Ciena Corp (CIEN) 2007 Q4 法說會逐字稿

Good day everyone, and welcome to the Ciena Corporation fourth quarter 2007 results conference call. Today's conference is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the Chief Communications Officer, Ms. Suzanne DuLong. Please go ahead.

Thanks, Steve. Good morning, and welcome everyone. I am 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 three segments. Gary will provide some brief introductory comments, Joe will review the financial results for the fourth quarter, Gary will then discuss the business in the quarter, and our outlook for Q1. We will then open the call to questions from the sell-side analysts. To ensure we answer questions from as many participants as possible, we ask that the sell-siders limit themselves to one question.

This morning's press release is available on National Business Wire and FirstCall. Before I turn the call over to Gary, I will 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 risks and uncertainties that could cause actual results to differ materially from the statements discussed today.

These statements should be viewed in the context of the risk factors detailed our 10-Q filed with the SEC on August 31st, 2007. The results we are discussing today are unaudited results. We continue to work through the process of our year-end audit and completing the 10-K. Given our desire to be as forthcoming and timely as possible with our disclosure, we made the decision to present today's unaudited results to you. We have until January 2nd to file our 10-K for our fiscal 2007, 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 to everyone. Consistent execution of our network specialty strategy, and the well-timed introduction of our FlexSelect architecture, have enabled us to benefit from both pure network capacity-related growth, as well as the trend towards Ethernet IP based network infrastructures.

As a result, for fiscal 2007, we were able to deliver above industry average revenue growth, gross margin improvement, and operating margin expansion. And our commitment to drive actions across the Company to improve our financial performance has helped us gain significant operating leverage, driving Q4's as-adjusted operating profit to better than 15%. We believe that sustained execution of our strategy, positions us for continued measurable progress in growing the Company and delivering shareholder value.

I will talk to our business in the fourth quarter and our outlook, after Joe review's the quarters results. Joe.

Thanks Gary. Good morning everyone, and Happy Holidays of course! In the interest of time this morning, I am going to focus the majority of my comments on the quarter's results, as opposed to talking about all of the annual results. So getting started, this morning we reported fourth quarter revenue totaling $216.2 million. This represents an increase of 5.5% sequentially, and 35.2% year-over-year.

We had two 10% plus customers in the quarter, that combined to represent 46.5% of total sales in the fourth quarter. One was a North American based customer, the other is an international customer. For the year, we had two 10% plus customers, AT&T and Sprint. Combined, AT&T and Sprint contributed 38.1% of the total revenue for 2007. Sales from international customers remained steady for the quarter, with international sales representing 31.1% of total revenue.

Moving now to talk about quarterly revenue contribution across our portfolio. Our converged Ethernet Infrastructure group, which incorporates all products previously in our Optical Networking and Data Networking groups, increased to $180.9 million, representing 83.7% of total revenue. Ethernet access, which incorporates all of our access products, was $12.8 million, representing 5.9% of total revenue. And Global Network Services, which encompasses all of of our services-related offerings was $22.5 million, representing 10.4% of total revenue.

Within the converged Ethernet Infrastructure group, core switching was the largest contributor at $72.5 million. Our CN4200 Advanced Services platform contributed $39.2 million in revenue, roughly on-par with core transport, which contributed $41.4 million.

On the gross margin front, Q4's overall gross margin was 50.5%, up sequentially from the third quarter's 47.7%. This is better than our targeted mid-40s range, primarily as a result of a favorable product and customer mix, and our ongoing product cost reduction efforts.

Our product gross margin was strong at 55%. And reflecting our efforts during the last several quarters, our services gross margin improved to 11.9% of revenue in Q4, up from roughly breakeven in the third quarter. In the remainder of my comments today, I will speak to both the 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 fourth quarter totaled $82 million. Adjusted for non-operating and/or non-recurring charges detailed in the press release, our operating expenses totaled $75.9 million. Our as-adjusted R&D, sales and marketing, and G&A expenses for the quarter, came in higher than initially expected, due to the timing of certain expenses associated with prototypes, consulting fees, and higher sales commissions, among other things. Even so, our 15.7% as-adjusted operating profit is slightly above our 15% target, and represents a meaningful improvement versus the third quarter's level of 13.8%.

And with the exception of G&A on an as-adjusted basis, our OpEx was in-line with the target percent to revenue ranges discussed at our October Analyst Day. Our fourth quarter GAAP net income of $30.4 million, or $0.30 per diluted share, compares to a GAAP net income of 28.3 million, or $0.29 per diluted share, in the third quarter. Adjusted for the unusual and/or non-operating items detailed in our press release, including 123(R) related compensation expense, our fourth quarter net income would have been $50.3 million, or as-adjusted net income of $0.48 per diluted share.

Now let's turn to the balance sheet. We were cash flow positive for the third straight quarter, generating $14.8 million in cash from operations. This is in spite of the cash payment of $53 million, in connection with the settlement of our lease obligations, associated with our unused facilities in San Jose.

For fiscal 2007, we generated $112.2 million in cash from operating activities. Cash, short term and long-term investments at the end of the fourth quarter totaled $1.7 billion. You will note an increase in our short term investments, as we prepare to repay the $542.3 million of 3.75 convertible notes due in February 2008. You will also note in our GAAP results, we have taken a $13 million loss on marketable debt investments. So let me spend a few minutes on this.

