Q2 2025 Earnings Call Transcript

Good day, and welcome to Ciena Corporation's Fiscal Second Quarter 2025 Financial Results Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Gregg Lampf, Vice President of Investor Relations. Please go ahead.

Thank you, Michael. Good morning, and welcome to Ciena Corporation's 2025 fiscal second quarter conference call. On the call today is Gary Smith, President and CEO, and Jim Moylan, CFO. Scott McFeely, executive advisor, is also with us for Q&A.

In addition to this call and the press release, we've posted to the investors section of our website an accompanying investor presentation that reflects this discussion, as well as certain highlighted items from the quarter. Our comments today speak to our recent performance, our view on current market dynamics, and drivers of our business, as well as a discussion of our financial outlook. Today's discussion includes certain adjusted or non-GAAP measures of Ciena Corporation's results of operations. A reconciliation of these non-GAAP measures to our GAAP results is included in today's press release.

Before turning the call over to Gary, I'll remind you that during this call, we'll be making certain forward-looking statements. Such statements, including our guidance, commentary on market dynamics, and discussion of our opportunities and strategy, are based on current expectations, forecasts, and assumptions regarding the company and its markets, which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. Assumptions relating to our outlook, whether mentioned on this call or included in the investor presentation that we'll post shortly after, are an important part of such forward-looking statements, and we encourage you to consider them.

Our forward-looking statements should also be viewed in the context of the risk factors detailed in our most recent 10-K and 10-Q, which we expect to file with the SEC by June 12th. Ciena Corporation assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events, or otherwise. As always, we'll allow for as much Q&A as possible today, though we ask that you limit yourselves to one question and follow-up. With that, I'll turn the call over to Gary.

Thanks, Gregg. Today, we delivered strong fiscal second quarter results, including revenue of $1.13 billion, which is at the high end of our guidance and demonstrates the strength of both our strategy and our execution. This performance reflects continued strong demand across all customer segments, geographic regions, and our diversified portfolio. Notably, revenue from cloud providers stood out as a key driver in Q2. Specifically, we achieved record direct cloud provider revenue in Q2 that comprised 38% of total revenue, growing 85% year over year and reaching more than $400 million in a single quarter for the first time.

This really highlights the accelerating investments in AI infrastructure and our leadership in addressing this demand. Indeed, three of our top five customers this quarter were cloud providers, underscoring their sustained investments in AI expansion. Over the past quarter, market dynamics have not only validated our previous assumptions about customer network infrastructure spend but have also reflected an accelerating demand environment that continues to ramp and exceed our expectations. We believe this strength is differentiated for us as the market continues to evolve in our direction.

Accordingly, orders in the quarter were, again, significantly greater than revenue. Notably, we are on track for cloud provider orders to double in fiscal 2025 over last year as we benefit from the breadth and depth of our customer base in this critical segment. This outstanding performance showcases where we remain a very trusted partner for a wide range of network operators who are investing to scale their infrastructure for high-speed data center and cloud connectivity, including for emerging applications and use cases. To address this growing demand, we are deploying the entirety of our portfolio, including optical systems and interconnects, routing and switching solutions, software, and services.

As the global leader in high-speed connectivity, our WaveLogic technology remains a cornerstone of our competitive advantage. Specifically, our WaveLogic Xstream 1.6T WAN technology maintains at least an 18 to 24-month competitive lead in the market, as our photonic line systems continue to be the de facto industry standard. Demand for our reconfigurable line system (RLS) continues to increase, and our interconnects business is also ramping with tremendous activity and demand. We have new awards with three additional major cloud providers this quarter alone.

This momentum reflects the growing adoption of and demand for 400ZR and 800ZR coherent pluggable solutions, as well as our 1.6T coherent light solution, which we will be sampling by the end of calendar 2025, with commercial availability in the first half of calendar 2026.

As cloud providers expand their data center architectures with scale-up and scale-out AI-related deployments, we are broadening and deepening our relationships with them. In fact, we're addressing new data center-related applications, a strategy that we've spoken publicly about over the last few months, and where we recently secured two wins. The first is a very strategic win for an application involving the connection of regional GPU clusters, which is something the industry has been talking about for some time. For context, to support the massive scale and power requirements of AI training and inference traffic, data centers must become more distributed.

Historically, these traffic flows were primarily inside the data center, but they are now across multiple data centers over greater distances that require high capacity, low latency links. We are excited to report that our coherent 800-gig pluggables and RLS Photonics have been selected by a global cloud provider who is investing in geographically distributed regional GPU clusters. We will start to recognize revenue from this incremental opportunity later this fiscal year and ramping into 2026. As one of the first vendors to address this application, and with our coherent optical technology ideally suited for this type of connectivity, we expect to see more of these types of opportunities emerge as cloud providers evolve their data center network architectures to support their AI strategies.

