Ciena Corp (CIEN) 2007 Q1 法說會逐字稿

Good day, everyone and welcome to the Ciena Corporation first quarter 2007 results conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I'd like to turn the call over to the Chief Communications Officer, Ms. Suzanne DuLong.

Please go ahead.

Thanks Felicia.

Good morning and welcome everyone.

I'm pleased to have with me Gary Smith, Ciena's, CEO and President, and Joe Chinnici, our CFO.

In addition, Steve Alexander, our Chief Technology Officer, will be with us for the Q&A portion of today's call.

Our call this morning will be presented in four segments.

Gary will provide some brief introductory comments, Joe will review the financial reports for the first quarter, Gary will then discuss the business in the quarter and our outlook for Q2, and Joe will wrap up our prepared remarks with guidance.

We'll then open the call to questions from the sell side analysts.

So ensure we answer questions from as many participants as possible within the allotted time frame, we ask that sell siders limit themselves to one question.

This mornings press release is available on National Business Wire and First Call, and also on Ciena's website at ciena.com.

Before I turn the call over to Gary, I'll remind you that during this call, we will be making some forward looking statements.

Such statements are based on current expectations, forecasts and assumptions of the Company that include risk 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 10K filed with the SEC on January 10th, 2007.

We have until March 8th to file our 10Q for this quarter, and we expect to do so by then or before.

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

Gary?

Thanks, Suzanne and good morning everyone.

We are pleased to deliver today our 12th sequential quarter revenue growth.

Another indication of our continued progress in the execution of our strategy.

Our unique positioning of the transition specialist guided by our FlexSelect architecture vision for next generation networks is a strong enabler of our momentum.

We believe our ability to deliver sequential revenue growth despite industry wide softness in access related deployments, resulting from customer consolidation, we believe is testament to the breadth of our product portfolio and the role we've carved out for ourselves as a specialist in network transition.

We also believe implementation of our new comprehensive Ethernet strategy including the two new platforms we launched on Monday of this week, enhances our revenue potential in '07 and beyond.

I'll discuss our business in the first quarter and our outlook following Joe's review of the quarters results.

Joe?

Thanks, and good morning, everybody.

This morning we reported first quarter revenue totaling $165.1 million.

This represents an increase of 3.2% sequentially, and 37.1% year-over-year.

There were three 10% plus customers in the first quarter that combined represented 49.5% of total sales.

All three are North American customers.

One was also a 10% customer in Q4 '06, and all purchase across our product portfolio including core transport and core switching.

Sales of international customers decreased slightly representing 27.6% of total revenue in the first quarter as compared to 31.7% in the fourth quarter.

Now moving to talk about quarterly revenue contribution across our portfolio.

Revenue from our Optical networking products increased sequentially from $118.9 million in the fourth quarter, to $127.2 million in the first quarter, representing 77% of the quarter's total revenue.

Our Optical networking products consist of core transport switching, Metro transport and switching, and multi-service Optical access products.

At $48.6 million, long haul core transport related revenue was the largest contributor with Optical networking products in the quarter and represented 30% of total sales.

At $38.8 million core switching related revenue grew sequentially, and represented 24% of total revenue.

Of the $35 million in Metro transport and switching revenue, $26 million came from sales of our CN 4200 Advanced Services Platform, which grew 15% sequentially.

Data Networking product revenue remained roughly flat sequentially, contributing $4.9 million in the first quarter.

Revenue from our Broadband access products decreased from $13.7 million in Q4 to $9.4 million in Q1 and included a small amount of initial revenue from our CNX-5 plus platform.

Network and service management software increased from $3.7 million in Q4 to $4.8 million in Q1.

And at $18.8 million revenue from our Global Networking Services business remained flat quarter-to-quarter.

As we mentioned last quarter going forward, we're likely to adjust our commentary regarding product revenue to provide more meaningful data and better reflect the growing significance of application specific scenarios and other factors as they relate to our financial performance.

Turning now to gross margins.

We're able to maintain gross margins in our mid-40s target range despite a lower services gross margin in the quarter.

Q1's overall gross margin of 44.6% decreased slightly from Q4's level of 45.5%.

Product gross margin, however, remained strong.

Actually improving sequentially from 47.7% in Q4, to 48.7% in Q1, primarily as a result of favorable product mix.

At 12.4% services gross margin was adversely affected by a greater of mix of lower margin installment-related revenue and the fact that we are investing in additional services resources.

Gary will talk more about the drivers behind this investment in his comments.

In the remainder of my comments today I'll speak to both GAAP results and to what the results would have been if we excluded those items detailed in the press release.

On a GAAP basis our operating expenses in the first quarter totaled $70.8 million, compared to the fourth quarter when they totaled $68.9 million.

Adjusted for nonoperating or nonrecurring charges detailed in the press release, our R&D sales and marketing and SG&A expenses for the fourth quarter would have been $62.2 million.

This is up slightly as expected from Q4's $60.4 million as adjusted OpEx primarily due to increased R&D costs.

Our Q1 GAAP net income of $11.1 million or $0.12 per diluted share, compared to a GAAP net loss of $6.3 million or a loss of $0.08 per share in the same year ago period or $0.14 per share in Q4.

Adjusted for the unusual or nonoperating items detailed in our press release, including 123R related compensation expense, our first quarter net income would have been $20.1 million, or as adjusted net income of $0.22 per share.

As a reminder, beginning last quarter we are using GAAP taxes for the calculation.

In the past we had used a 35% rate for this calculation.

This compares to an as adjusted loss of $0.11 per share in the same period a year ago.

Now turning to the balance sheet.

Cash short term and long term investments at the end of the first quarter total $1.2 billion.