The $13 million loss represents less than 1% of our total cash position. The loss stems from a $45.9 million investment in commercial paper, issued by two structured investment vehicles, or SIVs as you know them, that entered into receivership and failed to make payments at maturity. The initial investment accreted up to $46.9 million during the quarter. This commercial paper was issued by SIV Portfolio PLC, formally known as Cheyne Finance PLC and Rhinebridge LLC. At the time of the purchase, each investment had a rating of A1 plus by Standard & Poor's, and P1 by Moody's, their highest ratings respectively.

We have reviewed current investment ratings, third party valuation analysis, company specific news and events, as well as the general economic conditions in determining the fair value of these investments. After giving effect to this loss, our investment portfolio at year end included investments with an estimated fair value of $33.9 million related to these two SIVs. To the extent that we determined that a further decline in their fair value is other than temporary, we may incur additional realized losses in fiscal 2008, up to the aggregate amount of these investments.

We have canvassed our investment portfolio, and at this point we believe our SIV-related exposure is limited to these two specific investments. While these two items are a small portion of our overall cash position, and understand this is a timely topic, I wanted to spend some time on this this morning, to ensure our position was clear.

Our accounts receivable balance decreased from $117.8 million at the end of the third quarter, to $104.1 million at the end of the fourth quarter. Days sales outstanding also improved from 52 in the third quarter, to 43 in the fourth quarter. Going forward, we expect our DSO range to be between 65 and 75 days.

On the inventory front, reflecting early results from our ongoing optimization efforts, our inventory levels ended the fourth quarter down slightly at $102.6 million, from $105.1 million in the third quarter. The inventory breakdown for the quarter was as follows. Raw materials, $28.6 million. Work in process, $4.1 million. Finished goods, $96.6 million. And a reserve for excess obsolescence of $26.2 million. Product inventory turns improved from 3.2 in the third quarter, to 3.4 in the fourth quarter. Finally, on headcount, we added 27 employees in the quarter, bringing our worldwide headcount to 1,797.

And now I will turn the call back over to Gary.

Thanks, Joe. Before I begin to talk about the business outlook, as many of you know, this is Joe's last conference call with us. And I have to say thank you to Joe for 13 years of outstanding dedication to Ciena. He has been instrumental in building Ciena's solid financial foundation, and he has helped navigate us through some tumultuous industry dynamics. I know I speak for everyone at Ciena when I say we wish him all the best.

As we announced in this morning's press release, following an extensive interview and diligence process, we have appointed Jim Moylan to succeed Joe. I am confident that Jim has both the skill set and professional acumen to meet the requirements of our growing business, and I welcome him to team. Joe will officially turn things over to Jim after we file our 10-K.

As Suzanne noted in the introductory remarks, we have until January the 2nd to file the K, and we expect to do so by then, if not before. In the remainder of my comments today, I will highlight our fiscal 2007 accomplishments and I will offer insight on our plans to build on that success in fiscal 2008.

At this time last year, we made a commitment to remain focused on the execution of our strategic plan. To continue growing faster than the overall market, and to improve our financial performance. With four consecutive profitable quarters in fiscal 2007, we delivered on that promise.

In summary, we achieved revenue growth of 38%. We surpassed a 10% operating profit on an as-adjusted basis for the year, and ended the year with a better than 15% operating profit, and we generated meaningful cash from operations. To get there, we implemented several actions to reengineer our business model and globalize our Company. At the end of last year, we also said that we would leverage our market momentum to go on the offensive, and further advance our technology leadership.

We achieved this goal in several ways, including expanding the breadth and depth of our customer base with significant growth in our international business, launching our FlexSelect architecture for Ethernet solutions, and increasing our R&D capacity by more than 40% during the year. And we accomplished this while improving key financial performance metrics.

Let's drill down a little bit further on the progress we have made with our customers, and detail some of the new business we secured in the year. At the highest level, we grew our business across the globe. Sales in North America were up more than 30% year-over-year, and international sales rose 55% with business won in 10 new countries for Ciena. And notably, our partner sales worldwide increased more than 45% in 2007.

In our traditional customer segment, the highly competitive Service Provider market, we added 12 new customers, and we sold new products into 14 of our existing accounts. Furthermore, our non-telco business contributed more than 15% of our overall revenue. We penetrated 19 additional customers in the government and research and education communities, and demonstrated a significant level of success in our ability to serve the enterprise market, with 85 new customer wins in that space.

On the portfolio, we made several moves to advance our leadership in converged Ethernet infrastructure. In February, we expanded our FlexSelect architecture, with a comprehensive strategy to make Ethernet a carrier class performance grade convergence vehicle, from the access network to the core. With that, we committed to adding new products and capabilities, to enable flexible converged Ethernet-based networks, for the delivery of any type of service, with unparalleled resiliency, service quality, and management control.

In-line with that, during fiscal 2007, we announced our CM3000 Ethernet access series, and the CM5060 multi-service carrier Ethernet platform, both of which are gaining interest in the market. In fact, we announced this morning the BT has selected the CM3000 series for its 21st century network. This agreement extends our expertise beyond the 21CN transmission domain, to provide BT with Ethernet access solutions, that will support the roll-out of new 21CN services and applications.

Looking ahead, we believe we can build upon our accomplishments in 2007, to continue growing faster than the market in 2008. As I have said previously, 2008 will be a year of focus and leverage for Ciena. First, we remain dedicated to improving our operations, to ensure we perform as a fast and agile global enterprise. Secondly, we are committed to attacking high-growth market opportunities, to deliver faster than market growth. And lastly, we will continue to carry out our FlexSelect architecture vision, to advance our market, technology, and thought leadership, in performance grade Ethernet.

