Ciena Corp (CIEN) 2008 Q1 法說會逐字稿

Good day, everyone.

Welcome to the Ciena Corporation first quarter 2008 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 Communication Officer, Ms.

Suzanne DuLong.

Thanks.

Good morning and welcome everyone.

I'm pleased to have with me, Gary Smith, Ciena's CEO and President; and Jim Moylan, CFO; In addition, Steve Alexander our Chief Technology Officer will be with us for Q&A portion of today's call.

Our call this morning will be presented in four segments.

Gary will provide some brief introductory comments.

Jim will review the financial results for the first quarter, Gary will then discuss the business in the quarter, our outlook and strategy, Jim will then review our guidance for Q2 and the remainder of the year.

We'll open the call to questions from the sell side analysts at that point.

This morning's 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 during this call we will be making 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 in our 10-K filed with the SEC on December 27, 2007.

We have until March 13, to file our 10-Q for the 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.

The sustained execution of our network specialist strategy continues to differentiate Ciena in our highly competitive market.

We believe we are squarely positioned to continue to benefit from spending on capacity requirements and advanced service delivery capabilities enabled by ethernet based architectures.

As a result, we delivered solid financial performance in Q1, including 5% sequential revenue growth, and a strong as adjusted operating profit of 17.4%.

We are capitalizing on this momentum and aggressively pursuing high growth market opportunities where we can help customers align their network architectures with the business values of their customers.

And we remain steadfast in striking the right balance between investing strategically in our business to fuel longer term revenue and earnings growth and maximizing short-term operating profit.

I'll talk to our business in the first quarter and our outlook after Jim reviews the quarters results.

Jim?

Thanks, Gary.

Good morning, everyone.

This morning, we reported first quarter revenue of $227.4 million.

This represents an increase of 5% sequentially and 38% year-over-year.

We had two 10% plus customers in the quarter that combined to represent 44% of total sales.

Both are North American based.

One was also a 10% customer in our fiscal Q4 of 2007.

Sales from international customers represented 26% of total revenue.

This is down from Q4 when we had one international customer as a 10% contributor.

Revenue contribution across our portfolio was generally consistent with the prior quarter.

Our converged ethernet infrastructure group which incorporates all products previously in our Optical Networking and Data Networking Groups increased to $191 million representing 84% of total revenue.

Ethernet access which incorporates all of our access products was $11 million or 5% of total revenue down slightly from Q4's $13 million.

And Global Network Services which encompasses all of our services related offerings was $26 million, up from $22.5 million in Q4, representing 11% of total revenue.

Within our converged Ethernet infrastructure group, core switching was the largest contributor at $70 million.

Core transport grew sequentially from $41 million in Q4 to $65 million in Q1, and our CN4200 Advanced Services platform remained our third largest contributor at $31 million in revenue.

Turning now to gross margin.

Q1's overall gross margin was 51.3%, up almost 1 point from Q4's 50.5%.

Our product gross margin remained strong at about 55%, and at 24%, our services gross margin recovered nicely.

Actually, being above our normalized high teens to low 20s range.

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

On a GAAP basis, we delivered an 8% operating profit in Q1, with GAAP operating expenses totaling $98.2 million.

On an as adjusted basis, we delivered a 17.4% operating profit, up sequentially from Q4's 15.7% and considerably better than our guidance of roughly flat sequentially.

Adjusted for non-operating and/or non-recurring charges detailed in the press release, our operating expenses totaled $78.1 million.

As was the case last quarter, on an as adjusted basis, our individual OpEx lines were in line with our target percent to revenue ranges, one minor exception being G&A, which was just slightly above the target range.

To recap, our target ranges are as follows.

R&D at 12.5% to 15.5% of sales.

Sales and marketing at 12.5 to 15% of sales, and G&A at 4.5 to 5% of sales.

Our Q1 GAAP net income was $28.8 million or $0.28 per diluted share.

Adjusted for unusual and/or non-operating items, our first quarter net income was $49.6 million or as adjusted net income of $0.47 per diluted share.

Now, for the balance sheet.

We were cash flow positive for the fourth straight quarter, generating $13.7 million in cash from operations.

This is after the final $10 million interest payment on our 3.75% convertible notes.

Cash, cash equivalents, short-term and long term investments at the end of the first quarter totaled $1.2 billion, which reflects the payment of the remaining $542.3 million in principal amount on the convertible notes.

Because our cash position is significant, let me spend a few minutes on it in light of recent market concerns about asset backed securities.

Let me start by recapping what we said last quarter.

In Q4, we recognized losses of $13 million which represented less than 1% of our total cash position related to two investments.

The loss stemmed from a $45.9 million investment in commercial paper issued by two structured investment vehicles or SIVs that entered receivership and failed to make payment at maturity.

At the time of purchase, each investment had a rating of A1 plus by Standard & Poor's and P1 by Moody's, their highest ratings respectively.

