Ciena Corporation (CIEN) Q2 2022 Earnings Report, Transcript and Summary

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ciena Fiscal Second 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Gregg Lampf, Vice President of Investor Relations. You may begin your conference.

Thank you, Rob. Good morning. And welcome to Ciena’s 2022 fiscal second quarter results conference call. On the call today is Gary Smith, President and CEO; and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Product and Services is also with us for Q&A. In addition to this call and the press release, we have posted to the Investors section of our website an accompanying investor presentation that reflects this discussion, as well as certain highlighted items from the quarter. Our comments today speak to our recent Q2 performance, our views on current dynamics 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 Ciena’s results of operations. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today’s press release. Before turning the call over to Gary, I’ll remind you that during this call, we’ll be making certain forward-looking statements. Such statements, including our quarterly and annual guidance, discussion of market opportunities and commentary about the impact of COVID-19 and supply chain constraints on our business and 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. These statements should be viewed in the context of the risk factors detailed in our most recent 10-K filing and our upcoming 10-Q filing, which is required to be filed with the SEC by June 8th and we expect to file by that date. Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events or otherwise. As always, we will allow for as much Q&A as possible today, though we do ask that you limit yourself to one question and one follow-up please. With that, I’ll turn it over to Gary.

Thanks, Gregg, and good morning, everyone. This morning we reported largely in line financial results. When considering those really a strong achievements against the backdrop of an increasingly challenging supply environment. This included revenue of $949 million, reflecting year-over-year growth of 14%, as we continue to take share and grow faster than the overall market. Building off an historic first quarter order flows. Our order flow in the second quarter remained very strong, with a book-to-bill ratio well in excess of 1.5. As a result, we continue to grow our backlog. In fact, with continued strength in orders in recent periods, we have seen significant expansion in our backlog since the end of fiscal 2021 from about $2.2 billion to more than $4 billion exiting Q2. We are clearly seeing a number of positive demand trends at a secular level that we believe are very durable over the long-term. And with our leading innovation, scale, customer relationships and investment capacity, we will continue to capture market share. Ironically, this significant growth and demand for our technology has exacerbated the impact of ongoing global supply chain challenges on our business. And in fact, Q2 really presented the most volatile set of supply chain conditions to-date, which in fact worsened as we move through the quarter. To put it simply, demand continues to significantly exceed supply and availability of supply is the most impactful factor in our performance and rate of revenue growth at this time. Within this context, we continue to execute well in Q2 and navigate these challenges through supply chain mitigation strategies. As a result, we delivered more products in Q2 than we did in the same quarter last year, including some notable highlights that illustrate our innovation leadership and the diversified business that we’ve built. To start with, non-telco revenue in Q2 was approximately 44% or up 15% year-over-year. This included direct web-scale revenue of 22%, an increase of 7% year-over-year, primarily for our Waveserver platform. Our top 10 customers in the quarter included for web scalars and we made our first product shipments to a new large web-scale customer in the U.S. We now have the top six global web-scale companies as customers of WaveLogic 5 Extreme in different stages and maturity of deployment. Overall, in the quarter, we added 16 new customers with WaveLogic 5E, bringing our total to 172. Q2 was a record quarter for shipments of WaveLogic 5E, up 50% year-over-year and more than double that of last quarter. To-date, we’ve shipped more than 35,000 WaveLogic 5E modems to customers globally. In routing and switching, our business is growing, driven by Tier 1 service providers, as well as Tier 2, 3 customers for our expanded routing and PON capabilities. Quarterly revenue there was up 27% sequentially and more than 70% year-over-year, including a strong contribution from the recently added Vyatta platform. And finally, platform software and services revenue was up 22% from this time last year. Looking at the overall demand environment, the shifts in business and consumer behavior have accelerated positive trends for our business, including cloud adoption, a greater focus on the network edge, which is really greater capacity closer to the customer, and the need of course for increased automation. These are strong and durable long-term secular drivers for the industry, creating an incredible demand environment for our business going forward. In optical, specifically, we are experiencing significant growth in our large installed base of customers around the globe, fueled by exploding bandwidth requirements. Adding to this positive dynamic is continued incremental opportunity to displace Huawei in many countries, particularly in Europe, as well as increasing public investments in network infrastructure. In routing and switching, we continue to secure new design wins around the world, primarily associated with growth in wireless and accelerated cloud adoption, again at the edge of the network. And we continue to expand our addressable market in this space, as we invest in new technologies and solutions to address additional use cases, such as residential broadband. In Blue Planet, demand continues for automation that enables differentiated digital services for a fully connected experience. 5G we believe will continue to fuel the need for OSS modernization, as new innovative services require end-to-end service lifecycle automation. These demand dynamics are present in our order book today and we expect continued demand to address these network requirements will result in a growing backlog as we move through the second half of the year. This level of demand far outpaces, frankly, our expectations for orders in the year, driving a backlog that reflects strong underlying secular demand. As a result, we have tremendous confidence in our forward growth opportunities. Now with that said, I want to be extremely clear. In this environment our revenue is not a function of demand or even production capacity for that matter. It is purely a matter of component, supply, availability. And that, of course, brings me to supply chain, and as we all know, we remain in a very constrained supply environment, particularly with respect to semiconductors and integrated circuits. And I think it’s important to remember that these particular parts are relevant to multiple industries, from telecom to consumer electronics to automotive and others, which only serves to exacerbate this global supply challenge. And of course, we continue to employ a range of supply mitigation strategies that we’ve previously discussed, including, placement of large advanced purchase commitments for critical components in short supply with extended lead times and qualifying engineering alternatives to expand our sources of supply. However, as I mentioned earlier, supply chain conditions appreciably worsened as we moved through Q2. Specifically, we saw a significant increase in both volume and magnitude of supplier decommits, that we weren’t able to fully mitigate in two areas that are critical to our business. Firstly, a number of key optical subcomponents suppliers, as they themselves have publicly noted, have been unable to fulfill their supply commitments due to constrained access to semiconductors. Second, we’ve seen additional supply decommits for a number of integrated circuit suppliers centered really on low value commoditized parts that are essential to the operation of our finished products. The second dynamic has been largely related to the COVID lockdowns in China. And while we have by design, a very low overall supply chain exposure to China, our revenue is being affected given that China is effectively the primary source of many of these low value commoditized parts that are essential to the production of IC and SMIC. On both of these issues, there simply aren’t enough parts to go around and satisfy demand across a number of industries and market segments. Just to reiterate, these dynamics do not represent the Ciena specific challenge rather this is an industry-wide global challenge. And despite the willingness of network operators to spend, we expect that the length and severity of current supply conditions will impact both overall industry growth rates, and of course, our own revenue growth. That said, when our industry begins to see improvement in supply dynamics, our scale, investments, customer relationships and strong balance sheet puts us in the best possible position to service industry demand. With that, I’ll turn over to Jim for more detail on Q2 and to discuss our guidance. Jim?

