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spk03: Good day, and welcome to the CNS Fiscal First Quarter 2024 Financial Results Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Greg Lamp, Vice President of Investor Relations. Please go ahead.
spk01: Thank you, Dave. Good morning, and welcome to Ciena's 2024 Fiscal First Quarter Conference Call. On the call today is Gary Smith, President and CEO, and Jim Moylan, CFO. Scott McFeely, Executive Advisor, 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 drivers of our business, as well as a discussion of our financial outlook. Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations. A reconciliation of these nine GAAP measures to our GAAP results is included in today's press release. Before turning the call over to Gary, I'll remind you that during this call, we'll be making certain forward-looking statements. Such statements, including our quarterly and annual guidance and our long-term financial outlook, and discussion of market opportunities and strategy, are based on current expectations, forecasts, and assumptions of our company and its markets, which include risks and uncertainties, that could cause actual results to differ materially from the statements discussed today. Assumptions relating to our outlook, whether mentioned on this call or included in the investor presentation that we will post shortly after, are an important part of such forward-looking statements, and we encourage you to consider them. Our forward-looking statements should also be viewed in the context of the risk factors detailed in our most recent 10-K and our 10-Q, which will be followed with the SEC today. 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'll allow for as much Q&A as possible today, though ask that you limit yourselves to one question and one follow-up. As a reminder, we'll be hosting investor group meetings with the sell side at OFC later this month. We look forward to seeing many of you in San Diego. With that, I'll turn it over to Gary.
spk09: Thanks, Greg, and good morning, everyone. As you've seen from the press release today, we reported strong fiscal first quarter results, including revenue of 1.04 billion and adjusted gross margin of 45.7%. Our Q1 performance also included very strong profitability metrics, with quarterly adjusted operating margin of 13.2% and adjusted EPS of 66 cents. Additionally, we generated $250 million in free cash flow within the quarter. The drivers of bandwidth demand remain strong, and we believe very durable. And network traffic is increasing as a result. And we remain incredibly focused on growing our business and capturing additional market share. Specifically, we are taking advantage of bandwidth growth and cloud adoption trends to extend our leadership in optical and to expand our addressable market, particularly in metro routing and broadband access. Fundamental to these growth ambitions is the expansion of our relationship with cloud providers as they rapidly grow their global networks. Reflecting these expanded relationships, in Q1, non-Telco revenue accounted for over 54% of our total revenues. And of that, direct cloud provider revenue was 346 million in the quarter, up 38% year over year, and both of our 10% customers in the quarter were in fact cloud providers. Orders from cloud providers were also up year over year in Q1, and we continue to secure new deals with all of the major players in this segment. In Q1, for example, we had a significant design win for our 400G ZR Plus pluggables with a very large cloud provider, which we plan to begin shipping and taking revenue on later this year. We were also recently selected by a major cloud provider as their primary vendor for its future global architecture based on our RLS platform. So it is very clear that we've been broadening our engagement with cloud providers, including discussion around how we can leverage our leading innovation as AI becomes a growing driver of traffic and a great opportunity for us. In fact, with about 50% plus market share in data center interconnect, We are incredibly well positioned to benefit as more data centers are built and when AI traffic flows begin to come out of those data centers. We are also developing solutions for inside the data center, a whole new market for us. And this is based on our next generation pluggables family as existing technologies are unlikely to satisfy the rapidly increasing requirements for this critical application space. This momentum really exemplifies the strong confidence we have in our position with cloud providers and our belief that we will have a very strong 2024 with them as we continue to expand these important long-term relationships. However, at the same time, the normalization of order volumes from our service provider segment is not materializing as we expected. We were very clear in our commentary last quarter that our fiscal 2024 financial performance would be largely determined by the timing and magnitude of order flow from our service provider customers, particularly those in North America. More specifically, we expected to see orders from these customers begin to increase significantly in Q2. And as we sit here today, it is taking longer than we and many in the industry anticipated for these customers to absorb their high levels of inventory. This is in part due to difficulties installing and deploying equipment, including site readiness and access to fiber, which is limiting their placement of new orders and the absorption of existing inventories. In addition, in other parts of the world, we are seeing some caution driven largely by macroeconomic concerns that are contributing to lower than expected order volumes from service providers in certain international geographies, almost entirely and predominantly being Europe. Our current view, based on our discussions with customers, is that we now expect a recovery in order patterns from service providers to occur more gradually over the next few quarters. And Jim will speak shortly about how we expect this to impact our business outlook. But I want to emphasize that we and our customers view these dynamics as temporary. And to be clear, we are confident in the durability of the underlying demand drivers in the industry and our ability to continue to take share and