Ciena Corp. (CIEN) Q3 2020 Earnings Call Transcript

Ciena Corp. (NYSE: CIEN) Q3 2020 earnings call dated Sep. 03, 2020

Corporate Participants:

Gregg Lampf — Vice President, Investor Relations

Gary B. Smith — President and Chief Executive Officer

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

Analysts:

Simon Leopold — Raymond James — Analyst

George Notter — Jefferies & Co. — Analyst

John Marchetti — Stifel — Analyst

Meta Marshall — Morgan Stanley — Analyst

Rod Hall — Goldman Sachs — Analyst

Paul Silverstein — Cowen & Company — Analyst

Tal Liani — Bank of America Merrill Lynch — Analyst

Amit J. Daryanani — Evercore ISI Institutional Equities — Analyst

Michael Genovese — MKM Partners — Analyst

Alex Henderson — Needham & Company — Analyst

Samik Chatterjee — JP Morgan — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Ciena Fiscal Q3 2020 Financial Results Conference Call.

[Operator Instructions] I would now like to hand today’s conference over to Gregg Lampf. Please go ahead.

Gregg Lampf — Vice President, Investor Relations

Thank you, Carnie. Good morning and welcome to Ciena’s 2020 Fiscal Third Quarter review. We are conducting today’s call from various remote locations. 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 the Q&A.

In addition to this call and the press release, we have posted to the Investor 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 Q3 2020 performance, developments in our business, and our view on current mortgage dynamics, including with respect COVID-19 as well as our 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 I turn 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 and long-term financial targets are based on current expectations, forecasts and assumptions regarding the Company and its markets which [0:09:52] 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-Q filing as well as in our upcoming 10-Q, which is required to be filed with the SEC by September 11. 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 so we ask that you limit yourself to one question and one follow-up. With that, I’ll turn the call over to Gary.

Gary B. Smith — President and Chief Executive Officer

Thanks, Gregg, and good morning, everyone. Today we delivered outstanding third quarter results across the board and similar to last quarter, our performance in Q3 demonstrates that our strategy, focused on innovation leadership, diversification and global scale has enabled us to manage well through the challenges of the current environment. The Ciena team has been a key elements of our performance and businesses as we know are all about people.

Their focus, resilience, and drive to innovate and serve our customers is unrivaled in the industry. I remain incredibly proud of our global workforce and their collective efforts, including their continued volunteerism and charitable activities. Notwithstanding a strong quarterly performance and the resiliency of our business model, we are seeing negative effects of the pandemic and greater economic uncertainty weigh on our near-term outlook.

We believe that this is being driven by an impact on the velocity, and to some extent, de-prioritization of new business initiatives in general, as well as an increasing customer caution on budget decisions and the timing of spend, namely with service providers, as they are in turn beginning to feel the negative effects from large segments of their enterprise businesses.

As we said last quarter, despite the favorable increase in bandwidth requirements, we are not immune to these dynamics as they continue to play out in the market and we will provide more color and perspectives on this momentarily. Firstly, I’d like to discuss the key performance metrics in our third quarter and provide a few highlights from across the business that really emphasize the inherent resilience and competitive strength of our business.

So far this year we believe we’ve taken an additional 1%-plus of global market share, and I would stress that this is largely without the benefit of an increasing number of significant strategic design wins that we have yet been able to monetize, given the current climate. Accordingly, we delivered outstanding financial performance in Q3.

We had a great revenue quarter and our gross margin, opex management, and operating margin were all very strong, and in fact better than expected. Indeed, our adjusted operating margin exceeded 22% and I think this really demonstrates the differentiated operating leverage in our business model that we’ve created. And we had excellent cash flow, finishing the quarter with approximately $1.2 billion in cash.

Our performance this quarter also reinforced our innovation leadership and strong competitive position in critical areas of the network. Our latest generation modem, WaveLogic 5, remains the only 800 gig solution available in the market and is in volume production today. We are not just sampling or trialing this leading technology, we’re actually shipping it for commercial deployments with a range of customers, including service providers, webscalers, subsea operators, and research and education institutions.

In fact, we’ve already secured roughly 50 design wins for WaveLogic 5 Extreme and this is a rate faster than previous generations, as the networks today are more ready than before for a step function in capacity to support demand. In just over three months of commercial availability, we shipped more than 1,000 WaveLogic 5 coherent modems to almost 40 customers around the globe with several of those networks already carrying live traffic.

I think this is a strong testament to our innovation leadership and clear validation of our ability to execute and deliver against aggressive technology roadmaps, supported by a very robust supply chain. In addition to our market leading optical performance, we had several new wins in Q3 for our Packet business.

We now have more than a dozen customers for our Adaptive IP Solutions, including Telefonica UK and SK Telink, which we announced in Q3. And this is amongst additional Tier 1 service providers who valued our automated open and lean approach to IP architectures. And of course, we also continue to see strength with existing customers of our packet portfolio like AT&T.

On the Blue Planet side, in Q3, we delivered on a strategic mobile transformation in the Asia Pacific region, secured significant up-sell business with several large service provider customers domestically and internationally and added a number of new enterprise logos as well.

Now moving to the overall market, secular demand drivers for connectivity obviously remain very much intact as network traffic grows and the adoption of cloud architectures continues apace. So the fundamentals of our business are absolutely unchanged as we look to the future. Nevertheless, as I alluded to in my opening remarks, late in the fiscal third quarter, we began to see some of the effects of COVID-19 manifest in our business to a greater degree than anticipated, as well as increased economic uncertainty.

