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Ciena Corporation (NYSE:CIEN)
Q4 2018 Earnings Conference Call
Dec. 13, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to Ciena Fiscal Fourth Quarter and Year End 2018 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press *1 on your telephone keypad. If you would like to withdraw your question, press #. Thank you. Gregg Lampf, Vice President, Investor Relations, you may begin your conference.

Gregg Lampf -- Vice President, Investor Relations

Thank you, Sharon. Good morning and welcome to Ciena's 2018 Fiscal Fourth Quarter and Year End Review. With me today is Gary Smith, President and CEO, and Jim Moylan, CFO. Both Scott McFeely, our Senior Vice President of Global Products and Services, and Rick Hamilton, our Senior Vice President of Blue Planet, will join us for the Q&A portion of today's call.

In addition to this call and the press release, this morning's report includes prepared remarks that were made available earlier today on the Investors section of our website. We have also posted an accompanying investor presentation that reflects this discussion as well as certain highlighted items from the quarter and fiscal year. Our comments today speak to our view on current market dynamics and how we're addressing the opportunity in front of us, our Q4 and fiscal 2018 performance, and include a discussion of our long-term financial targets and near-term outlook.

Before turning the call over to Gary, I'll remind you that during this call, we'll be making certain forward-looking statements. Such statements, including our guidance and long-term financial targets, are based on current expectations, forecasts, and assumptions regarding the company and its markets that include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed in our most recent 10-Q filing and in our upcoming 10-K filing. Our 10-K is required to be filed with the SEC by January 2nd, 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. With that, I'll turn it over to Gary.

Gary B. Smith -- President and Chief Executive Officer

Thanks, Gregg, and good morning, everyone. Today, we reported a remarkable year of performance in 2018, with outstanding fiscal fourth-quarter results including revenue, gross margin, and operating margin that were particularly strong. For the full fiscal year, we delivered sustained industry-leading growth and profitability, including double-digit percentage revenue gains and 22% growth in adjusted EPS.

This differentiated performance is driven by the consistent execution of our strategy. Our unique ability to successfully design and carry out a strategy to diversify the business, drive the pace of innovation, and leverage our global scale has given us a clear and accelerating market leadership position. The fundamental demand drivers for our business remain very strong. Specifically, the cloud providers continue to invest in network infrastructure assets to drive their business. And here, we are operating from a position of strength, with more than 40%-plus market share in the global web scale DCI market.

Our outlook for Asia/Pacific remains very positive, with a broadening set of growth drivers in the region and continued strength in key markets. Additionally, new initiatives related to fiber densification like 5G and fiber deep continue to drive new investment strategies from service providers and cable operators alike. And, we're seeing increased interest from service providers for software automation of these networks.

We have made significant long-term investments over several years to address customer needs in these high-growth markets and applications, and as a result, we are benefiting from that strategy and investment and believe we will continue to do so going forward. Executing on that strategy includes pressing down on our technology leadership and investment capacity. Key to that is the adaptive network, our vision of the new target end state for network operators. This vision includes programmable infrastructure that leverages our industry-leading WaveLogic coherent technology.

In addition to our modem current technology, our wins here are often driven by our roadmap, which extends beyond 400G and delivers multiple form factors, and our customer is confident that we will execute as planned on this roadmap. The adaptive network also addresses the shift in IP infrastructure away from the core toward access and aggregation, which includes supportive coherent optics and multiple new purpose-built hardware platforms in our packet networking portfolio. Also critical in delivering the full potential of the adaptive network is the software control and automation capabilities of Blue Planet, and as you know, we've invested heavily to build a comprehensive software automation suite and service delivery capability that enables our customers to scale their networks while bending down their cost curves.

As we enter fiscal 2019, Blue Planet will operate as its own division within Ciena. This formation enhances our ability to support a range of consumption models by allowing the software business to operate independently of our hardware business, where it makes sense. Along with this change, we will further break down the revenue in this operating segment to provide greater clarity into the performance of our automation business, and you can see this in today's press release.

The adaptive network vision is transforming the conversations we're having with customers, allowing us to demonstrate the holistic value of our portfolio and enabling our customers to more clearly see how they can evolve their networks. With that, I'll now turn over to Jim to review today's results in more detail and discuss our long-term targets. Jim?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Thanks, Gary. Good morning. Q4 was a strong end to fiscal 2018. Total revenue was $899 million. Q4 adjusted gross margin was 44.7%. Adjusted operating expense in the quarter was $278 million due to higher variable compensation tied to our strong performance. Adjusted EPS was $0.53. Adjusted operating income was $124.7 million or 13.9% adjusted operating margin. And, we again had record orders in the quarter, with bookings significantly greater than revenue, and we finished the year with $1.26 billion in backlogs.

Our performance in Q4 was a direct result of the continued momentum across our business. We are benefiting from both our leading market position and from strong demand, both of which we expect to continue going forward. Also, in anticipation of our adoption of ASC 606 in fiscal 2019, we've adjusted certain terms and conditions of a number of customer contracts. This resulted in a one-time approximately $16 million benefit to revenue and to gross margin in the quarter. This one-time revenue will not be repeated in future periods. And, to be clear, absent this dynamic in the fourth quarter, our results still would have been above our guidance range.