grow over the mid to longer term. In fact, there are several key highlights from our Q1 performance that really illustrate the strength of these fundamental demand drivers. In optical, we continue to take share and remain the undisputed leader across virtually every domain, including Metro, DWM, DCI, Submarine, and Long Haul. During Q1, we added 11 new customers for WaveLogic 5 Extreme, bringing our total customer count to 270. And to date, we've shipped more than 115,000 WaveLogic 5E modems. WaveServer had a record quarter as well in Q1 with more than $250 million in revenue, reflecting a 34% growth year-over-year. Quarterly revenue doubled year-over-year for our reconfigurable line system or RLS platform, with eight new customers in the quarter, bringing the total to nearly 70%. And for our WaveLogic 5 nano 400 ZR and ZR plus pluggables, we gained 19 new customers in the quarter and now have a total of 86 total customers. Looking ahead in optical, we're already taking orders for WaveLogic 6 Extreme, the industry's first and only 1.6 terabit solution, which will become generally available this summer. In fact, we've already announced two of these winds, Southern Cross and VOCUS. Further, WaveLogic 6 Nano, our next generation pluggables family, will feature products such as H100 Gig ZR in the latter half of calendar 2024. In routing and switching, where we've been making both organic and inorganic investments, we continue to execute our strategy to expand our TAM into faster-growing markets. And in Q1, we had double-digit revenue growth year over year for the combination of our 3,000 and 5,000 series platforms. And our 8100 continues to gain traction as we scale our metro and coherent routing capabilities. and we now have more than 50 customers around the globe for this platform. We continue to build momentum with this portfolio, including our Wave Router platform, of which we are building additional form factors to address a wider range of applications over time. Other portfolio highlights for Q1 include notably another very good quarter for platform software and services with 22% revenue growth year over year and 9% sequentially. We also saw 13% revenue growth year over year in our global services business. And this is most notable because it was driven by another strong quarter for installation and deployment. which really illustrates our role and visibility in helping our service provider customers work through some of their near-term absorption challenges. In summary, we delivered a strong performance in our fiscal first quarter. Our technology leadership position has never been better and will continue to improve. Our customer engagements remain focused on helping them meet the growing demand for bandwidth, digitally transform their operations and monetize their networks faster. And more recently, positioning them for the rise of AI and what it means to network infrastructure and operations. We remain very confident in the opportunities ahead and in the execution of our long-term strategy. With that, I'll turn it over to Jim. We'll provide details on the quarter's results as well as our business outlook, particularly in the context of the current service provider order dynamics that I referenced earlier. Thank you, Jim.
spk10: Thanks, Gary. Good morning, everyone. As Gary stated, we delivered very strong fiscal first quarter financial results. Total revenue in Q1 was $1.04 billion. Adjusted gross margin was 45.7%. reflecting a favorable product mix. Q1 adjusted operating expense was $337 million, a bit lower due to delays in certain internal projects and lower sales incentive compensation. With respect to profitability measures, in Q1 we delivered strong results, including adjusted operating margin of 13.2 percent, adjusted net income of $97 million, and adjusted EPS of 66 cents. In addition, we generated $266 million in cash from operations. Adjusted EBITDA in Q1 was $160 million. Finally, we ended the quarter with approximately $1.5 billion in cash and investments. Inventory levels came down $66 million from Q4 And we repurchased approximately 690,000 shares for $32 million during the quarter. We are continuing to target the repurchase of $250 million total during the year. As we turn to guidance, I want to reinforce a few points. Most importantly, the fundamental demand drivers of our business, including growth in bandwidth demand, remain very strong. Bandwidth demand has grown at 25% to 30% per year for decades, and with AI applications imminent, shows no signs of slowing. We continue to grow our business and gain share with cloud providers in connection with their network expansion and data center infrastructure build outs, and our deep relationships and engagements with service provider customers continue to position us well in opportunities across both optical and routing and switching domains. However, we remain in a period of uncertainty which has come about as a result of the whiplash effects on industry supply chains caused by shortages of key components, elongated lead times, huge orders by customers in response, and inventory bills of networking gear by our customers. They are working down this inventory, and things are getting better. However, it is taking longer than we and many in the industry anticipated for Tier 1 service providers in North America to work through these high levels of inventory, and this is impacting their placement of new orders. Additionally, we are seeing increased caution from certain European service providers related to macro concerns. All of this is largely consistent with what our customers, competitors, and suppliers have been reporting in recent weeks and months. We continue to believe that these dynamics are temporary and currently expect to see orders improvement over the next few quarters. Taking all of these factors into consideration, we are adjusting certain elements of our annual guidance for fiscal 2024. We now expect revenue for fiscal 2024 to be in a range of 4.0 to 4.3 billion, down from our previous expectations of 1% to 4% growth over fiscal 2023. With respect to adjusted gross margins in fiscal 2024, we continue to expect it to be in the mid-40s range with some variability by quarter. For adjusted operating expense, we intend to continue investing strategically both to advance our