Ciena Corp (CIEN) 2021 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Ciena Fiscal Q3 2021 Financial Results Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Gregg Lampf. Thank you. Please go ahead.

Thank you, Stephanie. Good morning, and welcome to Ciena's 2021 Fiscal Third Quarter Results Conference Call. On the call today is Gary Smith, President and CEO; and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, is also with us for Q&A.

In addition to this call and the press release, we have posted to the 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 fiscal third quarter performance, our view on market dynamics as well as a discussion of our outlook for the fourth quarter.

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 financial guidance, discussion of market opportunities and strategy and commentary about the impact of COVID-19 and supply constraints are based on current expectations, forecasts and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed 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 9. 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. (Operator Instructions) This call is being recorded and will be available for replay on the Investors page of our website shortly.

With that, I'll now turn the call over to Gary.

Thanks, Gregg, and good morning, everyone. The strong third quarter performance we reported this morning reflects a combination of our increasingly differentiated position in the marketplace and a robust demand environment. We delivered a record $988 million in revenue and a particularly strong gross margin that drove a 19.1% adjusted operating margin and a $0.92 adjusted earnings per share.

Overall, COVID-related challenges remain dynamic around the globe. But most of what we saw in the last several quarters is ameliorating. Importantly, the things we needed to happen in the market and for our business as we move through 2021 are materializing largely as predicted. Specifically, industry and economic conditions have improved noticeably. Service provider spend globally continues to improve, and our customers' network investments and operations are normalizing.

And we had strong order flow in Q3 and that outpaced revenue again. And this allows us to continue growing our backlog and positions us to deliver the stronger than typical uptick in our second half performance that we expected. Secular demand is very strong, and we are taking full advantage of our leading position to address the opportunities that are driving network investment, including: capacity adds to address bandwidth demand; the shift to the cloud with new architectures and network builds; intense focus on edge applications; and obviously, the need for network automation; as well as Huawei replacement opportunities.

Within the strong demand environment, however, there remain global and industry-wide supply chain constraints. And as we have consistently proven, we have best-in-class ability to manage through this challenge and to deliver outcomes for our customers better than anyone else in our industry.

However, as we've said before, we are not immune, particularly if supply challenges persist. And as has been, I think, widely reported, conditions have somewhat deteriorated and are posing headwinds for Ciena, including difficulty to fully address demand. We have also seen some extension of our lead times and some increased costs. As we sit here today, we believe these challenges will likely persist through at least the middle of calendar '22.

Moving to highlights from the quarter. Our competitive position remains strong, and we continue to take market share. With respect to innovation, we are investing across 3 key sectors: optical, where we are the world leader in optical systems and its associated technologies and we continue to drive our leadership in innovation and market share; routing and switching, where we are leveraging our optical expertise to offer a new architectural approach to disrupt the market with next-gen metro and edge use cases; and in software, where we are executing on and accelerating our automation strategy to digitize both service delivery and networking layers.

In optical, we are clearly the undisputed 800-gig leader, having been in the market for 18 months. We have secured the vast majority of opportunities globally and are now approaching 20,000 modems shipped. In the quarter, we added 11 customers for WaveLogic 5 Extreme, including Bharti and Windstream, bringing our total count to 106 customers. In addition, WaveLogic 5 Nano, our 400ZR product is generally available and currently with several key customers as part of our certification and adoption process.

We are also excited about the opportunity in next-generation metro and edge, where we expect to significantly expand our total addressable market from about $13 billion total currently to roughly $22 billion over the next several years. New use cases and technology disruption has created an important insertion point within this space for our architectural approach.

And we have all of the critical elements required to win, including IP routing, switching, optics, automation software and professional services. And as many of you know, we've been laying the groundwork for expansion in this area for quite some time, including significant investments in both product development and our go-to-market resources.

And as you probably saw this morning, we announced an agreement with AT&T to acquire its Vyatta virtual routing and switching technology. Vyatta's technology and software engineering team will bring additional resources to our routing and switching R&D team to address the growing market opportunity that we see with Metro and edge use cases.

This includes continued development of our adaptive IP capabilities, and that, in part, increases our exposure to certain 5G use cases. We also obviously look forward to extending our strategic relationship with AT&T by directly supporting this key piece of their network in their transformation journey.

Overall, as customers seek out new architectural approaches and alternatives to the status quo, we've secured several significant architectural wins around the world for switching and routing. In fact, in Q3, we had 10 new wins for our routing and switching portfolio.

