Ciena Corporation (CIEN) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to Ciena Corporation's Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only-mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's conference Mr. Greg Lampf. Sir, you may begin.

Thank you. Good morning and welcome to Ciena's 2017 second quarter review. With me today is Gary Smith, President and CEO; and Jim Moylan, CFO; and Steve Alexander, our CTO will join us for Q&A portion of the call. This morning's press release is available on National Business Wire and at ciena.com. We also posted to the investor section at ciena.com an accompanying investor presentation including certain highlighted items from the quarter being discussed today. In our prepared remarks, Gary will discuss management's view on the market and our momentum; and Jim will provide details on our financial performance as well as guidance regarding expected future results. We'll then open the call to questions from the sell side analysts taking one question per person with follow up as time allows. 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 are based on current expectations, forecast and assumptions regarding the Company that includes risk and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in context of the risk factors detailed in our most recent SEC filings. Our 10-Q 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. 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 available on ciena.com. This call is being recorded and will be available for replay in the investor section of our website, Gary.

Thanks, Greg, and good morning everyone. Strong fiscal second quarter results once again evidenced that we are benefiting from our unique position in the market and outpacing the competition in every dimension. We continue to deliver diversify growth enabled by our global scale, industry leading innovation and deep customer relationships across the broad set market segments. Notably, we are also the only industry player to participate in all key areas of the market including systems, software and now components, all with best-in-class technology. The net result is that we are consistently delivering differentiated financial performance including faster than market growth and increasing profitability. In Q2 specifically, we delivered strong quarterly top-and bottom-line financial results, including 10% year-over-year revenue growth, adjusted operating margin of 12.5% and adjusted earnings per share of $0.45. In addition, we experienced our largest ever quarter for shipment volume and orders in the quarter were greater than revenue. This was an excellent quarterly performance by any measure. It was underpinned by several dynamics that are positively influencing our business and advancing our competitive position. These include continued diversification, strength in our core or traditional business, accelerated innovation and emerging opportunities in adjacent applications. First, let me talk to diversification. We continue to see strong contributions from outside of North America and an increasingly broad set of customer segments. In Q2 for example, we delivered more than 140 million in quarterly revenue in Asia-Pacific, an all-time high. In the region, we are benefiting from our position as a leading provider for all of the major network builds in India, including Reliance Jio, who is many of you know has experienced unprecedented range of customer growth for its services. But other parts of Asia are also showing strength as well including Australia and Japan, both of which are important markets for us where we have very strong momentum, really illustrating the multiple dimensions of our growth in this region. We are building on our number one position in the submarine upgrade market and are now complementing that success with new cable build opportunities. In fact, during the quarter, we secured a critical upgrade on a new open cable property with the global web-scale customers. Our broader engagement with web-scale customers is expanding. With DCI still very much top of mind for them, the strong traction and increased adoption of our WaveServer platform is actually useful proxy for the growth opportunity overall, and really the growth that we see in this customer segment. With that in mind, our success in this customer segment including 43% year-over-year revenue growth is reflected in Dell'Oro latest DCI market share analysis, which put Ciena at the top of every single category that they measure. The second positive dynamic influencing of progress is in our business within our traditional areas of strength in terms of geographies, customers and solutions remain solid with room to grow. In North America for instance, we are benefitting from our leading market share and capturing new opportunities for growth, in particular with Tier-1 service providers. In the quarter, we once again built on our longstanding strategic relationship with AT&T, extending the application of our packet networking portfolio in the network with a new award for 10G and 100G NTE solutions. The global metro opportunity also continues to flow with many service providers, including an increase in metro-related revenue and orders from Verizon in the quarter, consistent with our expectations for a gradual ramp through the year. The third positive dynamic is around our leading technology and innovation engine, which has been driving the momentum that I just described. And looking forward, we’re bringing to market additional new solutions ahead of the competition, who frankly are struggling to keep pace with our increasing capabilities. WaveLogic Ai, our next generation coherent chipset will set new standards for reach and capacity, supporting rates of the 400G per wavelength and allows users to employ a single module that can be programmed for optimal capacity in DCI, metro, long-haul or subsea applications, something that our competitors are struggling to offer. WaveLogic Ai remains on track to be generally available on both our 6500 and WaveServer platforms this summer. Recently, we also announced new distribution channels of this technology with leading component vendors Lumentum, NeoPhotonics and Oclaro. These partnerships are designed to offer the market a compelling alternative to merchant modems whilst expanding our addressable market to include geographies such as China as well as new network operator and system vendor customers. Leveraging that innovation lead with WaveLogic, we also introduced Liquid Spectrum, our approach to redefining really how optical networks are fundamentally built. This software driven platform combines our Blue Planet software, WaveLogic Ai chipset and a reconfigurable Photonic Layer. This is a truly unique offering in the market. It is the first dynamic capacity on demand solutions that does not require pre-deploying hardware for peak periods of traffic. And I want to be very clear, our success to-date in the market does not take into account the technology advantages yet to come with WaveLogic Ai, which when combined with our global scale and deep customer relationships positions us extremely well to capture additional market share globally. And lastly, there are some very exciting opportunities for our business on the horizon in adjacent applications. These include 5G for service providers and Fiber Deep cable MSO customers. These longer-term opportunities are centered around the critical need for greater fiber densification of the network. As a market and technology leader in packet and converged packet optical, we are already partnering with customers today to help shape and support these strategic initiatives. We talk for sometime about our belief that in this changing industry environment and structure, we will see winners and losers emerged. And the Ciena is positioned as one of the clear winners in this industry shakeout. As we only vendor able to address the system software and component market, we are delivering innovations ahead of the competition that directly addressed the changing business and consumption model of our customers. Our Q2 performance in first half momentum is strong evidenced of our ability to capture that momentum and deliver increasingly differentiated financial performance. In fact, it’s interesting to note that we are really the only system vendor in our industry outside of China that is both growing and profitable. With that, I’ll turn over to Jim.

