Q3 2022 Ciena Corp Earnings Call

September 1, 2022

The conference will begin shortly to raise your hand during Q&A you can dial star one one.

Okay.

Good day, and thank you for standing by welcome to the CMS fiscal third quarter 2022 financial results conference call. At this time all participants are in a listen only mode. After the speakers' pre.

There will be a question and answer session.

To ask a question. During this session you will need to press star one one on your telephone.

Please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Gregg Lampf, Vice President Investor Relations. Please go ahead.

Thank you Michelle.

Morning, and welcome to <unk> fiscal third quarter 2022 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 on 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 Q3 performance our view on the current demand environment and supply chain conditions as well as a discussion of our financial outlook.

Today's discussion includes certain adjusted or non-GAAP measures are CNS 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 you that during this call excuse me will be making certain forward looking statements.

Such statements, including our quarterly and annual guidance discussion of market opportunities and commentary about supply chain constraints on our business results are based on current expectations forecasts and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ 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 an important part of such forward looking statements and we encourage you to consider them.

These statements should be viewed in the context of the risk factors detailed in our most recent 10-K filing and in our upcoming 10-Q filing which is required to be filed with the SEC by September eight.

We expect to file by that date.

Sina 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 I'll ask that you limit yourselves to one question and one follow up with that I'll turn it over to Gary.

Thank you, Greg and good morning, everyone.

Today, we reported lower than expected fiscal third quarter financial performance, including revenue of $868 million and adjusted gross margin of 40%.

In a moment I will discuss the specific supply chain challenges that impacted our results.

Continued actions to mitigate their effects on our customers and that business.

Before doing so however, I think it's important to understand the context of the current environment as it relates to Ciena and specifically <unk>.

<unk>.

Despite supply chain challenges elongated lead times strong secular demand trends show no signs of abating.

And we remain confident.

Fundamental macro drivers propelling this demand are durable over the long term.

As we all know these include five G cloud and automation in addition to infrastructure spending residential broadband funding and opportunities to displace Huawei.

Combination of the secular drivers and our market leadership, including our technology investment capacity and global scale is driving continued robust demand from customers in both absolute and relative measures.

In fact, we had nearly 60% order growth and our last four quarters versus the same prior four quarter period.

In Q3, specifically orders outpaced revenue by more than 30% and we continue to grow our backlog, which is now well over $4 billion.

And we project further growth in our backlog in Q4.

Obviously as we convert this large backlog to revenue and continue to win new business and a strong demand environment, we have confidence in continuing to gain market share as the supply chain challenges ameliorate.

Now, let me talk about supply chain.

In the face of this strong demand and challenging supply chain conditions persist.

I would like to note that at a high level. The majority of our suppliers on delivering to that promised, albeit extended lead times and we are also starting to see higher volumes.

And I think this is sort of consistent with recent market commentary that has pointed to some signs of improvement in the overall supply environment.

However, we have recently been challenged by the unpredictable performance of specific vendors and their associated component traits.

When we spoke to you after our second quarter and our outlook for the remainder of the year reflected commitments made to us by our suppliers in early June .

A very small number of them did not meet.

Specifically in the second half of Q3, we experienced substantial delays and lower than expected component deliveries from this very small group of suppliers.

These late notice did commence were primarily for certain integrated circuit components.

Presents a very small fraction of our overall materials.

However, these delays and <unk> commence impede our ability to build and deliver finished goods and systems such as modems.

For our customers and our ship product for revenue.

Put another way this relatively small number of low cost low value component is holding up a disproportionate amount of revenue primarily for our optical modems.

As a result, our Q3 revenue and adjusted gross margin were both negatively impacted to a significant degree.

And to size this for you.

But for this specific challenge.

We would have been a high end of our revenue range and in line with consensus gross margin expectations for Q3.

I would also say that certain of the supply dynamics have continued into our fiscal fourth quarter and are expected to negatively impact our current quarter's results, which Jim will discuss shortly.

We remain very focused on our investments and actions to minimize the impact of these challenges on our customers.

Firstly, we are working very closely with the small number of partners to resolve these acute challenges around delivery commitments and volumes.

Secondly, we continue to qualify engineering alternatives to expand our sources of supply and to pursue product redesign activities.

And thirdly, we continue to invest in our readiness with respect to contract manufacturing capacity as well as our inventory levels to be prepared when these components do arrive.

As a reminder, we also continued to place large advance purchase commitments in their various forms.

Premiums and expedite fees and access the broker market to secure additional supply.

While these actions have obviously been ongoing for a long time and that benefits take time to be fully realized we believe that we will start to achieve an improvement in volume and predictability with our suppliers as we move into fiscal 2023.

Okay.

But at the same time.

Horton to stay focused on the investments that we're making in our long term strategy to further open the aperture of our addressable market.

Our portfolio and solutions offerings are at the heart of our customers' network priorities and our innovation has never been stronger or more competitive than it is today evidenced by the strong order flows.

In optical in Q3, we added 14, new customers for wave logic, five extreme and despite the supply challenges, we had a record number of quarter for wave logic five shipments, bringing our total waived logic five extreme modem and shipped to date to more than 44000.

And for wave logic, five extreme specifically Q3 was strong with North American tier one service providers as well as web scale customers.

Also in the quarter, we were awarded sole vendor status with a large international tier one service provider for a major network upgrade.

I would also say that our switching and routing revenue grew 45% not all organic year over year as we continue to capture additional opportunities and expand that Tam in this important area with differentiated adaptive find pay approach, which is clearly resonating with customers.

Yes.

In Q3, we added 25, new adaptive IP customers, bringing the total to nearly 200 as customers continue to seek alternatives to many traditional legacy IP vendors.

Of those new customers, many more wins in key new areas, including five <unk> cell site routing residential broadband and enterprise with the UCP SD Wan solutions.

Of particular note is the momentum with our universal aggregation in PON solution, where our customer count has grown significantly this year and we are now expanding globally.

Indeed, as you can see in our Q3 results routing and switching portfolio has not been impacted to the same extent by supply chain challenges.

Certainly when compared to our converged packet optical segment and.

And I think this is consistent with some of the more positive recent commentary from others in the packet IP space.

Overall, we have tremendous momentum and the combination of significant secular demand drivers leading portfolio.

Our Tam expansion opportunities.

The business has never been positioned better.

As we are increasingly able to service the unprecedented demand we are confident in our ability to continue to gain share and expand our addressable market.

With that I'll turn it over to Jim.

Gary.

Everyone.

As Gary mentioned revenue in Q3 came in at $868 million, reflecting the impact from the late and incomplete delivery of key components by small number of suppliers adjust.

Adjusted gross margin was 40% in Q3, which was at the low end of our range.

Overall gross margin continues to reflect the negative impact of higher component costs and expedite fees. In addition to that dynamic in Q3 gross margin performance also reflects the specific supply chain in the quarter as the key components mentioned before.

Primarily related to our higher margin modem technology.

Had it not been for the lack of those key components revenue would've been approximately $60 million higher in the quarter and at the high end of our outlook range and adjusted gross margin would have been in line with expectation.

Adjusted operating expense in the quarter was $273 million. This is below our expected range.

During the quarter, we reduced our accrual rate for our annual incentive compensation plan, given our expected financial performance for the year.

With respect to profitability measures in Q3, we delivered adjusted operating margin of eight 5% adjusted net income of $49 million.

And adjusted earnings of 33 per share.

In addition in Q3 cash used for operations was $205 million free cash flow was a use of $227 million and adjusted EBITDA was $96 million.

We ended the quarter with approximately $1 $3 billion in cash and investments.

On the balance sheet, our current inventory levels reflect the current demand environment as well as the impact of the supply dynamics Gary mentioned.

Since 2021, we have been ordering all of the components and sub assembly required to meet our backlog based upon vendor published lead times.

And other than a handful of vendors, but supply chain is delivering at 90% reliability.

Lack of performance by that handful of vendors is preventing delivery to customers.

Therefore, we are accumulating components, while we wait for delivery of those specific remaining items that are necessary to produce finished goods.

We expect our inventory levels to reduce over time as the delivery performance for these key components stabilizes.

Finally in Q3, we repurchased approximately three 2 million shares for $155 million.

We have now completed our goal of repurchasing $500 million in shares in fiscal 2022.

With respect to guidance as we said last quarter in today's market environment. Our revenue is not a function of demand. It is a function of supply.

And as Gary said and we've repeated we have a very small number of suppliers that are not meeting their commitments floor, our expectations in terms of delivery times and volumes for a handful of low cost low value parts.

These decommit are having a disproportionate impact on our revenue we saw that in Q3 and we are seeing these dynamics continue in Q4.

As a consequence in Q4, we expect to deliver revenue in a range of 800 $880 million.

This range is lower than previously expected and incorporates a wider set of potential outcomes, reflecting our expectations for a continuation of key components supply challenges in the quarter.

Adjusted gross margin of approximately 40%.

Similar dynamics to impact gross margin in Q4, including lower modem volume and continued higher component costs and logistics expenses.