After giving effect to the $13 million loss, our investment portfolio at year-end included investments with an estimated fair value of $33.9 million related to these two SIVs.

Now, for the update.

There were no changes relating to these investments or other events during the first quarter.

As a result, there were no changes in our assessment of the fair value of these investments at January 31, 2008.

We did get a positive update after the close of the quarter.

We received a payment of $2.3 million from Rhinebridge LLC, one of the two SIVs I mentioned previously, and we have been informed by the receivers of Rhinebridge that this should be viewed as an initial payment, with more to come.

As we said last quarter, we have canvassed our investment portfolio and at this point, we believe our SIV related exposure is limited these two specific investments.

While these investments represent only a small portion of our overall cash position, we understand this is a timely topic so I did want to spend some time on it this morning.

Back to other parts of the balance sheet, our accounts receivable balance increased from $104.1 million in Q4 to $144.6 million in Q1.

Q1 reflects a more normalized receivables level versus Q4, which was unusually low due to customer mix and the timing of shipments during the quarter.

Days sales outstanding increased from 43 in Q4 to 57 in Q1 as a result.

Going forward, as a result of the strength of our business, and improvements in our cash to cash cycle, we expect our DSO range to normalize between 55 and 65 days, which is improved from our previous guidance of 65 to 75 days.

Our inventory levels ended the first quarter roughly flat from Q4 at $103.5 million.

The inventory break down for the quarter was as follows.

Raw materials $28.0 million, work in process $4.5 million, finished goods $100.8 million and a reserve for excess and obsolescence of $29.6 million.

Inventory turns improved from 3.4 in Q4 to 3.5 in Q1.

Now, I will provide a brief update on the acquisition of Worldwide Packets.

We closed this past Monday, so it's early days but integration is going well.

We had all critical business systems up and running on Day 1, and everyone is working hard to ensure the combined sales teams are well prepared and ready to sell.

We've had had very good customer feedback from both Ciena customers and worldwide Packets customers and we're excited about the opportunities ahead of us.

I'll talk about our expectations for future revenue from Packets for the remaining eight months of fiscal '08 in the guidance portion of my comments later on.

If you recall, we initially discussed Packets 2007 revenue being in the range of $30 million.

Since then, we've received their audited financial statements.

Shipments and services performed and billed in 2007 were approximately $34 million.

Due to revenue recognition criteria, $11 million of this amount was recorded as Worldwide Packets deferred revenue at their year-end.

While Ciena benefited from the cash, subsequently received related to the deferred revenue, due to the requirements of purchase price accounting, we do not expect to record this deferred revenue as Ciena revenue.

Consequently, the revenue guidance I'll talk about later on will be exclusive of any revenue related to this deferral.

I'll close on headcount.

We added 56 employees in the quarter bringing our worldwide headcount to 1853.

The addition of Worldwide Packets 180 employees brings that number to 2033.

Now, I'll turn the call back to Gary.

Thanks, Jim.

Let me start firstly by saying we remain acutely mindful of the broader economic environment and potential future market conditions.

Notwithstanding the uncertainty of the macro backdrop, the fundamental drivers of our carriers, customers, business, and therefore, Ciena's business are resilient and remain strong.

Both at a consumer level and more importantly at the enterprise level, the demand for increasing capacity and the transition to Packet friendly IP ethernet based architectures are alive and well.

I think most would agree that we are clearly in a period of bandwidth expansion driven by new applications.

Video, data, mobile, et cetera.

Our customers are bullish about this scenario and tell us they see it playing out for the foreseeable future.

In fact, on some levels, the industry may be underestimating the amount of bandwidth ultimately required given the infancy of so many of these applications.

In response, carriers are working to implement strategies that achieve two things: To increase role capacity where we have our heritage and substantial expertise, and secondly, to implement next gen capabilities including capacity management and service creation.

Where Ciena has leveraged their heritage to add software driven solutions for truly differentiated features and functionality.

To date, carriers have worked to transition their existing networks to support these application and growth needs.

Although this is a practical approach, customers recognize it's not an approach that will enable them to scale for the long term.

Nor will it position them to derive maximum value from their existing network assets and future deployments.

Therein lays the inevitable need to migrate from SONET SDH to ethernet based architectures and Ciena's fundamental opportunity.

Ethernet, it is a low cost, widely understood, ubiquitous standard.

It is the logical path to efficiently address both infrastructure scaling needs and the service delivery capabilities.

The technologies inherent flexibility and simplicity provide a means to improve time to market for new services, ease of network management and guaranteed quality of service.

All of this leads to our firm belief that a multi-year cycle of spending on ethernet centric infrastructure is just beginning.

This belief is grounded firmly in the reality that our customers business models are sound and they have real demand for real viable applications on their networks.

Customers are seeing significant traffic growth while they continue to plan for network transitions to accommodate that demand more efficiently, and I would add the activity we're seeing is success based.