On the operations side, we will leverage the strength of our business model to scale the Company for future growth. Our team is hard at work, identifying areas where we can further improve the efficiency of our business. Paramount among these activities is process and system improvements.

We have already made tremendous progress in this area, with the successful reimplementation of Oracle, which we completed last month. With that, we ensure ourselves a solid platform on which to scale and automate the entire business going forward. We are also highly focused on streamlining our supply chain for greater efficiency, as well as improving overall product life cycle management.

Moving to the growth of our business, we are entering 2008 with an acute focus on driving continued adoption of our FlexSelect architecture. Our expertise in transitioning networks to next generation Ethernet-based architectures combined with the Ethernet optimized portfolio we have assembled, enables us to meet the total cost of ownership and service delivery needs of our customers. Because of that, we are confident in our ability to build upon our progress in securing more customers, as well as extending our value into existing accounts with new products and features.

We also continue to see opportunity to apply our expertise in simple and highly reliable networks, to a wide range of enterprise applications, particularly in helping our customers deliver higher-value carrier managed services. We will continue to strategically pursue high growth market opportunities, like wireless back haul, where we can bring skill and evolving existing networks to better, more efficiently support higher capacity, higher value services.

Given our overall position heading into 2008, we are optimistic about our potential for a number of reasons. We are seeing a healthy level of RFP activity, including a number of opportunities in the Ethernet transport space, which is a sweet spot for our network specialist position. Our global account activities with service providers, enterprises, and partners, is on the rise. And we are seizing more opportunities to sell across our portfolio.

And finally, the architectural debate is in our favor. The Ethernet driven intelligence and automation we bring with FlexSelect is helping alleviate customers' concerns about network complexity, ease of management, and total cost of ownership.

In summary, we came a long way in 2007 towards growing the Company and stabilizing our business model. You will see us capitalize on that energy and momentum, and continue aggressively pursuing high growth market opportunities, where we can help customers align their network architectures with the business values of their customers. You will also see us working to leverage the strength in our operating model.

And I would like to give you three concepts to focus on in 2008. Firstly, innovation, globalization, and velocity. These will be pillars in the continued execution of our strategy, and key to our consistent goal of striking the right balance between investing strategically in our business to fuel longer term revenue growth, and maximizing short term operating profit and net income.

With that, let me conclude our prepared remarks today by talking to our guidance. I will remind everyone that the statements I have just made and those that I am about to make are forward-looking, and it is important to understand them in the context of the risk factors detailed in our most recent 10-Q. As stated in the press release, we expect to deliver sequential revenue growth of up to 5% for Q1 2008. For the year, we believe that we are well-positioned to continue to outperform the market, and we believe that we can deliver 20% annual revenue growth.

And as we said at Analyst Day, we have still got a lot of ground to cover between now and the end of 2008. So do I think there could be upside to the 20%? Of course. But there is also risk associated with achieving 20%. On gross margins, as we have 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, including product and customer mix. It can also be influenced by services revenue mix, as well as volume, pricing, and the effects of our ongoing product cost reductions. Based on the orders we have to-date and other contributors to visibility, we expect Q1 gross margin will be in the high 40s. Beyond Q1, however, we continue to believe that a mid-40s gross margin range is realistic for our business.

If we successfully execute and are able to expand our product portfolio to include higher value platforms and functionality, we may be in a position to talk about our higher gross margin range in the future. We expect our Q1 operating expenses will be within the percent of revenue ranges we discussed at our Analyst Day in October.

And to recap on that, we talked about an as-adjusted R&D and sales and marketing, both being at 12.5 to 15.5% range to revenue, and G&A in a 4.5 to 5% range. We expect our Q1 as-adjusted operating profit will be roughly flat with Q4's. We expect Other income, expenses, net in the first quarter will be income of approximately $8 million. We expect our first quarter income tax expense will represent primarily foreign taxes, which we expect will be approximately $1.2 million. We estimate Q1's diluted share count at approximately 109 million total shares. Finally, on cash, we expect we will be cash flow positive in Q1.

With those comments, Operator, we will now take questions from the sell-side analysts.

Thank you. (OPERATOR INSTRUCTIONS) We will go to Cobb Sadler with Deutsche Bank.

Thanks a lot, guys, and I want to thank Joe for the many years with Ciena. Hey, question on services gross margin, it was 13%, 12 or 13% for the quarter. It has been as high as 35%. Where do you see that going, and what were the dynamics during the quarter, to pull it up 1200 basis points? Thanks a lot.

Thanks, Cobb, this is Gary. I think you are aware, we had some particular challenges with our service business during the middle of the year, if you will. We identified certain improvements and actions that were under way, and they are beginning to kick in. I think we signaled that you would see a linear improvement in the services business, and I think we have demonstrated that in Q4.

I would expect it to be in the high-teens range, maybe early 20s over time as we move forward, but you know, in that kind of a range. You are going to get some fluctuations, you know, I think it is unlikely to be as high as 30, 35, Cobb. We are kind of targeting in the high-teens range for now.

Sounds great. And kind of a nit question, you do have some financial services exposure, I guess it is probably small, but could you tell us what you are seeing there with your enterprise customers? Thanks a lot.

We are actually, from the enterprise business, while important to us, is I think about 15% of our business but growing nicely. I think we have a very small exposure to it. We are actually seeing increased activity in that area, frankly. We are a new entrant to it, and I think we continue to see expanding opportunity there.

