Ciena Corp (CIEN) 2011 Q4 法說會逐字稿

Good day, everyone, and welcome to the Ciena Corporation unaudited fiscal fourth-quarter 2011 and year-end results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ciena's Vice President of Investor Relations, Gregg Lampf. Please go ahead.

Thank you, Shannon. Good morning and welcome to Ciena's fourth-quarter and year-end 2011 review. With me today is Gary Smith, CEO and President, and Jim Moylan, CFO. Tom Mock, Senior Vice President, Corporate Marketing and Communications is here with us as well. This morning's press release is available on National Business Wire and Ciena.com.

As was the case last quarter, we have included in the release much of the financial data that we typically would cover on the call. This allows us to abbreviate our prepared remarks so we can spend more time answering questions. We expect to use this format going forward.

In our prepared remarks, Gary will discuss management's view on the quarter and the year as well as our business progress. Jim will offer some color on our results and provide guidance for Q1. We will then open the call to questions from sell side analysts taking one question per person with follow-ups as time allows.

Before beginning our formal remarks, I wanted to announce that we will be hosting our second investor relations educational webcast next Thursday, December 15, at 12.30 p.m. Eastern. The topic will be OTN. Please visit the investor relations section of our website for more information.

Before turning the call over to Gary, I will remind you that during this call we will be making certain forward-looking statements. Such statements are based on current expectations, forecasts and assumptions regarding 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 most recent 10-Q filing. Our 10-K is required to be filed with the SEC by December 28 and we expect to file by that date. Ciena assumes no obligation to update the information discussed in this conference call whether as a result of new information, future events or otherwise.

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 press release available on Ciena.com.

As a reminder, this call is being recorded and will be available for replay from the investor section of our website. Gary?

Thanks, Gregg, and good morning, everyone. We're very pleased to report a strong fourth quarter with which to close our fiscal 2011. At $455 million, revenue came in towards the upper end of our guidance range. We achieved a 3.5% as adjusted operating profit in Q4, our second consecutive profitable quarter.

Order flow was also strong in Q4 which was our best ever in fact for orders. We also continued to control the things that are in our control. As a result of all these efforts, we achieved our significant -- next significant milestone in Q4, that of positive cash flow from operations.

We also made additional progress for the full fiscal year with all key business metrics moving in the right direction. Following the integration, we returned to as adjusted profitability for the year. And on a true like-for-like basis, Ciena revenue grew more than 10% in the second half of fiscal 2011 compared to the second half of 2010 which reflects our growing market share.

From a portfolio perspective, we integrated technologies across platforms and we implemented OneControl, our unified management system to bring these platforms under a single management system.

And our business became more global during 2011 with large international project deployments across many geographies. However, a consequence of this growth has been slightly elongated cycle times from order to revenue recognition.

All told, our team has achieved the milestones we laid out nearly two years ago despite a macroeconomic environment that remains uncertain and we consider the integration phase of our transformation to have been a success. Whilst we have a lot more work to do, we are closing the books on a solid year and look forward to 2012 with real excitement about the opportunities that lie ahead for our business.

The underpinning of the next phase of the Company's evolution is a focus on targeted growth and improved operating leverage. Through a combination of growth initiatives, which I will discuss in more detail in a moment, and the ongoing optimization of our supply chain and business systems, we have a roadmap to improve profitability we are beginning to execute against.

With a business that is already well aligned with the next gen needs of today's networks and applications, we expect these growth and optimization efforts to help us continue to grow faster than the rest of the market, expedite efficiencies and drive us towards our profitability goals.

With that context, I would like to take a few minutes to comment on the competitive landscape. We continue to feel good about our position relative to our competitors and in fact we believe that our momentum is building. Our customers are adapting to new market dynamics and their needs and behaviors are shifting. In this new market environment, we are finding that our positioning as the network specialist is increasingly valuable and differentiating. Customers are requiring more strategic collaboration and greater insight from their suppliers, a dynamic that aligns very well with our specialist strategy and approach.

Additionally, our vision for network modernization continues to be validated by customers. This architectural traction, combined with our proven approach to customer engagement, is driving gains for Ciena in both market share and mind share going forward.

