Earnings Call Transcript - CIEN Q1 2023

Operator, Operator

Good day, and welcome to Ciena’s Fiscal First Quarter 2023 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Greg Lampf, Vice President of Investor Relations. Please go ahead.

Gregg Lampf, Vice President of Investor Relations

Thank you, Jason. Good morning, and welcome to Ciena's 2023 fiscal first quarter results conference call. On the call today is Gary Smith, President and CEO; and Jim Moylan, CFO. Scott McFeely, our Senior Vice President of Global Products and Services, is also with us for Q&A. As OFC begins today, our team today is taking calls from the different locations. We ask for your patience during Q&A as we coordinate our responses please. In addition to this call and the press release, we have posted to the Investors section of our website an accompanying investor presentation that reflects this discussion as well as certain highlighted items from the quarter. Our comments today speak to our recent performance, our views on current market dynamics and drivers of our business as well as a discussion of our financial outlook. Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations. A reconciliation of these non-GAAP measures to our GAAP results is included in today's press release. 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 quarterly and annual guidance and our long-term financial outlook, discussion of market opportunities and strategy, commentary about our impacts of supply chain results on our business and results are based on current expectations, forecasts and assumptions regarding the company and its markets which include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. Assumptions relating to our outlook, which mentioned on this call are included in the investor presentation that will be posted shortly after, are an important part of such forward-looking statements, and we encourage you to consider them. Our forward-looking statements should also be viewed in the context of the risk factors detailed in our most recent 10-K filing and in our upcoming 10-Q filing, which is required to be filed with the SEC by March 9, 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. As always, we will allow for as much Q&A as possible today, though we ask that you limit yourselves to one question and one follow-up, please. As a reminder, we'll be hosting investor meetings with the sell side at OFC tomorrow and Wednesday. And we look forward to seeing many of you there. With that, I'll turn the call over to Gary.