Thank you, Gary, and good morning everyone. We had an outstanding Q2 across all financials and operating metrics. As we said before, we do believe that our consistent progress is best measured in the broader context of half and full year results. Combining our two most recent quarters, we delivered strong revenue growth and improved profitability in the first half of fiscal 2017. When compared to the same six months period last year, revenue is up 9.5%, adjusted operating profit is up approximately 25% and our adjusted net income is up approximately 43%. Now turning back to the quarter’s results, I’ll provide more color on the regional view as well as financial metrics across our portfolio. North America continues to be a key region for us, where we have leading market share across an increasingly diverse set of customers and applications including long-haul, metro and DCI. In APAC as Gary mentioned, India is currently a major contributor to our growth. We’ve driven nearly $100 million in revenue from India alone in the first half of fiscal 2017. And our number two customer overall in Q2 was an Indian service provider. We believe that the current broad infrastructure built out and India will be a long-term positive for Ciena. We continue to see more stability in EMEA. The region grew 10% year-over-year in Q2, and we continue to make progress with key customer segments. Lastly, catalyst performance in the quarter was consistent with our expectations as a number of significant builds from the last several years begin to wind down particularly in Brazil. And a few highlights across our portfolio, in converged packet optical, revenue from our WaveServer platform is really beginning to accelerate, gaining six new customers in the quarter. As a result, we now believe that revenues from WaveServer will exceed our previous projection of $50 million to $100 million for the full fiscal year. In packet networking, we reported strong quarterly revenue. In fact, we delivered record revenue for the first half of fiscal 2017. Specifically in Q2, we added six new customers to our 8,700 platform for a total of 49. And in software and software-related services, revenue increased 24% year-over-year led by momentum in software subscription as our focus continues on this increasingly important segment. Turning now to our fiscal Q2 financial results, total revenue came in at 707 million driven by the growth factors we mentioned including Asia-Pacific, submarine, metro, switching and web-scale. Q2’s adjusted gross margin was 45.7%. Operating expense was $235 million. We achieved $89 million in adjusted operating profit in Q2, and we delivered a 12.5% adjusted operating margin. We also continued to strengthen our balance sheet. In Q2, we refinanced our existing term loans further reducing our debt by approximately $93 million and reducing our go forward interest expense on the remaining term loan borrowings. And just as a reminder, the remaining $185 million in outstanding principal on our 2017 convertible notes will mature in our fiscal third quarter. We expect to repay this amount with cash on hand. As a result, our diluted weighted average shares outstanding count used in the denominator of our diluted EPS calculations will be reduced by approximately 2.4 million shares in Q3 and 4.8 million shares in Q4 and going forward. In Q2, we generated $72 million in cash from operations. We ended the quarter with just under $1 billion in cash and investments after the reduction in term loan borrowing during the quarter. And finally, adjusted earnings per share in Q2 was $0.45. I’ll now turn to guidance. For our fiscal third quarter, we expect revenue to be in the range of $710 to $740 million. We expect Q3’s adjusted gross margin to be in our target mid-40s percentage range, and we expect adjusted operating expense to be approximately 235 million. Our first half performance was strong by every measure, including outperforming the midpoint of our revenue guidance in Q2 and exceeding our revenue projections for the first half of the year. As a result, for the full fiscal year we now expect to achieve annual revenue growth in the range of 8% to 9%. In addition, we continue to expect to achieve the full fiscal year results that we indicated at the beginning of the year with respect to other financial metrics. As a reminder, this guidance included adjusted gross margin in the mid-40s percentage range, adjusted OpEx to average approximately $235 million per quarter and adjusted operating margin in the range of 11 to 13%. In closing, we believe that our business and financial performance stands in stark contrast to that of the competition. We are growing our business and expanding our market share with a greater diversity of customer segments, geographies and applications enabled by our global scale. And we are an innovation power house that continually pushes the boundaries of technology development and brings purposeful invention to market faster than our peers. As a reminder, our newest DSP WaveLogic Ai arrives later this summer and will set a new standard of performance for the industry. This foundation coupled with strong demand drivers in our business, is enabling us to deliver consistent financial performance including faster than market growth and additional operating leverage with greater profitability. Kelly [ph], we’ll now open the line for questions.