And finally, our Blue Planet software business continues to enjoy strong momentum with our adaptive network vision that is well aligned to network operators' automation priorities. With increasing customer engagements, we continue to win new significant deals resulting in quarterly revenue growth of 47% year-over-year in Q3. We expect to deliver a strong fiscal 2021, therefore, for Blue Planet likely towards the high end of the $65 million to $75 million annual revenue range we previously provided.

Shifting to overall diversification in our business across customers and regions, we had 3 10% customers in Q3, including 2 Tier 1 service providers and a web-scale customer. And highlighting our diversification, our top 10 customers in the quarter included 4 web-scale companies, 3 North American service providers, 1 international service provider, 1 MSO and a wholesale company.

Nontelco revenue in the quarter was strong at 42%. Web-scale revenue specifically grew 24% sequentially in Q3, with direct DCI business contributing 25% of total Q3 revenue. Regionally, strength in EMEA continued driven by web-scale, growing more than 16% year-over-year. EMEA represents our fastest-growing region in the quarter and, in fact, year-to-date as well.

In India, we continue to navigate through COVID challenges and make progress with revenue up 48% year-on-year and 26% year-to-date. And I think importantly, we are seeing investments by key customers for network upgrades in India as well as replacement of Huawei equipment.

As I mentioned earlier, we are investing to capture ongoing secular demand for optical, routing and switching and network automation solutions and to considerably expand our addressable market over time really as the shift to the cloud continues, driving additional traffic growth and a greater need for network transformation. As a result, we are confident in our strong market position and in our ability to continue to outperform the industry.

With that, I'll turn it over to Jim. Jim?

Thank you, Gary. Good morning, everyone. We generated strong Q3 revenue at $988 million. Adjusted gross margin in the quarter was once again very good at 48.5%, reflecting a favorable customer and product mix as well as a high concentration of capacity adds versus new builds. More specifically, we are not yet monetizing the new design wins to the extent we originally expected for this time frame.

Overall, we've been very pleased with the gross margins we have produced this year. They reflect the benefits of our scale and vertical integration as well as a lot of hard work in lowering unit costs of both our products and our services.

Adjusted operating expense in the quarter was $290 million. With respect to profitability measures, we demonstrated extraordinary operating leverage in Q3, including adjusted operating margin of 19.1%, adjusted net income of $145 million and adjusted EPS of $0.92.

In addition, in the quarter, cash from operations was $69 million, free cash flow was $54 million and adjusted EBITDA was $214 million. We ended the quarter with approximately $1.5 billion in cash and investments. Also in Q3, we repurchased approximately 483,000 shares for $26.2 million.

Turning now to guidance. As Gary stated, the demand environment is very strong. This was reflected not just in our Q3 revenue that was well above the high end of our guidance but also in our strong order flow in Q3 and an increased backlog. At the same time, global supply chain conditions have deteriorated, and we've always said that we would not be immune if those challenges persist or especially if they worsen.

Taking these factors into consideration, we expect to deliver revenue in a range of $1.00 billion to $1.04 billion in Q4. At the midpoint of this guidance range, our revenue growth from the first half to the second half of fiscal '21 would be approximately 26%. This would be a very strong second half performance, in line with the stronger-than-typical second half uptick that we forecast since the beginning of the year.

Also at the guide midpoint, we will deliver revenue growth for the year at just under 2%, above the midpoint of our revenue guide for the year. For adjusted gross margin in Q4, we expect a range of 45% to 47%. This reflects our expectation for more monetization of new wins as well as some impact of supply chain constraints.

And finally, in Q4, we expect adjusted operating expense to be in the range of $295 million to $305 million, slightly higher than expected. Our order flow is well above our plan as is our operating income, and this will result in higher variable compensation levels in Q4.

As always, we expect to provide detail about next fiscal year when we report our Q4 results in December. What I will say is that we are confident in a strong performance in fiscal year '22 even when factoring in supply constraints. As we have over a long period of time, we believe that we will outperform our competitors in both market share and financial results. Our technology leadership position, our expectations for continued strong demand environment and a very solid backlog going into next year will enable us to continue the momentum we have developed.

Before we move to Q&A, I'm going to hand it back over to Gary for some closing remarks. Gary?

Thanks, Jim. I'd just like to give a brief update on our new ESG effort recently underway with our partner, Digital Promise. With the return to school in many parts of the world, we're excited to launch the Ciena Solutions Challenge, which invites middle and high school students around the world to design solutions that can address sustainable development goals within their local communities. This program, focused on computational thinking and digital skills, is one of several programs within our digital inclusion commitment. To learn more about our programs like this and what Ciena is doing to help create a more sustainable and connected future, I'd encourage our shareholders and others interested to check our recently published sustainability report on our website.

With that, operator, we'll now turn questions from -- over to the sell-side analysts. Thank you.