You know, we are reading the newspapers and we understand what is going on in that sector, but I still think there is a lot of data needing to be moved around by these enterprises, and I think with the advent of video and things like that, which they see as a cost-saving measure, you know, I think that is going to continue to push their requirements for data up. So you know, I think we will continue to look at it carefully. We actually feel pretty good about that sector from Ciena's perspective.

We will go next to Nikos Theodosopoulos with UBS.

Yes. I had two questions. The first one is AT&T was probably your largest customer this year. Do you know if you look at AT&T on a pro forma basis including the Bell South acquisition, what kind of growth you saw in fiscal '07 over fiscal '06?

And then the second question is on gross margin, why do you think past the first quarter it goes back down to the mid-40s? You know, it seemed to me the RFP activity is in Ethernet platforms, you know, core director is doing well, what would cause a product mix shift, away from those areas back to the lower margin products past Q1? Thank you.

Okay. Let me take the AT&T one first. I wouldn't get into that degree of specificity around a customer, but I will offer you this. Clearly, you know, before the merger, both SBC, AT&T and Bell South were all large customers of Ciena, so I think it is natural that they continue to be a large customer as they have converged. I would also say, you know, that we are seeing an expanding role for Core Director, as helping integrate all of those networks as well. So, you know, we are pleased with our expansion within AT&T.

In terms of the gross margin, you know, it is the most difficult thing for us to predict with accuracy. There are a lot of moving parts that go to contribute up these numbers. You know, we continue to look at that very carefully.

I think we have signaled that Q1 is likely as best we can tell to be in the high-40s and it really is a mix, not just of the main product platforms, but also a mix within those product platforms, most classically represented in the transport space as cards versus chassis, but as we get into the converged Ethernet space, there is even a lot more complexity within that mix around software, and cards, and the kind of expansion, whether it's access, Metro, et cetera. A lot of moving parts to it.

We do expect, if we execute well over time, you know, as we get into 2009, that we may be able to sustain an increased range. But right now we still feel that the, as best we can tell, a range in the mid-40s is about right for our business dynamics that we see. Notwithstanding Q1 we are forecasting a mix that would give us in the high-40s.

Just a quick follow-up on the AT&T. I realize you don't want to get into too many details on one customer. Could you comment at least whether on a pro forma basis that customer grew above or below the overall revenue of the Company in '07?

Nikos, I mean, I think they did grow. I wouldn't say it was over and above. I mean, I wouldn't want to comment on specifics.

Okay. Thank you.

We will go next Marcus Kupferschmidt with Lehman Brothers.

What was the guidance for Other income?

Marcus, this is Joe here. It is about $8 million, buddy.

And that is a dramatic change from what we saw in October, if I am doing my math right.

That is correct. Don't forget, we have to pay down the 542, Marcus, and then we also moved some of our investments around into pure cash, and we have seen also a decrease in some of the rates in the money that we are getting.

You are moving your investments to cash because you are trying to be more conservative with where you park it, or because you need quick liquidity, with what you are doing with the Company?

It is both, Marcus because we have to pay down the 542 on the first of February, and given what is going on in the environment.

Right. Okay. And then going into the business, I guess talking a bit more about kind of the visibility in the business. I think your point is you are seeing things looking now versus six months ago, do you have more visibility in what you have won, and kind of a better pipeline now than maybe six months ago, or where are you in terms of how you look at the business you have won, as opposed to kind of all the opportunities and RFPs that you are looking at?

I would say, you know, overall, Marcus, I would say visibility is about the same it was probably at sort of Analyst Day going back a few months. We are seeing good activity, seeing good RFP activity and interest. I think we are seeing in our conversations with our customers both, two dynamics. One, you know, the demand for more capacity, particularly in the Metro-type areas, and also a desire to carry it more efficiently, and a desire to move towards sort of carrier Ethernet. So I would say it has been pretty good now for a few months.

My last clarification, the fact that 4200 goes up, long haul goes down, should we start thinking that your customer base is starting to spend more money in Metro, and less in long haul, or is the 4200 also being used in long haul applications, and we shouldn't be thinking about market dynamics changing around? Thank you.

Marcus, this is Steve Alexander. You know, what you see with all of these builds, is in effect if if you build a lot of capacity in the core, then you tend to go back and build it in the Metro side. If you are building in the Metro, you tend to load your core, so it flows back and forth. We are as the portfolio evolves converging 4200 and core stream together and so you are going to see kind of a natural transition over the customer base to the 4000 series.

We will go next to Simon Leopold with Morgan Keegan.

Thank you very much. Wanted to see if we could drill down a couple things. One, I wanted to see what the trends are in some of the legacy products that you don't talk about too much, particularly the maturing long haul products, and the Metro products that I believe are still contributing. If you could just give us a little bit more color there, and also want to throw in the data networking products as legacy, a little color on those?

Sure, this is Steve Alexander. You know, back to my earlier comment, we are converging call it the raw transmission products. So core stream evolved as a product, and now is hundreds of channels over mega-meters, and we are adding that feature set over time to the 4200. So that is a consolidation play, if you will on the portfolio side.

With regards to the Metro platforms, these go back to some of the online platforms and such. They continue to sell well to customers where there is a substantial installed base. We are adding the required features to, again migrate those over to the 4000. We brought our features out to market that we call FlexiShelf, which basically lets a 4000 series shelf be a channel shelf in to the online products, and such is one way to facilitate that.

I just wanted to go back to I think a topic many of us are trying to figure out is the trending on overall gross margin, of what is driving a step down after next quarter, or in the back half of the year, and really I think it' i a choice of are you being conservative, is it about product mix? Or is it about the competitive environment? Or is it about how the products are evolving, that a given platform like Core Director may have a lower gross margin later in the year because of something? So a little bit of help understanding what is driving this guidance?