Gary Smith, President and CEO

Thanks, Gregg, and good morning, everyone. Today, we reported outstanding fiscal first quarter results including higher-than-expected quarterly revenue of $1.06 billion and adjusted gross margin of 43.7%. In fact, Q1 was our largest revenue quarter ever, up 25% year-over-year. We also reported very strong profitability metrics, with quarterly adjusted operating margin of 12.6% and an adjusted EPS of $0.64. These results are a strong demonstration of our market leadership and continued demand for our market-leading technology across our complete portfolio. While supply chain has not completely recovered, and there is still some volatility in component deliveries, we are encouraged by the component availability in Q1 and our related strong shipment performance. This is both, I think, a proof point of our mitigation efforts and a positive indicator of our expectation for continued gradual improvements in the supply environment as we move through the year. We are very pleased with this progress as we continue to work hard to fulfill our customers' network capacity needs. With this strong momentum, we remain confident in our ability to grow faster than the market in both the short and long term and, of course, take market share. This confidence is underpinned by three fundamental beliefs. First, the positive overall demand environment and the strength of our customer relationships. Second, the market-leading strength of our portfolio to best service customer demand. And lastly, the visibility, particularly provided by our backlog. With respect to demand, we remain positive about the fundamental drivers, including 5G, cloud, AI, and automation and continue to believe that they are very durable over the long term. Indeed, these drivers require network operators to increase capacity, reduce latency, and optimize power consumption while also intelligently converging technologies. These are critical elements across the core metro and increasingly edge network segments. Our customers know that they must continue investing in key parts of their networks to address these areas of their business in order to remain competitive. There are clear signs, including our Q1 order book, that point to this happening. To service these demand dynamics, we continue to leverage the strength of our business model and our investment capacity to remain at the forefront of innovation across our portfolio. Our leading technology and strategic focus on addressable market expansions are closely aligned with our customers' investment priorities. In fact, you probably saw we just announced the sixth generation of our WaveLogic technology, which will once again set a new standard in coherent optics, where we have led the market for generations of this technology. WaveLogic 6 will be the first to support up to 1.6 terabits single-carrier wavelengths, 800 gig across the long-haul links and footprint optimized 800-gig pluggables that yet again, will have the lowest energy consumption. Our newest generation modem technology will be supported across a range of our optical and routing and switching platforms and will also be made available for use in third-party solutions. These breakthrough innovations in WaveLogic 6 are made possible through our unique expertise in coherent DSP and high-bandwidth electro-optics, leveraging state-of-the-art 3-nanometer silicon technology. In metro and edge, we continue to invest in market expansion and further solidify our role as the disruptive challenger in this space with a very compelling value proposition. These investments are positioning us to both pursue new opportunities and leverage our position with current customers to address use cases deeper in the network. Since we last spoke to you in December, we closed the acquisition of Tibit Communications, which further strengthens our solution in broadband access. Benefiting now from our vertical integration and a modern open architectural approach, we believe we are very well positioned to attack this rapidly growing market that is the focus of private and public investment across multiple regions. These portfolio investments will be supported by similar efforts on software and services designed to enable customers to realize additional benefits of network automation and execute on their network transformation strategies. Lastly, let me pick up on this point of we have very strong visibility given our backlog. As a reminder, going into 2020, we had accumulated a multitude of new design wins and WaveLogic 5 Extreme was only just beginning initial commercial deployments at that time. Given the dynamics of COVID and supply chain conditions, those wins only started to translate into orders during the last several quarters. As a result of these wins and industry dynamics during this period, our backlog grew from $1.2 billion at the end of fiscal 2020 to $4.2 billion as we entered fiscal 2023. It's clear that in recent periods, our backlog has far exceeded historical levels. In Q1, our backlog came down slightly because we significantly outperformed our revenue expectations. This is good news on a variety of fronts. First and most importantly, it means that we are delivering more product to our customers. Second, it's an indicator that the supply chain challenges are improving. Lastly, our market share gains are becoming evident as we convert this backlog to revenue. While we expect ebbs and flows with orders given the supply chain dynamics as we move through '23, orders for the year are off to a pretty good start. Even with these expected fluctuations, we expect to finish the year with a backlog that is higher than our historical levels, albeit down from the extraordinary level we had at the beginning of the year. Moving to additional highlights from the quarter that I think speak to our efforts to meet customer demand. In optical, WaveLogic 5 Extreme continues to be the world's most widely deployed 800 gig coherent technology, including 13 new customers in Q1, bringing our total customer count to 214. Q1 was our biggest modem shipment quarter ever overall, including for WaveLogic 5e, for which we've now surpassed 60,000 modems shipped to date. It was also, of course, our strongest WaveLogic 5e modem production quarter ever. In Routing and Switching, with a focus on next-gen metro and edge, we continue to press down our efforts and to expand our addressable market and gain market share. Overall, quarterly revenue for our Routing and Switching segment increased 39% year-over-year, and Q1 was, of course, also a record shipment quarter for these platforms. Within this portfolio, we secured new wins in Q1 for our Broadband Access Solution, which includes the recently acquired technology from both Benu Networks and Tibit Communications. Shifting to customer segments and regions in the quarter, non-telco revenue was 40% of total sales in Q1. This reflects a strong performance with web-scale, which included a 10% customer in the quarter. Direct web-scale was 24% of total revenue in the quarter and increased 47% year-over-year. We remain very positive about the year with this group of customers. In fact, in FY '23, we expect record revenue in web-scale and growth well above the corporate average. As we continue to focus on driving growth outside the U.S., Q1 revenue in the APAC region was up 41% year-over-year. This was largely driven by revenue growth in India, which was up 150% year-over-year in Q1 to $64 million, reflecting the strong demand environment in that market. Finally, we are placing an intense focus on customer experience; specifically, the combination of our investment in inventory over the last 12 months and a ramp-up of our service teams' readiness to deploy for our customers, as fast as possible as we ship product. In summary, we have great momentum in the market today, supported by robust fundamental demand drivers, a market-leading set of technologies and platforms, and strong visibility with our backlog. With that, we are confident that we will deliver outsized year-over-year revenue growth in FY '23 and that we remain on track to achieve the 3-year revenue CAGR outlook we previously provided. With that, I will now turn over to Jim to speak more on those items as well as to provide additional detail on the Q1 financial results. Jim?