(Operator Instructions) Your first question comes from the line of Tal Liani with Bank of America.

I want to ask about the verticals. And if you can speak about -- I understand there is strength in orders. Can you tie it with what kind of projects do you see that are being forward now? What is the underlying service that carriers and clouds are offering that necessitate the investment cycle now?

Thanks, Tal. I mean I would say that from a vertical point of view, we're pretty much seeing solid demand across most -- pretty much most of the verticals. I would say it's a combination, a sort of confluence of catch up on capacity. They've not -- the operational caution that has been around for the last sort of 12 months or so, so catching up on capacity. Also modernization of the networks and architectures particularly around the kind of metro edge, facilitating 5G, et cetera, are also now ameliorating. And people are investing and delivering operationally, coupled with I think the increase in demand is the adoption for the cloud has basically accelerated over the last 12 months.

So you've got those 3 dynamics in play. And really, I'd say the overall application is to drive greater capacity at the edge of the network for all of the sort of cloud applications that are well understood.

And Gary, can you talk about visibility? Earlier in the year, you had different kind of visibility. Now you sound a lot better. Does it mean that you have greater visibility into next year?

Yes. If you define visibility and order backlog, which is a key part of that, I think the answer to that is absolutely yes. When we went into this year, there was a considerable amount of uncertainty. We saw a great deal of caution from the carriers, both operationally and fiscally. I think we have seen that ameliorate as we thought it would.

But as Jim said, that's resulted in a pretty significant uptick in our second half, 26% growth in the midpoint of our guide here. And I think that bodes well for '22. I think we're going to have a strong '22. Obviously, it's a little early for us to talk about that, and we'll talk about that next quarter. But I think we're -- we've got better visibility now absolutely than we had when we started the year. And I think the overall dynamics of demand, I think, are very, very positive going forward.

Your next question comes from the line of Simon Leopold with Raymond James.

I wanted to see if we could discuss a little bit about how you see your gross margin trending. And I'm not asking specifically about the October quarter, but when you consider your order trends -- and what I'm struggling with here is it sounds like you've got pushouts of the new footprint expansion, which should be dilutive to gross margin. But I also suspect you've got a good order book on the routing and switching segment, which I imagine is accretive to gross margin. Help us understand the puts and takes, please?

Sure. I'm going to take you back, Simon, to pre-COVID days, just to remind you of what we said. What we said then was we believed that our run rate for gross margin was in the mid-45 -- mid-40s. And that included a reasonable amount of new builds.

We also said, as we started COVID, that for the next several quarters, we would enjoy a higher than that -- higher than mid-40s gross margin because we would not have the level of new builds in our revenue stack. That's exactly how this has played out. We actually were experiencing a good level of capacity adds, which are, of course, accretive. We've done pretty well on software, and we're doing pretty well on routing and switching.

So all of those things are impacting our gross margin as we have come through COVID. I would not say anything differently about what I think our gross margin is going to be once we get to the expected levels of new builds in our revenue stack, which is -- it's going to happen. We see that finally in our order book, and it's going to start hitting our revenue stack as we move into next year.

Now we also have the supply chain, which has impacted our fourth quarter. In fact, our fourth quarter guide, which is 45% to 47% does have a fair amount of expected premium cost in getting material for hitting our expectations for revenue. So that's what I'd say. I'd say we're going to be, we think, 45% to 47%, Q4. As we enter next year, it depends upon how much of the new wins are in our revenue stack and what the cost of the supply chain generate, but that's the expectation as we sit here today.

As I said, though, we've been very pleased with our gross margin performance. We've done a lot of work to take costs out of both products and services. We have scale. We have vertical integration. All of those things have helped us, and we're very pleased with what we've done so far this year.

And just as a follow-up, I'd appreciate an update on the opportunities for Huawei swaps. I know you've counseled the investment community to be patient, but I want to sort of reflect on what's different versus your prior earnings call, whether you've seen some evidence. You did mention some India traction, but appreciate an update on the Huawei opportunity.

Yes, Simon, I don't think anything has appreciably changed. As we've said, we've seen this dynamic for a while, and it is clearly a multiyear tailwind in its infrastructure. These things take time and those decisions take time, and then to execute on that, either cap and grow or migrate traffic operationally is very, very -- it's a big undertaking by the carriers. But it's underway.

And I would say to your point about India, the one sort of exception to that is, generally, the 2 areas here are Europe and India, with a few other countries in Asia. India, I would say, in the last sort of 6 months has accelerated that move. And they are actively replacing Huawei networks in India, and we've certainly been the beneficiary of that.

We have good order flow and good new wins in India, some of which is on the back of that. Obviously, it will take a little while to deploy over multiple years. But I would say India acceleration, EMEA on track.