We believe the long term industry dynamics are compelling and positive for Ciena and we are moving full steam ahead with the strength of our convictions and the continued execution of our strategy.

Our unique confluence of assets give us the ability to effectively address this market cycle and capture new opportunity.

In particular, we benefit from distinctive relationships with many of the world's largest carriers, our long term strategy and the cumulative investment in a holistic service defined architectural vision, FlexSelect.

And, our heritage and innovations, in match software, optical infrastructure, control plain integration and programmable port technology.

These tools and our understanding of carrier class networks allow us to credibly move ethernet from LAN applications to carrier infrastructure and services.

And our acquisition of Worldwide Packets adds market leading ethernet operating software and ethernet service delivery platforms.

In addition to bringing superb engineering talent and solid customer traction, the combination of our two companies extends our ethernet reach from infrastructure out into the network, actually enabling our customers to deliver new services to their customers.

More specifically, we're gaining critical ethernet operating software assets that enable the delivery of cost effective ethernet services.

In fact, we believe this to be the only available carrier class standards based operating system to enable multi-vendor interoperability as well as a consistent look and feel with fast and easy reconfiguration capabilities.

This strategic portfolio addition is 100% consistent with our FlexSelect architecture and vision for network transition.

We believe it will accelerate the implementation of Ciena's carrier ethernet portfolio, further improving our time to market, increasing our expected market share capture, and improving our overall return on invested capital.

We believe the convergence of optical and ethernet technologies will result in fundamental economic benefits for our customers.

Specifically, increasing profitability by driving top line revenue growth, lowering total cost of ownership, and managing network traffic growth intelligently.

Our R&D strategy is focused exclusively on building converged solutions that address each of these goals.

Our objectives going forward are twofold.

Firstly, we are committed to maintaining our leadership and strong hold in our traditional optical markets.

It is after all what is enabling us to credibly assert ourselves in the converged ethernet market and helping us to satisfy growing capacity demand.

We are dedicated to preserving our incumbency in this space by ensuring our platforms remain highly competitive.

Secondly, we are determined to see the leadership position in ethernet.

Our critical measure in this area is accelerating time to market.

We've demonstrated our ability to do so with platform enhancements like the ethernet processing for the CN4200 as well as our strategic acquisition of Worldwide Packets.

We are committed to expanding development resources on extending the values of our FlexSelect architecture across our portfolio, both in optical and ethernet areas.

In summary, we are making good progress against multiple aspects of our strategic plan.

Including driving key customer optimization and adoption of our FlexSelect architecture and increasing the velocity of our business through globalization efforts and infrastructure improvements.

As a result, we can confidently count our first fiscal quarter as evidence of our continued success in growing the Company and capturing these new opportunities.

It is with this confidence which in part enables us to increase our revenue expectations for Ciena's organic growth for the year.

Our growth reflects investments we've made in our portfolio and across our business, and we will continue to execute on this strategy, to ensure we capture the opportunity afforded by the definitive industry trend of migration to converged optical and ethernet network architectures.

With those comments, I'll turn the call back to Jim to talk about our specific guidance.

Thanks, Gary.

Before I talk about guidance, I'd like to spend a few minutes talking about a Ciena asset that I believe is not well understood.

As most of you are aware, we have accumulated substantial tax deductions from our operations and acquisitions which can be used to offset future tax payments.

The majority of these deductions are NOLs or net operating losses and they total $2 billion.

The tax benefit from these NOLs and other deductions is a deferred tax asset that in most cases would be on the balance sheet but it is not currently reflected on ours.

Because of our losses in prior periods, accounting rules require us to provide a valuation allowance against that deferred tax asset which effectively reduced them to zero or eliminated them from the balance sheet.

We regularly evaluate this valuation allowance to determine if there are grounds for reversal under the accounting rules.

Based on our expected profitability this year, we believe it is likely that we will be required to release all or a significant portion of this valuation allowance in Q4 of this fiscal year.

The exact timing will be subject to change based on the level of profitability we achieve and our visibility into future periods.

A significant portion of any future release of our valuation allowance will be recorded as an income tax benefit to the P&L, significantly increasing our GAAP net income.

We expect that a full release of the valuation allowance could approach $1 billion.

In recent years, our book tax rate which is reflected in our GAAP results has been generally equal to our cash tax obligation, which has been related primarily to foreign taxes.

This year, our GAAP taxes have also included federal alt min taxes, state taxes as well as non-cash domestic taxes that go against intangibles.

After any significant release of the valuation allowance, however, accounting rules dictate that our GAAP income tax expense which will include both domestic and foreign taxes will be at the a more normalized rate which is in the high to mid 30% range, even though our cash taxes will remain roughly at current levels.

We expect to be able to use our deferred tax assets to significantly reduce future tax payments.

At our current earnings level, we believe it will be more than 10 years before we are required to pay meaningful U.S.

cash taxes.

As a result, when we release our valuation allowance, we expect that our as adjusted presentation will include adjustments to our GAAP tax expense in a way that we believe continues to best represent our actual cash tax obligation.