James Moylan, CFO

Thanks, Gary. Good morning, everyone, and a special early morning greeting to those on the West Coast at OFC. As Gary noted, we had an outstanding Q1 that showcases our strong market leadership. Total revenue reached $1.06 billion, exceeding expectations. We shipped more products than anticipated, thanks to improved vendor component deliveries, especially toward the end of the quarter. Our adjusted gross margin was robust at 43.7%, driven by a favorable product mix and a particularly high volume of modems, which have higher gross margins than usual and accounted for a significant portion of our late-quarter shipments. Our adjusted operating expenses for Q1 were $329 million, reflecting our investments in TAM expansion and the operational expenses from the acquisitions of Benu and Tibit. In terms of profitability, we delivered impressive results in Q1, including an adjusted operating margin of 12.6%, adjusted net income of $95.6 million, and adjusted earnings per share of $0.64. Additionally, we utilized cash from operations during the quarter, mainly due to increases in inventory and accounts receivable. Our inventory levels show our continued investment in components and other raw materials to mitigate supply chain volatility for our customers. As supply conditions improve, we anticipate a reduction in inventory levels throughout fiscal 2023, although they will remain elevated compared to historical levels. We expect inventories to be lower in Q4 this year than in Q4 of 2022. Finally, our adjusted EBITDA in Q1 was $155.1 million. Following our successful term loan transaction in Q1, we concluded the quarter with about $1.2 billion in cash and investments. Just as a reminder, during Q1, we completed the acquisitions of Benu and Tibit for a total of around $292 million. With our strong balance sheet, we plan to return capital to stockholders, including our ongoing expectation to repurchase approximately $250 million in shares during this fiscal year. Now, regarding guidance, I want to clarify that the updated outlook I’m about to share is based on the same key assumptions we discussed last quarter and included in our earnings presentation, especially those concerning supply chain conditions. This point is crucial in our currently uncertain supply chain environment. We believe that the gradual improvements in supply conditions seen in Q1 will facilitate greater deployments of our accumulated design wins and attract new business from clients seeking top-tier technology across our range of products. Accordingly, in Q2, we anticipate revenue between $1.035 billion and $1.115 billion; adjusted gross margin in the low 40% range; and adjusted operating expenses around $335 million. For the fiscal year, we expect strong market share growth, as evidenced by our significant revenue over-performance in Q1 and our projections for Q2. Therefore, we are now forecasting revenue growth for fiscal year '23 in the range of 20% to 22%, up from our previous estimate of 16% to 18%. We maintain our belief that our gross margin for fiscal '23 will fall between 42% and 44%. This expectation is based on a higher proportion of line systems in our product mix over the upcoming quarters. Regarding adjusted operating expenses, we expect to average about $335 million to $330 million per quarter for fiscal year 2023, reflecting our intention to keep strategically investing in our future, particularly in opportunities for TAM expansion in next-generation metro and edge markets. This segment is growing rapidly, and we see potential to gain market share with our top-tier offerings. Today's quarterly results, along with our outlook for Q2 and fiscal year 2023, clearly indicate our strong performance. We are more optimistic than ever about our business position. The combination of robust demand drivers, our leading technologies and platforms, a growing addressable market, and strong visibility with our substantial backlog gives us high confidence in securing market share gains over the next few years. Jason, we'll now take questions from sell-side analysts.

Operator, Operator

Our first question comes from George Notter from Jefferies.

George Notter, Analyst

I guess I wanted to ask a bit about backlog. You said it was down slightly. Could you just give us a precise number? I think you said it was $4.2 billion last quarter, but just was curious on the update. And then also wondering if you're seeing any cancellations on that backlog, any more detail you could give us there? And then just also product lead times. Obviously, lead times have been extended in a lot of areas of the business. I'm just curious what the update is there?

Gary Smith, President and CEO

Let me take that, George. We don't normally give sort of a precise number on the backlog, but given the environment, I would say this: if we had finished at the midpoint of our guidance, we would have essentially replenished all of our backlog. We ate through some of our backlog principally because our revenue was $100 million over our expectation for the quarter. So we still have an incredibly healthy backlog that we expect to come down during the year. We do not think this level of backlog is sustainable or frankly, desirable. Customers want equipment. They don't want it sitting on our backlog. That really bleeds into the second part of the question on cancellations. We're not seeing any change or updates to that. It's very small and minor, just normal run-of-the-mill type cancellations. So we're very confident about the integrity of the backlog. What was the third question, George?

George Notter, Analyst

I guess it was just about product lead times. I know they've been extended for some time now. I'm just wondering if you're able to make a dent on this.

Scott McFeely, Senior Vice President of Global Products and Services

Yes, George, it's Scott. Product lead times have improved as we've just shipped more products and sort of built a bigger ship going forward. They will continue to improve throughout the year, although I don't think we will get them back to historical levels in this fiscal year. I'm not sure what the new norm will be, but they will be significantly improved as we go throughout the year.

