the second half. So, yes, we do expect gross margins will come in a little bit as we move into the second half. But we also expect that gross margins in the second half are going to be up, you know, sort of 100 basis points from where we had expected them to be. We're now calling margins in the second half to average 46% to 47%, which is what we call for Q3. And, yes, we'll have a good software mix. But remember, when we enter new projects, typically we experience lower gross margins, and that's going to be a higher percentage of our revenue than it has been in the first half. Overall, we're very pleased with our gross margin performance.
spk02: So, Jim, is it fair to say then on that that it's not a software mix necessarily reduction? thing going on in Q3. It's much more to do with new projects, spin-up and that, dragging, you know, the margins back down as we would expect it to. Totally. That's totally right.
spk14: You don't expect software to come in.
spk12: Yeah. And a little bit, Rod, is just the relative size. I think we'll continue to do well on software, but, you know, as a standalone piece, it's still relatively small to the rest of the business. You know, and that's why we pull it out separately for people to see the progress. Okay. All right. Great. Thanks, guys. Thanks, Rod.
spk08: Your next question comes from the line of George Notter from Jefferies. Please go ahead. Your line is now open.
spk09: hi guys thanks very much i guess i wanted to uh ask about the huawei market share capture opportunity um obviously it's been an ongoing narrative i think for some time um at some point i you guessed that there'd be some forcing function as huawei runs out of inventory on the component side but tell us what you're seeing in the marketplace regarding huawei right now thank you georgia i would say that you know the dynamic hasn't hasn't really changed with one
spk12: probably notable exception. I think the main area is, you know, the main region to date has been Europe, where you're seeing a, you know, slow or reduction in dependency upon Huawei, largely being run initially out of the RAN business, where they're seeing it first, and then getting to the core infrastructure. So that's taking time, and that's a dynamic that I think, you know, he's well understood and talked about. And he's definitely a tailwind for us, you know, over a period of time. I do think one notable change as I think about, you know, this year has been India, which I think is going much more aggressively to reduce their dependency. And we have seen, not yet deployed, mainly because of some of the challenges with COVID in India, but we've seen a lot of activity around the major carriers there, wishing to decrease their dependency on Huawei, gone out to RFP. We've won more than our fair share of those deals. And they are being, I think, probably more aggressive than we're seeing in other parts of the world. So that would be the sort of exception I would call out. But that's not yet on the scorecard because, you know, it hasn't been deployed, but definitely planning to reduce their dependency.
spk14: Huawei dynamic is positive for us for the long term, but we have always been cautionary about how fast it happens because in Europe it's just going to take a while for them to – replace, well, I shouldn't say replace, I should say move away from Huawei. They're not going to rip and replace in Europe. That's not going to happen. But as new infrastructure projects begin to come into play, then it's going to be difficult for Huawei to win, and I think that helps us. Great. Thank you. Thanks, George.
spk08: Your next question comes from the line of John Marchetti from Stiefel. Please go ahead. Your line is now open.
spk11: Thanks very much. Gary, I wonder if you could just spend an additional minute on the India market, maybe just talk about how maybe the last two or three months have gone and maybe compare it to what you saw last year where the country was really frozen in a tough lockdown and if that's starting to ease at all as you're looking into 3Q and even further into the second half of the year.
spk12: Yeah, I think it's had a Prior to the COVID piece, I think it had this sort of situation, just to remind everybody, as you say, John, it had these challenges around, A, had a vote out and was, you know, digesting that. Second of all, the economy and then some regulatory issues. So it's been, you know, a challenging two or three years on that side for India. But, you know, the underlying dynamics and demand, I think, are strong. We were just starting to see that move again when, of course, COVID hit. They had a very big lockdown. And very little got deployed. We began to see, you know, activity, I would say, beginning of this year. And we won some new deals then, and they were beginning to be deployed. And then, of course, you know, what's happened in the last few months has really, you know, slowed all of that down. You know, we would say from the experience that we're seeing, you know, currently, is it stabilizing and, in fact, improving? I would say that, you know, from talking with our team in India generally. Still got a long way to go, but, you know, I think it sounds like they're heading in the right direction. I would say that our view on the second half was obviously we've kind of de-risked that view in the second half, given what we were seeing. And so, you know, but I still think that India will be up for Siena year on year. It won't be as high as we had anticipated. But I think the order activity and RFP activity continues to be strong as they do their plans. And we're winning more than our fair share of that. So, You know, one's hopeful as we turn the year that, you know, we'll see a good step function in India, albeit a delayed one from the second half.