Specifically, we began to experience a meaningful slowdown in orders and a softening of our outlook. I would stress that the decline is broad based across our service provider’s customers globally, whose spend now appears to have been somewhat front-end loaded in the calendar year, resulting in lower orders in our third quarter from a number of our large customers in this segment.

We believe the softness in our order flow and our reduced visibility is the result of a couple of customer-related dynamics. Firstly, COVID-19 continues to have an adverse impact on the velocity of business in general, and particularly, new business initiatives. Limitation on physical access at ours and our technology partner sites continue to create challenges for executing on some network projects that we’ve already won.

And generally, in this uncertain environment customers’ ability and willingness to move forward with new business initiatives is constrained. In fact, the best evidence for this dynamic is evident in our recent gross margin performance, which reflects a larger percentage of revenue from existing businesses versus from new design wins and early life-in projects, which tend to carry somewhat lower margins.

The second dynamic is customers have grown more cautious about the near-term outlook for their businesses and are beginning to exercise greater restraints in respect to their capex spend. This is particularly evident with our service provider and MSO customers as certain large segments of their enterprise businesses are being negatively impacted by the pandemic and economic uncertainties.

Overall, I would say that customers are running their networks hotter and they are carefully prioritizing where and when to add network capabilities and they’ve proven their ability to do this for extended periods of time as we’ve seen before with previous economic conditions that are challenging. Conversely, with our Webscale customers, the year has pretty much so far played out as we expected directionally, with some COVID related reduction in spending.

Specifically, in fiscal 2020, as expected, one of our large Webscale customers reduced its optical spend as it had some absorption and changes to its architecture. While I would stress that we’ve gained share, significant share with others, including a new significant architectural win with one of the major players that is new to Ciena.

We now believe that overall optical spend growth in this Webscale segment will be flat to low single digits for this year versus the 7% to 10% that was expected at the beginning of the year. And I would stress that our competitive position remains strong in this key vertical and we remain confident that we have gained share in all of the other accounts, despite, well that one large customer absorbing during the year, therefore overall market share continues to expand in this sector.

While the strong diversity in our businesses generally enables us to manage through ebbs and flows in any one customer segment or geography, the breadth and magnitude of COVID-19 challenges and economic uncertainties are making it more difficult to do so. As a result of the broader economic conditions and related market dynamics, we now expect overall market optical growth, excluding China, will slow.

In fact, we now believe that the market will be roughly flat to down for this year, and this dynamic is already being reflected in some of the latest industry analysts forecasts and we expect that sentiment to continue. Accordingly, we expect our orders and revenue to be adversely impacted for the next few quarters. However, I would stress that we believe that these challenges will be short-term in nature.

With bandwidth demand increasing at approximately 25% to 30% year-on-year, we do not believe it will be possible for our customers to serve that level of demand for more than a few quarters without increasing capacity. Importantly, our competitive position is incredibly strong and we remain the clear market share leader. We believe that uncertain conditions will only reinforce, and possibly accelerate, a flight to quality in terms of vendor selection and the ability to maintain investment velocity.

And we have the scale, focus and balance sheet to not only continue differentiating ourselves, but also manage through these conditions effectively and we intend to press down on that advantage to ensure both our own and our customer’s long-term success.

With that, I’ll hand over to Jim to talk you through our Q3 results and outlook.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Thanks, Gary. Good morning, everyone. We’re pleased to report another strong quarterly performance with our Q3 results today, driven by continued execution of our strategy. Total Q3 revenue was $977 million which, like last quarter, reflects strength in our North America and EMEA regions. Q3 was also remarkable with respect to customer diversification with non-telco customers generating more than 43% of total revenue. This included Direct Webscale revenue, 25%; revenue R&E and enterprise, 9%; MSOs 9%.

Adjusted gross margin was 48%. This is higher than our estimate of current run rate gross margin. I’ll remind you that we said last quarter, we believe our current run rate margin is between 43% and 45%. It’s higher now because, as Gary mentioned, our revenue mix in the quarter included a larger percentage of revenue from existing business as opposed to revenue from new design wins and early-in-life projects, which tend to carry lower gross margins.

Adjusted operating expense in the quarter was $251 million, lower than expected, mainly due to continued lower travel costs as a result of COVID-19. With respect to profitability measures, in Q3 we delivered adjusted operating margin of 22.4%, adjusted net income of $166 million, and adjusted EPS of $1.06, above our expectations, largely due to the higher gross margin.

In addition, in Q3, cash from operations was very strong at $175 million. Adjusted EBITDA in Q3 was $241 million, and we generated free cash flow in the quarter of $160 million. We ended the quarter with approximately $1.2 billion in cash and investments.

Our balance sheet remains a significant competitive differentiator, particularly in the current environment where financial strength and resiliency are critical. And it affords us the flexibility to continue investing in our business for the long term.

Before I provide our guidance for the fourth quarter, I’ll reiterate Gary’s comments around long-term secular demand drivers, specifically that the underlying trend of growth in bandwidth demand remains intact and that our competitive position has never been stronger. However, the length and breadth of the COVID-19 pandemic and its effect on the global economy remains uncertain and it is leading to more cautious customer spending behaviors and ongoing difficulties with operationalizing projects.

This resulted in Q3 orders coming in significantly below revenue, something we have not seen for some time, and a softening of our near-term outlook. Taking all of that into account, including our revised view on market growth for this year of roughly flat to down, we expect our Q4 performance will be as follows; revenue in the range of $800 million to $840 million, adjusted gross margin in a range of 46% to 48%, and adjusted operating expense of approximately $255 million to $260 million.