leadership position in our key markets and to expand our addressable market in key growth areas. However, taking into account our current revenue outlook for the year, we are now planning for operating expense to average $340 to $345 million per quarter in fiscal year 24, down from our previous guidance of $355 million per quarter. With respect to Q2, we expect to deliver revenue in a range of $850 million to $930 million, adjusted gross margin in the low 40 percentage range, given expected product mix and lower volumes in the quarter, and adjusted operating expense of approximately $340 to $345 million. Finally, we are updating our three-year financial targets. As a reminder, given the severity and duration of the rebalancing of supply and consumption, our fiscal 2023 was a year of outsized revenue growth, over 20%, and well above our historical growth rate of 6% to 8%. Our outlook today is that, for these same reasons, our fiscal 2024 revenue growth rate will be substantially lower than the historical rate. Given this revised view, using our updated fiscal year revenue outlook of 4 to 4.3 billion as a baseline year, we believe that 6 to 8 percent CAGR best represents our long-term growth rate. In a market growing low to mid-single digits percentage, Ciena's expected revenue growth rate will ensure continued market share gains. In summary, the industry is experiencing some near-term headwinds as our customers recover from the supply chain challenges that they've seen in recent years. And with demand, though, continues to grow. at at least the historical 25% to 30% annual rate. Underlined demand drivers of that, which now include AI, ensure that this will continue well into the future. Our leading technology and focus on growing our portfolio to address new markets, as well as our deep relationships with both service providers and cloud providers, position us extremely well to address the evolving network priorities of our customers. We expect to continue growing our market share and to deliver profitable growth over the long term. Dave, let's turn the call now over to analysts for Q&A.
spk03: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. The first question comes from Samik Chatterney with JP Morgan. Please go ahead.
spk13: Thank you. Thanks for taking my questions. Maybe for the first one, if I can just ask for a bit more color on the order patterns you're seeing both on the telco and the web scale side. I mean, any color on the sequential order trends there? Because from the commentary of the Q2 guide, at least, it does appear like telco orders probably were a lot worse than you were expecting. But any more color there in terms of the magnitude of the sequential order trends between those two verticals that you're seeing? And I have a follow-up. Thank you.
spk10: Yeah, just to make, let me try to describe the dynamics here. We've just gone through Q1, which is, you know, historically a relatively low orders quarter for us, but they came in about where we expected and are slowly improving. But the premise for our guide for this year was our view, based on everything we had heard at the time, that Tier 1 service providers would be working through their inventory at a faster rate and would begin to normalize their ordering patterns by Q2. That was our premise for our plan and for our guide. What's happening is that it is taking them longer to work through their inventories. There are all sorts of issues too with respect to fiber, with respect to site readiness, with respect to labor. And all of this is causing them to take longer to work through the inventory that they have accumulated over the last year and a half. Let me make it clear, though, that they are working down that inventory and things are getting better. We do expect higher orders in Q2, but we do not think now that they're going to be at the level that would enable us to reach our Q2 guide and our full year guide. So that's what's happening. In Europe, it's really at the edges, but clearly the macro situation in Europe is not strong, and we're just seeing lower orders and expect to see lower orders from them for the year.
spk09: Samik, to your point on the cloud, that sort of contrast with the cloud, which you saw the numbers in Q1, we were up 38%. You know, year over year, we expect to see that continue to be strong throughout and good order flows throughout the year. Obviously, we've grown tremendously there. I think it's 50-odd percent growth last year. We're not going to see that kind of growth. But, you know, we're going to have a very solid year in the web scale.
spk13: Okay, got it. And for my follow-up, if I can just clarify, Jim, your comments about the long-term growth guide prior quarter. I think the previous guide was for fiscal 24 to 26 to be 6 to 8. I didn't exactly, it seemed like you were sort of reiterating that guide, but I didn't exactly capture what you were trying to imply in the updated long-term guide that you provided.
spk10: Yeah, if you think about what we said at the beginning of the year, we said 68 over three years, and that was starting off with a lower growth rate in 24, which implied perhaps a slightly higher growth rate in the later years. We're now saying that if you're doing a three-year forecast for us, you should take fiscal 24 as your base and assume a growth rate of 68%. Now, I That sounds like a guide. We're not trying to guide for 25 right now. It could well be better than that. We hope it will be. But we think for modeling purpose, it's as good a guess as any.
spk03: Okay, great. Thank you. The next question comes from Amit Daryani with Evercore. Please go ahead.
spk07: Good morning. Thanks for taking my questions as well. Maybe to start with, the updated guide at this point sort of implies that You know, you have a very steep ramp in the back half of the year for Q3 and Q4. I think you're almost implying like mid-teen sequential growth for the back half. Can you just talk about what gives you the confidence and you can get that kind of growth given, you know, the downturn you just saw from your Telco customers? And then, you know, maybe an extension of this, if the orders from these Telco customers don't materialize the way you expect, is the risk more that you're at the low end of the guide or how do I think of that dynamic as well?