For the foreseeable future, our as adjusted tax expense will again consist of federal alt min, state, and foreign taxes.

The short version of all that is it will be many years before we pay any meaningful U.S.

cash taxes and our as adjusted results going forward will continue to reflect that fact.

Let me conclude our prepared remarks today by talking to guidance.

I'll remind everyone that the statements I've just made and those I am about to make are forward-looking, and it's important to understand them in the context of the risk factors detailed in our 10-K.

Also, the guidance that I'm about to offer is inclusive of Worldwide Packets, both for Q2 and the remainder of the fiscal year.

When we report our Q2 results, Worldwide Packets will be included for roughly two thirds of the quarter and roughly eight months of the '08 fiscal year.

We expect to deliver up to 5% sequential growth in revenue from Q1 To Q2 inclusive of a small initial contribution from Worldwide Packets.

We expect Worldwide Packets will contribute between 35 million and $40 million in revenue for the remainder of our fiscal '08.

Remember this is eight months.

With the combination of revenue from Packets and our visibility into organic Ciena growth in fiscal year '08, we are raising our revenue expectations for the year.

We now expect to deliver annual revenue growth in a range up to 27% in fiscal '08, including the Packets numbers.

On gross margin, as we said, gross margin is difficult for us to predict.

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.

Previously, we stated our belief that a mid 40s gross margin range is realistic for our business.

We are executing well on the evolution of our product portfolio including both the delivery of higher value, more software intensive products, and ongoing product cost reductions.

Based on our visibility into expected order flow and product mix for the remainder of fiscal '08, we believe that we will be able to deliver gross margin in the high 40 percentages for the remainder of this year.

If we continue to execute on our product and portfolio strategy, adding additional higher value platforms and functionality, we may be in a position to talk about a higher gross margin range in the future.

Short-term, in part as a result of the addition of WWP related costs, our R&D investments are likely to exceed our target range of 12.5% to 15.5% of revenue; however, in spite of this increased R&D investment, our goal remains to achieve our target 15% as adjusted operating margin both in Q2 and for the remainder of the fiscal year.

We expect net other income of approximately $6 million reflecting both lower interest rates and lower cash balances as a result of the pay off on the convertible notes and the $200 million cash consideration for Worldwide Packets.

And of course, we all know there's been a lot of discussion about the Fed lowering interest rates yet again.

Any such action would of course a for example our interest income going forward.

And in keeping with my previous comments about tax obligations, we expect our second quarter income tax expense representing primarily foreign taxes will be approximately $ 1.5 million.

We estimate Q2's diluted share count at approximately 111 million total shares reflecting addition of the shares issued in the Worldwide Packets transaction and that was just for a portion of the quarter, of course.

And finally, we expect we will be cash flow positive in Q2.

Operator?

We'll now take questions from the sell-side analysts.

(OPERATOR INSTRUCTIONS) We'll go first to Cobb Sadler with Deutsche Bank.

Thanks a lot.

I had a question on the long term gross margin outlook.

Why could you really not guide to a level north of 50, you've been there for a couple of quarters and then your product mix shifted more to CN4200 more quarter after probably a little bit less WDM as a percentage of the mix.

So that's one of the questions and on the service outlook has that fundamentally changed or should we expect a migration back to lower levels?

Thanks a lot.

Hi, Cobb, this is Gary.

Yes, we had a couple of quarters above 50% and I think it's possible that we can continue to do quarters that are begin with a 5.

I think we're at the point where we're confident enough that it has moved up from the mid 40s given our recent performance and what we're seeing and I think it's a bit early yet to say it's going to be always starting with a 5, although clearly, as Jim talked about, in his comments, we think going forward certainly as you get into '09, 2010, you got a higher software content on a lot of the products, et cetera, which would I think that's certainly our goal is to get the margins North of 50.

I don't think we're quite there yet in being able to guide to there, but it's certainly possible that we can report more quarters that begin with a 5.

In terms of the services, commentary I'm encouraged by the recovery there.

I would expect it to be in the early 20s frankly, from what we can see right now.

Great and a follow-up, you mentioned a SONET replacement with Ethernet technologies.

Are you seeing a cap in grow by a lot of your customers for SONET and maybe replacing with some sort of ethernet product like the CM4200?

That's it.

Thanks a lot.

Yes, so what you see is the general transition away from CDM over to more ethernet packet, OTN, those sorts of service delivery mechanisms.

We'll go next to Ehud Gelblum with JPMorgan.

Hi, thank you very much.

Couple questions.

First of all, when you bought Worldwide Packets you commented on the dilution you expect to be in the mid single digit percentage range which we all sort of translated to about $0.08 of dilution.