With respect to our performance for the full fiscal year, last year at this time, we shared how we intend to manage the business and what to expect over the next three years through a set of long-term financial targets. In fiscal 2018, we achieved outstanding results against those targets. Annual revenue was up more than 10% from fiscal 2017, which was significantly above our target growth rate of 5-7%. Adjusted EPS for the year was $1.39, which exceeded our targeted 14-16% annual growth rate. Free cash flow generation for fiscal 2018 was $162 million, or 48% of adjusted operating income. While this was slightly below our target range, we remain confident in achieving our long-term goal.

And finally, adjusted operating margin for fiscal 2018 was approximately 11%, and we are confident that our 15% adjusted operating margin on an annualized basis is an achievable goal. This overall performance is a direct result of our focus on leveraging our leading technology and relationships to win new customer footprint and incumbency and drive long-term market share gains.

Following our strong 2018 performance, we will now provide a new set of three-year targets that reflect the performance of our business during 2018 as well as our current estimates of market growth. As we continue to focus on both top-line growth and bottom-line performance, we believe the most important indicators of our progress going forward will be revenue growth and adjusted EPS growth.

With that in mind, we believe we will continue to gain footprint and take market share. As a result, we have a new, higher target for annual revenue growth. We now expect to average approximately 6-8% revenue growth over the next three years. With respect to operating margin, through projected revenue growth and disciplined operating expense management, we expect to achieve at least 15% adjusted operating margin for fiscal year 2021. We will remain focused on driving increased profitability.

Given our expectations for higher growth and continued operating margin improvement, we have increased our target for adjusted earnings-per-share growth. We now expect to grow our EPS at an average of greater than 20% per year over the next three years. Finally, we continue to target annual free cash flow generation to be approximately 60-70% of adjusted operating income over each of the next three years.

We've also revised the three-year targets associated with the strategic drivers that underpin our summary financial targets. Specifically, we continue to target annual revenue growth for our optical systems business to be approximately 4-6% over the next three years. We also continue to target annual revenue growth for our global network services business -- what we call "attached services" -- to be approximately 4-6% over the next three years. In our packet networking business, we are increasing our expectations for this portfolio to target annual revenue growth of approximately 8-10% over the next three years. And, given the changes in our software and services business, we are providing new long-term targets that align with how we are organizing this business.

In our printed script, which we published earlier this morning, we stated that going forward, we will book our software segment reporting -- we will break it down into two revenue lines: platform software and services and Blue Planet automation software and services. We're giving targets for each of these revenue elements. Specifically, we are targeting annual revenue growth from platform software and services of 4-6% over the next three years, consistent with the expected growth rate of our correlated optical systems business. For our Blue Planet automation software and services, we are targeting $100-120 million in annual revenue in 2021, beginning with approximately $50-60 million in fiscal 2019.

I'd also like to provide a view into our expectations for fiscal year 2019. We expect to generate revenue at approximately the midpoint of our three-year target range of 6-8% annual growth. For the year, we expect to deliver adjusted gross margin in a range of 42-43%. We also expect to report adjusted OpEx in the range of $255-260 million per quarter. And finally, for our fiscal first quarter 2019 performance, we expect to deliver revenue in a range of $745-775 million, adjusted gross margin in the 42-43% range, and adjusted operating expense of approximately $255 million.

I'll now review the balance sheet in our capital allocation activities. We settled our 2018 convertible notes, with the majority being paid in cash upon conversion. With the recent performance of our stock price, we also exercised our option to convert the 2020 convertible notes, settling them with a combination of shares and cash. As a result, we now have no convertible debt on our balance sheet. We also refinanced our existing term loan, increasing it to $700 million, extending the maturity to 2025 and reducing our cost of borrowing.

In addition, we successfully executed our plan to return capital to shareholders. During fiscal 2018, we repurchased 4.2 million shares for an aggregate price of approximately $111 million. We have also changed the method of tax withholding on employee equity awards to use cash instead of selling shares, which further reduces shareholder dilution. Given our strong balance sheet and our expectations for cash generation over the next three years, today, we announced that our board of directors authorized a new program to repurchase up to $500 million of our common stock starting in 2019 and extending over the next three years or so. We expect we will repurchase approximately $150 million in Ciena stock during 2019. This replaces the existing program, but it does not change our overall capital allocation priorities or our previously stated intent to retain minimum liquidity in the $700-800 million range.

In closing, our business is built for and focused on the trends that are driving the market today and into the future. We've demonstrated the sustained ability to capture market share, and our strategy positions us extremely well in both the current and the expected market environment. Through continued execution, we expect to be able to invest in our business, grow revenue, and drive increased profitability in fiscal 2019 and beyond. Sharon, we'll now take questions from analysts.

Questions and Answers:

Operator

At this time, I would like to remind everyone in order to ask a question, press *1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. And, your first question comes from George Notter with Jefferies. Your line is open.

George Notter -- Jefferies and Company -- Managing Director

Hi, guys. Thanks very much and congrats on the terrific results. I guess I wanted to ask about the competitive environment out there. Obviously, there's been some dislocation with some of your competitors in North America, and obviously, even some of the Chinese guys, I think, are potentially looking to have some issues with U.S. relationships. If I just step back and look at the competitive environment, I look at your opportunity to take market share, it seems very robust, and I'd love to see what your thoughts are on that front and how you think that translates into share gains going forward.