spk09: Yeah. Hi, Amit. Yes, it's clearly a step function into the second half that we actually thought we'd start in Q2. We are seeing the orders, as Jim said. This is not a sort of binary event. We are seeing progress in the absorption, inventory going down, and we are seeing a gradual increase in the service provider orders. That sort of gives us confidence. And obviously, we We have deep partnerships with these guys and we're installing, you know, some of the equipment as well. So we, you know, particularly in North America where we have insight into it. I think the other dynamic, you know, that we're in a better position now is people have released their budgets and, you know, their budgets really haven't changed as I think most people have seen. CapEx has not changed at all amongst most of the major carriers for this year, and their intent is absolutely there. But what we've got greater insight into now is the planning and timing of those installations. As we've turned the year, the budgets have been released. We're now sitting in early March. we do have a better visibility into it than we did, and it's not as much of a step function, if you will, Amit, as we'd anticipated before. And that's where we've best reflected the change in the guide.
spk07: Got it. That's really helpful. And then, if I could just follow up, cloud continues to perform extremely well for you folks. I'm wondering if there's an element of some of the AI demand that's starting to come into your numbers right now, or do you think the AI opportunity is still much more of a future narrative, but it's not impacting numbers right now? Let's just understand what's driving the cloud trend and if you're starting to see some AI benefit already.
spk09: You know, I would say we're not really seeing the, you know, now there is some AI, you know, traffic, you know, with the various offerings, you know, Gemini, et cetera, you know, GPT that's out there. So that is generating some traffic, but obviously not an appreciable step function. I think, you know, our understanding with these guys is that's all to come, really, about how they monetize, you know, the broader dimensions of AI. They're investing massively right now, as we all know, in compute. and figuring out how to then release that for monetization, which will then flow into the network. So what we're seeing is just basically business as usual cloud growth. I think you are seeing an acceleration of that. You're seeing the SaaS companies do well as another sort of gauge of that. And I think we're seeing very robust. You saw it last year. We were massively in network deployments with these guys. And that was really cloud. I don't think you're seeing virtually any of the AI step function that we're all anticipating in those numbers yet.
spk07: Great. Thank you.
spk09: Thanks a lot.
spk03: The next question comes from Tal Liani with Bank of America. Please go ahead. Yes. Hi, guys. Hi, Tal.
spk14: How do we know that what we're seeing here in service providers is not structural. In your comments, you're talking about cyclical downturn that will recover absorption of inventory. When you talk to the carriers, they talk about a permanent decline in spending, their desire to spend less. Are there any parts of their spending that could be more structurally down that could be replaced by something else? or do you have really confidence that this is just cyclical?
spk09: Yeah, Tal, this is a good question, and obviously one that we're super focused on. I would separate it out. I would say in North America, I do not believe there's a structural sort of issue to it. You know, it's really about absorption, their capex, you know, what they want. Their intent is actually to spend more and absorb more, and I think with all the major servers provided, that is their intent. They want to catch up with their network builds. I do think... that there is a reticence around 5G. Obviously, you know, it's not been the monetization event for many carriers around the world that was anticipated. And I do think that, you know, there's a curtailing of that spending, which, you know, my own personal belief, I think, is structural. You know, I do not think that will have a major impact on the, you know, transmission and infrastructure build. I mean, they're very focused on access and the build out there in North America. So I think, you know, in total to it, I do not think there's a structural issue, notwithstanding my comments about 5G. You know, I would think a little bit differently on. I think they have some inherent structural challenges there. You have 180 carriers in Europe. You have some tiny jurisdictions with multiple carriers. It makes no economic sense. And I do think that, A, you're seeing a bit of a downturn in the economy in certain key countries like Germany, which is hugely influential in Europe. And I think they are more, you know, receptive to those kinds of challenges than the North American model where the economy, you know, continues to do well. So I think there are some structural issues associated with the European peace. And that, you know, that's not new news. But they are more sensitive to the economic challenges.
spk10: And India, we think, is still going up and to the right. They're going to continue to build out their economy. We had a big year with India last year. We're going to be sort of flattish with them this year. But India is going to be a great place for us for a long time.
spk09: We're not seeing any of that in Asia Pacific, either, that sort of uncertainty.
spk10: The one thing I would say, Tal, is the driver for our business is demand for bandwidth. And that has grown and continues to grow at very rapid rates. Now, the people who are building networks... To manage that demand, really, the structure has somewhat changed toward the cloud providers. If you go back 10 years ago, they weren't buying any network gear. They're buying a significant part of it today. It's very possible that that could expand over time. If there's any shift, that would be the shift from service provider to cloud providers.
spk09: Certainly in the long haul.
spk03: Yes. Great.
spk16: Thank you.
