Greg Lampf - VP, IR Gary Smith - President & CEO Jim Moylan - CFO Steve Alexander - CTO.

Patrick Newton - Stifel Nicolaus Simon Leopold - Raymond James Michael Genovese - MKM Partners George Notter - Jefferies Paul Silverstein - Cowen & Company Tim Long - BMO Capital Markets Meta Marshall - Morgan Stanley Stanley Kovler - Citi Research Doug Clark - Goldman Sachs Jeff Kvaal - Nomura Tal Liani - Bank of America Merrill Lynch.

Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Yearend 2017 Earnings Conference Call for Ciena Corporation. At this time, all participants are in a listen-only-mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded.

I'd now like to hand the floor over to Greg Lampf, Vice President, Investor Relations. Please go ahead, Sir..

Thank you, Caron. Good morning and welcome to Ciena's 2017 fourth quarter and yearend review. With me today is Gary Smith, President and CEO; and Jim Moylan, CFO. Steve Alexander, our CTO will join us for the Q&A portion of the call. As you may have noticed, this morning's report follows a different format than usual.

Our prepared remarks were reported and transcribed and were made available at 7:00 AM Eastern along with today's earnings press release and its accompanying Investor Presentation. We encourage you to review those remarks and supporting materials.

This include important information about our current strategy and longer term financial targets in addition to commentary around market dynamics and our Q4 financial results. We believe this approach will provide you a clear understanding of how we intend to manage the business and what to expect from Ciena over the next several years.

In today's live call, we'll give a brief summary of those comments, provide guidance for our fiscal first quarter 2018 and then move to Q&A. 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 include our guidance and long-term financial objectives, are based on current expectations, forecast and assumptions regarding the company and its market 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 in our most recent 10-Q filing and in our upcoming 10K filing. Our 10K is required to be filed with the SEC by December 27 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.

As Jim will review, starting this quarter, there are important changes to our GAAP and non-GAAP tax provisions that you need to be mindful of when comparing periods.

A detailed reconciliation of our non-GAAP measures to our GAAP result along with a comparison of our new method and prior method of calculating taxes for non-GAAP earnings is included in today's press release available on the Investor section of Ciena.com. With that, I'll turn it over to Gary..

Thanks Greg and good morning. The approach we've taken with today's earning report is intended to provide you greater visibility into how we're managing our business and also how you should be assessing our progress over the longer term.

For several reasons in particular that we've arrived at an important inflection point in the transformation of our business to a mature growth company we feel the time is right to provide detail on our long-term strategy, the drivers for our business and expectations for our performance in certain key areas.

The execution of our strategy over the last several years is proving out. Today Ciena is positioned in the market as a best-of-breed at scale and we continue to scale and diversify our existing business while expanding our addressable market and we are forcing the pace of innovation in our industry.

All of this is really enabling us to capture additional market share and consistently outperform the industry by delivering continued growth and profitability, a strengthening balance sheet and meaningful cash generation. With this strong foundation, we've identified several key drivers that will play a role in our continued success.

With respect to our portfolio, these include our optical systems business, where frankly we are the only player who can address the complete range of key applications on a global basis. And our global network services, where we've just begun a multiyear transformation process to improve our delivery capability and revenue expansion program.

Our packet networking business where we're adding IP capabilities that will enable us to play a strategic role in our customer's network densification initiatives such as 5G and Fiber Deep.

And out Software and Related Services business, where we are focused on migrating customers to our Blue Planet network domain controller platform and driving adoption of our Blue Planet analytics and orchestration platforms.

And finally, the component space, where we continue to drive business development efforts with our partners to make our WaveLogic modem technology available to a broader set of markets and customers.

In our prerecorded remarks posted earlier today, we provided specific financial targets for each of these drivers over the next three years and these are based obviously on our current expectations and assumptions around market dynamics and growth.

We also identified areas where these strategic drivers intersect with our go-to-market plans in key verticals, including our service provider customers, global content network providers, the submarine market, Asia-Pacific as a region and India specifically.

Many of these areas are already outstanding success stories for Ciena and we believe that they present important opportunities to both expand and gain additional market share going forward and we fully intend to press down our competitive advantage and advance our leadership positions in these key growth markets.

As you know, our market dynamics can be challenging and dynamic, but we have a durable model and have proven that we can deliver strong financial results even in this environment.