Gary B. Smith -- President and Chief Executive Officer

Thanks, George. Appreciate it. I would say in both of those, there's elements -- these kinds of dynamics have been around for a little while, and I think you're beginning to see that show up in our performance over the last couple of years. Frankly, in the revision that we've had for the forecast and the targets, rather, for the next three years, that's sort of encompassed in that, and I think that will continue to play through. We're clearly in a very strong position, both from an innovation point of view, a global scale point of view, and in what I would term this flight to quality, frankly. It's large carriers, web scale, and folks that really want to connect their data centers and want to understand that they're dealing with a player that has sustainability and can continue to innovate and support them, so I think they're incredibly positive dynamics for us showing up in our financial results and in our forecast for the year.

George Notter -- Jefferies and Company -- Managing Director

Got it. And then, just one follow-up. I assume that M&A is off the table to some degree. I'm just looking at some of the balance sheet changes you guys have made with the converts, and also the new repurchase program. I assume you guys are looking at nothing from an M&A perspective that we should anticipate going forward.

Gary B. Smith -- President and Chief Executive Officer

Obviously, nothing that we're talking about now. I wouldn't rule out that. I think as we look at our balance sheet, we still retain flexibility to look for those kind of opportunities if they're appropriate, but now, we're at a point with our balance sheet where we can take a balanced approach to it. Jim, I don't know if you have any thoughts on it.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

I'd say our balance sheet has never been in the shape in which it stands today. We've also been upgraded by the rating agencies several times over the last couple years. So, in addition to what's showing on our balance sheet, we have a lot of flexibility and a lot of ability to take down capital if we choose to for opportunities, so we'll continue to look.

George Notter -- Jefferies and Company -- Managing Director

Got it. Thank you.

Gary B. Smith -- President and Chief Executive Officer

Thanks, George.

Operator

Next question comes from John Marchetti with Stifel. Your line is open.

John Marchetti -- Stifel Financial -- Managing Director

Thanks very much. I just wanted to touch base real quick on the outlook on the gross margin side. You'd think, with some of the upside that we're seeing in revenue and some things like that, that we'd get a little more benefit to those gross margin lines. Just curious if you can walk through a little bit of the puts and takes there, and what you're seeing from a pricing environment or things like that that maybe weighing on that a bit.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Well, just to be clear, our costs per unit of capacity are variable, so we don't really get a big volume effect on gross margin. At the margin, yeah, we get a slight effect on gross margin as we get higher volumes, but for the most part, our gross margin is determined by our contractual prices, and what we've done over the last year or two is we've seen a lot of opportunities to take share.

And so, we've done that, and sometimes, when we're taking share, particularly if we're taking out an incumbent, we're going to take some one-time costs or early stage lower gross margins with the idea that over time, we will get back to a good gross margin on those contracts, and by and large, we've done that over and over again. As we look into this year, we are still enjoying the effects of some of the early stage gross margins from the deals we won last year, and we expect to see some more wins this year. So, I'd say that right now, our gross margin is in the 42-43% range, and that's what we've guided to.

John Marchetti -- Stifel Financial -- Managing Director

Okay. And, maybe as a quick follow-up to that, is there a big change margin-wise from a mix perspective as you continue to push in the DCI market and things like that? How should we think about that weighing on margins relative to something in the optical networking group?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Our gross margins across verticals are not that dissimilar. These are all big companies; they have the same choices to purchase from, and the competitive dynamic applies in all of those verticals. We do have higher gross margins on things like packet networking, and software, and those related services, but our optical and packet networking margins across verticals are not too dissimilar. Now, early stage gross margins of projects are lower than later-stage gross margins of projects, so that, we do see. It's a mix issue there.

John Marchetti -- Stifel Financial -- Managing Director

Thank you.

Operator

Next question comes from Simon Leopold with Raymond James. Your line is open.

Simon Leopold -- Raymond James -- Analyst

Great. Thanks for taking my question. Two things I wanted to check on: First, if you can offer any kind of update on progress on CenturyLink. That's been a bit quiet. And, from a longer-term perspective, I guess it's been well publicized that a number of your competitors are coming to market during 2019 with 400G and perhaps even 600G solutions. Clearly, you've enjoyed a time-to-market advantage at 400G. How do you see the dynamic playing out with that particular availability changing in 2019 from competition? Thanks.

Gary B. Smith -- President and Chief Executive Officer

Thanks, Simon. Let me take the first part of that. Obviously, I don't want to comment on specific customer RFPs. However, I would say that our adaptive network vision is incredibly well aligned with where CenturyLink wants to take its network. I would also add that we've recently refreshed our contract with them, and we expect to continue expanding our relationship with them, and that is reflected in our outlook that we talked about today.

Scott McFeely -- Senior Vice President, Global Products and Services

And, Simon, it's Scott McFeely. Thanks for the question. On the optical competitive landscape, I'd just maybe offer this. I think looking back in the rearview mirror, we have a track record of delivering market-leading capabilities when it comes to coherent optics. We have an extremely competitive forward-looking roadmap, and we're very aware of the claims in the marketplace of our competitors in terms of their future roadmaps as well.

Taking all that into account, we're very confident that we're going to continue to take share in the optical parts of our business, and probably more important than how we feel is how our customers feel. This customer group is a very sophisticated set of buyers. They're very aware of the roadmaps in the industry. They make buying decisions not just on points in time, but on a much more sophisticated set of criteria, top of mind of which is forward roadmaps and their belief in ability to execute those roadmaps, and I'd say if you look over the last couple of quarters in particular, more and more of those folks are voting toward Ciena.