Some of it, Simon, is clearly as we look at Q1, we have got better visibility there than we have in Q4. And so we have got orders on hand and other contributors to visibility, and we call it how we call it, but we do see overall a mid-40s range for the mix of products. Now, you know, we may be incorrect on that. It can fluctuate quarter-to-quarter.

And I go back to Q2 2007, when we went down to 42 or 43% as a gross margin. So you are going to see some fluctuation there.

Yes, Simon, this is Joe. You have got to also remember, right, there still are a lot of suppliers in the market in which we play, and like Gary said, we have got really good visibility into Q1 and Q2. Second half of the year, you don't know what it has in store.

Everybody is going to be looking for growth, based upon the way the economy is headed, it could be a tough time. I think part of the guidance on the margin front is the mid-40s looks and feels reasonably comfortable. We just don't know yet.

I guess what I am trying to get at is it is more about your sense of your shifting mix, or a stable mix assumption, and changes in the gross margin within that mix.

You know, Simon, frankly, it is all of the above would go into our consideration on it. The other thing that I would add is we are expanding into new markets, you know, new countries, new markets for Ciena, things like wireless back haul with some new customers, and typically when you do that, it is at a lower entry point from a margin point of view, and we are also being thoughtful about that as well. You know, and putting that into the mix. We have got a lot of new products coming out as well, that are working their way into the marketplace, so we are also mindful of that.

Okay. Thank you very much.

Thanks, Simon.

We will go next to Mark Sue, RBC Capital Markets.

Any further thoughts on the deceleration in your top line growth for the new fiscal year, considering you just did 38%? Is a large component of that related to the wind-down of major projects at AT&T and BT? Is it the new deals that are being slower to ramp, or are you just being conservative, so crazy analysts like myself don't raise numbers?

(laughter) Clearly keeping up growth rates of 30 to 40% get more challenging as the numbers get bigger. We still see our ability to outstrip the market that we play in, depending on which numbers you look at, sort of we are exposed to the higher growth markets, and they are classically sort of 10 to 15%, and we are confident we can grow higher than that. I don't think it is particularly project-based. We feel pretty good about the outlook.

We are seeing a good pipeline, particularly in the adoption of our architecture, with Core Director and mesh, and the number of new platforms that we are releasing, particularly mid-year and towards the end of the year. You know, but I think a 20% growth on balance is a pretty good performance in this marketplace.

And Gary, maybe lastly, if you could just give us your thoughts on your win rate when it comes to architecture deals, what that might be and what that might increase to?

Well, I mean, I think because we are a specialist focused player, I mean, when we engage in terms of our FlexSelect architecture, and folks really want to kind of move towards converged Ethernet, I would say that win rate is very high. When you are just looking at moving bits around, pure transport, you know, that can vary because there is a number of other players in the market space there. So you know, it does vary. When it gets into our sweet spot, which is around converged Ethernet, our hit rate as you would expect, goes up pretty dramatically.

Thank you, gentlemen, and good luck, Joe!

Thanks Mark, take it easy!

We will go next to Tim Savageaux with Merriman.

Hi, good morning.

Hi, Tim.

Nice quarter, and Joe, congratulations and good luck!

Thanks, Tim.

You are welcome. So I have a question, I mean, we are talking a lot about guidance and gross margins, and I think you guys are actually implicitly signaling something through your operating expense spending. So you have brought it up to a new plateau. The last time you did that, we all got kind of concerned about it, and you delivered a lot of top line growth, and a lot of margin expansion.

So at this point you appear to feel confident enough to sort of breech by some measure the $70 million per quarter operating expense level, and yet you are continuing to talk conservatively on the top line and the gross margin side, which is why we find ourselves in this sort of annual disconnect discussion. I am a little bit disappointed. I didn't get to ask the 20% growth question, because I normally get to every year.

But so as you look at how you are managing your business and the operating expense levels that you are comfortable with, what should we take out of that, with regard to your views on potential gross margins and top line growth, and the fact that we plateaued at 60, moved to 70 million a quarter a little while ago, and that was accompanied by a great deal of expansion.

You mentioned a balance between investing in the business and delivering short-term operating profitability. For the moment, you seem a little out of balance, at least between what you are doing and what you are saying. I wonder if you could address that issue?

Yes, why don't I do that, Tim. You know, I think to the balance, we are focused on I think at this stage in the Company's evolution, you know, we have got to, what we sincerely hope is a stabilized business model. And we have indicated that one of the milestones for that is operating profit of around 15%. In fact, we exceeded that in Q4.

So we are focused on two things, essentially. You know, one, continuing to deliver to the bottom line. And around that 15% kind of range, as we talked on Analyst Day, is where we are targeted. We are investing in new platforms and extensions, to make sure that we continue to outperform the market, and we are focused on '09 and 2010, in terms of many of those platforms. You know, a lot of that investment takes two to three years to bring out, in terms of new platforms. If we are successful with those, then clearly that will help drive both the top line and potentially in the future, improve our gross margins as well.

So it is a balance. I would encourage you to focus on our overall operating profit, as opposed to fluctuations in our OpEx from quarter-to-quarter. But I can understand your drawing some parallels to that, and if that happens to be true in 2007, then that will be great.

Okay. Thank you.

We will go next to Tim Long, Banc of America Securities.

Thank you. And congratulations Joe as well, and good luck! Another one, different way of looking at the top line growth for the year. I understand the 20% tougher to grow off a big number.