And looking at our full-year fiscal 2017 results as well as those over the past several years, we've consistently grown both our top and bottom lines within these market conditions.

Hopefully, with the additional details we've provided today, you'll get a strong sense of our confidence in the future as well as our long-term plans for managing the business to continue to grow faster than the market and expand our profitability at the bottom line. With that, I'll hand over to Jim..

Thanks Gary. In addition to the strategic drivers and long-term targets, our recorded commentary available earlier today include some important tax-related matters and detail on how we're thinking about capital allocation.

On tax, we have two matters this quarter that impact our measures of profitability and will require you to adjust your models accordingly.

First, the reversal of our valuation allowance on our deferred tax assets, or DTAs for short, resulted in a one-time tax benefit of $1.1 billion on our Q4 income statement, substantially increasing our GAAP net income and EPS for Q4 and fiscal 2017. We've adjusted out this impact in our Q4 non-GAAP results.

Going forward, in accordance with GAAP, we will be making a full tax provision of approximately 36% to 37% against our GAAP net income.

Because of their size and ability to offset taxes, these DTAs are a valuable asset and you should view this tax valuation allowance reversal as a strong indication of our positive sentiment about Ciena's future and forward profitability.

It's also important to note that while we'll be taking a GAAP provision for these taxes, we do not expect to pay cash taxes in the U.S. for the foreseeable future due to the utilization of these deferred tax assets. Second, in accordance with SEC guidance, we are changing how we calculate our provision for income taxes in our non-GAAP net income.

This change, though it will not affect our actual cash tax payments or our cash flows, will result in a full tax provision of 36% to 37% against our non-GAAP income before tax. Therefore, it will result in significantly higher tax provisions on a non-GAAP basis then you have seen before.

In a further sign of the company hitting an inflection point, today we announced that our Board of Directors authorized a program to repurchase up to $300 million of our common stock through the end of fiscal 2020.

This return of capital to shareholders is in addition to the $288 million of 2018 convertible bonds and associated shares for which we intend to use cash to settle at the end of fiscal 2018. Our current thinking is a repurchase of approximately $100 million for fiscal 2018, but it could be more or less depending on the stock price and other factors.

We believe these steps are a strong reflection of our continued confidence in our long-term growth strategy and our strong balance sheet and cash flow generation.

As we think broadly about capital allocation, we still believe it is important to retain a meaningful percentage of our capital on our balance sheet for the business and we will maintain a healthy balance sheet and leverage level.

However, we are committed to driving shareholder value over the long-term and we intend to incorporate the return of capital to shareholders as part of our overall strategic and operational plans. With that I'll comment briefly on the results we reported today and provide detail on our Q1 outlook.

Overall, we delivered a strong fourth quarter with revenue toward the high-end of our guidance range, strong order flow, adjusted gross margin within our target range, operating expense in line with our plan and strong adjusted operating margin.

Looking ahead, for fiscal first quarter 2018, we expect to deliver revenue in the range of $625 to $655 million, gross margin in the low to mid-40s range and operating expense of approximately $238 million. On gross margin specifically, I'll remind you that we have several new wins that are coming to revenue.

As we've said, the earlier stages of deployments often require high startup costs and carry correspondingly lower margins. We expect this dynamic to continue for the next couple of quarters as we continue to aggressively target market share through new footprint opportunities around the world.

As we've said before, our overall financial performance and individual financial metrics may vary from quarter-to-quarter. However, as Gary said, we are managing the business for long-term value.

When viewed annually for example, we have delivered consistent financial performance with respect to topline growth, profitability and cash and we expect to continue to do so in the future. In fact, in our reported remarks available earlier today, we offered a set of longer-term financial targets that illustrate our confidence in our future.

Specifically, we expect to continue growing our revenue faster than the market. Based on our current estimates of market growth, we expect to grow our overall annual revenue at approximately 5% to 7% on average over the next three years.

Also, as we previously indicated, we have a long-term target of achieving 15% adjusted operating margin on an annualized basis and that still remains an important and achievable goal.

We also expect to grow our adjusted earnings per share at an average of approximately 14% to 16% per year over the next three years and we expect annual free cash flow generation to be approximately 60% to 70% of adjusted operating income over each of the next three years.

In closing, we're very pleased with the maturity and strength of our business and our growth prospects and that gives us the confidence to provide transparency into our longer-term goals and how we plan to achieve them over the next several years. Caron, we'll now take questions..