The second win is for a focused application inside the data center for out-of-band network management. These networks operate separately from the main data traffic network and provide remote access to monitor and manage data center systems. We recently worked with a global cloud provider to co-develop a solution based on our existing technologies, designed to significantly reduce the complexities of these networks and streamline the management of its large-scale data center operations. Now turning to service providers, it's now been several quarters of an improving trend line with service providers as their network investments in high-speed infrastructure become more durable and sustainable following a long period of underinvestment.

We are seeing growth and strength across the board with service providers in core optical transport, routing and switching, and software to address the connectivity needs of their own customer base and to support cloud providers' growing bandwidth demands. As a result, our business with Tier 1 North American service providers gained momentum in Q2. We also had several new customer wins in both the Americas and international regions, including Europe. This momentum is driven in part by new fiber builds as well as MoFEN. In fact, alongside the record performance of DirectDCI in the quarter, we also achieved an all-time record for MoFEN activity in the first half of fiscal 2025, which further demonstrates how we're supporting the strong nexus between service providers and cloud providers.

I also want to touch on the momentum of our software business. I'll start with the Navigator network control suite, which is our multilayer domain controller. This provides a comprehensive set of capabilities to help network operators plan, provision, monitor, and troubleshoot their networks. Orders for Navigator increased significantly in the first half of fiscal 2025 by more than 30% year over year, driven by increased investment in the unique capabilities of this microservices-based and differentiated platform.

Similarly, Blue Planet had a record performance in Q2, achieving its highest ever quarterly revenue at just under $30 million. This milestone reflects the success of our deliberate transformation efforts over the past couple of years, positioning Blue Planet to better serve our customers' digital transformation needs and journey. Today, Blue Planet is at the leading edge of several large provider projects, particularly as the industry incorporates AGENTIC AI and data-driven intelligence to drive transformation. Before I turn the call over to Jim, I'd summarize by saying that we are very encouraged by the strong activity across all segments of our business.

In the context of favorable market dynamics and an accelerating demand environment, we have strong momentum that we are confident will drive continued growth. In particular, we are very pleased with the validation from customers that we can strategically provide high-speed connectivity, which is absolutely critical. In the short term, and as we've been talking about for some time, we are now seeing more AI traffic come out of the data center for training, as I mentioned earlier, and general monetization. That's driving cloud traffic.

Our technology is ideally positioned to address these connectivity needs at scale. With that, Jim, can you please provide us with updates on our financial performance in Q2 as well as our outlook?

Thank you, Gary. Good morning, everyone. As Gary noted, we delivered strong fiscal second quarter results. Total revenue in Q2 was $1.13 billion.

This included two 10%+ customers, one cloud provider and one service provider. Adjusted gross margin was 41%, in line with our guidance, driven by product mix and, to a lesser extent, the cost of tariffs. During the quarter, we navigated a new and, in the early days, a rapidly changing US SAP tariff environment. We responded in real-time with mitigation strategies to minimize the impact both on our customers and our P&L.

However, as a result of the dynamic conditions, as well as the need to adjust our billing systems and our customers' systems, we absorbed a net impact to our bottom line in the mid-single-digit millions of dollars in the quarter. Adjusted operating expense in Q2 was $369 million. This was higher than expected, driven entirely by higher incentive compensation associated with very strong order performance in the quarter and our overall financial performance in the first half of the year. Both trends are expected to continue.

Absent this higher incentive comp, OpEx is on our plan and our guide. With regard to profitability measures in Q2, we delivered an adjusted operating margin of 8.2%, adjusted net income of $61 million, and adjusted EPS of $0.42. In addition, we generated $157 million in cash from operations. Adjusted EBITDA was $117 million. Finally, we ended the quarter with approximately $1.35 billion in cash and investments.

During the quarter, we repurchased approximately 1.2 million shares for $84 million in this fiscal year. Some additional highlights from the quarter: We had an excellent quarter in optical. As Gary mentioned, our WaveLogic technology remains a strong competitive advantage. We added 24 new WaveLogic 6 Extreme customers in Q2, bringing the total to 49 within just two quarters of general availability.