We issued-- excuse me, we used $11.3 million in cash for operations in the first quarter primarily driven by increased working capital required to fuel the business.

This compares to $15 million used in Q4, which included our $10.2 million semi-annual interest payment on our outstanding 3.75% convertible notes.

Other items on the balance sheet.

As expected our accounts receivable balance at the end of the quarter, increased from $107.2 million at the end of Q4 to $139.4 million in Q1, primarily as the result of timing of revenue recognition and payment terms.

Days sales outstanding in Q1 were 76.

Going forward we are increasing our target DSO range from the 65 to 70 range we've talked about previously to between 75 and 85 days as a result of our increasing international business and longer payment terms.

As expected, inventory levels ended the first quarter at $103.5 million, down from Q4's level of $106.1 million.

The inventory breakdown for the quarter was as follows.

Raw materials $29.6 million, work in process $7.8 million, finished goods $89.4 million and a reserve for excess or [absolesence] of $23.2 million.

Product inventory turns improved from 2.8 in Q4 to 2.9 in Q1.

And finally turning to head count.

Our worldwide head count at the end of the first quarter totaled 1,588, an increase of 103 from Q4 largely reflecting the ramping of our R&D facility in India.

And now I'll turn the call back over to Gary.

Thanks, Joe.

With our Q1 results we feel like we're off to a good start to 2007.

We're building on the solid progress we made in 2006, and we're pleased with the increasing alignment we see between our portfolio and the direction our customers are headed with their networks.

We're also excited about new opportunities we're targeting with our comprehensive Ethernet strategy, including the recently announced Ethernet enhancements to our FlexSelect architecture.

I'll spend the first portion of my prepared remarks today talking to our Ethernet strategy and the announcements we made this past monday, and then I'll wrap up with comments about our business and outlook.

Consistent with our strategy to go on the offensive in 2007, this week we launched the latest extension of our FlexSelect architecture, our FlexSelect for Ethernet solution, including both new products and feature enhancements.

The essence of our FlexSelect architecture is a set of strategic tools integrated across platforms that create a software defined reconfigurable network for any service mix.

This implementation of next-gen networks is being adopted by our customers worldwide and continues to be a significant driver of our continued growth.

Building on that proven approach to network transition, we announced monday the incorporation of a comprehensive strategy to enable Ethernet as a key element for profitable network and service convergence.

Driven by its economic value and ubiquity, Ethernet is increasingly being applied to parts of the network where Ciena has significant presence and expertise.

From Broadband access and Metro agregation to regional switching and long-haul transport.

FlexSelect for Ethernet enables our customers to evolve Ethernet into a foundation for building their business.

By providing them the means to profitably scale higher value IP and Ethernet services while it's at the same time protecting legacy services and network investments.

Through a series of new product and feature developments, we are driving critical qualities in to Ethernet that make it a practical and economical vehicle for network transition and convergence.

In other words we are making Ethernet performance grade to build next-generation networks that are as resilient, deterministic, and manageable as traditional circuit networks.

Along with Monday's strategy announcement, we also introduced two additions to our portfolio to enable Ethernet access over any media as well as the delivery of any service over Ethernet.

We've added the 3,000 Ethernet access series to extend the each of Ethernet to all business locations, whether served by copper or fiber connections.

This represents a strategic expansion of our access portfolio in to the high growth business Ethernet services market while it's leveraging our existing Broadband access expertise.

We've also added the CN 5560 to the multi-service carrier Ethernet platform to enable the cost effective transition to converged Ethernet switching in metro and edge aggregation networks.

This platform facilitates a reliable, scalable and cost effective infrastructure by enabling any service over Ethernet.

These product announcements and the debut of our FlexSelect for Ethernet strategy mark the next steps in the implementation of our FlexSelect vision.

During the last several years we've invested significantly to create a targeted solutions portfolio with a unified vision that Ethernet is the most efficient and economical foundation for next-generation service aware networks.

I think the thing that's critical to understand about our FlexSelect architecture is that the vision behind it permeates our thinking and our entire product portfolio.

Whether incorporated in new features for our traditional Optical platforms or the foundation of completely new products like those we announced on Monday, our FlexSelect vision already is a driving force behind our revenue growth and is increasingly a driver for our R&D investments.

With the adoption we're seeing of FlexSelect and the success of multi-service platforms like the CN 4200 and now with the debut of our FlexSelect for Ethernet strategy, Ciena is rapidly establishing itself as far more than just an Optical expert.

I believe it's as a result of that market positioning and our innovative solutions portfolio, that we continue to see indications of strong demand, including what I would characterize as a robust order pipeline.

We expect we will continue to benefit from the wave of both wireline and wireless infrastructure expansion we've seen in the last year.

Largely driven by global mobility and access as well as a growing volume of bandwidth intensive services like video and storage.

These demands are most visible with traditional telco service providers.

However, as we've said previously, we are also seeing our other customer segments, including cable, government, and enterprise, implement transition strategies to better support a growing range of services.

And as a result of network and service convergence, the lines between traditional telco and these other customer segments are blurring, which we believe translates in to growth opportunities for Ciena.

Whereas a year ago, many of our customers were focused on simply adding bandwidth to existing network infrastructure, we're now seeing the beginnings of real transition to next-generation Ethernet-based architectures.

Importantly too, customers are looking for more than a single point-to-point solution.

We're hearing more often that customers want to vendor with whom they can partner to implement a turnkey next-generation network complete with installation and support resources.

We believe our portfolio is well aligned with market direction and we expect we'll be able to continue to distinguish ourselves in the market place.

As a result of this we're optimistic about our ability to continue to grow faster than our overall market.

While it's not without its challenge, we believe at this point we're on a trajectory to deliver revenue growth of 27% to 30% for the fiscal year.

