Ciena Corporation (CIEN) Q1 2014 Earnings Report, Transcript and Summary

Gregg M. Lampf - Vice President of Investor Relations Gary B. Smith - Chief Executive Officer, President and Director James E. Moylan - Chief Financial Officer and Senior Vice President of Finance Thomas Mock - Former Senior Vice President of Corporate Marketing & Communications

Tal Liani - BofA Merrill Lynch, Research Division Amitabh Passi - UBS Investment Bank, Research Division Natarajan Subrahmanyan - The Juda Group, Research Division Mark Sue - RBC Capital Markets, LLC, Research Division Ehud A. Gelblum - Citigroup Inc, Research Division Brian T. Modoff - Deutsche Bank AG, Research Division Paul Silverstein - Cowen and Company, LLC, Research Division Simon M. Leopold - Raymond James & Associates, Inc., Research Division Kent Schofield - Goldman Sachs Group Inc., Research Division Michael Genovese - MKM Partners LLC, Research Division Roderick B. Hall - JP Morgan Chase & Co, Research Division Dmitry Netis - William Blair & Company L.L.C., Research Division Mark McKechnie - Evercore Partners Inc., Research Division

Welcome to the Q1 2014 Ciena Corporation Earnings Conference Call. My name is Richard, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Mr. Gregg Lampf, Vice President of Investor Relations. Mr. Lampf, you may begin.

Thank you, Richard. Good morning, and welcome to Ciena's first quarter 2014 review. With me today is Gary Smith, CEO and President; Jim Moylan, CFO; and Tom Mock, Senior Vice President, Corporate Communications. This morning's press release is available on National Business Wire and ciena.com. We've also posted to the Investor section of ciena.com an accompanying investor presentation, including certain highlighted items from this quarter being discussed today, as well as our historical results. In our prepared remarks today, Gary will discuss management's view on the market and Jim will offer some color on our results and provide guidance for Q2. We'll then open the call to questions from the sell-side analysts, taking one question per person with follow-ups as time allows. Before I begin, I'd like to remind everyone of our Analyst Day at the New York Stock Exchange on April 3. We hope you can join us live or online. Before turning the call over to Gary, I'll remind you that, during this call, we will make certain forward-looking statements. Such statements are based on current expectations, forecasts and assumptions regarding the company 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-K filing. Our 10-Q is required to be filed with the SEC by March 13, and we expect to file by that date. Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events or otherwise. Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today's press release available on ciena.com. This call is being recorded and will be available for replay from the Investors section of our website. Gary?

Thank you, Gregg, and good morning, everyone. As you've seen in this morning's press release, we reported an excellent first quarter that represents further progress and validation of our network specialist approach. We continue to see the benefits of the strategic decisions we've made over the past several years, as well as our leading market position. Momentum was strong in the first quarter, despite typical seasonality. Our Q1 performance is highlighted by revenue that grew 18% over the year-ago period and a very good performance on gross margin, strong adjusted operating margin of 6% and EPS of $0.13. With consistent execution and ongoing improvement in operating leverage, we continue to make progress towards achieving our long-term operating targets. In fact, we continue to feel good about conditions and trends in our overall market. We're seeing further evidence of a shift to more converged and programmable networks that are underpinned by open architectures. The accelerating acceptance of software-defined networking is also influencing the direction of network architectures and decisions. And all of this represents a great opportunity for Ciena. Capitalizing on this multiyear architectural migration depends upon learning the customer network decisions that are being made today. And that requires the ability to bring the right solutions to market now. Our OPn architecture is designed specifically to address this shift. And as a result, we continue to take share. As evidenced by our #1 position in global Packet-Optical for 2013, according to Dell’Oros most recent market report. And while the initial deployments of this architectural shift may have started in the core of the network, we are now seeing deployments in the Metro as well. One customer that highlights this shift is AT&T, with whom we've begun deployments of 6500 in the Metro. The converged Metro market opportunity overall is beginning now. And we see Metro as a larger, global opportunity than the core of the network. We have this visibility into customer plans, due in part to the increasingly strategic nature of our customer relationships worldwide. Our engagement methodology as part of our network specialist approach is helping us expand our role as a trusted advisor with customers around the world. As you know, expanding our role in customer networks and our reach across markets is a critical element of our strategy, particularly as we pursue this multiyear opportunity. Our recently announced global partnership with Ericsson should further enhance Ciena's role and reach. It also validates, I believe, our best-of-breed Packet-Optical technology and our strategic positioning. Through a Packet-Optical distribution agreement, a converged IP optical joint development and distribution agreement, and SDN collaboration framework, this partnership creates the potential to increase our addressable market by significantly expanding the role we play in transforming customer networks, as well as our reach in terms of the number of customers to whom we have access. Early customer feedback has been very positive, and we believe this partnership is a leading example of how the market is evolving. Strategic partnerships between players who offer specialized expertise, working together across the network in an open ecosystem. It's a model that more customers are choosing, and it aligns perfectly with our network specialist approach to architecture and collaborative engagement. We continue to see this specialist approach as a competitive advantage today and over the long term, as it is deeply embedded across every aspect of our business. In fact, it is a fundamental driver of the markets' growing preference for Ciena -- a preference that is clearly demonstrated in our differentiated performance. In summary, our network specialist strategy is working in a changing industry structure. Our opportunity beyond pure optical is expanding, and we are executing well to take advantage of that opportunity. As a result, we remain confident in our ability to continue to gain market share, whilst absolutely improving operating leverage. I'll now call -- turn the call over to Jim.

