Ciena Corp (CIEN) 2010 Q1 法說會逐字稿

Good day everyone, and welcome to the Ciena Corporation fiscal first quarter 2010 results conference call. This call is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the call over to Ciena's Investor Relations consultant, Ms. Robin Weinberg. Ms. Weinberg, please go ahead.

Thanks, Kathy. Good morning and welcome everyone. I'm pleased to have with me Gary Smith, Ciena's CEO and President and James Moylan, CFO. In addition, Tom Mock, SVP of Strategic Planning, will be with us for the Q&A portion of today's call.

This morning's prepared remarks will be presented in three segments. Gary will review our financial performance in the first quarter, discuss our view of the market environment and provide an update on the integration planning around our pending acquisition of the optical networking and carrier ethernet assets of Nortel's MEN business. Jim will then detail our Q1 financial results, speak with you about expected financial metrics for the combined organization and provide our guidance for Q2. We'll then open the call to questions from the sell side analysts. This morning's press release is available on National Business Wire and on Ciena's website at Ciena.com.

Before I turn the call over to Gary, I'll remind you that during this call we will be making some forward-looking statements. Such statements are based on current expectations, forecasts and assumptions of the Company that could 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 22nd, 2009. We will file our first quarter 10-Q on or before March 11th. Ciena assumes no obligation to update the information discussed in this conference call whether as a result of new information, future events or otherwise.

Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results of operations. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today's results release available on or website at Ciena.com. Lastly, as a reminder, this call is being recorded and will be available for replay from the investor portion of our website. Gary?

Thanks, Robin and good morning everyone. At $175.9 million, our fiscal first quarter came in relatively flat, which was somewhat lower than we previously anticipated. The primary reason for the lower reported sales was revenue recognition delays associated with initial deployments of new platforms with certain customers. Despite that, our strong order flow in Q1 continues to give us confidence that the market environment is in fact improving. Our Q1 adjusted gross margin was within our mid to high 40s target range of 46.4, and our non-GAAP operating expense remained essentially flat with our fiscal fourth quarter. We also generated $4.5 million in cash from operations during the quarter. And in fact, if we excluded the $11.4 million of cash spent on acquisition and integration related costs, we would have generated nearly $16 million in cash from operations during the quarter.

I'd like to talk briefly about our current view of the macroeconomic environment and provide an update on our integration planning related to the Nortel transaction. We're thinking about the current market environment essentially in three ways. Firstly, while global market conditions still indicate some uncertainty, we see signs of improvement, particularly in North America. This improvement has manifested itself in the form of more positive sentiment amongst our customer base, an increase in overall levels of activity and a growing pipeline of opportunities.

Secondly, as you've heard me say before, and as validated in public statements by a number of our customers, the fundamental demand drivers of our business remain intact. Demand for network optimization is strong, and we appear to be in the early stages of an industry-wide optical upgrade cycle. Our customers are facing new service demands on their networks and traffic growth continues to pressure existing infrastructure. Some thing that can no longer be ignored. The growth of data traffic on wireless networks alone is a clear evidence of this trend. As a result, we're starting to see increased spending in selected areas to address these challenges. And we're encouraged by recent announcements from service providers that they plan to increase their CapEx budgets somewhat this year.

And thirdly, and this is a view clearly more specific to the current Ciena standalone business, we're bringing several new solutions to market including new switching platforms, Carrier Ethernet Service Delivery platforms and carrier managed service solutions. By continuing to invest in our portfolio during the recent challenging market conditions, we're able to bring new solutions to market in the near term to more quickly address the areas of concern in our customers' networks. And we will continue that balanced and disciplined approach to investing in the months ahead. So while the reality is that a recovery will not happen overnight, and we're likely to experience some turbulence as we come out of a global recession, we believe that we are well positioned to be among the beneficiaries of an improving environment.

As a standalone company, Ciena has enjoyed a unique position to service customers with the solutions and support required to enable true next generation network models. Following the close of the Nortel transaction, Ciena becomes the leading global equipment provider exclusively focused on the foundations of these networks. Converged optical Ethernet. That leads me to our pending acquisition of the Nortel assets, a topic I know people want to hear more about. I can tell you that we remain on track to close the Nortel transaction later this month. We're working diligently to ensure a smooth transition of the business for the benefit of both our customers and employees. And we're pleased with the progress of our integration planning efforts, which have been driven by a team comprised of dedicated internal resources from both companies and third party experts.

As we've said before, the Nortel assets allow us to accelerate the execution of our strategy and increase our ability to compete more effectively. In particular, the combination results in greater scale in both R&D and customer breadth and gives us stronger operating leverage. However, we're realistic about the challenges and risks associated with such a complex integration process but we're confident in our ability to achieve success and are highly motivated and excited. Particularly given the continued endorsements from our customers and our employees. With that in mind, I'd like to update you on the milestones we outlined last quarter and they include establishing the leadership structure of the combined enterprise, determining our combined product portfolio, establishing our go-to-market strategy and field alignment, and describing our revised target operating model.