Importantly, based on our year-to-date performance and these projections, we now expect to achieve approximately 17% adjusted operating margin for fiscal year 2020, above the revised target that we provided last quarter. This level of expected performance for fiscal 2020 reflects a combination of current market dynamics as well as deliberate initiatives we’ve taken in several key areas of our Company over the last few years to reduce expenses. It also demonstrates the long-term operating leverage potential of our business model.

I’ll close by looking beyond Q4. Based on what we see today and with our limited visibility, we expect current market dynamics, in particular the challenges around restrained customer spending as well as business velocity, will persist for a few quarters. As always, we remain focused on executing our strategy. We have experience and a consistent track record of successfully managing the business through difficult times.

Today, we are an even stronger and more diversified business than during this challenging macroeconomic environments. And, as a result of our fundamental strength, we have the unique capability to continue investing in our business, in our people, in our products, and in our customers, with a focus on managing the business for the long term and continued market leadership. And we expect, even during this time of lower revenue, to generate strong gross margins and profitability.

Carmen, we will now take questions from the sell-side analysts.

Questions and Answers:

 

Operator

Thank you. And your first question will come from the line of Simon Leopold with Raymond James. Please go ahead with your question.

Simon Leopold — Raymond James — Analyst

Great, thank you very much. So, in terms of what’s going on with these trends and what sounds like some absorption and weaker trends. Is there a split in terms of what’s going on U.S. telcos versus international telcos and the Webscale? It sounds to me — the impression I have is that the issue is more acute with U.S. telco and cable? And are you seeing that behavior extending outside the U.S. or into hyprescale? Thank you.

Gary B. Smith — President and Chief Executive Officer

Thanks, Simon. I would say that it’s quite widespread, both domestically North America and internationally and it service — it’s largely services providers and MSOs. So it’s sort of across the board there and I think the dynamic to that is the fact that they can run their networks a little hotter. But I also think in terms of the economic caution, they’re beginning to see impact of large sections of their enterprise customers, you know, have challenges and I think that’s a consistent issue not just in North America but in Europe and around the world.

So there is some logic as to why we’d see it in international carriers as well. Obviously, some carriers are more exposed than others in the sort of — to various extends. But it is quite widespread amongst the service provides. On Webscale, I think it’s much less so, because I think it’s a different — different set of dynamics there, and I think they’re largely performing as we thought. I think the growth rate this year is going to be lower than we had anticipated, but I think that’s to do with some challenges around building out data centers, etc. That has slowed, particularly internationally, their ability to do that.

And you had one Webscale player in particular had a large absorption and is running their network hotter as well. But we saw pretty good growth with all of the other Webscale players. So I think it’s less Webscale and more service provider, Simon, for sure.

Simon Leopold — Raymond James — Analyst

Thank you, and can I just…

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

One other thing I’ll mention Simon — One other thing I’ll mention Simon is that we’re seen particular weakness in India. And remember, India started the year with a few secular factors. COVID has hit India and India has been shut down basically for the whole month. So, India has been a clear effect on us.

Simon Leopold — Raymond James — Analyst

Great. And as the follow-up, I wanted to see if you could maybe offer us an update on the prospect for winning business as a result of Huawei backlash, whether it’s because operators choose to move away from Huawei or Huawei simply can’t build products. This is something we’ve been hearing more about, the U.S. Government is taking further actions. So we’d love to hear your latest on that topic. Thank you.

Gary B. Smith — President and Chief Executive Officer

Yeah, I think that’s generally a positive dynamic for us and a sort of tailwind that I think is going to stretch out over the next one to three years. I would say that that dynamic is going to take time. These are big strategic decisions by large carriers, and predominantly in Europe is what we’re talking about.

We are engaged with those carriers. We have secured some of those design wins and they will roll out, but I think it is a one to three year dynamic and the operational challenges around those kinds of decisions are non-trivial as well. They’re very ensconced into those networks, the back office. And it’s not just an economic challenge for the carriers. It’s a big operational challenge too.

So, yes, we think it’s a very positive dynamic for us. I think it plays out over a longer period of time than perhaps the media might lead one to believe. But it is happening and we are securing wins as a result of that dynamic. They are in our design wins, but they’re not showing up in revenue yet.

Simon Leopold — Raymond James — Analyst

Thank you very much.

Gary B. Smith — President and Chief Executive Officer

Thanks, Simon.

Operator

Your next question is from the line of George Notter with Jefferies. Please go ahead with your question.

George Notter — Jefferies & Co. — Analyst

Hi guys. Thanks very much. I appreciate it. You know the fun thing about this is, we just came through an earnings season, of course company is on a June quarter and we didn’t see this sort of guidance from companies like Infinera. Certainly Juniper is a name that I tend to comp with you guys in terms of service provider exposure. Could you just talk about why your experience here seems to be quite a bit different relative to some of those other names?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Yeah, I’d say, George that you will be hearing this from our competitors, peers, and even customers, frankly. We have a quarter that’s slightly off in terms of most of our peers, competitors and customers and so since this phenomenon really occurred late in our quarter and specifically in the last month of the quarter, it might not have been evident to them at the time they did their earnings.

We believe this is very broad and everyone will be talking about this over the next several quarters. We have the kind of global stability that others don’t quite have, particularly with global service providers, which is where it is focused. And so I think that’s why we’re seeing it a bit earlier than others.