Operator, Operator

Our next question comes from Tal Liani from Bank of America.

Tal Liani, Analyst

I have a follow-up on the previous question and another question about cloud. First, when I examine the results from all the companies in the networking space, they all show very strong revenues, and margins are increasing due to higher revenues, but the backlog is decreasing. My question is about the environment. You and Cisco seem confident, but how much of this strength is merely a result of backlog adjustments and historical orders, with the risk that this may diminish once the backlog returns to normal levels? How much of it reflects a genuinely robust environment that necessitates a strong underlying network? If you could discuss the environment, the orders, and the types of projects and customers, I would appreciate it. The second question, which is connected to the first, pertains to cloud. We've noticed that cloud is doing well, for instance, with Arista reporting a 47% increase. How much risk is associated with relying on possibly one large customer or a single quarter, especially with their budgets potentially being reduced? What risk is there that cloud growth may slow down as the year progresses?

Gary Smith, President and CEO

Okay. Let me take the first part of those multiple questions, Tal. I would say, first of all, one has to step back from the environment that we're seeing, which is the sort of whipsaw around the whole COVID piece, then enormous pent-up demand, then supply chain issues, etc. You're seeing a very turbulent set of dynamics over the last couple of years, and we're still living through it this year. If you sort of look through that dynamic and when we get to some kind of new normal, let's sort of assume that's '24, then I think you can look back on this and say that the consistent market demand has been strong, mid-single digits, which I think it is consistently and historically been. I think all of the dynamics and signals that we see are consistent with that. The desire for bandwidth in all its various forms, closer to the end user consumer continues unabated. But that has typically translated into optical market growth of the mid-single digits. If you look at Ciena over that period, and again, similar to historical norms, we are a few percentage points above that. Looking at our CAGR for the next three years, which we gave last quarter, it's in the 10% to 12% range. Clearly, we're going to take a lot of share, mainly because of the wins that we secured in '19 and '20 and '21, now coming into revenue. Yes, we've got outsized revenue this year. There's no doubt about that, and that will obviously normalize at some point, but we will continue to grow faster than the market. Overall demand Tal continues to be strong from that perspective. Moving on to web-scale. Obviously, we have relationships with all of the major web-scalers. It's not just one single one that we did have a 10% this quarter, but it's across the board. We're going to be up significantly for the year, as I said, 47% for the year. We expect growth this year to continue to be above our corporate average. We're continuing to see good activity with these guys as well.

James Moylan, CFO

Just to add on to that a little bit, Tal, we've been through a period over the last three or four years with the web-scalers of tremendous growth across just about every metric in their businesses. It's sort of natural they are looking at their business in the wake of what's going on in the world, and we've seen a lot of noise out there in the market about what they're doing with their people and what they're doing with their CapEx. But if you look through all of that, the underlying business remains strong. Their cloud businesses are strong. We don't see any impact on their demand. There's turbulence and pushouts and things like that. But we don't see any significant change in the fundamental nature of their business. They're growing.

Operator, Operator

Our next question comes from Samik Chatterjee from JPMorgan.

Samik Chatterjee, Analyst

I had a couple of questions, and to start with one that we received this morning. Gregg, you mentioned, or rather Gary, that you would have replenished the backlog if you had reached the midpoint of the guidance for the first quarter. Last quarter, you indicated that you were building backlog under the assumption of hitting the midpoint. One question that has arisen is whether, despite the strong order numbers, there were areas of weakness that contributed to a slight shortfall in the order numbers you had anticipated. I have a follow-up as well.

Gary Smith, President and CEO

I would not describe it as that. It's a very, very strong Q1 for us. If you think about it, that kind of number is very strong. I would caution folks that I understand people are fixated on orders in the backlog. The backlog cannot and should not maintain the levels that it is. The order flows, whilst they're good will not match shipments. We expect that during the year. Very simply, we expect to end the year with less backlog than we went into it. That's a good result for our customers and a good result for us. I think we had a very strong Q1 in orders. But I would caution particularly on just taking order metrics on a quarterly basis right now; we're going to see some ebbs and flows during the year. There's no doubt about that. Last year, we had 25% order growth. If you look at the end of, I think it was Q3 in FY '22, if you look at the trailing 12 months, it was up 60%. That's not sustainable. While it's wonderful, and it's a great demonstration of all the wins we have had, we've got to take them to revenue in this next phase of the business. We still believe we're going to have a very good '24 and go in with a strong backlog. It's not going to be a linear line from an order point of view.

