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Edited Transcript of CIEN earnings conference call or presentation 5-Sep-19 12:30pm GMT

Q3 2019 Ciena Corp Earnings Call

LINTHICUM Oct 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Ciena Corp earnings conference call or presentation Thursday, September 5, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary B. Smith

Ciena Corporation - CEO, President & Director

* Gregg M. Lampf

Ciena Corporation - VP of IR

* James E. Moylan

Ciena Corporation - CFO & Senior VP of Finance

* Scott Alexander McFeely

Ciena Corporation - SVP of Global Products & Services

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Conference Call Participants

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* Alexander Henderson

Needham & Company, LLC, Research Division - Senior Analyst

* George Charles Notter

Jefferies LLC, Research Division - MD & Equity Research Analyst

* Jeffrey Thomas Kvaal

Nomura Securities Co. Ltd., Research Division - MD of Communications

* Jim Suva

Citigroup Inc, Research Division - Director

* John Warren Marchetti

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

* Meta A. Marshall

Morgan Stanley, Research Division - VP

* Michael Edward Genovese

MKM Partners LLC, Research Division - MD and Senior Analyst

* Paul Jonas Silverstein

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Ryan Boyer Koontz

Rosenblatt Securities Inc., Research Division - MD & Senior Analyst

* Samik Chatterjee

JP Morgan Chase & Co, Research Division - Analyst

* Simon Matthew Leopold

Raymond James & Associates, Inc., Research Division - Research Analyst

* Thejeswi Banavathi Venkatesh

UBS Investment Bank, Research Division - Associate Director and Analyst

* Timothy Patrick Long

Barclays Bank PLC, Research Division - MD

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ciena's Fiscal Third Quarter 2019 Financial Results Conference Call. (Operator Instructions) Thank you.

Mr. Gregg Lampf, Vice President, Investor Relations, you may begin your conference.

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Gregg M. Lampf, Ciena Corporation - VP of IR [2]

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Thank you, Sharon. Good morning, and welcome to Ciena's 2019 fiscal third quarter review.

With me today is Gary Smith, President and CEO; and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, will join us for the Q&A portion of today's call.

In addition to this call and the press release, we have posted to the Investors section of our website an accompanying investor presentation that reflects this discussion as well as certain highlighted items from the quarter.

Our comments today speak to our fiscal third quarter financial performance, our current view of the market environment and our industry position as well as our guidance for the fiscal fourth quarter and some commentary around fiscal 2020.

Before turning the call over to Gary, I'll remind you that during this call, we will be making certain forward-looking statements. Such statements, including our guidance and any commentary about our long-term financial targets, are based on current expectations, forecasts and assumptions regarding the company and its markets that include risks and uncertainties that could cause actual results to differ materially from the statements discussed today.

These statements should be viewed in the context of the risk factors detailed on our most recent 10-Q filing and in our upcoming 10-Q filing, which is required to be filed with the SEC by September 12, and we expect to file by that date.

Today's discussion also 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. Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events or otherwise.

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

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Gary B. Smith, Ciena Corporation - CEO, President & Director [3]

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Thanks, Gregg, and good morning, everyone. Today, we reported another very strong quarterly performance as we again benefit from our strong competitive position within the industry and continue to gain market share.

Third quarter revenue was up 17% year-over-year and more than 10% sequentially. North America contributed significantly in the quarter, including from service providers and our web-scale customers. And in fact, for the first time ever, our top customer in the quarter was a web-scale company, followed closely by a Tier 1 service provider.

EMEA also had a strong performance in Q3, up nearly 50% sequentially, largely on the strength of our web-scale business even as some of our more recent service provider design wins have yet to ramp in EMEA.

In addition to meaningfully outpacing market growth from a revenue standpoint, so far in fiscal 2019, recall that as we entered the year, we indicated that we would significantly increase profitability this year and beyond.

In Q3, we performed extremely well on measures of profitability, including 16.2% adjusted operating margin and adjusted earnings per share of $0.71.

Our consistent and differentiated financial performance continues to essentially be driven by outstanding execution of our strategy as well as a solid overall demand environment and favorable industry dynamics. Specifically, we continue to diversify our business across geographies and customer segments. As an example of this, in Q3, our top 10 customers were comprised of 3 web-scale companies, 3 North American service providers, 2 international service providers, 1 MSO and 1 wholesale network provider.

Importantly, we also continue to have the most compelling portfolio today and the most credible and robust roadmap for future development, made possible by our considerable investment capacity, capability and vertical integration.

We are the strongest operator in the market today for coherent optics. This was recently recognized by analyst firm IHS Market in its 2019 Network Hardware Vendor Scorecard Report, in which Ciena secured the highest overall global score.

During the quarter, in a vote of confidence of our ability to be first to market and well ahead of the competition with single wavelength 800-gig systems, we booked our first orders for our WaveLogic 5 powered 6500 platform, with a large subsea customer in the Asia Pacific region.

Importantly, I would highlight that our degree of vertical integration means that we are not beholden to the merchant market and its delivery dates, rather we are in full control of our own development timelines.