Your next question comes from the line of George Notter with Jefferies LLC.

I guess I want to kind of revisit the gross margin discussion. So you guys have printed significant upside relative to your guidance on gross margins for 2 quarters in a row now. And I guess I'm kind of curious around why we've expected much more significant new build activity across these 2 quarters and then actually not seeing that new build activity as the quarter has progressed. Why has that business shifted out so much?

Well, as we come into any quarter, we have expectations of what our mix is going to be and things move around. So I certainly wouldn't read anything ominous in the fact that it's been a little slower to develop than we thought. COVID has had some effect.

I'd say that we have started to see in our order book the effect of some of these wins. And we're definitely going to see those things come into our revenue next year. So I wouldn't read anything into it other than there's an ebb and flow in our business. And I think the good news is we're doing so well with our mature customers, and we have such a high preponderance of capacity adds.

Just to add to that, if I can. I do think -- Jim, you talked about it at the end there. I do think generally capacity adds in catch-up has been prioritized over new business rollouts. Those rollouts are absolutely going to happen. In fact, we've won a number of new deals in the last quarter, indicating the modernization of these networks. But I think carriers -- I'm going to be generalizing here, but I think prioritize the capacity a little bit more than we thought, and that is resulting in better margins for us in Q3.

Got it. Okay. And then I guess I also thought I'd just ask about the Vyatta transaction. I think that was an asset that came over from Brocade back in 2017, and we really haven't heard much about it within AT&T and -- maybe you can kind of talk about why you're buying that asset and what it really gives you going forward?

George, it's Scott here. The asset itself, you're right in terms of the history. AT&T has used those to further their network transformation and a couple of different use cases around the edge and virtualizing their capabilities around sell-side routers for their 4G and 5G backhaul and their enterprise business services for SMB. So those use cases very much in the sweet spot for what we're trying to accomplish in our next-generation metro and edge campaign.

So if you look at the assets that we're picking up as a capability set to enhance our revenue switching portfolio as we address the increased market size of next-generation metro and edge, it obviously deepens our relationship with a really important customer of ours, AT&T. And we pick up an engineering resource in a location that we had no presence before in the U.K. So those are really the 3 dimensions of value for us.

Is there a revenue run rate that comes with that product line?

There is. It's not material to our business really, but there is a revenue run rate. And we'll reflect that in our '22 plan when we get to that.

Your next question comes from the line of Rod Hall with Golden Sachs.

I guess I wanted to start off with the revenue guide. And Jim, maybe just ask you if you've taken a shot at estimating how much impact to that guide there was from supplies or if you can give us any color on how much of an impact on revenue the supply situation is in the guidance.

Yes. I'll start by saying, remember we overperformed in Q3. And when you take everything into account, we're probably low tens of millions below what we could have done were it not for the supply chain issues.

And that's been in the guidance?

Yes, it's in the guidance. For the full fiscal year, it's low tens of millions.

For the fiscal year, but also low 10s in the fiscal Q4 guidance. Is that the way we should think about it?

Yes, I think you should. Yes.

Okay. And then the other thing I wanted to just check, the gross margin guidance. I know you kept the high end of the range unchanged and you dropped the bottom, I guess. The 45% level, I was curious what that corresponds to. Is that if some of these expediting costs and so on go up or continue to go up and 47% is assuming kind of they hold where they are? Can you give us some color around the -- either end of that margin guidance, what it takes to get to 47% and what happens if you end up printing 45%?

There's always going to be variation in our gross margin because, as I said earlier, we start the quarter with an expectation of what's going to roll through and things change. So I think the difference between 45% and 47% is mostly going to be mix. Is the mix going to be different from what we expect. I mean we've already set up our supply chain for the quarter. So I don't expect any more costs out of the buying of parts or anything like that. It's -- I'd say it's going to be mix that's going to drive the ends of the range.

And is it fair to say that mix would be driven by these deployments, I guess, the big North American deployments in particular. So what in the mix might change one way or the other in the forward quarter?

It could be the deployment of the new wins. But remember, we have a lot of different customers. We have a number of different products. We have software mix. We have a lot of things that can impact our margin. And so generally speaking, it's going to be the mix of all of those things and 45% to 47% is where we think will come out.

Your next question comes from the line of Meta Marshall with Morgan Stanley.

This is [Erik] on for Meta. Congrats on the quarter. So maybe I just want to ask, given some of the order flow you were seeing in presumably that being gated by supply chain converting into revenue, does that have any impact in smoothing some of the normal seasonality you would typically see into the first half? I understand it's early to comment on '22. But anything you can tell us there?