Could you just give us an update are we still looking at basically $0.08 or so of dilution in fiscal '08 from the roughly 35 million to $40 million in revenue that you're expecting and if you can give us a break down as to how that impacts the gross margin, I see what your gross margin combined numbers are but if we could kind of break out this characteristics of Worldwide Packets and how we get to the $.08, I'd imagine the vast majority of that like $0.07 actually comes from the lost interest income, but just if you can give us an update and if that's still what we're looking at from the deal?

Yes.

Nothing has changed since the numbers that we talked about in our call reporting Worldwide Packets transaction.

We announced the deal as you recall, we said we expect a dilution to be in the mid single digit range on a percentage basis off then current First Call as adjusted EPS consensus of $1.62.

That's where we are today.

It is possible that dilution could be less than what we originally thought when we did that calculation but it's still too early to know for sure.

As I said earlier, things are going well with the deal, and all notes and comments that we get from customers and their internal operations are positive.

As far as where it's coming from, you should know that some of it is related to the interest income but most really is related to R&D.

We are going to spend money there to finish building out their deliverables on the AT&T contract.

On the gross margin profile, I think as we mentioned in the call, it's a little early for us to tell but we expect it to be in the 40s.

It's in that kind of area.

We'll go next to George Notter with Jefferies & Company.

Hi, thanks very much.

Just kind of building on the Worldwide Packets questions here for the full year guidance are you expecting much from AT&T in your full year guidance from AT&T on Worldwide Packets or is that more a 2009 event?

We think it will mostly be a 2009 event.

We expect very little revenue from AT&T in our fiscal '08.

Got it.

And any sense for how much AT&T contract could contribute?

I know the question was brought up on the prior conference call on the Worldwide Packets deal but any sense?

George, I think it's very early days, we're working with AT&T on that.

Clearly, it's a widespread deployment and we're excited about it from an opportunity point of view, but I really think it's early days yet.

And then just one last question, on your visibility, how would you characterize visibility going forward?

Is it same, equal, to or better than the visibility you had exiting last quarter?

I would say it's the same.

Similar kind of visibility to us.

Got it.

Thanks very much.

We'll go next to Mark Sue with RBC Capital Markets.

Thank you.

Gary, any thoughts on how things are shaping up in Europe and I ask since we're getting some mixed signals from alternative carriers there, maybe you can parse your reply from what you're seeing with Tier 1's versus the others?

That would be helpful.

Europe particularly, we actually feel pretty bullish about.

We're seeing good activity amongst the Tier 1's and among some of the emerging carriers there, particularly in places like Eastern Europe, in some of those emerging markets.

We're probably not the best overall barometer to talk about the European markets given our relatively small position in there, but I think from -- we're seeing good traction with 4200 , I think particularly the ethernet activity over there, I think is increasing.

I think they're frankly, from an ethernet services point of view probably ahead of North America, so that would be natural and it was a lot of excitement around the Worldwide Packets piece of

Got it and then coming back to North America, without mentioning customers, any thoughts on how maybe a carrier which begins with the letter V is looking for a converged networks?

I wouldn't like to speculate as you say on a particular carrier, but I think most of the major carriers are looking at converged architecture, looking at transitioning it, looking at mesh architecture for example.

I think most of the Tier 1's in North America and globally are.

That's helpful.

Thank you, gentlemen.

We'll go next to Vivek Arya with Merrill Lynch.

Thank you.

Gary, just one question.

On your organic growth rate expectations, from what you said at the end of the last quarter versus what your expectations are now, can can you please tell us what the difference is?

Are you expecting to grow faster organically than you did before or is that organic growth rate the same and most of the upside is coming from the Worldwide Packets acquisition?

Yes, I think we guided I think coming into the year in a range up to 20%.

Clearly as you get more into the year and we've had a good start to the year, in all aspects, I think clearly we've got increased visibility because you get closer to the end object, which is the end of the fiscal year, so our visibility has got better from that perspective and I think guiding up to 27%, but that includes Packets but if you take the Packets thing at about 35 to 40%, that would roughly put our organic growth at 35 million to $40 million, that would put our organic growth at about the 23% range, so we've increased our range for our original organic business.

Okay, so that's what I wanted to find out.

I wanted to split that out so people can see the Packets piece and our original business.

Got it, good, good.

The other thing is where are we in the deployment cycle for the CoreDirector product?

You have seen very strong deployment cycle at AT&T and perhaps there could be Verizon later in the year.

So at the customers that are already deploying the CoreDirector, where are we in the deployment cycle?

Are we towards the later innings, are we toward middle innings?

If you could give us a sense of that.

Well, sure.

The CoreDirector addresses what might term the mesh networking aspects, right, and one thing to keep in mind, the converged ethernet architectures just love kind of mesh implementations, ethernet likes a mesh architecture and so what you see is continuing adoption of mesh architecture globally.

It will come in some sort of a wave action as you get large buildouts and such, but the adoption of mesh and adoption of converged ethernet, the use of mesh to provide higher resiliency connections is continuing worldwide.

Got it, and just one last question.

Is last year I believe AT&T Sprint remain 10% plus customers.