In the combined market for WDM and switching, Dell'Oro's recent numbers show that we are in the number one position in North America and now have moved into number two position worldwide. And with respect to mind share, the recent global survey by Infonetics shows that Ciena is considered by service providers to be the leader in multiple categories.

Of note, Ciena is number one in customer awareness, number one in technology, number one in R&D and roadmap, number one in overall transport and switching and number one in Packet-Optical Transport.

This momentum that we are experiencing is evidenced by the diversity of wins we have seen since the third quarter, wins that span the entire portfolio.

In switching, we secured our first major OTN win in Latin America with a Tier 1 provider. Additionally we were awarded the OTN switching business by a major Indian service provider. And customers who are using the 5400 platform for layer one switching now total 15 with deployments in 19 different countries and on six continents.

On the packet side, AAPT and Fibertech were recently announced as customers for end-to-end carrier Ethernet solutions from access through to metro aggregation; AAPT in support of the national broadband network project in Australia, and Fibertech for mobile backhaul applications in the US.

As expected, we also had a strong quarter for transport. We are pleased to have expanded our relationship with BT to include 100 gig coherent transport, a path to 400 gig and unified management with OneControl. And in the submarine transport market, Southern Cross, Reliance, and Tata were all announced in Q4 as Ciena continues to grow our presence in that space. All told, we now have more than 100 customers for coherent transport.

So growth in Q4 and the fiscal year has been healthy. But as I mentioned a few moments ago, we are targeting some new growth initiatives as we look forward to 2012 and beyond. Specifically, we are evolving our go-to-market coverage model to help capitalize on the momentum we've built in 2011.

We see opportunities to further expand our geographic reach in markets such as Brazil, the Middle East, Russia, Japan and India. We also see opportunities to diversify our customer base and support additional network applications like infrastructure for cloud-based services and Internet content providers. Finally, we plan to build on our initial success in submarine, mobile backhaul and business Ethernet service applications.

To help us target these geographies and verticals, we are pursuing various sales initiatives and strategic partnerships especially in enterprise applications. These are intended to complement our direct sales force and help us turn our momentum into the next phase of growth for this space.

Overall in summary, we continue to make steady progress. We believe we have built the platform for growing a balanced business and we continue to believe that we are well-positioned to achieve improved operating leverage going forward.

Now I'll hand over to Jim for some color on our Q4 financials and our Q1 guidance. Jim?

Thanks, Gary. Good morning, everyone. I'll take just a few minutes to provide detail on the results that we published earlier today. As a reminder, I will be speaking only to non-GAAP results. Please refer to this morning's press release on our website for the reconciliations to our GAAP results.

As part of our early efforts to build operating leverage, including supply chain optimization and business process reengineering, we have made significant progress, improving metrics across the business and we remain confident that there is much more we can do.

We generated $42 million in cash from operations in the quarter and we also achieved about $30 million in free cash flow. Our cash position is up by approximately $55 million and we ended the quarter with $592 million in cash and liquid investments.

Inventory levels declined to $230 million driven primarily by our ongoing supply chain optimization efforts. Turns improved to 3.7 times. We saw DSOs come down a bit as we gained some efficiencies in our cash cycle. However, we know we have more work to do to improve our DSOs and we believe that the steps we are taking will result in days of sales coming down over the course of 2012.

And finally, OpEx came in just over $180 million, a little higher than we expected but this was largely due to the increase in commissions associated with the strong order flow that Gary mentioned earlier.

Stepping back from the quarter to take a look at the fiscal year as a whole, we believe the year was a year of steady progress and evolution. We are pleased with our performance overall including revenue of $1.7 billion, operating margin showed improvement through the year and we are focused on continuing this momentum. Additionally, as you will see in our upcoming 10-K filing, our backlog at fiscal year-end was up by approximately $100 million compared to 2010 reflecting the strong order flow we have seen in recent quarters.

Next I'll discuss guidance for fiscal first quarter of 2012. Absent any significant changes in exchange rates, our guidance is as follows. We expect revenue to be in the range of $435 million to $455 million. We typically have experienced reductions in both order volume and deployment activity toward the end of the calendar year which is of course the holiday season and again early in the next calendar year. So we anticipate that our fiscal Q1 revenue will be impacted somewhat by the seasonal effect on our customers' procurement and deployment cycles.