WaveLogic 5 Extreme and Nano also performed well with continued adoption among cloud customers and service providers. We added 10 new WaveLogic 5 Extreme customers in Q2 for a total of 344 customers overall. WaveLogic 5 Nano pluggables continued ramping, now shipping to 178 customers, including both cloud providers and service providers. Overall, our momentum with coherent pluggable optics was strong in Q2, and we remain on target to double our year-over-year revenue to at least $150 million in fiscal 2025. Pluggables are proving to be a great complement to our optical systems business.

I also want to highlight the performance of our routing and switching business. This is being driven by AI momentum and an improving service provider environment. In Q2, we secured a significant win with a Tier 1 service provider in India, where we displaced a major competitor in the access domain. We also added eight new broadband customers in Q2. Additionally, we introduced the first 800-gig router to our coherent routing portfolio and expanded our flagship WAV router family with WaveLogic 6 Extreme capabilities, making it the industry's first generally available 1.6 terabit coherent router.

All of this performance confirms that we have the right portfolio with best-in-class technology for our customers who demand the highest-performing connectivity for today's dynamic demand environment. With that, let's turn to guidance. Given recent developments, it appears that the tariff environment will remain challenging. For purposes of our guidance, however, we are assuming that the current tariff structure does not change.

Under this current tariff structure, we expect the total cost of tariffs to be approximately $10 million per quarter. We expect to mitigate most of the quarterly impact as compared to Q2. Therefore, we believe the net effect on our bottom line in future quarters will be immaterial. So for the fiscal third quarter, we expect to deliver revenue in a range of $1.13 to $1.21 billion. We expect Q3 adjusted gross margin to be roughly in line with Q2. And we expect adjusted operating expense to be approximately $370 million to $375 million.

Again, this includes higher incentive comp. Base OpEx is on our plan and on our guide. While the geopolitical environment has fluctuated quite a bit during the past few months, strong demand dynamics continue to drive momentum in our business.

As a result, we have increased visibility and are in a position to update all three elements of our annual guide. We now expect to deliver revenue growth of approximately 14% for fiscal 2025. At the same time, given the mix of products, including a higher proportion of newly introduced solutions and the RLS, all of which are still ramping, we expect annual gross margins at the lower end of our previously assumed range of 42% to 44% for fiscal 2025. With respect to OpEx, we expect to be on plan and guide for our base OpEx for the fiscal year. However, given our strong financial performance, particularly on orders and revenue, we expect operating expense to average $360 million to $370 million per quarter for the year.

Michael, we'll now take questions from the sell-side analysts.

Michael, before we do that, I'd just like to take a moment to acknowledge and recognize Jim's upcoming retirement. Given today will be his last earnings call with us all. As you know, for the past eighteen years, an incredible seventy earnings calls, Jim has been an incredible partner and member of our executive team with a lengthy list of significant contributions to the growth and the performance of our business. We will certainly miss Jim's leadership and his wealth of knowledge.

Importantly as well, and I think I speak for all of you who know him on the call as well, we'll miss his wit, his warmth, and his humor that makes working with him such a joy. So while we'll be sad to see him go later this summer, we all wish him the very best in his well-deserved retirement.

Thank you, Gary. With that, we really will open up for calls from the sell-side analysts, please. Thank you, Michael.

Certainly. We will now begin the question and answer session. To ask if you would like to withdraw your question, and the first question comes from Samik Chatterjee with JPMorgan.

Hi. Thank you. Thanks for taking my question. I guess, Gary, if I go back and from the last earnings call, you already had indicated that you were seeing a strong start in terms of orders to this quarter.

But when I listened to the commentary this morning, it just sounds more like you've seen probably more acceleration through the quarter with the cloud customers. But just maybe if you can talk about the linearity of the orders with the cloud through the quarter because, overall, it sounded more sort of optimistic than what we heard from you ninety days ago. And in terms of visibility, how do you think about visibility beyond FY25? You're talking about doubling of orders, and how do you think about the sustainability of that?

So kind of growth or investments from them into fiscal 26. And then I have a quick follow-up. Thank you.

That was a pretty comprehensive question. Thank you, Samik. So I think in direct answer to the first part of that, I think we saw strong order flows in Q1. That continued in Q2, and probably accelerated in Q2 and the activity. And I'd say sort of two things about it.

One, service providers, nice steady increases underpinned all of that. And I think that very sustainable and durable. And then the cloud, I think we're seeing a step function here in demand. You know, we're seeing cloud growth in terms of traffic flows, and then we're seeing these incremental opportunities as well that are emerging, this regional GPU one that I talked about specifically today, is really incremental to our thought process for the year.