Thank you, Gary. Good morning, everyone. We delivered Q2 revenue of $949 million in line with our guidance. Adjusted gross margin in the quarter was 43%, also in line with our guidance and consistent with our expectation for a revenue mix that includes a larger proportion of lower margin common equipment. It also reflects significantly higher component costs and also higher logistics expense. We expect these dynamics to continue as we move through the remainder of this year. Adjusted operating expense in Q2 was $301 million. It is important to point out that while our results were in line with guidance, this achievement was a significant task in the current environment and required outstanding execution across a number of functions inside Ciena. Moving to profitability measures, we delivered adjusted operating margin of 11.3%, adjusted net income of $76 million and adjusted EPS of $0.50. In addition in Q2, cash from operations was $106 million, free cash flow was $86 million and adjusted EBITDA was $129 million. We ended the quarter with approximately $1.6 billion in cash and investments. Also in Q2, we repurchased approximately 1.5 million shares for $87 million and received 900,000 shares of common stock, pursuant to the final settlement of the accelerated share repurchase program, which we implemented earlier in the year. We continue to expect to repurchase approximately $250 million of shares in fiscal 2022 in addition to the ASR. Turning to guidance. Overall, industry supply chain conditions make providing guidance extremely challenging at this time. Conditions were more difficult in Q2 than in previous quarters, mainly because of a higher number of decommits from our supply base, caused both by semiconductor availability and China lockdowns. Demand drivers are very robust, but as Gary said, in this environment, our revenue is not a function of demand, it is purely a matter of components supply availability. Also, with the current state of the supply chain and the resulting greater uncertainty, there is a wider range of potential outcomes in the coming quarters than has been the case. As always, we are providing our best perspective today about our expected performance in Q3 and for the fiscal year. Importantly, this view assumes that our component suppliers deliver on their most recent commitments and that we don’t encounter any substantial new decommits that we cannot successfully mitigate. With that, in Q3, we expect to deliver revenue in a range of $870 million to $930 million. This lower range for expected revenue is entirely driven by conditions in our supply chain. We expect gross margin for Q3 in the low 40s percentage range, which reflects a continuation of the same dynamics that we saw in the second quarter, a higher percentage of revenue from line systems and common equipment, again, coupled with greater than expected component costs and higher logistics expense. And finally, we expect OpEx of $305 million to $310 million. With respect to the full fiscal year, we’re adjusting our expectations for exactly the same reasons and with the same assumptions. We now expect to deliver annual revenue growth in fiscal 2022 in the mid-single digits, gross margin for the fiscal year we expect to be in the low 40s percentages, our operating expense will be roughly consistent with an average of $300 million per quarter for the full year, perhaps a little bit higher in Q4, mostly due to compensation expense, and finally, operating margin in the low-double digits. Generally speaking, the growing consensus view in the industry is that supply chain conditions will take at least several more quarters to return to a normalized state. Given the persistence and unpredictability of these challenges to-date, we believe that is a reasonable assumption at this time. But it is entirely possible that this timeline will continue to change. It is an incredibly dynamic situation. Furthermore, it is critical to remember that there will not be a light switch moment, that is a single moment in time when conditions improve and the flow of supply returns to normalize levels. Any recovery, when it begins will be gradual and will occur over time. In summary, we’re mindful of the variability of outcomes the supply challenges present in the near-term, but we are prepared to benefit, when a meaningful and sustained recovery in supply dynamics occurs. Importantly, we are extremely positive about the durability of the underlying secular drivers, which continue to drive a significant and growing backlog that reflects not only a strong demand environment, but also our continued market leadership. Combined with our relationships with customers and suppliers, and the mitigation steps we’re taking to address current challenges, we are very well-positioned for long-term growth and success. With that, we will now take questions from the sell-side analysts. Rob?