spk11: Got it. And then just maybe shifting gears to overall order growth. You know, you talked about that being up significantly higher than revenue. I'm just curious if you can comment at all about that's more heavily weighted towards tier ones. You obviously had a very good sequential quarter in web scale, just as we're looking into that second half. you know is it a function of those networks that you talked about running hotter you're starting to see that ease out and those orders now are coming in for second half deployments is it a function of now having time to evaluate 800 and doing those deployments just curious if you can give us any color there on some of that order growth uh that you saw thank you
spk12: Yeah, no, I would say generally, you know, it's across the board. We're seeing it with, I think the dynamic is obviously very different as you go to each of the web scale players, but I would say generally they have been constrained in their ability to roll out and connect new data centers. You know, just like the carriers have been constrained in terms of their ability to deploy, first of all, both logistically, but, you know, more latterly out of caution and run their networks hot. So slightly different dynamic, obviously, between the two. But we're generally seeing most of them now, and I would describe it to some extent as being catch-up on their capacity build-outs, which, you know, I think has been largely, you know, they've been running it hotter the last sort of nine months or so. And I think that's what we're seeing, is I'd describe it as sort of catch-up and then a return to a more normalized approach to the development of their networks. So, you know, as Jim sort of talked about, a lot of the new business that we've won, we actually think we'll end up now deploying in the second half, what we kind of hoped and expected. So that's good news, coupled with this catch-up. And I think we were expecting, you know, a big step function in our second half. And I think we're now much more, you know, we've got real confidence around that in terms of what the activity that we're seeing and the backlog that we've got as well. So I would say, you know, really, John, it's across the board. It's Tier 1s in North America, Tier 1s in Europe. You know, we talked about India. I would say, you know, Japan is still a challenge for us. That's more specific to us because of what's going on with DoCoMo and NTT. But generally, across the board, you know, we're seeing a catch-up on capacity, and we're seeing, you know, increased leaning in on the deployment of new architectures and new builds.
spk14: COVID affected everyone's spend, really, across the board in terms of customers, but it had a much more severe effect on the service providers than it did on the web scale. So we did expect and hoped for a big improvement in service provider spend as we came into our second quarter, and we have seen that. But I would say, as Gary said, this is across the board. I think that everyone is seeing the need for network. The network is more important than it ever has been. And we expect that trend to continue for us.
spk04: Thanks, John.
spk14: Thank you.
spk08: Your next question comes from the line of Simon Leopold from Raymond James. Please go ahead. Your line is now open.
spk06: Thank you for taking my question. This is Maurice for Simon. I just wanted to go back to the question on the European opportunity on the back of the Huawei backlash. Maybe you could talk about what you're seeing in terms of the pricing dynamics as some of that Huawei footprint starts to gradually become available and competitors look to gain a piece of that footprint. And then I have a follow-up.
spk12: I would say, you know, this dynamic has been going on for a while. I don't see any particular change in the pricing dynamics. I would say, you know, as Jim talked about earlier, I think, you know, the main priority of the Europeans is to de-risk themselves around their RAM business. And that's where they're focusing their attention and dollars right now. Underlying to that, as they look at changing their network infrastructure and transport architecture, They are, you know, looking to decrease their dependency on Huawei. And so those are the entry points, if you will. And that takes time, you know, both in terms of the evaluation, the decision, and the actual deployment. It's a big deal for these carriers because they're all integrated into their back office, their systems, their support, and that doesn't happen quickly. And, you know, this has been going on for a couple of years. We've won a number of those, and we're now kind of deploying. And that is sort of an ongoing tailwind for us. But we're not seeing any particular, you know, change in the dynamics there. It obviously benefits us and other competitors that are not Huawei. But it's a very long-term play. And really, I would stress again, it's the RAND vendors that are really seeing a significant probably uptick in the shorter term from it.
spk13: And any time there's been a major piece of infrastructure that's competitively contested, it's always a very competitive and tough pricing environment. And that hasn't changed. And the fact that the trigger happens to be a move away from Huawei, I don't think is going to change that either.