Samik Chatterjee, Analyst

Yes. I understand we are talking about small numbers here. But maybe switching gears here to WaveLogic 6, you just mentioned that the WaveLogic 5 orders had really started to come in more in the recent quarters. So how do you think about the likelihood that with the release of WaveLogic 6, so quick in succession that customers start to push out sort of their move to WaveLogic 5 and wait for WaveLogic 6 to be in the market, just given that it's so sort of following on the heels of the WaveLogic 5 orders starting to pick up?

Scott McFeely, Senior Vice President of Global Products and Services

Samik. First of all, just a point of clarification. The WaveLogic 5 orders were a big part of that order growth that we saw in the last 18 months. It's a microcosm of the whole order dynamic that Gary said. What we are doing now is we are in an accelerated way, converting those to revenue, bringing them to shipments to our customers. So just I thought I heard you say something a little different. Just a point of clarification there. I think about WaveLogic 6, the timing, as we said, is first half of '24. We'll start to see design wins against that earlier than that, I suspect. It takes several cycles for the next generation of technology to actually overtake the previous generation of technologies in terms of shipments or revenues. This past quarter was the first where WaveLogic 5 was the biggest number of units that we shipped across all of our generation of technology, and it's been available for a couple of years.

Operator, Operator

Our next question comes from Paul Silverstein from Cowen.

Paul Silverstein, Analyst

Gary, I apologize for revisiting this topic, but I want to clarify. Regarding investor concerns about capital expenditures from both carriers and web-scale, it seems from your comments that there isn't any indication of weakness. It sounds like the strength is quite broad-based, if I understood you correctly. What factors are contributing to this? What explains the disconnect here? I'm aware that capital expenditure trends in individual companies' revenue do not always align. Can you provide any additional insights into what is driving your strength in relation to the outlook for this year, especially considering the cutbacks that many of your customers have mentioned?

Gary Smith, President and CEO

Well, I think first of all, you're dealing with a lot of pent-up demand, orders that have been placed because of extended lead times. Carriers and web-scale want the equipment; there's no doubt about that. For the first time in the web-scale area, we're seeing them manage to their budgets. Even though they want all of the equipment, they can't take all of the equipment in the year. We are seeing that. That is built into our guide. Even with the massive uptick that we're seeing in web-scale, that is built into our guide. They're scheduling stuff out into '24, which is great because it gives us backlog and visibility there. We know they want the equipment to complete the networks that they're driving. So that actually is sort of a positive dynamic, but they are managing to their budgets. On the carrier side of things, again, they've got pent-up demand, and they are, as usual, managing to their budgets and CapEx. The priority for them is actually in this space and is on capacity to build out their networks. General economic uncertainty out there is unavoidable, but given the particular demand dynamics around capacity in their networks, we've got good visibility, not just in the backlog, but in the activity with them. That's how I would characterize the two groups. We are not seeing any push out on the carrier side from a budget point of view.

Paul Silverstein, Analyst

As a follow-up, the numbers clearly show that ZR, at least currently, is not having a negative impact. I understand that all indications point to you having the lowest power solution in the market, which is crucial. You've now introduced WaveLogic 6 built on 3 nanometers. I believe no one else has announced 3 nanometers, which, while not necessarily related to ZR, should continue your progress in power efficiency. Please provide any updates on your involvement in that opportunity.

Scott McFeely, Senior Vice President of Global Products and Services

Paul, I don’t think our perspective has changed much since the last time we chatted. I firmly believe we've got the best pluggable product in the marketplace, both from power and reach. There are starting to be some external references to validate that. We still think that the ZR market for campus DCI is very much in front of us. There've been some early movements, but I don't think they've moved into the network as fast as people had expected. As that sort of inventory position and those customers bleed off, we think there will be opportunity for us.

James Moylan, CFO

No, it was not, Paul. They were a little bit later in the quarter, and there was no meaningful revenue contribution at this stage.

Operator, Operator

Our next question comes from Tim Long from Barclays.