spk03: Thanks, Tom. The next question comes from Simon Leopold with Raymond James. Please go ahead. Yeah, hey, thanks, guys. It's Jeff Kochi in for Simon.
spk02: So just hoping you can maybe hash out the strength in Europe this quarter, maybe how that reconciles with your comments on maybe the weakening macro outlook there, as well as Huawei swaps or displacement opportunities. Sounds like it's going really well in India. Anything? Thank you.
spk10: I'll deal with the first part. Our regional report reflects the region into which we deliver equipment. It doesn't necessarily reflect the type of customer. So the big jump in deliveries into Europe were driven by cloud providers, not the service providers in Europe. On the Huawei thing, there's still an opportunity ahead for it. Now, the whole... supply chain and COVID situation was actually a benefit to Huawei because they had gear and service providers really wanted to stick with the status quo. They didn't necessarily want to build out stuff. And so for a combination of those two reasons, Huawei did pretty well over the last two years. The desire of Western economies to reduce their dependence upon China in general and Huawei in particular has not abated. And we think that once we get through all of this dynamic of supply chain and everything else that happened over the last few years, their desires will evince themselves in substitution of Huawei. We're seeing it in some places already, in the Nordics in particular, in some places in Southern Europe. But we think it's going to continue.
spk02: Great, great. Appreciate it. For my follow-up, you know, we are getting – There's been a lot of noise, buzz, rather, around the intra-data center opportunity for coherent technology. Maybe you could just help us understand how that could be cost-effective or when it will be cost-effective and what you think about the timing there and the sizing of that opportunity for you guys. Thank you.
spk15: Yeah, a way to think about it is as the flow rates between GPUs increase, And as the distances increase as they're forced to because of constraints like power, a lot of the techniques that were used in the WAN part of the network that brought Coherent to the forefront will replay themselves inside the data center. And some of the leaders in Coherent, we being the market leader there, are going to have opportunities to use our technology in sort of that adjacent market. Now, from a timing perspective, I think you're looking at, you know, sort of the next generation, which is probably 2025 and beyond. To get in there, the consumption models will be quite different than, you know, the system business on the WAN. But the key fundamental technologies are the same things that we've been working in in the coherence space over multiple generations.
spk02: Great. Yeah, I think... Coherent is put out a forecast for Datacom transceivers could be like, you know, 15 billion by 2028. Is there a percentage that you would put that could be coherent?
spk15: Yeah, at this point, I think it's a little early to try to size how that slices off. There's obviously a, you know, if you're coming at it from the existing generation of technology, you're trying to extend the life of that technology as long as you possibly can. and then the substituted technology that we're talking about here is obviously trying to intercept. Where that saws off, I think, is still a bit of a crystal ball.
spk10: Just to be clear, we do have a development track to develop those kinds of products in our R&D roadmap, and we are talking with major data center providers. So we're going to stay right on top of it, and when and if the shift occurs, we're going to be a part of it, we hope.
spk16: Thanks, guys.
spk03: The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.
spk08: Great. Thanks for taking the question. I wanted to dig into Europe a little bit. I know in the past, maybe some of that European telco spend was actually kind of indirect cloud spend as they kind of helped with data center builds for some of those customers. And so just wanted to get a sense of kind of if any of the weakness you're seeing is kind of on the indirect part and if any of that's just due to kind of power constraints that we're hearing about in kind of building out data centers or just any commentary there on kind of the indirect portion. And then maybe just as a follow-up question, just as you know, Jim, on how much you plan to kind of work down inventory levels across the year would be helpful. Thanks.
spk09: Hi, Matt. Yeah, there is, you know, there has been a shift over a few years where particularly the cloud providers used, you know, wholesale type capacity in Europe. Increasingly in the last sort of couple of years, they've been going direct and taking dark fiber. And I think that has impacted some of the service providers, particularly the wholesalers, and obviously they come direct to us as opposed to through the carrier. So I think you have seen that dynamic, particularly in Europe. That's not the case in most other international jurisdictions where you've got regulatory issues and the rest of it. So it's much more of a hybrid in other countries such as India. But I do think that has impacted somewhat some of the wholesale capacity in Europe is now direct into the hyperscalers.
spk10: On the inventory question, Matt, You know, we said that we were going to improve and reduce our inventory levels this year, and we will. As you saw, we reduced our inventory by $66 million in Q1. And we've slowed the rate of material into our system to match our demand forecast. So we are confident we're going to take our inventory down this year. Because Q2 is going to be a bit lower than we expected, and the rest of the year a bit lower as well, we're probably not going to get down as low on inventory as we said we would. I think we said we were going to get it down by $300 million or something like that. And I think we'll get it down by a couple of hundred million, I would think. But I think, on the other hand, it might grow in Q2 because the situation is a little bit late-breaking for us and we can't react to it quickly enough. But we will drive inventory down for the year by at least a couple hundred million.