But our focus is not solely on revenue growth.

We're also working to deliver continued improvement in our other financial metrics as a strong financial position truly enables our ability to continue to invest and grow.

Let's talk first about gross margin.

As we've said previously gross margin is one of the more difficult metrics for us to predict with accuracy, as it can fluctuate as a result of a number of variables most notably product mix.

While our overall gross margin in Q1 was adversely affected by lower services gross margin, as Joe noted, our product gross margin actually increased quarter-to-quarter as a result of a favorable product mix, and our ongoing efforts to work on product cost reductions.

Let's spend a few moments on the services revenue and the gross margin.

In Q1, we had a higher mix of installation related revenue, which tends to carry the lowest gross margin within the service product mix.

During the quarter, we also invested an additional service resources to support some larger builds and to address growth we're seeing in new regions where we do not yet have support infrastructure.

We're also seeing an increasing number of turnkey opportunities, particularly in Europe, and we believe our increased service capabilities will enable us to more effectively execute on the business we have, and positioned us to better compete for new business.

We expect that as a result of efficiencies that will come as we scale, we will be able to improve our services gross margin towards the bottom end of our 20% to 25% target range as we move through the balance of the year.

Finally, let's spend a few minutes on operating expenses.

GAAP and adjusted OpEx was up over Q4 as expected primarily driven by modest increase in R&D spending.

At this point we see opportunities that we believe warrant additional OpEx investment over the balance of the year.

As a result, we expect OpEx will increase in real dollars throughout the balance of '07.

However, I expect that OpEx will decline as a percentage of revenue through the balance of the year.

We are making solid progress towards normalizing our business model, and have demonstrated measurable success in our strategy to grow our way back to profitability through investments and innovation rather than cost cutting, but we are not about to allow our discipline to fall by the wayside.

We continue to see opportunities on which we believe we can capitalize and will look to invest prudently accordingly.

In summary, we made good progress in our fiscal first quarter and expect to continue to do so in Q2 and the remainder of 2007.

And we see indications of growing strength in both the size and the health of our addressable market.

We said when we reported Q4 that we were going on the offensive in 2007, and with one quarter behind us, we do see increasing opportunities to help our customers align their network architectures with the business values of their customers.

We're leveraging both our technology leadership and our incumbency in some of the largest service providers in the world in an an increasingly receptive market.

With FlexSelect we have a driving and unifying vision and strategy.

In addition, we're looking to build on the progress we've made thus far in normalizing our operating model.

We continue to believe that solid execution will enable us to grow faster than the market and continue to improve our overall financial performance including profitability.

In general, we're pleased with the momentum we're seeing with customers and with the visibility this is affording us.

With that, Joe, will you walk us through the guidance for Q2?

Definitely.

Thanks Gary.

Before I begin to offer our guidance, I'll remind everyone that the statements Gary just made and those that I'm about to take-- make are forward looking.

It is important to review the risk factors detailed in our most recent 10K in order to understand the factors that might cause actual results to differ materially from this guidance.

In addition, the guidance I'm about to discuss is on a GAAP basis.

Following my comments on GAAP guidance, I will also share with you our expectations or as adjusted EPS.

As stated in the press release, we expect to be able to increase our fiscal second quarter revenue sequentially by between 5% to 10% from our fiscal first quarter revenue.

Now this is a broader range than we've previously talked to everybody about.

In part, this broader range is driven by our participation in larger deployments, and in more turnkey deployments, and the fact that revenue recognition associate with such projects is often difficult to pinpoint within any given quarter.

However, we believe the range represents the opportunity in Q2, and reflects the market and customer dynamics we're seeing.

Turning to gross margins, as we've said in the past, gross margin is difficult for us to predict with accuracy, and we expect it will continue to fluctuate from quarter-to-quarter.

Our gross margin ultimately depends on a combination of factors, the primary ones being product and customer mix, but it can also be influenced by volume, pricing, services revenue mix and the effects of our on-going product cost reductions.

We continue to expect gross margins to be in the mid-40s range for 2007 though quarter-to-quarter it could move outside that range.

We expect our second quarter GAAP operating expenses in real dollars will increase moderately from Q1, reflecting continued investment in R&D and sales as well as the ramping of our India facility.

And as Gary noted, while we expect OpEx to increase in real dollars, it should decrease as a percentage of revenue in Q2 and through the balance of the year.

We expect other income expense in the second quarter will be income of approximately $9 million.

On our tax rate, once again as we previously discussed we are not likely to pay significant U.S. federal taxes for sometime on our GAAP profits given our sizable NOL position.

Accordingly, our quarterly income tax expense should represent primarily foreign taxes, which we expect in the second quarter will be approximately $0.5 million.

We estimate 2Q's diluted share count of approximately 94 million total shares.

As a result we expect to depending primarily on revenue our GAAP net income for Q2 will be in the range of $0.11 to $0.14 per diluted share.

I'm now going to discuss EPS on an as adjusted basis.

As a reminder because our NOL position-- of our NOL position, our as adjusted EPS calculation will not include any adjustment for taxes.

In other words we'll use our GAAP taxes for that calculation.

Excuse me.

On that basis, exclusive of unusual or nonoperating items, such as amortization of intangibles and share-based payment expenses related to 123R we expect our as adjusted net income for Q2 will be in the range of $0.23 to $0.26 per diluted share depending of course on large part on the revenue in the quarter.

And operator, now we'll take some questions from the sell side analysts.

Thank you. [OPERATOR INSTRUCTIONS] We'll go to Brant Thompson of Goldman Sachs.

Hi, good morning, gentlemen.

I was wondering if you could talk about a few things relative to the guidance that you're giving.