Simon Leopold -- Raymond James -- Analyst

And, just to clarify, the gross margin guidance you've offered -- does that assume some gross margin pressure from these competitive forces?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

We're trying to give our best view of gross margin going forward, taking into account everything we're seeing in the market today, Simon.

Simon Leopold -- Raymond James -- Analyst

Thank you very much.

Operator

Your next question comes from Paul Silverstein with Cowen. Your line is open.

Paul Silverstein -- Cowen and Company -- Managing Director

Thanks, guys. A handful of discrete questions. First off, can you characterize pricing environment and have you seen any change in pricing behavior from Coriant/Infinera? Secondly, Gary, I think you've made comments in the past -- including the last earnings call -- about a number of carriers in Europe and elsewhere being full up with Huawei above and beyond the current-year political environment in terms of U.S. vis a vis China and recent actions by the U.K., Japan, and other regions, but can you comment -- are you seeing any benefit, or is it too early?

And then, in your guidance, you have commented in the past about AT&T and Verizon. What are your expectations -- what do you have embedded in the guidance? Finally, there have been concerns in the investment community about web scale CapEx. Can you make any comment on your outlook? I trust from your guidance that there's been no change. I recognize we're talking DCI, not intra-data center, but any insight would be appreciated. Thanks, guys.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Paul, that was four questions.

Paul Silverstein -- Cowen and Company -- Managing Director

Yeah, but they're all very discrete, Jim.

Gary B. Smith -- President and Chief Executive Officer

Let me run through the first one. On the pricing environment, overall, the dynamics that we're seeing are not new, and so, I would say no real changes in the overall pricing environment. You've still got some very desperate competitors out there, and that dynamic is still in play, but as Scott commented, I think it's now about a flight to quality, and folks that are going to be around can sustain their roadmap and have got global scale, so that dynamic has not particularly changed.

Regarding the European commentary around some of the China competitors, again, I would say that that dynamic has been in play as it relates to us, actually, for quite a while, not withstanding the publicity of the last few weeks. And so, that really has been baked into some of the wins that we've already had. I think, really, about rebalancing of the market and the customers in some of those dimensions combined with what I would describe as this flight to quality and sustainability and innovation. So, we haven't seen any particular change in that. I think that's been under way for a while. Regarding Verizon, we had a strong year with Verizon this year, and I would expect a strong year in 2019 as we expand our relationship with them. Thanks, Paul.

Operator

Next question comes from Tal Liani with Bank of America. Your line is open.

Dan Bartus -- Bank of America -- Vice President

Hey, guys. This is Dan Bartus on for Tal. I appreciate you taking the questions. I wanted to focus mine on the packet networking business and the increase in your outlook from 6-8% to 8-10%. Maybe you can just speak about any color of what you're seeing in the markets to raise that. Maybe it's somewhat 5G-related. And then also, just generally, that's very strong growth versus what we're seeing in other networking areas -- for instance, routing -- so, if there's anything you can call out in terms of why that growth rate's deviating from other networking market trends, that'd be helpful as well. Thank you.

Scott McFeely -- Senior Vice President, Global Products and Services

Tal, thanks very much. It's Scott McFeely.

Gregg Lampf -- Vice President, Investor Relations

It's Dan.

Scott McFeely -- Senior Vice President, Global Products and Services

Sorry, Dan. I think if you look forward from our packet networking business, it's probably important to actually understand where we're coming from as well. So, we've been working really hard to actually diversify that business outside of the dependency on a fairly concentrated set of accounts, and we've made great progress on that in 2018, so part of our forward projection is to leverage and take advantage of that work that we've done in '18. But, if I look at broader industry dynamics, the opportunity to drive fiber densification and to the access network driven by things like 5G and fiber deep in the MSO space gives us great opportunity. That drives a new set of platforms and a new set of capabilities, including integrating coherent optics into these platforms. It starts to move that market into a place where we have more strength. I think those are the key dynamics that we see looking forward.

Dan Bartus -- Bank of America -- Vice President

Okay, good. Thanks very much.

Operator

Next question comes from Jim Suva with Citi. Your line is open.

Jim Suva -- Citi Research -- Analyst

Thank you very much, and congratulations, and thanks for all the color so far. Can you give us a little bit of an update on the web scale and non-telecom-related markets? I think last quarter, you saw some very strong growth there, so just curious about how that's going. And then, a different but unrelated question is in the past cycles -- going from 2G to 3G, 3G to 4G -- there's been a pause before the major rollout. Any sense on should we expect that to happen? It appears on your results that it looks different this time, and if so, why would that be the case? Thank you so much.