Thanks, Gary. Good morning, everyone. I'll cover highlights of our first quarter performance. As always, I'll speak only to non-GAAP results. Please refer to this morning's press release for reconciliations to GAAP numbers. We continue to believe that the adoption of our approach and our increasing diversification are good measures of our steady progress in expanding our role and reach. In addition to the future benefits of our new partnership with Ericsson, we made good progress in both areas this quarter. In Q1, we saw a strong rate of adoption for both packet and OTN solutions. For example, our first quarter Packet Networking segment revenue was up 13% year-over-year and packet switching revenue on 6500 was up 15% compared to last year. Also, we are addressing increasingly diverse, high-bandwidth applications. We shipped 3x more packet capacity on 6500 than we did 1 year ago and 43% more packet capacity overall. We also continued to add customers for our OTN switching platforms in Q1. Compared to the first quarter of last year, we recognized more than double the revenue on our 5400 switching product. In terms of our financial performance, we saw continued momentum. Our overall revenue was strong at $534 million, representing an 18% increase over the first quarter of 2013. Orders were up 7% over Q1 of last year and, as expected, were slightly lower than revenue. As we have discussed before, our customer order flow is typically lighter compared to trend in our first quarter. Overall, however, we maintained good visibility into the business. We expect order flow to increase from Q1 and remain strong during 2014. We're very pleased with Q1's adjusted gross margin. At 43.4%, it was higher than expected, largely as a result of improved mix. Adjusted operating expense in the first quarter was $200 million, coming in lower than expected, primarily as a result of delays in certain R&D projects, which we now expect to occur in Q2. With an adjusted operating profit of $32 million, Q1's adjusted operating margin was 6%. We ended the quarter with $440 million in cash and investments. We conserved cash in Q1 because we built working capital. This is partly due to a back-end loaded quarter, which resulted in high accounts receivable and partly the result of a decision we made to plan for the strong and broad-based order flow we expect during the rest of the year. We are making a strategic investment to improve the velocity of the business. In response to strong overall customer demand and our desire to reduce lead times for Converged Packet Optical products, we made a deliberate decision to increase our levels of finished goods inventory for those products. We expect to continue to invest in this level of inventory during Q2. While this investment may result in more cash use short term, we do expect it to improve customer service levels and we expect to generate free cash flow for the full fiscal year. Turning to guidance for the fiscal second quarter of 2014, absent any significant changes in exchange rates, our guidance is as follows: For fiscal Q2, we expect revenue in the range of $540 million to $570 million; we expect Q2 adjusted gross margin to be in the low 40s, lower than Q1; we expect Q2's adjusted operating expense to be in the $210 million range. As we have discussed in the past, our OpEx spend does include some large project-related expenditures, particularly in R&D. The timing of these projects does lead to some variability in our quarterly OpEx. And as we stated earlier, some of those Q1 expenditures were deferred to Q2. Therefore, we expect OpEx in Q2 will be higher than the average for the year. That said, we continue to expect that the quarterly average for OpEx during the fiscal year will be approximately $205 million. We continue to expect that OpEx will grow at a rate that is lower than our revenue growth. With regard to other income and expense in the second quarter, we project an expense of approximately $11 million related to the interest on our convertible notes. We expect our tax obligation for Q2 will continue to be related solely to foreign taxes. As for share count, we estimate Q2's basic share count at approximately 105 million total shares. Diluted share count will vary depending upon your projections about our profitability. In closing, Q1 was an outstanding quarter for Ciena, and we expect 2014 to be a strong year. We have momentum in the market, and we remain confident that we will achieve the low end of our target range of 7% to 10% for adjusted operating margin for the full year. We are committed to capitalizing on the opportunity before us by expanding our role and reach in the market. And we are committed to continuing to deliver steadily improving financial performance. That concludes our prepared remarks. Richard, we will now open the line for questions.

[Operator Instructions] Our first question online comes from Tal Liani from Bank of America.

My question is about the comments you made on 2014. You speak about preparations for bigger orders and strong order trend in 2014. Can you give us the nature of these orders? What kind of products are you expecting? And is it in the high-margin bracket, low-margin bracket? And what is the nature of it? Are these kind of 100-gig migration projects or it's more Metro? Just to understand the composition.

Yes. Tal, thanks. It's really very broad-based. We expect strong orders across the product portfolio, both on the Converged Packet Optical side and the Packet Networking side. So really, it's very broad-based. It's U.S. and international. We did mention that we began Metro deployments with AT&T, and we expect that to continue for the year. One thing I'd say, just as a point that sometimes gets asked, we have now over 100 -- 100-gig customers and 170 Coherent customers overall. So we continue to make progress and gain customers for our flagship transport products. But again, just an overall, strong order quarter for the year -- our order for the year. I would say that the decision that we made about inventory related specifically to Converged Packet Optical, because over the past several quarters, we have seen higher demand in the quarter than we projected and that we built for.