One, just give us an indication-- Gary you had mentioned with the new product announcements that they have the ability to impact revenues in '07 and '08, are you-- how much of new product revenues of the ones that were recently announced is baked into the guidance?

And then, second, from a bigger picture standpoint the year-on-year growth that you showed this quarter and that you're suggesting for next, is that on average a much higher rate than anything that we saw year-on-year growth wise in 2006?

Or, are we getting to the point where we can start to say, that we're certainly not-- 2006 was not a real peak growth year based on all of the trends we're seeing in the market, and that we can start to potentially move up from here?

Thanks.

Brant, why don't I take that.

In terms of the new products that we announced on Monday, while it's-- we anticipate some revenues for them in 2007, as they begin to get traction, I think it's fair to say they're fairly small in relative terms to the overall revenue expectations.

In terms of year-on-year, I think it's sort of too soon to say '07 versus '06.

I think we grew over 30% last year, and I think we, we're looking in a range right now of 27% to 30%.

I think we're encouraged by what we see.

We see a robust pipeline.

We have also got, as Joe mentioned in his commentary, a number of larger projects some of them turnkey, and so that's sort of the variability within the quarter guidance that we gave, and that clearly is the same throughout the year.

But the encouraging thing is that we can see these kinds of projects and these kinds of growth.

So I think in summary, Brant, I think it's too early to say in to the year, we've just got through our first quarter, but we're certainly encouraged by what we're seeing.

Great.

Thanks.

We will go next to Marcus Kupferschmidt of Lehman Brothers.

Yes, hi.

Good morning.

Just wanted to clarify in terms of the discussion of the revenues for the quarter, could you talk about what the quarter after revenues were?

I thought you said core switching.

I missed that number.

Sure, Marcus, good morning.

Hey, Joe.

I'm fumbling through the script here.

38.8.

38.8 Marcus.

That is core director, 38.8?

That's correct, sir.

Okay and can you give us a sense of--as you think about the next quarter two, do you think the quarter after contribution can remain this kind of steady?

And also help us think about where you think Broadband business could go given we've seen such a big decline over the past couple quarters?

Thanks.

Sure.

I'll tell you what I'll cheat and take the first one I'll give Gary the second one, Marcus.

In terms of core director, I would go back to Gary's comment about the business feeling robust.

So I would tell you there on the core director front, it could definitely go up.

It could be slightly flat.

And marginally it could go down but I would handicap more than anything it's going to go up, but it's going to be based on [inaudible].

But I would tell you that the business for core director is as robust as probably two or three of the other product lines that we're seeing right now.

So although I can't predict where we're going to end up 90 days from now, but it feels like it could be up.

So why don't I take the Broadband one, Marcus.

I think we saw like others some softness, predominately in North America due to the sort of consolidation that was going on.

I think from our perspective right now, my personal view is that I think DSL could come back a little bit in the remainder of the year, so we're seeing good initial traction with some of our platforms, particularly some of the newer ones, so I would say overall, we would-- I personally for the remainder of the year would expect to see for us a small uptick in some of the Broadband business.

And I assume that's baked in the guidance?

Yes, sir.

Thank you.

We'll go next to Nikos Theodosopoulos of UBS.

Yes, thank you.

I had a couple of quick questions.

On the-- I just wanted to first clarify, Gary, earlier I think you said that annual revenue growth should be 27% to 30%, and just wanted to clarify that.

And I guess, given the comments about OpEx and operating income, I wanted to see, do you still think that the Company will get to a 10% operating margin at some point this year exclusive of option expense?

So that's the first question.

And I just wanted to understand a little bit more on the DSOs.

This quarter they went up, and you're raising the target, yet the international mix this quarter actually was less.

So can you help us understand what caused it to go up this quarter given international did not go up?

Thank you.

Why don't I take the first part of that Nikos in terms of the-- my commentary about the overall year.

I think as I said it's not without it's challenges, but we--given the amount of projects, et cetera, but we think a range in the 27% to 30% growth for the fiscal year.

Joe do you want to address some--?

Yes, so Nikos let me-- your second-- the second part of your one question had to do with 10% operating margin possible for '07, and I would say, yes, definitely.

It's going to be more back end loaded because of some of the business that we're seeing right now.

It is, again I'm going to keep using the word robust, it is robust.

But as I think I've talked to many of you about before, a lot of the strength in the business we're seeing are from the tier 1s and each of the tier 1s want it my way, so to speak, so that means Steve's sitting across the table from me here is got to do a little more R&D.

So it's going to be pushed more toward the back end of the year.

The third part of your question was related to DSOs.

If international business is down, why the DSO's going up?

Because we effectively going on a forward looking basis, we see that the international portion of the business is, again as robust as the rest of it is, I hate to be redundant here.

But it's going to be a big-- it should be a big piece of the business.

And then there are a couple of U.S. pieces of businesses, where the payment terms are getting longer.

So that's, that's the reason why the DSO guidance is going in to a different range.

Okay.

All right.

Thank you.

Yes, sir.

We will go next to Tai Liani of Merrill Lynch.

Hi, guys.

Question-- two questions first is on service margins and then on OpEx.

On service margins, the decline sequentially was quite substantial, but you had improvement throughout the last few quarters, and then you also say it's going to come back to sort of the 25% level in the next few quarters.

So how do I look at the decline in service margin?

Is it related to a single customer in Europe that is maybe not paying as much for services?

Or is it-- just more details on that.

And then I have another question on OpEx not related, so let's take one-by-one.

All right Tai, this is Joe, and I apologize for chuckling but I know where you are headed there.

In the case of the services margin, again, it's a function of what we're getting services revenue from if it's out of warranty work or if it's maintenance work, the margins in that type of business are quite good.

