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Good day and welcome to Ciena's Fiscal First Quarter 2024 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Thank you, Dave. Good morning and welcome to Ciena's 2023 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 Investors 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 non-GAAP measures to our GAAP results is included in today's press release. Before turning the call over to Gary, I'll remind you that during this call we will be making certain forward-looking statements. Such statements including our quarterly and annual guidance and our long-term financial outlook and discussion of market opportunities and strategy are based on current expectations, forecasts, and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. Assumptions relating to our outlook, whether mentioned on this call or included in the investor presentation that we'll post shortly after are important part of such forward-looking statements and we encourage you to consider them. Our forward-looking statements should also be viewed in the context of the risk factors detailed in our most recent 10-K and our 10-Q which will be filed with the SEC today. Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events, or otherwise. As always, we will allow for as much Q&A as possible today, though we'll ask that you limit yourself to one question and one follow-up. As a reminder we will 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.

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 $0.66. 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

[Operator Instructions]. The first question comes from Samik Chatterjee with J.P. Morgan. Please go ahead.

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% 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 we're going to have a very solid year in the web scale.

Okay, got it. Thank you.

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

Good morning, thanks for taking my questions as well. You know, maybe to start with, the updated guide at this point sort of implies that you have a very steep ramp in the back half of the year for Q3 and Q4, I think almost implying like mid-teen sequential growth for the back half. Can you just talk about what gives you the confidence that you can get that kind of growth given the down-tick you just offered to your telco customers? And then 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?

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, you know, 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 have deep partnerships with these guys and we're installing some of the equipment as well. So we particularly in North America where we have insight into it. I think the other dynamic that we're in a better position now is people have released their budgets and 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 -- 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.

Got it. That's really helpful. And then if I could just follow up, cloud continues to perform extremely well for you folks. I am wondering if there is an element of some of the AI demand that's trying 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 your numbers right now, let's just understand what drives the cloud trend and if you have time to see some AI benefit already?

You know, I would say we're not really seeing the, now there is some AI traffic with the various offerings, Gemini, etcetera, GPT that's out there. So that is generating some traffic, but obviously not an appreciable step function. And I think, our understanding with these guys is that's all to come really about how they monetize 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've seen the SaaS companies do well as another sort of gauge of that. And I think we're seeing very robust, we 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.

Great, thank you.

Thanks Amit.

The next question comes from Tal Liani with Bank of America. Please go ahead.

And India, we think, is still going up in to the right. They're going to continue to build out their networks. 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.

Your next question comes from Simon Leopold with Raymond James. Please go ahead.

Just to be clear, we do have a development track to develop those kinds of products in our R&D road map. 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.

That’s all, thanks guys.

The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

On the inventory question, Meta, we said that we were going to improve and reduce our inventory level 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 expect 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 of hundred million.

Great, thank you.

The next question comes from George Notter with Jefferies. Please go ahead.

Depending on the product line.

Got it. Okay. And do you think it's the case that customer inventories are -- is the issue -- 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?

I would say it is North America. It's one or 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 1s, but it is sort of shared challenge across most of the larger carriers in North America who have obviously tried to get out ahead of the whole supply chain piece. But now you've got this dynamic, where we and other vendors are turning up with enormous amounts of equipment. I mean, I think we shipped 24% more equipment last year than we did the prior year. And you think about all those trucks turning up at the same time with a bunch of other vendors to put the system together, and that's causing the challenges around their capacity and all the various facets of people, storage, logistics, fiber availability, etcetera, to back up. And it's just taken longer than we all including them, would like or anticipate. And to your earlier point, until we kind of move down through that path and particularly with reduced lead times is it's super logical as to why we see the orders being what they -- 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.

And to be clear, in this context, we're referring not just to telecom service providers, but MSO service...

Thank you guys.

Next question comes from Michael Genovese with Rosenblatt Securities. Please go ahead.

Okay, great. And then I guess my next question, just the competitive environment for DCI, I mean it seems like you've maintained a very high level of market share in DCI. As

And just to be clear, we have roughly 50% market share globally 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.

Thanks so much.

Thanks Mike.

Next question comes from Alex Henderson with Needham. Please go ahead.

Yes. That's the dominant dynamic, Jim, you're right. I think there's some nuances in there. 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 routing and switching portfolio, for example. As those solution sets get more sophisticated, as our customers are, and we'll continue to look to us to do more installation. Mixed geographically, in some parts of the world, we do those installation services ourselves. In some parts of the world, the customers do themselves, in some parts they turn to third-party partners to do it. And there's -- 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 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.

Okay, thanks.

The next question comes from David Vogt with UBS. Please go ahead. David, your line might be muted.

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 2022, 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, helpful Gary. Thanks Jim. Appreciate it.

Next question comes from Ruben Roy with Stifel. Please go ahead.

Yes, thank you for taking my question. Gary, I had a follow-up on some of the commentary around AI and then just increasing order rates with cloud. And just trying to work through not seeing yet sort of the impacts of traffic growth outside of the data center, the traffic that you mentioned being created by the GPs, etcetera, and yet the order rates are up. So, am I right in assuming that the cloud DCI business is mostly for a long haul and if that's the case, can you talk to sort of how you're thinking about the sustainability of sort of those orders around that specific business, cloud DCI?

Yes. I think it's more of a mix than you think around long haul and metro amongst these. When we talk about them and we all tend to, these hyperscalers as a sort of generic grouping. You think about their business models, they're all very different, be it search, be it cloud, etcetera, 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 data center connectivity, point to point. They are -- they use 6,500 in full configuration with resilience, etcetera, across there. So they are fully blown intelligent networks. So, to your point, Ruben, around that on the traffic they're obviously flowing right now is data center to data center. The opportunity is 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 general consumers. And it has to pass across that network. And also from a model point of view, it needs to talk to the instantiation locally, be 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 we're all sort of -- we're 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 has -- that investment has not flowed to the network yet.

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 with 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. It's -- yes, it's their campus/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 surprise, it's our software portfolio and it's our services portfolio as well. So, it's quite a broad set of solutions that were in those -- in that segment with.

Understood. Thank you.

Great. Thank you, Ruben, and 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.