So if I asked the same question in a different way, is your visibility or your confidence level into 2014 better than the confidence and visibility you had last year in the same point of time? I'm trying to interpret your comments and your willingness to spend money on inventory. Is this a sign of increased confidence of the trends and some deals that are close to be, closed or to be signed, et cetera?

Tal, this is Gary. Yes, I would say to answer that direct question, are we more confident now than we were 12 months ago, has it come through? I think the answer to that is yes. We've seen a steadily improving environment and our execution, I think we're confident in. So I think we're in a stronger position now than we were -- where we were 12 months ago. Hence I think we're comfortable making this kind of investment in the business. I would also say that we're confident in our ability to drive the operating leverage from this, too. So I think all of those elements come together. And I would reiterate what Jim said, it is very broadly based. I think we are seeing a shift towards the Metro. We mentioned AT&T, you've got CenturyLink, there's other customers there as well. So I think expanding our role and reach now, I think, is absolutely appropriate.

Our next question online comes from Amitabh Passi from UBS.

Jim, just a clarification on the gross margin guidance. Can you give us any help? If we looked at it on a year-over-year basis, do you expect fiscal 2Q gross margin to be higher than last year, in line, slightly lower? Just any help there.

As we've said before, Amitabh, gross margin is a difficult number for us to call because there are so many moving parts and things move in and out of our quarter in a way that's difficult to project. Finally, when you look inside the margin inside the products and look at the various elements in there, whether it's cards or chassis, it's just very difficult to project. We think, based on what's going to happen in Q2 and what the backlog looks like, that we will be down from Q1. But overall, we feel good about the long-term trend in our margins. If you think back to everything we've said about what's happening in our business, we've said we're going to drive operating leverage, and we think that we will drive operating leverage this year. If we get gross margin improvement, then it will be even better, but we don't necessarily have to have gross margin improvement in order to drive operating leverage this year.

Excellent. And just as a follow-up. I wanted to clarify your commentary around the 100-gig grab, that AT&T and the Metro. Was this the first quarter that you actually started ramping? Or is this something that's been now going on for a couple of quarters?

I think, specifically to the Metro, we called out that we are beginning that deployment with AT&T. In the Metro we're actually beginning -- the number of other customers too in terms of CenturyLink. We've not specifically said that it's 100-gig, but of course, 6500 is, of course, 100-gig capable. And in fact, in certain aspects of the Metro it's 400-gig capable, depending on the distance, even with the current iteration of WaveLogic. So I think it's really -- we intend it here as a highlight, there's a number of Tier 1s now moving out from the core into the Metro deployments. These decisions are being made this year, and we're actually seeing real deployments for this kind of converged architecture out of the Metro.

Our next question online comes from Subu -- Subrahmanyan from The Juda Group.

I wanted to ask about the packet portion in the 6500 that you're shipping being referred to that in the past. I just wanted to get a sense, Gary, of how much over OTN is really the packet functions, Ethernet, MPLS in the 6500 today. And then, Jim, on the operating margin comment. I wanted to clarify, it sounds like you're suggesting that to the 7% to 10% to be at the low end of that. You still -- through the year, expect that low 40% gross margin. Is that a fair characterization?

Subu, this is Tom. Maybe to start with the packet questions on 6500. We are seeing the packet content in that product line increase' in fact, it's up this quarter over last quarter. Kind of historically recently, about 25% of the shipment -- about 25% of the systems we've been shipping out are packet-capable. And we're seeing that trend continue and in fact, increase, as we move into the Metro. Now Gary mentioned as we move into the Metro that convergence is more important. That is -- that in fact, is true, as you get closer and closer to the end users, having that capability built-in to the platforms and Metro becomes more and more important.

Yes. And on the operating margin comment. I just want to clarify. Our guidance that we gave last quarter and that we have reiterated now is that the full year will show a number for adjusted operating margin in the low end of our range. But we're still confident about that. There's going to be quarterly fluctuations, as there always is, is -- in the numbers in our income statement, and we've always said that the best way of thinking about us is over half years or longer periods of time because there's going to be quarterly fluctuations. But with that said, we've always predicted our business that way. We've done what we said we were going to do.

Our next question online comes from Mark Sue from RBC Capital Markets.

Still trying to see, longer-term, the impact of the financial model as it relates to the deeper push into the Metro and also the partnership with Ericsson. These 2 things are somewhat new versus when the original operating margin targets were provided. So when we see the higher revenue base and we see an uptick in the Metro and also the time expansion and distribution expansion with Ericsson, should we intuitively think about more R&D spending, but more -- but less sales and marketing expenses? Just kind of how the mix shift of this $205 million per quarter run rate will change and the trend maybe not over the next few quarters but over the longer term as you get further traction in these 2 segments?