If it's traditionally installation stuff, that's where the margins are not that good, right?

It's low end stuff.

And what you saw in the first quarter and potentially what we see even in the second and third quarter, again, is the installation piece of that business and that revenue is going to be quite large.

Similarly with the business-- the hardware business being pretty robust so is what we see and have visibility too in the way of services specifically installation margin.

So in that kind of business you don't make great margins on them, and that's why we're talking the way we are about the business.

The key thing to remember there, though is the more installation services business we have means the more footprint we're getting, the more chassis we're putting in.

So we feel pretty excited here about what it provides in the way of an annuity and what it means for future revenues, and future revenues and good margins.

So hopefully that answered your question, and we can go on to part two.

Okay.

So-- by the way just from modeling point of view, going from 13% this quarter, how-- how long does it take you to go back to 25%?

Wow.

I'd say you won't be there in Q2, and you probably will not be there in Q3.

Again, based upon the kind of visibility we have towards the kind of business that we're doing.

We don't go out -- we don't give you guidance going that far out, so it's difficult for me to help you out here at this point in time.

That's enough information.

That's okay.

Sorry about that.

Second question I have on operating expenses, more focus on R&D, if I look at the consensus this is your guidance your above revenues, gross margin is sort of in line, you haven't changed it, but your EPS is below, and the variable there is really operating expenses.

And the way you describe it, you say R&D or OpEx would increase moderately.

Can we take the word moderately and try to apply more mathematical terms to it?

If you expect revenues to be up 27% to 30% in the year, are we talking about 5% growth in OpEx or 15% or 25%?

Just to give it some kind of ranges?

I'd say, again, this ones a tough one to call because of the stuff that Steve's working on.

But when you talk about moderately, I would talk about several million dollars, again, and if you're talking about the GAAP number, you got to remember that stock comp is in there, and it's a fairly nice sized number, and you have to also-- I mean-- this is a tough, this is a rat hole to go down, but it's also tied to the fact that when we make new option grants and hand out new equity, which has traditionally been on a-- it happens once a year, we just went through one of those cycles.

It usually happens in the-- like the November/December time frame, and in the case of the first quarter it was a bit depressed because the first quarter only had several weeks of the expense associated with the new equity grants.

And therefore going forward you'll have a full quarter impact.

So just from a modeling point of view, again, it's-- the sequential growth we've seen now in OpEx, should we expect this to slightly accelerate throughout the year?

Is that the right way to interpret what you said?

Tai, let me sort of answer it from another direction.

I think what we've also said is that it won't go up proportionate to revenue.

Right.

So we've given revenue guidance out there, so I think what we're trying to, as best we can, take a perspective on that.

We're very disciplined on the OpEx side.

We see opportunities both in sales and R&D is the other thing that I would add.

So what you're seeing during the course of the year we would expect OpEx to go up both in the R&D and in sales as we see opportunities both that are impactful for this year, but just as importantly in '08 and '09.

So it's a combination of those two things, but we do see consistent leverage of the operating model going over the year and an improvement in the overall financial performance as well.

Gary, I have one last question, which is more big picture question.

Ciena's position in the industry.

There are two trends that we see right now in the market.

We see the impact of consolidation of carriers, mainly in the U.S., and we see the month for bandwidth, traffic is booming.

Can you layer on top your-- and be as specifically as you can, but layer on top-- your Company on top of these two trends?

How much upside do you see from consolidation of carriers, and how much upside do you see from the booming traffic, and I'm not referring to quantifying it, but rather just give examples of where you play in these two trends?

Well I mean if you look at the industry dynamics you've got certain consolidation within larger customers, really kind of early days to that, but we think we're well placed given what we can see right now.

You're also seeing consolidation in the vendor community, which I think is also throwing up some opportunities for us as well as a specialist player.

And I think the two dynamics that we're seeing from the customer side is, A an increase in overall traffic demand, but we're also seeing folks wanting to look at a more converged network and move to next-generation Ethernet-based convergence around layer zero to 2.5 with IP on top of it.

So you've seen both of those trends which I think is helpful to us.

And I think both now and in the, the visibility that we have I think we're pretty well placed around that.

And specifically an example to that is core director, which is embedded in a lot of the largest carriers around the world and that is the perfect architecture, the perfect mesh architecture in which to drive migrate a lot of these networks.

So I think we're-- we feel like we're pretty well placed right now.

Not would its risks and challenges, as always, but I think, we think the investments of the last few years are beginning to pay off for us.

Do you feel you need to acquire a Company?

Tai, we think that we're pretty well placed right now with the technologies that we have and the pallet that we've put together, but I certainly wouldn't rule out opportunistic acquisitions as they would fill out the portfolio, but we feel that we've got a lot of the core technologies that we need, and we're able to partner with some folks for that as well.

So I would never say never, but right now we're concentrating on our business.

Great.

Thank you.

We'll go next to John Marchetti of Morgan Stanley.

Hi, thank you.

Couple of quick questions for you.

On the deferred revenue line, Joe, you've talked in the past about a lot of that being on the services side.

I was wondering if you had any visibility there in terms of how much of that deferred services revenue might be implementation or installation work going forward just from a gross margin point.

And then secondly on the 4200 I think it was 22 and change last quarter, we're at 26 this quarter.

So it looks like that growth there is slowing.

Just wondering if that is a revenue recognition issue, if a lot of that is in the finished goods inventory, just a little bit of color there, please?

Sure, John.

Good morning.

Good morning.

In terms of the deferred revenue, it-- it's predominately is services, and you're going to see that in the Q when it comes out here in the next day or so.

But it isn't necessarily installation, it's more maintenance.

Okay.

It's more people buying the maintenance contract.