And I would also say that that momentum both on service providers and on the cloud players is continuing into Q3. So, you know, and this exceeds our expectations for the year. I think, you know, given this notion around traffic coming out of the data center, to both do training and for monetization. We are beginning to see that. For sure in addition to these other applications.

So you know, I think at this stage, obviously, it's early to predict next year and the three-year piece. I think reasonable to assume that given the step function in demand, I think we will revise the three-year guidance when we get to the end of this year. Obviously, not appropriate to do that now. But I think what's behind your question there, Samik, is, you know, is this a long-term trend?

And I think the answer to that is absolutely yes.

Got it. Got it. And for my follow-up, on the gross margin side, and I know mix is sort of impacting this year, but one of the concerns that we hear from investors is as you ramp on pluggables and you this year, you also have the core and light products ramping next year. Is that a headwind in terms of mix to the overall March and long-term margins for the company?

Can you just address that concern if there is a change in terms of the longer-term thinking for gross margins for the company just given where the expansion opportunities that you're pursuing? And before I pass it over to you, Jim, thank you for your help all of these days. Thank you.

Thanks for the question, Samik. We've always said that mix is the single most important element of our gross margin number in any given quarter. And that certainly affected us in Q2 and likely will affect us in Q3. As we look out though, we really are not backing off our view that mid-forties percentage is the right gross margin for us at least as a target, and we think we can get there in a couple of years. What's happened in this quarter is that we have exceedingly high demand for pluggables and our new reconfigurable line system.

Both of those are at lower than corporate average margins for slightly different reasons. The RLS, the reconfigurable line system, has always been based on a razor-razor blade type pricing model. And so when we sell a lot of RLS without a lot of capacity adds, we are gonna enjoy lower margins than our mid-forties. That's just a fact.

It's becoming the industry standard. It's a good thing for future margins because we will sell the capacity, at least most of the capacity to go into those line systems. So that by its very nature, will improve over time. On the pluggable side, what I'd say there is that we are in the very early stage of ramping our pluggables business.

It's gonna be, you know, we said at least $150 million this year. It's with 20% of this ship of the market. It's gonna grow. That share is gonna grow.

And our cost points are not as good as we'd like them to be. Those cost points will decline over time and our margins will improve. We're also gonna generate gonna introduce the next generation of plugs, the 800-gig plug, an 800ZR, ZR Plus, all of that generation will come out and those should be higher performance, and better gross margin. So there is a path to getting to gross margins not gonna happen in Q3, and I think it will definitely start to happen next year.

The other dimension on mix is WaveLogic 6 Extreme.

Part of our system business. Gary talked about the momentum that we had in that in his prepared remarks. That's in the early stages of ramp well. So it has the same dynamic as the pluggables, lots of levers to pull on operational supply chain efficiencies and design cost reduction that you do over the life cycle of a product, and that will naturally lift the margins in those parts of the portfolio.

The other thing I would just add to add to all of that is Samik, we're you know, given what we're seeing around the dynamics of demand, and how sustainable that is, given what Jim and Scott have talked around the gross margin mix, you know, being a bit of a headwind in the short term for us. We're confident we'll get through that. We've done that before. That makes us even more confident in our operating margin targets.

You know, for getting into those mid-teens as we get to 2027. And I think we'll see continued improvement both in the second half of this year and also in 2026. On the journey.

Alright. Great. Thank you. Thanks for all the call.

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

Thanks for taking the question. And Jim, thank you as well for all the service and certainly appreciate getting a full year's heads up on your retirement. So a nice glide path without a shock to the system. So grateful for that as well.

So I wanted to see if maybe we could unpack the top customers a bit, and then you mentioned three out of the five were cloud. And the two ten percent customers, one being serviced by our one cloud. I guess what I'm trying to get a better sense of is what were the more specific percentage contributions from the two over ten percent and how much of overall revenue is coming from the top five customers in the quarter? Thank you.

Yeah. The largest customer was 13.4%. And the second one was our service provider, AT&T, at 10.4%. The top five, I'd have to quickly calculate, but it would I'll do that and get back to you, Simon.

Okay. And then just I'll ask to follow-up while you're looking at those numbers. In terms of some of the trends from these cloud customers, so comfortable that visibility's improved. It sounds like a good trend.

I know we're not ready to provide guidance for fiscal 2026. But I guess folks are trying to look for what sort of the sustainability of this due to this you get a better sense that you'll see a broadening base of contributions from cloud book direct and indirect that it should continue to grow next year. How should we think about the longer-term trend beyond the end of fiscal 2025?