Also in Optical during the quarter, our momentum continued with Tier 1 service providers, including a sizable award for a 400 gig metro optical architecture with a large North American customer, and we also won a new metro and long call build with a Tier 1 MSO.

With respect to Packet Networking, our continued investment in this portfolio to introduce new features and functionality is driving new business. In the third quarter, we landed a significant packet win with a Tier 1 service provider customer in North America. We also secured a design win in EMEA with a Tier 1 service provider. With this momentum, we are expecting a strong finish to the year for our overall Packet Networking portfolio.

Our Blue Planet portfolio also continues to evolve and mature, drawing increased customer engagement. In fact, we recently solidified a new win with a service provider in the APAC region for the entire suite of Blue Planet intelligent automation software solutions. And overall, I would say that our automation software portfolio continues to gain traction globally. And in fact, we remain on track to deliver on our FY '19 revenue target of between $50 million and $60 million.

In summary, our ability to deliver the industry's leading innovation while diversifying our business and leveraging our global scale is the foundation of our success. Our strong market and technology position and continued execution of our strategy is enabling us to deliver extraordinary financial performance and drive continued share gains.

Customers continue to pursue a flight to quality, with vendors who offer leading innovation and engagement models, and those with the financial strength and stability to deliver consistently now and into the future. We meet those stringent requirements, and we are confident that Ciena is the strongest long-term partner to customers around the world. Today's quarterly results are testament to that competitive advantage.

With that, Jim will take us through the Q3 results and our outlook. Jim?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [4]

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Thanks, Gary. Good morning, everyone. We delivered a very strong topline performance in Q3 with revenue of $960.6 million, representing 17.3% growth year-over-year. Of note, in the third quarter, non-telco revenue was 41%. This includes customers like web-scale, MSOs, government and enterprise, and demonstrates the continued diversification Gary spoke about earlier.

With respect to web-scale as a stand-alone customer segment, direct

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27% of total revenue in the quarter. Our year-to-date order flow is strong and exceeds our year-to-date revenue. As expected, after incredibly strong bookings in Q2, our orders moderated somewhat in Q3 and came in under revenue for the quarter.

Moving to gross margin. Our Q3 adjusted gross margin was 44.7%, reflecting the benefit of a stronger-than-expected product and geographic mix in the quarter. Q3 adjusted operating expense was $273.2 million.

With respect to profitability measures, which have been a focus for us, as Gary mentioned, we delivered strong results in the third quarter, including adjusted operating margin of 16.2%; adjusted net income of $112.3 million; and adjusted EPS of $0.71.

In addition, in Q3, our adjusted EBITDA was $178 million, and cash from operations was $83.1 million. We ended the quarter with approximately $843 million in cash and investments.

Finally, we continue to execute on our share buyback plans. In the third quarter, we repurchased approximately 1.1 million shares for $45.4 million and remain on track to buy back approximately $150 million in share value by the end of fiscal 2019.

Looking ahead, in fiscal fourth quarter 2019, we aim to deliver revenue in the range of $945 million to $975 million; adjusted gross margin in the range of 42% to 43%; and operating expense in the fourth quarter to be approximately $275 million.

In closing, we posted exceptional third quarter results today by continuing to execute on our strategy of delivering the industry's leading innovation while diversifying our business and leveraging our global scale.

Combined with our Q4 outlook, fiscal 2019 will be an extraordinary year for Ciena, marked by significant market share gains as we advance our competitive position and drive double-digit revenue growth and increase profitability. Considering that expected annual performance this year, we believe it's important to comment at high level and somewhat earlier than usual on our current views of fiscal 2020.

We have never been more confident of our ability to continue taking market share and we expect to grow revenue next year at a rate of roughly double that of current expectations for market growth, which is in the low single digits. That performance would be consistent with current consensus revenue expectations for 2020.

Additionally, we expect to achieve new operational efficiencies and additional leverage as a result of several actions we've taken during the last 12 to 18 months that will positively impact the business. As a result, we have increased confidence in our ability to achieve our target, 15% operating margin in fiscal 2020 and drive meaningful EPS growth. We will provide additional detail on fiscal 2020 during our fourth quarter earnings call in December.

With that, operator, we'll now take questions from the sell-side analysts.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from George Notter with Jefferies.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [2]

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Congratulations on these terrific results. I guess I wanted to start out, Jim, maybe asking a question about gross margins. If I go back, you thought of the company as a 42% to 43% gross margin business over the short and intermediate term as you guys were taking footprint. And, obviously, the gross margin result was much better here, 44.7%. I think you guys had a positive surprise last quarter as well, of course. But it seems you guys are still adding footprint. So what do you think about gross margins now? Is this sort of the new norm for you guys, even in a mode where you're taking footprint? And tell us what's going on in the margin side.

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [3]

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As we've always said, George, that there are a lot of variables that impact our gross margin: new deals, sometimes we'll give credits to customers for big new deals and sometimes those hit our results and sometimes they don't. And so that's something that -- it's hard to call exactly when they're going to hit. As a result of those kinds of variables, we have shown some volatility in our gross margins. It's moved from 41% to 44.7% over the past 6 quarters. I believe that right now we're in a 42% to 43% range.