Do you think in 2008 we see other Tier 1 customers being part of that 10% plus list?

I think that there is certainly a possibility of that.

We've got a cadre now of Tier 1 customers including people like at any one point in time within a quarter, within a year, we've had people like TelMax, Cable Wireless, British Telecom, Swisscom, et cetera, so I think we're getting to the point where we've got I think it's about two-thirds of the large carriers worldwide and they're all capable of getting to be 10%, so it's an expanding list.

Okay, thank you.

Thank you.

We'll go next to Samuel Wilson with JMP Securities.

Thank you.

This is Doug Ireland for Sam Wilson.

Could you please give us some more details around the litigation settlement that noted for $7 million?

This is -- it's a case that we have been working for awhile.

We paid just under $8 million.

We also, there's an indemnification in here and in the settlement which we've not valued because we don't think it has much value.

That $8 million or so was actually paid in the first quarter and so our cash performance is actually better than it looks because of that $8 million.

In addition to the $10 million in interest that we paid during the quarter, so that's the settlement, we're proud of the cash performance and by the way, that settlement did resolve all claims, so it should be behind us totally.

And did that settlement have an impact on the earnings per share?

It did on the GAAP earnings per share, but we adjusted it out for the as adjusted.

Okay.

Thank you.

We'll go next to Scott Coleman with Morgan Stanley.

Hi, Scott.

Hi, there, thanks, guys.

Sorry if this has been asked already, but I'm curious if you could walk us through how the revenue break down particularly between switching and transport impacted gross margins.

I would have thought gross margins would have come in a little bit lower on the product side given the mix you reported so I'm just curious what happened there?

Scott, this is Gary.

We had strong product mix and also both in terms of software content, the services business improved 10% of our business, that that improvement helped, we've also got cost reductions on certain platforms, CoreDirector was up, you had a strong show in from 4200, some of the software packages across that and some of the network management and the overall mix was positive and that's why it took it up about a full point.

Great, thanks, Gary, appreciate it.

You're welcome.

We'll go next to Paul Silverstein with Credit Suisse.

Gary, can you hear me?

Hi, Paul.

First off, I just want to build on Scott's question and just clarify, you mentioned that the 4200 was strong but I think sequentially it was actually down, and down a lot, which against Scott's point, wouldn't that have an adverse impact on gross margin?

It seems like I guess my question is did transport margins increase and as that a trend?

Well, you got strong showing from CoreDirector which is high software content, 4200 was down slightly in there, but again, had a good mix on it, we had good software content within the 4200 that we shipped, and also the transport profile was strong as well, in terms of the product mix within transport.

Are transport margins increasing?

Well, overall but we've got improvement on transport, CoreDirector and on 4200 really due to cost reductions.

I apologize, on the long haul, specifically on Long Haul transporter are you making improvement there as well?

Across the portfolio, yes.

All right, on AT&T, I know there's only so much you want to say, but relative to the announcement, I guess it was earlier this week on that international buildout where they specifically reference among other things mesh architecture, a lot of concerns on the Street as to how much leg is on that buildout that is getting long in the tooth.

Can you give us any insight in terms of how much further there is to go?

Without going too specific about them, the comment long in the tooth I would certainly not subscribe to.

As Steve said earlier, I think mesh architecture generally and within these large carriers has just been adopted.

Now, you've got some at different stages of that rollout, but I think there's a long way to go on this.

I think it's got a lot of legs.

These are very large networks that are scaling up, and the whole point about this is they're putting mesh further out from the core into the regional into the metro and getting much closer to the customers.

I think this whole rollout of mesh architecture has a long long way to go.

Can you give us any sense for chassis to line card ratios?

You mean something relevant really on transport?

I mean, you've got, we don't really spend a lot of time focusing on that anymore.

It's not hugely impact full in our business.

We are putting new chassis out there, we've got a couple of builds where we're putting chassis with low line cards out there but really the margins are improving around cost reductions, not just mix.

We're less sensitive to that than we used to be.

Great.

Thanks, Gary.

Thanks, Paul.

We'll go next to Tim Savageaux with Merriman.

Hi, good morning and great quarter.

Thank you.

Want to follow-up on a little bit of the discussion here regarding mesh architectures, and whether it's AT&T's announcement, also recently the OFC show both the Qwest CTO and Bob Metcalf spent a lot of time talking about these architectures and I wanted to know to what extent Qwest is a CoreDirector customer, sounds like they should be and also sounds like Verizon should be but as you look at all of this commentary when people talk about mesh and G.79 and OTN, should we just assume they're talking about the CoreDirector or what are the full implications of that architecture for Ciena and for the industry?

What sort of competition do you have there?

You guys have obviously been early in staking your name on to this kind of architecture but if you can describe kind of what those carrier comments mean from a Ciena product perspective and maybe try and put a little more quantification, Joe Berthold, and an OFC said this reminded him of SONET 25 years ago in terms of the adoption of mesh architectures.