[Operator Instructions] Your first question comes from a line of Paul Silverstein from Cowen. Your line is open.

Thanks for taking the questions. Jim, Gary, can you also discuss what linearity look like in a quarter, and perhaps, even more importantly, what has been -- what the bookings look like over the past four weeks leading up to today? And then I’ve got, and, Jim, related to that, what would guidance be for July and for the October fiscal year, but for the supply chain impacts, how much revenue was impacted? What was the gross margin impact? Thanks.

Yeah. With respect to linearity, as has always been the case, we are back end loaded. Typically, it’s because of the timing of our orders. But in this case, it has to do with the delivery of components to our contract manufacturer. So we’ve had a very non-linear flow of orders. They’ve been strong really the entire year and not necessarily in the last month of the quarter, even though it’s strong in the last month of the quarter, it’s not as back end loaded on the order side, but on the supply side, it has been back end loaded, and therefore, our revenue has been back end loaded.

So, Paul, the other thing I would add in terms of the linearity of orders. As Jim said, it’s been pretty consistent. Q2 was over 1.5 ratio to revenue and we expect to continue to build backlog for the second half of the year as well. So we are seeing very consistent demand, which is really driven by just the increase in traffic and the adoption of cloud at both the consumer and enterprise level on a global basis. So, initially there was a little bit of catch up and then there’s some forward ordering, but it’s not that much. We in fact -- we’ve only got. In 2023, requested, we’ve only got a few $100 million. Most folks would take everything we’ve got right now. So that’s why we talked to this very sustainable order flow demand.

And to your specific question about what our guide would have been, it’s -- a number that is almost beyond the pale, Paul, because we’ve got backlog of over $4 billion, as Gary said, only a few $100 million of that is true 2023 demand. All the rest of it is asked for by the customers in this year. So our revenue for this year would have been extremely high if we were able to get the components to manufacture it. Now, I don’t think people should take that as the -- if you just run the numbers there and figure out what our revenue could be this year, you shouldn’t take that as our run rate. This is a catch up. It’s the fact that they’re all trying to get ahead of everybody else with their orders. But it does speak to the strength of demand and what we think is very doable demand.

Jim, just be clear, you all, I don’t think you provided the backlog number, last quarter it was $2.17 billion coming out of October. What was the backlog increase in April? And just to be perfectly clear with respect to my question about linearity and order strength, the forward indicators you’re looking at, order growth and all the other leading indicators that speak to future demand. There’s been no attenuation of recent events, I mean, obviously, this goes to the concern, the widespread concern about a macro slowdown translating into slower economic activity for virtually everybody, yourself included. You’re arguing that’s not what’s going on, this is purely supply driven. But again, my question to you is, looking at demand trends, looking at all the different forward indicators, you’re not seeing any attenuation strength?

No. We’re not, Paul. I mean the rough rounded numbers we came out of the year at over $2 billion. We came out last quarter with over $3 billion. We came out of this quarter with over $4 billion. And everything that we’re seeing and forecast with our customers tells us that, might not continue at that pace, but we’re going to continue to grow backlog with the order flow. And the other thing I’d say about macroeconomics, whilst no industry is immune from that, I do think that cloud adoption has proven to be incredibly resilient in the ups and downs of various economic moves. And I think it’s sort of fundamental to how the world works now around getting greater bandwidth closer to the customer and that we’re not seeing any signs of that letting up at all, in fact, the opposite. If you look at web-scale, they’re planning to build more and more data centers again closer to the customers around the world and we are, obviously, in partnership with them about their long-term planning. We’re not seeing any slowdown on that whatsoever. Thanks, Paul.

Thank you. That’s my follow up, just to be clear, you can’t see them in the numbers because of a supply chain situation, but the strength you’re referencing that was broad based geographically across product markets and across class?

Absolutely. Yes.

Yes.

Absolutely. Verticals, regions, products, particular strength in our routing and switching business, which as you know, that’s a focus for us.

Appreciate it. Thanks, guys.

Thanks, Paul.

Your next question comes from the line of Amit Daryanani from Evercore ISI. Your line is open.