And finally, adjusted Opex of approximately $315 million.

This reflects a return to more normalized levels from the atypical Q3.

Q3, as a reminder was below our original outlook due to the reduction in the accrual rate for our annual incentive compensation plan.

Additionally, in Q4, we expect a higher level of variable sales compensation, reflecting the extraordinary level of demand we have described.

For the year will really approximately on the guide we gave at the beginning of the year absent the changes in our annual incentive compensation plan, which I've discussed.

As we look to next year.

We remain set up well for outsized growth next year and continue to expect to deliver revenue growth significantly above our annual long term target of 6% to 8%.

The strong demand environment, and our backlog reinforced our confidence in these expectations for fiscal year 'twenty three.

And our current revenue expectations for 2023 remain at the level, we referenced when we reported Q2 90 days ago.

With that we'll now take questions from the sell side analysts Michelle.

As a reminder to ask a question you will need to press star one on your telephone please standby, while we compile the Q&A roster.

The first question comes from George Notter with Jefferies. Your line is now open.

Hi, guys. Thanks, a lot for the question I guess.

Sort of stepping back bigger picture here.

Can you talk about.

How you're dealing with these issues in terms of customer conversations.

I guess one thing I'm curious about is just on a relative basis. It seems like you guys are doing worse.

<unk> your competition in terms of deliveries here.

I'm kind of wondering.

Is this going to impact <unk>.

Long term market share long term opportunity for CN.

How how permanent do you think the damages here in terms of your customer relationships.

So George let me, let me take that I mean, I think listen we've got very close relationships with all of our customers many of which go back some of which go back decades.

So I think we have strong degrees of trust and transparency with them.

And we can only talk about what we see in terms of the challenges from a supply chain point of view and the difficulties that were encountering that but we've been very transparent with them.

And I think the best way of sort of answering that is sort of summary, George is really we're continuing to see very robust orders.

We've not seen cancellations we've seen.

Orders continue to well out strip.

Revenue.

The statistic that I kind of shed about 60%.

Year on year.

Order growth for the last four quarters sort of testament to it.

They understand the challenges that.

We're having but I.

I think because of our technology and our relationships.

We believe that.

When all of the the smoke clears from all of this begins to ameliorate that we will actually gain share given the outsized demand, but we.

<unk>.

Got it.

Okay.

Comment on.

George on the vendor side.

I can tell you that.

We do see some improvement on most components.

In fact for the majority of our vendors for everyone except these key.

Components that we're talking about we're seeing about a 90% deliverability performance against promise lead time, which is pretty good.

So we're focused of course on this very small number less than a handful of vendors that are not delivering in fact, they're they've been quite unreliable and have caused us great difficulty, we're dealing with them appropriately at all levels of the company.

We're hoping that performance improves as we move through time and in the meantime, we're taking a lot of steps to deal with it in case it doesn't such as.

We specify parts on our boards et cetera.

Yes, that's what I wanted to ask about so where are you in the process of redesigning these components out how many components.

Typically are we talking about when might those redesigns be done just give us any more detail there that would be great.

Yeah.

As Roger Scott.

So just in terms of dimension it.

And as Jim said, the vast majority of the supply chain is.

Pretty much delivering to their promises were talking about a very focused that.

Of components here and to put it in perspective, let me say that it's a couple of handfuls of component parts.

On a handful of vendors.

Obviously, we have a significant amount of redesign work going on as.

As a vehicle to get at those problem components. In addition to working with the existing components suppliers to get to get a better answer out of them as well on the design side, Georgia.

Fall into two categories. One is the sourcing exercise, where you may be able to find alternative components.

That better.

That are plug replaceable.

In that case, you still have to get in line to lead times from those component providers, but it's it's a less of a heavy lift on our side for the second category of course is where you need to redesign in order to take advantage of those component parts and those are hardware redesigns and those are multi quarter activities all of that activity I think starts to come on board in two.

And in 'twenty, three and we'll start to see.

Gradual benefit from that as we go throughout the year. In addition to continuing to work with the existing component suppliers.

And to be clear again. These this handful of suppliers has been very reliable in the past. This is a new phenomenon of courseware in unusual times, but when we have spoken to guidance in past quarters, we have always based our expectations of revenue upon their published lead.

And the fact that they have met those lead times in the past. So that's how we came up with our our view of the world.

That's why we've guided where we have.

Okay. Okay. Thank you.

And a number of those vendors Georgia.

<unk> multiple parts to us and in many cases.

Many of their parts are performing as they as they promised this was a very focused subset.

Okay. Thank you guys.

Please standby for our next question.

Our next question comes from Ben Swinburne with Morgan Stanley Your line.

Line is now open.

Great maybe just kind of.

Jumping on George's question is there a way to size kind of the.

The impact of.

Products already redesigns or we can just get a sense that given that we're a year through this that you've already redesigned and that's made X number of revenue available to us what kind of balance out some of the.

<unk> drops that we're seeing.

And the second piece would be just as you kind of continue to express.

In fiscal 'twenty three.

What are you basing that confidence on would be helpful. Thanks.

Well I don't know.

So that second part first.

Martha.

We're basing that confidence on first of all incredible visibility and backlog.

So that's.

That's number one number two.

The actions that we've taken which are multifaceted.

We're trying to get out ahead of US. This is not a reactive piece I mean, we've talked about this for a while we knew that demand was going to increase substantially this year than we planned as we shared with you for well double digit growth.

This year and we took a.

What we thought were the right.

Supply chain actions in place for that in terms of placing orders in terms of actually engineering work to reduce that dependency.

Those things start I think to kick in as we come as we come out of this year or into 'twenty three.

Whilst we're cautious given the impact.

We're seeing both in Q3 and Q4.

We believe that they will ameliorate from actions that we've taken and the work that our partners are doing also to ameliorate the issue. So.

We have we have very good confidence as we as we turn the year that this will start to improve it won't be.

And on off switch it will be.

Process that improves.

We start in Q1, but it does give us confidence.

In the year, we start to grow out of this.

And maybe just to give you.

Some sizing on the activities.

If you look at our total component.

Bill of materials, if you like for the entire portfolio we've had.

Multi sourcing activities under its qualifying alternative parts that adds about 10% or.

Two our approved vendor list, obviously focused on on the challenge areas.

The timing challenge with that of course is when you when you identify new component you get their new orders and you get in line on their lead times. So.

Those activities were ongoing throughout 2022.

The lead times in history would suggest that those are going to start to come and have an impact on our ability.

A wider aperture if you like for the supply components in 'twenty three.

On the redesign side, we've got.

Multiple tens of redesign activities on the go right now, which was probably about 10 times more than we would have in a normal year.

All of those are in front of US those are all 2023 impacts because they really are hardware redesign. So they will help in 'twenty three as well.

Maybe put another way to look at it if those problems that didn't exist.

On that very small handful of components.

We would have.

<unk> had revenue in the range of our original yearly guide and then some just on the just on alleviating those those small number of components.

Hopefully that helps to dimension it Brent.

Okay.

Thank you made it.

Please standby for our next question.

Our next question comes from Paul Silverstein with Cowen and company. Your line is now open.

Claus.

Backlog increased to exactly.

So significantly greater than $4 billion, but what was the sequential increase what was the book to Bill. This quarter remember was one five over $1 five last quarter what was it this quarter.

And Jamie.

Im sorry circle.

Yes.

The next question from Joe.

Ask your second question as well Paul.

Headcount was up almost 500 sequentially.

Massive growth total head count more than we've seen in a long time.

That all about.

So let me take the first part of that and then Jim can talk about the headcount growth.

The revenue two orders orders were about 30% above revenue in Q4, I'm sorry in Q3, we expect as well the orders to be above <unk>.

Revenue in Q4, so we're going to create more backlog. The backlog goes we turn out right. Now is about four is approximately $4 4 billion pool.

I apologize Gerry that result.

<unk> from previous quarter.

Oh, yes, yes, yes, absolutely our bottom line.

It's up a few hundred million dollars alright.

Alright, and been fortunate on the lawsuit.

Jim go ahead.

Go ahead.

Yeah.

Okay.

Thank you.

We're going to limit two questions. Paul So I was just wondering.

Plenty of respond let me because those are just a clarification. The real question is relative to the order and the backlog, what's the risk percentage to say youre, just masking weakness by laying off on supply chain and what's the risk.

With respect to the robust orders and backlog, what's the risk that that's a function of customers not willing to step out of line.

On orders and for that matter, the continuing to place orders with both of them related to the fact that supply chain remains tight.

That real demand is not reflected.

Nominally appears to be extremely strong orders and backlog.

I would answer the question Paul.

Your second question I'm sorry.

I would answer it like this.

Yes.

The order book is made up of sort of three elements.

My view.

One is a little bit of catch up from all the COVID-19 time, but thats sort of flushed through to a large extent right. Now do you have a little bit of forward order and because of supply chain lead times and the rest of it yes, it's nowhere near what you would imagine that might be that's very much with certain customers, who absolutely want to secure.