spk06: Thanks. My follow-up question, Jim, this is the second consecutive quarter that we're seeing a sequential increase and actually another record high on CNI inventory levels. So I'm just wondering if this concentration is related to getting you ready for the sort of demand that you anticipated in the second half of the year, or perhaps it's a combination of that as well as an effort to build some inventory buffer that will help you navigate the supply chain limitations we're seeing in the industry. So maybe if you could offer some corner around that and how we should think about inventory for the remainder of the year. Thank you.
spk14: Yeah, I'll start and Scott can continue. It's all of the above, frankly. We do expect, and our guidance would lead you to think, that we're going to have a big uptick in the second half and we had to build inventory for that. The other thing, though, is that with supply chain, we have always been very proactive in terms of making sure that we had good inventory levels as we moved into shortages in some areas. This year is no exception. We've also had some MDs of certain products, and we had to get last-time buys. So it's all of those things combined. We do think that inventory levels will come down over time. We'll have to watch and see what happens as a result of this semi-issue and whether there might be last-time buys associated with that as we move through the year. But over time, we do expect our turns to get back to something approaching our more normal levels.
spk13: Jim, you covered it. In fact, the question kind of was bang on in terms of the dynamics is really primarily to we've talked in the past of our supply chain resilience and the strategy that we've built in not only how we architect it, but how we invest to service our customers. And I'm convinced our customers reward us for that, by the way. So that's one driver of it. And it's certainly serviced extremely well as we're staring at the semis. challenges of the industry. The second piece is, as we've noted a couple times in the call here, is we built a plan and an expectation that we were going to have a substantially bigger second half than first half, and we bet on success. So we were getting ready for that second half.
spk04: Thanks, Mauricio.
spk08: Your next question comes from the line of Jeff Gwal from Wolf Research. Please go ahead. Your line is now open.
spk14: Yes. Thanks very much. And I've got a question for you, Jim, and let me ask it the most direct way, but I can ask it another way if you prefer.
spk03: And that is the margin structure that you've given us for the second half is really, you know, I mean, it's noticeably better than where you've been historically. Do you think that that is sort of a new baseline for Sienna?
spk14: Or do you think that over time you'll get back to that mid 40s range? in the out year? Well, here's what I'd say about that, Jeff. We have been experiencing very good gross margins. We have taken a lot of costs out of our product, and we have great technology. All that has contributed to our improvement in gross margins. We have called up our gross margins a few times over the past year or so. But it's a very dynamic environment in which we find ourselves now. The dynamic that we've said that new projects will cause margins to get back more toward the mid-40s is still there. We're just not, because of our underlying performance in gross margin, expecting it to be as significant as we expected for the second half of this year. As we move through time, we'll address this issue of gross margin more fully. But we do like our performance so far. Okay. So new wins turning back on is part of the guidance for the second half of the fiscal year. Absolutely. Yes. Okay. Okay. Great, great, great. And then let me follow that up by asking, is it possible that one day that you'll get back to talking about that 68% long-term sales growth? We're going to revisit the issue of long-term guidance as we turn the year. We've been through an incredibly dynamic period in our market with all sorts of behavioral changes on the part of our customers and with good reason, of course. And that caused us to suspend our three-year guide. Although I would say, remember, we just – we did talk about the future as we began this year. We said that we still expected the market – to grow in the low to mid single digits overall, and we expected to take share in that context. We just didn't continue that thought to give a number in terms of our revenue growth. I won't say that we're going to as we come into the first part of next year, but it's certainly what we're thinking about as we sit here today. Okay. Thank you very much.
spk08: Your next question comes from the line of Amit Dabriyanani from Evercore ISI. Ed, your line is now open.
spk15: Good morning, and thanks for taking my questions. I guess the first one I had was in the web-scale business. I was hoping to just maybe touch on what's happening over there. I think the business was down on the year-over-year basis. I'd love to understand what's happening in web-scale. And then as you think about the back-half narrative, how do you think the web-scale business performs versus the back-half guide that you provided?