Mark, I'm going to address the OpEx piece of this and Gary's going to address the longer-term aspects. On the OpEx side, none of the things that we've talked about recently, whether it's the wins on the Metro or the Ericsson partnership, we think, have an effect on near-term OpEx in any significant way. There might be inside of our OpEx some movement between projects, but we don't expect that to impact this year's OpEx. If we look ahead and think about the fact that possibly the Ericsson partnership will bring us through customer engagements some need for additional R&D, then we'll make those decisions as they come. But we're still confident that we're going to grow OpEx at a slower rate than we're going to grow our revenue. And I think we're going to grow our revenue at a very nice pace, faster than whatever the market grows at.

So Mark, let me sort of -- I think you've got to separate the 2 things out -- obviously, the Metro and the Ericsson elements. I think on the Metro side, this is something we've been planning for many, many years. And we've, in fact, been investing in the whole 6500 concept is really a converged platform for both -- for all of the traditional segments into a converged architecture out into the Metro. So that's clearly not new to us. We've been spending and investing in that area for a number of years and been engaged with a number of customers. So I would say, we also internally have been viewing that Metro shipments would start at the beginning of 2014. So the reason we're calling it out is that we're actually are comforted that, that's on track. So that's completely within our plans, it's completely within our financial model. I would say on the Ericsson side, very early days. As we've said, we don't expect a large impact financially during 2014. We do obviously see it as being incrementally accretive to us as we go forward over the long term. Very encouraged by what we've seen so far, and I think it's also very consistent with our view of expanding our role and our reach over the long term.

Gary, if I can follow-up. One of the other things that we used to talk about was your architectural approach. Are you starting to see that more in terms of larger deal sizes, customers purchasing your equipment and software across a range of products? Just kind of maybe revisit that part of larger deals with your architectural approach.

I think we are seeing that. I think we're seeing it manifested in 2 ways. One, we're seeing larger deals -- some particular larger international ones that we've secured over the course of last 18 months, which I think talks to our architectural vision. I think what we're also seeing is that's manifesting itself in multiple engagements within large Tier 1s. So that architecture is being adopted across a wide array of the network. And so that's also consistent with us having broader and deeper engagements with many of our Tier 1 customers. And I think the Metro is an illustration of that. As you get into the Metro, you're actually getting closer to the service delivery, and therefore, you've got lots more opportunity to engage across a broad array of services with the customers.

Mark, one metric that we've been sharing with people over the last few quarters that sort of demonstrates that, is if you look at the number of customers in our top 20 that are multiproduct customers in any given order is, it's typically running 16 to 18 out of 20.

Our next question online comes from Ehud Gelblum from Citi.

A couple of questions. First of all, Jim, on the build-up in inventories. I want to go back to that for a quick second. Was that caused by a particular customer that, perhaps, gave you an opportunity to win a deal because you could differentiate on the time to deployment? And so you said, "Sure, I'll build up the inventory so you can do that." And allowed you to be able to add another customer or was that maybe from a couple of customers saying that or was that just kind of a general thought that you guys had that you wanted to speed that up over the last year end [ph] , so add inventory and it'll get more in-depth questions.

Definitely broad-based, Ehud. We've seen over the past several quarters that our ability to project 6500 demand has been less than great. We expanded it every quarter in terms of the need for customers as compared to our design build. And as a consequence, we think that we want to try to improve customer service overall. This is important in some aspects, particularly some elements of the market like the enterprise segment where lead times are very important. And so it's broad-based. It's not driven by any 1 customer, and we think it's going to help both our customers and the velocity of our business once we get this fully implemented.

Okay, that's helpful. I assume that it stays to that level. You obviously, won't have to build it, it don't take up new cash. But that working capital will stay roughly at that level as we go forward, right?

We always know that working capital as a percent of revenue is going to have to stay within a range. So as our revenue grows, our working capital will grow, right? I think that the one thing I do feel confident about is not just in our ability to drive operating leverage, but for the full year, we're going to drive free cash flow.

Right. Okay. Your other -- it seems -- things seem to be clicking now at AT&T and they have been for some time, but as the Metro starts going and I'm assuming the longhaul gets going at some point in the future too. Your other large North American customer fell -- didn't fall, but was sub 10% for the second straight quarter after being pretty big for a number of quarters in the past. How should we think about that opportunity as they kind of digest what you sold them in the past and take on another vendor? Is that something that -- we should see them hop back up again the next quarter or the quarter after that? Or not 'til we get into the end of the year and into 2015?

I think -- if you look at the North American landscape, you've got 4 or 5 very large Tier 1 players. And in fact, you've got Verizon. You've got CenturyLink. You've got Sprint. You've got Comcast. And many of them at any point come into the 10% range or fluctuate through that and we're actually selling multiple things, into -- back to the earlier point we're making, we're in multiple parts of their network. Specifically, I would disclose that Verizon was sort of our largest 100-gig customer for the quarter and was extremely close to 10% for the quarter. So it's going to fluctuate, but we're very confident in our position in these Tier 1 accounts, both in terms of our embedded base and in terms of the opportunity going forward.