spk08: Great. Thank you.
spk03: The next question comes from George Nodder with Jefferies. Please go ahead.
spk05: Hi, guys. Thanks very much. I guess I'm curious about where your product lead times are right now. I'm wondering if product lead times are quite short, and that's leading to some of the excess inventory issues. taking longer to bleed off. Can you just talk a little bit about that dynamic, lead times versus buffer stocks at customers?
spk15: George, lead times, we have a very broad portfolio, so lead times vary. But if you wanted a single number on it, we sort of have published 12-week lead times to our customers. The reality is, as we've executed through Q1, we are executing in a much more better rate than that in terms of lead times. We're approaching getting back to sort of pre-pandemic lead times. Not quite there yet, but approaching getting back to that. And I think that does have an impact in terms of our customer order behavior patterns. If they don't need to place it with 52-week lead time, they're not going to place it with 52-week lead time.
spk05: Got it. And then, I'm sorry, normal pre-pandemic lead times were what range? Also 12 weeks?
spk15: Depending on the portfolio for us, it was mid-single digits for weeks.
spk09: Depending on the product line.
spk05: Got it. Okay. And do you think it's the case that, you know, customer inventories are It sounds like the issue is mostly North America. Is it broad-based across North America, or is it more concentrated around a handful of customers?
spk09: I would say it is North America. It's one of two examples internationally, but they're not super meaningful to this conversation. I think it's mainly North America, and it's mainly the tier ones. But it is sort of shared challenge across most of the larger carriers in North America, who obviously tried to get out ahead of the whole supply chain piece. But now, you know, you've got this dynamic where we and other vendors are turning up with enormous amounts of equipment. I mean, you know, I think we shipped 24% more equipment last year than we did the prior year. And, you know, you think about all those trucks turning up at the same time with a bunch of other vendors, you know, to put the system together. And that's causing, you know, the challenges around their capacity and all the various facets of people, storage, logistics, fiber availability, you know, etc. to back up. and it's just taken longer than we all, including them, would like or anticipate. And to your earlier point, George, until we kind of move down through that path, and particularly with reduced lead times, it's super logical as to why we see the orders being what they are. They are improving, and we are seeing the deployment. I want to stress that. This is not a sort of binary event. It's We're seeing improvements in absorption. The inventories are coming down. We're seeing an increase in orders in service providers. It's just not the step function I think we collectively anticipated.
spk10: And to be clear, in this context, we're referring not just to telecom service providers, but MSO services.
spk09: I'd include cable in there too, yeah. Thank you, guys.
spk10: George.
spk03: The next question comes from Michael. Genovese with Rosenblatt Securities. Please go ahead.
spk04: Oh, great. Thanks. I wanted to follow up on the last question because I understand mostly what you're talking about with these North American service provider challenges, but the comment on fiber availability, could you flesh that out a little bit more? I'm kind of struggling to come up to speed with what that means.
spk15: Yeah, Michael, you probably can appreciate the majority, like the big builds and equipment consumptions are when people are putting down new routes or lighting new fibers. The process of procuring those fibers, even though everybody has intentions to put more fiber in the ground, as North American customers have announced. There's a process of construction there, and it takes time. And I think it's exasperated by, you know, the labor market in North America as well. So getting access to the fiber, tension is there. Timing is taking longer. Going through characterization of that fiber and then finally doing the construction to light it is just taking longer than we had anticipated with the volume that they're trying to do. They're working through it, you know, our visibility to it and where we can help our customers is on our installation services, and you can see that is up, you know, period over period quite substantially. It is happening. It's just taking longer than we anticipated going into the year.
spk04: Okay, great. And then I guess my next question, you know, just the competitive environment for DCI, I mean, it seems like you've maintained a very high level of market share in DCI. As As ZR has become more important, are you finding a different set of competitors in the market? How has the competitive environment changed recently in DCI, if at all?
spk15: Yeah, I think two different views of it, I guess. The ZR impact has not impacted our business at all. In fact, you can see record quarters for Wave Server in our Q1 2018 and 24 results, you know, a massive wave surge. And that's all DCI, or for the most part, all DCI. So it's clearly not impacting our business as some people may have impacted. Our business with the web scale was up like 57% year on year for 2000, last year for 2023. So, you know, again, big parts of that is various different flavors of data center interconnect So, you know, clearly not having a negative impact there. And, in fact, I think if you do the math on the market size, you'll conclude that we gained share with the GCNs last year. In terms of the number of competitors from a pluggable perspective, yeah, you start to get different sort of consumption models. At the end of the day, you know, it's still a very limited number of folks that are investing in the key technologies that go into these ZR plugs. You get various different ecosystems that are trying to put them together. I'm a firm believer from a philosophy perspective. If you don't own some of the core technologies, you're probably not long for that world. But, you know, that'll take some time to play out. And as you know, you know, we own and control our own destiny and all those key technologies.