You know, as the as I'm sharing appreciate, obviously, we don't want to get ahead of ourselves into giving sort of detailed guide for 2026. But clearly, with the kind of dynamics that we're seeing, Simon, I think about it. You've got a broadening application base, you know, I talked about the GPU clusters earlier and the inside the data center focused application there. And you've also got a broadening amount of cloud providers. You know, we've had significant new wins over the first half of the year, more and more of these cloud providers, not just the large four, are now really leaning into the network.

And so I think you've got a broadening set of players and you've got a deepening set of applications, which obviously gives us confidence in the sustainability and durability of it.

The two big wins that Gary spoke about earlier both of which have applicability outside of the original customers. The regional GPU clusters in particular are something that the industry's the industry has been talking about for, you know, years. And now the demands for data flows inside the data center has brought that phenomenon about. So this is a big trend for us.

We think it will be at least considered if not adopted by other cloud providers. And the inside the data center connectivity is being looked at by other cloud customers as well. So both of those have applicability outside of the original customers. And the answer to your question, Simon, the top five customers were 45% of revenue.

Thank you.

Thank you, Simon.

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

Yep. Thanks a lot. I guess I have two as well. Maybe to start with, you know, when I think about the 14% growth outlook for the year, can you just talk about what are you sort of assuming from a growth basis in cloud versus telco for the year?

And then really if I kind of look at what you implied for October quarter specifically, I think you're implying some of the uploading and digit sequentions around $1.2 billion. So would that imply that, you know, a lot of the auto momentum you're seeing right now is more likely to convert to revenues in fiscal 2026 versus the back half of this year?

Yes. Quick answer to that. I mean, this is yes. I mean, given the scaling demand, we're not gonna be able to and a lot of it is scheduled for out further because of the size and scale of it.

So we're certainly, I think, going to be going into 2026 with an increased backlog. I think that's where you're going with this, and that's absolutely a reasonable assumption. We are ramping our supply chain pretty strongly, and we've we started that last year, and we're continuing to increase that. So we can address that because we do think it's very sustainable, and we've got good visibility to it.

So we are going to go into 2026 even with, you know, the increase to sort of 14% growth in the year, we're still gonna be leaving the year with a larger backlog than when we entered it. That's for sure.

Super helpful. And then, you know, if you could spend a little bit of time on the pluggable opportunity, and you talked about you deploying your pluggable optics with one of these distributed GPU clusters. Can you just talk about what distance are these pluggables being used for right now? And if I think longer term beyond the $150 million number you talked about, how big do you think this market can be, and where do you think your market share could eventually get in that space?

Thank you.

Okay. Let me take the second part of that, and then I'll pass Scott to give you some, you know, more on this sort of architectural side. I would say that, you know, we've been engaged with multiple players over this kind of architecture where because of power and space constraints, they cannot get all of the GPUs in a single data center. So this is the first one that we've seen, and we believe one of the first deployments like that.

And it's just a couple of the regions and it is hundreds of millions of dollars. Of both 800-gig pluggables and line system. So, you know, in terms of sizing, it's pretty material. And, you know, this is one player just beginning to roll this piece out.

So this is a very sizable and substantial opportunity for us.

Yeah. In terms of the overall pluggable piece, you need to differentiate sort of our pluggable participation and sort of the class metro campus DCI, which is, you know, the 80 kilometers plus kind of domain with this regional GPU clustering application that we're talking about. In the latter case, you know, what we're really talking about here is a simple way to think about it is an express overlay network between GPU clusters. That has massive capacity reaches, you know, 100 to 150-kilometer type range, requires resilience, latency, requires WDM.

And is right in the sweet spot of coherent technologies. It's what we've been talking about for a long time, which is as power becomes a bigger constraint, they need to distribute these GPU clusters capacity goes up. That's gonna create more opportunities for coherent. And, you know, this is an instantiation of that.

It's coming across as, you know, pluggable opportunities at 800 gig. And it's coming across as line systems. All incremental to the use cases that we've been pursuing in the past.

Great. Thank you very much, and best of luck to you.

Thanks, Amit.

And your next question comes from Ruben Roy with Stifel. Please go ahead.

Thank you, Scott. You probably just answered this question, but just so I understand on the GPU cluster opportunity, it seems to me, you know, from the prepared remarks and what you just said, you know, that you're uniquely positioned given that you have both aligned systems and the pluggables. And that's, you know, part of this new architecture that, you know, some folks are thinking about. Is that the right way to think about it?