That was very helpful, I appreciate it. Last comment on -- can you give us a similar update on Vodafone and how that build is going, the pace of that, and how we should see it lay out?

Without getting sort of too specific, it's a new relationship for us, that we were awarded late last year. We're continuing the rollout. It's going well. And I think there's a larger opportunity as well on the project spring, which is well publicized. And I think Ciena is in a good position to help, I think, execute with Vodafone over the next few years on a more global basis.

Our next question online comes from Mr. Brian Modoff from Deutsche Bank.

So coming along the lines of we were talking about an LTE Mobile World Congress, Deutsche Telekom is demonstrating 480 megs per-customer type data rates on 2-carrier aggregation. Talking to that other customer that was almost 10% of your revenues, they talk about having fiber deep into their network and out to almost every base station. How do you see the impact of LTE builds globally on your business into this year and into next year, particularly as they start to accelerate?

Brian, it's Tom. From the perspective of LTE, anything that tends to increase the amount of traffic on the network is a good thing for us. And it certainly will push a lot of the cell towers that aren't fibered today to be fibered. And as they get fibered, they get fibered for ethernet. So I think broadly that, that plays to our strengths. A couple of things we've done in the last year or so to make our products more friendly to a global LTE market, I think, will also be helpful to us. We've added some features in our carrier ethernet products, basically to make them more -- make them fit more easily into a backhaul network outside the United States.

And then if I can have a follow-on, can you talk a little bit about the impact of the upgrades you did in terms of your chip module? You talked about last quarter, there was a modest impact on your margins, WaveLogic 3 chip. Yes, how do you see that impacting your margins or helping your margins as you move through the year?

One thing I'll say right now, the lion's share of what we're shipping out in terms of Coherent today is WaveLogic 3. And we recognize that as we -- as the industry evolves, we need to continue innovation. That's one of the reasons we're on our third generation and beginning work on our fourth generation and those sorts of things. So where I would go with that is to say that most of what we're shipping in terms of Coherent today is WaveLogic 3.

Our next question in line comes from Mr. Paul Silverstein from Cowen and Company.

I'm going to apologize, I think I realized that if you may have already said this, I do apologize for your's and others' time. But first of all, the note [ph] you updated on the new wins for 100G, 40 plus 100 and then optical switching.

Yes, we didn't give that. But what I can tell you, we have 21 new 100 gig customers. We now have a total of 119 100 gig customers. And we have 170 total Coherent customers, continue to gain share and to bring customers to our Coherent products.

And Jim, also switching accounts, did that increase at all this quarter, the new ones?

It did. The number of...

I think we added 3 new customers, switching customers, during the -- [indiscernible] during the quarter.

Gary, that's up to 42 total, is that correct?

I think it's more IP. If you look at the 5400 now, we have almost as many 5400 customers as we had Coherent [ph] first customers. I think we're close to...

It's around 40. But -- both, around 40 customers.

All right. And that's more on the 100 gig. That's a big step, but I don't remember you all having a number that high with your 100 gig customers that's going to help you. But that's something, a big step up from previous quarters. [indiscernible] the question. All right. [indiscernible] is that -- is our tier 1s helping you choose which one you want or are these [ph] not getting down to small customers?

It's a pretty broad-based mix. I also point out that a lot of the 100G customers that we're saying are -- they're coming online at 100G, were prior 10 and 40G customers.

All right. I've got 3 quick questions. First of all, has it proved in stream [ph] since you started shipping your 100 gig, that if you had a 40-gig customer, almost all of that 40-gig customer is upon -- will simply equate to 100 gig that have great review? Or have there been a lot of instances where that 40-gig customer turn to one of your competitors, Huawei or you, whoever, for 100 gig?

I think it's been pretty unusual that we have a customer who is a current installed base customer for 6500 at 40 or 10, that wouldn't go to 100 on our equipment.

So [indiscernible] Go ahead, I'm sorry Jim.

I was just going to say that this is going to be an evolution, certainly, 100 gig has been an important product and great for us and great for our customers. But some customers, in certain parts of their network are going to stay at 100 -- 40 gig, some even are going to stay at 10 gig. It just depends on the customer itself. But as Tom said, losing the customer on an installed base is quite unusual for us.

So let's say you got another 50 additional customers that it looks like from accounts you did, that are 40 gig that haven't gone to 100 yet. If they get to 100, they're likely to go with you. That would be the read?

I think it's likely. That depends on -- there are all sorts of things in the daily discussions with customers that could change. But yes, I think it's likely.

All right, let me ask one last question. If I look at your total customer base, other than AT&T and Verizon, and if I've done the math right, it sounds like all those other customers in the aggregate grew by 16% year-over-year following, I think, a 17% or 18% growth in the previous quarter since your straight quarters of high teens growth. Do you have been -- I know you won't change the focus on Verizon exactly, like how did you build out of that. AT&T and Verizon of your size, I get it. But if you look at your non-AT&T and Verizon customer base, do you have -- the 2 quarters you just put out, is that extraordinary or consistent with the earnings you've announced in the last several quarters, with your Vodafone relationship, I don't mean to [indiscernible], but I'm trying to understand to what visibility about that type of growth in that 75% of revenue that comes from other than AT&T and Bell.