Next year's revenue when we have some orders that are scheduled for next year for 2023 that is not the majority of the backlog the vast majority of the backlog customers would take immediately because they have real needs.

And I think what we're seeing is a very strong step function in in demand.

Unfortunately at a time.

We've got the constrained supply chain. So if you look at the actual demand of our customers.

They would roll this product into their network very quickly and put traffic on it so I'm very comfortable that the demand characteristics there and what we're seeing in our large backlog is not just a function of mitigating the supply chain lead times for some of that for sure with one or two customers.

Most of it.

Absolutely take the equipment. So we take a lot of comfort from that.

And we know them very well, we speak to them every day.

We know that their system their networks need this gear and we've had no essentially no order cancellations we don't.

Don't think there is a significant risk there on the people side.

Our head count is generally in line with the plan, we set out at the beginning of the year recall that I said that absent that.

The changes to the accrual rate for our incentive compensation plan for the company our Opex would be approximately what we guided at the beginning of the year, which was approximately our plan. So it's well in keeping with what we plan to do and as we said in the past, we do think that as network.

Converge across a few layers then it's very important that we add to our capability in the routing and switching layers of the network. We are of course, the best in the world in optical.

That we will have the best converged solution as we develop these capabilities in order to develop those capabilities, we have to bring people into our R&D shops around the world we have to bring people into our sales force in order to sell these capability. So that's that's why the head count has grown.

I think it will probably it's not going to grow at that level next year I would say I think we're just about at the level that we need to be.

So if.

If we're growing it.

Okay, R&D and sales.

For routing and switching.

Generally, yes, not all but generally yes.

Alright, a personal thank you.

Thanks, Todd I'd say routing and switching Paul but also the off box software capabilities to manage those those forward looking solutions as well.

Thanks Scott.

Please standby for the next question.

The next question comes from Simon Leopold with Raymond James Your line is now open.

Thanks for taking the question.

For me as well first one is we've seen the <unk> awards for spectrum in India occurring and.

Recall that in the past <unk> had some very strong business in India.

And if you could maybe talk about what youre seeing in terms of that particular opportunity.

And what Youre expecting in fiscal 'twenty three in terms of contributions from the region.

And then I'll ask my follow up after.

So yes, no we are seeing.

Strong cyclical activity in India. After a very challenging set of years, we are incredibly well placed there with all of the major players, including all the web scale very.

Focused area for the major web scale players too is the fastest internet.

Growth.

Country in the World.

You can see now things are very turbulent given all the supply chain challenges, but we were up pretty robustly in the quarter.

It's about 44%.

From a revenue point of view I wouldn't I wouldn't sort of bet too much to that because <unk> got ebbs and flows largely driven by supply chain at this moment in time, but I think it is a moniker around the growth that we see there and we expect a very robust.

2023 in India, driven by all of the spectrum stuff with Geo and policy et cetera.

Great and then I might.

Follow up I hate to talk more about supply chain, but I need to get a better understanding of these.

Low end parts that ended up being the constraints.

Are these parts that are unique to the vendors and therefore did not have an option to multi source.

That's what's leading to redesign or was there some misstep on your part that you didnt multi source because these seem to be readily available parts.

Just need to understand a little bit better about that particular components.

Talking about.

Sorry, sorry.

I'm sorry.

<unk>.

I would categorize them as.

Multi industry.

And our low cost Ics.

We views in that family for for many years across many generations of our products and have been very consistent in terms of their availability.

The challenges are.

<unk> in.

Perfect Hindsight do I wish we had designed multi sourcing there of course, we have but frankly going back a year that wouldn't be the area of the product portfolio. We would have concentrated our multi sourcing activities on because it's been a very reliable.

Part of the supply chain ecosystem in the past.

As we sit here now obviously, we are working on those multi source activities. Both in terms of alternative sources.

Obviously, we are working on those multi source activities. Both in terms of alternative sources that can be plugged replaceable those are few and far between but also the physical redesign of the board is to be able to access.

Multiple alternatives.

Thank you.

Thanks, Dan.

Please standby for our next question.

Our next question comes from Alex Henderson with Needham <unk> Company. Your line is now open.

Great. Thank you very much.

I wanted to go back I guess like minds kind.

Kind of situation, we want to go back to the cancellation question.

Clearly you haven't seen cancellations in the current environment that would make a lot of sense people accelerating orders and then canceling them, but can you talk about your history of cancellations.

If you go back over the last.

Recession.

What kind of cancellations or did you see in that environment.

Have you had.

My understanding that your net cancellation rate is something under 1% and pretty much every quarter in the history of the company is that is that accurate.

To what extent does the order required the service provider or other vendor to do a lot of work.

Before they put the order and we set the RFP up which makes it expensive for them to cancel and then the second piece of that is.

What's going on with your pricing you talked about price increases before.

Is that something that reduces the risk of cancellation.

Yes, just historically.

Alex our order cancellation rate has been well under 1% in fact, I can think of a handful of cases in the past and we've seen the order cancellations.

Not done before.

Does bond larger customers order this gear because they need it not by and large 100%. That's why they ordered this stuff they don't buy it.

I hope that they will need it so when they order it and its specified for their system of their network.

They're going to take eventually now.

We're not making our customers, particularly happy right now with our extended lead times, we're going to make we're going to do better than that in the future and we will deliver this backlog.

The other thing I think.

Sure.

To point out is that these arent commodity items and most for the most part and our customers. These are networks that are designed to our specification. These are solutions that are integrated into their back office and we've talked about in the past in a totally different context.

The length of time, it takes to do new product introduction into these large scale service providers web scale.

That is the stickiness that also prevents them from just saying, Okay. I mean, I think order order X Y Z take it down the street to somebody else.

Thank you.

The second piece of that question was around price, which I don't hear you mentioning and I do have a follow up question on the supply chain, which is.

To what extent give.

Given additional lockdowns in China that are alarming the market right. Now are you at risk that those Ics those low priced Ics, which tend to be more commoditized and may be sourced in China are exposed to risk.

Due to those lockdowns.

At the beginning of this calendar year, we went out to our customer set and negotiated the price increase which was consistent really across the customer base. We did it to cover the costs. The increased costs that we were seeing now we chose not to repeat.

The backlog we place the price increase on orders after a certain date.

And it so happens that we are not seeing any effect.

<unk> of that price increase yet because we have not yet completed delivery of the backlog that was in place before the price increase went into effect. We think that late this year and in early next year, we will see a positive impact from that I was.

Very pleased with the way they're customers react to it.

It was a negotiation.

You want to answer the second part.

Yes.

In general obviously has been difficult to predict around the world.

There is that over.

Overriding risk to some degree for everybody in the industry, but the specific news.

Although China over the last 24 hours and that particular province, we don't have any direct operational exposure to that.

<unk>.

Certainly havent had any.

Signals at this point in time from our suppliers that they have exposure either and that's something that we're going to have to monitor relatively new news.

Subjectively, it's not a province that is ever come up in any of my.

Dialogues.

One around the supply base.

Just to be cleared the question is how much of those Ics are coming from China, specifically as opposed to that particular province, nobody is expecting that particular $21 million $20 million.

Chinese to be the issue.

But broadly if there is a broad shutdown in China.

Are these.

Yes, the general statement I would say is.

The direct supply from those component providers is not from China, that's not to say, though that they don't have sub components in there that trade.

<unk> supply chain a tertiary effect.

It comes from China.

The direct components from the vendors that we deal with are not sourced out of China.

Perfect. That's what I was looking for thank you.

So SaaS.

Please standby for the next question.

And our next question comes from Jim Suva with Citi. Your line is now open.

Thank you I believe.

Mentioned that fiscal 'twenty three year sales outlook is unchanged from 90 days ago.

But if you just had weakness this quarter because you couldn't meet it with supply and then thats continuing to get into Q4, why wouldn't actually fiscal 'twenty three.

A stronger outlook than 90 days ago.

Well, what I'd say is that.

We're taking a balanced view to 'twenty three as we look at it now we've not guided to 23 the number than consensus is.

It's $4 2 billion I don't think Thats, a terrible number to use in reference and we'll guide appropriately as we go through time, but remember we're not expecting all of the.

Particular component demand I think the supply issues that we have seen to ameliorate immediately and our balanced view is that it will improve but not get us to the point, where we can deliver everything in our backlog next year by the way I hope I'm wrong.

If we could deliver.

If we could get more of these key components we will.

Deliver more revenue, but that's not our expectation today.

Jim This is gerry.

Obviously, we're not guiding to 23 right now we haven't finished this year and thats been a.

And that's challenging enough right now given the supply chain pieces that we're seeing but given the backlog we've got in the ameliorate and activities in place if oil stays in the course that axon, we will start to see improvements as we get into 'twenty three too early to call that.

Consensus right now is about $4 two as Jim said, and I think thats, probably a reasonable probably a reasonable number given what we are saying I understand the math.

We went into this year, we're planning for double digit growth.

When you sort of step back from it.