Yes. Good morning. Thanks for taking my question. I have two as well. I guess, first one, maybe, simplistic, I think about the backlog has ramped up from $2.2 billion to $4 billion in the last four quarters over the last year, how should we think about how much of this is due to just demand is stronger? It’s a natural buildup of backlog versus customers that are placing longer duration orders maybe because they’re worried they won’t get supplies? So I think is a way to think about, yes, the backlog has gone up? How much of that is due to duration going extended by your customers versus all the other supply chain issues you’ve talked about?

Yeah. No. That’s a good question, Amit. Let me give you sort of a data point here that I think will help with. I think you’ve got a confluence of sort of three things going on, you’ve got a little bit of catch up, that certainly was the case sort of probably 12 months ago, where carriers were very conservative during COVID, both cons -- both from an operational perspective and from a fiscal perspective, they were playing a bit of catch up, that’s largely flowed out. Then we are seeing a little bit of, certain customers looking at security of supply and giving us more visibility longer into the cycle, that’s absolutely happening. But an interesting data point around, is it real traffic that they’re trying to buy for and address or is it just security of supply chain. Of the $4 billion plus, in hardware, we’ve only got a few $100 million that is requested for 2023. All the rest of it is requested for 2022. Now, that’s not going to happen clearly for all the reasons that we’ve just talked about. But it does give you, I think, a great insight into the fact that there’s not that much forward ordering in that backlog, which is real demand that folks want.

And just another clarifying couple of points here, our backlog is definitely a double-edged sword here. It’s great to have the demand. It’s great that the orders are placed on us as compared to our competitors. But part of the reason that we have such a big backlog is because our lead times are longer than we’d like them to be and we’re not making our customers delighted as we like to do. And so the fact is that, when we get new orders, which we’ve had a ton of this year. Most of them are being scheduled out in the latter part of this year, in some cases into 2023. As Gary said, it’s not really 2023 demand, but that’s when we can deliver it. So it’s -- as we say, it’s a double-edged sword. We’re glad we have the orders, but we’d like to delight our customers.

Fair enough and it’s really helpful. I guess, just my follow up would be, in the past when we’ve had a revenue challenge or headwind gross margins are typically done really well. It’s been a mix of new products versus existing ones. Just to run on, everyone has seen the revenue headwind, but we aren’t seeing a gross margin offset or tailwind? So maybe just talk about, why aren’t we seeing that headwind, because imagine historically, low revenue that meant better gross margins for the company. So why is that not happening this time around?

Amit, what -- I’ll take the first part of that and then maybe Jim or Scott can talk to the actual sort of increase in cost. The first part of it is really mix. And so, Amit, what we’re seeing is, remember, we’ve won a lot of new global strategic carriers and web-scale build outs that we’re now deploying, so a lot of that is really think commons and line systems, which tends to be lower margins. So just the general mix on the business given the size of it, even though routing and switching is doing well and software is doing well. It really the large part of the mix is around those line systems right now. Now it bodes extremely well for the future, because then we can put in cards and modems, which tend to be higher gross margin. So you’ve got a different mix really based on the demand that we’re seeing and a lot of its new-builds that were both with new customers and with existing folks.

Yes. And just to put some numbers on it, Amit. Remember, last time, we’ve talked about what we believe to be our long-term gross margin or run rate gross margin, I should say, is around mid-40s. We said 44% to 46%. So, I’m going to shorthand it at 45%. We went into COVID, there was a smaller percentage of new-builds because of the difficulty of getting supplies and people out to locations and so we had a higher percentage of capacity as, which are higher in gross margin. So we enjoyed that. But we said, as we entered this year, that we thought that our gross margin this year was going to be 43% to 46% overall, because we did expect a higher proportion of new-builds and commons and photonics, which are inherently lower margin. That was our expectation coming into this year. Now, what’s happened is, we are seeing that, but we’re also seeing significantly higher premiums that we’re paying to get parts. We’re trying our best to supply our customers even if it costs us money and gross margin, which it is, and also higher logistics costs. The rough math for the effect on this year’s gross margin of those two ladder points, meaning premium and logistics costs is roughly 400 basis points, you can think of it that way. So you can do math and get to where you think our gross margin might be without these. We are reasonably confident that we’re going to get back to those mid-40s at least as we come out of this supply chain situation, but we can’t give you a prediction as to when it’s going to occur.

Thanks, Amit. Appreciate for your question.

Thank you.

Your next question comes from the line of Tim Long from Barclays. Your line is open. Your next question comes from the line of George Notter from Jefferies. Your line is open.

Hi, guys. Thanks very much. I guess, I wanted to ask about purchase commitments. I think you said in the monologue that, one of your mitigating initiatives was to ramp up purchase commitments. Can you tell us what that purchase commitment number was, and I think, if I recall correctly, we printed the 10-K, that number was about $430 million. So just curious if that number is up?

Yeah. That’s up quite significantly, George. It’s up to about $1.8 billion today. We’ve essentially laid out to our supply chain at least the next 18 months of what we see is demand. So if they deliver on that, we’re going to do very well.