With the caveat that this is all subject to the closing of the transaction, I'll start with the organization and leadership of the combined Company. And I'm pleased to tell you that we've chosen our senior management and extended leadership teams and defined their areas of responsibility and accountability. And we have already identified, confirmed and aligned substantially all of the entire organizational structure. Much of what remains to be completed in the organization is the result of our need to comply with local legal requirements, particularly in Europe. We expect to have resolution on the remainder of the organization shortly after deal close.

We structured the Company around two elements that are essential to our success. Quite simply, the product portfolio and our customers. Firstly, on the product side, Philip Moran, President of Nortel's MEN business will serve as our Senior Vice President of our Global Products Group. In this role, he will drive all aspects of Ciena's products and will report directly to me as a member of the executive team. Philip will build on the combined Company's history of innovation and quality to lead the end-to-end development and delivery of products, software and solutions. Working closely with Steve Alexander, our Chief Technology Officer, Philip will own a number of functions including R&D and product management and product introduction. Philip will also oversee Supply Chain Management.

On the customer side, Mike Aquino, currently head of our global field organization, will continue serving in his role to drive clarity, accountability, and agility in satisfying our global customers' requirements. Essentially this group are aligned around the end-to-end responsibility for the customer experience, including account management, channel sales, field systems engineering and industry channel and field marketing, as well as Customer Service. We've been diligent in our process to fill key positions and retain critical talent to ensure that we assemble a world class team comprised of employees from both companies to lead us forward. And I think we're succeeding at this goal. To date, virtually 100% of the employment offers we've extended to Nortel employees have been accepted.

With the leadership in place and the resources of both organizations aligned to this structure, we're ready to execute once the transaction closes. As I just mentioned, the product portfolio is one of the key elements of the combined organization and we're bringing together two complementary technology bases to build a portfolio of greater depth and we think customer relevance. To that end, we made excellent progress to finding the combined solutions set and we'll be ready to announce our portfolio when the transaction actually closes. Our progress in defining the portfolio ensures that at deal close, our engineering and field teams can move forward with clarity. And our customers afforded the assurance they seek in Ciena as a strategic partner and we understand that our customers and partners want Ciena to be decisive and swift in this critical piece of integration planning. We've already gathered critical input and validation through consultation with customers of both companies, and I have to say that response to our portfolio vision has been overwhelmingly positive.

We also have clear plans for ensuring continuity of supply at deal close, and in fact we've already successfully managed the transition of the vast majority of Nortel supply contracts. You'll hear more about the specifics of our combined portfolio once the deal closes. For now, I can tell you that Ciena will be the only Company exclusively focused on converged optical Ethernet which really rests on three key areas of expertise. Maximizing the capacity, scalability, and reliability of our customer's networks, essentially through optical technology. And maximizing the flexibility, efficiency and economics of their networks through ubiquitous Ethernet technology, and pulling and uniting those capabilities together with the industry-leading control plane and management software.

This leads me to the second element of our combined Company, our customers. We've aligned our field operations to fit the capabilities and strengths of the combined Company. In simple terms, the go-to-market strategy of the combined Company is framed around five major regions. The US, Canada, EMEA, CALA and Asia-Pacific. Within these markets, the global field organization will be focused on driving sales into Tier 1, Tier 2 wireline, wireless and MSO service providers, as well as government and enterprise markets. And we will leverage the combined strength of our partner relationships to enhance that market coverage where appropriate. We built our organization to ensure tight alignment between Ciena's global functions and those local and regional teams to better facilitate rapid customer response.

With the exception of certain regions such as EMEA, central Europe which remains subject to information and consultation processes, the leadership and organization structure of the combined global field operations team has already been established around this model and is ready to move forward at the time of closing. We're firmly committed to ensuring a seamless transition for our customers and for our partners and to this end we've established a dedicated customer experience team focused on facilitating effective customer engagement throughout the transition process. In addition, to ensure Nortel customers will be able to do business with Ciena immediately after the deal closes, we are well along in the process of successfully managing the transition of the majority of Nortel's customer contracts.

Given our progress to date in these three critical areas, organizational structure, product portfolio, and the go-to-market strategy, combined with some resource alignment that is already undertaken and Nortel and separately at Ciena in preparation of the close, we're very pleased with where things stand on the transaction and the integration planning. Including the ability to secure operational efficiencies moving forward. While we recognize the scale of this integration and the scope of work we face in the coming months, we remain confident in our ability to I'm flex and execute and with transparency and deliver on the operating leverage and value of the combination.

With that, I'd like to hand over to Jim who will take you through the details of our Q1 results.

Thanks, Gary. Good morning everyone. As Gary said earlier, we reported first quarter revenue of $175.9 million, representing a 5% improvement over the same period a year ago.