George Notter — Jefferies & Co. — Analyst

So is it fair to say that sort of the meat of the pressure on orders really came in, in the month of August?

Gary B. Smith — President and Chief Executive Officer

I would say that, from an outlook point of view, orders, I mean Q3, we delivered a fabulous Q3 and so it really didn’t impact Q3 much. But our outlook towards the end of — the end of Q3, I think it began to change.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Yeah, remember we said that our orders in Q3 were meaningfully lower than our revenue which is the first time that’s happened in a long, long time. So, we definitely saw the orders effect in Q3, didn’t see a revenue effect in Q3.

George Notter — Jefferies & Co. — Analyst

Got it, okay. And would you — is there a book-to-bill ratio you could share with us?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

We haven’t given that, but I’d say our backlog did come down.

Gregg Lampf — Vice President, Investor Relations

Thanks, George.

George Notter — Jefferies & Co. — Analyst

Okay. Alright, thanks very much.

Gary B. Smith — President and Chief Executive Officer

Thank you.

Operator

And your next question is from the line of John Marchetti with Stifel. Please go ask your question.

John Marchetti — Stifel — Analyst

Thanks very much. I just like to follow up a little bit on that timing question that George just asked. Gary, is it a situation as your customers are starting to get their own operations back to normal, and as you suggested, they’re starting to look at what their business prospects are that you think really drove the sort of sharp deceleration in what you’re expecting for the second half of the year?

Gary B. Smith — President and Chief Executive Officer

I think it’s a combination of these factors, John. I think there is a certain extent with pull forwards, you had a number of carriers who were in a position to secure continuity of supply, place those orders on. We had a very strong Q2 orders as we said. So I think you’ve got that dynamic and a little bit of bleed off in absorption. And I think you’ve got these other two elements that whilst overall the logistical issues around COVID have eased a little bit, I think that’s fair.

I think they’re looking at it and saying, they’re not prioritizing their new business initiatives sort of new route wins and new adoption of technology generally, they’re focused on how do we keep the network going and run it a little bit hotter and I think they’re also bumping into, frankly, the realities of some of their enterprise customers really suffering significantly in whole sectors such as retail, transportation, hospitality, restaurants and that’s beginning to impact their perspective on outlook. So I think John, it’s also the three of those elements coming together, if you will.

John Marchetti — Stifel — Analyst

And then, maybe as a follow-up there Gary, how do I think about your expectation for the continued momentum in 800 gig adoption? Obviously you’ve gotten off to a stronger than expected start or a very strong start with WaveLogic 5 and particularly Extreme, how do we — do you expect that to slow then as customers keep evaluating this or how should we think about that if they’re sort of pulling back on some new projects stuff. Thank you.

Gary B. Smith — President and Chief Executive Officer

Sure. Scott, do you want to take that?

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

Absolutely Gary. Thanks, John. It’s interesting because as you pointed out, the pace of new design wins is actually, is quite pleasing to us and I sort of compare it back to the previous generation and we’ve got over 50 design wins in our back pocket now and that’s probably about twice the rate of design wins from the previous generation in that same time period.

But interestingly enough, as I look at the volume shift against those, it’s actually probably a little bit smaller than the first piece. I think that’s exactly a microcosm of the broader picture that we’re talking about. Obviously monetizing new technology goes through a couple of phases, but if I simplify it, you know there is a selection phase and then there is an operationalization phase.

Selection phase is everything from the competitive RFP tenders, the -based cost [Phonetic], trials, commercial negotiation contract etc. We’ve gotten through that at a great rate and RFP pace hasn’t slowed down at all. What has slowed down is the operationalization of this stuff and you can see it sort of in a slightly lower set of volume units that are shipped against a bigger number of design wins. Those design wins don’t go away, by the way. We will monetize those going forward in the future. It’s just a little bit slower than we would like.

Gregg Lampf — Vice President, Investor Relations

Thanks, John.

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

Thank you.

Operator

And your next question is from the line of Meta Marshall with Morgan Stanley. Please go ahead with your question.

Meta Marshall — Morgan Stanley — Analyst

Great, thanks. A couple of questions from me. One, you know one of your competitors is talking about one of the ways the Huawei opportunity could kind of come to fruition is a move to open line systems in Europe, in particular. And just wanted to kind of get your sense of how you saw the Huawei opportunity kind of coming? And over the next couple of years, do you think that that could be the trigger that would cause a move to open line systems?

And then, maybe second point, you noted earlier in the year and that your visibility with Webscale customers is pretty high. Just a sense of — clearly there has been a slowdown in some international goals [Phonetic], but just how do you view your visibility with Webscale customers versus your service provider customers? Thanks.

Gary B. Smith — President and Chief Executive Officer

Sure, I will take the first one Meta and Scott and, feel free to add to this or answer the second piece. I think it’s unlikely to move to an open line system in Europe with Huawei. The Huawei replacement is quite a complicated set of issues around back office operational elements etc. So I think that’s going to take a while to play out.

As I said, that’s probably a one to three year opportunity. We’re already beginning to deploy on a couple of those that we’ve won. And architecturally, I don’t think that’s going to create any kind of shift to open line system frankly. I don’t really see that. Scott, I don’t know whether you have any additional color on that.

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

I would agree with that totally, Gary. I mean open line systems is not a new phenomenon from a technology perspective or even from a deployment perspective, you look at how we — how are some of the Webscalers consume the technology. The issue for the large European or any global carrier is, is all the operational challenges of a new vendor, whether that’s just the transponder systems or a closed loop system, it doesn’t really change that dynamic and that’s the gating factor for actually switching off of Huawei.