spk10: And just to be clear, we have roughly 50% market share globally with data. with web-scale companies. If you take out that which Huawei does, which is just about entirely in China, then it gets to be a bit higher than that. So we're very comfortable with our share position, and we think it's going to remain at that level. Probably hard for us to gain share from this point because they all want a second source, but we'll take 50% plus.
spk09: Thanks so much.
spk10: Thanks, Mike.
spk03: The next question comes from Alex Henderson with Needham. Please go ahead.
spk12: Great, thanks. I was hoping we could talk a little bit about the mix between product and service and the 24 expectations. I realize that service was up quite a bit in the January quarter, but it was actually down significantly quarter to quarter because the January quarter is typically a lockdown quarter for most service providers. In terms of mix, you pointed out that there was a shift to transceivers, which they will install, but not line systems. So I'm assuming that the line systems installation is going to increase meaningfully quarter to quarter. And therefore, you're looking at, what, $210 million to $220 million of service, which would imply that the product sales are down, what, 25 to 35 percent, something in that range? And, you know, how does that play out over the course of the year, you know, as the installation continues to be churning through what's been shipped as opposed to new shipments? And then does it fall off at some point after an undershipment period, you know, so we get out into the fourth quarter and into the first half of 25, does this service start to roll off? Can you give us some guidance on that?
spk10: Let me give a little context here, Alex. You have to think about that services business. Really, it's two businesses. One is maintenance and one is installation. Those are the two things that we do. And we have some other consulting-type practices and advanced-type services, but those two make up the bulk of it. The maintenance expense is going to essentially as our product sales grow because almost everybody takes maintenance with our product. So that's one piece. On the implementation side, it's not one size fits all. For most of the larger carriers in the U.S., we don't do a ton of installation. Now, we have started to as they are trying to work through their inventory levels. But in the past, we didn't do a lot of installation for them. In places like Asia, South America, sometimes in Europe, we do a lot of installation. So our services mix is going to be, I think, more related to where our sales are. And I'd say this, that we love expanding our implementation business, and we'd love to continue to help our big customers here in the U.S., and that's what we're trying to do. Scott?
spk15: Yeah, absolutely. That's the dominant dynamic, Jim. You're right. I think there's some nuances in there. You know, the installation services pieces of it, it varies by geography and it varies by portfolio. So historically, we haven't done a lot of installation services on our running and switching portfolio, for example. As those solution sets get more sophisticated, our customers are and will continue to look to us to do more installation. You know, mixed geographically, in some parts of the world, we do those installation services ourselves. In some parts of the world, the customers do it themselves. In some parts, they turn to third-party partners to do it. And, you know, it varies quite a bit on the mix of where that revenue is coming from, and that's going to change over time. In addition to that, it's not a major piece of it, but our services team is also busy, you know, trying to expand their service offers to our customers, and that we hope to grow over time. We think our service business is going to continue to grow at or above the growth rate for the company.
spk12: Just to be clear, though, the seasonal swing between the January and the April quarter, normally services are lower in the first quarter because of the lockdown. Are we expecting it to be up sequentially, you know, 212, 215, something like that, in which case the majority of the quarter-to-quarter decline is in the product side?
spk10: You know, it's always very risky to try to give individual slices of what we expect of our business. I would think this. Because of the dynamics that we talked about, because we will show growth in Q2 in our overall business, it is likely that services will grow as well. So I don't have a number for you, but I think it will probably grow just like the revenue will grow in Q2. Okay.
spk16: Thanks, Alex. The next question comes from David Vogt with UBS. Please go ahead. Hi, David.
spk11: David, your line might be muted. Sorry, guys, I was on mute. Thanks again for all the color. Maybe just digging back into backlog and orders, maybe, Jim, can you help us understand where backlog exited the quarter? I think last quarter you'd mentioned it was roughly around $2.6 billion. So what we're trying to figure out is what the orders look like going forward and how to kind of triangulate the growth rate in 25 in terms of an order trajectory. And I have a follow-up.
spk10: We ended backlog at Q1 at $2.2 billion. So you can sort of calculate what our orders were in Q1. We said last quarter that that we expect our backlog, generally speaking, to come down for the full year because we are approaching historical levels of lead times and customer ordering behaviors are probably going to track those in the past, which means that our ending year backlog is going to approach a level like the levels we had prior to all the craziness of the past three years, which traditionally has been about 35% to 40% of the coming year's revenue. And that consists of a billion dollars or so of services and about a billion dollars of products and software. That's what it's been historically. I mean, that's what makes up the 2.2.