Tim Long, Analyst

Yes, two, if I could, as well. First, I wanted to touch on Routing and Switching, which seem to reflect a little bit higher in the quarter. Can you talk a little bit about kind of growth in use cases or sales or what it takes to keep that business scaling? And then secondly, a little bit higher level, looking at the service businesses as a whole, continue to lag product. Most companies in the peer group have seemed to match revenue there. Could you talk a little bit about why we've seen service underperformance in a pretty weak gross margin accordingly this quarter?

Scott McFeely, Senior Vice President of Global Products and Services

Let me take the second one first, the services piece. It really has more to do with the project mix and timing of sort of product revenue delivery versus sort of installation projects. I don't think there's a sustainable difference in the performance of the services business relative to our equipment business here. It's really just timing and project-based, particularly on the installation-based services. That has both the revenue ratio that you pointed out and also has a margin implication because we carry a bit of fixed cost on the services piece, and the revenue timing is off a bit. You see it as a bit of a headwind from a margin perspective in the short term. So that's the services dynamic. On the Routing and Switching piece, you're absolutely right. Good quarter in Routing and Switching. There have been a few in a row, so we're pretty excited about the momentum there. In many of the use cases, we are challengers that are building to next-generation architectures. We think that the future is still very much in front of us in terms of getting at that expanded TAM that we talked about. Just to remind you, the key use cases that we've been focused on include wireless transport, next-generation residential broadband with XGS-PON, enterprise edge in both the physical and virtual capability, and then a converged metro core benefiting both from our IP capabilities but also our optical strengths there. We’re pretty excited about being the challenger in that space and the continued opportunities in front of us.

Operator, Operator

Our next question comes from Simon Leopold from Raymond James.

Simon Leopold, Analyst

I'm going to ask sort of the two combined because I think they're related, but I wanted to see if you could talk a little bit about your expectations for India. I picked up the comment from Gary on the quarter at $64 million. I think last year, you were about 2% of revenues. Just want to get a better sense of the sustainability and outlook for India. The related question is, more broadly, your thoughts and updates on being able to displace Huawei, not just India but outside China, globally, how you see your position to win share from Huawei versus your competitors?

Gary Smith, President and CEO

Simon, let me take the India one. Yes, I think we're beginning to see what we generally anticipated in the industry, which is a strong build-out in India. You saw that in our results. I would expect India to have a very good year, and probably a good three years for us, quite frankly. There's a whole investment cycle there driven primarily by the 5G build-out. The investment there is the fastest-growing internet market in the world, and we have #1 market share and are well-positioned there. We're very positive about India; it’s going to be a strong cycle. A lot of decisions have already been made regarding the displacement of Huawei. India is moving very quickly relative to other parts of the world on this. We’ve certainly benefited from that, with wins now rolling out, which is direct replacement. I think Europe is the other market area where they are changing out Huawei, but that is a multiyear process in Europe. We believe we are winning our fair share of that in Europe. That will continue over the next few years as infrastructure is replaced.

James Moylan, CFO

I would add that Huawei has a pretty significant market share in the PON area. That's one reason why it's interesting to us because we believe that they will face the same resistance in the PON area as they're having in the core of the networks.

Simon Leopold, Analyst

Just to clarify the India comments. I think the prior peak, I think 2018 was about 9% of revenue. So a smaller revenue base. Just wondering, is this business likely to be material enough to not maybe consistently, but at least get close to 10% of revenue? Or is this sort of $64 million-ish a sustainable level? How do we think about that?

Gary Smith, President and CEO

I think it's possible to grow in absolute percentage terms as a part of our revenue. Everything else is growing, and you look at the uptick in switching and routing, particularly in web scale, etc. Would it touch 10% again? That’s probably a little high, but it can certainly be a major contributor to us; there’s no doubt about that.

Operator, Operator

The next question comes from Meta Marshall from Morgan Stanley.

Meta Marshall, Analyst

Great. A couple of questions for me. Just maybe starting on gross margins. As you think about the year and supply chain, seemingly releasing a little bit sooner than expected, understanding you're leaving gross margins about the same for the year. But is there anything that we should think of differently as more new deployments, less supply chain overhead? Just anything they consider there? And then second, just given the topical nature of it right now, just wondering how you guys see the AI opportunity for DCI and whether it's relatively small because it's mostly in data center traffic or whether you think that could be an additional growth driver for you guys?

