Earnings Call Transcript - CIEN Q2 2022

Operator, Operator

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

Gregg Lampf, Vice President of Investor Relations

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

Gary Smith, President and CEO

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

Jim Moylan, CFO

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

Operator, Operator

Your first question comes from Paul Silverstein from Cowen. Your line is open.

Paul Silverstein, Analyst

Thank you for your questions. Jim, Gary, could you explain the linearity in a quarter and, more significantly, what the bookings have been like in the past four weeks? Also, Jim, in relation to that, what is the guidance for July and the October fiscal year? Additionally, regarding the impacts of the supply chain, how much revenue was affected and what was the gross margin impact? Thank you.

Jim Moylan, CFO

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

Gary Smith, President and CEO

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

Jim Moylan, CFO

In response to your question regarding our guidance, it's a figure that is almost unbelievable, Paul. We currently have a backlog exceeding $4 billion, and only a small portion, a few hundred million, is genuine demand for 2023. The remainder has been requested by customers this year. Our revenue could have been significantly higher if we could obtain the necessary components for manufacturing. However, it's important to note that this should not be interpreted as our regular run rate. It's more about catching up, as everyone is trying to get ahead with their orders. Nonetheless, it highlights the robust demand we see and what we believe is very achievable moving forward.

Paul Silverstein, Analyst

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

Jim Moylan, CFO

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

Paul Silverstein, Analyst

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

Jim Moylan, CFO

Absolutely. Yes.

Gary Smith, President and CEO

Yes.

Jim Moylan, CFO

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

Amit Daryanani, Analyst

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

Gary Smith, President and CEO

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

Jim Moylan, CFO

Our backlog is certainly a mixed blessing. It's encouraging to see demand and orders coming in, especially compared to our competitors. However, a significant part of our backlog is due to longer lead times than we would prefer, which means we are not meeting our customers' expectations for satisfaction. While we have received a lot of new orders this year, most of them are scheduled for the latter part of the year and in some instances into 2023. As Gary mentioned, this isn't really demand for 2023, but rather reflects when we can deliver. So, while we're pleased with the orders, we would prefer to exceed our customers' expectations.

Amit Daryanani, Analyst

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

Gary Smith, President and CEO

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

Jim Moylan, CFO

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

Gary Smith, President and CEO

Thanks, Amit. Appreciate your question.

Tim Long, Analyst

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

Jim Moylan, CFO

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

Gary Smith, President and CEO

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

Gregg Lampf, Vice President of Investor Relations

Thank you.

David Vogt, Analyst

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

Gary Smith, President and CEO

David, I'll address the recession aspect first and then respond to Scott regarding the initial part of your question. We are certainly aware of the macroeconomic challenges that the world seems poised to face. However, I want to emphasize a few points: In our discussions with our diverse customer base, we aren't observing any significant changes in their forecasts, demands, or long-term plans. We have considerable visibility into the overall trends for the next one to three years regarding their operations. While the industry is not immune to recessions, it has historically performed well during such times because access to the network remains essential. Network operators and major industry players will continue to invest in improving their networks and increasing traffic. Hence, we are confident about the sustainability of the demand we are experiencing. Currently, our focus is on addressing the backlog and meeting the pent-up demand. As Jim mentioned, we may not experience order flows at the current pace for the rest of the year, but we do not anticipate a dramatic decline or sudden drop-off either. The dynamics of this business are evolving, and customers are adapting to a longer-term ordering approach. We expect that lead times will improve over time, and we foresee enhanced long-term visibility with our customers.

Jim Moylan, CFO

We are informing our customers about longer lead times, which means it's crucial for them to place longer duration orders with us. They need our gear, and while we do not claim that the current rate of order intake is sustainable, we firmly believe that the demand for our products and services will continue to increase and capture more market share.

David Vogt, Analyst

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

Jim Moylan, CFO

Well, I mean, if you just look at the delivery dates, it probably wouldn’t be in next year’s. But all we can say about next year today really is that, given where we think our backlog will be at the end of this year, we do expect to have a significantly higher growth rate in 2023 than the 6% to 8% we’ve promised in the past. And I can’t give you an exact number because I don’t know the number. But I think it’s going to be a great year next year.

Gary Smith, President and CEO

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

Rod Hall, Analyst

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

Gary Smith, President and CEO

Five.

Jim Moylan, CFO

We have five more answers for you, Rod.

Rod Hall, Analyst

I wanted to explore the verticals a bit more. Looking at the cable numbers, they usually rise seasonally in April, but this time they have remained flat. I'm unsure if this is due to supply issues. Could you discuss the demand dynamics in this area? Additionally, government demand has significantly increased, especially in April. Could you elaborate on the demand dynamics in those verticals? I'm interested in understanding how much is driven by supply factors and how much is related to demand.

Gary Smith, President and CEO

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

Rod Hall, Analyst

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

Gary Smith, President and CEO

I think the forecast may decline in Q3 depending on shipping capabilities. However, if we look beyond the fluctuations, we are observing consistent government investment in their networks for a variety of reasons, which gives us confidence in that area. We feel optimistic about this for the upcoming years, as there is significant network build-out and modernization happening across various government networks.

Jim Moylan, CFO

Our technologies fit their needs very well too.

Tal Liani, Analyst

Hey, guys.

Gary Smith, President and CEO

Hi, Tal.

Jim Moylan, CFO

Hi, Tal.

Tal Liani, Analyst

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

Jim Moylan, CFO

I don’t believe that’s the main factor. What really drives this is the ongoing demand for bandwidth, which has consistently increased regardless of economic conditions for the past 20 to 30 years. Therefore, I don’t think a lack of supply will hinder that demand. As long as customers continue to seek services from them, the demand will be there, and we have not observed any decline in that.

Gary Smith, President and CEO

I think that at a web-scale level, there's no benefit in building a data center if you can't connect it. I understand the perspective, but I want to clarify the context. We are shipping more than we did last year, which means we are providing connectivity to our customers, although they aren't receiving the full capacity they desire. This isn't a simple situation; we are growing. We just reported a quarter with a 14% revenue increase despite these challenges. It's not that we're failing to deliver; we are meeting some of the demand from our customers, but not all of it. No one else is performing better than we are, so there aren't many alternatives available, and I'm sure customers aren't looking to leave the queue. Additionally, we have the leading technology and continue to maintain that position. Those are the dynamics we're seeing, Tal.

Scott McFeely, Senior Vice President of Global Product and Services

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

Tal Liani, Analyst

Right. And Gary, maybe a follow-up question is, isn’t this environment encouraging more cloud companies to self-manufacture solutions instead of purchasing from vendors, as it would give them better control over the supply chain? Do you think that white box solutions or self-designed, self-manufactured options could grow in response to the current environment?

Gary Smith, President and CEO

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

Gregg Lampf, Vice President of Investor Relations

Thank you.

Simon Leopold, Analyst

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

Gary Smith, President and CEO

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

Gregg Lampf, Vice President of Investor Relations

ZR.

Gary Smith, President and CEO

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

Gregg Lampf, Vice President of Investor Relations

Simon, thank you for your question. Appreciate it.

Operator, Operator

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