Thank you. [Operator instructions] Our first question comes from the line of Patrick Newton with Stifel. Please go ahead..

Yeah. Good morning. Thank you for taking my questions.

I guess just first for you Jim on the longer-term outlook or focus on '18 within the longer-term outlook, how should we think about the growth rate within -- it was 5% to 7% I guess reasonable for this current year? And in respect to gross margin, should we think about the gross margin expanding from this kind of lower base as you see the market to drive you towards that 15% op margin target?.

Yes, we stated that the 5% to 7% annual growth is sort of an average over the next three years and we have previously already indicated a lot of people that we thought we'd be at the low end of that range for 2018. We think that the market is growing in the low single digits. We think we'll grow in our couple of percentage points above that.

So that provides our view of our growth rate in 2018. It will be at the low-end of the 5% to 7% range in our view today. With respect to the gross margin, to me the fact that we're going to have a slightly lower gross margin for a couple of quarters is a big positive.

Because it means we're taking market share and when you take market share and when you're not an incumbent, there are costs associated with doing that. There are startup costs, there are lower early margins and deals and so this is a positive for us. It's going to result in a better growth rate for us for the future.

We believe that this phenomenon given the deals that we've already won and that we expect to win is a couple of quarter phenomenon and then we should return to something more mid, that's our view today..

Great.

And I guess just shifting to WaveServer, can you update us on what revenue was actually achieved in '17? Thoughts on how WaveServer could trend in '18 and how we should think about displacement of the 6500 and whether or not collectively WaveServer be in a positive versus displacement is a net tailwind or a headwind for Ciena in FY '18?.

Yeah, you'll recall that early in '17 we said we expected WaveServer to generate between $1500 million of revenue. We increased that estimate as we came through the year and for the full year, we were above the $100 million by a meaningful amount. That's a great thing for us because we have a product that competes very well in the DCI segment.

In fact, we're number one in the DCI segment overall. It is a lower price point than the $6500. So, it does represent a bit of a headwind as far as the actual growth rate. But I would say that having that product is a tailwind to our prospects in the DCI segment and to our future growth rate in the industry..

And any view on growth potential of WaveServer in '18?.

I am not going to share that today. I would say that WaveServer is going to be a growth product for us we think a long time. By the way we've been competing with WaveServer with WaveLogic 3. We now have introduced WaveLogic AI.

We had a relatively small contribution from WaveLogic AI in Q4, but it will be significantly higher in 2018 the WaveLogic AI piece and we think WaveServer will be a growth product for us..

Thanks Patrick..

Thank you..

Thank you. And our next question comes from the line of Simon Leopold with Raymond James..

Thank you for taking my question. I wanted to just check on a shorter-term aspect of India on the back of one of the component suppliers in the industry had mentioned the sense that India had paused or seeing some slowing and it's been an important market and it sounds like it remained so.

But maybe if you could highlight a little bit shorter-term perspective given it's been helpful to you in the last couple quarters?.

Yes Simon. In fact, India was a good contributor to our growth and overperformance at the topline in Q4. In fact, it doubled sequentially from Q3 to Q4. APAC overall was up about 29% sequentially as well.

So, you benefit of diversification and our footprint in India, we are seeing and I think these numbers illustrated no signs whatsoever of slowing down in India. And you think about the sort of demographics you're dealing with and the infrastructure they’ve got to build out, that shouldn't be a surprise.

We will have grown in India for the full year almost 100% year-on-year and we're very positive about India going forward as well..

Great. And I wanted to shift over to cable TV industry, both long and short-term perspective. In the prepared remarks, you talked about fiber deep opportunities.

So, could you help us set some context of where you are in terms of the cable TV vertical today, your level of confidence regarding these opportunities maybe timeline sizing, I'm picking up some of the same commentary and it sound like cable infrastructure has I think a meaningful cycle in front of us on Fiber Deep.

I want to try to put this in context of what this means for Ciena? Thank you..

Sure Simon. Steve Alexander here.

So, we've been a supplier into the cable space for quite a while and try to build out a lot of what you might call the backbone of the cable infrastructure and what Fiber Deep refers to is a long-term objective for the MSOs to replace a lot of what you would call the old analog co-ax plant move the fiber closer to the customers, increase the data rates out of the edge of the network and we play in all that space.