James Moylan, CFO

As we've always said, Meta, the most important element of our gross margin historically and for the future is mix. We have won a lot of deployments and new projects with customers all over the world, including the web-scalers, which calls for our new Reconfigurable Line System. We expect to deliver a much higher proportion of RLS to a bunch of customers, and those deployments will have a dilutive effect on our gross margin. It hasn't happened to a great extent so far, but it will happen. We think it's going to impact our margin to the downside over the next few quarters. On the other side, we do think that exception costs, which we estimated last year cost us probably 300 basis points or 400 basis points to our gross margin, will begin to come down. These are costs that we pay to brokers for components on the broker market as well as higher logistics costs. It's a combination of a mix shift and these exception costs influencing our margin right now. We stated in Q1, we had a higher percentage of modems, which have higher than average gross margins. That percentage of modems will come down as we go through the year and start to deliver RLS. We think all of these things will tend to average themselves out, and we do think over the next few years we will get back to mid-40s gross margin that we enjoyed back pre-COVID.

Scott McFeely, Senior Vice President of Global Products and Services

Meta, on your AI question, you're right. The community of interest right now is largely in the back end of the data center. But as you look at data center architecture becoming more distributed due to the requirement of having to get more and more power to service applications and the traffic that AI generates, that's going to have a bleed effect on the WAN side traffic, which is a good thing for those of us in the bandwidth business. That will be both in the web-scale direct networks as well as the service providers who service those web-scales. There are interesting dynamics in the architectures as people look into the future of worlds with AI inside the data center. Those architectures are yielding conversations about where coherent technology plays. In the future architectures, we see opportunities in this new space. It's beyond the timeline of our three-year revenue guidance.

Operator, Operator

The next question comes from David Vogt from UBS.

David Vogt, Analyst

Great. I apologize if I'm going to belabor the point about backlog and orders. It certainly sounds like based on the backlog draw that maybe book-to-bill was less than 0.9 in the quarter. Is that correct? If we extrapolate that trend for the full year, does that mean backlog comes down in the mid-teens based on your expectations? If I roll that forward, can you kind of square your comments about share gains in optical if the optical industry is growing sort of mid-single digits? Because if I take the midpoint of your guide, I would assume that in the back half of your three-year plan, '24 and '25, Ciena revenue would only be growing around 6%. So I just would love to get some clarity on that.

Gary Smith, President and CEO

First of all, on the backlog, no, that isn't the right assumption. It was more than 0.9 for Q1. It was about that. Backlog for the year end, as we've said, I think everybody needs to get their head around the fact that we're not going to have 25% order growth year-on-year. The specific dynamics built up for that. We expect to end the year with a bigger backlog than we would normally take into any fiscal year. That backlog is still going to be very strong. The focus is to ship the backlog that we have and reduce our lead times. We gave a three-year guide, a CAGR that we gave last quarter. We're 36 months out into that. I don't know as many companies that give that specificity as us. We're confident around a 10% to 12% growth in that CAGR. Obviously, we're having an outsized year this year as we ship the backlog. If you look through all of that and the dynamics around various quarters and even various years, that's very strong, 10% to 12% in a market that is growing about 5%. That has been what Ciena has done for the last decade or so. Given the leading technology, investment profile and scale of the customers, that's a very strong performance. I don't know many companies of our size in our space that are talking about a midpoint of the range of 21% for the year.

James Moylan, CFO

Just to be clear, our future has not changed. We still feel great about our position in the market and our ability to grow. We did give a range, David. So to jump quickly to a mathematical equation there is probably not the right approach in this time of turbulence and change. We feel great about our ability to grow faster than the market.

Operator, Operator

Next question comes from Amit Daryanani from Evercore ISI.

Amit Daryanani, Analyst

I guess, Gary, maybe towards the end of what you were talking about on the backlog dynamic, is there a way to think about where you think your backlog exits this year? Historically, you've talked about if memory serves me a backlog number in a normalized range should be in the $750 million to maybe $1 billion range. How long does it take you to get to that normalized backlog? Is it a '24 process or much beyond that as well?