Just looking at the sequentials though, obviously looking at a pullback from what has been several quarters in a row of 5% sequential, so just curious about that, particularly in the context of concentration of your customer base, I think at the Analyst Day you talked about two or three customers in a given quarter, generally being about 50% of revenues.

Is the concentration something that might be causing a hiccup in that sequential growth rate going forward, and how do you think we will look as far as 10%, or meaningful customers next year? Will we see a swap-out with some new ones in there, or do you expect more concentration?

Tim, you know, if we look at it quarter-to-quarter, you know, there are a number of customers that come in and out on a quarterly basis of being 10% contributors, and I think all of you are familiar with our larger accounts, which include people like British Telecom, TELMEX, et cetera, so in any one given quarter, we have got a number of those accounts that can rotate through. At any one time, you can say that we have got concentration within particular accounts. The trick is to get enough of them, so that when one is digesting a build, you have got others that are rolling stuff out.

The other thing I would say around sort of risk and diversification, is that even within those larger accounts, those big Tier 1 accounts, people like Verizon, we are actually selling more platforms to them. So you are not just dependent on a single built-out as we were traditionally, for example, in the long haul space. We are very mindful of it. It is still concentrated around some large carriers. The good news is, there are more of them. The other good news is we are selling more things to those same accounts.

The other thing that I would also bring into play is we are also looking to getting to new international markets. You saw a pretty significant expansion this year. Also outside of our traditional space, 15% of our business came from the enterprise and government space as well. I would expect that to continue to grow this year as well. That gives you sort of more balanced business.

We shouldn't read into the sequential slowing of growth in your Q2 or Q3 to mean that one of the larger carriers is slowing significantly?

No, no, I mean, I think it is more a general comment from us, around things that we can't quite see yet. Simple as that, really. You have got more visibility into Q1 and Q2. We have got good sequential growth, I think we were over 5% growth from Q3 to Q4. We have signaled it could be as high as 5% from Q4 to Q1, and then we will clearly look at that as we go through the year.

Okay. Thank you.

Thanks, Tim.

We will go next to Paul Silverstein with Credit Suisse.

Gary, I hate to bring this up again, and I certainly don't want to make a speech, I will let others do that, but I guess I am still trying to understand the 20%. Can you just refresh my memory, how long have you been talking about 20% growth for? This isn't the first time you have referenced that number, is that correct?

We talked about it in our Q3 analyst call, I believe, and then we amplified on it on the Analyst Day.

So is it just a function that you have strong near term visibility, and things get more uncertain as you go out in time, or is it really grounded in hard information, things have to happen for it to be much better than 20?

I mean, I would say yes to both of those things. I mean, we have got better visibility in Q1 and Q2, and I think it is just a function of the further out you go you have less visibility to it. I would say that we are seeing good activity. We are not seeing anything that would give us undue cause for concern in that. It is just, it is a general perspective that we are offering up, which is we have only just completed our FY '07.

In terms of the RFP activity you referenced, among the RFPs that are out there, are there any that are extraordinary in size and scope that, I recognize haven't necessarily won, but that could potentially drive significant growth?

You know, we see a number of RFP activities, and there are some decent-sized ones out there, Paul. I don't think there are any that are sort of world changing from that perspective. We were pleased to secure the BT one, which we announced today. That is our first real sort of big one in the Ethernet access space. There are some others out there like that, and those are ones that we are going hard after. But I don't think there is anything in there that would be sort of game changing.

And the other thing, I would say is RFPs are not the only measure that we are seeing. You know, in fact, from an industry-wide perspective, you know, folks, their purchasing models are not as based around RFPs, as perhaps they were sort of 10 years ago. We have seen that trend. But it is certainly something that we look at in our pipeline.

Okay. Thanks a lot.

Thanks, Paul.

We will go next to Phil Cusick with Bear Stearns.

This is Jonathan Kees for Phil Cusick. Thanks for taking my question. Great quarter, guys!

Just want to start with housekeeping first. You guys said that 4200 was 39.2 million for the quarter. Last quarter it was 23 million. And I guess I am wondering, is this apples-to-apples? Because there was a DNS and Metro was separate at 24. And now you have 4200 at 39, and no mention of DNS separately. Just wondering if on a historical basis this is an apples-to-apples comparison?

The answer to your question is, Jonathan, yes, it is absolutely apples-to-apples, which is why we split that out.

It is a function of the great progress the sales team has made in getting that thing rolled out, the customer base is expanding every single quarter, pretty much every single month. And what you had happen is in the fourth quarter, a lot of it was triggered by the [reverec] aspects of the individual contracts that we signed up for the product.

I would also add, Jonathan, I think when we launched the product, you know, I think we talked publicly around what kind of run rate can we get up to in '07, and we talked about 40 million. I actually think it took us longer than we thought to actually get there, because of revenue recognition, et cetera.

If I am adding up the numbers correctly here, then with the long haul stuff, okay. So then DNS and the other Metro stuff would be about 20ish then, in order to get --?

That is about right, Jonathan, yes.

Thank you for clarifying that. Then the other question I had was I wanted to I guess talk some more about operating margin. There has been a lot of discussion on the call by gross margin and about top line, and I guess I wanted to spend some more time on the operating margin. Obviously you are still reaffirming the ranges that you gave during the Analyst Day. You had also said during Analyst Day that 15% would be a target in fiscal year '08. You reached it in fiscal year '07. Is there a potentially new target? Is there a potential range?