I would say this, Erik. I think it's definitely too early to tell. We haven't finished this -- we're just about finishing up this year. I do think that, as Scott said earlier, I do think that the supply chain issue, our view is will likely continue for the first part of the year. And obviously, when we do give FY '22 guidance as we come out of the year, we'll take that into account as we have for the last couple of quarters here.

I would say that I think we're very well placed to navigate it -- through it better than anybody else in our industry, but we're clearly not immune from that. But our scale and vertical integration and very sophisticated supply chain enables us to mitigate a lot of those customer delivery issues, but we aren't immune from it.

Got it. That's helpful. And if I could squeeze one more in on hyperscale. I mean as you're seeing the strength there in looks like EMEA continuing, is that just a continuation of some of the scaling build-outs, the hyperscalers are doing in that region? You kind of mentioned the 800-gig products starting to test, but if you could update us on maybe some of the expectations for timing and share as 800 gig starts to ramp even more.

I'll take the first part of that and then maybe Scott can comment on the 800-gig adoption there. But I think the engagement with those web-scale folks is multifaceted. It's connecting their data centers, both long haul. It's their global networks as well. We do a lot with them in different countries. We're the #1 supplier to all of them on the submarine cable side.

So we have a pretty intimate relationship with them across a very broad range of applications. And I would say that they're continuing to roll out both additional data centers and increasing connectivity within their existing data centers, both within North America and internationally. So we're seeing pretty healthy demand dynamics across the board on that.

Scott, do you want to talk about 800-gig?

Yes. And Erik, just 1 thing to add to what Gary said. The other part of the relationship with them is they still do a lot of business in parts of the world, EMEA, Europe, as well through managed service providers. So our relationships with the service providers in those geos also benefits their relationship, and we get benefit from that. So that's part of that EMEA growth as well.

Your 800-gig comment, Erik, I just want to clarify something that we said. So our 800-gig product is represented by our WaveLogic 5 Extreme product, and that's been in the marketplace now for almost 1.5 years, approaching 1.5 years. So we're almost at 20,000 units shipped to that. So it's well beyond trials, it's mainstream deployment. What you might be referring to is our WaveLogic 5 Nano. And as Gary referred to in the script, as our 400-gig ZR product, which just recently went generally available. And that's the derivative of the same technology that's going through trials. So hopefully that clarifies it.

Your next question comes from the line of Paul Silverstein with Cowen and Company.

Guys, relative to the light revenue guidance, first off, are you seeing any demand weakness? Or is that all a function of supply chain? Second, Jim, if I recall for a while, you've been talking about restraining OpEx growth to low single digits, which with any decent revenue growth should result in some strong operating leverage.

But after OpEx declined for 4 straight quarters, you grew OpEx by 15% year-over-year in Q3 -- over 15%, almost 8% in Q2 and if I did the math right, your guidance works out to over 6% in Q3. The question being, has something changed in your OpEx growth plans? Or do you still plan to go back to that low single-digit growth that you've been previously referencing and this is just a transitory issue?

And finally, are you seeing any impact relative to Street concerns about 400ZR in particular? Are you seeing any impact from any of those? I know it's still early in 400ZR. Those are the questions.

Okay. So let me get -- so the first of your 3 questions, I'll try and answer, Paul, and then maybe Jim, on OpEx. On the revenue guide, I wouldn't describe it as light. I would say 26% kind of uptick in the second half is pretty solid, and it's also in the higher end. And the midpoint of that is kind of in the high end of our original kind of guide at the beginning of the year, where we had very little visibility. So it's largely kind of playing out as we thought.

And I would categorically say nothing to do with demand. We would be able to get greater revenues in Q4, probably by low tens of millions if we were -- had unfettered access to everything we wanted as normal from a supply chain. So read into that, $20 million or so. But if we also look, we overachieved by more than that in Q3.

So it's all about supply chain. And I do think those challenges will continue for the first half of the year, but the demand dynamics are incredibly strong.

And on the OpEx call, we also said consistently that we are committed to growing our OpEx at a lower rate than our revenue. And we've done that consistently over the past decade. The COVID years were a brief exception to this because we -- our revenue was affected by COVID, and our plan for OpEx, well we continue to invest. But again, we've grown revenue faster than OpEx for a long, long time, and that would be our expectation going forward.

Now with respect to the specifics of OpEx for this year, we're right on our plan overall. If you'll recall, we went through a whole recitation of how we expected our OpEx to perform. At the beginning of the year, we said something like we thought we would average about $280 million a quarter. We were very low in Q1.

And we said that we were going to be a little higher for the last 3 quarters, $285 million to 2 -- I guess it was $285 million for the last 3 quarters of the year. And yes, we're a little higher than that this quarter. We are seeing a bit of FX with respect to the weaker dollar effects.