Sequentially, Q1 revenue was roughly flat with Q4's $176.3 million. We had one 10% plus customer in the quarter, that represented 24% of total sales. This customer is North American based and was also a 10% customer in Q4. Sales from international customers represented 30% of total revenue in the quarter, roughly flat with Q4.

Turning to our three major product groups. The first, optical service delivery, which includes transport and switching platforms as well as legacy data networking products and related software, accounted for $108.6 million in revenue, representing 62% of total revenue for the quarter. Within optical service delivery, our CN4200 platform was again the largest contributor in the quarter at $55 million. Core switching contributed $23.4 million. And long haul transport added $23 million in the quarter.

Our second product group, Carrier Ethernet Service Delivery, or CESD, includes our service delivery and aggregation switches, Broadband Access products and the related software. CESD had another strong quarter, increasing more than 33% sequentially from Q4, contributed $40.4 million or 23% of total revenue in the first quarter. As with last quarter, a large majority of Q1's CESD revenue came from our Ethernet service delivery aggregation and access platforms. We remain very pleased with the prospects for continued future growth of this product set, which as you know, stems from our acquisition of worldwide. And finally, our Ciena specialist services group, which includes all of our services related offerings reported $26.8 million in revenue in Q1, essentially flat with $27 million in Q4.

In the remainder of my comments today, I'll speak both to the GAAP results and to what the results would have been if we excluded those items which we detail in our press release. On gross margin, Q1's GAAP gross margin was 45.6%. Adjusted for share based compensation and amortization of intangibles, Q1's non-GAAP gross margin was 46.4%. Q1's non-GAAP gross margin included a $3.3 million benefit as a result of an out-of-period adjustment to our accrued warranty liability. Our GAAP products gross margin for the quarter was 48.6%. And our GAAP services gross margin was 29%, once again better than our target mid-20s range as a result of the mix of services revenue in the quarter.

On a GAAP basis, Q1's operating expenses totaled $130 million. This total includes acquisition and integration related costs of $27 million, stock-based compensation of $7.4 million, and $6 million in amortization of intangibles. Excluding those items, Q1's adjusted operating expenses totaled $89.6 million, roughly flat with Q4, and aligned to our guidance. Our Q1 GAAP net loss was $53.3 million, a loss of $0.58 per share. Adjusted for the unusual and/or nonoperating items detailed in our press release, our first quarter net loss would have been $11.4 million, a loss of $0.12 per share. With respect to cash flow and the balance sheet, we continue to be pleased with our working capital management and we continue to be cash flow positive. We generated $4.5 million in cash from operations during the quarter, a sequential increase from the $1.9 million we generated in Q4. That takes into account $11.4 million of cash expended on acquisition and integration related costs during the quarter. At January 31st, 2010, we had approximately $1 billion in cash, short-term and long-term investments.

During Q1, we paid a cash deposit of $38 million for the Nortel acquisition. When we close, as a result of the aggregate consideration to be paid on the Nortel transaction, we'll be reducing our cash position by approximately another $492 million, and we will be issuing $239 million in convertible notes to Nortel. I should note that the purchase agreement provides for a reduction of the cash consideration to be paid, based on the amount of working capital which will be transferred to us at closing, so the actual cash paid at closing will likely be less than the $492 million which I quoted earlier. As we previously disclosed, Ciena may elect to replace some or all of those convertible notes with cash equal to 102% of the face amount of the notes, if replaced prior prior to the closing of the transaction.

For Q1, our accounts receivable balance was $105 million, down from $118 million in Q4. Days sales outstanding were 54, down from 60 days in Q4, as a result of good collection work. Inventories totaled $95.4 million in Q1, up slightly from $88 million in Q4. Product inventory turns were 3.4 times for the quarter, slightly down from 3.7 times for Q4. Inventory breakdown for the quarter was roughly aligned to that in Q4. Raw materials totaled $18.3 million, work in progress, $2.2 million, finished goods, $98.2 million, finally, we have an accrued reserve for excess and obsolescence of $23.3 million. On headcount, as of January 31st, 2010, our worldwide headcount was 2,197 people.

Before I talk about Q2 guidance, let me add some additional color to Gary's comments on the Nortel integration planning. I'm sure you can appreciate that because we've not yet closed the deal, our ability to provide detail on the combined Company's financial metrics is limited. However, as we move forward, we are committed to giving you the information you need to evaluate the performance of the combined Company. It is our goal to provide additional detail on that at our Analyst Day in April, if not before.

At this early stage, I can tell you that our current thinking is to describe the business in the following broad areas. Transport, switching, Carrier Ethernet Service Delivery and software and services. We plan to be aligned to your interests in giving you enough detail to understand our performance on an as-adjusted basis, before any acquisition and integration related costs and before the typical items we adjust for that are described in our press release. We also plan to report separately on deal related costs, so you can follow the progress of the back office integration. We also plan to describe our target operating model and our time line for achievement of certain milestones including expected operational synergies. Also, for the next several quarters, we'll describe separately the revenue contribution for the Ciena and Nortel product sets, so you can track their individual performances.