If you think of what we're able to accomplish in terms of wireless backhaul space moving Photonics out to the edge, we're going to do essentially the same thing here with the Fiber Deep activities.

And as you know the cable folks touch a lot of not just residences, but the small medium enterprises they have to play in, in the wireless backhaul as well and you're going to see the technologies and the platforms that we've got feed directly in solving those problems for us..

And I assume that's your packet products as well as the optical transport platforms, is that correct?.

Think of it as all of the above right. As you get out to the edge, it's clearly a packet, converged packet optical play.

When you get into the core where you are basically managing tens of hundreds of wavelengths, it's more the classic core optical pieces, but absolutely it's everything that we've architected for the last several years in terms of a converged packet optical architecture system and product suite. Thank you, Simon..

And I think you've said 10% to 15% of revenue from cable in the past.

I just want to make sure we're level setting that?.

Yeah, I think it's in that range Simon. And I think we would also concluded that this is a key part of our growth opportunity going forward into Fiber Deep and given our footprint into pretty much all of the major cable operators globally, it represents a great opportunity for us..

Thank you..

Thanks Simon..

Thank you. And our next question comes from the line of Michael Genovese with MKM Partners..

Thanks very much. How should we think about U.S.

Tier1 in fiscal '18? Would that be flat or should we see some growth in Tier 1?.

Mike, what I would tell, this is Gary. If you define Tier1 broadly as T&T and Verizon I guess if you want to take a fairly narrow view of that definition, I think that's probably going to be flattish for the year in 2018. At least that's what we're thinking of flattish to maybe slightly down overall if you combine the two.

That's certain what we're thinking..

Okay. Great.

And then more of a longer-term I think looking into fiscal '19 as the modem business grows into the DCI market, should we actually think about that starting to eat up some of the WaveServer opportunity? Should we think about it going more towards modems in fiscal '19 and beyond in DCI?.

That's not the way we see it Mike. We think that there will be some opportunities to sell some modems, but the WaveServer is going to be a good product for us for a long time in our view.

Steve do you have something?.

Michael, I think the way you want to look at it is WaveServer first a very specific application or space right, which is very broad globally. It's when folks want a small package, very high density. The modems, look at them as allowing us to grow market share, right. They're going to allow us to address markets that we can't get to today.

So, to Jim's point, we view the modem business as very much of a tailwind for what we're trying to do..

I appreciate it. And congrats on the full year outlook..

Thank you, Michael..

Thank you. And our next question comes from the line of George Notter with Jefferies..

Hey guys. Thanks very much.

I guess I was just curious about the initial feedback you're getting from customers on WaveLogic AI, I guess both on the WaveServer side and then also on the 6500 and can you confirm that you did ship WaveLogic AI and the 5500 and October?.

So, it started at the end of this. So, the answer is yes, we did ship it in October. I think that the way away you can kind of get your arms around it in some sense as we do track roughly how long it takes us to ship a certain number of modules right and every time we've increased data rate, the time to ship has decreased right.

So, when we shipped 40, one went to 100, it shipped same number in half the time roughly. When you go to 200, a similar thing happened and we're seeing the exact same rapid uptake in the AI, which is 400 Gig. So, the acceptance into the market has been wonderful. It's coming from the same place as you would expect.

It's the folks who need maximum capacity on fibers. It's the ones who can move very quickly in terms of bringing a new technology into the marketplace and such. But we're very happy with performance so far..

Great. And then as a quick follow-up, I guess it runs into your response there, but as I look back at 16-QAM transition several years ago, you guys took a lot of market share through that period of time.

As you think about WaveLogic going forward, can we think about that being the catalyst for you guys taking market share and do you think you can take market share at the same or greater magnitude than you did on the 16-QAM cycle? Is that the right way to think about it for us?.

I think that's a big part of our thinking around market share in the next three years, but I think you also got to combine that in the context with our channels to market etcetera as well and our footprint.

So, I think you put those two together and we're just at the early stages of this technology ride with AI and then we've got the next follow-up to that already well underway as well. So, our thinking is we took about 2% market share globally this you’re and that was before the AI came to be shipping. We just shipped it in the latter part of Q4.

So, I think it's a key element of how we think about the next -- the growth rates for the next few years. So, our overall thinking when we combine all of that is that we'll grow about 1% to 2% faster than the overall market..