Got it. Okay. And then the other thing I wanted to ask about was, your inventories started to inflect I think just a couple of quarters ago. Look, obviously, this supply chain environment has been around for a couple of years and so purchase commitments are just inflecting. Now, inventories are just inflecting in the last quarter or two. I guess I’m wondering if like this is more an execution issue at Ciena or do you think by and large you guys have executed, as well as anybody else?

Let me take the first part of that, George, and maybe, Scott, can talk to the inventory a little more precisely. Listen, I think that, I think today we’ve navigated it extremely well. I mean, you look at the performance. We shipped more in the second half than we did in the first -- in the first half than we did in the previous year. Revenues are up 14% in the quarter. So I think the numbers talk to themselves, particularly when compared to the competition. So we’re a much larger installed base. We’re a much larger business with larger market share, but we’re still growing the business and shipping more. It’s not where we want to be or where we could be if we had supply. So I think, generally, we’re navigating through better than anybody else. But it’s not -- it isn’t where we want to be from, as Jim said, from a customer satisfaction point of view.

And George, just to speak a little bit to the inventory position, a couple of dynamics there that are all rooted in conscious decisions and it really relates back to Jim’s comment of we’re not pleased with the way we’re servicing our customers. So we are making investments and component inventory, where we can get our hands on it in preparation for the last remaining items that come in in order for us to turn into finished goods so that we can do that very quickly for our customers when they become available. We’ve also complemented that with manufacturing capacity expansion. So, again, we can turn components into finished goods as fast as possible for our customers. So it was a conscious decision. If you look inside that inventory number, you’ll see it more of it is shifted actually to the component level versus the finished goods level as well, you can see that dynamic happening,

Just to the point of our purchase commitments, George, if you read the statement and how we describe it, we talk about non-cancelable purchase commitments. If you think about the -- and there are certain procedures that we have to go through in order to cancel. But our actual total purchase commitments even a year ago were much higher than the $400 million that we disclosed, because we considered that a lot of it was canceled. Today, we given the demand situation, we’ve sort of viewed essentially all, perhaps not, essentially all of our forward purchase commitments as non-cancelable, because we’re not going to cancel them, we need to stop. So if you could see inside that logic, you would have a different view of what our purchase can -- our total purchase commitments were even a year they have been a lot higher.

The other thing I’d add to that, George is that, I just remind everybody, that’s rule component cost. That’s -- there’s no transformation on that. That doesn’t include the inventory that we’ve got on that. So if you add all of that lot together, we basically have provided commitments out to our supply chain for key elements for the next 18 months.

As I think about the kind of manufacturing side of this, I know, for example, going back to OFC, we were talking to some of your customers. I know lead times were more than a year. Where are lead times now and do you think there’s some potential for you guys to lose share that -- now that we’re hitting, again, longer and longer lead times and it’s frustrating of certain for customers?

Yeah. Lead times, George, are 100% a function of the component availability. It’s not a function of our manufacturing capacity. So I’ll point that out. And the numbers are you sort of quoted is kind of in the range of where we’re sitting today from a lead time perspective. And bending the curve on that, again, goes back to when do you believe the components supply industry starts to show better performance. You want to talk to the durability of the demand and…

Yeah. I mean, I think in terms of the competitive environment, our market share like that, let’s look at a couple of data points here, our market share in the first half, we think, increased 1% during all of this.

That’s revenue. That’s not…

That’s absolute revenue. Yeah. That’s not shipments. I mean, we shipped actually more than that. But it’s -- that’s excluding China. So we grew 1%. And I think the other two data points is our revenue grew more than the competition in the first half. So we’re shipping more and we’re a much bigger company than a lot of those folks in optical share. And then the other testament to it is the order flow, I don’t think anybody is seeing the kind of order validation from the customers, knowing what our lead times are and we’re still increasing our backlog. We’ve been very transparent with our customers. But remember, our products are highly differentiated. We have by far the best technology and relationships with these customers. And I think global scale and balance sheet and those relationships are absolutely critical to coming through this with a winning hand and that’s what we’re focused on.

And just as importantly, all of our competitors are looking at the same supply chain conditions that we are and so it’s unlikely that anybody is looking at wildly different than what we’re able to provide.

Okay. Thanks, George.

Great. Thank you.

Thanks, George.

Your next question comes from the line of Fahad Najam from Loop Capital. Your line is open. Again, your next question comes from Fahad Najam from Loop Capital. Your line is open.

Good morning. Gary, if I look at your backlog commentary and the quantification you provided and across your competitors, the cynical New Yorker may says, I have the networking, the optical networking market hasn’t been growing this fast, broadband space I think haven’t really changed much in the last since the COVID pandemic started. So where is this all incremental demand coming from or is it just a pure function of customers double order, not forward ordering, but double ordering in order to secure more supply? What do you say to that?