Also with flooding in Thailand having disrupted some supply chain activity, we could see a relatively small effect on Q1 revenue, likely less than $10 million. However, we are working with good success so far to mitigate this intact.

We expect Q1 adjusted gross margin to be within our target range in the low 40 percentages. Adjusted operating expense is expected to be slightly higher than Q4 levels in the low $180 millions. With regard to other income expense net in the first quarter, we project an expense of approximately $9.5 million related to the interest on our notes.

We expect our tax obligation for Q1 will continue to be related solely to foreign taxes. As for share count, we estimate Q1's basic share count at approximately 98 million total shares. Diluted share count will vary depending upon your assumptions about our profitability.

That concludes our prepared remarks and with that we will move on to Q&A. As a reminder as we have done in past quarters, in order to maintain fairness we will be taking only one question per sell side analyst with follow-ups as time allows.

Shannon, we will now open up the line for questions.

The question-and-answer session will be conducted electronically. (Operator Instructions). Mark Sue, RBC Capital Markets.

Thank you. Good morning, gentlemen. If I balance your comments on the strong order flow versus the near-term guidance, does the first fiscal quarter represent something as a bottom in revenues? If you could help us understand the seasonality and how we should see things progress in 2012?

And maybe I should do that -- if you could dive in deeper into the segments Switching, how we should see the trends develop Transport, and also if we should also factor in a rebound in the Carrier Ethernet as well?

Yes, Mark, here is what I would say about that. We talked a little bit in our remarks about the seasonality of our business. We are certainly seeing seasonality in order flow and customer activity on the deployment guide. In the past we have always talked about seasonality in our order flows, but there were always other things going on in our business which sort of masked the seasonality. We now believe that because of year-end slowdowns and a slow start to the beginning of the year, there is going to be seasonality in our business. Generally speaking, we are -- we believe that the second half of the year is going to be stronger than the first half of the year.

As far as a bottom, you know, we always hesitate to talk about sequential movements other then the following quarter. But as I say, we do believe second half will be stronger than the first half of the year. Gary, would you like to address the --?

Yes, the product segments, Mark, Transport was clearly up strongly as we expected in Q4. I would expect to see a strong showing in Transport going forward, clearly, and also, Switching was up. We had a strong Q3. It was up so the second half of 2011 was strong in Switching and we have got good momentum there, and we expect a strong showing in Switching into Q1 as well.

CSD was down in Q4 really reflecting I think some of the lumpiness in the nature of that business. I would expect that CSD to be up in Q1. That is certainly what our current projections are showing.

Okay, got it. So in aggregate, you're seasonality is increasing on a quarterly basis but your order flow is improving on a year-over-year basis. So would you say that your confidence on the business in the pipeline is actually stronger now -- and your visibility?

Yes, I think Jim mentioned on the call, our overall for the year, despite the economic uncertainty and then finishing up all of the integration, our backlog grew about $100 million on a like-for-like basis year to year, so I think we expect to continue to grow the business on this basis.

That's helpful. Thank you, gentlemen.

Tal Liani, Bank of America Merrill Lynch.

Yes, hi. This is Eric Ghernati for Tal. Jim, just at the analyst meeting you talked about a long-term target model of 10%, 12% operating margin. You know, you are right now at 3%, depending on the forecast, you could be looking at -- you are most likely going to be looking at negative operating margins starting Q1. But your forecast then implied like triangulation around the 8% to 10% for 2012. Can you just give us an update on how we should take about operating margins for 2012? Thanks.

Sure. Well, the first thing I would say is -- you could certainly get to a negative operating margin in Q1, but we don't actually expect that. That is the first point I would make. But as far as the 10% to 12%, we still see a path to that. We did not give a timeline. We said it was likely not going to be in 2012, and hopefully over time we will be able to give you a little more color on that but at this point in time, I would just reiterate what we said before. We think we can get to 10% to 12%; it is not going to be and 2012.

As far as the full year, we are not in a position to give guidance as far as our operating margin for 2012. We do believe that we are going to see growth in the top line, and as far as overall OpEx, our design point for the business, although this is not guidance in any way, shape or form -- our design point is sort of to hold our OpEx relatively flat in dollar terms to that which we did in 2011.