Got it. Okay. Thank you..

Thanks George..

And our next question comes from the line of Paul Silverstein with Cowen & Company. Please go ahead..

Hey guys.

Can you hear me okay?.

Yeah. You're a little weak Paul to be honest with you, but we can hear you..

You just see what I look like.

But let me start off, I just want to confirm some stuff you said, Jim with respect to gross margin, the softness is exclusively a function of the new wins and can you comment on what you're seeing in terms of the rate of price decline? Has it changed, accelerated, decelerated or it constant? I assume it's constant with what you said before..

Generally speaking, the pricing environment has not changed. As we've always said, attacking incumbency is going to affect our gross margin and that's exactly what -- it happened a bit in Q4. It's going to happen a bit in Q1 and probably another quarter.

It's all about taking market share and one thing that's partly in respect to George's question is that it's getting tougher for the smaller companies in the industry to allocate the capital that's necessary to innovate and grow. So, I think that's another aspect of our story, but we're going to press our advantage here..

And Jim on the key gross margin leverage historically, I think you said historically that software will be $25 million, so it's one percentage point to gross margin and if I recall, the last reiterations of WaveLogic, all had some benefit to your gross margin? Is there any reason why that won't continue going forward that as you ship 6500 WaveServer with AI that there will be some incremental benefit to your gross margin all the things being equal and then as your software revenue grows, we won't see that continue to have a positive effect?.

No question. Those two, also we expect growth in our packet business at a higher rate than our overall optical business and that's another margin enhancer. So, we feel very good about our margin progression. As I say, the fact that we're going to be a little bit lower for the next couple quarters, you should view it as positive.

It implies a bigger growth rate going forward..

All right. Let me ask the next question from then. My apologies on the call, but with respect to the weakness that you guys called out on U.S.

Tier 2 and government, can you give us an update on that?.

Paul, I am going to take that. In Q4 the government came back a little and so did the Tier 2 carriers. So that was helpful and we're forecasting a reasonable performance in Q1 as well. So, both the government stuff and the regional Tier 2 carriers are going to describe them that they actually -- we had an uptick in Q4 over Q3..

Let me ask one last question guys. I know it's hard enough to predicting good times, bad times are much harder, but relative to the guidance you just put out for last three years including this year, how much visibility, how confident are you? You're obviously in a volatile business since the ongoing issue..

Here is how I would answer that Paul. What company in this space articulate its growth targets and then breaks it down into segments with ranges and assumptions over three years and I think that should talk to itself. The performance that we've had over the last five to six years is one of consistent drive in the top line and bottom line growth.

We think that's going to continue for the next few years. So, we have better visibility than we've ever had and that you can translate into its various forms of customer interaction, pipeline forecast, conversations with customers. We've got a good backlog going into the year.

So yes, there is always volatility and things moving around, but I think the diversification and global scale of the business now enables us to power through those things, which is why we've given the longer-term targets that we put out there this morning..

Thanks Paul..

I appreciate it. Thanks guys..

Thanks Paul. You bet..

Thank you. Our next question comes from the line of Tim Long with BMO Capital Markets..

Thank you. Two questions if I could. Jim, can you talk a little bit about you mentioned $238 million OpEx in the quarter, not fully making up for the gross margin tick down sequentially and year-over-year.

So, if could just give us a sense if you expect that to continue through the year or do you think there will be some OpEx make up to make up the little different so that we could see the consistent level of OpEx improvement that we've seen in the past few years? And then secondly, if you just touch on the services business a little bit light again, just talk about what needs to happen to get that business moving again in positive direction, thank you?.

Sure. Yeah on OpEx you might be looking at the comparison of Q1 OpEx this year to Q1 OpEx last year and I'd say that it's always can be tricky to compare quarter-over-quarter comparisons for us. We have movements in our OpEx because we have big projects that result in spend. So that's the first thing I'd say.

I'd also say this that we've never said that we're going to be able to hold our OpEx flat. There are things that require us to spend a bit more including merit increases and things like that, but we do commit and we have actually done this every year at least the last five.

We do commit to holding our OpEx growth at a rate below our growth of revenue and so you can expect to see that as we move through the year..

On the service one, Tim and really, I think we're talking about attached services to our global systems business, it was actually up 10% sequentially in the quarter.