And for Q4, it's really all about the fact that we're so outperforming on orders and our operating income that our incentive compensation will have to reflect this overperformance in Q4. We are absolutely though, on plan with respect to our OpEx for this year.

And on your last one, Paul, on the 400-gig ZR, the short answer is no, we're not seeing any impact on our business right now. I don't think our perspective of the opportunity set has changed. We sort of see the market being on total addressable market in the sort of $0.5 billion per year range as it gets up to full maturity. We think 2022 is the first year where you start to see some significant revenue opportunities there.

Our product addressing that is the WaveLogic 5 Nano, which recently went GA. We think it is the best performing plug in the industry in terms of optical performance and power. So we're quite excited about its opportunity. And I'll remind you, the folks that I think will be the first movers in this, a couple of the large web scalers, for that particular application, it is upside opportunity for us because we don't largely participate in those applications today.

Your next question comes from the line of Alex Henderson with Needham.

Just a quick one to start with just a data point. [You gave us] 24% quarter-to-quarter growth in the web-scale. Can you say what that was on a year-over-year basis? The question I wanted to address though was around the supply chain issues and the mix. Did the supply chain impact capacity adds differently than new footprint builds? Is there any variance in that as a result of the parts that you're able to get? Or is that completely independent of the conditions?

Alex, let me take the first part of that. I think I'm right in saying that the -- if you looked at year-over-year direct DCI, I think it's about 1% growth currently as you close out of Q3. I think that might be greater as we look at Q4, but I think that's -- I think it's just over 1%.

On your second -- just you'll remember that the first part of this year, our revenue stream was very much impacted by COVID. All customers were down or -- well, they were lower than what they would have been.

Including web-scale. Yes.

Including web-scale. So that 1% is -- it reflects that phenomenon.

And Alex, to your second question, I mean, the other challenges in the supply chain is the much written about semiconductor challenges that is multi-industry really. And that doesn't have a concentrated impact, it's actually pretty widespread across the whole portfolio. So I wouldn't draw any conclusion as to one part of the portfolio versus the other being more hit.

The follow-up I wanted to ask was on Vyatta. You said it wasn't material to revenues, but you're obviously bringing in assets and to that extent. I would assume that you're bringing in costs associated with it. And I would also assume that that's predominantly in the R&D line. Is that an accurate calculus? And if so, how much -- what's the scale of the costs that you're bringing in?

Not a material number, Alex. We'll address all of that revenue, OpEx, et cetera, once we get to close and once we -- and when we talk about next year.

Just to confirm the opening part of your question, yes, it is largely almost entirely in the R&D line.

Your next question is from Samik Chatterjee with JPMorgan.

I guess if I can just start with the strong backlog that you have and I understand you're constrained on supply capacity a bit here. But investors that we speak to generally assume that because of the constraints that you have and the strong backlog, it should lead into some pent-up demand for next year and helping above typical level of revenue growth.

I know you don't have a guide for next year yet, but most investors seem to be still benchmarking you to the 6% to 8% prior long-term growth guidance that you have. So I was just curious how should we think the period by this backlog once supply constrains ease and leverage investors think will be pent-up demand that is reflected in your strong backlog would be great.

Thanks, Samik. I would say that, I mean, first of all, it is too early for us to talk about '22. We haven't even finished the year that we're in yet, and we never give guidance at this time for '22. We've said a couple of forward-looking comments around supply chain challenges continuing. So I would certainly consider that as we turn into the year. I think we've got this dynamic where you've got very strong secular demand. We've won a lot of new business. We're incredibly well positioned, offset that against the sort of supply chain challenges.

And I would also say that we've as -- the effects of COVID, basically, we've been running with lower backlogs than normal. So to some extent, we've just kind of replenished the coffers there. So I think we're in a much more normalized position going into '22. And when we absolutely think that we'll see decent market growth next year, and we will outperform the market, we will continue to take share. There's no doubt about that.

Okay. Got it. And if I can follow up, I think, Jim, you mentioned that the new award push outs, new award-related deployments and push outs at the back is -- largely kind of ebbs and flows in the business. Just curious how is it different from what we saw last year during COVID just given some of the pushouts that happened back then. What's giving you the visibility that is not kind of the similar situation as we saw last year?

Well, I think, first of all, the new wins are showing up in our order book now. And so it's just a question of time before we get to revenue on them. That's the main thing, I would say.

I'd also say that, as we said earlier, COVID has certainly driven people to add capacity as opposed to new build-outs. And that's caused the dynamic that we've seen, but it is coming. No doubt about it. The new business will show up in our revenue stack.