Now, there will be some quarterly movements up and down as the spend in R&D in particular adjusts to meet to customer demands but overall, we will be better in our operating margin for the full year than we were in 2011 and we will be profitable for the full year, we believe.

Thanks for that. If I could squeeze in one more for Gary. Gary talked about how your value add proposition with the large carriers is improving. Are you worried at all that some of your competition right now that there is a lot of concerns around their profitability and their future that they could get even more aggressive on pricing and that could lead to an even more aggressive pricing environment for you with the customers especially as some of those are expected to come after the 100 gigabits market (inaudible) here in North America? Thank you.

Eric, that's a good question. I think what we are seeing is certainly from some of the legacy generalists. You know, but that sort of environment has been around for a while. It is challenging from a pricing point of view, but it has been for a long time. Don't see any particular change to that.

You know, I think because we are a much more of a focused specialist player and I think because of our leadership on the technology space and the solutions we are able to bring to market I think we're very confident that we've got a very robust value proposition that is very valued by these key customers. And I think if you look at the roadmap of evolution for us over the next 12 months as well, I think we are going to continue to evolve our technology lead and leverage off our relationships during 2012.

So I would describe it tough environment but it has been for a while and I think we are very focused on the value propositions and the relationships that we have with the major carriers.

Blair King, Avondale Partners.

Thanks for taking the question. Just on the Thai flooding, if you could just characterize what your sense is regarding sort of the current vendor relationships that you have relative to meeting market demand. And, Jim, I know you mentioned maybe $10 million could be impacted. And so it there is any color you could put around that $10 million being reflected in your guidance and also to the extent that you've started to qualify any alternative vendors with the assumption that perhaps maybe some of your current vendors may not be able to meet demand. If you could help us just understand what the thought process around all of that is, that would be really helpful.

Hey, thanks, Blair. We will try to help you there. Generally speaking, the Thailand flooding was -- had some meaningful impact on the supply chain worldwide for sure. We had done some planning prior to that flooding in sort of an enterprise risk management sense and we had built up some spare inventory, and that is helping us this quarter. But as we saw the extent of the flooding and the effect on suppliers, we undertook a whole range of activities, including working through and making sure that we had as much of excess inventory to bridge the gap until the suppliers get back online including qualifying secondary sources, including going to other plants on the part of some of those suppliers.

So we have undertaken a wide range of activity. Our supply-chain people have worked very hard and I think have done a very good job in mitigating what originally looked to be -- it could have been a meaningful number for us and now we have got it down to less than $10 million.

Now, I think it is possible it could be significantly less than $10 million. We did in terms of our guidance try to take into account that there could be an effect on Q1.

Okay. Just one last follow-up. To the extent that you do qualify new suppliers, does that fuel another round of qualification by any customers and potentially lead to delays in revenue recognition?

I don't believe so, Blair. No. I think if you go back to the basic point that the supply chain was disrupted and we are working hard to get all of that material back into line in terms of getting to revenue, it is not so much that the customers will have to go through a bunch of customer qualification, it is just having the material ready on time to deliver to them.

Thanks, Blair. Next question.

Simon Leopold, Morgan Keegan.

Great. Thank you very much. Was hoping we could drill down a little bit about trends in the optical switching marketplace. And I am trying to think about how to model that over multiple quarters.

So what I am looking for from you is, one, if we could get some insight of mix between the CoreDirector and the 5400? And two, if we could get an understanding of what is the number of CoreDirectors you have sold over time with sort of the idea of wondering how many we could replace?

And the last part of this is, do you envision maybe an inflection point of customers upgrading CoreDirectors to swap in 5400s in that maybe there is some step function either later this year or next year? Thank you.

Simon, why don't I have a run of that. I think first of all, we upgraded a lot of the capabilities on CoreDirector to support OTN and very high density capacity both to be able to evolve the current CoreDirector base up to scale into OTN and greater speeds but also to support the larger 5400 family as well. So we have got -- it is really a complete family. It is completely integrated. It is completely backward-compatible from a software point of view. So we really do view it -- CoreDirector is a sort of homogenous family of platforms. So we don't really discern between the two.

But having said that, I will give you some sort of factoids around the 5400 platform specifically. You know, we recognize the most 5430 revenue in the quarter. It was up significantly from the previous quarter. We achieved six new customers for 5400 in the quarter. We now have 15 total customers.