We certainly haven't given up on getting to the mid-40s. I don't know exactly when that's going to be. I don't think it's going to be next year. But I would say that we're going to post significant profitability this year and next year really at this range of gross margins.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [4]

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Got it. And then just as a follow-up. I guess I also wanted to ask about customer attitudes. You guys have talked about taking market share, but curious about customer attitudes around Huawei. Historically, they've been ever-present I think in the international side of your business, and I think, historically, they've been pretty disruptive on industry profitability. But do you see things changing there? Are they getting invited to RFPs? Do you see them competing with you on new business? Or is that changing, given all the security issues that are out there?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [5]

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George, this is Gary. I think it depends very much on what region you're talking about and what country. I do think, over the last couple of years, you're seeing sort of a potential rebalancing of spend in the face of sort of overdependence on them. They've taken such a large market share in telecom infrastructure, generally. I think just from a market point of view, I think the rebalancing of that, I think you're seeing now.

It's really difficult to discern the impact on our business to date. I would say no substantive impact to date, but we are in the infrastructure business, and that takes time for decisions to roll through in terms of revenues. I think it is very geographically dependent, but overall, I would say that a lot of the international carriers are looking to reduce their dependence over time.

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Operator [6]

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Next question comes from Paul Silverstein with Cowen.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [7]

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I've got a lot of questions. I'll try to keep it to 2 or 3. First off, Jim, just to clarify, I've seen a slide deck -- you reiterated your 6% to 8% growth on the costs. Some time ago, you said double the single-digit market growth rate. I trust you're still talking 6% to 8% for next year, just to be clear for fiscal '20 on revenue growth?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [8]

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Yes. Yes. We also said that we think that the current consensus number is consistent with about where we're going to be.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [9]

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Well, you're anticipating this. So when you say that you're referring to growth or you're referring to the absolute dollar number given that this year's going to be a larger beta from consensus?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [10]

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The revenue dollar number.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [11]

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The dollar number. Okay. What drove the gross margin upside in Q3?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [12]

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We just expected to hit a couple of new deals affecting the quarter, and it just didn't hit the quarter. So I'd say that's it in a nutshell. It's hard for us to call the number within a couple of percentage points, Paul.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [13]

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But Jim, the translation of that would be your line card to chassis ratio was better because you didn't have those new deals?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [14]

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Generally, yes. Although the new deals can mean more than just commons. Well, we can have credits or other things that affect the capture of new deals.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [15]

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All right. I'll ask one last question, out of respect for others on the call. With your 800 gig coming out into the year, you just announced your first customer, what are you factoring in, in terms of the glide path for revenue? To what extent does that prove to be meaningfully incremental? And what time frame? If you and Gary could comment on that?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [16]

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(inaudible)

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [17]

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Gary, I apologize. Before you respond, not just 800 gig narrowly defined, but also the greater reach you're going to have with 400 gig and the impact that's going to have on your service ladder customers, not just from a direct web-scale standpoint.

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [18]

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Yes. I think -- Paul, it's Scott. I think that's what gives us the confidence to say we're going to continue to have an extremely strong competitive position and grow significantly faster than the market. So that's sort of factored into the guide, if you like, and that's certainly part of that.

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Operator [19]

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Next question comes from Simon Leopold with Raymond James.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [20]

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I'd like to just squeeze in quick clarification that -- hopefully for the benefit of all. Jim, when you talk about the 15% operating margin comfort for fiscal '20, I just want to confirm that that's the value you expect for the full year, not a target you hope to achieve in 1 or 2 quarters for the year, but the net for all of fiscal '20?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [21]

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It's a full year number. Our first quarter is always sort of out of trend line and we don't get to a high gross -- or operating margin in Q1. But we will make up for it in the subsequent quarters, and we're certainly targeting 15% for next year.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [22]

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Great. That's what I thought, just wanted to just make sure. And then in terms of the WaveLogic 5 introduction in 800 gig, I think there might be some confusion among some folks about how synonymous those 2 launches are. So just to confirm, you've talked about WaveLogic 5 coming out this year. Does that also mean that the 800-gig features are available in calendar '19 as well simultaneously?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [23]

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Yes, so trying to clarify, WaveLogic 5 is our brand for that generation of coherent optics. Certainly, it includes the acting capability, and as I said, we're -- we made great progress since we talked to you 90 days ago, and we remain confident about our target for the end of the year, and that would be in acting customers' hands in the form of products.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [24]

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And given the strength in EMEA, you did comment earlier about kind of the trends relative to Huawei. Maybe if you could help double-click in terms of some of the trending in EMEA. So we've talked about Deutsche Telekom in the past. I guess I'd like a better understanding of how you see the drivers in that particular region given that there's maybe some relative slowness in terms of deployment of 5G in EMEA? How much of this is about single customer? How much of this is about Data Center Interconnect? Just help us understand that trend, its sustainability from the EMEA strength?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [25]

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Simon, this is Gary. I think it's pretty broadly based in terms of the strength that we're seeing there. I would say that the revenue growth in Q3 was largely driven by the web-scale Data Center Interconnect and the expansion of the data centers there, and we think that's going to continue. We have a number of Tier 1 wins that really haven't got to meaningful revenue, and we expect that over the course of the next 6 to 12 months to come in.