If you get to sort of the midpoint of the guide in <unk>.

In Q4.

Basically taken that number down by about half a billion dollars.

And Thats really all supply chain related I understand the point does that all roll into next year, we will.

It doesn't work like that because I don't think there's going to be a magic switch on on.

On supply chain, but but.

That's probably the best number we have right now.

Thank you and then my follow up is other companies have gone to the broker market or secondhand market.

They've had some shortages of parts I assume you'd probably tried to but it just happened. So late in the quarter is that what happened because if he said they are low priced parts in a handful why not pay up a bit of a premium.

Product out the door into sale.

We certainly have gone to the broker market. That's one of the reasons. In fact it is the biggest reason why our margins have deteriorated from the sort of mid forty's level, but I'll tell you. This that the broker market is not as.

Robust as it was a year ago, because everybody's going there to buy their parts. So.

We've done it we do it where we can and we will continue to do it.

Thank you so much.

Thank you.

Please standby for the next question.

The next question comes from Tim Long with Barclays. Your line is now open.

Thank you.

Two as well first one sorry to beat a dead horse here, but we hear all the mitigation.

What not that you guys have been going through for the supply chain here.

Just it's been a long time here coming in most of the industry are improving not getting worse. So when you think about kind of higher level, you think about your procurement your ability.

Estimate ability to redesign.

What have you guys been doing as far as like processes internally and personnel.

To try to.

Address these problems better so not just kind of what you guys have done, but what kind of investments you're making in people and process to ensure that it doesn't continue to happen and then I've got a follow up on web scale.

So Tim let me, let me walk you through the steps of mitigation, including.

Your processes and people question. So so first and foremost obviously, we're out there from a process perspective, putting.

The larger demand on the supply base with long lead times and in fact.

Overriding their lead times are actually extending them.

So that's that's one number two is.

We've stepped in.

To put ourselves between ourselves and the direct component suppliers, where in the old world. When these things are moving on 90 day turn times.

The contract manufacturers that do a lot of that so we have added resources basically.

To manage the component suppliers and chase parts, if you like.

Directly ourselves.

Obviously, there's a focus in terms of governance on the key the key components that are challenges we have broad.

Significant more resources from an engineering perspective to bear on the redesign activities throughout the year.

<unk> will pay off but they will pay off in front of us because they're longer lead time, and we've made significant investments in our manufacturing capacity such that land.

The specific constraint components get solved we can turn that into finished goods and start servicing our customers faster than than we would've been able to before so we're looking at all aspects of that they will pay off.

These are things that take time, Tim the other thing I would add to that is.

We have a supply chain team and process that has navigated through some incredible challenges and outperformed everybody else.

If you were to be in hindsight to it which is.

<unk>.

A wonderful thing would we have bought some of that engineering talent in earlier to get multi sourcing maybe but the challenges we wouldn't know which components to focus on quite frankly.

So we won't be defensive to it but I don't think there's really much else. We could have done is we do as you look through that hindsight.

A wonderful thing, but the other thing I would say Tam.

<unk>.

We're not happy with where we are in terms of the performance we're about half a billion dollars down because of this issue and impacting customers.

But I would say, we are experiencing more relative and absolute demand than anybody else and we are still shipping more equipment than anyone else and ask space. So.

<unk>.

I would remind everybody of that.

Okay. Thank you and just a follow up on the web scale I noticed kind of was down a little bit more sequentially, particularly if you compare to service providers. So.

Curious about that and related to that I would guess web scales are probably your most and patient customer base does.

All this stuff going on it seems like once you introduce an optical system. There is a lot of drama around the componentry, we're in a plug of ball.

Not so not as much much much lower bill of material much smaller part count. So is there a risk to that customer base that.

Potential transition to more bundles and their network could accelerate.

Because of the more difficulty around <unk>.

A system.

So thank you.

Tim I'll, let Scott take the <unk>.

Plug or a part of that but my answer to that would be no. We're absolutely not saying that web scale, we're down in revenue for the quarter Thats just really.

Turbulence from supply chain, what was the question the answer is supply chain.

So I think that.

The demand, we're seeing very strong order flow for our systems 6500 architecture around the web scale players and I think that will be.

Continued to be robust as we as we go through.

23 on the portable side, Scott you answered.

Just Tim.

Where we are deployed today from a web scale perspective is not the <unk>.

Patch, where applicable habit flexibility as we've said in the past that level of conversation on the web scale space for the most part for US is as new territory to epitaph upside so what youre seeing when you look at <unk>.

<unk> over quarter, our period over period is 100% supply chain related.

We referenced one of the key challenge areas for Us is modems.

There are obviously, a big consumer of modems, so to correlate very well very well on <unk> in general.

Great.

As we've said consistently we.

We think it's very early innings for that ZR plug a hole application.

We're confident that we have the best plug available, there's we have shipped them to <unk>.

45, plus customers, including large web scale pieces of it we think that's going to be.

A growing piece of our business as we go into 2023 as well.

Thank you.

Okay.

Please standby for next question.

Our next question comes from Rod Hall with Goldman Sachs. Your line is now open.

Yeah, Hi, guys. Thanks for the question.

I guess I wanted to come back to the range of outcomes. That's possible in 2023 I think what you guys have said is your long term growth model at 6% to 8% and that would begin in 2023.

And obviously now.

Higher growth in that range in 2023, so I wonder if you would be willing to at least say.

From a breadth of outcomes point of view that.

Possibilities.

Supply situation were to persist in the beginning of the year that you might even be below that 6% to 8% range.

And acknowledging that it is.

Also possible you could be well above consensus.

But I think when I hear back from investors. This morning, some of them are saying Hey, this is a stock.

I would like to own.

Clearly the demand situation is great, but given the supply uncertainty 'twenty two.

Three numbers could be a little bit punchy.

This supply thing continues to be a problem in the beginning of the year. So.

Just wondering if you could kind of comment on.

How that range looks to you and what the risk to the maybe even at 6% to 8% growth might be thanks.

Then I have a follow up.

It would be my my response to that Rod first of all.

We're not giving guidance.

For 'twenty three we haven't finished 22 yet.

So we normally give that as we as we.

We turned the year and Youre, absolutely right I mean look what happened in 2010.

Supply chain et cetera.

I would say that.

Given what we're seeing now.

If that does not deteriorate then we have very high confidence in exceeding that 6% to 8%.

If you look at sort of a full point to let's just take that as the current consensus based on a midpoint in there that's more than 20% growth that's entirely possible.

If the supply chain stays.

With some stability and we fix some of these.

Particularly the issues that we're seeing right now more than that right now would be kind of speculation.

Okay, Alright, thanks again, the whole point there rod is the number 6% to 8% is not a meaningful number right now.

We have a depressed level of revenue. This year. So 6% is it's not a relevant number.

I said, we haven't guided to next year, it's very hard for us to give a range but.

But we haven't given.

What I would say if you got a big backlog and it could be a lot higher than that if we got the parts.

Yeah makes sense, Okay, and then the second question I had I guess, mostly for you Gary but it's related to the Salesforce you had mentioned that you are accruing.

For the call it plan.

Our incentive based compensation I Wonder are you worried that it's going to be tough to retain salespeople. The labor market is still pretty tight.

I guess the other peripheral companies maybe not in optical that are having better luck on supply. So I wonder how youre feeling about retention of salespeople what the what's the plan there.

Okay.

That's a good question the large amount of the bonus accrual that we changed the Jimmy is actually non sales and non sales related and most not all of the sales force were actually comped on orders. So we've had an extraordinary order.

So.

I feel pretty good rod, but the sales force and quite rightly you have been.

On the whole well compensated and we have a highly tenured sales force, we have the largest and best equipped optical salesforce in the world.

I'm talking about systems engineering, the sales folks as well so.

Thanks.

Largely compensated on orders so.

Dave generally had a pretty good year.

But the question pertaining to our general employee employee.

But and of course were not happy to lower the accrual range for for our general set of employees. We have in the last couple of years paid out very well against that incentive comp plan and this year is probably not going to be as good in our accrual reflects that but we're trying to deal with that.

As best we can with merit and other things.

Sure Great question.

Thank you Sarah.

Yes.

Please standby for the next question.

Okay.

The next question comes from Amit <unk>.

Your own nanny with Evercore Your line is now.

Okay.

Perfect. Thanks, a lot I am glad I snuck in here.

I guess, maybe the first ask you as well, but a close one I have is I think July quarter, you talked about a $60 million of missed due to the supply chain issues.

Third quarter guidance.

240 million below where the street, whether what you had implied in the past is all of that will be related to the same supply chain issues or is it something else happens it almost seems like the backdrop for the effect of the October quarter guidance in July .

What is the top of recovering from what you're hearing from your suppliers is it going to happen in Q1 or is there a much longer lead time for this recovery the bottleneck to EMEA.

Okay.

In general.

Yes.

If I heard and understood the question correctly.