When I was talking to-- I guess it was Tai, we had the question about where you get the good margin from and it's the out of warranty stuff.

It's the people that are-- they buy the service and maintenance contracts.

In the case of the 4200, again, it is tied to rev rec, there is a lot of finished goods in the-- in both of our warehouses now because we have one here and one in Europe, and there is a lot sitting out in the field being installed.

So it is tied to rev rec, so that is a good point.

But it will be lumpy, it will go up and down.

But I'd say the range is a range that should grow over time and I would, again, point back to the robustness-- and it's the robustness in the business across the board, not just quarter after or core transport.

Thank you.

We'll go next to Tim Savageaux of Merriman.

Hey,guys, good morning.

Morning, Tim.

Question for you on the DOL a mathematical question, I guess second.

First of all on the overall trajectory of operating expenses.

I wonder if we can expand on that a little bit?

So the program going back a couple of quarters was to try and sort of keep operating expenses somewhere in the-- around the $60 million range, and you are up a couple million here, and up I gather three or four more.

Now even doing that and factoring in a mid-40s gross margin I'm still coming in above the high end of your guidance range.

And that's the mathematical question if we can get to that in a minute.

But more broadly, I wonder if you could share with us, what's on the other side of this operating spending rainbow, which is to say, to the extent you're going to ramp this up in advance of any meaningful contribution, I think it's incumbent on you to share with us, why you're doing it?

And exactly what kind of opportunities Steve is looking at across the table over there.

Can you spend some time talking about that?

Why don't I take that, Tim, and then Steve can talk about some of the opportunities that he sees in that.

I mean first of all we've said very clearly that we're going to get operating leverage on the business.

So it's not going to grow proportionately to our revenue and gross contribution over all--

Right but it's going to grow more than you said it was going to grow before.

Now the top line is as well, and the issue is kind of balancing that.

Yes, so I don't think we're-- we're not saying anything different in terms of the our overall operating model, and our ability to get there.

We are seeing, I think, some more opportunity to capitalize on that, but we'll-- that will flow predominantly through '08 and '09.

We want to make sure that we've, we're fueling the tank for future years, as well.

And clearly I'm not going to give kind of guidance to that, but I think you're seeing an increased revenue ramp this year, and I think we'd be remiss we were not to be opportunistic in maximizing those opportunities that we see in front of us in the marketplace both from a sales and from an R&D point of view.

In terms of the math question, I mean I think you've got a range on the revenue, you've got a mix on the revenue, and you know Tim it's not absolutely pure math when you take those into account.

What we're trying to do is give you range and a feel as best we can predict about within the quarter, and all of the parameters, the variables that we have there.

So really my answer to the math one is really around the range on the revenue side would effect-- clearly cascade on the mix right the way through the balance sheet.

Steve, do you want to talk about some of the opportunities in the marketplace?

Sure, so Tim, I think that the way you'd like to look at it is what FlexSelect really allows us to do is bring a tool box to market that lets people make transitions.

As they looked at the bandwidth demands coming into the network and they want to understand how do they-- basically we put together a cost effective infrastructure, one of the key tools they want in there is Ethernet and you might call it performance grade Ethernet going forward.

And really that's what FlexSelect let's them have.

And so if anything we've seen more and more adoption of Ethernet as the way to provide large amounts of capacity and bandwidth at a reasonable cost point.

And so we look out there there's lots of opportunity, and as you pointed out it's a balancing act, right.

You want to invest the funds that we have for the best return that you possibly can.

But it's all focused around the transition of networks over to Ethernet and the increasing need for highly capacity Ethernet.

Okay thanks.

Thanks, Tim.

We'll go next to Phil Cusick of Bear Stearns.

Hi good morning, this is [Jonathan Keys] calling for Phil Cusick.

I had a couple of questions for you, one is I guess more of a housekeeping.

You talked about Broadband and long haul and transport, how it's going to be trending forward.

Wondering if you could also talk about data networking and the outlook for that, sure that baked in the goods, but just some more elaboration on that.

And the second, I have a more general question in terms of the market.

Let me talk a little bit around the data networking side of it.

What you see going on is effectively the different levels of convergence, you're seeing data networking features and attributes showing up on multiple locations in the networking infrastructure.

And it's important not to be limited by what you might call traditional definitions of the products and such.

And so you look at a product line like core director.

A lot of the core director today is used for making the transition, if you will from the TDM infrastructure now with inner working that with Ethernet and such, right we've introduced Ethernet services line modules on the quarter record to make that happen, and with the most recent additions to the portfolio, that all speaks to effectively multiple services over Ethernet and then Ethernet over multiple types of media.

Clearly fiber is one of those medias, copper is one of those media, and that really drives the demand going forward.

So you're looking for data networking to start churning down goods, it's being cannibalized by the other segments?

Well I wouldn't say it's trending down perse.

What you're seeing is the convergence of the two worlds, right.

The way you get high bandwidth is you go Optical, and so when you look at it and you say, okay, so my data is being carried optically so that is-- is that a data product or an Optical product?

So that's effectively convergence right in front of it.

Okay.

All right.

And then the second question I had is more on a broader level of just basically, are you seeing pricing competition?

How does that look relative to your expectations?

You had two of your biggest competitors merge back in December.

That's on the one side, and then on the other side you had a upstart just announced plans a couple of days ago to go public.

Just wondering how the pricing competition are, relative to probably getting sandwiched from the top and from the bottom there?

Jonathan this is a world that we've lived in for a long time.

And we're used to competing in it.

And I would describe the pricing market-- we're not seeing anything different than we've seen for a while, and we continue to run our business on the basis that it's going to continue to be a highly competitive environment.