So we actually feel quite bullish around our business in EMEA. And I think -- back to my earlier comments around sort of somewhat overdependence on Chinese vendors, I think that's particularly the case in Europe. And I do think that most of the major carriers are looking to reduce that dependency over time. And I think that's a positive to -- dynamic for us. So we feel pretty bullish as we turn the year about Europe.

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Operator [26]

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Your next question comes from Rod Hall with Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [27]

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I wanted to start with the saving of revenue this year and then maybe talk a little bit about next year as well. So the guide implies kind of flattish revenue as we look into Q4, and yet you've had very strong trends up through this stage. I just wanted to see whether -- what's maybe driving that sequential change or lack of change in revenue, whether that is what you're seeing in enterprise and government? Or is there some pause ahead of 800 gig? What -- just kind of help us understand why that guide is what it is in Q4. And realizing that this has been an extremely strong year, in the middle part of the year.

And then I also kind of wanted to extend that into the next year, are we seeing some pause ahead of the 800 gig? And would you, therefore, expect seasonality to be any different as we move into next year? Kind of help us understand how next year phases in terms of revenue in your minds, and then I've got a follow-up.

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Gary B. Smith, Ciena Corporation - CEO, President & Director [28]

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Sure. First thing I'd say, Rod, is that with our guide for Q4, we will have posted, assuming we hit it, around 15% revenue growth this year, which is extraordinary, after 10% last year. And we've always said that individual quarters can reflect ebbs and flows of orders and customer actions and all that sort of thing. And so I guess I would emphasize that we're going to grow 15% this year, not that our revenue for Q4 is flat to Q3. We also think that as we move into next year, we're going to go back to the long term range of revenue growth that we have said, which is 6% to 8%. So, and of course, that's off of a much bigger base and it's going to be at significantly increased profitability. So that's what I would emphasize here.

With respect to the quarterly flows, we did have a particularly strong revenue quarter in Q1. It had to do with ebbs and flows frankly, and certain customers wanted a lot of equipment early last year. We think that next year, our quarterly flows are going to be more like what they've been traditionally.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [29]

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And would you -- could you just answer -- are you guys seeing pent-up demand for 800 gig? Do you think that that product becomes available in volume? I'm assuming you still expect volume by the end of Q1, that you'd see some release of demand? Or how do you think that affects the revenue numbers, especially as you move to the first couple of quarters?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [30]

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Hey, Rod, it's Scott. The way I look at this is the demand for coherent optics from a port perspective continues to increase. The bandwidth demand continues to increase, and it's -- it gets served by the best data-to-shelf technology that we have. People are not sitting there waiting for the next -- they have been - they have needs for this bandwidth and it's going very quickly from the factory into the network. So I don't see a pent-up wait for 800 gig at all. I see continuing increase in bandwidth demand.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [31]

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Okay. And then I just -- one more if I can, and then I'm done. I just wanted to check on the competitive environment in hyperscale and see whether you guys have seen -- because you've seen such strength there. I mean it's an amazing performance there. And I'm wondering if some of these alternative 600 gig solutions just aren't gaining traction? Can you just say kind of what's going on competitively? And whether you guys are kind of winning head-to-head with 400 gig solutions against that 600 gig that's out there? Or is it anticipation of 800 gig? What is -- kind of give us an update on what's going with hyperscale right now.

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Gary B. Smith, Ciena Corporation - CEO, President & Director [32]

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Yes. I would say that we're obviously having a very good year in web-scale. We've got a long of long-term projects and sort of good visibility into it. We think our market share is now greater than 50% globally. Market growth, we think is about 12%. And we've grown -- I think we've grown about 50% year-to-date. So we're clearly taking share and our competitive position continues to be very strong.

Obviously, there's the competition there. We can't expect to have no competition in that space. But a couple of things I would stress. We've established incumbency and embedded in their systems, and we have a great roadmap for them. And I think we're very confident around that continuing to be a very strategically important piece for us globally. That's the other thing I would stress, is our global reach is helping where we partner with a lot of these web-scale players in different world, and I think that's helping our competitive position.

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Operator [33]

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Next question comes from the Tejas Venkatesh with UBS.

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Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [34]

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Given the changes in the 10% customers, I wonder if you're able to share these specific percentages of your top customers? And then relatedly, did Verizon go below 10%? And what does that mean on a go-forward basis?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [35]

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Yes. Actually, AT&T for the first time in a long time was not a 10% customer, it was just under 10%. And nobody should read anything into that, except that we're growing in a bunch of customers and we're still doing very strongly with AT&T. So the other customer, of course, was Verizon. We're having a great year with Verizon. The percentage is 12 -- you'll see it in the Q. They're 12-ish to 13-ish, sort of.