Paul, I think you highlighted a good element here around -- we're trying to build a broader, balanced business. And there are a lot of other customers, large Tier 1 customers, both in North America and around the globe that are now significant customers for Ciena. They might not feature over 10% because we're growing so fast, but our customer base is increasing significantly over the last 2 to 3 years. We have very large Tier 1 players internationally that are very meaningful to our revenue stream and also in North America as well. And I think the last couple of quarters highlights that.

All right. Gregg, I apologize, one last question. With respect to your Metro platform, are there synergies -- similar synergies? Just basically can you control plane [ph] , if not other synergies, for the long haul in the optical switching, et cetera? But are there meaningful synergies for a customer that's using one or more of your platforms, other platforms, that will lead them to upgrade with you -- will lead them to use you for Metro?

The answer to your question is yes. I mean, it's all part of a converged architecture, where you've got a single platform that can do multi functions what was classically called, long haul, OTN, et cetera. It's part of our open architecture, so you've got a single platform that can have multi functions and support multiple services. The economics of that are very compelling. So therefore, any footprint we've got on 6500 in any major carrier is an opportunity for multiple different kinds of sales.

Our next question online comes from Mr. Simon Leopold from Raymond James. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: Great. I had 2 generally quick clarifications and then a question. On the clarification side, if you could just talk a little bit about the increase in DSOs and a little bit more color in terms of the switch CoreDirector 5400 contribution in the quarter. And then what I was hoping we could really drill down a little bit more on would be the international trends. In this quarter, you had a steep sequential drop, but we know there's lumpiness. You've had, I think, a good progression of international. I'd like you to speak more to international as an opportunity and the color you could give in terms of international regions, international opportunities. And the bottom line is, I'm trying to get a sense of how does international grow relative to domestic in 2014?

Well, on the first point, Simon, I spoke to the fact that we had a back-end loaded quarter. And what that means is that we ship a lot of stuff in the last month of the quarter, given our typical acceptance terms. Even in North America in payment terms, if you ship in the last month of the quarter, it's very difficult to collect in the last month of the quarter -- before the end of the quarter. So as a consequence, we ended up with pretty high DSOs, much higher than we expect to see going forward. So I think it is -- hopefully, that's an anomaly. By the way, we always have back-end loaded quarters, so I don't mean to imply that we don't and we won't. But it was a particularly back-end loaded quarter, and that was the result -- that resulted in high DSOs. Expect it to go down as we move through the year.

And answering your question, Simon, around switching, we're still seeing our switching business grow. In fact, in this -- if we look at this quarter in 2014 versus this quarter in 2013, we're up about 74%.

On the international... Simon M. Leopold - Raymond James & Associates, Inc., Research Division: Was at 17%, Tom?

7-4. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: 74%. Okay.

Yes. On the international question, Simon, I think we're -- again, we're seeing broad-based opportunity. Regionally, I'd characterize it as Europe steady with a more positive outlook. I think that's specific to us around some of the wins that we've had there. I would say Latin America, Brazil, I would also say India, look very good markets for us for 2014. And we've already secured a number of key customers there that we're rolling out during the course of this year. In terms of North America versus international, I think we see growth in both, frankly, during the course of 2014. And that's part of our strategy around expanding our role and our reach, building a broader-based business. And I think it's also consistent with the architectural shift that we're seeing that these carriers make these kind of decisions to move to these next-generation networks. It's opening up particularly internationally opportunities for Ciena that were not there before.

Just one comment I'd make about the international versus the U.S. business, too. And we've alluded to this in the past, but they are quite different in terms of the time to revenue cycle. In North America, as a general comment, what we do is we ship and we recognize revenue. Outside of North America, we tend to be involved in broader network deployments, where we're actually doing the installation ourselves. And so we have to wait until we get to final network completion, acceptance and light-up, before we get to revenue. As a consequence, that means it just takes longer to get to revenue, generally speaking, outside of North America than it does in North America. And you can see that in our inventory levels in our deferred cost of sales. You can see that, that's high and that's mostly, in fact, almost entirely international.

Our next question comes from Mr. Kent Schofield from Goldman Sachs.

I would assume it's safe to say you have more visibility into your OpEx than you do to revenues. But there obviously is some variability, especially around the R&D projects like we saw last -- this last quarter. If you can -- can you talk a little bit about the R&D project pipeline and what that means to meeting your operating margin target? And then I do wonder a little bit if there is some of what you discussed on the international side of things, if that has an impact.

Yes. I'll address that, Kent. We've said before that we're going to average about $205 million this quarter, and we believe that to be true. I'd say that if you look at our annual operating plan, our OpEx tends to come in very close on an annual basis to what we project at the beginning of the year. Another case where we said what we're going to do for the year, and we've done that, and we expect to continue to do so. So on an annual basis, OpEx is well planned and planned out at the beginning of the year. There are times when, as a result of great performance, that we exceed incentive compensation targets, and so we get some variability for the year as a result of that. But again, as we've said, we have very good project -- forecast ability of operating expense on an annual basis. It's just that within R&D, and in some cases, other parts of our operating expense, it is project-based. The timing of the execution of those projects -- or completion of those projects is sometimes difficult to get to. But overall, on an annual basis, we do have a pretty good job of projecting. And everything that we've said about being confident in our ability to get operating leverage takes that into account.