spk12: I mean, I would say that, you know, you see normal ebbs and flows to the web scale players, and obviously they all have very different business models, and we talk about them generically. You know, I would say a couple of things to it. One, you know, we continue to perform very well with them. They've also been constrained around their connectivity and ability to, you know... ability to deploy new data centers and connect them i think that is getting better um you know and the fact that year to date we're at about four percent up uh you know as we get to the half year is about what we what we thought You know, we think we'll see growth for the year in about the mid sort of single digits. And we will actually – tough for us to take even more share than we already have. But we're absolutely confident of maintaining the share that we've got. And we do think that the second half will improve on the first half in terms of revenues. Absolutely. We'll see an uptick along with the rest of our business on that. So – You know, I think we're pretty optimistic around that space. They seem to be getting back into the swing of being able to build out these data centers around the world. And I would say that's a key point. It is around the world where we're partnering with them. It's not just in North America. And that has been particularly constrained for them outside of the U.S. for obvious reasons. And that seems to be getting better. So, you know, we're pretty optimistic about the second half for us a minute.
spk15: Perfect. And then if I could just kind of hear you talk a bit more about free cash flow expectations in the back half of the year. Q2, I think, was exceptionally strong, so I don't know if you'd call that something like a one-off there. But how do you think about H2 free cash flow? Because historically, that's been the stronger half of free cash flow. Is that the same that happens this time, despite the ramps that you're expecting?
spk14: I would expect that we'll have better free cash flow in the second half than we had in the first half, although I would say that we had a particularly strong Q2. But we're going to – we've said in the past, and I don't think we've guided to this recently, but in the past we've said that our free cash flow is going to be, you know, 60 percent or 70 percent of our EBIT, and that's the kind of number that, you know, we kind of expect. Thank you. Thanks, Annette.
spk08: Your next question comes from the line of Alex Henderson from Needham & Co. Please go ahead. Your line is now open.
spk05: Thank you very much. So you've addressed the issue associated with Huawei, but I was wondering if you were to look at the broader environment, whether there's been any change in pricing, one, as a result of Huawei receding from the market, Two, because of Nokia saying that they're going to try to drive to profitability. And three, you know, that you have such an advantage with the 800 gig. Is that causing better pricing environment for Sienna as a whole? Can you talk a little bit about what's going on in the pricing realm?
spk12: Yeah, Alex, this is Gary. I don't think it's really, really changed. The Huawei dynamic has been around for a long time, so no real change to that. I think where we're getting increased margin, I think, is a reflection on the scale of the business, the technology that we have. and the vertical integration that we have in the innovation that we're bringing into the market, and that's, you know, helping drive our gross margin. I think the pricing environment generally has not changed. We haven't seen any appreciable change in behavior from any of the main competitors.
spk14: This is a competitive market, Alex, and as Scott said, Whenever there's been an opportunity for market share gains as a result of, you know, something like a Huawei or anything else, it is a competitive battle to get that market share. And we're going to expect to see that as we move to the next, you know, couple of years, trying to get a Huawei market share.
spk13: One way you asked that question related to 800 gig pricing, Alex, one way I would think about it, in most of the competitive engagements, it comes down to a total cost of ownership conversation. And within that, it's what's the cost per bit, not necessarily explicitly what's the cost for an 800 gig capable, but what's the cost per bit that they're trying to achieve. What the 800 gig WaveLogic 5 technology allows us to do is to participate in that market pricing, but at a much more competitive cost basis. And that has actually... partially a partial factor in our margin dynamic as well.
spk05: Great. Thanks for that answer. The second question I had for you is you addressed the component supply constraints and basically saying that it was not impacting your outlook for the back half of the year. It wasn't constraining your expectations. But I wanted to ask a little bit more subtle question of whether that actually might negatively impact your ability to exceed the forecasts. Is that a governor on the growth rate within the band in the back half as a result of the inability to produce more if you had orders in excess of what you thought going into the period?
spk14: Well, what I'd say is that we expect to be able to meet our current call for the second half based on our current view of the supply chain conditions. Lead times have lengthened, and so to achieve a significant upside to the numbers that we've called would be difficult. I wouldn't say it's impossible, but I would say it would be difficult.
spk05: That's very helpful. Thank you very much. Thanks, Al.
spk08: Your next question comes from Samit Chatterjee from JPMorgan. Please go ahead. Your line is now open.