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Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [36]

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Got it. Understood. And then I'd like to ask a follow-up to your comments about fiscal '20 revenue growth. There are, of course, a number of moving parts, including 800 gig coming on, the strength of pluggables and then the strength in packet. How are you thinking quantitatively about these puts and takes?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [37]

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Well, we talked about 800 gig. If we're going to be first in market with 800 gig, and that's important. I'd say that what's most important is that we show a most credible roadmap, and customers believe that we're going to deliver on what we're saying. And so 800 gig is going to be a part of our story next year. But as Scott said, really, it's the growth of coherent demand that's going to drive our results, more so, well, maybe not more so, but at least as much as the fact that we'll have 800 gig in market. Packet, we're going to grow. We said at the beginning of this year, 8% to 10% was our 3-year growth rate. We're going to be around that this year, maybe a little bit better. And then the other piece that we were asking about?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [38]

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Is asking about pluggables, and I'd say, Tejas, from a timing perspective in the market, our perspective is that pluggables don't really become a material or meaningful marketplace until 2021. So not really big piece of our 2020 plan.

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Operator [39]

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Next question comes from Michael Genovese with MKM Partners.

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Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [40]

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Can you talk about where we are in the 400G telecom cycle in terms of both long haul and metro? How early or late are we in those rollouts?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [41]

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I'll say this 2 ways. So 400 gig, when you think about it on the fiber side, people have been using it as a cost per bit solution for a long time. What hasn't happened yet is 400 gig e-clients being the normalized interface into these things. When that happens, I think 400 gig around the world will be the dominant transmission side on the fiber side as well because you need to be able to carry it end-to-end transparently. That, to me -- everybody is very hyped about 800 gig versus 600 gig. But that to me is the real key with our WaveLogic 5 technology, is we'll be able to carry that 400 gig signal everywhere in the world. And that will be a first. That will be absolutely a market differentiator. And so that's your specific question. I think we're at the very early cycle because the clients haven't gotten there yet.

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Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [42]

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Okay. Great. And then I want to ask a broader question just on the outlook here. Because basically, you beat the quarter but didn't raise the outlook. But everything you're saying on the call makes a lot of sense and sounds very positive. I just want to sort of directly ask though, is there anything either macro-wise or company-specific in the last quarter that makes you more cautious than before or is this just sort of a nice sort of conservative outlook that we are getting?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [43]

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I wouldn't say it's conservative. We try and give the best outlook that we can -- the most accurate one that we see and pass that on. I think what you're seeing is an extraordinary year, as Jim said, where we're growing sort of 15% in a market that we think is really sort of growing 2% to 3%, and we've been pretty consistent around that.

So obviously, trees don't grow to the sky, and you're talking about much, much bigger numbers than we thought. We're kind of a year ahead of where we thought we'd be when we gave you sort of 3-year guidance. I think, basically, what we're saying is a return to more normalized growth. We can -- we're probably more confident than ever around 2 things: One, our ability to continue to take share globally; and number two, the operating leverage that we can get going forward. So we actually think we're in a very strong position. We're not seeing anything. There's normal ebbs and flows on the macro side, but we're able to drive through that because of our diversification.

You're seeing some slowness in places like India, some of which was anticipated. But I think the fact that we've now got a business of global scale that's so well diversified allows us to drive through these -- many of these issues.

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [44]

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And just to state the obvious, our forward-looking statements are very consistent with what the world is expecting, both for Q4 and for next year. So our guides are right where the market is. The one thing we've said is that our profitability next year is going to be very strong. And so our bottom line performance is going to be very, very good next year.

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Operator [45]

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Next question comes from Jeff Kvaal with Nomura Instinet.

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Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [46]

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I wanted to delve into, Jim, that last point about profitability. But specifically on the gross margin side, I think, traditionally, we have been accustomed to periods of rapid revenue growth where the margins suffer or lag a little bit, given the new deals that you're signing. And then I guess, I'm a little -- I'm wondering why we wouldn't maybe breakout that 42% to 43% range if the revenue growth starts to slow a little bit, I mean, obviously off a great fiscal '19? I mean, shouldn't some of those new deals be maturing a little bit, and therefore the margins maybe edging up a bit?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [47]

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Well, I'd say that we certainly expect to get back to the 45% gross margin number. We're just thinking that it's not next year. All I can say about next year, in particular -- and we haven't really guided for next year's gross margin; I don't think it's going to be at mid-40s level -- the improvement in profitability is really going to come from our actions that we've taken to transform our business. But that's what I say, it's a mix question. And by the way, we're still developing our 2020 plan in detail. And so there's still work to be done, but we still feel good about being able to hit 15% operating margin next year.

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Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [48]

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Okay. And then, secondly, would you mind just being as specific as you can about what we should be expecting for WaveLogic 5 timelines when -- which products in customer hands, and win through trials and win contributing to revenue? I just want to make sure we have all that laid out.

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [49]

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What we've said consistently is the target -- and we're confident with the target, is have a product in customer's hands by the end of the year. The products that will -- it will instantiate on first will be Waveserver and on 6500. And we would expect that to ramp through the first quarter and start to be a material revenue contributor after the first quarter.

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Operator [50]

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Next question comes from John Marchetti with Stifel.