I think you've been clear that it's the Ericsson opportunity, the longer-term opportunity. But when do you think it's fair for us to start peppering you guys with questions as far as traction there? Is it 2015? Do we have to go out into 2016? How should we think about when we should start to see some traction?

Kent, I mean, I think we'll provide commentary as we get to maybe towards the second half of this year. But I would think we begin to see some financial impact as we get through 2015.

Our next question in line comes from Mr. Michael Genovese from MKM Partners.

Two questions. First is on the Ericsson guidance. I just want to get more color on why we're putting off expectations for revenues from that deal until fiscal '15 given that when we ask Ericsson about it, they say they're super excited and their sales force is out there right now, pitching the product and trying to get deals done.

I'm very glad to hear that. Thank you, Mike. I think we're excited about it, too, and we see excellent opportunities for it, expands our role and our reach. And I think we -- the initial take, as I said, is the customer feedback has been very positive, too. Just from our experience, these things take time to secure and customer adoption cycles are not immediate. Therefore, by the time it shows up into our revenue, there's a lag there. Particularly, as Jim just highlighted, when you look at international business, even though it expands our reach, it does take time for those revenues to show up into our recognized financials. So that's why we're being a little more cautious around that. But you should not interpret that as lack of excitement on our part at all. I think it's just the reality of the agreement.

Great. And then the second question is about -- just if you could talk about the risks to CapEx this year. I mean, clearly, you're doing great with AT&T, and congratulations on the 6500 deal there. But given that they're the most aggressive in terms of transforming their network for NFV and SDN, if you could talk about that as a risk factor and also potential carrier M&A globally this year, just your views there.

Yes, I think -- this CapEx gets a lot of focus. And obviously, I can understand that. But I think the predominant issue for us, it's not about the absolute CapEx or the total aggregate growth, it's around what they spend it on. And I think what we're increasingly seeing is the spend towards this next-generation architecture, as the architectural shift gets -- gains momentum. So it's not in absolute terms how much any of these carriers spend, it's what they spend it on. And I think we are -- we saw it last year. I think we're seeing increasing momentum this year. They're spending less on legacy and more on the new stuff. And that's good for us, because that's where we've got our investments, that's how we've structured the company. Specifically around sort of software-driven networks, NFV, et cetera, that's all an opportunity for Ciena. That's absolutely consistent with our open architecture, which we launched about 18 months ago. And we've been diligently driving our R&D to deliver on some of those items that are pertinent to us over the last 18 months. So we're very well positioned for that. And frankly, the faster that shifts, the better for Ciena.

Our next question in line comes from Mr. Rod Hall JPMorgan. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Just a couple. I wanted to go back to the AT&T comment and just see if you guys could talk a little bit more about the structural nature of that deal. Is it -- are we talking about a structural decision similar to what we've heard from Verizon, where they're going to roll 100 gig in all their Metro areas? Or is there something more piecemeal than that? Can you guys just give us some idea on that? And then also just how that project progresses over time. It looks like it's pretty early stage, so, I guess, that runs for quite a while. And then also related to that, if you guys could talk about -- or maybe not really related to that, but could you talk about the inventory build related to specific deals versus just a strategic decision? I mean, are there some deals that are driving that inventory decision or is it really just a broad-based, strategic decision? And then the last thing, I wanted to see if, Jim, could you just update us on the order backlog? I know it was about $1 billion exiting Q4. Could you give us any sort of color or update on what the backlog looks like now?

Rod, who don't I take the first one. I don't want to get too specific around individual customers. We called out a couple today, really, to illustrate this trend towards the Metro. I wouldn't like to say too more than that. It's very aligned with our architectural vision and what's happening in terms of the shift that's going on across the board. And I think more and more Metro adoption, people like CenturyLink, et cetera, I think it's just testament to that architecture becoming a reality.

Yes. And on the inventory question, this question came up a bit earlier. It is certainly a strategic decision based around a broad-based belief that we're going to have strong order flow on the Converged Packet Optical products this year. And as I said, the demand for 6500 has continued to grow faster than we have projected. And as a result, we haven't always, every quarter, been able to meet customer demand for that product. This decision that we've taken is an attempt to get to where we're serving customers better, improve lead times, increase and improve our customer service levels. On the backlog, the backlog did go down a bit in the first quarter. We did say that orders were less than revenue, pretty much as we expected. We do think that we'll have strong order flow for the rest of the year, so I don't derive any discomfort about the fact that it did decrease a little bit in Q1. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Can you quantify it at all, Jim?

No.

Our next question in line comes from Dmitry Netis from William Blair. Dmitry Netis - William Blair & Company L.L.C., Research Division: Hate to beat the dead horse to death on the AT&T opportunity. But just a clarification there, I know you didn't quantify whether it was 40G or 100G.