And I think an interesting point, which talks to one of your lines of questioning there is, half our customers are outside the US, further 5400, and half in fact are not existing CoreDirector customers.

So I think this hypothesis which is proving out that the OTN market that the 5400 addresses is a much broader market than just the -- in principal sort of TDM switching that CoreDirector initially served. So, we do think this is evolving into a larger market than the existing CoreDirector, and as we'd thought.

And do you know how many CoreDirectors you have sold over the past 10 years or so?

Gosh. Yes, I don't know as I have got that number to hand, Simon, but the CoreDirector customer list now is -- in the mid-double digits. And we are seeing with 5400, when we look across our base of prospects as well as our base of current customers, a number that is pretty similar to that. So I think we are seeing -- while it is still early days for 5400 series, we are seeing that beginning to ramp in the business.

Great, and then just the last part of the question was do you envision any kind of inflection point in sales or more steady growth?

I would say it is more steady back to Gary's original point around the two interoperating the network and I would remind you that particularly for customers who are current CoreDirector customers, we are still selling new CoreDirectors.

Yes, we are seeing expansion within the existing CoreDirector base as well. Some of that, Simon, is just additional capacity but some of it is the additional features that we put on CoreDirector and continue to develop the software architecture as well.

Thank you very much.

Kevin Dennean, Citi.

Great. Thanks very much and thanks for taking my question. Clarification and then a question please. On the clarification, just want to make sure your guidance -- does that include or contemplate a potential $10 million impact from Thai flooding? Or is there -- is that potential $10 million an additional factor to think about with the first quarter?

Kevin, we have attempted to incorporate the effect of Thailand into our guidance.

Great.

I don't want anybody to get fixed on the $10 million number. What we are trying to do is quantify it in a way that says it is not going to be a huge effect on us. And as I said, it could be a significantly less than $10 million. So I wouldn't get too fixed on the $10 million, but yes, we tried to incorporate that into our guidance.

Okay, great. Thank you for the clarification, Jim. And then for Gary or I think Tom Mock is there, can you talk about your share gains? Can you give us a little bit more color? Obviously it seems like you are growing internationally, but can you talk along the lines of maybe where are these share gains are coming? Are they primarily long-haul, are they in the metro space?

And maybe if you can talk about who you think you are gaining share from now and going forward? Is it your major competitors in Huawei and Alcatel Lucent or is it more coming from gaining shares versus niche players who might not have the same coherent capabilities that you might -- that you do?

Yes, I tell you, it's a bit of both and you actually nail the two drivers here. I think we are taking share from niche players who don't have coherence and we are also gaining share from existing players who do But where our performance is superior to theirs.

In terms of kind of what we think we have done in market share, we were globally number three last we talked. We are globally number two now. We think we are growing a bit faster than the market as we speak and as a result of that. We think we have picked up a bit of share over the last couple of quarters.

It is difficult to quantify -- I wouldn't necessarily use a quarterly number to draw an annual conclusion but I do think that we have seen ourselves grow -- the markets probably growing at about 8% or so. We have seen ourselves grow at around 10%. That gives you some idea of the level of sheer cap that we are undertaking.

So, Kevin, the only thing I would there is I think overall if you look at the spaces we play it in, I think -- and I look back at 2011, I think the players that we have taken significant share from is really the sort of legacy generalists who haven't got the focus into this kind of space I think as just a general comment.

Great. Thank you very much.

Nikos Theodosopoulos, UBS.

Yes, thank you. I wanted to ask about operating expenses. Maybe if you could elaborate a little bit on this quarter. You mentioned that the slight higher expense versus guidance was due to commission rates on bookings. I just want to understand how that's factored in versus commission rates on sales?

But then more importantly as I look out to next year, I just want to clarify something. I think, Jim, you said earlier you are hoping to keep overall OpEx for the year about flat. And for the first quarter, the guidance is in the low 180s. So if I just take the 2011 OpEx number and divide by four, I get about $181 million. So should I read into that that as sales grows throughout the year, the plan is to keep the OpEx flat? And can that be achieved as you pursue these new initiatives in selling to enterprise and cloud providers, etc.? Thank you.