spk11: Great. And so maybe if I just extrapolate that comment In 24 into 25, maybe I'm doing the math wrong here, but it would imply that your order growth rate in 25 would have to be up somewhere like 35% to 40% relative to 24. Are we doing the math right? And if that's the case, what does that imply for SP orders coming back next year? I know you didn't give full year guide yet. It's early, but just trying to kind of triangulate on how we get to that 6% to 8% multi-year target that you just provided. Thanks.
spk10: Rather than give you a number for our growth rate and orders next year, what I would say is this. A healthy business, which we've had for a long, long time prior to the supply chain disruption and COVID and all that sort of stuff, we typically ran orders in a given year at some fraction above our revenue, whether it was 5%, whether it was 10%, some number like that. So we're not at those levels right now. which means that we do have to have some catch-up as we move through the next couple of quarters and possibly some catch-up next year. But that's what we expect our order volumes to be, 1.05 to 1.1 times our revenue for a year, for example, and it varies by quarter.
spk09: And that's obviously a function of the lead time piece as well. So typically, if the world ever gets normalized, it would be slightly ahead of the revenues for the year. Now, there may be some bumpiness as we get into that. I mean, for example, in 22, I think our orders were close to $6 billion, just to give you an order of magnitude around the challenges that we're having from a backlog point of view. Got it.
spk11: Helpful, Gary. Thanks, Jim. Appreciate it.
spk03: Thanks, David. The next question comes from Ruben Roy with Stifel. Please go ahead.
spk06: Yes, thank you for taking my question. Gary, I had a follow-up on some of the commentary around AI and then, you know, just increasing order rates with cloud and just trying to work through, you know, not seeing yet, you know, sort of the, you know, impacts of traffic growth outside of the data center, you know, the traffic that you mentioned being created by the GPUs, et cetera, and yet the, the order rates are up. So am I right in assuming that the cloud DCI business is mostly for a long haul and you know, if that's the case, can you talk to sort of how you're thinking about the sustainability of, you know, sort of those orders around, you know, that specific business cloud DCI?
spk09: Yeah, I think it is. It's more of a mix than you think around long haul and metro amongst these, you know, when we talk about them and we all tend to, you know, these hyperscalers as sort of, you know, a sort of generic grouping. You think about their business models, they're all very different, you know, be it search, be it, you know, cloud, et cetera, you know, Azure type services. So therefore, their networks are actually very different as well, and including all of the submarine cables and the metro piece and the rest of it. So these are now very large, very complicated global networks that is not just simple, you know, data center connectivity, you know, point to point. They are, you know, they use 6500 in full configuration with, you know, resilience, et cetera, across there. So they are you know, fully blown intelligent networks. So to your point, Ruben, around that, and the traffic that they're obviously flowing right now is data center to data center. The opportunity is, you know, when you get the AI applications coming out of the data center to monetize, they have to go to the WAN. They have to go to consumers in their various forms, be them enterprise or, you know, general consumers. And it has to pass across that network. And also, you know, from a model point of view, it needs to talk to the instantiation locally, be it edge compute or whatever the devices are. It needs to maintain connectivity to it. It's not just you dump the model down there at the edge of the network and you're good to go for a month. This stuff has to maintain connectivity. So, you know, we're all sort of... Very excited about the opportunity, but that hasn't yet come out of the data center, but they're obviously investing massive amounts of investment in the compute and in the application and monetization of that. That investment has not flowed to the network yet.
spk15: The other dynamic on the AI piece, having impact on the WAN traffic, is because of the massive amounts of compute and the power required to do that, every one of the cloud providers is talking about the need to further distribute their compute platforms. And that's going to mean more data centers, more geographical distribution. And guess what? When you do that, you've got to network them together. So that's going to be more transport, more networking gear. That's going to be another dynamic as AI starts to have an influence on, I'll just say, the classic transport part of the network. I think I'd add, Gary, in terms of where are we today with these folks? Yes, it's their campus slash metro DCI. It's their terrestrial core networks. It's their submarine networks. But it's also across our transport portfolio. It's line systems. It's coherent modems and however they want to instantiate it. And to some people's surprises, it's our software portfolio and it's our services portfolio as well. So it's quite a broad set of solutions that we're in that segment with.
spk06: I really appreciate the detail, guys. That's really helpful for me. If I could sneak in a quick one for Jim on gross margins. Jim, just sort of maintaining the mid-40s for the full year, given lower volumes and lower revenue. Can you just – I might have missed this, but did you talk through mix or linearity of how you think gross margins play out over the next several quarters?
spk10: Yeah, I think they're going to be a bit lower in Q2, and that's a – Mix and volume, because as we said, we're not going to have the volume that we expected in Q2. But I think we'll average in the mid-40s for the full year. We started the year at 45.7. It was a good, strong start, and we'll get back to something like that.
spk06: Understood. Thank you.
spk01: Great. Thank you, Reuben. Thank you, everybody, for joining us today. We appreciate your attention, and we look forward to seeing everyone at OFC. Thank you, and have a good day.
spk03: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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