[Operator Instructions] Our first question comes from the line of Patrick Newton with Stefil. Your line is open.

I guess, first one I wanted to focus on was clearly a lot of strength out of India. You’ve been very consistent and talking about how this is going to be a multi-year tailwind. But a question I can certainly get from investors is, how could this -- can this be and how long? So, I guess any commentary you can provide on both the near and immediate term optionality from India?

Yes, Patrick, good morning. I’ve had this question fair amount in the last few months. Our view on it is that it is mostly -- I mean you think about the big opportunity in India, you got 1.2 billion people coming online. And I think you’ve now got a political environment and a commercial environment that’s really inducive to the kind of investment that we’re seeing. You’ve got three. I think you’re ending up there as three large players that are building out into the marketplace. And from our perspective and all of engagements with them, we believe this to be multi-year. Given the nature and scale of this, you have to draw that kind of conclusion. And obviously, we’re privy to some of the plans -- the future plans of the rollouts. So, I think we’re -- our perspective is that it is absolutely multi-year and I think it will be a very consistent business for us.

The only other thing I’d add Patrick is that, our Asian business is broader than India as well. We’re growing in Australia. We’re taking share in Japan. And so, we feel great about APAC in general and India in particular.

Thank you for the detail. And I guess just shifting to the DCI opportunity. It’s great to see that you’ll now exceed the high-end of your prior guidance range. I’m curious if you’re benefiting at all from a major competitor seeing their product refresh slipped roughly a quarter and then we think about linearity of the business through the year. Can you help us understand how we should about WaveServer revenue contribution in the first half of the year versus second half?

Yes, I think from a competitive dynamic, I think the interesting thing about that is we’re seeing an enormous demand for WaveServer, which is really the -- it’s really the first specialist open architecture platform that was designed for that market. And I think we’re seeing very strong momentum in there and I think the thing to bear in mind is, as Jim was talking about in the commentary, we haven’t yet released it with Ai chip in it as well. So, we’ve got that to come. So, we’ve already got a competitive advantage with the existing platform and with the roadmap that we have to it; we’re absolutely convinced that we can stay ahead of competition on it. The other plan I would make is that, it’s not just about technology; it’s really around the relationships and global scale of these folks, particularly the web-scale folks. Because increasingly, the business is not just North America, it’s outside of North America. And so partner with the global web-scale folks, you have to have Tier 1 relationships in all the countries that they’re moving into. And we’re somewhat unique in that we have that. So, it’s a combination of leading technology and global scale that is really leveraging our growth in this space. So, I think it’s less about who’s gotten the best product at the time and really more about the complete picture.

Thank you. Our next question comes from the line of George Notter with Jefferies. Your line is open.

I wanted to ask about the gross margins. You guys are still kind of talking to mid-40s gross margin guidance, but obviously there is a good amount of revenue growth here. You’ve got new products coming. What’s the getting factor now as you look forward on gross margins? And how do you see the opportunity to grow that level above mid-40s? Thanks.

George, I still think that we’re in that mid-40s range right now. You’ve got a lot of dynamics as we go into these new markets and new applications and new platforms where you’ve got some downward pressure on margins, but you know we clearly go up to the size that we are, that we can deal with that. I still think we’re in that range for the foreseeable future. Now to your question, what is the dimension that takes us up from there? I think it’s our software business and I think we’re making good progress on that, but it’s from a small number you know to impact the overall gross margin. I think really we don’t move up from that until we get meaningful contribution from our software business.

Thank you. Our next question comes from the line of Rod Hall with JP Morgan. Your line is open.