Gary Smith, President and CEO

Amit, the honest answer is I don't know what the new normal is going to look like. The dynamics of this are largely driven not necessarily by demand. Demand has been solid. It’s by the ability of lead times to meet that demand. Lead times in this space, even in very large infrastructure projects were 10 to 12 weeks; I'm not sure they will return to that level for that kind of product. For the access and the edge, absolutely. Two weeks, or whatever the dynamics should be. But I'm not sure what the new normal will look like or when that kicks in. There’s still volatility around the supply chain. It’s getting better, and that's great. It’s difficult to predict exactly when we'll get back to some kind of new normal or indeed, what that new normal might look like. It will be better lead times than we're seeing right now. That will reflect in carrying a lower backlog into the business. That’s the same for everybody in this space. For us, it’s different because we had enormous amounts of backlog from new wins in the '19 to '21 timeframe that have now translated into orders and backlog, which gives us visibility over the next 12 months or so.

Amit Daryanani, Analyst

Got it. If you could spend a minute talking about the growth rate. You talked a fair bit about APAC and India doing well. How do you think EMEA stacks up for the year from that growth perspective? I sort of think about it; the Jan quarter is a little bit weaker there versus the rest of the geos. Just touch on what you're seeing in EMEA for the year. That would be helpful.

James Moylan, CFO

We believe that all of our regions will grow pretty meaningfully this year. EMEA is going to grow. It may not quite hit this company average but will grow significantly this year. India is probably going to grow above average, and web-scale will be well above average.

Operator, Operator

Our next question comes from Jim Suva from Citigroup.

Jim Suva, Analyst

My question is about gross margins. You mentioned a range in the low 40% area. I want to clarify that you are not stating 40% specifically, but rather the lower part of the 40% range since your full-year forecast is between 42% and 44%. With the long backlog and lead times, should we expect more visibility in pricing power? Is the anticipated lower margin due to reduced modem shipping next quarter? Why might the margins be expected to be lower? I may have misunderstood.

James Moylan, CFO

It is low range, low 40s, not below 40. Look, there's a range in gross margin, and the mix can change. Our expectation is low 40 percentages. So what is that? 41%, 42%, 43%, I don't know. But it’s some number like that. It is absolutely related to a mix change towards line systems and away from modems. There's nothing sinister about that; it just has to do with the flow of our deliveries and the fact we won a lot of new projects and a lot of new deployments that start with line systems. That's why we think it will be low 40s in Q2, and we believe we will average 42% to 44% for the year. Again, our expectation is to return to the mid-40s or maybe even beyond. We’ll see as our business mix changes more. We’ve had a lot of change; we've had a lot of exception costs, and we've had this mix shift between modems and line systems, but that should equalize over time and get us back to the mid-40s.

Operator, Operator

Jason, we will take one more question, please.

Fahad Najam, Analyst

I apologize if I'm going to ask you to repeat on the backlog; I hate to revisit it, but it's too early here in the West Coast. Could you remind us what portion of your $4.2 billion in backlog was longer duration meaning beyond the next 12 months? I have the real question that I wanted to ask you.

Gary Smith, President and CEO

Faha, I can't hear you very well, but I think the question was what percentage going in of the $4.2 billion was outside of FY '23? I don't think we broke that down.

James Moylan, CFO

I would say that a lot of it would be taken by customers if we could deliver it to them; a significant percentage would be taken. But lead times and component availability are sort of disturbing the situation as we know.

Fahad Najam, Analyst

Now to my question. Regarding your announcements on the WaveLogic 6 products, you also introduced the WaveLogic 6 nano and the 800-gig ZR. While the timeline hasn't been specified, I assume it's expected in the first half of '24. If that's the case, it appears that you might be outpacing the current market leaders in the 400-gig pluggable market by accelerating your offerings. What kind of opportunity do you foresee for Ciena in '24 or possibly '25 from ZR? How significant of a catalyst could that be for your business, particularly in the cloud?

Scott McFeely, Senior Vice President of Global Products and Services

Yes, I wouldn't look at it as trying to disrupt the natural flow of 400 gig ZR. It is the next step that interested customers want to take. There's a whole ecosystem around moving to these generations, including the entire switch fabric has to get upgraded. We are doing it because there are efficiencies, and we're doing it in parallel with our WaveLogic 6 Extreme. We want to be ready for that market, but I wouldn't necessarily think it was driven by trying to disrupt the 400-gig ZR market. We think it's the natural evolution for our customers that play in that space.

Gregg Lampf, Vice President of Investor Relations

Thank you, everyone, for joining us today, especially, again, as Jim said, those of us on the West Coast at OFC. We're looking forward to meeting with a lot of you in the next couple of days, and we'll see you then. Thank you very much.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.