Your next question is from the line of Fahad Najam with MKM Partners.

I had a clarification if you have not only provided the build down of the 3 10% customers, what -- how much...

Sorry, you wanted 3 10% customers...

How much in total?

Yes, how much.

How much in total? Certainly, over 30%. Hang on for a second, we'll get that for you, Fahad.

It's around 38%.

38%.

Okay. I wanted to kind of follow up on Samik's question. And I think you've historically said that you think the industry is growing mid-single digits. Do you still have that view?

Yes. I think the -- if you look at the last decade, pretty consistently, it's been in the mid-ish single-digit growth and we've been able to continue to outgrow that. Now I think a lot of -- all that was all disrupted with COVID like most industries, where we had pretty much, I think, flat from an industry growth point of view.

I do think that we will return to -- at some point here more normalized growth in those mid-single digits. I don't see any reason that, that wouldn't be the case. Secular demand and getting higher bandwidth closer to the customer is absolutely everywhere about every application around the globe whatever you look at, be it 5G, be it fiber-to-the-home, FTTP, Internet of Things.

So the secular demand, I think, is very positive. So yes, I would expect the industry to return to a more normalized piece. And as I said, I think we will continue to grow faster than that.

Gary, if I can ask you to maybe double click on that comment because I think I want to tie this to one of your comments in prepared remarks about the emergence of the new Edge Cloud opportunities, I think, is entirely new build-out of network infrastructure. And so I just wanted to make sure that if that significant TAM expansion that you're talking about correlates to the overall industry growth. Or does that really kind of industry go to a next level because optics is getting pushed deeper and deeper into the network?

Yes, Fahad, actually, that's a good question. When I answered your question, I'm generally talking about the optical systems space. And I think you are seeing, particularly as we're a challenger in this edge metro convergence basically. And so for us, it's an expanded TAM. And you've also got certain segments of that market that are growing faster than the mid-single digits as well.

You've got some in the overall core routing that's actually going down. Obviously, we're not targeting that. I don't think the world needs another core router vendor. But in the convergence space, we have some unique assets that we think we can disrupt and challenge that market space over time. And that will, I think, in the long term, provide us a better growth opportunity than even the one we're seeing now.

Your next question comes from the line of Jeffrey Kvaal with Wolfe Research.

Yes. Also struggling with the new button with the mute button. Two questions for you. I guess, first is what can you tell us about your inventory balances? A lot of other folks in networking, although not necessarily in optical have greatly expanded either their inventory balances or their purchase commitments. I'm wondering what you're able to do there, what you might be able to get done in the future to help give us a little bit better visibility on your ability to reach the demand that you've talked about?

Yes. So Jeff, for sure, we are reaching out to our supply chain and making increased commitments, both in terms of volume because we're growing the business and duration that is going to have an impact on inventory balance. You've seen some of that already, and that's going to continue. So you will see higher than what may have been our normalized inventory levels and lower turns as a result for the foreseeable future.

Okay. And we can expect them to go up from where we are now, I guess, Scott, that's your point.

Yes.

Okay. And then secondly, it looks like the services business had a strong quarter. I'm wondering if you could deconstruct that a little bit and let us know how much of that is ongoing and how much of that was onetime.

Yes. If you think of our services business had a really simple level. You think of it in 3 bins, sort of the maintenance of the existing installed base networks and the customer relationships. That's a pretty steady state, if you like, and predictable. There is -- the second piece of it is around installation projects. That's very tied to our new projects and business wins, so that will sort of ebb and flow with the projects.

And the third piece of it, which is we're quite excited about is a set of professional services around helping our customers transform their networks from legacy networks into next gen. That's actually had quite a good run. It's still relatively small -- the smaller of the 3 those pieces, but that's actually contributed to the good services mix that you saw in the quarter.

How is sustainable is that, Scott? Should services go back to a more normal run rate in future quarters?

We think that, that third bin in the professional services mix in helping our customers migrate their networks is going to be an opportunity for us going forward in the future. And we think that we have an opportunity to grow that.

Your next question comes from the line of Amit Daryani with Evercore ISI.

I have 2 as well. I guess, first off, maybe I missed this, but could you talk about the gross margin impact from supply chain headwind in October quarter sort of how you are thinking of that? And then broadly, do you think supply chain headwinds peak in October quarter? Or do you think it continues to get worse and deteriorate as you move into the first half of the fiscal year?

We didn't talk about an effect in Q3. There was very little effect of the supply chain situation in Q3. Q4 is going to impact us. Now with respect to next year, we do know that the supply chain is going to continue in that sort of constrained state. But how much and how that's going to affect gross margin, it's really too early to say.