Gary B. Smith -- President and Chief Executive Officer

Jim, I'll take the first part of that. Our non-telco business continues to prosper and expand, and I think in '18, we ended up at about 35% of our total business is now non-telco -- obviously, the web scale folks being the largest element of that. Our perspective on the whole web scale and sustainability around that is -- and, Scott touched on this -- their CapEx -- we've got good visibility to that, and I think that continues to be strong, both in terms of their data center connectivity broadly, and also in their submarine markets, which were strong as well. So, I think in the order backlog that we have, the roadmap alignment that we have with them, the CapEx discussions that we're having with them, I think we have pretty good visibility to that, and I think it's very sustainable.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

And, on the question of pausing, what I'd say is that we've been first to market with every generation of coherent optical technology, and so, as a consequence, we really haven't seen any big pauses as we've moved from generation to generation. Some of our competitors have seen pauses as they worked hard to get to whatever we had in the market. And, the other dynamic that's going on for us is that the first and most aggressive consumers of the next generation of optical capability are the web scale guys because many of their connections are relatively simple. They don't have big metro networks yet, although they probably will, and so, it's just easier for them to adopt new generations, and their certification cycles are quicker. As a consequence, we don't expect to see any sort of pause in our results as we go to WaveLogic 5.

Gary B. Smith -- President and Chief Executive Officer

The other thing I would say as well -- the other dynamic in play here -- is diversification of geos and markets. You've got different markets at different evolutionary parts of their lifecycle, and I think that's playing through as well given our very diversified geographical spread and scale.

Scott McFeely -- Senior Vice President, Global Products and Services

And, I think you also asked a bit about the wireless side of this -- the 4G to 5G transition in wireless. For our business, it's a little bit less about that and more about the fundamental drivers behind that, which is bandwidth and user experience, and the response to that is actually more fiber, and that drives the need for coherent optics, so that's really what's driving our business more than necessarily the wireless standards.

Gregg Lampf -- Vice President, Investor Relations

Thanks, Jim.

Jim Suva -- Citi Research -- Analyst

Thank you so much for the detail. It's greatly appreciated. Thank you.

Operator

Next question comes from Rod Hall with Goldman Sachs. Your line is open.

Ashwin Gupta -- Goldman Sachs -- Managing Director

Yeah, hi. Thanks for taking my question. This is Ashwin on behalf of Rod. I was wondering if you guys can comment on opportunity in India in fiscal '19. Obviously, strong growth this fiscal year. How are you thinking about that next year? And then, North America revenue looks like it kind of vacillated throughout fiscal '18. How are you thinking about that in next year as well?

Gary B. Smith -- President and Chief Executive Officer

Let me take the India one. Obviously, we've had a strong run in India with very good growth, and I think it's probably close to about 10% of our total revenues, actually, in '18. Obviously, you can't keep growing at that kind of growth rate, but we still expect growth out of India as we go forward. We've got a very diversified base there -- all of the major carriers, plus the government, the Department of Defense network, and we're very much aligned with all of the web scale activity there, and as you know, it's the fastest-growing internet market in the world. So, we do absolutely see growth. It ebbs and flows from quarter to quarter, but as we look at '19, we're still going to see pretty good growth out of India.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

And, on North America, we've had good years. It's been driven by GCN growth. Our GCN direct sales were up over 100% from '17 to '18. We think that that will continue -- we won't grow at that rate again, we don't believe, but we'll have a good, strong year with GCNs in 2019. But, we also think that service providers in North America will come on stronger as we come into 2019, so we expect a good year in 2019 in North America.

Ashwin Gupta -- Goldman Sachs -- Managing Director

Thank you.

Operator

Your next question comes from Samik Chatterjee with J.P. Morgan. Your line is open.

Samik Chatterjee -- J. P. Morgan Chase -- Vice President

Hi, good morning. Thanks for taking my question. I just wanted to dig into the optical systems group. When I look at the fiscal year '18 performance, that appears to be the group where you had the most upside driving your strong performance this year. When we look forward into your new three-year targets, we're not really seeing an increase on that front, while you've spoken about market-share wins continuing into next year. So, I'm just wondering -- is there more you need to see in terms of market share wins to change the guidance there or increase the guidance there, or is there -- why is the guidance remaining the same when you've seen this upside in FY '18?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

We grew our optical business over 10% -- double digits -- in '18, and that's a great performance. We're going to continue to have good performance out of optical. We don't think that 11-13% is a sustainable long-term growth rate for optical. We'd love for it to happen. It was driven on the backs of GCN performance -- the 100%-plus growth we had in GCNs -- and we just don't think those kinds of growth rates can continue, but just to remind you, we did increase our overall revenue growth rates from 5-7% to 6-8%, so we see good times ahead.

Gary B. Smith -- President and Chief Executive Officer

Samik, I would just add the context for that around the optical market -- the growth rate that we think on the optical market is probably in the mid-single digits, 5-6%, something like that. So, we are still planning on taking market share here going forward.

Samik Chatterjee -- J. P. Morgan Chase -- Vice President

Okay. Can I quickly clarify on the gross margin guidance? You guided to a fiscal year '19 of 42-43%. Do you specify guidance for fiscal year '20 or '21 embedded in your operating margin guidance?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

We haven't given that sort of guidance, but we have given you EPS guidance for three years, we've given you cash flow guidance, and we have given you...what's the other piece that we gave?

Gregg Lampf -- Vice President, Investor Relations

Revenue.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Revenue. So, we've given you a lot of facts about our three-year targets. Now, I will say this -- oh, we said we're going to have operating margin of at least 15% in 2021. I would say this: Because our growth rate is higher than we expected it to be and we expect some very disciplined OpEx management as we move through the next few years, getting to a 15% or so operating margin target can be accomplished -- we believe -- at gross margins below the 45-46% range that we had been talking about. So, we still target to get to 20% in 2020, but we won't get there by a gross margin --

Gregg Lampf -- Vice President, Investor Relations

I think 15%.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Excuse me, 15%operating margin in 2020, not 20%. But, we'll get there, again, by higher revenue growth and by a lower percent of OpEx to revenue.