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John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [51]

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Gary, I was wondering if you could talk a little bit about the DCI strength in the European market. I'm curious if that's customers that traditionally haven't necessarily participated with you on the web-scale side or if it's more of the traditional set just sort of expanding into that market, just curious if you're seeing some new participants in there? Or if it's more a geographic expansion of existing relationships?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [52]

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I think for us, I think it's actually both, John. We're seeing some new wins. And what I would say would be the sort of smaller web-scale data center connectivity type folks. And we're also seeing some of the larger global players that you know and love get more aggressive into Europe as well. So I think it's a combination of both of those things. I think it's pretty healthy market right now in the web-scale space.

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John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [53]

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And then, if I can, just coming back to the 800 gig for a moment. You've given the expectation obviously for some initial adoption, particularly within the DCI market and you mentioned the subsea win. How do we think about that maybe moving into the telco market as we go through fiscal '20? You mentioned, obviously, that on the network side or the transport side you've been seeing fairly decent uptake of 400 gig there. Curious what your expectations are for 800, particularly on that telco side as we look into next year?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [54]

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Like every technology cycle, the cost per bit is important to all of our customers, and having your hands on this market-leading technology gives you a market leadership place in cost-per-bit. So no question there will be interest in the service providers there as well. Maybe less so in terms of an application that uses 800 gig. But in other applications, and we talked about one, whether it's our offering 400 gig E or using 400 gig E as the service capability, they need to be able to transport that all over their network. And they're going to need technology, the WaveLogic 5 technology to do that.

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Operator [55]

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Next question comes from Samik Chatterjee with JP Morgan.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [56]

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I just wanted to start off with seeing if you can help me address one of the kind of questions that we get most often from investors, which is, given that you had been posting revenue growth last year, roughly 15% this year, then you're guiding to kind of 6% to 8% next year, one of the broader impressions investors have is that the 5G spend of telecom service providers spent towards -- preparing towards 5G will start to moderate, and -- but bigger with the large tier ones like AT&T and Verizon. So I just wanted to see if you could help us address how you're thinking about the ramp of revenues with the telecom service providers, particularly the large tier ones from here on. And how you're thinking about kind of investments from them towards 5G preparedness?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [57]

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First thing I'd say is that we don't sense any slowdown with respect to North America. We see a lot of strength in North America generally speaking. And we've also taken share in North America. So we believe that North America is going to be a very strong market for us as we move into next year. We are seeing a bit of a slowdown in India, that's part of the reason why we -- our orders flow slowed a bit this quarter. It's really a period of digestion on the part of the Indian players. We think they're still committed to long-term buildouts. And all of that's factored into our outlook.

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Gary B. Smith, Ciena Corporation - CEO, President & Director [58]

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Samik, I would say specific to the 5G piece, I still think you're at the fairly early stages of that buildout. You're seeing carriers build out converged metro networks. We saw some of the wins that we had this quarter that are indicative of investment to basically facilitate 5G traffic and backhaul across a converged network. I think we're at the early stages of that buildout. I'm not specific now talking about just the pure RAM piece of it, I'm talking about the infrastructure to make it all work. So I think you'll see that over the next 1 to 3 years as a buildout on a global basis with most of the major Tier ones.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [59]

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All right. And if I can just quickly follow up on the APAC commentary that Jim had. Just in terms of what's your visibility in getting that region back to growth. You had -- I understand the decline in India. But as we look into next year, kind of what's the order flow? And how are you thinking about APAC for next year?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [60]

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Yes. We think in APAC, we'll grow next year. The slowdown from last year really is mostly in India as a result of the big service providers digesting the big spends they've had. They made it to their buildouts, and we think they're going to come back online for us. So we'll expect to see some growth out of APAC next year. India is not the only place where we're doing particularly well. We're doing well in Japan, Australia, some of the smaller countries like Vietnam and Korea -- South Korea.

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Operator [61]

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Next question comes from Tim Long with Barclays.

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Timothy Patrick Long, Barclays Bank PLC, Research Division - MD [62]

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Two, if I could. Gary, could you just go back to the kind of web-scale players? Obviously, you've been really strong and I think you mentioned you had pretty good visibility. But obviously a lot of other companies in the sector have had some severe lumpiness there and some weakness. So do you think that business is diverse enough? And enough customers and you have enough visibility that we won't see some kind of disruption into that business over the next year? And then secondly, if you could just touch on Blue Planet. We've been kind of at a level -- the last few quarters actually gone down a little bit. You mentioned a key win there as well. How should we think about that business? Should it be kind of maybe taking another step function up at some point or start to grind higher as we move to the next year or 2?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [63]

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Yes. So let me take, first of all, the web-scale piece. I think demand there and our relationships are pretty broadly based. 3 of our top 10 customers for the quarter were in -- were web-scale players, and that gives you some sort of insight into the balance of the business. And then there's multiple smaller web-scale players and data center players too, which were also is a growth market for us. None of which particularly get to large concentrated spend. But in aggregate is pretty important to us.

So I think, in summary, we feel pretty confident around our ability to continue to be the #1 provider in web-scale going forward. We've got over 50% market share, we were up nearly 50% year-to-date, which I think is sort of testament to our competitive position. And I think we have the technology that we have rolling out over the next 18 months, we're pretty confident around being able to continue to be the #1 player there.

And I think demand, overall, we see no abatement in the proliferation of data centers around the globe by all of the major web-scale players. And there are more web-scale players coming online as well. The sort of -- I guess you'd call them the sort of medium-sized web-scale players. So we're pretty bullish around this space generally over the next couple of years.