I say to that, we’re not seeing that. There may be some minimal amounts of that. But given the fact that this is not commodity stuff, you can’t swap and change around it, and the relationships we have with our customers, I think, that is not a dynamic that we’re seeing. With -- what’s driving that is real bandwidth growth. And when you think about what’s happened during the pandemic, people were using more bandwidth, but carriers weren’t spending and this market was kind of flat for about two years. And we expected an uptick, which we began to see about 18 months ago. So I think it’s -- the demand from the customers has continued to increase from the consumers of this, both the consumers and the enterprise base. What we’re seeing is just an uptick in cloud adoption, both at a personal level and at a global enterprise level. It’s about getting bandwidth much faster, closer to the customer in their various forms. And that’s why we’re seeing an uptick across all of the sectors, submarine, datacenter interconnect, Metro, Edge, all of the engagements that we have are all about how do we get more capacity, more efficiently out to there. So this is not embedded in some false security of supply demand piece, absolutely not. This is about real demand of traffic and for all the reasons that I think we can all understand and we see in our daily lives.

One thing I’d say, though, is this, that for a long, long time, this industry has grown at low-to-mid single digits overall. And we’ve grown at sort of 8% and our last guide for three years said, we do expect the industry to continue to grow at that historic rates and we expect to grow at 6% to 8%. So, none of that has changed in our view. The world continues to act as it has been acting. So we’re not saying that this kind of order flow is going to continue for the long-term. We think that order flow will be good. It’s not going to be at the higher levels that we’re seeing this year. So I don’t want you to think that we’re calling up our growth rate. I would say this, I think, given what we think our backlog will be at the end of this year and assuming that our suppliers deliver on their commitments to us, we’ll have a growth rate in revenue next year, that’s well above the 6% to 8% than we’ve seen in the past and I can’t give you a number on that. But it’s going to be good. But again, our long term view of the future of the industry is grows at 3% to 5% and we’re going to grow in that world 6% to 8%. That’s what we think today.

My follow up is to kind of really piggyback on George’s question on the extending lead times and the supply chain shortages. To what extent are these forcing your customers to change architectures, maybe pivot to more pluggable, you can plug a plug book into an existing router, you don’t have to set up a new power system or power supply, et cetera. Do you think there is a risk of customers adopting pluggable faster because they still need the bandwidth?

No. Not at all. In fact, I think, ironically, the dynamic may be the opposite, because in order to take advantage of those pluggable is you actually have to upgrade your entire switching or routing infrastructure to a 400 gig infrastructure that is constrained by the supply chain as well.

Appreciate the effort. Thank you.

Thanks, Fahad.

Your next question comes from the line of Tim Long from Barclays. Your line is open.

Thank you, sir, for that before. Two questions if I could. First, let’s just beat a dead horse and then a second one. Jim or Jim and Gary, the last guidance implied no decommits and when we look at the Q4 to get to the full year, looks like a pretty big sequential increase, probably, something like 20%. I’m not sure exactly what mid-single digits for the year means. Why would we assume that the de -- that everything gets delivered as expected, what visibility do we have that the supply chain is going to live up to the commitments they have when that hasn’t happened over the last multiple months here? That’s number one. And then number two, I was hoping you could just dig more into the switching/routing part of the business. Obviously, you’ve added Vyatta, if you could just talk about how much that helped the numbers. And you talked about expanding TAM and use cases. So if you could just, Gary, maybe give us a little color on how you see the trajectory of that business potentially moving over the next few years here? Thanks.

Tim, I’ll take the first part. And what we’ve always tried to do and what we continue to do today is, we’re trying to give you or give the world, a set of numbers that are reasonable and reflect our view of what the world looks like today. We expect that there will be some decommits. I will say this, that we had decommits in Q2, which we were largely able to mitigate and therefore we came in line with our revenue. Hopefully, we built in enough sort of margin for error that we can handle some decommits. But again, it’s our best view of the future, and yeah, it’s -- if you look at the entire year, roughly $250 million or so below what we’ve said about the year in the past, roughly half of that is because of the fact that our optical subcomponent vendors are unable to get parts and the other half is because of the China lockdowns. It’s not precisely 50%, but roughly half and half.

And to your question about breaking down a little bit the dynamics that are going on in the routing and switching business, I’ll say, say this just to repeat, the business itself was up 27% sequentially quarter-on-quarter and about 70% year-on-year, that’s a combination of organic growth and inorganic growth with Vyatta. I’d say roughly split in half and half roughly between the two. What’s driving that? Primary use cases for that portfolio that we’re focused on are all centered around the evolution of the mix, the Metro and the Edge. We see growing interest in our wireless transport infrastructure, as people build out fiber-to-the-tower and look at architectures moving to 5G. Enterprise connect, as Gary talked about enterprise connect into the cloud, a new space for us around residential access, getting all interest in the architecture there and then backing off from that, bringing all three of those use cases back deeper into the network, a common routing and switching aggregation platform. So those are the four areas that we’re investing in. We think it represents a significant TAM expansion over the years for us and the early signs, as you can see in the results year-over-year, we’re having some really good early successor.