Samik Chatterjee -- J. P. Morgan Chase -- Vice President

Sure. Thanks for the color.

Operator

Next question comes from Meta Marshall with Morgan Stanley. Your line is open.

Meta Marshall -- Morgan Stanley -- Vice President

Great, thanks. A couple of quick questions: 1). On the Blue Planet business, I just wanted to get a sense of line of sight to the $120 million target, and just whether there's contracts or RFPs out there that you're responding to, and then, maybe a second piece to that being whether Packet Design or DonRiver were an organic addition to that. And then, maybe a second question: Gross margins were particularly high this quarter, and I think everybody's talked about it. What is the contribution -- you said gross margins would be depressed due to new deals. We haven't really seen that yet. When do we start to see that? Is it just because there have been so many more new deals, or is it just because we haven't seen the margin compression from some of the new deals yet? Sorry, a little convoluted there. Thanks.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

I'll take the gross margin piece and Rick can talk to Blue Planet. Our adjusted gross margin for the year was 43%, and that did have the one-time effects that we had in Q4. So, first of all, I believe our gross margin is 42-43% because that's what we did -- sort of -- in 2018, and secondly, we are seeing the effect of new deals, both in 2018 and 2019. So, we're trying to do the best we can to give you our outlook for gross margin, and I believe that it's between 42-43% today. Rick?

Rick Hamilton -- Senior Vice President, Blue Planet

Relative to the line of sight to $100 million -- not to comment specifically on that, but we see pipeline activity that we're super confident in. This digital transformation that the carriers in particular are going through is generating a host of new opportunities, so the activity is incredibly strong there, and I think we're super confident in our ability to execute in that space.

Meta Marshall -- Morgan Stanley -- Vice President

But, to the question of what contribution of what Packet Design and DonRiver had to that $120 million...

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Well, here's what I say: Packet design and DonRiver combined were something like $20-25 million run rate, roughly speaking. So, next year, we said $50-60 million. That's going to be a combination of growth in those two acquisitions as well as pretty significant growth in our base Blue Planet automation, and we're extending our capabilities in that space. It's probably not going to be that important for you going forward how much comes from DonRiver, how much comes from Packet Design, and how much comes from the base Blue Planet business because we will be selling solutions that combine those capabilities, and it might not even be possible to identify which is which.

One thing I would say is that it is going to be higher percentage of services in that revenue line, and so, whereas overall, the gross margins will be accretive to our base gross margins, they're not going to be straight software margins. They're going to be a combination of software and services margins. Do you have anything to add, Rick?

Rick Hamilton -- Senior Vice President, Blue Planet

No, I think you got it. That's great.

Meta Marshall -- Morgan Stanley -- Vice President

Thank you.

Gregg Lampf -- Vice President, Investor Relations

Thanks, Meta.

Operator

Next question comes from Michael Genovese with MKM Partners. Your line is open.

Michael Genovese -- MKM Partners -- Managing Director

Great, thanks. First, to clarify, the three 10% customers -- were they the same as last quarter?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Let's see. Yes, they were.

Michael Genovese -- MKM Partners -- Managing Director

So, one was the hyperscale, then?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Yes.

Michael Genovese -- MKM Partners -- Managing Director

Okay, great. And then, my question -- I want to revisit the gross margins question, and the difference between 42-43% and 45% that we're seeing -- I'm hearing from you -- I think you're saying it's 100% explained by this land-grab environment where there's footprint to be grabbed and lots of big new wins in countries where, say, Huawei has been removed. You guys are winning big deals, and that's the reason for the difference. That's what I'm hearing, but I'm wondering if there are any other factors. Is that 100%, or are there other factors in there, and how important are those other factors besides the land-grab environment that we're in?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Remember, in Q4, we had $16 million of one-time revenue, and it was all gross margin because it was all software, and that affected our gross margin in the quarter by about a percentage point. So, the 43 points -- actually, adjusted for the one-time -- we didn't adjust it out, of course, but it was 43.7% gross margin. For the year, our gross margin was about 43% including the one-time item. So, I think you have to take all this into account. Yes, we are taking market share, and there are early project costs and lower gross margin. We're seeing that, we saw it this year, and we're going to see it next year. There's nothing else in it, other than the one-time item that we talked about. By the way, this is going to be good going forward because our market share is going to be bigger, and hopefully, over time, the industry environment is going to improve for us.

Michael Genovese -- MKM Partners -- Managing Director

Okay. So, just to tie the ribbon there, what I hear from that is that longer-term, you still believe that 45% would be normalized? I don't want to put words in your mouth. Do you think that 45% is still --

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Absolutely. We were doing 45% for two years, maybe over two years, and we think that's a good gross margin for us, but even at that time, we didn't think that was going to be our ultimate goal. We still have goals of getting to gross margins above 45%, but it's not happening now because we're taking a lot of share.

Michael Genovese -- MKM Partners -- Managing Director

Thanks, Jim. Keep up the great work.

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Thanks, Mike.

Operator

Your next question comes from Tejas Venkatesh with UBS. Your line is open.