The space that is the challenge is consistent between Q3 and Q4, it's that small number of IC components that we talked about that is getting in the way of us maximizing the production of our bonus. So it's the same challenge a little bit different dynamic, though in Q3 and Q3, obviously, we had a perspective going into Q3.

The guide of what the commitments were.

On all components, including those and in that particular case and those components. Those commitments were met and they were it was too late for us to mitigate it going into Q4 same sort of dynamic and set of components and we're giving you our perspective as.

As the environment and commitments it today.

Got it and then could.

Could you just touch on how do you think free cash flow stacks up in Q.

Q4 and fiscal 'twenty three.

Working capital still going to be a use of free cash flow in Q4, so potentially.

Our leading hospitals that can look through some of the same free cash flow expectation for Q4, and then broadly for 'twenty.

Yes.

I would say is that we consumed a fair amount of free cash in Q3, we built a lot of inventory.

Yes.

Is that we will probably build a little more inventory as we move through the next couple of quarters.

And hopefully.

23 progresses, and if we get to the kind of numbers. We're looking at that inventory level will start to decline and our free cash flow will start to build next year. So I think next year, we will have a good free cash flow I won't qualify it in any other way except to say, we will have a good free cash flow next year.

Thanks I appreciate it.

Thank you everybody for joining us today, we do look forward to connecting with everyone. During the day today as well as had a few events next week during the labor day weekend and recurrence.

Okay.

This concludes today's conference call. Thank you for participating you may now disconnect.

The conference will begin shortly to raise your hand during Q&A you can dial one one.

[music].

Okay.

[music].

Okay.

Yeah.

Yes.

[music].

Yes.

Okay.

[music].

Yes.

[music].

Yeah.

Okay.

Yes.

Yeah.

Yes.

[music].

Yes.

[music].

Yes.

[music].

Thank you.

Sure.

Yes.

Okay.

Yes.

Okay.

Sure.

Okay.

[music].

Yeah.

[music].

Yes.

[music].

Yes.

Okay.

Yes.

[music].

Okay.

Yes.

[music].

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

[music].

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

Great.

Okay.

Yes.

Okay.

Yes.

Okay.

Sure.

Thanks.

Good day and thank you for standing by welcome to the CMS fiscal third quarter 2022 financial results Conference call. At this time all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session.

To ask a question. During this session you will need to press star one on your telephone please.

Please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Gregg Lampf, Vice President Investor Relations. Please go ahead.

Thank you Michelle.

And welcome to CNS fiscal third quarter 2022 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.

Our comments today speak to our recent Q3 performance our view on the current demand environment and supply chain conditions as well as a discussion of our financial outlook.

Today's discussion includes certain adjusted or non-GAAP measures of CNS 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 you that during this call excuse me will be making certain forward looking statements.

Today.

Assumptions relating to our outlook, whereas I mentioned on this call or included in the Investor presentation that we'll post shortly after are an important part of such forward looking statements and we encourage you to consider them.

We expect to file by that date.

<unk> 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 I'll ask that you limit yourselves to one question and one follow up with that I'll turn it over to Gary.

Thank you, Greg and good morning, everyone.

Today, we reported lower than expected fiscal third quarter financial performance, including revenue of $868 million and adjusted gross margin of 40%.

In a moment I will discuss the specific supply chain challenges that impacted our results.

And our continued actions to mitigate their effects on our customers and that business.

Before doing so however, I think it's important to understand the context of the current environment as it relates to Sienna and specifically demand.

Despite supply chain challenges and elongated lead times strong secular demand trends show no signs of abating.

And we remain confident that the fundamental macro drivers propelling this demand are durable over the long term.

As we all know these include five G cloud and automation in addition to infrastructure spending residential broadband funding and opportunities to displace Huawei.

Combination of the secular drivers and our market leadership, including that technology investment capacity and global scale is driving continued robust demand from customers in both absolute and relative measures.

In fact, we had nearly 60% order growth and our last four quarters versus the same prior fourth quarter period.

In Q3, specifically orders outpaced revenue by more than 30% and we continue to grow our backlog, which is now well over $4 billion.

And we project further growth in our backlog in Q4.

Now, let me talk about supply chain.

In the face of this strong demand and challenging supply chain conditions persist.

I would like to note that at a high level. The majority of our suppliers on delivering to that promised, albeit extended lead times and we are also starting to see higher volumes.

And I think this is sort of consistent with recent market commentary that has pointed to some signs of improvement in the overall supply environment.

However, we have recently been challenged by the unpredictable performance of specific vendors and their associated component traits.

When we spoke to you after our second quarter and our outlook for the remainder of the year reflected commitments made to us by our suppliers in early June .

A very small number of them did not meet.

Specifically in the second half of Q3, we experienced substantial delays and lower than expected component deliveries from this very small group of suppliers.

These late notice did commence were primarily for certain integrated circuit components represent a very small fraction of our overall materials.

However, these delays and deep commence impede our ability to build and deliver finished goods and systems such as modems.

For our customers and our ship product for revenue.

Put another way this relatively small number of low cost low value component is holding up a disproportionate amount of revenue primarily for our optical modems.

As a result, our Q3 revenue and adjusted gross margin were both negatively impacted to a significant degree.

And to size this for you.

But for this specific challenge.

We would have been at the high end of our revenue range and in line with consensus gross margin expectations for Q3.

I would also say that certain of the supply dynamics have continued into our fiscal fourth quarter and are expected to negatively impact our current quarter's results, which Jim will discuss shortly.

We remain very focused on our investments and actions to minimize the impact of these challenges on our customers.

Firstly, we are working very closely with the small number of partners to resolve these acute challenges around delivery commitments and volumes.

Secondly, we continue to qualify engineering alternatives to expand our sources of supply and to pursue product redesign activities.

And thirdly, we continue to invest in our readiness with respect to contract manufacturing capacity as well as our inventory levels to be prepared when these components do arrive.

As a reminder, we also continued to place large advance purchase commitments in their various forms.

A premiums and expedite fees and access the broker market to secure additional supply.

Okay.

At the same time, it's important to stay focused on the investments that we're making in our long term strategy to further and open the aperture of our addressable market.

In optical in Q3, we added 14, new customers for wave logic, five extreme and despite the supply challenges we had a record number of quarter four wave logic five shipments, bringing our total wave logic five extreme modem and shipped to date to more than 44000.

And for wave logic, five extreme specifically Q3 was strong with North American tier one service providers as well as web scale customers.

Also in the quarter, we were awarded sole vendor status with a large international tier one service provider for a major network upgrade.

<unk>.

In Q3, we added 25, new adaptive IP customers, bringing the total to nearly 200 as customers continue to seek alternatives to many traditional legacy IP vendors.

Of those new customers, many more wins in key new areas, including five <unk> cell site routing residential broadband and enterprise with the UCP SD Wan solutions.

Of particular note is the momentum with our universal aggregation in PON solution, where our customer count has grown significantly this year and we are now expanding globally.

Indeed, as you can see in our Q3 results routing and switching portfolio has not been impacted to the same extent by supply chain challenges.

Certainly when compared to our converged packet optical segment.

And I think this is consistent with some of the more positive recent commentary from others in the packet IP space.

Overall, we have tremendous momentum and the combination of significant secular demand drivers leading portfolio.

Our Tam expansion opportunities.

The business has never been positioned better.

As we are increasingly able to service the unprecedented demand we are confident in our ability to continue to gain share.

Spend addressable market.

With that I'll turn it over to Jim.

Thank you Gary.

Everyone.

As Gary mentioned revenue in Q3 came in at $868 million, reflecting the impact from the late and incomplete delivery of key components by small number of suppliers.

Adjusted gross margin was 40% in Q3, which was at the low end of our range.

Primarily related to our higher margin modem technology.

Adjusted operating expense in the quarter was $273 million.

This is below our expected range.

During the quarter, we reduced our accrual rate for our annual incentive compensation plan, given our expected financial performance for the year.

With respect to profitability measures in Q3, we delivered adjusted operating margin of eight 5%.

Adjusted net income of $49 million and adjusted earnings of 33 per share.

In addition in Q3 cash used for operations was $205 million free cash flow was a use of $227 million and adjusted EBITDA was $96 million.

We ended the quarter with approximately $1 $3 billion in cash and investments.

On the balance sheet, our current inventory levels reflect the current demand environment as well as the impact of the supply dynamics Gary mentioned.

Since 2021, we have been offering all of the components and sub assemblies required to meet our backlog based upon vendor published lead times and other than a handful of vendors and the supply chain is delivering at 90% reliability.

Lack of performance by that handful of vendors is preventing delivery to customers.

Therefore, we are accumulating components, while we wait for delivery of those specific remaining items that are necessary to produce finished goods.

We expect our inventory levels to reduce over time as the delivery performance for these key components stabilizes.

Finally in Q3, we repurchased approximately three 2 million shares for $155 million we.

We have now completed our goal of repurchasing $500 million in shares in fiscal 2022.

With respect to guidance as we said last quarter in today's market environment. Our revenue is not a function of demand. It is a function of supply.

And as Gary said and we've repeated.