So, I wanted to ask, I wanted to go back to the AT&T win Gary that you had talked about and just ask, if you could just confirm that’s incremental, it sounds like a new win? And also maybe Jim you could comment on whether you still expect AT&T to be flat to down for this year. I think that’s what you said last quarter. So does this new win change that at all? And then I have a follow-up.

So, this is Steve Alexander. I’ll take you through the AT&T piece real quick on the product side. So, the NTE as Gary referred to like this is the move of the edge of the network away from kind of give you rates up to 10 gig and then 100 gig rates. And keep in mind, many of the platforms that we’ve put in market 8,700 in particular were built in anticipation of this change, right, the increasing in the late from the edge of the network up by effectively in order of magnitude. So, to us, it is further evidence of increasing importance into the provisioning of high-end services at the end.

And with respect to the second question, Rod, we do expect AT&T to be flat to down this year as we’ve said. We do expect a strong second half with AT&T. And generally speaking as we’ve often said, we have a great relationship with that customer. We’re involved in many of their strategic initiatives, and I think they’re going to be an important customer for us for a long time.

Okay, and then thanks, Jim, and also Steve. And then my follow-up was with regards to linearity in the quarter. You guys had -- I know there had been some concerns about book-to-bill exiting the last quarter with net of it really seems to have played out. You guys have reported a very strong revenue number here. I think being the most people’s expectations. So just wondering how good an indicator is book-to-bill? And can you comment on linearity in the quarter?

Yes, we -- as we said, we did have a greater than one book-to-bill in the quarter. We had strong order flow and we expect strong order flow for the rest of the year. I know there was some concern last quarter about our statement made. But we’re going to have -- in the first quarter, we’re going to be lower than trend; and in the leg of quarter, we’re going to be higher than trends. So, we expect a very strong quarter on year on orders.

Thank you. Our next question comes from the line of Jess Lubert with Wells Fargo Security. Your line is open.

I wanted to squeeze two in here. First for Gary, I was hoping you could update us and what you’re seeing with Verizon? How close they were to being a 10% customer and how the metro build there is progressing? And should progress with the second half of the year? And then for Jim, it looks like total inventory was up sequentially after seeing a pretty big jump in Q1, and it sounds like you saw record shipment. So, I was hope you could help us understand, how much of your inventory jump as a function of equipment sitting and customer networks waiting approval where you have high visibility versus a continued build up and anticipation future demand?

Hi, Jess, let me do with the Verizon one. The answer -- the quick answer to your question is that, we are very close to 10%. And in fact, if you look at the full six months, I think they came in at about 9%, so very close to it. In fact, there was in India customer was actually our second largest customer in Q2 and then Verizon, so very close to it. So normal ebbs and flows with Verizon, but basically specifically on the metro side, both revenue and orders were up in the quarter, and we expect that continue to be a steady ramp during the second half of this year. I think deployments again this is a very large project, we think we’ll go out to 20-20. Size of the opportunity could be extremely large, we mentioned hundreds of millions. And the sort of split between us in competition, we seem to be getting about per share on the initial rollout in here. And it’s a mix of large and small metros. The things that I would also remind folks of is, our engagement with the Verizon, everybody is focused on the metro for understandable reasons. But we actually have quite a broad relationship with them that’s long-haul that includes now packet for the first item and also switching.

And on the inventory question, yes, a bit of it is offset, but I think generally speaking our inventory levels reflect the fact that we expect the strong second half. And we have to build in anticipation of that. My guess is that our inventory will be down by the end of the year though.

And Jim, just would it be fair to say visibility coming into the second half is better than the first half given some of the orders and the inventory you’re looking at right now?

What I’d say there is that we’ve had very good visibility in our business for a long, long time, really, the last couple of years because our backlog has been growing. So, I’d say marginally could it be better, yes. But we’ve had good visibility for a long time.

Our next question comes from the line of Tim Long with BMO Capital Markets. Your line is open.

Thank you. Question then a follow-up. Talking about WaveLogic Ai out in this summer, I think Jim and Gary both talked about some potential market share gains there. Could you give us a little color on where do you think those gains will come from? What applications? What products? Where do you think, you’ll get the most bang there? And then on the follow-up, just on the software line, it did tick down a little bit in the quarter last quarter was pretty strong. So, was there anything else to the sequential move a little lower in the software line? Thank you.