Gary B. Smith — President and Chief Executive Officer

On the second part of your question made around the Webscale piece, we have very good visibility with the Webscale folks. Obviously, you’ve got less, you know less customers there and more concentrated set of players and that’s largely played out as we thought.

We do have a significant new design win with a new Webscale player, which is new to Ciena. We were always missing one of the large Webscale players, which we’ve now added to our design wins and that’ll start to roll out as we go — as we go through next year.

We have pretty good visibility to their demand dynamics. The only dynamic we’re really seeing there is a slight slowdown in the build out of data centers, which again is largely a logistical issue and largely outside of the — outside of the U.S. to do with their submarine cable provisioning etc. which is to be to be expected.

Meta Marshall — Morgan Stanley — Analyst

Okay, thanks.

Operator

Your next question is from the line of Rod Hall with Goldman Sachs. Please go ahead with your question.

Rod Hall — Goldman Sachs — Analyst

Yeah, hi guys, thanks for the question. I wanted to focus in on the margins a little bit and see if — I know, Gary, I’m trying to piece together your commentary that the margins are so much better — the gross margins are so much better because of the move towards existing projects, that all make sense to me.

But then the fact that you’re talking about the weakness developing late in the quarter and then you guys are guiding margins down a little bit for next quarter. I’m just curious, are we — would you then say we’re at a new normal from our gross margins here due to that mix shift or does that mix shift continue to play out over the next few quarters as the new business maybe is a little bit weaker. So I’m just kind of curious what the trajectory of gross margins should be here?

And then my second question is on the opex. I just — I get that you’re getting a natural benefit in opex from the lack of travel. But could you just talk maybe, Jim, a little bit about, are you going to take any proactive opex control measures here or do you really not need to take measures because you’re getting this natural opex impact from the lock-downs and so on? Thanks.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Thanks Rod. On the gross margin point, we are and we expect to be in a range higher than our sort of run rate margin of 43% to 45% as long as our revenue remains at a slower pace. And that’s because our revenue is going to be at a slower pace, because our mix of revenue consists mostly of existing business and not a lot of the new wins that we’ve not yet monetized are the new wins that we’re going to get once the coronavirus effects on the business ameliorate.

So, yes, our gross margin is likely to be above our run rate margin for the next several quarters. We do think that once we get past this, because again we’ve said it’s a few quarters, we will be back in the business of monetizing new wins and winning new business and we think that our margin will trend toward that 43% to 45%. That’s our view today.

On opex, what I would say is that we’re actually quite a bit below our opex expectation for this year, mainly due to travel and some other things that COVID has affected and our ability to get things done. Actually, when we go into next year, we intend to invest in our business significantly. We think that it’s the right thing to do strategically.

We believe that we can attack a number of new markets and architectures with the things that we’re bringing to market in our innovation machine and so we don’t intend to reduce our capex — our opex by any significant amount. Of course we’re going to be trimming around the edges, sure, but not in any meaningful way.

Gary B. Smith — President and Chief Executive Officer

The other thing I’d add Rod around that is that during the course of the last two to three years — the course of the last two to three years, we have significantly improved our operating efficiencies from an expense point of view and we’ve done that during a very deliberate move to optimize our operating expenses, which we basically have reduced consistently during the last two to three years, which has helped produce the bottom line performance that we’ve got.

And I think, I’d just emphasize what Jim said earlier around profitability and I think it talks to; A, the strength of our overall business model and what we’ve done; two, our competitive position that even during this reduced outlook period, we will still be profitable as a business and we will still generate cash. So, I think that says a lot for the strength of both the business model and our competitive position.

Rod Hall — Goldman Sachs — Analyst

Okay, thanks. I guess I was just assuming that — on the gross margins, I was assuming that there ought to be some trajectory, continued trajectory upward or it seems like there might be a mix shift continuing because these things don’t always happen overnight. So — but it sounds like you’re saying that the gross margins have kind of peaked here due to that mix shift and now it will stay at this level for the foreseeable future. I guess is that the right way to see it Jim or am I right to think that this didn’t happen overnight and there is some sort of [Indecipherable] trajectory [0:37:20].

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

I think that what you just said is correct. Our margins are very high 48%, and we don’t expect them to go up from here. We think that they will be in the 46% to 48% range in Q4. Remember — your comment about not happening overnight, remember we’ve enjoyed pretty good gross margins so far this year and part of that is, and in fact the most, the largest part of it was in Q2 because Q2 was affected by the lack of new wins. So, this hasn’t happened overnight. It’s been a function of moving through this year.

Gregg Lampf — Vice President, Investor Relations

Thanks Rod.

Rod Hall — Goldman Sachs — Analyst

Okay, all right, thanks a lot guys.

Gary B. Smith — President and Chief Executive Officer

Thanks, Rod.

Operator

Your next question is from the line of Paul Silverstein with Cowen & Company. Please go ahead with your question.

Paul Silverstein — Cowen & Company — Analyst

Yeah, some clarifications if I may. First off, Jim, have you backed away from your previous statements regarding holding opex growth to low-single-digit next year and beyond? I think I know you made that comment previously?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

No, no, I did not make any — I did not make the comment that we’re going to hold our opex growth to low — to below revenue. I’ve made no comment about that. I will say that our opex this year is artificially low as a result of the lack of travel, and so we’re going to see an increase in opex next year as we return to travel and we intend to continue investing. But no, it’s definitely our intent that we continue to drive operating leverage by growing revenue and opex.