spk01: Hi. Thanks for taking the question. I have a couple. Just wanted to start off with seeing if I can get a bit more visibility on what you're seeing with the North American tier one service provider customers. Clearly, you indicated you're seeing either strong orders or revenues from them. But how much of this is attributable to, you think, like return to normal levels of spending relative to or relative to just spending more tied to some of their wireless equipment deployments that are going to happen in the back half here relative to C-band and having to invest to support that wireless equipment deployment? Just trying to get any insights you have of what is the driver here in their returning to a higher level of spending and have a follow-up, please.
spk12: Yes, I mean, I think largely it's to do with them playing catch up on their capacity. You know, I think, you know, fully understandable when the sort of COVID piece hit. They were very focused on just achieving endpoints, security, services to our homes, basically, and they didn't want any disruption on the network operationally, and they were very cautious around doing anything on the network, and so they ran it hot. I think what we're seeing is more a function of a bit of a catch-up of that, and then a return to a more normalized approach of the development of their network, i.e., you know, their new architectures, new business, new deployments. So I think you've got a combination of those two things going on. And I think there might be a little bit around RAN priority earlier on, you know, last year, et cetera. But I think it's more about, you know, this dynamic of caution on the network, operational caution, and also fiscal caution. I think people are generally in the economy feeling a lot more confident now, and that includes the carriers. And I think you're seeing that in some of their various comments around, you know, generally in CapEx. So I think it's more to do with those dynamics than it is, you know, prioritizing RAN versus, you know, versus transport, et cetera, because, you know, the RAN won't work without the transport. So, you know, they're pretty closely aligned, really.
spk01: And a quick follow-up. I know in the press release you mentioned you have one 10% customer, which is accounting for 15%, I think. We saw a sequential move up significantly on DCI, but just wanted to get some color. I know you probably won't name it, but was it a service provider or was it more of a DCI web-scale customer?
spk14: We'll tell you it's AT&T. It's the biggest customer that we've had historically and continues to be a very strong customer for us. Great. Thank you. Thanks for taking the questions. Thank you.
spk08: Your next question comes from the line of Fahad Najam from MKM Partners. Please go ahead. Your line is now open.
spk15: Thank you for taking my question. I wanted to revisit Jeff. question, but I'll ask you in a more nuanced way. If we look at the broader macro environment, probably the best time I can recall for the climate movement sector in my memory, and I've been in this business for 20 plus years, you have 5G build-outs, you have, yesterday we heard Facebook talk about 75% of your growth in their network consumption. We've got stimuluses coming from Biden administration's infrastructure bill of $100 billion on top of the $20 billion for RDOF, various stimulus spending plans from various governments across the globe as they try to recover from the global pandemic. You're still talking about 0.3%, you're going down for the second half. and not kind of giving us more forward-looking outlook on top of the fact that you already have the market leader 800 gig your largest competitor huawei's in a case so why why hold back on giving us a more forward-looking outlook what are you concerned about you know all the things that you mentioned with respect to the conditions in our market are true but uh
spk14: Nothing ever moves quite as fast as we might expect it to sometimes, and there are natural constraints on the service provider's ability to spend quickly. It's a great time to be in the networking business, and we're the best, at least at the optical layer, and so we're going to benefit for a long period of time from all the trends that you talked about. I just think that as we look into the second half of the year, That's what we expect. And we did mention that the supply chain is going to make it difficult for us to exceed these numbers. And we'll talk about, as we enter the next year, what we think about the next several years. I'm not promising we'll give numbers, but I will say that we will talk about it. We like where we are as a company.
spk12: The other thing I'd just add to that part by way of sort of context is, you know, depending on your sort of numbers, but rough out onto the guidance, consensus, whatever, you're talking about a massive uptick in the second half. You know, you're talking about a 16% increase. in the second half versus the first half, or in order of magnitude around that, which is a significant uptick from where we'd normally be. And I think we're all dealing with a period of great turmoil around the COVID for the last couple of years. I would also say the other thing is, I don't know many companies that actually gave annual guidance for this year, which we gave. you know, clearly predicated on a set of assumptions which, you know, fortunately seem to be playing out. But as Jim said, there's also some headwinds to this thing. You know, we've got some supply constraints. We're not immune to that. We navigate through better than anybody else in the industry, but we're not immune to it. We have, you know, India is not going to be as strong as we thought. We've de-risked that. So, you know, there's lots of sort of puts and takes on a global basis. But, you know, I totally agree with the underlying secular demand is super positive. And as we saw prior to COVID, extremely strong. And I, you know, I'm very confident that we will get to that kind of an environment, you know, once we get through this.