Sure. So, it’s Steve Alexander, I’ll address the Ai piece of it, right. So to the points that were made earlier, all the success we’ve had in the market, the share gains and stuff, we’ve really done off of the prior WaveLogic 3 platform with Ai. There is other the number of improvements that come into place, right. So, you would expect it to have impact across the entire portfolio. First, 400 gig per wavelength chip it has a whole series of features that we’ve talked about in the past with regards to the ability to have software control throughout the entire platonic layer. It produces a number of the analytics information necessary for the automated network that we are enabling for the future. So, Ai will have broad reaching impact on the portfolio. And again you know, it’s the first end market with 400 gig per wavelength. So, it does represent an entire new level of performance.

And on software side, I note first that we’re up 20% over last year in the quarter. We had a particularly strong quarter in Q1 and this is a very nascent market and there’re going to movements up and down, but overtime we do expect this segment to grow.

Thank you. Our next question comes from the line of Vijay Bhagavath with Deutsche Bank. Your line is open.

Yes. So, I’d like to get your view Gary on how speed transitions impact you business. Where I am coming from is, it’s Verizon or whoever else starts to rollout 200 gig versus 100 gig prior. Would that mean more ASP for you, better margins versus 100 gig and a similar type process in the cloud guys as they go to 100 gig, 400 gig and on and on. How do this speed transition impact pricing and margins help us understand? Thanks.

So, Vijay, let me -- this is Steve. Let me give you some insights, similar to one when we’ve had conversations in the past. Historically, we’ve seen the web-scale folks be the first adaptors of the higher rate speeds, right. So, we’ve been shipping 200 gig for several years now. Every time we do that, we’re able to provide better economics for our customers, right. So, if you can double the rate for the same basis platform, you’re cutting their effective cost per bid in half. And so, you would expect, as you go 200, 400 as things go faster and faster, we’ll continue to produce better economics for our customers. We look at it again on a kind of a platform basis and these chips more and more are programmable. And so, the customers are free to set them to the type of application that they need, and with the introduction of Ai later this year, they’ll actually become much more capable automatic operation, and letting the systems basically signal as fast the physic allows. So, we view it as providing a programmable platform, that’s a way we view this, and we think that plays very well into the way we see the customer demand evolving.

Perfect. A quick follow on for Jim. Packet networking software platforms were down quarter-on-quarter. How should we think of gross margins, in particular product gross margin heading into the back half since software and packet networking is what drives margins? Thanks.

Yes, Vijay, the one thing that we’ve often said is that, quarter-to-quarter movements can be misleading. And if you look year-over-year, our first half or anything that’s of longer duration, you’re going to see nice upward into the right movements. So, I guess in general what I’d say is that those two segments do have high -- or those two products or segments have higher gross margins than our average. And overtime, as they grow as a percentage of our business, we will see higher gross margins on average

The cautionary note on that though, if you just take this quarter as an example, both were slightly down in the quarter and our gross margin was up. So, I’d caution you on that.

Our next question comes from the line of Dmitry Netis with William Blair. Your line is open.

My question is kind of goes back to kind of North America and AT&T, and if I’m doing my math correctly. You had about 15 million to 20 million, maybe close to $15 million headwinds from AT&T as it kind of came down to 15%. I’m being presumptuous here, correct me if this isn’t AT&T, but I presume it is? And so that headwind, what help to overcome that headwind? Was the pick up almost entirely outside the North America, markets like India you discussed or was there also strength outside say Verizon, AT&T. Verizon seems to have stayed pretty flat here quarter-over-quarter. What are you seeing outside those two accounts vis-à-vis, the CenturyLink and the Level 3s and some of the consolidation that happened? How did that, if at all helped overcome the headwind?

I mean, I think it goes back to the fundamental strategy that we’re executing on, which is around global scale and diversification. And so, AT&T and Verizon, particularly a great customers for us and have grown over the years, but really the Company is growing faster than that. And if you look at the example in North America or outside of AT&T, was actually up about 13%, if you take that out. So, you’ve got very good strength in North America, I know some other competitors are saying softness and CapEx changes. We are not seeing that, and that’s because we are way more diversified both in terms of customer and in application even in North America. So, we’re benefiting from that strategy and approach in North America and obviously because we’ve got broader scale, the example, Jim was giving around Asia-Pacific in general with submarine market with strong quarters Australia, Japan and India, Europe was up 10%. So, it’s a broad based. So, I think that really is been a fundamental tenant for the strategy of the business and that’s how we’re able to withstand these kinds of ebbs and flows.

Can I jump one quick follow-up here? Thank you. That was very well presented. My follow-up is on the web-scale side of things. Is that still in that 10%, 15% have you kind of crossed that threshold at all? Is it still in that range? And you have discussed a major projection expansion with the top five operators. It wasn’t in the 10% category. So, I would just love to get some thoughts around where that customer is? Was that the same customer that you’ve mentioned the submarine expansion with and what your thoughts on web-scale and kind of how it’s tracking?