Paul Silverstein — Cowen & Company — Analyst

And Jim, this is the direct question in terms of keeping it to low single digits. Do you already have a plan in place or you have a number in mind or you’re just thinking that you’ll keep it below revenue growth?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Well, I don’t have a number in place for ’21. But I — just to clarify, I’m going to state this again, for the modelers among you. Our opex this year is artificially low and so the comparison between ’20 and’ 21 opex is going to be affected by the fact that 2020 opex is artificially low. If you go back and compare over longer periods, absolutely, we’re committed to that trend.

Paul Silverstein — Cowen & Company — Analyst

And then going back to the Indecipherable] [0:39:45] issue, the softness you all are referencing, I recognize it’s fairly new vintage [0:39:50], but is it — when it hit are you — has it stabilized, are you still seeing erosions as you’re going week-by-week over the course of the last month and have — over and above demand issues, have you had any meaningful competitive losses?

Gary B. Smith — President and Chief Executive Officer

Let me take the last one first. I think the answer to that is, no, absolutely not. Scott alluded to it and I want to be clear around this, we’ve seen operational challenges around the COVID thing and the accumulated issues around that, but the RFP activity has continued and we are winning more than our fair share on that. If you look at the market growth that we’ve had in the first half of the year, we think we took over a percentage point of global market share in the first half of the year and that — you know and we’re just beginning to roll out WaveLogic 5.

We’ve got a number of significant design wins that we’ve not monetized yet and we keep adding to those every quarter. So we are winning more than our fair share of it. So we’re growing market share and we’re growing, importantly, the design wins for the future, some significant design wins against some inherent competitive accounts. So, we’re in a very strong position from a competitive point of view. Jim, do you want to take the first part.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Yeah, what I’ve said here Paul is, as we’ve said a lot in the past, we do a lot of forecasting and we do a weekly look at what we’re seeing in the quarter. And what I would say is, over the past few weeks, as we’ve rolled up our view for Q4, it’s been in the range of the number that we’re talking about.

Paul Silverstein — Cowen & Company — Analyst

[Indecipherable] [0:41:42] can I — guys can I just ask the one…

Gregg Lampf — Vice President, Investor Relations

Sorry Paul. We’ve got to mind the others, sorry.

Gary B. Smith — President and Chief Executive Officer

Thanks, Paul.

Operator

Your next question is from the line of Tal Liani with Bank of America. Please go ahead.

Tal Liani — Bank of America Merrill Lynch — Analyst

Hi, Two questions. First is, I’m trying to understand the kind of weakness you’re seeing. How do you describe it? Is it projects that ended and you just don’t see follow-on orders or new projects or are there any projects that are in the middle and basically corporate carriers or customers are putting a hold on them and say, you know what, don’t continue with the original plan. I’m trying to understand how severe and what’s leading to this break — the foot on the break?

Gary B. Smith — President and Chief Executive Officer

I think what’s leading to it, as I said, is these dynamics, mainly Tal, focused on new business initiatives. So where service providers have to either put stuff through their lab and go through all of that kind of process and integrate into their back office or do large deployments where they need to get out to multiple sites, etc., we’ve seen a slowdown in those new business initiatives.

We have not seen, to your point, which you would see in other — certainly I’ve seen in other economic recessions where things get canceled and projects get completely put on ice. We haven’t seen any of that. It’s more about just the velocity of new business initiatives in general slowing down. And then I think what we’ve seen more recently, and that’s something we’ve pointed out in Q2 that we were seeing and the cumulative effect of that is certainly accelerated. So it’s more about new business.

Nothing because really — and folks aren’t saying, hey, we’re not going to continue with this project, absolutely none of that. And as I said, we’ve seen plenty of RFP activity and planning has continued apace. I think what we’ve seen in the last couple of months or so is just increased scrutiny about budget spend, Tal.

And really, I think that’s related to just caution on behalf of the service providers as they are being hit by issues with certain segments of their enterprise customers. So that’s very much what we’re seeing and they are running the networks hotter. The secular demand and the RFP activity and their general planning has continued to play through, which is why we think this is a relatively short term issue.

Tal Liani — Bank of America Merrill Lynch — Analyst

Got it.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

I’d also come back to India, Tal, because we’ve had several wins in India this year. But India have been shut down and the spend in India is very, very low. We’ve gained share, Huawei has been pushed out of India, but we’re not seeing the activity to roll those projects out. So that’s a significant piece of what’s going on here.

Tal Liani — Bank of America Merrill Lynch — Analyst

Got it, my second question is about gross margin. So I heard what you said about the gross margin, that it’s going to be 46% to 48%. And I want to take you back a little bit to the history of the Company. In prior down cycles, gross margins fluctuated in a great way. I’m talking about 45% to 37% kind of percent. This time you’re talking about a slowdown, but not much impact on gross margin, why? Why don’t we see — with lower volumes and maybe less project starts, why don’t we see greater impacts on gross margin?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Well, first of all we’re a lot bigger than we were during that time period and we have a much broader set of customers. But secondly, this is an interesting situation Tal and that the effect of this pandemic is to slow down the rollout of new projects, which typically carry lower gross margins. You know, we always have this chassis versus line card effect, and we always or very often have the fact that to win new projects we have to make concessions to customers. And we’re not seeing those kinds of early-in-life projects roll through our revenue right now.