A very small number of suppliers that are not meeting their commitments floor, our expectations in terms of delivery times and volumes for a handful of low cost low value parts.

These documents are having a disproportionate impact on our revenue.

We saw that in Q3, and we are seeing these dynamics continue in Q4.

As a consequence in Q4, we expect to deliver revenue in a range of 800 $880 million.

This range is lower than previously expected and incorporates a wider set of potential outcomes, reflecting our expectations for a continuation of key component supply challenges in the quarter.

Adjusted gross margin of approximately 40%.

Similar dynamics to impact gross margin in Q4, including lower modem volume and continued higher component costs and logistics expenses.

And finally, adjusted Opex of approximately $315 million.

This reflects a return to more normalized levels from the atypical Q3.

Q3, as a reminder was below our original outlook due to the reduction in the accrual rate for our annual incentive compensation plan.

Additionally, in Q4, we expect a higher level of variable sales compensation, reflecting the extraordinary level of demand we have described.

For the year will really approximately on the guide we gave at the beginning of the year absent the changes in our annual incentive compensation plan, which I've discussed.

As we look to next year.

We remain set up well for outsized growth next year and continue to expect to deliver revenue growth significantly above our annual long term target of 6% to 8%.

The strong demand environment, and our backlog reinforced our confidence in these expectations for fiscal year 'twenty three.

And our current revenue expectations for 2023 remain at the level, we referenced when we reported Q2 90 days ago.

With that we'll now take questions from sell side analysts Michelle.

As a reminder to ask a question you will need to press star one on your telephone please standby, while we compile the Q&A roster.

The first question comes from George Notter with Jefferies. Your line is now open.

Hi, guys. Thanks, a lot for the question.

Yes.

Sort of stepping back and looking at the bigger picture here.

Can you talk about.

How you're dealing with these issues in terms of customer conversations.

I guess one thing I'm curious about is just on a relative basis. It seems like you guys are doing worse.

Vis vis your competition in terms of deliveries here.

Yes, im kind of wondering.

Is this going to impact.

Long term market share long term opportunity for CNS like how how permanent do you think the damages here in terms of your customer relationships.

So George let me, let me take that I mean, I think listen we've got very close relationships with all of our customers many of which go back some of which go back decades.

So I think we have.

Long degrees of trust and transparency with them.

And we can only talk about what we see in terms of the challenges from a supply chain point of view and the and the difficulties that were encountering that but we're being very transparent with them.

And I think the best way of sort of answering that in sort of summary, George is really we're continuing to see very robust orders.

We've not seen cancellations we've seen.

Orders continue to well out strip.

Revenue.

This statistic that I kind of shed about 60%.

Year on year.

Order growth for the last four quarters sort of testament to it.

They understand the challenges that.

We're having.

But I think because of our technology and our relationships.

We believe that.

All of the the smoke clears from all of this begins to ameliorate that we will actually gain share given the outsized demand that we see.

Got it.

Right.

Go ahead Tom.

George on the vendor side.

I can tell you that.

We do see some improvement on most components and.

In fact for the majority of our vendors for everyone except these key.

Components that we're talking about we're seeing about a 90% deliverability performance against promise lead time, which is pretty good.

So we're focused of course on this very small number less than a handful of vendors that are not delivering in fact there.

<unk> been quite unreliable and have caused us great difficulties, we're dealing with them appropriately at all levels of the company.

We are hoping that performance improves as we move through time and in the meantime, we're taking a lot of steps to.

To deal with it in case it doesn't such as.

Re specify parts on our boards et cetera.

Yes, that's what I wanted to ask about so.

Are you in the process of redesigning used components out how many components specifically are we talking about when might those redesign be done just give us any more detail there that would be great.

As Roger Scott.

So just in terms of the dimension it.

Jim said the vast majority of the supply chain is pretty much delivering to their promises were talking about a very focused set of.

The components here and to put it in perspective, let me say that it's a <unk>.

Couple of handfuls of component parts on a handful of vendors.

Obviously, we have a significant amount of redesign work going on.

<unk>.

As a vehicle to get at those.

Some components in addition to working with the existing component suppliers to get to get a better answer out of them as well on the design side, Georgia. They fall into two categories. One is the sourcing exercise, where you may be able to find alternative components.

At.

Better flood replaceable.

And in that case, you still have to get in line to lead times from those component providers, but it's it's a less of a heavy lift on our side for.

The second category of course is where you need to redesign in order to take advantage of those component parts and those are hardware redesigns and those are multi quarter activities. All of that activity I think starts to come on board in 2023, and we'll start to see.

Gradual benefit from that as we go throughout the year. In addition to continuing to work with the existing components suppliers.

And to be clear again leased this handful of suppliers has been very reliable in the past. This is a new phenomenon of course, we're in unusual times, but when we have spoken to guidance in past quarters, we have always based our expectations of revenue upon their published.

Lead times and the fact that they have met those lead times in the past so.

How we came up with our our view of the world.

That's why we've guided where we have.

Okay. Okay. Thank you.

And a number of those vendors Georgia.

Upon multiple parts to us and in many cases.

The many of their parts are performing as they as they promised this was a very focused subset.

Okay. Thank you guys.

Please standby for our next question.

Okay.

Our next question comes from Matt.

With Morgan Stanley . Your line is now open.

Great maybe just kind of.

Jumping on George's question.

A way to size kind of the impact of.

Products already redesigns or we can just get a sense that given that we're a year through this that you've already redesigned a match made X number of revenue available does that kind of balance out some of the.

<unk> drops that we're seeing.

And the second piece would be just as you kind of continue to express confidence in fiscal 'twenty three.

Are you basing that confidence on would be helpful. Thanks.

One of them.

So that second part first.

Martha.

We're basing that confidence on first of all incredible visibility and backlog.

So that's that.

Number one number two.

The actions that we've taken which are multifaceted.

And we're trying to get out ahead of US. This is not a reactive piece I mean, we've talked about this for a while we knew that demand was going to increase substantially this year than we planned as we shared with you for a well double digit growth.

This year and we took a.

What we thought were the right.

Supply chain actions in place for that in terms of placing orders in terms of actually engineering work to reduce that dependency.

Those things start I think to KKR knows we come as we come out of this year or into 'twenty three.

Whilst we are cautious given the impact.

We're seeing both in Q3 and Q4.

We believe that they will ameliorate from actions that we've taken and the work that our partners are doing also to ameliorate the issue. So.

We have we have very good confidence as we as we turn the year that this will start to improve it won't be.

And on off switch it will be.

Process that improves.

We start in Q1, but it does give us confidence.

In the year that we start to grow out of this.

And maybe Matt just to give you.

Some sizing on the activities.

If you look at our total component.

Bill of materials, if you like for the entire portfolio we've had.

Multi sourcing activities, whether it's qualifying alternative parts that adds about 10% or.

Two our approved vendor list, obviously focused on on the challenge areas.

The timing challenge with that of course is when you when you identify new component you get their new orders and you get in line on their lead times. So.

Those activities were ongoing throughout 2022.

Lead times in history would suggest that those are going to start to come and have an impact on our ability.

A wider aperture if you like for the supply components in 'twenty three.

On the redesign side, we've got.

Multiple tens are redesigning activities on the go right now, which was probably about 10 times more than we would have in a normal year. All of those are in front of US those are all 2023 impacts because they really are hardware redesign. So they will help in 'twenty three as well.

And maybe maybe put another way to look at it if those problems.

Didn't exist.

On that very small handful of components.

We would have had.

<unk> revenue in the range of our original yearly guide and then some just on the just on alleviating those those small number of components.

Hopefully that helps the dimension of frame.

Okay.

Thank you made it.

Please standby for our next question.

Our next.

Question comes from Paul Silverstein with Cowen and company. Your line is now open.

Charles.

Backlog increased to exactly.

So it was significantly greater than $4 billion, but what was the sequential increase what was the book to Bill This quarter. If I remember it was one five over $1 five last quarter what was it this quarter.

And Jamie.

I'm sorry, the circle.

Yes.

Next question Joe.

Ask your second question as well Paul.

I see head count was up almost 500 sequentially.

Massive relative to the total head count was more than we've seen in a long time, what's that all about.

So let me take the first part of that and then Jim can talk about the headcount growth.

The revenue two orders orders were about 30% above revenue in Q4, and I'm sorry in Q3, we expect as well the orders to be above.

Revenue in Q4, so we're going to create more backlog. The backlog goes we turn out right. Now is about four is approximately $4 4 billion pool.

I apologize Gerry that result.

Up from previous quarter.

Oh, yes, yes, yes, absolutely our bottom line.

It's up a few hundred million.

Alright, and then Fortunately <unk> Luke.

Go ahead Jim.

Go ahead.

[laughter].

Thank you.

We're going to limit two questions. Paul So I was just wondering.

Paul you respond let me because those are just a clarification. The real question is relative to the order and the backlog what's the risk for Cynics say Youre, just masking weakness by line often supply chain, what's the risk.