I'll close our prepared remarks today by talking to our guidance for Q2 of 2010. As noted in the press release, our guidance comments today and likely in the answers to any questions about forward-looking results, will be limited to our expectations of Ciena's performance as a standalone Company. They will not reflect the addition of any revenue, margin, or expense associated with the acquisition of Nortel. We currently anticipate fiscal second quarter revenue to be in the range of $185 million to $195 million. Based on current expectations and product mix, we also believe that adjusted gross margin will be within our target range of mid to high 40s. We believe Q2 non-GAAP operating expenses will be roughly flat with Q1's.

We expect other income and expense net in the second quarter will be an expense of roughly $2 million. As for taxes, we expect our tax obligation for Q2 will be related to foreign taxes. Depending upon your assumptions, you may need either our diluted share count or our basic share count. We estimate Q2's basic share count at approximately 93 million total shares. We estimate Q2's diluted share count at approximately 114 million total shares.

Kathy, we'll now take questions from sell side analysts.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). We will pause for a moment to assemble the queue. And we'll go to our first question with RBC Capital Markets, Mark Sue. Please go ahead.

Thank you. Gary, the, does that all get recognized in the current quarter and are there any specific features that the customers are waiting for Ciena. As we look at the pending combination of Nortel and Ciena, do you feel that there will be more product rationalization? Less rationalization. Any thoughts on the product point of view would be helpful.

Firstly, on the rev rec, I think the items that we weren't able to recognize, I characterize them -- and there were two of three of them -- all really relating to new platform introduction of one sort or another. The thinking around Q2 is we're not necessarily expecting all of those deals to come through in Q2 but rather over the course of the next couple of quarters. So when we look at the 2Q guidance we've kind of blended that on an assessment of risk and likelihood of other things. When we look at guiding for future quarters, we take those things into account. So I'd sort of characterize it overall as really putting new platforms out there and the revenue recognition challenges associated with those. In terms of the product integration and alignment with the Nortel platforms, I think that's going extremely well. I would highlight that clearly the -- some of the high capacity transport technology that Nortel have, we're looking at parlaying that across the portfolio. So I think from an alignment around the portfolio perspective, I think we feel better about it now than we did last quarter, than we did when we first started the due diligence on the acquisition. So the more we get into it and the synergies that we see in terms of cross-selling, in terms of parlaying the technologies across the portfolio, Mark, I think it's fair to say we feel better about that now than we did.

Okay. And Gary, just a quick follow-up. Should we take that $798 million, annualize that and your comment, we need to reduce anything there and then I guess your comments on optical upgrade cycle also applies not only to Ciena but also the Nortel business as well.

I think the portfolio that we're bringing to market around converged optical Ethernet, I think the timing of that looks to be very favorable, given what we're seeing, admittedly the early stages but given the capacity demands in terms of upgrade requirements across the board, I think the timing for that is very good.

That's helpful. Thank you and good luck, gentlemen.

Thanks, Mark.

We'll move next to Subu Subrahmanyan from Sanders Morris.

Thank you. Gary, could you touch on what particular platforms were impacted by rev rec. Clearly, a quarter after revenues declined pretty substantially so was it the upgrade to FS, if you could talk about that a little bit more?

Sure.

And then --

Sorry, go on.

My other question was in terms of impact on gross margin of what we've seen in terms of the mix shift and how you expect that going forward as you get more of the rev recognize from the Core Director platforms.

In fact, we had -- because we've got a number of new platforms coming to market, it was across the board we had CSD platforms that we had anticipated taking revenue from on a first office application. We had some of our high capacity optical transport components that we couldn't complete the complete delivery of the system, we had a few component supply issues so we couldn't take revenue on that. Then the other one, you know, to your point was around a software upgrade that wasn't completed in time. So I think really it was across the board. I think particularly relating to Core Director FS.

We do see good traction with that. I think this is probably the sort of low water mark as it were if you could describe that for Core Director. I think based on the traction that we have and the order profile, we really do think that we're going to see a strong second half improvement in Core Director and Core Director FS and we began at the end of the year to take revenues for the 5430 as well. We've secured about four new customers for Core Director, Core Director FS, recently, and we haven't taken revenues on any of those yet. So again, that gives us some comfort around the second half ramp.

From gross margin impact, mix shift.

I think we've hovered around the sort of mid-40s with some elements coming in and out affecting that but I would expect, given that visibility and the sort of change in profile of some of these other more software oriented platforms, I would expect overall the gross margins to improve. I think they'll still be in the range but I would anticipate an improvement in gross margin, all other things being equal.

Thank you.

And next we will go to Jefferies & Company's George Notter, please go ahead.

Hi, thanks very much. Wanted to know about the integration costs. Coming out of the announcement of the deal you guys were talking about $180 million in cash integration costs. I know you have to sort of replicate the IT infrastructure on the Nortel side but can you talk about that? Is that still a fair estimate going forward?