Yeah. I think, you know, over time, the opportunity we believe is big enough that there'll be multiple vendors at play. But with our leadership in coherent and as we said, RLS being sort of the de facto standard for line systems, we are certainly gonna get our unfair share or the bulk of the early move on this piece. So we're quite excited about it.

We've been working on it with the lead customer for some time around looking at the feasibility. And super focused on delivering to it.

Great. Thank you. And as a quick follow-up for Gary, wanted to talk about Blue Planet. It's shown quite a bit of momentum over the last several quarters, and you talked a little bit, Gary, about AGENTIC AI and some of the things that some of your customers are thinking about.

I'm wondering if you could just kind of delve into that a little bit, opportunities longer term and, you know, any detail on use cases that you're talking to your customers about and, you know, how you're thinking about that in terms of growth going forward.

Thank you. Yep. If you think about the sort of software assets that we've got that are strategically embedded on the service provider side, you've got Navigator around the sort of the main piece was a complete sort of services-based architecture. And then, as you know, we had a kind of a lot of learning around Blue Planet being a microservices software platform for OSS.

And I think we're seeing a lot of momentum now on the Blue Planet side. We're, you know, we're very focused on things like the inventory, confederation of inventory. And you think about that strategically, you basically get to have the dataset within these service providers of what is out there. And really without that, it's very difficult to, you know, have a GenTek AI if you haven't, you know, understood what the whole inventory of your network is.

So we're sort of, we believe, uniquely placed to be able to leverage that into the future, and that's what we're focused on developing and engaging with a number of very large service provider customers on. We've got a great position in a number of those large service providers. And we've got the right architecture that will scale up for that. It's early days.

But, basically, you know, we're in a tremendous position from a relationship and a trusted partner point of view and from an architecture point of view, Ruben, to really leverage that into, you know, something where we become management for allows and facilitates the AGENTIC AI.

Great. Thank you.

Thank you.

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

Great. Thanks. Maybe just a second. Kind of on the routing wins that you guys were talking about.

Just wanted to get a sense, you know, you guys had invested a lot in that business over the past few years. You know, where was kind of one of the service provider wins kind of one of the, you know, finally kind of seeing some of the benefit of that investment. Then maybe just secondly, get the question in ahead of time, just on installation capacity, you know, are you guys seeing kind of more requests for installation capacity just as kind of your increased in revenue would point to kind of, you know, an increased need for capacity increases.

Yep. So I think on the routing and switching side, Meta, you know, I think it's, you know, it was completely aligned with the service provider journey. And I think, you know, my own view of what's happened with service providers over the last few years, they've really underinvested COVID, then supply chain whiplash, and challenges around that, and then 5G. Where they've had to invest enormous amounts of money and capital and focus on 5G.

And that's largely not worked out. From a, you know, profit-generating point of view. So I think, you know, we're at a point now where they're returning to, you know, I think, a very sustainable sort of scalable investment thesis. And that includes routing and switching.

And I think the two go hand in hand. And I think, you know, with the service provider uptick that we're seeing, we're seeing now an investment in new routing and switching applications and a number of new wins. So that's encouraging for us. And I think that will absolutely continue.

To your point about EF and I, which I think is a very important point for a couple of reasons. One, the increased shipments, we've got really good visibility to what's happening with those shipments. And we are the EFNI partner for a lot of our large customers. Including the cloud customers.

So we have good visibility to what's happening. And I will say to you that, you know, that's in balance, and the need for EF and I is gonna go up exponentially similar to the ramping of our supply chain and demand. And we're seeing a lot of activity across the board for EF and I both in service providers and in the cloud, obviously, to help install this massive amount of investment over the next few years.

I mean, just to continue on the routing and switching piece. I mean, we've been very encouraged by the number of logo wins that we've had over the last number of quarters. Logo wins, obviously, are a precursor to orders or a precursor to revenue. In line with the sort of service provider dynamics.

The order book on routing and switching for the last number of quarters has been, you know, quite a bit in excess of the revenue piece. To put a dimension to that, orders in the first half of the year in routing and switching were greater than 75% of total orders last year for routing and switching. So there's momentum there, and we would expect that to flow through the revenue with the strong second half.

Great. Thank you.

Yep.

And your next question comes from Adrian Colby with Citi. Please go ahead.

Hi. It's Adrienne Colby for Atypical. Thank you for the question. I was hoping we could go back to gross margin.

I think last quarter you had been expecting gross margin to trend up from the Q2 levels into the second half and the back half of the year. So I just wanted to understand better what's changed, you know, perhaps the production scaling of the 400CRs, is trending differently from expectations. We've talked about the product mix impacts, so I think that's well understood. But just trying to understand what shifted in that outlook.