Thank you.

Yeah. Thank you.

Your next question comes from the line of David Vogt from UBS. Your line is open.

Great. Good morning and thanks for taking my question. I just want to come back, my line cut out earlier. I just want to come back to the lack of supply and specifically ICs. I guess it’s our understanding that this is a fairly well known headwind. And I guess I’m just curious, how do you square that commentary that, the book-to-bill and backlog are strong, but I would imagine your customers are incredibly sophisticated. They know they’re shortages of ICs. So is there risk that they’ve already adjusted their order cadence a little bit earlier and so that raises some risk that there could be an air pocket later, maybe not this year, but into 2023? And then I didn’t hear any discussion of maybe what a recession might look like next year, if we do move into a more slower growth GDP environment? What that would look like for your, not only your order growth and your backlog, but what your customers might respond to? And then I have a follow up on the numbers being pushed out into next year.

David, let me take the recession one first and I’ll then take Scott for the first part of your question. I think we’re, obviously, mindful of the macro sort of economic challenges that it looks like the world is going to go through. But I would say a couple of things, in our conversations with all of our customer base and its diversity. We are not seeing any lead up in their forecasts and demands, and their long-term plans. I mean, we’ve got pretty good visibility into the next one year to three years around the overall dynamics of what they’re seeing to do. And so I -- listen, I think the industry is never immune to a recession, but it’s generally performed extremely well during the recession, because people need access to the network. And network operators and web-scale are going to continue to invest in their network in getting more traffic out there. So, I think, we feel very good around the durability of the demand that we’re seeing. And in terms of fulfilling what we’ve got, I think what we’re trying to do right now is just really catch up with the backlog and the pent-up demand. I mean, as Jim said, I don’t think we’re going to see order flows at the rate that we’re seeing them right now will this year, but I don’t think it’s going to fall off a cliff, we’ll go through an app pocket either. I think you’ve seen a change in the dynamic around this is really an infrastructure business and I think people are getting used to ordering out longer term. And I think you will see that, these lead times will get better over time, for sure. But I think you will see greater long-term visibility with our customers.

And remember that, we’re advertising and talking to our customers about longer lead times. It’s absolutely imperative that they then place longer duration orders on us than has been the case in the past, because they do need the gear. And we’re not -- as we said, we’re not claiming that this rate of order intake is sustainable. But we are -- we do strongly believe that demand for our service -- our products and services will continue to grow and will continue to take market share.

Great. Maybe just as a quick follow up. That’s helpful. So you’ve given lead times at least appear to be persistently long and not tightening here in the near-term. How would you handicap sort of that $250 million revenue shortfall, the likelihood of being able to capture that next year, given where lead times are and where commits are at this point and your purchase order commitments, right? So, I mean, obviously, it’s a difficult visible -- it’s difficult visibility to predict, but you mentioned that you’ll obviously think you’ll grow faster than 6% to 8% next year, but is the expectation based on your order book and where your supply chain is today that you would be able to capture most, if not all of that next year?

Well, I mean, if you just look at the delivery dates, it probably wouldn’t be in next year’s. But I -- all we can say about next year today really is that, given where we think our backlog will be at the end of this year, we do expect to have a significantly higher growth rate in 2023 than the 65 to 8% we’ve promised in the past. And I can’t give you an exact number, because I don’t know the number. But I think it’s going to be a great year next year.

And I would just add that I think sort of, and again, we’re not talking about 2023 right now. But our sort of view is what’s going to happen is, we’ve got to get greater predictability from supply chain and we’ve got to get the volumes that supply chain have committed for 2023. We’re not really banking on improved lead times from suppliers.

Thank you, David.

Your next question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

Yeah. Thanks, guys. Appreciate it. I just had five more questions on supply and I wondered if you could pick the all five and…

Five.

We have five more answers for you, Rod.

No. I wanted to dig into the verticals a little bit. I’m just looking at the cable number was kind of usually that seasonally up in April and it kind of flat lined. I don’t know if that’s supply oriented. So I just wondered if maybe you could talk a little bit about dynamic -- the demand dynamics there? And then likewise, government is up a lot. I mean, that was a big number in April. Just curious if you guys could dig into those vertical demand dynamics a little bit? How much is affected by the supply, how much of this is demand, but just curious what’s happening there? Thanks.

Yeah. Rod, I would say, the cable piece is purely supply. I mean, we’re seeing very strong demand now to that and it could have been a lot greater if we’d have had, hate to use the S word again, supply. So I don’t think there’s anything to that. Government, it was a couple of larger projects that we delivered in the quarter. You got a lot of ebbs and flows on the government stuff, very project based. But I think cable space together with the sort of Tier 1 carriers in North America, very robust demand, and again, it’s really a function of just us supplying.