Tejas Venkatesh -- UBS Financial -- Associate Director

Thank you. Are you seeing any change in customer thinking around the use of pluggables, and how is Ciena approaching it?

Scott McFeely -- Senior Vice President, Global Products and Services

From a pluggable perspective, I think -- take a look at the different application spaces. The move of miniaturizing coherent optics actually is a theme that's out there in the future. I think the application space where it will be applicable is a very specific subset of the market, and in particular, I think the places you'll see move first is the cap is very short-reach data center interconnect, and our move as we push coherent optics into the service provider access network and fiber and bandwidth gets deeper into their access network on the backs of things like 5G and MSO fiber deep -- that second access piece of the market, by the way, is a totally new space for coherent optics and a totally new space for our optical business, so it's new opportunity for us.

If you remember, back when we made the announcement to make our coherent technology available outside of our system business, one of the longer-term motivations for that was pluggable market space, and we're very much still on that path, and if I look at what it takes to be successful in that space, it takes a technology capability around the DSP, it takes a technology capability around electro-optics, which we own through our acquisition a couple years ago of TeraXion, and I'd also put to you that it also takes a knowledge of how to put these things together from a whole transmission system perspective, and we think we're uniquely positioned across those dimensions to be able to take advantage of those two opportunities.

Tejas Venkatesh -- UBS Financial -- Associate Director

And, as a follow-up on Blue Planet, how broad is the traction you're seeing? Is it one or two customers that are driving this? How broad is this? I think in the past, you've disclosed how many customers you've had, so, hoping to get an update.

Rick Hamilton -- Senior Vice President, Blue Planet

Relative to our core business, I'd say it's as broad as that, as we have applications across service providers worldwide. We have traction in the data center space, and we're actually seeing some traction into the higher-end adjacent markets like the top-tier enterprise space. So, the technology and the need is applicable fairly broadly.

Tejas Venkatesh -- UBS Financial -- Associate Director

Thank you.

Gregg Lampf -- Vice President, Investor Relations

Thanks, Tejas.

Operator

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

Tim Long -- BMO Capital Markets -- Analyst

Thank you. Just two questions, if I could. Gary, Jim, you've mentioned new deal activity as it relates to gross margin. Just give us a little more color on what you're seeing for the pipeline for the next year or two. What kind of deals are out there? Are there really large ones? What verticals are you seeing them in? What product sets? What applications? Secondly, back on the web scale, could you just give us an update on what you think their -- are there any intentions for them to vertically integrate more in optical? Thank you.

Gary B. Smith -- President and Chief Executive Officer

Why don't I take the first part of that, Tim? The dynamic that Jim is talking around earlier on -- I think we saw that coming into '18, and I describe it as this flight to quality by a number of large Tier 1s around the world. We saw that play out in '18, and I absolutely think that dynamic is going to play through in '19. What we're talking about here specifically -- Ciena has most of the Tier 1 carriers around the world. There are a few that we do not have, and many of those have actually started engaging with us and we secured in '18, and we think that there's more that are going to come our way in '19.

And, they are very geographically dispersed, but I would highlight a couple of areas. One would be Japan, where we're doing particularly well there, with a couple of large new Tier 1s to us. We're seeing this dynamic in Europe. I think the poster child for that is the one we've talked about publicly -- Deutsche Telekom -- but there are others there as well. And, I also think you're seeing that in North America as well. The large carriers in North America are looking very carefully around their partners as they move forward. It is predominantly manifested in optical transport, but when you talk about packet optical now, you're talking about a converged network of regional, metro, long-call, and including some data center connectivity as well. So, it's very broadly based. I think it is a shift that you're seeing in the industry, and I think that's continuing to play in '19. And frankly, that is reflected in a great year in '18, strong guidance for '19, and upping, basically, our targets for the next three years.

Scott McFeely -- Senior Vice President, Global Products and Services

Tim, on the web scale piece, you asked about vertical integration around optical. I'd say this: As we talked about in the pluggable conversation, in the very short-span camp is metro DCI. Some of them will consider moving to a pluggable if you consider that a case of vertical integration, but if you take a step back and think about our interactions with the web scale, certainly, technology leadership is an important aspect of that, and it has driven the market share we have there, but the relationship is multidimensional. So, as they move international, as they get involved in submarine networks, as they get more sophisticated in terms of their network and have back-office integration around that, it becomes a multidimensional relationship over time, and having that technology leadership position has put us in a good position to be able to grow that relationship as we go forward.

Tim Long -- BMO Capital Markets -- Analyst

Thank you.

Gregg Lampf -- Vice President, Investor Relations

Thanks, Tim.

Operator

Next question comes from Jeff Kvall with Nomura. Your line is open.

Jeff Kvall -- Nomura Securities -- Managing Director

Yes, thanks. I'm hoping to clean up a couple things left over. First, can you talk a little bit about some of the things that seemed a little bit lumpy to the good quarter, Latin America in particular? Could you help us also follow up on -- you had some strength in the packet business last quarter. How's that progressing? Jim, for you, obviously, congratulations, no convert! That's wonderful! That's been a 15-year journey for you. So, we don't need to sweat that on the income statement anymore. Could you help us, one last time, walk through what the implications of closing the convert out means for the income statement?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Thanks. Let me take the second one, and maybe Scott can take the first one. I think the great benefit of no longer having convertible bonds in our capital structure means that we can plan our capital structure and our balance sheet more carefully and with more certainty about what's going to happen. The second thing is that there's no longer going to be any uncertainty about the share count. You will know what the share count, and just for your information, we think that next year's share count will average around 156 million shares, starting a bit higher -- maybe 157 million -- and going down slightly as we do the combination of distributing shares and buying in shares. So, the implications on our income statement and our EPS.