spk15: Appreciate it. I have a follow-up on your routing and switching. You had a major win with OpenReach in the UK. How big can this part of it be? It seems like you're increasingly winning a far greater share of wins than is appreciated by the investment community. just help us understand what's where in which uh segments of use cases are you winning are you beginning to actually kind of take share away from the junipers and even potentially cisco's in the risk of the world can you just help us understand what's happening without being switching
spk13: Yeah, so from a numbers perspective, I mean, I revert back to Jim's comment. We're going to take a look at giving you a longer-term perspective of how we think that portfolio will grow as we get into the end of the year. I will say this, though. The growth rates are going to exceed the overall C&A average growth rates. We've invested very substantially, and it's not just a recent phenomenon. For the last couple of years, in terms of increasing the addressable market of that portfolio, particularly in terms of its IP capability, its next-generation IPOS capability, and that opens up new market opportunities for us around the metro and edge deployments, which, as you know, are undergoing a lot of significant architecture changes. That is an opportunity for non-incumbents. So we're pretty bullish about the opportunities there. It'll show up in applications around the edge, wireless X-Hall, self-site routers, connectivity from users to content in various different places. And OpenReachable is one example of that. Thank you.
spk08: Your next question comes from the line of Tim Long from Barclays. Please go ahead. Your line is now open.
spk10: Thank you. Two quick ones, if I could. First, Gary, you talked about the U.S. Tier 1s looking pretty strong. I think someone mentioned government stimulus and rural broadband. Can you just give us your perspective on how you think that will impact Siena over the next few years as the smaller and more regional telcos get potentially more funding and more optical reach into the networks. And then second, if you could just give us an update on the subsea segment. I think it's a little bit smaller business, but it seems to be there's some good dynamics there as well. Thank you.
spk12: Yeah, Tim, on the rural piece, you know, really talks to this thing that, you know, I think a number of the questions sort of, you know, got to the strong sort of underlying secular demand. I think, you know, really it's all about getting... you know, greater bandwidth closer to the customer, you know, be it 5G, Internet of Things, a lot of rural broadband initiatives. Obviously, the one that we're focused on is, you know, and talking about is the U.S., but you've got those in different parts of the world, too. You've got them in multiple countries. I think people are recognizing, you know, particularly during COVID, that, you know, any inequalities that exist need to be addressed in the various countries' population, and you've seen a number of those initiatives kick off. I'd just caution, you know, that it is – well, first of all, it's government at the end of the day. Second of all, it's infrastructure. And these things always take, you know, a little bit of time to work their way through. But, you know, as we come out of the year and look to the next, you know, few years, this is a very positive underlying dynamic, basically, if you couple that with – 5G and just basically, as we view it, getting high speed closer to the customer, which is really about fiber. So we feel very, very positive around those dynamics. Similarly, kind of subsea. You know, you look at things like web scale and as they look to expand, you know, into various countries, you know, they're basically the largest owners, I think, now of subsea capacity in the world are the web scale players. It's no longer the PTT carrier consortia that control all of those cables, which was the case 10 years ago. And I think that's a very positive dynamic for the future overall in that that subsea market, as you look at speeds of connectivity out to the terrestrial networks, we're seeing a continued momentum in the need for new cables, basically. And I think you're seeing a bit of a cycle going from adding capacity to existing cables. You're still going to see that, but I think we're into a big cycle of new cable build-outs. And, you know, there'll be a bit of a lag effect, you know, to us on that because you've got to get the cable in first and then we'll come on top of it. But I think that's pretty positive over the next few years.
spk00: Okay, thank you.
spk04: Thanks, Josh. Thanks, Tim. And thanks, everyone, for joining us. We do apologize for the webcast challenges. We will accelerate the availability of the transcript, make available the information for the replay and archive, so please keep an eye on that on our website. We look forward to catching up with everybody over the next few days and at our conferences next week. Thanks, everyone. Have a good day.
spk08: And this concludes today's conference call. Thank you for participating. You may now disconnect.
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