We’re doing great with the web-scale customers. They’re important part of our business. And as we said earlier, number one in all aspects of the DCI market. So that’s just sort of indication and well we’re doing with them. They like our technology and they remain in the 5% to 10% range on a direct basis, and they remain in the sort of 15% to 20% range in terms of both direct and indirect. As far as the big win that we’ve talked about last quarter, not a turn of revenue from that win as of yet, we do expect that to come on strong as we move through the rest of the year.

Thank you. Our next question comes from the line of Tal Liani with Bank of America Merrill Lynch. Your line is open.

Hi, good morning guys. This is Dan Bartus on for Tal. Thanks for taking my questions. The first one I just wanted to understand the submarine market a little bit more. So, what has changed there that has put you guys in such a good competitive position? Is it more about fewer competitors, just trying to get a read on that a little bit more? And how much should that be a second half driver for you guys? And then second question is on EMEA improvements, so there again just wanted to dig in more, is it market stabilization? Is it more the sales restructuring that you guys did that’s bearing fruit partnership with Ericsson? Just trying to get a read on what you guys are seeing in the region? Thanks.

So, let me take the -- this is Steve Alexander. I’ll take the submarine piece of it. The single biggest determinant in the submarine space is the technical performance, how many bps you can get down the cable, right. So, it plays right into the strengths that we’ve had all along with the WaveLogic family. And again, I’ll point of the fact that all the wins today have been off the WaveLogic 3 platform. Clearly, our customers know what’s coming with Ai, but the results you’re seeing all have been off of the WaveLogic 3. The second piece after technical performance is the relationships and to the point Gary made earlier, on a global basis you have to be talking not just to the web-scale folks, but also to the Tier-1 operators because they all have rolls in these large cable deployments.

On EMEA, I would say really it’s a confluence of things. Some of it is the change that we made about 18 months or so to focus really on customers that appreciate the value proposition. And I think then it’s a combination of the technology as Steve talked about, we clearly have not missed a technology cycle here at all. And I thank the European market appreciates that. And also, I think we’ve got some very deep relationships. In Europe, we go back a long way and I think it’s the confluence of these things that have enabled us to both stabilize and start to grow the business again. I mean its people like Vodafone, LGI, British Telecom; and we’re seeing the sort of spend as they build out their metro networks.

Just one other point on the submarine market, remember that the early days of our presentation in that market were in the upgrade piece of the business, and we achieved number one market share, and we stayed at or near the top in terms of market share and that market pretty much since the last three or four years. But what is coming now is a series of new cables and as a result impart due to our sort of proof that we have the best technology, the builders of cables want to have best in breed on both the cable laying side and on the optical gear. And we’ve started to place very well in the market as well, we’ve announced our partnerships with TE SubCom, so that’s going to be I think an extender of our business in the submarine market going forward.

Our next question comes from the line of Greg Mesniaeff with Drexel Hamilton. Your line is open.

I wanted to ask you guys about your -- you mentioned customer diversity and wondered, if you can give us any color on your dealings with the cable MSOs and particularly, if you have any products in the pipeline designed for their industry interfaces? Thanks.

It’s a good question. We’ve increased over the last few years of relationships for the cable space principally North America, but obviously some of that place as well and some other parts of the world, I mentioned LDI. So we’re in, all of the real major cable operators in North America, and we’re actually seeing the last 18 months, we’re seeing good steady growth. Probably Comcast is our largest customer there and we’ve got pretty much all of our portfolio including Ethernet business services with Comcast. So we’re seeing very good steady healthy growth there. I think the big opportunity with these folks is really as they look to put fiber deeper into the network, densification of the fiber closer to the network. We’re already seeing activity in that space and we’re collaborating closely with most of the cable operators in North America.

So, what about products -- what about products specifically geared towards cable interfaces like DOCSIS?

So, in DOCSIS clearly plays on the -- what -- effectively as the co-ax side of it. And we see a lot of growth in the fiber end of this thing, right. In terms of the Fiber Deep opportunity to Gary’s point of densification and the great common denominator in all this generally tends to be Ethernet formatted packets. Everything is being carried, which is IP, but there’s tremendous amount of commonality and now in terms of how they’re building and actually in deploying equipment that into the field. So, when we look at how technology is like WaveLogic play, they match very well into what the cable operators want to do, just increased the capacity per fiber out closer to the customer. So we think we’re well placed for this.

Our next question comes from the line of Jeff Kvaal with Nomura. Your line is open.