For the year it was slightly down and I think some of that was really around deployment services down specifically in CALA and predominantly in Brazil where we had a very, very large deployment in the last -- in the previous couple of years.

I would say though as we think about our services business and it was great opportunities for it, when you think about it very simply, you look at the growth of our platform business over the last few years, the combined aggregate growth is 7% to 8% at least.

So, we're putting more footprint out there and I think it's a great opportunity for us to get a great yield and attach rate of our services as we offer different diversified services to the customer base.

So, it to be clear, we see the service over the next three years as a growth opportunity both in terms of revenue and in terms of margin over the next three years..

Thank you, Tim..

Thank you..

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

Great. Thanks guys.

Speaking to the software target that you guys put out there, just wanted to get a sense of where you're seeing the strongest Blue Planet demand and what guides some of that view on the software growth pick up? And then second, following up on Tim's question of just do you need to invest services ahead of that? What is the timeline to turn in some Blue Planet trial into revenue and is a significant amount of services involved in that, thanks?.

Meta, the segments with the Blue Planet software and services, which we've separated out this year so people could see it, was actually up albeit from a fairly small base by close to 30% for the year and that included subscription services, the maintenance services around it and the consulting services.

I still think we're at the very early days of this and I think one of the key elements that I think will drive Blue Planet growth over the next couple of years is we've launched our domain manager into the market in Q1 we've just started to ship and I think that will be well adopted and is eagerly anticipated by our existing customer base.

And I think that thing gives us a great platform to expand into the Blue Planet analytics, which we're also just bringing into market and I think rather than the nascent market of orchestration, which is still frankly not mature enough yet from an ecosystem point of view, I think we can get a very good footprint and are very confident in our growth of Blue Planet now on the back of the domain manager and analytics and then I think you'll evolve into the orchestration services over time.

So, I think we have a pretty high degree of confidence now having got experience over the last couple of years in this space. The growth rates that we've set over the next two to three years, I think are absolutely achievable and I am very encouraged by the traction that we're seeing with Blue Planet as we turn here..

I am going to try to answer the OpEx question Meta. On the attached services side, there is not an OpEx investment or frankly a CapEx investment to get to the growth we're talking about. It's really transforming our business and looking all the levers we can pull.

We are on the planet side incurring some OpEx to increase capability and that is flowing through our OpEx today.

Does that answer your question?.

Yeah. No, that's helpful.

I think I just wanted to get a sense of is the update mostly from your Tier 1 customer or is there larger customers? Are you seeing traction in Tier 2 and is it different once you're talking about analytics versus orchestration and that will be it for me?.

It is both Tier 1. We've had some significant breakthroughs in the last few months with Tier 1, but obviously Tier 2 as well. I think it's more about domain management and automating existing services than it is virtualized orchestration.

And I think one of our learnings over the last couple of years is exactly that, is that market whilst we still feel very positive about the virtualized SDN/NFV market, it's not yet at a point of maturity in the broader ecosystem that's going to drive meaningful revenues.

What we have discovered is a very large appetite to automate existing services and so domain manager and analytics particularly, proactive analytics is really I think the beachhead if you will for Blue Planet that we're targeting that in the next couple of years..

Thanks Meta..

Thanks guys..

Thank you. Our next question comes from the line of Stanley Kovler with Citi Research. Please go ahead..

Hi. Good morning. Thanks for taking the question. Jim, I just wanted to ask you a little bit more on the tax front, particularly what do you think the impact could be for you guys if U.S. tax reform is passed and we've seen a number of companies that have deferred tax assets make some comments about once again the potential revaluation of those.

So, I just wanted to get your take on that and the potential impact to the tax rate, non-GAAP tax rate and P&L thanks..

No question that the tax rate changes there will be an impact on our GAAP P&L, but the key point around our tax situation is that we have these deferred tax assets, which means we're not going to be paying U.S. taxes for a long, long time.

The amount of tax we paid over the past three or four years has been in the range of 5% to 7% of our net income before tax. It's been almost -- well it's been exclusively non-U.S. income taxes and U.S. state income taxes. So, no matter what they do with respect to the tax rate, that will not have an effect on our cash flows to any significant extent.

Now as you said and again there will be changes in our tax provisions if the tax rate changes, but we'll try to make it clear as we make the adjustments that we have to make what the real effect is to us and most importantly what the cash effect is to us..

Got it. Thanks.