So it’s just interesting. We’re seeing an improved gross margin in this period of lower revenue. Now, and I think this persists for a while because we have expectations of a bit lower revenue. However, once we get back to normal and we’re winning, we think our gross margin is going to come in a little bit. And as we’ve said, our run rate margin is 43% to 45%. We believe once we get back to this fully incorporating new wins and new business.

Tal Liani — Bank of America Merrill Lynch — Analyst

Thank you Tal.

Operator

Your next question is from the line of Amit Daryanani with Evercore. Please go ahead.

Amit J. Daryanani — Evercore ISI Institutional Equities — Analyst

Thanks for taking my questions guys. I guess I have two as well. First off when I think about the softness you guys have been talking about on the service provider side, could you perhaps just maybe reflect and tell us when you’ve see this happen historically, how long do these soft patches typically last for you.

And I guess when I think about service providers wanting to run their network harder without adding more bandwidth, I don’t imagine they have a lot of flexible capacity lying around. So when you talk to these service providers, are they simply holding off these projects for a quarter or two or do you think they’ll defer it for much longer than that?

Gary B. Smith — President and Chief Executive Officer

Amit, I — having lived through a number of these downturns personally to it [0:47:36], I think a couple of things I would say. Generally, the carriers can run their networks hotter for longer than we all would expect, I would say that. But I would also say that each of these downturns have their own particular dynamics. And this one obviously is driven by the sort of pandemic and where — you’ve also got this rather unusual dynamic where capacity increases have happened as we’re all working online.

So it’s a bit sort of counterintuitive in many ways or paradox to it. So, I think you look at all of those things, you look at the planning activity as I talked about, and that’s why we’re inclined to a view that depending on what happens with the global economy, all things being equal and we see an amelioration of the impacts of COVID, it’s probably a few quarters, given those dynamics. So that’s the sort of perspective around it.

Amit J. Daryanani — Evercore ISI Institutional Equities — Analyst

Perfect, that’s helpful. And then if I could follow-up quickly, you had extremely impressive free cash flow generation this quarter. Sounds like it should be sustainable, didn’t seem like a one off thing. How does your capital allocation process change, given the strong free cash flow generation, driven by [0:48:53] what you see in the end markets right now? Thank you.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

Yes, as I’d say that we’ve had strong cash flow really for a couple of years, three years now, going back to 2016 or something like that. So that has continued. And I believe that it will continue. Now, with respect to capital allocation, essentially our first and most important capital allocation is to fund our business and invest in our business in a way that will drive continued leadership and in fact expanded leadership.

That means spending on R&D for the projects that we need to, spending to put enough people in the field that we can address customer needs, and finally in the support function so that we can make all that happen. That’s our top priority. Other than that, in terms of capital, we do spend a little bit on servers and lab equipment and that sort of thing.

But even during this period of time of low revenue, we’re likely to generate excess cash. That’s our expectation and we have had a share repurchase program in place. We did suspend it in the middle of Q2, just out of an abundance of caution. If things continue, I would expect we would do something like that going forward. Now, by the way, we’re also interested in doing acquisitions, but we haven’t done anything big in a while.

Gregg Lampf — Vice President, Investor Relations

Thanks Amit.

Amit J. Daryanani — Evercore ISI Institutional Equities — Analyst

Thank you.

Operator

Alright, your next question is from the line of Michael Genovese with MKM Partners. Please go ahead.

Michael Genovese — MKM Partners — Analyst

Thanks very much. First just a clarification, can you give us any color on how big WaveLogic 5 and your Wave server were in the quarter?

Gary B. Smith — President and Chief Executive Officer

Scott has some statistics on that, and I’ll fill in when he talks. Scott, do you want to take that.

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

Yeah, on the WaveLogic 5 piece Mike, we’ve said we shipped over a 1000 units in the quarter [0:51:06]. If we extend beyond the quarter to today and the beginning of the general availability, it’s probably pushing more towards the 2000 mark today. On a port shipment perspective, those are split roughly equally between the 6500 family and the Wave server family.

Gary B. Smith — President and Chief Executive Officer

Did that answer your question Mike?

Michael Genovese — MKM Partners — Analyst

Yeah, that’s great. So, my main question is really, I want to ask the competition question on a more detailed basis. You have such a strong experience in 400 gig leadership. But now some of the suppliers in the industry are talking about other vendors finally years late coming to market with 400 gig.

And then also given your 400 gig experience and how long [0:51:52] you did it, it does seem like one competitor has a pretty compelling 800 gig offering in trials right now. Can you just talk about the competitive environment going forward and how vigilant you are and, I understand that up until now it’s been great, but looking forward, could it change and what are your thoughts on that?

Gary B. Smith — President and Chief Executive Officer

Scott, do you want to take that?

Scott McFeely — Senior Vice President, Global Products and Services, Ciena

Yeah, I would say that Mike, as I said earlier we [0:52:19] actually had a greater rate of design wins at the WaveLogic 5 cycle that we did at the WaveLogic Ai cycle and I think that speaks to the competitive strength of the offer. Optical performance is one thing and we’re very comfortable with the optical performance.

But it’s also the system capabilities that go along with that, everything from the client mix that we support, the marketing structures we support, the protection schemes or the control plane schemes, the back office APIs, etc., etc., the number of product variants, all those dimensions we feel very comfortable that we have a leadership position. All of them are important in terms of customer selection criteria.