Yes, we have not deliberately -- that's up for the customer themselves to talk about. I'd say that 6500 is obviously 100 gig ready, and in fact, 400-gig ready in keeping with our overall architecture. But it wouldn't be appropriate for me to go into any more detail on that, frankly. Dmitry Netis - William Blair & Company L.L.C., Research Division: Okay. And then are there other vendors involved in this Metro deployment? Or is it just exclusive to you?

Again, I think that's -- that wouldn't be appropriate for me to comment on, I think. But the point that we're trying to highlight there, and I think we called out CenturyLink and a couple of others about a quarter or so ago, is really the shift towards the Metro opportunity, generally, across the globe, we see as a larger opportunity than just the core of the network. And I think that's what's driving a multiyear opportunity for us across multiple carriers as we get this architectural shift from a multiple networks down to a single, multiservice architecture. And that's really what we're highlighting. Dmitry Netis - William Blair & Company L.L.C., Research Division: Okay, I appreciate that. But could I just ask about the 100G long haul with AT&T, I mean, and the timing of that? I know that...

Dmitry, honestly, I think it's inappropriate for me to talk about that. Yes, [indiscernible] sorry. Dmitry Netis - William Blair & Company L.L.C., Research Division: Understood. Let me just ask a couple of more quick ones here. On the Packet Networking...

I have time for a couple of them. Dmitry Netis - William Blair & Company L.L.C., Research Division: Just real quick ones. On the packet networking, I appreciate it was up 13% year-over-year, but it did go down 16% quarter-over-quarter. Was this related to a specific project? I mean, some color you can provide with what really we should be expecting out of this product?

I wouldn't -- no, Dmitry I wouldn't read too much into that. I mean, I think you may see some ebbs and flows. It's not always going to be linear in each area here. And I think also, this quarter is a challenging one for deployments because most carriers don't like to deploy in December or in January, and they take -- a lot of that packet stuff is really out of the edge of the network. So there's not that many deployments, and I think it's more attributable to that. In fact, I think it's probably going to be up in Q2. Dmitry Netis - William Blair & Company L.L.C., Research Division: And then last one for Jim, real quick, on the other income loss, I think you had this additional $6 million loss on that line. I think that contributes to roughly $0.05 dilution in earnings. Could you explain where that's coming from? And I think you guided for $11 million interest expense going forward. So does that imply we shouldn't be seeing that additional $6 million of interest expense, potentially, that you saw?

Yes, the other income and expense amount in Q1 was related to FX. And in particularly -- in particular to Brazil, where the Brazilian real did diminish against the dollar pretty significantly for the year. It's a balance sheet translation effect and it really results in the fact that we now have assets, in some cases, sitting out in foreign currencies. As we expand our role and our reach around the globe, I think you're going to see potentially some FX effects. We are getting more active in hedging these risks. And so hopefully, we'll control them going forward. But that's what it is.

Our final question comes from Mr. Martin McKechnie from Evercore Partners.

Right at the edge here, they better be brilliant questions. But the question I have is probably for Gary and Tom on the Metro. Can you confirm, I've always looked at it as around 3x the size of the long-haul opportunity, so maybe develop that a bit? And the margin profile for that, I think we're looking for better packet content there. And then, I'm sorry, the 2 other ones would be quick ones. DSO is up. You have a lot of guys ask questions there, but -- is would you expect the April quarter -- all quarters are a bit back-end loaded for you, but the April quarter a little less so. And then finally, Jim, if you could talk about the R&D project that we had the uptick, that pushed the spending into April.

Okay. Mark, thanks. On the DSOs, I would predict that over the year, that's going to come down. The first quarter was particularly back-end loaded more so than we've seen. As I say and as I've said, we've always had some back-end loading to the quarter. It's just the way our business works. But first quarter was particularly back-end loaded. So I expect that to improve as we move through the year. And the...

The R&D.

The R&D. Without getting into the specific projects, we have -- we spend almost $400 million a year or so on R&D. There are a lot of projects inside there, some of which are quite large, and they consist of prototypes. We have third-party services, they're involved in these things. Our ongoing employee expense is very predictable, and we know where it's going to be. But with respect to third-party services, with respect to prototypes, things move around. We feel good about adherence to our roadmap for the year. So nothing that's happened in Q1 gives us any cause for concern about our roadmap progress. It's just that a couple of things that expected to get done weren't finished. That's it.

Mark, I'm going to take the Metro question. I think in broad terms, it's difficult to scope out in terms of absolute sizing. But I think, directionally, 2x to 3x is not unreasonable -- the opportunity in the Metro versus the core. I also would concur in a margin expansion opportunity over time as well. I think, particularly, as you put more functionality in there, clearly, more packet capability, more OTN, more switching capability. And also, I think there's an opportunity for some NFV-type capability as you get to the edge of the network as well. So that is part of our opportunity from a financial model point of view to drive leverage over time and to improve our gross margins over the long term.

Thanks, everybody. We're going to conclude the call now. Appreciate your time. And again, we look forward to seeing everyone in New York at the New York Stock Exchange for investor day on April 3. Thanks again.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.