Yes. You'll recall that our original guide for the year on gross margin was 42% to 44%. We're now saying that it's going to be at the low end of that range. And it is essentially that demand for two products in particular have greatly exceeded our expectations, the RLS systems and our plugs.

And as I discussed, both of those are currently below corporate average gross margins. We do have a path to improvement. And you should see improvement in gross margins certainly next year. Q3 is probably gonna look more like Q2 and probably a little improvement in Q4. But again, as Gary said earlier, we're committed to improving those gross margins and to getting our operating margin back to the 15% to 16% level by the end of the three-year period.

Thank you for that clarification. Then I was just hoping we could talk about the MoFEN opportunities maybe talk a little bit more about your pipeline. I know you've said that this is one of your strongest quarters in terms of orders there. Interested if you're seeing some expansion beyond India. I know that's been an area where you've had significant traction.

Yeah. We're seeing a lot of movement activity in India. It's not translated to a massive amount of revenues yet, but we've taken the orders and it will. We're seeing movement throughout the globe.

And I think it just really goes hand in hand with the whole cloud build-out. You know, they can't build everywhere with their own network, and so it's all augmented by these MoFEN opportunities. We're seeing that in North America as well. There's been some, as you know, large announcements around some of the larger carriers partnering there, you know, with Lumen and Zayo, etcetera.

We're seeing that reflected in pretty much all parts of the globe, you know, Asia outside of India, we're beginning to see that in Europe. You know, we've seen activity, you know, it's the largest amount of activity that we've seen, and it really just goes hand in hand with the overall strategic plans for these cloud providers.

Thank you.

And the next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead.

Hey. Good morning. And congrats on the results and increased outlook. Had a question on the cloud front.

And, Gary, I think you mentioned a step function. I think you were referring to demand. It looks like we saw another major change in the quarter, and that's diversification of your cloud business among several providers. It seems like your top customers, the smallest percentage of that total bucket that it's been in a while or at least in recent history.

And I wonder if you could talk about that trend, of customer diversification within cloud and whether you expect to see that continue? I know it can be kinda lumpy, but be interested in your thoughts overall on that.

Yeah. That's a good point, Tim. I mean, I'd say overall, we're seeing we start with the sort of foreknown, the hyperscale as it were. We're seeing increases in all four.

You know, step function increases in all four cloud players directly with us. And also through things, you know, as I was talking just with, you know, MoFEN as well. So it's all consistent with that. And then we're seeing them really, you know, and I think it's a sort of hierarchical flow is how I think about it.

You know, they've been very focused obviously on power and GPUs and scaling all of that. Now it's about scaling it out, and it's now about the network. And they're very focused, all of them. On, you know, making sure that the network does justice to all this massive investment that's gone on in compute.

So I think this is the phase that we're entering now. That's why we're seeing it across all of the hyperscalers. As you say, it's lumpy. You know, some are, you know, leaning in more than others, but they're all I think, showing a step function increase in the importance of the network.

And then you've got a whole other set of players as well that is expanded out from a cloud point of view that are now leaning in on the network. And so you've got a broadening out. It's not just the large four anymore. It's a much larger group of players that are now recognizing that if they're going to monetize and to opt it's all about the network.

And you know, that's why we think it's very, you know, diversified, durable, and sustainable. And it's all about high-speed connectivity. That's really what it's about.

Great. Thanks very much. And, Jim, congratulations. Been great working with you.

And your next question comes from Ryan Koontz with Needham and Company. Please go ahead.

Great. Thanks. Wanted to follow-up on your comments around tariff mitigation and your different levers there around supply chain, customer surcharges. And if you can kind of broadly characterize, you know, how, you know, negotiations are going with your customers there, in terms of, you know, passing some of those costs along, ten million hit from tariff doesn't sound like that much relative to the big scheme.

Thanks.

Yes. Any discussion of tariffs gonna have to be caveated by the fact that we only know what the regime in place is now. And it could very well change soon. But under the regime in place now, and given all of the exemptions that are in the current regime, we are likely to experience a cost of about $10 million per quarter.

Now, if other schemes come in place and the potential for tariff go up, we do have a range of things that we could do. We could move manufacturing operations. We could change some flows in our supply chain. We can do a number of things like that, which would reduce it.

With respect to passing on to customers, it's gonna be a, you know, a complicated situation because in not in all cases are we gonna actually pass a tariff along to them, some cases, it might result in some price increases. General price increases, etcetera. So all of those things that that's about as far as we're willing to go today. But we think that the net cost to our bottom line is gonna be immaterial.