That sounds like a pretty big trend, so wonder if you could talk a little more about it?

So Tim, I think clearly, we think everybody should be a CoreDirector customer, so I think that's pretty basic there.

The mesh architecture affords -- or provides the carrier a way to give a couple things.

One is very rapid service creation turn up and service velocity related and the other is you can do a much better job on protection and restoration and architecturally, the data networks tend to look meshier than they do like rings.

People thought of the Ethernet rings as much as they did about SONET.

So at the state we're in, we are very well differentiated.

We've created the first real control plan in that space, that's the G.709 and the G.8 SONET combined with G.709 for OTN, GIS, so we clearly believe we're leading the pack in that space.

We have to do more in terms of bringing the features that we were able to put out in the, call it, core mesh architecture and move them into the mesh architecture as well, but that's clearly on our trajectory.

If I could follow-up just real quick.

I mean, it seems like despite this being a hardware business , it's what's really bringing you in both in the core and maybe with Worldwide Packets at the edge, are software control systems.

Is there any sort of effort on your part to connect those two in the core and the edge and where does standards kind of play in

So Tim, you're a great straight man, right?

The thing that's most valuable here is software software software, and it is all about the control plain and the ability to building networks that handles wavelengths and time slots and packets all equally efficiently, and that speaks to convergence of the various layers that speak to convergence of the ways that you actually operate the network.

Standards, will evolve to get there.

You can see what happened with with the G.8 standards and the G.709 out there now with OTN.

You're starting to see that with the adoption of things like TBT on the Ethernet side and clearly as an opportunity for us is to converge all that together and create what's effectively a software based operating system for ethernet mesh network.

Great.

Thank you and congrats once again.

Thank you.

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

Thank you very much.

Wanted to see if we could touch a little bit more on what's going on in the competitive landscape particularly in light of a number of your larger competitors have either gone through mergers or various forms of restructuring, trying to understand where you see the process right now or are they kind of getting out of that?

Are they responding with lower pricing and therefore fighting you that way and really getting a sense also if you could throw in Huawei if you're seeing them more because that's certainly one we hear about in the press but don't see much in most of your customers, thanks.

Yes, Simon, I would say that the competitive environment remains challenging and it has done for a while.

I mean, I think the challenges particularly of the larger players is twofold.

One, it's very difficult and challenging to do these cross border integrations and acquisitions and I think they're struggling from all of the obvious challenges of that particularly when you talk about size of the companies that are coming together, very complex, takes awhile for that to get resolved and I think the opportunity for us during this is that we've had a vision around the architecture that we've invested in strongly in the last few years, and those features, functionalities and platforms are coming out and we've had a cohesive strategy around that, and we've acquired the pieces that we need to bring that the to market faster and Packets I think is a great example of that with the ethernet operating software.

While we've been focused on a single homogeneous vision and architecture, I think the challenge a lot of these folks VHS merging two or three conflicting product lines, and so therefore, the confusion that's created in the market and the inefficiencies on their R&D I think is going to last for a little while.

I think the second challenge they have is considerable part of their revenues come from SONET and SDH type architectures which frankly, I think people are looking to move away from.

And as the shift continues towards ethernet converged architectures at layer 0 to 3, I think it gets more challenging for some of these larger players and that's why you're seeing us take market share in there, but clearly, these are formidable players with tremendous assets and great incumbency and probably the biggest challenge we have, Simon is really just the sheer incumbency that some of these players, Alcatel Lucent have globally.

But that's something we've been used to fighting ever since the birth of Ciena, so, I don't think anything is particularly changing.

So what are they doing to respond?

Because it's unimaginable that they're doing nothing but it sure doesn't look like they're doing enough to keep up with your win rates.

Well, I would say that it's easier for us really because we're a focused specialist.

We're in a particular area putting all of our emphasis on that, and it's frankly easier for us.

they've got a lot of other considerations, a large customer base of installed legacy equipment and they can't leave that stranded with their customers so I think they have a more complex set of issues frankly, to deal with than we have and we can move faster, we're a smaller organization, we don't have some of the issues that they have, that they're dealing with.

So I think the fact that we can move faster and we're very focused gives us good competitive advantage when you're at the early stages of this kind of shift.

Just one quick one and I know this is a hard question for you to answer but if you could do your best, if we could get some kind of update on the activity at BT, because that's been a customer we've been watching for some time that seems to sort of pop-up and down, maybe a little bit more color on the progress and activity and how you see that particular customer?

I'll try and do my best, Simon.

I think in terms of BT, I mean, we continue to work with them on the rollout of the project.

I actually think it's going pretty well.

It's a large project.

You'll see some ebbs and flows around the project, and depending on which vendors you talk to, depending on which part of the network they're in, you will see their ebbs or flows on that but overall, large complex project that I actually think is going reasonably well certainly from the perspective that we have.