Yes, George, it is a good estimate going forward. Just to clarify, the $180 million is really transaction and integration costs and includes the cost arising from the transaction itself, such as professional fees, bankers and lawyers and related costs. But yes, the $180 million is what we think it will cost and we're well along in our planning. We focused of course on day one, which will be the close date, to ensure that we can seamlessly operate the business at that point and doing some planning for day two, which will be the day that we remove our reliance on the MBS business and actually have our own IT infrastructure in place.

Got it. Just to be clear, how much of that 180 do you think was spent thus far?

We've expensed $27 million.

Great. Thank you.

And we'll move next to Paul Silverstein with Credit Suisse.

Gary, I might have missed it but did you quantify the revenue recognition, the revenue that was subject to those four items that you called out?

We didn't quantify it. But I think if you look at the higher end of our range, when we went into this, we anticipated revenues up as much as 5%, which would have taken us to that sort of 185. And so any kind of combination of these rev rec would have taken us toward the high end of that range, Paul.

The translation is it was somewhere in the order of $10 million.

I would say slightly shy of that, they varied in size but I think that's a reasonable view.

Okay. In none of the revenue -- the four items you called out, I didn't recall hearing anything about Core Director, so they were all -- it was either transport or the worldwide packaged Ethernet stuff.

There was a software release that we didn't recognize.

Okay. And then Gary, the 5400 --

Not Core Director.

It was not.

It wasn't Core Director, no.

The 5400 platforms, that family of products, that comes out the second half of the year?

It's out in sort of limited release right now. It's in a number of Tier 1 labs, receiving certification. We would expect it to be shipping GA towards the end of the year, certainly, and I would expect to begin to take some small revenues at the end of this fiscal year.

Gary, can you just help us understand the difference between the 5400 platforms and the Core Director FS?

Tom, do you want to?

The biggest issue, Paul, is size of the platforms. The Core Director platform is basically a 640 gigabit platform. But the 5430 can scale all the way up to over 7 terabits. The other thing to keep in mind too is that the 5430 platform has the capability of doing a hybrid switching fabric so it can do both, it can do GA switching, sonic, or also packet switching. So we're really looking at that as the way of helping service providers transition to a next generation packet based architecture.

And again, you're expecting GA end of this year?

That's correct, Paul.

All right. And Gary, Tom, to address ARPUs like the Verizon, the packet optical, how big a deal is it to integrate the Nortel optics? I assume that's what you'll do to integrate the 100 gig and the 40 gig into those platforms. How big a deal is that in terms of getting that product commercial?

We've done that sort of integration in products before. You may recall that we actually did that kind integration on the original Core Director platform a few years back and as Gary mentioned, we're looking to take the Nortel 40G and ultimately 100G technology and push it across our platforms.

One last quick question. Gary, you referenced strong order book. Can you give any quantification or any additional insight on that.

We had a very good quarter last quarter in terms of order flow in Q4. Q1 is normally a low water mark for us, given that it straddles a bunch of holidays and end of year stuff, from an order point of view, it's right through to the end of January. We were considerably up, I would say this, Paul, considerably up on this time last year.

Okay. Thank you.

Thank you.

And Nikos Theodosopoulos with UBS has our next question.

First question is can you elaborate a little bit on the $3 million adjustment to gross margin, why that was taken in the quarter and will there -- do you anticipate other adjustments, other meaningful adjustments like this for the remainder of this fiscal year?

Yes, the warranty reserve is one of several estimates that we make as part of our financial closing process. In looking at the calculation this quarter, we decided that a new methodology better estimates the reserve. I'll note that we've had several minor adjustments that we've reported to you in earlier quarters, such as the higher excess and obsolescence provision that we made last year. Right now, I don't anticipate any more for the rest of the year but these things do happen from time to time.

Okay. And this new method took place in this fiscal year?

Yes, this first quarter.

Okay.

And I would mention also that this adjustment is not going to have any effect on our target gross margin as Ciena standalone.

Got it. Okay. And the restructuring this quarter, about $11 million of the $27 million, or I should say the integration and restructuring costs, $11 million of the $27 million, sounded like they were cash related. Can you remind me what the total cash portion will be for the $180 million? I had thought it was going to be a higher percentage would be cash but this quarter was less than 50%.

Yes. The $180 million is essentially all cash, some of which is capital in nature, but the reason why we only spent $11 million in cash during this quarter was that we had previously spent around 12 or so.

Okay. So we should still look at the vast majority of the $180 million being cash related?

That's right, $180 million is cash.

Okay. All right. And my last question is more on the product. When I look at the portfolio, clearly there are a couple areas where I'm just wondering what the Company's going to do. If I look at the 4200 versus the Nortel 5200 and 6500, those seem to be fairly competitive products and I'm just curious, do you anticipate keeping and investing in both products post the deal or do you envision favoring one of those two portfolios?