Gary B. Smith — President and Chief Executive Officer

And Michael, I would add that the best way of measuring that is obviously customer reaction. And if you look at the design wins that we’ve had, going forward they’re pretty significant and that takes away a lot of them from competitive incumbency. So we’re winning [0:53:26] new business against the incumbent suppliers. And that’s the best way of measuring that and those design wins will translate into money as we go forward.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

And just to emphasize, by the way, there is no other 800 gig in market right now, and we don’t know when there will be a competitive 800 gig in the market.

Michael Genovese — MKM Partners — Analyst

I appreciate that, thank you.

Gary B. Smith — President and Chief Executive Officer

Thanks, Michael.

Operator

Your next question is from the line of Alex Henderson with Needham. Please go ahead.

Alex Henderson — Needham & Company — Analyst

Thank you very much. I was hoping you could talk a little bit about the split between the degree to which this is a pure macro event associated with weakness in outlook of the service providers versus the ability to do new installs, the ability to do new systems deployments. Clearly you’ve had a lot of design wins but those design wins are stuck in the pipeline as a result of inability to use deployments.

Conversely, one could argue that the service provider weakness is somewhat independent of that ability to do installations. So can you split between those two? And I think the primary question, everybody’s dancing around here in terms of the question and I know you don’t give guidance beyond one quarter, but should we expect that you’re hitting the low mark in the October quarter or is there a risk that the January quarter, which is normally seasonally weaker quarter, would actually be down as well?

Gary B. Smith — President and Chief Executive Officer

Alex, let me take the first part of that, and I want to be clear around this whole new business piece. First of all to answer your question, it’s very difficult to discern. This stuff is happening in real time and it’s really difficult to discern the precise delineation between how much of it is COVID, logistics, etc. and how much is economic caution. I would say this, in the velocity of new business, yes, when we started out in this, it was largely logistics, getting people to sites and just the speed of all of that stuff. That’s still there. I would say that’s eased a little bit.

The second element to it, though, is the prioritization within these carriers of these new business things. That also, I think they’re de-prioritizing that to focus on running their networks hotter and various operational challenges that they’ve got. So, there’s two nuance but important elements going on there.

So it’s not all just about sheer logistics. It’s about their prioritization of those new business initiatives as well. And the second piece is, which is, I would say more current or more of a recent phenomenon is just their hesitancy to release budget. And I think that’s really largely by, in talking with the executives of the service providers, they’re beginning to feel the impact of exposure to certain enterprise elements, particularly things like hospitality, retail, transport, all the things that we know have been dramatically impacted. That’s beginning to show up to the service providers around the world and that’s, I think, encouraging caution on their part. So I can’t [0:57:05] give you a 50%, 50% answer Alex, but it’s a blend of those.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

And with respect to your — the second part of the question, Alex, I know we’re not making it any easier on the folks out there who have to do numbers and consensus and all that sort of thing. But we’re not in a position right now to talk about 2021. We’re in as low a visibility point as we’ve been in some time. We’re just now working up our 2021 plan and we’ll give you as much information as we can, frankly, when it’s appropriate. But for now, we really can’t talk about 2021.

Alex Henderson — Needham & Company — Analyst

Well, if I could just follow up on one last point on that same question, could you just talk about, will the book-to-bill might be below 1 again in the October quarter because you might have some visibility to that?

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

It’ll be — because our revenue is lower, we’re definitely going to have a much better book-to-bill in Q4 than we had in Q3, I’ll tell you that.

Gregg Lampf — Vice President, Investor Relations

Hey Alex, you do have to move on.

Alex Henderson — Needham & Company — Analyst

Alright, thank you.

Gary B. Smith — President and Chief Executive Officer

Thanks Alex.

Operator

Alright, your next question is from the line of Samik Chatterjee with JP Morgan. Please go ahead.

Samik Chatterjee — JP Morgan — Analyst

Hey, thanks for taking my question. I guess if I can just start with how should I be thinking about the impact of the order slowdown here on your ability to meet the longer term revenue model that you have 6% to 8% in fiscal 2021? Primarily because it sounds like you will be falling short of that. I’m a bit surprised if we like take two years, both fiscal 2020 and 2021, you’ll be below that long-term model, but clearly when we’ve had COVID which has exceeded bandwidth needs so maybe any color on that, how are you thinking about fiscal 2021 and what are we missing here?

Gary B. Smith — President and Chief Executive Officer

So Samik, I think obviously we’re not talking about longer-term stuff here right now, given what we’re seeing, but I am just reminding 2019, we grew over [0:59:08] 15% if you’re talking about revenues. This year I think has been sort of unprecedented in terms of the COVID piece.

And I think, as you say, there’s a paradox here and the bandwidth demands have gone up and that’s why we think this will be a more short-term phenomenon. But obviously we’re not in a position to talk about future forecasts at this stage, as I’m sure you’d appreciate.

We’re only just finishing our Q3 anyway. We’re one of the few companies that has continued to provide guidance both for full year and we have three year targets out there as well. And obviously, at some point we’ll — as we get to probably towards the end of the year, we will look to advise on those.

James E. Moylan, Jr. — Senior Vice President, Finance & Chief Financial Officer

But one thing we are confident about is giving our fundamental strengths, our market position, our technology, and our people, that we’re going to continue to gain market share as we go through the next couple of years or several years, because we think that we have the strategy and we have the package to do that and we intend to.

Gregg Lampf — Vice President, Investor Relations

As you see, that will be the last question of the day. We look forward to speaking with everyone during the course of the day and the next several. We hope you’ll enjoy the holiday season coming up and thanks for joining us today.

Operator

[Operator Closing Remarks]