We don't see any dislocating technologies out there or anything that we think is going to particularly affect that more than the-- what we've seen in the last 18 months to two years.

We expect it to continue to be a very competitive environment.

That's how we plan our business, our operations, our cost reductions in terms of the, the overall portfolio.

So nothing more aggressive?

Nothing beyond expectations?

No so far.

Still tough.

Okay.

Great.

Thank you very much.

Thank you.

We'll go next to Ehud Gelblum of JPMorgan.

Hi, thank you very much.

Couple questions if I could.

First of all, Joe, when you look at your gross margin the diversity between the services and the product, product being very strong this quarter, services margin being low.

Just want to clear a couple of things.

Services gross margin is low because installation revenues are low.

That's a good thing.

You're getting new product in there.

How long do you expect that to stay low?

How long do you expect the installations to go on before that starts coming back up again?

And conversely on the product gross margin side at what point do we see that come back down again?

And how do we plan for that going forward?

And then I have a follow up on OpEx.

Sure, Ehud, no problem.

Let me just qualify something.

The installation business is robust.

That would drive the margin down.

I think I-- I thought I heard you do the opposite there.

The installation revenue is pretty robust--

Yes, it is currently and that's what's driving the lower gross margin.

At a certain point, though, you have more follow up business than you have new installation, I would assume.

Yes, so the trend is I'm looking at there, I think the installation business stays robust, through like I said the second and third quarter.

I feel pretty good about that, it will probably be the same in the fourth quarter, but I didn't want to go there with Tai on that one, and I'm going to stick to my guns and only go out to the third quarter, but it is-- it looks strong between the book of business that we have right now and what we see coming down the pike.

In terms of your other question, on the product gross margin, I think Gary mentioned it in his prepared remarks as I did, it's a function of the product mix itself.

If you go back to Marcus's question early on about what are you seeing with core director?

It's pretty strong because of the fact that it is a pure switch, switches carry a much higher gross margin than some of the other products do.

If the core director mix is strong like it, it could be, then the product margin stays stronger for that next couple of quarters, but I, I can't overemphasize how it will blow right down to what you get acceptance on in the quarter.

Right.

Would you look at services gross margin-- or services installations as being a leading indicator of future revenue?

It's one of them, but it's a bloody good one.

Okay.

That's what I thought.

Gary, when you look at what you-- your comments before on acquisitions, of course you have to say you would never rule something out that's just kind of almost boiler plate language.

Do you think that you're-- and on acquisitions you're-- the question earlier is any different than it would have been a quarter ago, two quarters ago, three quarters ago?

So we think that you're now looking for acquisitions when you wern't before, or is it just to that boiler plate and you've always have to be-- keep your eyes open?

I don't think it's really changed over the last few quarters to be honest, Ehud.

I mean we continue to look at things that might help the, and leverage the corporate position.

I would say this, we don't see any obvious holes in our portfolio from a technology point of view, so we feel pretty good about that.

I would say that we would not make-- having invested in the business heavily in the last few years and now sort of moving towards a more sort of more normalized business model.

I think we would be very prudent around not impacting a drive in our target to get to a more normalized business model.

And that's why we're watching very carefully our internal investment in terms of our OpEx on just opportunities that we're seeing there, we're staying very disciplined about it, but really, we want to make sure that we maintain our target of getting to a normalized business model.

Okay.

That's very helpful.

On the OpEx again, if I can just try to understand what it looks like.

First of all, at what point did you, during the quarter or during the last six months did you suddenly feel that it was worthwhile?

That there were opportunities that were worthwhile spending OpEx on, I mean is that to support this 27% to 30% revenue that you have this year?

Or this is you're laying the ground work for '08 and '09?

And then, is this a temporary ramp, in which case it settles out, I'm not expecting it's going back down again, but on an absolute dollar basis it this a temporary ramp for the next three, four, five quarters and then it flattens out in our-- the way you model it and think about it?

Or is this something that you think will continue on?

Let me answer the question like this, I would say it's a more recent perspective that argue, we are constantly looking at the market place and looking at the business model, our pipeline, what we're seeing in the marketplace, and then looking at though variable levers that we have.

And I think it is fair to say that I think we're getting comfortable, if that's quite the right word around the fact that we, we see some sustainable opportunities there that we really want to make sure that we're taking advantage of.

First of all on the sales side in certain market segments, and also from the R&D side.

We're seeing good acceptance on our architecture in a number of these platforms and we want to make sure that we maximize that.

We're very careful about as we look forward on that making sure that that's not impairing our ability to, to get to a normalized model.

And I would describe it like this.

Our number one priority right now is to drive to a normalized model.

We clearly need to look at the fuel for '08 and '09, and I think it would be remiss of us not to invest accordingly.

But I would restate as a sort of discipline that we're following, as the-- OpEx as a percentage of revenue we believe will decline throughout the year.

And I think that's a clear kind of statement on, on our part.

There's a lot of moving parts it to, not the least of which is the revenue, but I think we've given guidance on that in the 27% to 30% range.

So we're going to continue to be disciplined about it, and as we go in to next year we'll look at what the marketplace is doing then and what's a suitable return on our investments, both in the short and the long term.

So it sounds as though these OpEx actions are not to support the 27% to 30% of this year, but to set the barometer--

I would say, I would say on aggregate that's a fair comment.

I would say that's the case.

It's to make sure that we can continue to maximize the opportunity that we see-- we're beginning to see now in '08 as we come out of our fiscal year.

So there not reactionary?

No.

One last thing is do they level off in '08 or '09 or do you continue --?

I think that's a little further ahead on the guidance.

I would say this, as a percentage of-- of our revenues, I would expect them to come down.

Thanks.

Appreciate it.

Thank you.