Going forward.

Got it. Thanks. Thanks, Jim. Congrats. And I care if I could follow-up on your momentum in pluggables or maybe for Scott on CR. Is this still dominantly driven by cloud operators or are you seeing much service provider traction? Where are we in the service provider adoption cycle for your pluggable CR products? Thanks.

Yeah. From a ZR perspective in terms of that application, Ryan, it is dominated by cloud in terms of the volume. Pluggables, you know, have existed forever in terms of service provider deployments for different reasons, for modularity and we do ship our plugs into service providers. But the volume for ZR is dominated by the cloud.

Got it. Thanks so much, Scott.

And your next question comes from Karl Ackerman with BNP Paribas. Please go ahead.

Yes. Good morning, gentlemen. I have two, and I'll just ask them at the same time, if I may. You indicated that mix of plug wells and line system are the biggest driver of margins.

First, does the increased backlog exiting 2026 assume a higher mix of transponder blades? Second, on pluggables, clearly volume plays a larger role here. But you did speak about a several hundred million dollar opportunity from your initial player. So could you discuss where you are on having a fully integrated coherent transceiver giving your IP across BSPs CertiS, Electro Optics.

Thank you.

The short answer to your first question is yes. We will be selling more capacity next year. That's one of the reasons why we can have the confidence that our margin will go up next year. Gross margin and operating margin for that matter.

Yeah. And on the second one, you know, from a capability perspective, all the major seminal ingredients, we own our own IPR. On. And as we ramp it over time, a greater proportion of the mix will be on our own components, and that is part of the cost improvement plan.

Thank you.

Your next question comes from David Vogt with UBS. Please go ahead.

Great. Thanks, guys, for taking my question. And Jim, congratulations and good luck. Maybe one to start with you, Jim.

So, obviously, you've spent some time talking about sort of the dynamic with RLS and pluggables. Can you kinda remind us again, should we expect something similar to what we saw maybe in fiscal 18, 19, and 20 from a systems and transponder capacity perspective. Recognizing that, obviously, COVID was a little bit different. But is that the kind of way we should think about the trajectory of capacity additions and the impact on gross margins going forward, and then I have a follow-up more specifically on margin.

So recall, we had an exceptionally high margin in 2020. That was because COVID did sort of reduce the level of activity with respect to new networks. And so in order to get the capacity to adding capacity to existing line systems. And so we generated, I think, a 48-point something percent gross margin. In one or two quarters of 2020. I don't we don't foresee that kind of move in the next three years.

We do see though, a move back to the mid-forties just based on the fact that all of the things we've talked about, WaveLogic 6, the fact that we're coming out with a new generation of pluggables, which will be higher performance and better gross margin. And our cost position on the basic 400ZR will improve. So for all those reasons, we do have confidence that gross margins will improve as we move through the next year or two.

Got it. And that's helpful. And as a follow-up, so if I just maybe take your commentary that the gross margin guide is gonna be at the low end, but you're taking the revenue guide to the high end or above the high, excuse me, to 14%. That's largely sounds like driven by RLS systems and pluggables.

You know, just quick math. It looks like sort of the incremental profitability I know it's below corporate average, but it seems like it's pretty materially lower. You know, in the, you know, the low double-digit range. But, you know, can you kinda help us understand what's going on there?

Obviously, you're talking about and even that's adjusting for the mitigation strategies from tariffs and the impact of the quarter. Just trying to understand the magnitude of, you know, how the pluggables and the RLS revenue is impacting the gross margin for the balance of this year? Thanks.

Well, you've done some math. I'm not going to confirm it. But what I will say is this, we think that given the mix of products in Q3, it's gonna be, you know, maybe a little higher than gross margin in Q2, but probably in the same range. We do see improvement in Q4.

Great. Thanks a lot, guys.

Thank you.

Thank you, everyone, for listening.

Okay. This is Jim. I'll be retiring from Ciena Corporation at the end of August, and this is therefore my last call, as Gary said, as CFO. I've greatly enjoyed getting to know all of you.

And I wish you well in all of your future endeavors. Also look forward to seeing many of you at the end of this month in New York and Boston. That'll be fun, and I'm looking forward to it. For those of you who are in the enviable position of having recommended Ciena Corporation for purchase, I believe you've made a good call, a great call, actually.

For those of you who are not yet in that position, there is still time to get in on what I believe is a very bright future for this company. Good luck to all.

Thank you, Jim. Thank you, everyone. We look forward to connecting with you over the next few weeks.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.