And you think, I mean, the government number, Gary, does that kind of ratchet back down again, April just was a pulses project oriented revenue or is that…

Yeah. I’d say, they -- I think the forecast for it, depending on the ability to ship. But I think that’s likely to go down in Q3. But we are seeing -- for step back from those ebbs and flows, we are seeing the sort of consistent investment by the government and in their networks for all kinds of reasons that we’re going to probably know and so we do feel good around that space. I mean, I appreciate you highlighting it. We feel good around that for the next few years. There’s a lot of network build out and network modernization that’s going on within the various government networks.

Our technologies…

Right.

…fits their needs very well too.

Great. Okay. Yeah. That’s all I’ve got. Thank you very much.

Thanks, Rod.

Your next question comes from the line of Tal Liani from Bank of America. Your line is open.

Hey, guys.

Hi, Tal.

Hi, Tal.

The risk the things get canceled next year, because customers don’t get the products. So if I’m thinking about the cloud or the service providers, having their side of the operation ready for products and not running any operation, so they don’t get the revenues associated? Why start a project if there’s still supply chain issues? So the question is about the sensitivity of demand to supply basically?

I don’t think that’s the driving force. So I think the driving force here, Tal, is underlying demand for bandwidth. And that has continued to grow through every economic condition we’ve had for 20 years or 30 years. So I don’t think lack of supply is going to constrain their demand. I think it’s -- they’re going to have the demand as long as their customers are demanding services from them, and as I said, we’ve seen no reduction in that.

I think on the web-scale, specifically, there’s no point building a data center, if you can’t connect it. I mean, I get the point. But I want to get the sort of context of this, right? We are shipping more than we did last year. So we are shipping stuff. So we are providing connectivity to these folks and they’re just not getting the full capacity that they wanted. So, this is not a sort of binary situation. I mean, we are growing. We just posted a quarter with 14% revenue growth, despite all of this stuff. So it’s not as if we’re not getting stuff out there. So we are satiating some of the demand for our customers, but it’s not everything that they want. And there aren’t -- no one else is doing it better than we are. So there’s not a lot of other alternatives to that and people wouldn’t want to get out of the queue, I’m sure. And by the way, we’ve got the leading technology and continue to have that. So, that -- those are the dynamics that we see, Tal.

And the fundamental constraints if you follow the chain is common to everybody.

Right. And Gary, maybe a follow up question is, what -- isn’t it -- isn’t this environment bringing up more voices within cloud to self manufacture solutions, rather than buy from vendors, just because they’ll have better control over the supply chain? Do you think that maybe white box solutions or any anything that is more about self design, self manufacturing? Don’t you think that this can actually grow as a response to the current environment?

I think, Tal, from the conversations that I personally have, I think, the opposite is actually true, frankly. I mean, we’re able to navigate through it, because we’re a specialist focused player and we’re vertically integrated. So we’re actually in a better position to go and do that. And I think to Scott’s point on the ZR pluggable thing exactly the same reason is actually pushing that market out because it’s more difficult to get the infrastructure to support that. So the DIY stuff is actually more difficult than it was before.

Got it. Thank you.

Thanks, Tal. Operator, we will take one last question.

Your final question comes from the line of Simon Leopold from Raymond James. Your line is open.

Hey. Thanks for taking the question. Kind of surprised nobody’s asked this actually. You talked about the supply chain worsening and I get that. But it does seem to somewhat contradict some of the commentary we heard from some of your optical component suppliers, basically they guided to improving telecom shipments in their respective June ending quarters. And I just want to make sure I understand whether or not you’re indicating that that’s not really going to be the case or this is more about timing and why you don’t sound more constructive, if there’s something else in forming the challenges in optical components? And then just a quick follow up, if I might, it’s just an update on your own shipments of ZR pluggable? Thank you.

Yeah. Simon to the first one, simple summary is, yes, it’s timing. So the history says of, when they see improvement when we actually get it through our supply chain and out to our end customers, it is timing. They did talk, though, about the gap or some of them talked about specifically to the gap that they had in their June quarter. So if you map that to our timing, it has an impact on our Q3 and to some degree on our Q4 as well. I’ll just remind you, though, that we also said there was two dynamics. One was the optical subcomponents that you pointed out, the other one was integrated circuits that largely was due to China again there. It’s second order effects in the supply chain that takes a while to work their way through from China being open up again to us being able to turn that into finished goods for our customers. So, again, 100%, timing based.

ZR.

Oh! ZR, so on the ZR side, Simon. I don’t think our perspective has changed at all. We have shipped ZR into a number of customers around the globe, working through their evaluation cycles. As you’re probably aware, the majority of the volume over the next season or so is going to be dominated by a couple of players. We are fully engaged in those players and we expect to be successful there in those, because we firmly believe we’ve got the best plug on the market. But for us and for the industry, it’s largely going to be a 2023 event from any materiality.

Simon, thank you for your question. Appreciate it.

Thank you.

And thank you everyone for taking the time today to connect with us. We look forward to connecting with everyone here the balance of today and to the next several days. Thanks very much.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.