Nikos, that might have been more than one question, by the way.

It was one topic.

All right. First of all, essentially all of our commissions are paid on bookings. There is some small piece of commissions which are driven by a couple of other things at least in 2011, I should say. But -- so the commission number is purely driven by the very, very strong orders that we had in Q4, and that is essentially all of the difference from what we expected. And as we said before, it is good news to get big orders, and so [overriding] OpEx because our commission dollars are higher is to me a good news story.

With respect to moving into 2012, I just went to be clear, as I said that we are not at this point giving guidance with respect to OpEx by quarter for 2012. We do see that there is going to be some quarterly movements up and down in terms of our OpEx particularly with respect to R&D because we have to meet certain roadmap requirements with respect to customers. We also from time to time will see movement in the commission's line as our orders move around.

But generally speaking, the message that I am trying to convey is that we do believe that we can hold OpEx relatively flat as we move through 2012 with some quarterly movements, which means that we will have as much operating leverage as our topline growth can generate.

The other thing that I would add to that from a go to market perspective, Nikos, is just the increased use of things like partnerships as well which we worked hard on in 2011 and you will see that -- the evolution of those relationships we talked about more in 2012 as well. So when we talk about operating leverage, it is also in terms of a more efficient go-to-market model as much as it is the other items we have talked about on business process, reengineering and supply chain as well. So it is both.

Got it. Thank you.

Jeff Kvaal, Barclays Capital

Yes, gentlemen. Thanks very much. I was wondering if we could spend a little bit of time delving into the orders and the backlog. Are you able to give us any color on whether -- which particular areas are stronger and that might be either by product or by region, what have you? Thanks.

Without getting into it into detail, Jeff, I would say overall, we are seeing strength across the portfolio. Clearly it is reflected in sort of the revenue growth into the Transport and Switching this quarter. But we're also -- we had a decent quarter from a Carrier Ethernet point of view as well and I think that will be up a little bit in QA1 as well.

In terms of -- so in products, I would say sort of across the board and increasingly as we get more and more convergence across the portfolio, it is tough to sort of split all of that out. But I would say good growth in both infrastructure builds and on the enterprise side of the access metro piece.

From a geography point of view, continue to see sort of sluggishness out of Europe but it's not been too bad. It certainly hasn't -- we haven't seen any material change in it over the last couple of quarters but I think it continues to be obvious caution particularly in Continental Europe particularly.

North America has been reasonable. Latin America and the countries that we are focused on in Asia, places like India, Japan, etc., have been pretty solid for us. So overall, we haven't seen any appreciable change in geographic market characteristics.

Okay, thank you. And then could I clarify, Tom, your comment about 8% and 10% revenue growth? Was that a forward-looking or backward-looking -- market and Ciena growth -- is that a forward or a backward?

That was backward looking, Jeff. That was over the last year.

Thanks, Tom.

Brian Modoff, Deutsche Bank.

Hi, a couple of questions. First in your comments around coherent technology, as you win against competitors, some of which also possess coherent technology, what are -- are there certain technological reasons for that? If so, can you describe?

And then when you talk about not achieving the 10% to 12% target for this year, what is it going to take for you to achieve that target? Thanks.

I will take the coherent one, Brian. The thing I would say that probably gives us the greatest advantage today on the coherent side is our ability to go to longer distances and the reason that is important is because if I can go longer distances than my competitors between re-generators, then they buy fewer devices and ultimately the cost of building the network goes down.

Adding the generators is one of the most costly things you can do from both a capital equipment standpoint and also from an OpEx standpoint. So I would say that's probably the biggest issue.

Another one I think that contributes, though, is the ability to have a broad range of solutions that can cover a broad range of distances as well as a broad range of applications and the ability then to take that and integrate it with some of our switching solutions. I think in many cases, the ability now that we have got to have OTN Switching and our Transport as well as in our Switching portfolio and being able to integrate that together with common management has given us a more rich solution than some of our competitors.

And then the question on margins?

Yes, on the question on the operating margin, Brian, we believe that there is a lot of operating leverage in this Company. We are certainly going to have to look at our OpEx every year and modify it according to the needs of the business. But as we have said many times, we don't believe that we have to increase our OpEx at a rate that anywhere near approaches the rate of growth we expect in our sales line. So the number one thing we need to do is to grow our topline. And if we grow our topline, we are going to start moving through that 10% to 12% and the rate of movement toward it will be driven by how fast we grow.