And then Blue Planet growth, I think, 2 quarters in a row, it seems to have inflected much higher 45%, 60% in a growth vector. Can you just touch on were there a couple of big projects that are ramping up and that's what drove it? Or just sort of what drove that growth and the durability of Blue Planet growth as you go forward would be helpful to understand.

Well, I'd say first off in full disclosure, it's from a relatively small base. So those numbers look spectacular, but they're from a small base. I would say that what we are seeing now is adoption by significant Tier 1s around the digitization of their service layer basically replacing the old legacy back-office systems. And we are seeing that move forward in a sort of step function this year. It's not necessarily showing up in all of the numbers. We're seeing very good numbers both on orders and revenue relative to the plan. And I think we'll probably be over on both and the high end of our guide on revenue.

But perhaps even more importantly with that, we're getting significant footprints in potentially multiyear rollouts of the digitization on the service layer, in things like inventory management, service provisioning, et cetera. So it's very encouraging with Blue Planet. And we'll talk a little bit more about that, I'm sure, as we go through the -- we talk about '22 and beyond as we talk about that at the end of this year, but very encouraged by what we're seeing.

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

Two, if I could, as well. Gary, I just wanted to go back to the metro edge TAM and kind of challenger piece there. Could you maybe just click down, give us a little more info on how timing to attack that extra TAM and how are you going to get there. Is it adding the Vyatta assets? Is that a part of it? Is it leveraging installed base because it's an area that obviously could be a big growth vector for you guys?

And then second, if you can just touch on a few point markets, India, given the macro issues there as well as submarine?

Yes, let me just talk on the metro edge, obviously, this has been a journey we've been on for a while. We've been investing in key strategic assets in the packet space, in routing, switching in the software, the convergence with optical and our architectural vision with the Adaptive IP is a much simpler, highly-automated architecture.

And we are the challenger in that space. We are securing wins with that, as you've seen over the last sort of 18 months or so. And I think that's gathering momentum. We're excited about what we're seeing. Still early days. I think this is a 2- to 5-year expansion of our opportunity.

And whilst it's a big market, we're challenging there some very strong incumbents. But I think we're proving -- we've got a very compelling differentiated value proposition with the assets that we've got. And I think that will be an important market for us, and it's a key investment. And we're scaling investments, both at the front end of our business and our go-to-market capabilities and support.

And also, as Scott talked about in our engineering capabilities and Vyatta is another key add to that. We're bringing some really tremendous specialist talent into the company.

So what was the second question?

It's India submarines. We said earlier that India is a place which has moved very aggressively to exclude Huawei from new builds. There are opportunities for us. We have taken advantage of those opportunities. We have several new wins. We expected this year that those would -- that India would start to show in our revenue stack a little higher, and that has been the case. It's not quite 5% of our revenue, but it's up very nicely. Year-to-date, it's up 26%. Quarter-over-quarter, it's up a lot more than that. But I think the year-to-date number is much more meaningful, up 26%. It's going to be a great place for us to be for a long time.

On the submarine. Submarine is up a lot this year, at least in the quarter. It's up 27% in the quarter. It's about flat year-to-date. We've done extremely well in the submarine market. It plays to our strengths. The submarine market requires long reach at high capacity, and we're the best in the world at it. I think we'll continue to win there.

And we'll take one more question.

Your last question comes from the line of Jim Suva with Citi.

When we think about the supply chain issues, have you materially changed your pricing for things also about like, say, shipping? And have they fully folded into your gross margins? Or are they still kind of being calibrated. And then on your bookings and orders, is there any concern about customers double ordering or ordering ahead knowing that they have supply chain issues? Or in the optical components, is it just kind of not as much of a concern as maybe other sectors that we see where there's double ordering?

Jim, just if your first question was around our costs, we're certainly seeing the costs of both procuring components and the logistics costs having an impact on the margin, that's fully baked into our gross margin guidance for Q4.

On your second question...

Your second question, was that about orders on us or orders that we're placing on our supply chain?

Kind of orders on both sides coming in as customers -- are there a chance that they're double ordering, and you guys have seen the shortages? Does it make sense to order a little more to have some buffer as we progress in the quarters ahead?

I think given the nature of the industry, it's extremely unlikely. The intimacy we have with these customers on the system side, so I think that's a sort of 0 risk, frankly, on that side. And on the supply chain side, I think the relationships that we have, again, on the supply side there is very intimate and long-standing.

Thanks, everyone, for joining us today. We appreciate it. We're looking forward to catching up with folks today. And over the next several days, we've got a number of conferences we're attending. Thanks, and stay safe.

Thank you. This concludes today's conference. You may now disconnect.