If you are sticking with the ranges for OpEx, then obviously then dollars that you are spending in OpEx are going up throughout the year. So are you going to be sticking pretty closely to that? Are you going to, is there more play for operating margin, just as much as you had for gross margins? If you could elaborate on that, that would be a great.

I would say that yes, we are sticking with the ranges which would be around about that, we gave 15 as a milestone, and we hit that a little sooner than we thought in Q4. But generally how we think about the business, I think the challenge as we go through into 2008, is making sure that we can sustain a 15% operating profit, and clearly we are going to try and do better than that if we can.

But the ranges that we talked about, of the way we are going to kind of frame our thinking about the business, and how we are going to manage it during FY '08, and that is the balance between investment, and making sure that we deliver good growth, and deliver to the bottom line as well.

So would you say that is just as much upside or downside potential for the operating margin, as you would have for the gross margin?

I would say clearly it can fluctuate as the gross margin. But I think overall, if we look, we feel pretty good about 2008 from a revenue perspective, and the 20% growth, and is there opportunity to do more than that, you know, absolutely. Is there risk to it? Yes.

So that is sort of our balanced perspective right now. Similarly with gross margin, you know, we are talking about sort of a normalized range, if you will, in the mid-40s, that is our best perspective. We are starting out in Q1 of late-40s is our best view to it. We think the operating margin is on an as-adjusted basis should be about flat with Q4, which we achieved 15.7.

Okay. Great. Thanks for elaborating on that, and good luck, Joe!

Thank you.

We will go next to Brant Thompson with Goldman Sachs.

Thank you. Couple of questions. First, you talked about your non-telco business being 15% of revenues. Was wondering if you could remind us of what it was a year ago, so we can get an idea of the growth rates that we are seeing in that business, and any commentary on the type of margins you see in that business, and how they differ from the corporate average?

The second question is just around any other major cash outlay items in 2008 that we should have on our radar, and then the third is just an update on the competitive environment on the switching and the 4200 business in particular, in terms of who you compete most against now, given that so much has changed in the landscape.

Okay, why don't, I will take the first one. Joe can take the cash one, and then Steve will finish up on the 4200 for your single question. First of all, on the enterprise side, I am not sure the exact comparison, but I think I am pretty confident, in saying it was below 10% of our business in 2006. So it has had significant growth last year, albeit off a relatively low number.

In terms of margins, tends to be high margin, you know, i.e., generally over 50% into enterprise and government, et cetera, and I think we are seeing particularly the 4200 family begin to do very well in some of these enterprises. As I said on the call, we have won about 80 odd new customers during the year on the enterprise side, and I think that gives us a good base to grow from. So we are optimistic about the future of that space.

Joe, on the cash?

Sure, hi, Brantley. In terms of cash, at this point in time, as far as I am aware, there really isn't anything major, any plans to use big hunks of the money. If you take a look at the fourth quarter, or the first quarter we had to use 50 million for that, to buy-out that lease. In terms of anything similar to that, all of that stuff has been predominantly done with, so there is no other big needs there, or demands on cash for that.

In terms of the capital, you might spend a little bit more money, in terms of investing in the R&D functions in India, and somewhere else. I think the only big thing out there, outside of the norm that you are going to have, is don't forget we have to repay that debt on February the 1st, which is 542.

And on the competitive side with the 4200, one thing to keep in mind is that the 4200 now is a family of products. It started out as a four slot configure. We added a two slot config, we also added 17 slot config to it. It is all the 4200 family. So that changes your competitive landscape in the pure transmission space, which is moving bits from A to B, that is probably one of the most fragmented fluid markets there is in the Telco space. As we went to the smaller platforms, we brought in a whole another set of competitors that typically had specialized in small transmission boxes.

As we have added the larger shelf, the 4200 RS, the regional shelf, or the ROADM shelf, for the that feature set, we again brought in a whole bunch of other competitors in that space. It remains the large suppliers that we have always competed with, and you see them distributed throughout the globe, you have some very clear highly competitive markets in EMEA, and in Asia, and again in North America, and the competitive landscape changes a bit. As we add features and functionality and the family grows, we fully expect the competitive landscape to change, evolve, and grow it often.

Great. Thanks, Joe, congrats and good luck!

Thanks Brant.

We will go next to with Ehud Gelblum, JPMorgan.

This is [Ian] Khan for Ehud. Congrats, Joe! Sorry to see you go.

We will talk to you, don't worry about it.

Okay. We will talk to you later. Just want to follow up to the cash. You gave some annual cash flow numbers at the Analyst Day. And unless I missed it, you didn't necessarily reiterate those exact figures today. Any change there?

This is Joe. Definitely not.

Okay. And then on the contract announced at BT, the CN3000, could you discuss a little bit of the incremental impact to, as an order of magnitude in terms of revenue, what that means for you guys at BT, what might the timing of the revenue be, what is the margin profile for that product, and then does that fall into Ethernet access or in to converged Ethernet?

I can answer your last question a little easier, Ian. (laughter) Yes, it falls into Ethernet access. We have just announced the deal. I would say we would expect to see that roll out probably, you know, second half of the year, we have known about it for a little while. So we built it into our guidance and revenue, et cetera. And then I would expect to be ramping up probably even further as we get into 2009.

It is a plus 50% gross margin type of product or -- ?

That is not something, you know, we would comment on. Typically as you get towards the edge, even in Ethernet access, it is not too dissimilar from this sort of transmission-type analogy. As you get closer up to the edge, the margins tend to go down. You know, and as you aggregate, where you have got more software, the margins tend to go up.