Second part of your question was the Blue Planet, yes. I think you're going to get ebbs and flows quarter-on-quarter on the revenues, but we're actually seeing increased engagement across the customer base where the suite of automation capabilities strengthen. So we're going to -- we're pretty confident of achieving our target for the year.

I would expect that to increase next -- decent growth as we go through the next couple of years. It's still a nascent space. We're learning -- we're putting together that portfolio, which I think is now in a pretty good place. So I'll expect pretty good growth in that space over the next 18 months or so.

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Operator [64]

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Your next question comes from Jim Suva with Citi.

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Jim Suva, Citigroup Inc, Research Division - Director [65]

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My question is regarding your commentary about the fiscal '20 revenue growth outlook and the market commentary you gave. It's very clear that it sounds like you said that you'll grow twice the markets. But then you mentioned that you're comfortable with consensus numbers on a dollar basis. But the question is, well, with a higher base, shouldn't it be higher? Or are we just kind of splitting the numbers 2Q? What I mean is off a higher base, if we still grow 4% to 6% or double the market growth, you should be higher than consensus. Or am I just kind of misunderstanding what you're discussing?

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James E. Moylan, Ciena Corporation - CFO & Senior VP of Finance [66]

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Yes. Just to be clear. We laid out at the beginning of this year a long-term growth rate of 6% to 8% for revenue. And we said this year, we were going to grow a little -- and I'm talking about 2019, we were going to grow a little faster than that. We have grown quite a bit faster than that 6% to 8% range. What we've said is that next year, we're going to return to that 6% to 8% range. And if you take a number in that range and apply it to where we think our revenue is going to be for this year, you will get pretty close to the consensus number. So that's why we're referencing the consensus number.

I'd just say that we've had a year of great growth in 2018. We've had an extraordinary year in 2019. We've gained a number of points of market share. We've never been more confident about our ability to grow faster than the market and to keep taking market share, and we believe that's going to happen next year. So I guess that's the way I'd answer it. All numbers that we've given for forward-looking statements are consistent, both with what we've said and what the market is expecting.

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Operator [67]

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Next question comes from Meta Marshall with Morgan Stanley.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [68]

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Great. Just a question on your merchant DSP business. Any pick-up -- and I know that that's been something that you've been willing to offer, but there hasn't been a lot of traction there. So any pick-up of interest after or kind of given the pending acquisition of Acacia? And then maybe more broadly, any inbounds from end-customers who were some of -- customers of some of Acacia's customers, of just -- what their thoughts on kind of the acquisition were?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [69]

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Hey, Meta, it's Scott. So, I'd say this. So we have had some traction on our, what we call, our microsystem business. And the revenue in 2019 is on plan. It's not material to overall results. We've had, I'll say, enhanced and increased engagement since the dynamic changes somewhat with the Cisco Acacia news. And that may create opportunities for us. And we'll see how that plays out over the next 12 months or so. We remain on our multiyear target of $50 million and our 3-year plan. We think that will be coincidental with when we think the plausible market will start to materialize in 2021.

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Operator [70]

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Next question comes from Alex Henderson with Needham.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [71]

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So everybody focuses on 100 to 200, 200 to 400, 400 to 600, 800. Are we now getting to the point as you see it where we're going to run into a limit to how far we can push the bit rates up? And are we approaching a Shannon's Limit type of environment and how will the -- how do you see the world changing if we're not pushing that bandwidth up but rather improving performance within the brackets that we've already established?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [72]

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So I'll say this, Alex. We're -- certainly there is laws of physics, but we're not there yet. And we certainly believe there's a number of future generations that acknowledge that they're going to bring economic value to our customers. The other thing I'd say is getting at that economic value is getting more and more costly. And only ones that I think are going to be able to do that journey are the ones that have scale. And we're pretty confident that we'll be amongst those folks.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [73]

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So along those same lines from a competitive perspective, it's our understanding that both NEL and Nokia have had issues with their DSPs as they tried to implement subcarrier capabilities and constellation shaping at 600 gig and have delayed their product rollout timelines. Is that having any impact on your ability to win business, particularly in EMEA and APAC?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [74]

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I'd say this and consistent with what we said last quarter is, one of the drivers of our upside surprise to the year was, I'll just say, the lack of competitive headwinds that we did expect to see in the marketplace going into the year. And that has continued to be a reality for us in the back part of the year as well. And so the short answer is probably yes.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [75]

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And just going back to your product, your 800 gig product, because I don't -- I just want to make sure I understand it fully. You've taped out the DSP for 800 gigs, you've got the DSP back and you're on schedule to roll that out in the fourth quarter. That is not a -- it's a full 800 gig product in the calendar fourth quarter here, correct?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [76]

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What we said is year-end is when we will roll it out to customers and we're confident with that. By the way, when it fixates from the DSP is not just the DSP, it's all the other components that go into a modem. And people, I think probably are a little bit confused because they go out into the merchant component market and they see others that don't have the components to support beyond the DSP for 800 gig. That's not our situation. We 100% control the key innovation technology for that entire drivetrain, and that's why we're able to be out in the market earlier than anybody.