We'll go next to Cobb Sadler of Deutsche Bank.

Hey thanks a lot.

Just the question earlier on pricing, kind of what you're seeing, I have a private competitor that may have filed?

I mean what-- are you really seeing pricing kind of across the board?

Or my take is those guys are really only a tier 2, tier 3 player.

I mean has it affected pricing in you're Tier-- in the tier 1 market for major customers globally?

I would describe it like this, Cobb, I mean, we've competed in this market place for a while.

We don't see anything particularly different now in the various segments that we operate in.

I would say there is a number of competitors that we see in the various segments that we play-- and it continues to be a tough pricing environment, I don't see that that's going to get any different.

Okay.

And you kept gross margin guidance the same.

There's really two major deals that you're starting to deploy in into more aggressively now, one North America, one Europe.

Do you think that once you get through the initial chassis in common equipment deployment that margins could go up after kind of a three quarter kind of initial equipment deployment cycle?

Or do you expect 45% to be kind of the number for a long time?

I think, Cobb that's, this is Joe, this is a long range-- I think that's the long range that we see.

I would go back and qualify your first statement that again, think about what Gary said about the business being robust, it's just not as you're putting out there two large builds that we're doing.

Believe it or not there are several others.

So but in the near term I'd say that the mid-40s is the right place to be.

Your point on pricing is good, but we have to see where that [inaudible].

Okay great.

And one last follow up with the lucid Alcatel deal, are you seeing any customers worry about supplier concentration?

Are you picking up any, just kind of business there with maybe a large customer that may have a lot of equipment from each one of into them and looking for another source now that they've combined?

Thanks a lot?

Cobb I think it's fair to say that we are beginning to see that now, as they-- the merger settles in.

I think there are a number of opportunities that we're seeing.

I'd kind of liken it to sort of landing slots in airline pilots.

As the carriers look for a suitable and appropriate blend of suppliers, I think that so far it's early days, but I think that is throwing off some opportunities for us in some of the larger carriers.

We'll see if we can capitalize on that.

Okay.

Great.

Thanks a lot.

We'll go next to Simon Leopold of Morgan Keegan.

Thanks a lot.

I think like many others I'm trying to figure out some of the trending that's going on here.

So I want to go about it perhaps a little bit differently, maybe in two parts.

One is looking at the customers that were big in this quarter, if you could maybe clarify if one of those was just a carrier, we would typically associate with the cable TV space in MSO, and how you see that trending forward if that assumptions correct?

And the second part in terms of the Broadband business, AT&T had made some commitments to the FCC about extending it's Broadband to 100% coverage.

Some of that's through WiMax, some of it through DSL.

And it seems like your products would fit that application well.

Want to get your sense of how you're thinking about that particular opportunity as you go out toward the back half of this year?

Thanks.

Simon, why don't I take that.

I think in terms of the carrier, I think it's fair to say that all the Telco carriers of the 10 percenters.

In terms of the Broadband business, I actually think that it could uptick a little in the second half of the year.

I think it's too early to tell specifically-- from a customer specific point of view.

Steve from a Broadband perspective, what do you--?

So I-- I agree with you Gary.

I think you'll see more and more role out when you look at the opportunities that are created to the comment you made earlier, Simon I think the portfolio does fit very well in there.

We basically offer the ability to take remote terminals and rapidly upgrade them to provide Ethernet over copper, and advance DSL and such.

So I think it is a good fit we have to let it play out.

So more specifically in your April guidance you've got certain assumptions in there and you've implied that you expect some improvement, but it's not reasonable for us to think it's a step function back to the 20 million plus level that we saw last year?

Is that--

I think that's a fair assumption, Simon, yes.

Okay.

Great.

Thank you.

Thank you.

And due to time constraints, we'll take our final question from Tim Long of Banc of America.

Thank you, just two real quick ones here.

First, Gary, if you could just-- you mentioned consolidation, but it didn't seem to have any impact in the quarter.

Do you think in, in the quarter that just passed and in the upcoming one is there any hang over in your view holding the numbers back a little bit or impacting the revenue recognition anything like that?

And then second for Joe.

Given the changes to the services gross margin in the near term and, and the little higher OpEx, could you update us on your view of time line to a more sustainable cash flow operating cash flow positive generation?

That would be great.

Thank you.

Tim, let me answer the first one.

I mean I think it's fair to characterize it as I think some of the consolidation did affect our-- we weren't immune from what other folks saw in terms of the Broadband in Q1.

I wouldn't describe it-- I can't remember your exact words as sort of pent up demand or anything sort of deferred et cetera.

I think our own view is it should by its natural means uptick a little in the second half of the year, and I think that's what a number of other folks are getting-- some visibility to, anyway.

Joe.

Do you want to-- ?

Sure.

Morning Tim.

On the cash flow front I'm glad you brought that up because we hadn't touched on that yet.

In terms of what we're heading to do, I'd say from operations in any one given quarter we could definitely be cash flow positive, whether it be this quarter, Q3, Q4.

In total because of a little bit of CapEx we got going on, for again Steve's ramp in India, and things of that nature, we're going to --we could use some.

So we get total cash burns in to a plus or minus situation.

So it's tough to call depending on when Steve buys his stuff and when we get it in.

I think the more important, though is go back to the comment about the robustness of the business.

It's going to be-- the cash flow will be driven by work in capital.

It will be depending on where the AR ends up and where the inventory ends up to meet the customer demand, but I think overall it's not in a bad position.

All right.

Thank you.

All right.

Thank you.

And at this time I'll turn the conference back to Management for any additional remarks.

Thanks, everyone for your time this morning and for your continued interest and support.

Thank you.

That concludes today's conference call.

We thank you for your participation.