I was hoping that we could unpack the gross margin performance a little bit. I think if we look historically, when you post the strong quarter in Asia-Pacific and a little bit of later one in North America that will be negative on the margin structure. Similarly, if you in the past posted a steadily down quarter in software, that would be a negative on the gross margin. But yes, your gross margin was up, was up nicely. So, I’m wondering what that tells us about some of the underlying assumptions that we might have had historically and what that tells us about where the gross margin might go overtime.

Firstly, I’d say Jeff is that, there are lots and lots of variables that can affect our gross margin. The maturity of a certain rollout -- early days, we’re going to have lower gross margins. Later days, we’re going to have higher gross margins. The mix of the products -- the sort of stage we are in market, when we’re attacking. We tend to have lower and higher when we’re mature and incumbent. But all of those go into this calculation and some more important in some quarters and others. Having said all that, we’ve had extremely good gross margin performance now for three or four years. And then coming from the 42% up to the 45% range plus or minus, we think that’s where we are today. We think they’re going to be fluctuations in our gross margin this year as we move through the year, but we think mid-40 is where we are as a company. We have said a few times that in order to get to this 15% operating profit margin, we do need to show consistent growth margin improvement and we’ve estimated that in a 100 to 200 basis points, and we still believe that, that’s going to happen. We think that it’s not a feature of this year. We think that as we grow our software revenue in particular and to some extent our packet revenue than we are going to trend towards that in slightly higher than mid-40s range that we’ve talked about for this year.

Okay. And then secondly, you talked last quarter about XO as a part of Verizon, you didn’t mention it at this time in talking about Verizon, but if there is anything to add we’d be all ears?

I believe this is now closed and a complete part of Verizon. I mean we’ve got a big footprint at XO, which they’re going to continue to build on now s part of Verizon. They’ve gone to integrate it into the network and a lot of that is based on Ciena Technology.

Okay, so that a share gain opportunity for you or should we expect it to be?

I think they’re both customers I would say. It’s a neutral for us overall.

Thank you. Our next quarter comes from the line of Michael Genovese with MKM Partners. Your line is open.

Thanks a lot, just two quick questions. First of all, it seems like it’s already encompassed in your annual quarterly OpEx guidance. But just could you quantify for us or help us understand the OpEx commitment for the merchant silicon and component initiative that you’re dealing? And then secondly, just any comments on the federal demand, what you’re seeing in the federal market right now?

Yes, we did say that the merchant modem business was going to add to our OpEx by a single digit millions of dollars, and it definitely is encompassed in our guidance for OpEx for the year. We said just now that our OpEx for the year is going to be exactly what we said at the beginning of the year, which is that we’re going to average sort of $235 million a quarter.

On the fed question Mike, I think you know like everybody we’re seeing some weakness. We’re very positioned with the multi-facets of the fed overtime. But I think it also talks to this fact that we’re a much broader based company of global scale and diversified and we can deal with these ebbs and flow like we can the M&A activity of our customers. And that’s a good example of that.

And Jim, just the single digit million is up per quarter or is that an annual number?

No that’s an annual number.

Thank you. Our next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open.

Great, couple of questions. You mentioned orders being greater than revenue this quarter. I just wanted to get a sense of, do you already have orders coming from products that are based on WaveLogic Ai that will just come out in the next quarter and you already have those purchase orders? And then kind of the second question is just the pace of metro RFPs. Are we getting to the stage where now we’re getting towards more deployments? Or are you still seeing kind of a pick-up in metro RFP activity? Thanks.

On the first one, Meta, we may have some orders for Ai, but I think it’s absolutely de minimis. So, we’re not seeing the -- another way of saying it, we’re not seeing the benefit of the Ai platform from an order point of view. I think that’s fair to say in the order flow so far. In terms of metro activity, I think you can parse it a little bit by geography. Basically the North American choices that already made. That would -- that both sailed couple of years ago, and we’re in deployment mode. The highest profile of which I guess is probably Verizon, but same thing AT&T, Comcast. I’d say the CenturyLink et cetera. They’ve chosen their players, and that’s all done. You are seeing opportunities in one of the different geographies. But even that, I would say most of the players of this made their choices and they’re deploying. So, we’re very much into the deployment phase and that will be a multi-year -- given the nature and scale of this thing, it will be a multi-year deployment places like India. And I think a key element behind this metro, one of the elements behind it is getting ready for 5G. It’s basically densification on fiber of the network, getting it closer to the user. We’re already seeing many networks around the world begin the planning for that.