The other thing I would say about BT is what Century 21 has enabled us to do is actually broaden out our channels to BT, and so we're now selling BTGS in different parts of BT, and I think we're in about nine or 10 different countries now in addition to the UK, so it's enabled us to really spread out within BT, and that gives you more balanced revenue stream.

You're not just dependent on the large project.

Great.

Well, that's helpful.

Thank you very much.

Thanks, Simon.

We'll go next to [Jack Monte] with Lehman Brothers.

Hi, guys, thanks for taking my question.

I guess I'm just trying to understand the traction that Worldwide Packet is having with customers in fiscal '08.

Who are the big customers driving the revenue at Worldwide Packet?

Jack, I would say clearly the largest one, although we also said it's probably likely to be not impactful on revenues in '08 is AT&T.

That's clearly one of the largest wins in the industry this year.

But they've got a series of other customers as yet unannounced in both Tier 1 carriers, cable, other tier 2 service providers, some of the municipalities.

Basically this ethernet revolution touches everybody, and it widens the opportunity, and again because of the applicability of their ethernet software, it allows a much broader customer base and they've got for a young Company, a very impressive list of international customers too, so that was the thing that impressed us and really their competitive advantage is around their software offering, around converged ethernet.

And I guess with regard to interest income, the guidance last quarter was I think for $8 million.

What was the key driver of the upside there?

The guidance for, are you talking about this quarter?

Yes, I'm talking about going into the January quarter, the $8 million for January?

Sure.

It just has to do with with the timing of how market interest rates affect our portfolio.

And so we do have some longer term assets out there, out to a year or even longer so we don't get immediate affect in our interest income from market, Fed funds type rates, so that's basically it.

Okay, thanks a lot.

And our final question comes from Ehud Gelblum with JPMorgan.

Hi, thank you very much.

Excuse me, I lost power before, so sorry, I cut out earlier.

So thanks for squeezing me back in in the end.

Just wanted to again dig a little bit deeper into Worldwide Packets.

The 35 million to $40 million that you say you are going to be recognizing from them this year, I guess that sort of translates more into a calendar year '08 number of somewhere around $60 millionish or so, which would be double the 30 million they did last year.

Can you give us a sense as to how much of that is from this AT&T contract that you are getting with them?

Yes, let me, in round terms, if you calendarize it, we're taking eight months of them, so we're still around the $60 million mark, I think that's a reasonable assumption.

I would say around the AT&T, very very little is in that expectation.

There's a lot of activity going on but we'll most certainly probably make shipments during the fiscal year, but frankly, I personally think it's unlikely we'll take any meaningful revenues from AT&T, just because of the scale of the project.

So the 35 million to $40 million really does not include any a AT&T revenues.

Do you expect AT&T to start maybe in '09?

Yes.

And they could actually see some growth in that $60 million as well?

Yes.

Yes, I mean they've got engagement with a number of other Tier 1's and across-the-board, so I would expect their business outside of AT&T to show very strong growth rates.

So if that were to potentially double again into the hundred plus range and AT&T be an addition--?

Without getting into next years guidance, a little early, I think we'll have to wait and see on that but we're very pleased by what the we're seeing and clearly, by taking that technology, their software and leveraging it across our portfolio and our sales engagements, we hope to get some very positive upside to this.

And what we're seeing so far is very encouraging.

Right.

Finally, the gross margin profile of their business, it sounds likely it's a little bit on the lower side just because it's more on the access side as you mentioned in the past and is that basically why you've been guiding gross margin back down into the high 40s from the 50% range?

Well, it's a little bit about mix, we've done right now.

They do have as we've said the Ethernet operating software, which tends to be obviously software much much higher gross margins.

We do over time think that their margins will improve on that.

They have very good road maps basically to improve that gross margin.

Okay, and then as that gross margin goes up and as your own gross margin goes up, could we start seeing you sustainably move above the 15% operating margin, you did 17 plus this quarter but guiding back down again, it sounds like all the gross margin numbers are going in the right direction and if we just at a certain point as revenue leverages your OpEx you should be able to get comfortably above 15% of it?

Well, I mean I guess this quarter is testament to that coming in at 17, I think it's absolutely, we have the potential to do that.

It also gives us the potential to invest.

We see some great opportunities now with traction that we've got and so I think we've got this double benefit we're going to manage strongly to the midteens objective in terms of our operating profit.

I think that's important and we'll stay very disciplined about that.

I think we can do that at the same time, increase our investment strategically, so that we can insure growth in '09 and 2010 going forward, so I really think it's a double benefit.

You start to get stronger gross margins, you got a stronger business.

Right, appreciate it.

Thanks so much.

Thanks.

And that concludes the question and answer session today.

Mr.

Smith I'll turn the conference back over to you for any additional or closing remarks.

Thanks.

I appreciate everybody's time this morning and for your continued support and we look forward to talking with you over the next few weeks.

Thank you.

Once again that concludes today's conference.

We do appreciate it.