With respect to the robust orders and backlog, what's the risk that that's a function of customers not willing to step out of line.

On orders and for that matter, the continuing to place orders with both of them related to the fact that supply chain remains tight.

That real demand is not reflected by.

What nominally appears to be extremely strong orders and backlog.

I would answer the question this is Paul.

Your second question I'm sorry.

I would answer it like this.

Yes that does.

The order book is made up of sort of three elements.

My view.

One is a little bit of catch up from all the COVID-19 time, but thats sort of flushed through to a larger extent right. Now do you have a little bit of forward order and because of supply chain lead times and the rest of it yes, it's nowhere near what you would imagine that might be it's that's very much with certain customers, who absolutely want to secure.

And I think what we're seeing is a very strong step function in in demand.

Unfortunately at a time, where we've got the constrained supply chain. So if you look at the actual demand of our customers. They.

Debates.

Absolutely take the equipment. So we take a lot of comfort from that.

And we know them very well, we speak to them every day.

We know that their system their networks need this gear and we've had no essentially no order cancellations we.

We don't think there is a significant risk there on the people side.

Our head count is generally in line with the plan, we set out at the beginning of the year recall that I've said that absent the changes to the accrual rate for our incentive compensation plan for the company our Opex would be approximately what we guided at the beginning of the year, which was approximately our plan.

So it's well in keeping with what we plan to do and as we said in the past, we do think that as networks converge across a few layers. Then it's very important that we add to our capability in the routing and switching layers of the network.

Of course, the best in the World in optical we think that we will have the best converged solution as we develop these capabilities in order to develop those capabilities, we have to bring people into our R&D shops around the world we have to bring people into our sales force in order to sell these capability. So that's that's why the.

Head count has grown.

I think it will probably.

Not going to grow at that level next year I would say I think we're just about at the level that we need to be.

So the bulk of those people.

People are growing.

Okay, R&D and sales.

For routing and switching.

Generally, yes, not all but generally yes.

Alright, I'll pass it on thank you.

Thanks, Pat I'd say, I'd say routing and switching Paul but also the off box software capabilities to manage those those forward looking solutions as well.

Thanks Scott.

Please standby for the next question.

The next question comes from Simon Leopold with Raymond James Your line is now open.

Thanks for taking the question.

For me as well first one is we've seen the <unk> awards for spectrum in India occurring and.

Recall that in the past <unk> had some very strong business in India.

And if you could maybe talk about what youre seeing in terms of that particular opportunity.

And what Youre expecting in fiscal 'twenty three in terms of contributions from the region.

And then I'll ask my follow up after.

So yes, no we are seeing.

Strong cyclical activity in India. After a very challenging set of viewers. We are incredibly well placed there with all of the major players and including all the web scale. It's a very focused area for the major web scale players too is the fastest internet.

Growth.

Country in the World.

You can see now things are very turbulent given all the supply chain challenges, but we were up pretty robustly in the quarter.

It's about 44%.

2023 in India, driven by all of the spectrum stuff with Geo and policy et cetera.

Great and then on <unk>.

Follow up I hate to talk more about supply chain, but I need to get a better understanding of these.

Low end parts that ended up being the constraints.

Are these parts that are unique to the vendors and therefore did not have an option to multi source.

That's what's leading to redesign or was there some mis step on your part that you didnt multi source because these seem to be readily available parts.

Just need to understand a little bit better about the particular components.

Talking about.

Okay.

Sorry, sorry.

I'm sorry.

<unk>.

I would categorize some of those.

Multi industry.

And our low cost Ics.

We views in that family for for many years across many generations of our product and have been very consistent in terms of their availability.

The challenges are.

And yes in perfect hindsight do I wish we had design multi sourcing there of course, we have but frankly going back a year that wouldn't be the area of the product portfolio. We would have concentrated our multi sourcing activities on because it's been a very reliable.

Part of the supply chain ecosystem in the past.

As we sit here now obviously, we are working on those multi source activities. Both in terms of alternative sources.

Obviously, we are working on those multi source activities. Both in terms of alternative sources that can be quite replaceable. Those are few and far between but also the physical redesign of the board is to be able to occur.

Multiple alternatives.

Thank you.

Thanks, John .

Please standby for our next question.

Our next question comes from Alex Henderson with Needham <unk> Company. Your line is now open.

Great. Thank you very much.

I wanted to go back I guess like minds kind.

Kind of situation, we want to go back to the cancellation question.

Clearly you haven't seen cancellations in the current environment.

Would make a lot of sense people accelerating orders and then canceling them, but can you talk about your history of cancellations.

If you go back over the last.

Recession.

What kind of cancellation did you see in that environment.

Have you had.

My understanding that your net cancellation rate is something under 1% and pretty much every quarter in the history of the company is that is that accurate.

To what extent does the.

Order required the service provider or other vendor to do a lot of work.

Before they put the order in to set the RFP up which makes it expensive for them to cancel.

And then the second piece of that is.

What's going on with your pricing you talked about price increases before.

Thats something that <unk>.

<unk> the risk of cancellation.

Okay.

Yes, just historically, Alex our order cancellation rate has been well under 1% in fact, I can think of a handful of cases in the past and which we've seen order cancellations.

Not done because by and large our customers order this year, because they need it not by and large 100%. That's why they ordered this stuff they don't buy it.

The delegated so when they ordered and its specified for their system and their network.

They're going to take eventually.

<unk>.

Making our customers, particularly happy right now with our extended lead times.

We're going to do better than that in the future and we will deliver this backlog.

The thing I think.

To point out is that these arent commodity items and look for the most part and our customers. These are networks that are designed to our specification. These are solutions that are integrated into their back office and we've talked about in the past in a totally different context.

The length of time, it takes to do new product introduction into these large scale service providers and web scale.

That is the stickiness that also prevents them from just saying, okay I'm going to take order order X Y Z take it down the street to somebody else.

Thank you.

The second piece of that question was around price, which I don't hear you mentioning and I do have a follow up question on the supply chain.

Which is.

To what extent give.

Due to those lockdowns.

The backlog we place the price increase on orders after a certain date.

And it so happens that we are not seeing any.

Very pleased with the way they're customers reacted to it.

It was a negotiation.

You want to answer the second part.

Yes.

In general obviously has been difficult to predict around the world. So there.

Or is that over.

Our overriding risk to some degree for everybody in the industry, but the specific news.

Auto China over the last 24 hours and that particular province, we don't have any direct operational exposure to that and.

Certainly havent had any.

Signals at this point in time from our suppliers that they have exposure either but that's something that we're going to have to monitor relatively new news.

Subjectively, it's not a province that is ever come up in any of my.

Dialogues.

Evelyn around the supply base.

Yes, just to be cleared the question is how much of those Ics are coming from China, specifically as opposed to that particular problems nobody is expecting.

That particular $21 million $20 million.

Chinese to be the issue.

But broadly if there is a broad shutdown in China.

Are these.

Yes, the general statement I would say is.

The direct supply from those component providers is not from China, that's not to say that they don't have sub components in there that if I if I trade.

<unk> supply chain in a tertiary effect.

Comes from China.

Direct components from the vendors that we deal with are not sourced out of China.

Perfect. That's what I was looking for thank you.

Thanks, Alex.

Please standby for the next question.

Your next question comes from Jim Suva with Citi. Your line is now open.

Thank you I believe.

And that fiscal 'twenty three year sales outlook is unchanged from 90 days ago.

But if you just had weakness this quarter because you couldn't meet it with supply and then that is continuing to get into Q4, why wouldn't actually fiscal 'twenty three.

A stronger outlook than 90 days ago.

Well, what I'd say is that.

We're taking a balanced view to 'twenty three as we look at it now we have not guided to 23 the number than consensus is.

It's $4 2 billion I don't think Thats, a terrible number but to use in reference and we'll guide appropriately as we go through time, but remember we're not expecting all of the.

If we can deliver.

If we could get more of these key components we will.

Deliver more revenue, but thats not our expectation today.

Jim This is gerry.

Obviously, we're not guiding to 23 right now we haven't finished this year and that's been.

And that is challenging enough right now given the supply chain pieces that we're seeing.

Given the backlog we've got in the amelioration activities are in place we full stays in.

And of course with Exxon, we will start to see improvements as we get into 'twenty, three but too early to call that.

Consensus right now is about $4 two as Jim said, and I think thats publicly a reasonable probably a reasonable number given what we're seeing I understand the math.

We went into this year planning for double digit growth.

When you sort of step back from it.

You get to sort of the midpoint of the guide and in Q4.

We basically taken that number down by about half a billion dollars.

And Thats really all supply chain related I understand the point does that all roll into next year, we will.

It doesn't work like that because I don't think there's going to be a magic switch on.

On supply chain, but.

That's probably the best number we have right now.

Thank you and then my follow up is other.

<unk> companies have gone to the broker market, our secondhand market when they've had some shortages of parts I assume you'd probably tried to but it just happened. So late in the quarter is that what happened because if he said they are low priced parts in a handful why not pay up a bit of a premium and still get your product out the door into sale.