We've made great progress on the plan. The customers that we deal with are very intimate with where we're at in the technology, and the vote of confidence was with the Q3 orders this year.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [77]

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But just to be clear, the DSP has come back, correct?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [78]

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We don't comment, Alex, on internal milestones. Methodology, there are multiple chips in it. I'll just say we're extremely confident on where we're going to be in the marketplace.

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Operator [79]

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Next question comes from Tim Savageaux with Northland Capital.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [80]

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Congrats on the results. My question kind of references briefly, and that's around 400 gig ZR which ostensibly was the driver or at least one of the main drivers for the Cisco-Acacia acquisition. I wonder if you could refresh us on Ciena's position on the kind of pluggable market in general, ZR in particular, I think 2021-type expectation was given for the beginnings of the ramp there and just how does Ciena plan to participate in that market? Do you view that as kind of more threat or opportunity? And if that has changed at all, post the Cisco-Acacia acquisition?

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Scott Alexander McFeely, Ciena Corporation - SVP of Global Products & Services [81]

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So a couple of things. The 400 gig ZR as a spec basically is single span, think of it as 80-kilometer Metro DCI opportunity. There's lots of dynamics going on in the Metro DCI as the GCNs look at their architectures and what not. And I think that for sure that will be the case with 400 gig ZR's adoption in the marketplace and obviously the availability of the technology and there's lots of engineering and science to go into making that available. But also the users that add upgrading there, they're switching infrastructure to be able to take advantage of it and figuring out the operational paradigms that go around it.

It will be a portion of the market. Our perspective is ZR specifically will be a small portion of that market. We have a bet in that off of the technology investment we have on WaveLogic 5. I don't -- I personally don't believe there will be, like some people think, 100 different players in this market. It think it will be very limited because of the investment in technology required, and we expect to make an offer there. I think you can think of it as an alternative to some of our dedicated transport Waveserver revenue today, but not 100% substituted either because this market is growing at such a substantial rate.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [82]

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If I might be able to follow up quickly. We moving on? Okay. Great. And you mentioned also previously kind of the -- was -- Cisco-Acacia obviously speaks to vertical integration as well, clearly endorses your strategy from a DSP standpoint. But there are other elements I think previously referenced in the kind of optical food chain or ecosystem in terms of components. I think you mentioned you've got a fair bit of vertical integration going on there. But in general, I'd say if we think strategically for Ciena is some steps toward increased vertical integration more likely than kind of incremental pieces of technology in new markets for Ciena? Or if you could talk about your overall strategic view on vertical integration as you stand now and maybe heading forward?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [83]

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I would say, overall, I think we're -- we've invested both organically and somewhat inorganically over the years in ensuring, as Scott said, the capability to be very vertically integrated. Because the issue is, as Scott said, it's not just the DSP, it's the ability to have an ecosystem of the technology around that to bring it to market. And we own pretty much all of the elements around that. And so we're able to pace our own destiny around that. And I think that is a key competitive advantage for us. So I -- sitting here today, I don't think there's anything that we particularly lack on that vertical integration journey. So we feel like we're in a pretty good place overall with that -- what we got.

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Operator [84]

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Our last question comes from Ryan Koontz with Rosenblatt Securities.

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Ryan Boyer Koontz, Rosenblatt Securities Inc., Research Division - MD & Senior Analyst [85]

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I wonder if you could speak to the 5G trends and the metro investments required to that. Are you starting to see direct opportunities? And how you feel like you're positioned with regards to the 5G Metro upgrades?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [86]

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I think what -- we are beginning to see that. And I think we began to see it in hindsight about sort of 12 months ago. And it sort of manifests itself in various forms, but largely, it's sort of converged metro architecture. And you got most of the major Tier 1 carriers now at some point in that buildout, and that includes Verizon's story, one of the most public ones in North America around that. We've got AT&T. You've got Central Link, you've got a bunch of Tier 1 carriers in Europe. So I think they're all at sort of various stages of it. But I think when we announced a couple of wins this quarter in that space, and I think you'll begin to see that buildout really over the next 1 to 3 years, which I think is going to be a pretty healthy underlying dynamic for the industry.

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Ryan Boyer Koontz, Rosenblatt Securities Inc., Research Division - MD & Senior Analyst [87]

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Is that mostly the 6500 platform? Or are you also seeing some packet opportunities there, Gary?

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Gary B. Smith, Ciena Corporation - CEO, President & Director [88]

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It's both because of the nature of it being converged some kind of taking a slightly different infra -- architectural approach. But generally speaking, it is a converged architecture that includes packet. And so increasingly, we're seeing that as the integrated capability of packet on 6500, and then some of the aggregation pieces are still standalone as well. So it's an opportunity for our packet portfolio overall, and that's why we're continuing to increase our investment in the packet portfolio, writ large.

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Gregg M. Lampf, Ciena Corporation - VP of IR [89]

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And with that, we thank everyone for joining us this morning. We look forward to catching up with you folks over the next several weeks. Thank you and have a good day.

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Operator [90]

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This concludes today's conference call. You may now disconnect.