Got it. Is there any different reception or change surprises that kind of came out of your came out of your OFC announcement that kind of your partners Lumentum or NeoPhotonics or any way who kind of came back with different feedback after the OFC announcement about enthusiasm or excitement about that announcement?

I mean I think these obviously -- we’ve been working on this for quite a while with these partners. So, I’d say it is well researched from our point of view. It’s very well researched from that point of view. These are probably the premier component players in our space with deep and long relationships. And so they’ve done their homework extensively, so I think we’re in a good place with them. As we’ve said, we don’t think, this is really a second half of ’18 impact to us and I think we’re making good progress towards that.

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

First, just wanted to get a clarification on the services gross margin, if I’ve done my math correctly, it was just over 50% this quarter, which looks like the highest level we’ve seen it kind of breaking out. If you could clarify what if anything was unique or special about services this quarter and how that’s trending? And then in terms of question I wanted to ask was whether or not you’ve seen any kind of pause, which is not evident in your revenue guidance ahead of the release of WaveLogic Ai. Just wondering maybe there is some pent up demand or customers waiting which could lead to better than seasonal behavior once the product is out in the market. Anything you could give us to help us understand the product cycle transition? Thank you.

On the services margin, Simon, as I said earlier, there are lots of variables that go into the competition of our gross margin. It so happened that we had a very good quarter in services. We have spent a lot of time and effort improving our cost structure and services and that’s a piece of it. That improvement has certainly factored into our view that we’re in a mid-40s kind of range today. I wouldn’t read a lot into it, except that is was great and we are proud of it and we’ll see what happens going forward.

And then, Simon, as far as the Ai, I mean clearly, our customers are in the labs with it. They’re looking at it, right. All lights are green, right. It’s on scheduled. We expected that in the summer timeframe, but all the impacts of that are basically built into what we’ve been saying.

But I guess what I’m trying to understand is, could we see a better pattern once Ai is available on the market? Does that lead to some kind of inflection where there is pent up demand that might become more evident in October and January? That’s what I’m really trying to understand.

I think Simon, I think we’ve got a pretty close relationship with those folks and they are very aware of the roadmap, and I think that is mapped into the performance that we’re predicting for the second half. So, we’re seeing nice uptick in second half and some of that is due to the Ai beginning to appear on the streets.

And certainly Ai is a factor in our confidence, in our future. We’re saying this is not just a 2017 performance, this is a multi-year performance. We’re going to continue to grow and we believe we’ll continue to increase the profitability.

Thank you. Our next question comes from the line of Fahad Najam with Cowen & Company. Your line is open.

So my question is -- two questions. One on the gross margin, if our checks are right, the new AT&T includes significant software components. Why shouldn’t gross margin be paid in the mid-40s? Help us understand what is gearing to that, and then regarding your long-term 15% operating margin guidance. Do you think against the backdrop of all the positive trends you’re seeing? Do you think you get to that milestone sooner than what you were previously anticipating?

Yes, Fahad on the gross margin. Just to remind you, we are -- typically, when we’re in early stages of deployments or when we are taking market share, we’re going to enjoy less than corporate average gross margins on those kinds of deals. And we have been taking share, and we do have a fair amount of early staged deployments in our results this year. So, yes software is doing well and I think it’s going to continue to do well. We’ve got a lot of other positive things going on in our gross margin. but we are in early stages of deployment with a number of projects and customers. So, that’s offsetting piece. I think overtime as we said, we’ll see improvement in our gross margins as software continue to grow, but we strongly believe this year we’re a mid-40 gross margin type company.

Thank you. Our next question comes from the line of Catherine Trebnick with Dougherty. Your line is open.

Quick question on subsea, after the TCI conference this year they talked about over 12 of the new subsea systems coming online are funded by the content providers. Any possibility publicly you could stay how many of those you’re involved in that are coming online from the end of this year into 2019? Thank you.

Hi, Catharine. Yes, with we’re involved with a number of those. I wouldn’t like to put the exact specification to it. I think we’ve called out a couple of them that we’ve already secured and we’re working on the other. Some of them, there are different stages of evolution and maturity, but we’re incredibly well placed for them. And I think it also talks this fact around a lot of the web-scale folks really very focused now and growing outside of North America. And so partnering with not just in the submarine, but on where they land and then getting network capacity DCIs pulled up in these various countries. We’re partnering with them as well. And so I think our ability that global scale in Tier 1 customer relationships is actually helpful in pulling through our submarine business as well. So, we’re seeing a pretty aggressive expansion from this folks, not on just submarine cables, but also growing outside of the North America base.

And thanks everyone for joining us today. We look forward to catching up with everyone today and over the next several weeks.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.