And I just wanted to follow up on use of cash question? Clearly a focus on our free cash flow generation for the next three years and in the presentation deck you alluded to some more M&A where do you see that happening potentially? Is that going to be more of a vertical integration focus, horizontal software and how are you thinking about the space of short reach optics as a potential growth area thanks?.

So, as we think about M&A, I think there are two or three different buckets to it. One is industry consolidation, which I think is looking more like atrophy frankly of some of those smaller players. So, I think inclined more to think about vertical integration and the expansion of our software capability to support Blue Planet.

Those are things that I think we could potentially look at there..

And with regards to the short reach optics, we identified being able to take the coherent technology the WaveLogic chipset and such and move it into the short reach interconnect almost a pluggable kind of a market here back when we talked about the modem reveal her back at OSC at the beginning of the year.

And so, we think that 400 gig and above is a good place to intersect that and so that's going to be an area that we have to keep our eye on, have a keen interest and think we can make some real difference..

Thanks, and Steven, you mentioned I think in the deck there is about a $50 million opportunity there in the near term for that modem piece.

I guess where I was going with the short reach optics question is if there's any potential to expand the portfolio to other components as well that you wanted to get into?.

Well, we'll certainly keep our eye on it right, wherever we think we can make a difference in terms of the economic performance of our customers where we change the game if you will in terms of how the market structure is. We'll certainly watch it.

In the past, the very short reach things are things that are commoditizing these as a plug-in off you go. So, we'll watch it and keep our eyes on it, but I wouldn't say anything more about it at this point..

And just one clarification there Stan, we stated that we have in our plan a $50 million opportunity for the modem business. These are very early days in that business. We are actually making great progress. We have samples in our partners and in our customers, being trialed. We like the prospects for that business.

The $50 million is simply a placeholder. We're so early that it's hard for us to predict a number. It could be significantly greater than that or it might not turn out to be anything, but that's the number we put in our plan..

Thanks Stan..

Thank you. Very helping..

Thank you. And our next question comes from the line of Doug Clark with Goldman Sachs..

Thanks for taking my questions. First one is just kind of a housekeeping item. The backlog you've always giving on an annual basis.

Can you give us an update of what that is before the 10 Gig comes up?.

Yeah, it's $1.13 billion..

Okay. Perfect and then I had a follow-up question on the gross margin impact from the Tier1 wins. I think we're generally aware of Verizon in India dynamics of the ramps going on there.

It that where the new wins that you're talking about are coming from or is it elsewhere and if you could give us a little more details of the existing customers, new footprint, market share gains that would be helpful?.

Yeah Doug, this is Gary.

It is predominantly international and it is predominantly new wins for Ciena, new customers for Ciena and I think to some extent it's this dynamic with Lodge service providers around the world expressing concern around the sustainability of innovation of some of the A, smaller players and B, smaller regional indigenous providers.

And I think I'd highlight Japan in that regard and Asia-Pacific particularly. We're also seeing some of that there. We had some tailwinds in the last six months of carriers that have never been deploying of Ciena. So, they're new customers to Ciena and we're seeing a number of them.

Again, predominantly in Asia, but also in Europe we have a couple of significant ones in Europe of Tier 1 carriers that we've not had before and so that we're at the early stages of deployment, we're just beginning with them and the cost of those are weighing on the margin a little bit. This is not a new dynamic.

We've seen this obviously before as we continue to drive our revenues and grow market share, but I think we are beginning to see more of this shift by some of these large international Tier 1 carriers..

Perfect Gary, that was helpful and then just final question for me taking a little bit more of a near term perspective. The first quarter guide is a bit below typical seasonality, marginally off of a favorable seasonal fourth October quarter.

So, I am just curious if you talk about the near-term seasonal dynamics that are impacting revenues and maybe the contrast you said that both government and Tier 2 U.S. were actually slightly better.

So, I am curious what the near-term key factors are?.

Q1 was pretty much in line with what we thought from a plan point of view. In fact, it's right in line with our plan on Q1. Q1 is always a challenge for us, when you think that we straddle November, December, January. So, you miss budget times and people don't like deploying at the end of the year still.

That's still a cultural thing within the carriers. So, I think the midpoint of our guide I think was bang on what we thought. We had a very good order flow in Q4, which has given us a good backlog going into the year as Jim just called out.