We certainly have gone to the broker market. That's one of the reasons. It's in fact, it's the biggest reason why our margins have deteriorated from the sort of mid <unk> level.

I will tell you this that.

The broker market is not as robust as it was a year ago, because everybody has to go in there to buy their parts.

Done it we do it where we can and will continue to do it.

Thank you so much.

Thank you.

Please standby for the next question.

The next question comes from Tim Long with Barclays. Your line is now open.

Yes.

Thank you I've got two as well.

First one sorry to beat a dead horse here, but we hear all the mitigation.

What not that you guys have been going through for the supply chain here.

Just it's been a long time here coming in most of the industry are improving.

Getting worse. So when you think about kind of higher level, you think about your procurement.

Our ability to estimate ability to redesign.

What have you guys been doing as far as like processes internally and personnel.

To try to.

So Tim let me, let me walk you through the steps and mitigation of including.

Your processes and people question. So so so first and foremost artists who are out there from a process perspective, putting.

The larger demand on the supply base with long lead times and in fact.

Overriding their lead times are actually extending them.

So that's that's one number two is.

We have stepped in.

To put ourselves between ourselves and the direct component suppliers, where in the old world. When these things are moving on 90 day turn times.

The contract manufacturers that we do a lot of that so we have added resources basically.

To manage the component suppliers and chase parts, if you like.

Directly ourselves.

Obviously it is a focus in terms of governance on the key the key components that are challenges we have brought.

Significant more resources from an engineering perspective to bear on the redesign activities throughout the year.

Those will pay off but they will pay off in front of us because they're longer lead time, and we've made significant investments in our manufacturing capacity such that land.

These are things that take time, Tim the other thing I'd add to that is.

I think we've basically done all of the right things and we were very proactive with it and we're trying to get out ahead of that 18 months ago and I look at all the things that we've done and frankly I think it's all the right stuff, we have a supply chain team and process that has navigated through some incredible challenges and outperformed everybody.

Els.

If you were to be in hindsight to it which is.

A wonderful thing would we have bought some of that engineering talent and earlier too to get multi sourcing maybe but the challenges we wouldn't know which components to focus on quite frankly.

So it won't be defensive to it but I don't think there's really much else. We could have done is we do as you look through that hindsight.

Wonderful thing, but the other thing I would say Tim.

<unk>.

Not happy with where we are in terms of the performance, we're about $5 billion down because of this issue and impacting customers, but I would say, we are experiencing more relative and absolute demand than anybody else and we are still shipping more equipment than anyone else in our space. So.

I would remind.

Everybody of that.

Okay. Thank you and just a follow up on the web scale I notice.

<unk> was down a little bit more sequentially, particularly if you compare the service providers. So.

I asked about that and related to that I would guess web scalar probably your most and patient customer base.

Does all of this stuff going on it seems like once you introduce an optical system. There's a lot of drama around the componentry, we're in a plug of all.

So not as much much much lower bill of material much smaller part count. So is there a risk to that customer base that the potential transition to more plug the holes in their network could accelerate because of the more difficulty around.

The system.

So thank you.

Okay.

Got it.

The applicable part of that my answer to that would be no. We're absolutely not saying that web scale, we're down in revenue for the quarter Thats just really.

Turbulence from supply chain.

Was the question the answer is supply chain.

So I think that.

The demand, we're seeing very strong order flow for our systems 6500 architecture around the web scale players and I think that will be.

Continued to be robust as we as we go through.

'twenty three on the applicable side, Scott you answered.

Tim.

Where we are deployed today from a web scale perspective is not the.

Patch, where applicable have applicability as we've said in the past that level of conversation on the web scale space for the most part for US is as new territory and potential upside so what youre seeing when you look quarter over quarter. Our period over period is 100% supply chain related we referenced one of the key <unk>.

Alonge areas for us is modems.

Now there are obviously, a big consumer of modems, so to correlate very well very well on <unk> in general.

Alright.

As we've said consistently.

We think it's very early innings for that ZR plausible application.

We're confident that we have the best plug available, there's we have shipped them to <unk>.

45, plus customers, including the large web scale pieces of it we think that's going to be.

A growing piece of our business as we go into 2023 as well.

Thank you.

Okay.

Please standby for our next question.

Our next question comes from Rod Hall with Goldman Sachs. Your line is now open.

Yeah, Hi, guys. Thanks for the question.

I guess I wanted to come back to the range of outcomes. It's possible in 2023 I think you guys had said is your long term growth model at 6% to 8% and that would begin in 2023.

And obviously now.

The supply situation has become much less predictable and certainly could run into the beginning of 'twenty. Three I think you would agree with that and on the other hand, you have this huge backlog and you could see much higher growth in that range in 2023, So I wonder if you would be willing to at least say.

From a breadth of outcomes point of view is that okay.

A possibility if the supply situation were to persist in the beginning of the year that you might even be below that 6% to 8% range.

And acknowledging that it is also possible you could be well above consensus.

But I think when I hear back from investors. This morning, some of them are saying Hey, this is a stock I.

I would like to own.

Clearly the demand situation is great, but given the supply uncertainty 'twenty two.

Three numbers could be a little bit punchy.

If the supply continues to be a problem in the beginning of the year. So.

Just wondering if you could kind of comment on.

How that range looks to you and what the risk to the maybe even the 6% to 8% growth might be thanks, and then I have a follow up.

It would be my my response to that Rod first of all.

We're not giving guidance for throughput.

'twenty three we haven't finished 22 yet.

So we normally give that as we.

We turned the year and Youre, absolutely right I mean look what happened in 2010.

Supply chain et cetera.

I would say that.

Given what we're seeing now.

If that does not deteriorate then we have very high confidence in exceeding 6% to 8%.

<unk>.

If you look at sort of a full point to let's just take that as the current consensus based on a midpoint in there that's more than 20% growth that's entirely possible.

If the supply chain stays.

With some stability and we fix some of these.

Particular issues that we're seeing right now more than that right now would be kind of speculation.

Okay, Alright, thanks again, the whole point there rod is.

Number 6% to 8% is not a meaningful number right now.

We have a depressed level of revenue this year, so 6% to 8%.

Not a relevant number and as Gary said, we haven't got into next year, it's very hard for us to give a range.

But we haven't given.

What I would say is we got a big backlog and it could be a lot higher than that if we got the parts.

Yeah makes sense, Okay, and then the second question I had I guess, mostly for you Gary but it's related to the Salesforce you had mentioned that you are accruing.

For the call it plan.

Our incentive based compensation I Wonder are you worried that it's going to be tough to retain salespeople. The labor market is still pretty tight.

There are I guess other peripheral companies maybe not in optical that are having better luck on supply I wonder how youre feeling about retention of salespeople what the what's the plan there.

Okay.

That's a good question the large amount of the bonus accrual that we changed for Jimmy is actually non sales non sales related and most not all of the sales force there actually comped on orders. So we've had an extraordinary order your survey.

I feel pretty good rod that the sales force and quite rightly you have been on.

The whole well well compensated and we have a highly tenured sales force, we have the largest and best equipped optical salesforce in the world.

I'm talking about systems engineering, and the sales folks as well so I think they are.

Largely compensated on orders so that Dave generally had a pretty good year.

But the question does pertain to our general employee employee.

As best we can with merit and other things.

Sure Great question.

Thank you sorry thank.

Thank you.

Please standby for the next question.

Yeah.

The next question comes from Amit <unk>.

Garo nanny with Evercore Your line is now.

Okay.

Perfect. Thanks, a lot and I'm glad I snuck in here.

I guess, maybe the first to ask you as well, but the first one I have is you know I think July quarter, you talked about a $60 million Miss due to the supply chain issues.

October quarter guidance at 240 million below where the street was what you had implied in the past is all of that will be related to the same supply chain issues or is there something else happens it almost seems like the backdrop for that effect the October quarter guidance in July and then.

What is the top of recovering from what you're hearing from your suppliers or is it going to happen in Q1 or is there a much longer lead time for this recovery the bottleneck to EMEA.

Okay.

In general.

Yes.

If I heard and understood the question correctly.

Three guide of what the commitments were.

As the environment and commitment sit today.

Got it and then could you.

Just touch on how do you think free cash flow stacks up in.

Q4, and fiscal 2000, and working capital still going to be a use of free cash flow in Q4, so potentially negative.

These include hospitals that look this underlying free cash flow expectation for Q4 and in <unk> 'twenty.

Yes.

I would say is that we consumed a fair amount of free cash in Q3, we built a lot of inventory.

Yes.

Is that we will probably build a little more inventory as we move through the next couple of quarters.

And hopefully.

We will have a good free cash flow next year.

I appreciate it.

Okay.

Thank you everybody for joining us today, we do look forward to connecting with everyone. During the day today as well as had a few events next week during the Labor day weekend. It was closed.

This concludes today's conference call. Thank you for participating you may now disconnect.

Q3 2022 Ciena Corp Earnings Call

Request a DemoDemo

CIEN

Ciena

Earnings