As we said before, we're going to give more details about our portfolio when we close the deal. But I think a couple things probably bear mentioning there, particularly around the 6500 and 4200. If you look at where a lot of the R&D investment around 6500 has been spent, it's really been spent around making long distance, high capacity possible in the network and being able to manage that traffic appropriately. We focus 4200 is more around short distance Metro applications and enterprise and carrier managed service applications so there's probably less overlap there than you might think.

I'll look forward to that post the deal.

We'll move next to Sanjiv Wadhwani with Stifel Nicholas.

Switching was down looks like around 40% or so sequentially. Can you just give some color around what might have happened over there and second question, worldwide packet's obviously very strong, is this a lot related to wireless back haul mostly or are you seeing a lot of business Ethernet services also? And then any thoughts on AT&T and Clearwire for the rest of 2010. Thanks.

Okay. Let me take the Core Director one. Core Director by its nature, we've seen it in the past, it can be very lumpy, so you've got existing customers that deploy this in sort of waves. The forecast from those customers is very positive for the second half of the year and we've seen that historically as well. So I think we have a high degree of confidence around the installed base, continuing to have an uptick in the second half.

Also, we've put a lot of new features and functionality in there in terms of the Core Director FS, which is really things like OTN capability, which really link that then into the 5430 and beyond. And so we're going through some of the transition, I think possibly with that, as that gets certified in labs, et cetera, as they begin that upgrade. We've also won with that platform about four new customers, very recently for that, that we haven't taken revenue yet either and we'll recognize those in the second half. So that gives us some comfort around that as well and the pipeline and activity around Core Director FS and in particular, OTN capabilities. So I think as we sort of step back from it and look at that, I think we feel pretty confident around the second half of the year for Core Director.

In terms of the CESD, which resulted really from the Worldwide Packet acquisition, we're very pleased now with the traction that that's taking. I would say that wireless backhaul clearly features very prominently in terms of the applications there. I would say that we're beginning to shift now to some of the business Ethernet stuff as well. That does take longer in terms of integrating into our systems and into the marketing and sales constituencies around the front end of these carriers. But we are starting to see that. It's somewhat success-based. But we now have a broad range of carriers that are using the CESD platform to deliver Ethernet based business services.

Got it. And AT&T and Clearwire sort of for the rest of 2010?

We see continued strength.

Got it. All right. Thanks so much, guys.

And next we'll go to Tal Liani with Banc of America, Merrill Lynch.

First, we saw Nortel's $800 million or so in revenue recognition for nine months. Can you give us a sense of what the corresponding order rates were? I believe in the past Nortel had large deferred revenues.

That's not something we can talk to, to be honest. I mean, the plan, Jim outlined the sort of framework for how we're going to discuss all that and I think we're looking to give a very robust set of facts out on milestones as we go forward, so you can see the information that you need. But we're not really in a position to do that right now.

Got it. And then just secondly, just conceptually on this whole portfolio integration issue, I know there's been a lot of discussion on the optical side but what about overlap on the Ethernet switch side, will you need to rationalize more of their platforms just because your own CESD platforms are newer and I believe doing so well? And I think in the past Nortel had about a $200 million or so annual run rate in its Metro Ethernet products.

We clearly will give details of this at close but what I would offer you is if you look at Ciena's strengths it's really in sort of world class switching, software integration. I would also say our carrier Ethernet services as well, you can see the traction for yourselves. So I think those are the things that we would focus on and then the high capacity, 40 and 100 gig transport from MEN.

Got it. And just two very quick ones. Services gross margins declined a lot sequentially. Any specific reason for that?

As with our products, our set of services that we offer, there's a range of margins which we experience based on I guess you might say the complexity of the service offering. And our margin can move around on services, just as it can on products, depending upon the mix. So there's no trend to be taken from that. It was better than we had thought and hope that will continue to be good.

And just a final one. What's your view on the balance sheet after you pay for the Nortel assets? I believe you're planning to pay more cash or at least considering paying more cash than you thought before. Thank you.

I'm not sure what the reference is to the more cash. This is the cash that we negotiated during the auction and it is the amount that we've been talking about for a while. We will issue a $239 million convertible at the close and we have the right to take that out if we so choose but I can't comment any further than that.

I see. Actually, that's what I was referring to, that instead of issuing issuing notes that you could perhaps consider paying cash instead of issuing additional notes.

I misunderstood your question. Yes, we can substitute cash for the convert if we so choose.

Will you -- then are you comfortable with the balance sheet after all these cash payments?

I didn't say we're going to substitute cash for the convert. I said that we have the right to do it if we so choose.

Okay. Thanks.

Thanks.

And we'll move next to Jeff Kvaal with Barclays Capital.

Thanks very much. First of all, on the revenue recognition delays or revenue deferrals, when we are thinking about modeling the balance of the year, should we think that the April quarter is particularly high and, therefore, not really gone from that? I'm trying to get a sense of how we should look at the progression. Is there a big lump that is in the April quarter that would come out again in July?