The other thing I'd say just to close out the modeling comments is that our non-GAAP tax rate -- we believe -- will be around 24% going forward. There are a lot of tax entries in our books this year. There may be some going forward that are tied to the Tax Reform Act, but I will remind you that we are not a taxpayer for the next several years, at least, because we have the big NOLs, and so, a lot of the entries -- in fact, all of the entries -- that are GAAP-related are mostly non-cash items. So, those are the two modeling questions. Gary?

Gary B. Smith -- President and Chief Executive Officer

In terms of the strength in Q4, I think as we've talked many times, the nice thing now is we've got a very diversified business, and we can deal with ebbs and flows of markets, customers, product lines... If you look at the strength in Q4 relative to Q3, if you like, we had a very strong quarter in the MSO space, cable area, particularly, trying to get fiber closer to the customer, CALA, which I think is steadily recovering from some of the challenges we had a couple of years ago. I would also highlight in Q4, we had a very strong quarter in Japan, and also, Waveserver continues to grow quarter on quarter from Q3 to Q4. A bit of a proxy for the web-scale-type connectivity. I think we had a stronger packet quarter as well in Q4.

Jeff Kvall -- Nomura Securities -- Managing Director

Great. Could I just ask Jim -- interest -- what kind of interest should we be penciling in, then?

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Well, the only debt on our books is $700 million of term loans. The interest rate on that is roughly 4.5-5% depending on what LIBOR does. There are probably some minor entries in our interest expense relating to the amortization of debt cost, but $35 million plus a little is where we're going to be for the coming year.

Jeff Kvall -- Nomura Securities -- Managing Director

Great. Thank you both very much.

Operator

Next question comes from Catharine Trebnick with Dougherty. Your line is open.

Catharine Trebnick -- Dougherty and Company -- Vice President

Thanks for the question. This quarter, you did 11% year-over-year growth in Europe, and last quarter, it was 27%. So, going back to your discussing carriers moving away from the Chinese vendors, can you pretty much quantify -- which I know you don't want to do -- but give some color on how much of the opportunity in Europe you feel you've conquered? Thank you.

Gary B. Smith -- President and Chief Executive Officer

You're absolutely right, Catharine. The split would be very difficult from a dynamic point of view, but let me answer it like this. I do think the strength we're seeing in Europe will continue through '19, and I do think overall, it's about this flight to quality in its various forms. This dynamic is not new, and we saw it over the last couple of years, and I do think it will continue, and that's encapsulated in our forecast. Particularly in Europe, I think you're dealing with a couple of dynamics. You're dealing with this concentration of supply and trying to rebalance the vendor marketplace, and I think we are certainly benefiting from that.

And also, I think there's been some underinvestment, frankly, in the carrier space in Europe for about the last three to four years, and I think you're seeing that being addressed. And also, the web scale folks are also building out into the submarine and into Europe market. That's also providing strength in the European area as well. So, I think it's a confluence of dynamics as always, but I think we feel pretty good around our European business moving forward.

Catharine Trebnick -- Dougherty and Company -- Vice President

Well, do you see any new opportunities in Europe in particular? I know you announced Tele2 during the quarter.

Gary B. Smith -- President and Chief Executive Officer

Yes, we do. We see additional opportunities for new wins in Europe, to be very specific, and we're engaged with a number of carriers, and we think they'll expand and invest in their networks, and some of those are new customers to Ciena.

Catharine Trebnick -- Dougherty and Company -- Vice President

All right. Thank you very much.

Gary B. Smith -- President and Chief Executive Officer

Thanks, Catharine.

Gregg Lampf -- Vice President, Investor Relations

Thanks, Catharine, and we've come up on 9:30. We appreciate everybody's interest. We're looking forward to catching up with everybody over the next several weeks. Have a happy holiday and happy new year.

Operator

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

Duration: 60 minutes

Call participants:

Gregg Lampf -- Vice President, Investor Relations

Gary B. Smith -- President and Chief Executive Officer

James E. Moylan, Jr. -- Senior Vice President, Finance and Chief Financial Officer

Scott McFeely -- Senior Vice President, Global Products and Services

Rick Hamilton -- Senior Vice President, Blue Planet

George Notter -- Jefferies and Company -- Managing Director

John Marchetti -- Stifel Financial -- Managing Director

Simon Leopold -- Raymond James -- Analyst

Paul Silverstein -- Cowen and Company -- Managing Director

Dan Bartus -- Bank of America -- Vice President

Jim Suva -- Citi Research -- Analyst

Ashwin Gupta -- Goldman Sachs -- Managing Director

Samik Chatterjee -- J. P. Morgan Chase -- Vice President

Meta Marshall -- Morgan Stanley -- Vice President

Michael Genovese -- MKM Partners -- Managing Director

Tejas Venkatesh -- UBS Financial -- Associate Director

Tim Long -- BMO Capital Markets -- Analyst

Jeff Kvall -- Nomura Securities -- Managing Director

Catharine Trebnick -- Dougherty and Company -- Vice President

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