Okay. Thanks, guys.

We will go next to Hasan Imam with Thomas Weisel Partners.

Thank you. Hey, Joe, good luck at your next job and hope you have more fun!

Thanks, Hasan.

My question, I just wanted to drill down a little bit on the OpEx front. So your OpEx ramp this quarter was faster than revenues. And I am just wondering where you're spending that money. Is that primarily India, headcount ramp, and when does that end?

Okay. I will do that one, Hasan. It was not primarily headcount. We didn't add very many people in the quarter.

It was predominantly on prototypes, some one-off type things, and although we haven't talked about it, and it took this long to get there, the order intake in the fourth quarter was strong, and I am not allowed to use the word strong any more than that. So I can't, I have to find some other word, after Analyst Day. But it was very strong, and consequently that translated into commissions coming in a lot higher than what we had anticipated for the fourth quarter.

So there was the biggest single pieces that I think are things to be concerned about and worried about. The prototype things are not ongoing. You are not going to have those every quarter, and the commission, as long as that order rate keeps coming up, I am sure Gary would love to keep paying those, the way they are going.

What about the India headcount ramp? When do you think that kind of tapers off?

We met within a couple of headcount of what our goals were for 2008. 2007. We have plans to continue to grow our R&D capacity into 2008. What we are going to do is keep a careful eye on what the business model requires, and what we think is a prudent level of investment.

Okay. And then one last question. In terms of the 40G contracts that are coming up in AT&T, Verizon, et cetera, just wanted to hear what your position is there, given that you have more heavily bet on 100G. So should we expect you not to be meaningful players in these contracts, and then kind of wait for 100G upgrade?

We have a 40-gig solution in market today. It is a product that we have through the StrataLight relationship that we have had for quite a while. That is actually used by several of the other suppliers in the space fulfilling 40-gig needs. We are competitive in that space. I do think we are focused internally on a lot of activity around 100-gig.

The next gen switch platforms and the transmission platforms and such, are focused on that. We expect to be able to provide competitive solutions at 40-gig and 100-gig.

On the 40-gig side, would you say you are at-par with some of the leaders? I know that in the past, Steve has talked a number of times about really putting more of your eggs in the 100G basket.

I think what we have done is looked at the way we want to approach the market, and again the 40 gig comes to us through StrataLight, technically it is as good a product offering as available out there today. We are looking at the 100-gig approach, in terms of where 100-gig Ethernet is going to go and what the impact is going to be on the market there, but we are comfortable with our position at 40-gig today.

Thank you.

Due to time constraints we will take our final question from Subu Subrahmanyan with Sanders Morris.

Thank you, and Joe congratulations, and thanks for all the help also! My question actually is on just wanted to revisit the non-operating income point, and see if you wanted to talk about EPS guidance, and also just the trajectory of operating expenses going forward, because the way I calculate it, you had about 17.5 million in non-operating income for October, going down to about 8, and I just wanted to understand kind of the impact on EPS, and how much of that could be offset by lower OpEx?

Sure Subu. In terms of the, I will do the non-op and I'll let Gary talk about the OpEx on a go-forward basis, as well as the operating profit number.

The non-op income as you are calling it, is a question of positioning the 542 to be paid down, and the way the rates moved around, and what kind of investments we had, and where we moved it from. So it is really a question of just the mechanics, and the actual investment vehicles that we were involved in.

In terms of the big number, you know, we had to take the write-down in the quarter, which was an unfortunate situation, but we had to do what we had to do there. So in terms of, I like the 8. Could it be a little bit higher than that? Yes. It depends on where we end up for the quarter, and what we do. Aside from that, I don't feel real comfortable going into that a lot further right now.

I will take the second part of it on OpEx, as we said, we gave the ranges out which we still, which we believe are applicable going into FY '08, and what we are focused on is the overall operating profit, and delivering that. We hit that milestone a little earlier than we had anticipated. But around that 15% is where we are focused from an operating profit perspective going forward, and we would expect in Q1 for our operating profit to be flattish with Q4. And it was 15.7 in Q4.

Understood. If I could just follow up. Is that 8 million kind of a good run rate for the rest of the year on a quarterly basis, Joe, and do you want to kind of venture EPS guidance, because obviously creates a variance on the EPS number?

Okay. The 8, theoretically, go back to what we talked about at the Analyst Day, we could generate as much as or up to $200 million. So the 8 in theory should grow, depending upon where the rates go, and what kind of investment vehicles we can get our hands on. So the rate, the 8 could grow.

In terms of the EPS guidance, we don't typically do that, and I am not going to set a precedent for the new guy coming in here, because I don't think it is a proper set-up for him. He and Gary can talk about that, and figure out what they want to do during the next quarter.

Got it. Thank you.

Mr. Smith, I would like to turn the conference over to you for any additional or closing comments.

Thank you. I would like to thank everyone for their time this morning, and for your continued support. I would like to sort out a couple of summary pieces if you like. Thank you for your support during 2007.

As hopefully you can tell, we feel good about 2008, and certainly our visibility is good into the first half of the year, and we are very focused on leveraging our operating model. You know, we think we are in the sweet spot in the market. We are well-placed on the product cycle point of view, and we are very focused on continuing improving financial performance.

With that, I would like to reiterate my thanks and best wishes to Joe, as many of you have passed on today. I am sure you will have a chance during the next few days to do that, and we would like to wish everyone a Happy and safe Holiday season! Thank you.

This does conclude today's conference. Thank you for your participation. You may now disconnect.