I wouldn't sort of describe it as sort of big lump. From time to time, we get this. We have a lot of -- I think there's two things I would talk to, Jeff. One is it's a lumpy business anyway and I think when you're coming out of a recession, you can get some anomaly. We've seen this before. This is somewhat compounded by the fact that we're bringing in a number of new platforms to market and so while that's good news overall, it can create some challenges and we clearly saw that in Q1.

But I would think as those platforms get to a degree of maturity and adoption and the revenue recognition gets more compacted, that then I think you'd start to see a more regular cadence of the business. I mean, what we've seen so far in terms of, as we've dug out of the recession, I guess our low point was Q2 was $144 million. We then went to 164. We spiked to 176. We're flat this quarter. From what we're seeing from our overall pipeline and activity, I would expect to see an uptick for the remainder of the year.

Okay. All right. That makes sense. And then secondly, on the Nortel integration, just to be clear, should we expect to hear about synergies for you on the close and that's announced in March or at your Analyst Day in late April.

I would say it's more likely to be the Analyst Day in April, Jeff. It gives us a chance to get our keys to the door and finalize our pieces there and we'll certainly share -- the intent here is to share a model and then the milestones along that so that we can collectively measure our progress.

Okay. Thank you, Gary, very much.

Thanks, Jeff, appreciate it.

We'll move to Michael Genovese with Soleil Securities.

More on the revenue deferral issue. Short and long-term deferred revenues looks like they went up $5 million quarter-over-quarter and you were talking about these deferrals being more in the closer to the $10 million range. Could you just speak to that? I would assume some of these orders that you got did not meet the qualifications to go into deferred revenues for the quarter. Is that right?

There was a fairly high correlation between the growth in our inventory balance this quarter and the revenue which we did not recognize. And so the fact that our revenue grew was because we had -- in some cases it was actually at customer locations and we just couldn't get the rev rec. That's how I would answer that question, Mike.

Okay. And would you describe -- I mean, would you describe this weakness in Core Director in the quarter as a -- do you think the transition and the fact that Core Director FS is right on the horizon, the 5410 is probably out, the 5430 is coming, I mean, do you think that it's kind of freezing in the short term customers ordering what we call Core Director one because they anticipate these new products coming.

I can certainly point to some examples where some customers are certifying the Core Director FS so they can upgrade their existing Core Directors. So I think there are some examples of that. I wouldn't classify it as sort of widespread but I think that's certainly a factor in it. I think it is more just the lumpy nature of that, quite frankly.

Got it. And then finally, I don't know if you can comment on this at all, but can you make any comments, do you care to make any comments about the current status of domain vendor selection at your largest customer?

I would choose not to at this time. I think there's enough speculation in the market.

Okay. Actually, I'm sorry, let me fit one more in. This is a second quarter in a row where you guided share count, diluted share count up significantly but this quarter didn't happen. Can you talk about why would the share count jump from 93 to 114 and why didn't it happen this quarter?

It didn't happen this quarter, Mike, because had there's a calculation under which you derive diluted earnings per share. It so happens that when we're in a loss position, you don't make that calculation. So that your basic share count is exactly the same as your diluted share count. I just gave you the diluted share count in case someone's model depicted a considerable profit for next quarter.

Got it. Thanks.

And next we'll go to Blair King with Avondale Partners.

Just wanted to circle back on the working capital contribution out of the cash payment for Nortel. I think you've addressed this in the past but I just want to make sure that I'm clear, that the $492 million in cash that you'll pay would be adjusted out of the Nortel working capital contribution and I'm wondering do you have an update on what that might be?

Yes, let me just give you the basic situation. The purchase agreement calls for our getting the working capital that we need to operate the business. We've estimated that to be about $167 million. We're not getting some aspects -- some elements of working capital. That's part of the agreement. So to the extent that the elements of working capital that we get at close are less than that $167 million, there will be an adjustment to the purchase price, based on the difference between 167 and whatever comes over. We really haven't spoken to that difference at any point in time, so I won't comment any farther. But I would expect that we will actually not put out $492 million in cash at closing.

Okay. Got it. And then I know you don't want to touch on this, but I'll ask anyhow. Could you give us a sense as to what thought process you might go through that would substitute the convert into equity? Or cash, I guess.

I'm not going to be able to answer that one, Blair, but thanks for the question.

All right. It was probably a little too direct. The last question I have is just on the SG&A. So there was $11.4 million in the quarter that was attributed to the acquisition and integrated related costs. Is it fair to say that $11.2 million is within the SG&A line this quarter?

Remember, we're reporting these items as adjusted, without it, so you're asking the question do the GAAP results include the $11.4 million.

Okay, all right, got it. All right. Thanks. That settles it. Thank you very much, appreciate it.

Thanks, Blair.

Next we have Morgan Keegan's Simon Leopold.

Wanted to get back to another question but asked a different way. Particularly around the area of backhaul. I presume that you have multiple products participating in backhaul initiatives that I would include the 4200. So I want to know, first of all, does that make sense and then secondly if you could frame what percentage of your sales come from that application?