So, I think Doug it's pretty much in line with what we've seen from a Q1 performance point of view at the top line..

Thanks a lot..

Thank you. Our next question comes from the line of Jeff Kvaal with Nomura..

Thanks. I'd like to delve into that EPS growth target a little bit if we could.

Jim maybe would you mind breaking down where the 14% to 16% growth begins and then what are the elements of that growth?.

When you say begins….

No, what are we measuring from, is it the current EPS number or is it, the number changes etcetera.

Yes, remember that you have to take into account the fact that we are going to have to provide a 36.5 or so approximately provision going forward on our non-GAAP earnings and so you should look at the number for 2017, which is a $1.14 or so and that's the starting point. You should expect a 14% to 16% CAGR over the next several years.

The elements of it frankly are if you look at the growth rates we've provided above for the three-year period starting with 2017 and you apply an assumption of what gross margin is going to do over the next three years, you'll get -- that's how you get to the 14 to 16 percentage. Its math frankly.

Did I answer your question Jeff?.

Well I was just getting warmed up on this topic Jim a little bit..

We have another opportunity to have a conversation here Jeff..

Whatever the impact, how quickly is OpEx going to grow relative to revenues and then how important is the buyback in your convert treatment to the EPS growth?.

The buyback number is not a huge aspect of the numbers that we're talking about here. Now it does assume by the way that we do convert I'm sorry, use cash to settle the 2018 converge. That is buried in that assumption, but as far as the buyback, that's not a big element of it.

With respect OpEx growth, I don't know how to answer the question of how fast will OpEx grow before revenue, but what I can say is that as you've seen in our past five or six years, we have grown revenue a few percentage points faster than we've grown OpEx. That's clearly our plan this year and you can expect that in our plans going forward.

That's been our intent and we've delivered on it. And the other thing I'd say is that we've reiterated our 15% operating margin target out there in the next three years. So that's a lot of numbers but I'm sure you can put that into your model and come up with our EPS growth rate Jeff..

We'll plug it in there Jim. Thank you very much..

Thank you, Jeff..

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

Hey guys. My question is about we see when we look at the market we see some consolidation in the space, in one of your biggest competitor Alcatel went through mergers over the last few years right and consolidation.

The question is do you think that it's important for you in the long run or not important maybe it could help you in the long run if you're part of a bigger corporate that sells more than just optical? Do you see any interest among your customers to bundle optics purchases with other things such as radio access network, routers or anything else?.

Tal, this is Gary. It's a strategy question really. I think -- listen what we've seen plenty of evidence from in the last 10 years that this generalist model there is notion of end-to-end bundling and the rest of it simply does not work and is not sustainable.

How much more evidence do we need? Alcatel Lucent, Nortel, NSN, Marconi etcetera, the model is not sustainable because I think the world generally is moving to a best-of-breed at global scale. So, you've got to have global scale to be able to have the velocity of R&D required and the velocity of go-to-market relationships and resources.

So, I think the evidence that we've seen in the market over the last 10 years would actually say best-of-breed at global scale is where the market is heading because even these large companies just cannot afford to sustain the degree of velocity in each of the segments to maintain leadership and you've seen that on the Rand side as well.

And so, with the exception of course of China Inc., but that's an entirely different -- an entirely different model..

And I'd just say that that's not the way customers purchase this equipment. They purchase it individually by domain for the overwhelming majority. We have seen a couple of instances where customers have tried to bundle in their purchasing and frankly they haven’t worked very well.

So, it's our view that for the foreseeable future best-in-breed is going to win..

Thank you. I have one more question if I can? Huawei and ZTE in Europe, were the Chinese in Europe and the rest of the world let's say outside of China, do you see an increase in the competition level or 0stabilization.

How do you characterize the pricing pressure, margin pressure that comes from Chinese players globally?.

I would say listen, we've been used to competing them outside North America and outside of China. that's who we compete with. Huawei and Ciena are number one or two in the world depending on which market you're in and which segment you have. Our view is that it is being stable now for about the last couple of years.

We've not seen noticeable aggressive pricing or it's just been a pretty stable in the last couple years..

We've seen some acts by smaller vendors to try to retain relevance or retain market share that have been pretty aggressive pricing, but in the overall context of the market, that is not a key feature of pricing in the market. Overall pricing in the market is about the same as it's always been..

Got it. Thank you..

Thanks Tal..

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