Your assertion, Simon, in fact is true. 4200 in addition to some of the carrier Ethernet stuff does participate in that. I think in the past we talked a lot about 4G and WiMAX but we're also seeing some of our products now going to 3G wireless upgrades. With respect to the percentage of that that's around 4200, it's really hard to tell because once the traffic arrives at the sales side and gets down on a combined network it's just hard to separate it out.

Maybe asked a little bit differently, of your total revenue, maybe a range that you think of as attributable to backhaul projects?

I don't know that we've really gone there. I mean, one measure you can make of the growth of it is as Gary mentioned earlier, a good bit of the CESD revenue is coming from wireless backhaul so that will give you some color as to where that might fit. For us to be able to break out I think is really hard just simply because we don't always know what our customers use the equipment for.

That makes sense. Shifting gears a little bit, I want to get a little bit of better understanding about what kind of product mix you're anticipating for the April quarter, because you've got a decent improvement in revenue and I'd like to get a sense of how concentrated it is or broad-based that might be.

I would say, depending on the final mix, I mean, I would expect to see most of the platforms up across the board, 4200, CESD and Core Director.

Proportionately all the same or do you -- I guess really where I'm going is I'm wondering if we should anticipate maybe a pop in Core Director given the degree of weakness this quarter?

I would probably be more inclined towards the second half, Simon, in terms of the Core Director. I think we'll see it sort of bottom out Q1, Q2, and then the profile we're looking at right now, things can change, but the profile right now is strong Q3 and Q4.

Okay. And just one last one around the gross margin. We've seen a pretty big volume shift from the worldwide packets products and I'm just wondering, I assume that the gross margin contribution in the past has been near the corporate average. I'm wondering if on the higher volume that's now above the corporate average, if we could get some sense of the gross margin contribution there?

I would answer the question like this, Simon. As we continue to roll out enhancements to that platform around the software, then that tends to be more in the higher range. And if you look at the new platforms that we're rolling out as part of CESD, some of which we didn't recognize this quarter, that tends to be in the higher range as it's more aggregation and switching.

Thank you very much.

Thanks, Simon.

And next we have Ehud Gelblum with Thomas Weisel.

This is for Ehud for Hassan. Going back to the $180 million transaction costs, just had one more follow-up question on this. You mentioned $27 million was recognized and I see all of it was in the GAAP, was a GAAP measure. Is there any likelihood going forward that part of this is not going to be in the GAAP and actually flow down to the adjusted number?

Let me answer it this way. The $180 million does include some capital expenditures and so they won't show up immediately in our financial results. They'll show up as depreciation or amortization over future periods. With respect to whether we'll be able to break all of those costs out and show them separately from our as-adjusted, I think there's a possibility that some of those amounts, we just won't be able to in following the rules around as-adjusted results totally break them out of our as-adjusted results. However, if that is the case, we'll point out to you where those numbers are so that you can get a clear picture of what our business is doing, without any transaction and integration costs.

Got it. Just one follow-up on the supply issues that led to the rev rec delays. Was this because of a sole supplier or is it because huge uptick in demand that cannot be met on a timely basis or some other reason?

I think this was very specific to some high capacity expensive components. I wouldn't describe them as sort of single supply but there aren't that many people in the world that can supply them. You're probably looking at a couple. You're also seeing experiencing some lengthening of lead times across the board but nothing significant so I think that also talks to an overall uptick.

Great. Thanks.

And our last question will come from Douglas Ireland with JMP Securities.

Thank you. I think we're about a year into the access cycle now and I was wondering if you have any thoughts about how much longer you expect the carrier CapEx to be focused on the access layer and when you expect to see the sort of 100 gig core cycle revenue begin to ramp?

I don't know that -- the access impact on our business is really more in additional traffic in aggregate hitting the network, because most of our equipment goes in the Metro part of the network or the core part of the network. So we would probably benefit from a rise in access traffic more than we would -- than we would benefit from increased investment in the access part of the network. With respect to 100G, we've seen a lot of trends in the network now that are causing capacity growth. Mobile backhaul we talked about a good bit because of increased use of wireless data, greater use of video and in fact greater use of high definition video. More real-time video content, I think are all things that are contributing to that.

In terms of when that's going to drive 100G to market, there are a number of different elements that impact that. You're starting to see 40G beginning to be pretty widely deployed in networks in response to that. We believe that it will be a time yet before 100G becomes the common currency of bandwidth in networks. One of the things that we're confident about is that the technology that Nortel's brought to the table around 40G and the ability to upgrade is equally applicable in 100G. We think we're in a pretty good position to benefit from that when it does happen.

Thank you.

Thanks, Douglas.

That does conclude the question-and-answer session for today. At this time, Mr. Gary Smith, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you, Kathy. Thanks for everybody's time this morning. It's very much appreciated for your continued support and we look forward to seeing everyone hopefully at our Analyst Day in April in New York.

That does conclude today's conference call. We thank you for your participation.