Now, the other thing is that we still would like to get to a sort of a mid-40s gross margin and to do that, that is going to be driven by mix which means higher switching and higher CESD. We do think that's going to happen over time as well.

Jeremy David, Morgan Stanley.

Hi, good morning. It's Jeremy David on behalf of Ehud Gelblum. I wanted to see if I could get a little bit more color on the products -- on the product mix in Transport, all that mix change from Q4 to Q3 -- from Q3 to Q4 and how you see that changing into Q1?

I wouldn't say that we see a big change in mix, Jeremy. As we have observed in the past, on the Transport side, we do more business in the long haul than the metro, but we still do a significant bid in the metro and we do most of our businesses, as we have noted in the past, with service providers although we do have some optical transport gear going into private optical networks today.

But in terms of mix relative to products, we are not seeing a big change. We talked last quarter in terms of the mix of line rate that we were approaching half of our revenues coming from 40G and 100G and we are still in a position today. The 40G and 100G percentage is up a little bit in the quarter but that is going to vary around quarter-to-quarter as we move ahead.

And I think -- and that is just reflective of the broader trend in the industry now that, particularly for long haul backbone applications, the trend is clearly toward 40G and 100G. 10G will be around for a bit because there is still a good bit of 10G in metro but I wouldn't expect any -- we haven't seen any big changes in this quarter although 40G and 100G continues to increase at a steady pace. But I don't expect that particular dynamic to change as we look forward either.

Okay so just to clarify, you said 40G/100G was up in the quarter, so should I understand that the 6500 was up quarter over quarter and in terms of the mix as well?

I think that would be a fair conclusion, yes.

All right, thank you.

Nathan Johnsen, Pacific Crest Securities.

Thanks. I was wondering if you guys could dig a little bit deeper into the puts and takes going into CESD right now? It seemed a little bit weaker in the quarter but you guys are clearly expecting some growth next quarter. I was wondering if you guys are expecting CESD to rebound faster than overall business or kind of trend study with overall growth next year?

And then just whether that is being driven by still primarily by backhaul or if you are starting to see a more significant driver from actual enterprise usages? Thanks.

Yes, thank you, Nathan. Yes, if I look at these sort of trending for CESD, it didn't -- it was down in the quarter. Overall for the second half of 2011, was up over the first half but I still think we are seeing kind of lumpy deployment schedules and largely still anchored within the wireless backhaul kind of rollout which tends to be lumpy.

I think we have now got about 150 customers so we are broadening out the customer base significantly and I think we had six new customers in Q4 as well for that, some of which we announced, AAPT and Fibertech. So I think that shift is beginning around the Ethernet business services and I think the more we get into that, I think that will give us a little bit more predictable revenues, revenues going forward.

So I would expect overall good revenue growth year on year for CESD. But it really needs for this -- the carrier -- the Ethernet business services to really start kicking in on top of the wireless backhaul.

Thank you.

Rod Hall, JPMorgan.

Yes, thanks for taking my question. Just a couple -- I guess one clarification, one question. The clarification, Jim, is on the OpEx, going back to that. If you could talk a little bit about just so we can track this, what percent of it is variable and what percentage is fixed just so we can have some idea what the gearing ought to look like over time?

And then I wonder if you could talk a little bit about how you guys see pricing dynamics for coherent in 2012? We have got some PIK base solutions coming that promise to offer lower prices or lower cost anyway and I just wonder how you see that pricing developing through the year? Thanks.

Yes, Rod, I will talk to the OpEx. It sort of depends on how you define fixed versus variable but essentially all of our OpEx really is people and people-related costs other than some amount of cost in R&D related to prototypes and third-party services and that sort of thing. It is essentially all variable. So we can make choices as we need to make up or down.

With respect to going forward, the R&D line really is driven by the demands that we see coming from roadmap requirements and what we need to do in the marketplace. And at any point in time, as I said, quarter-to-quarter, there could be movements up and down depending upon activity in a particular account with respect to prototypes or certain features that our customer wants.

On the sales and marketing line, the one thing that I have said in the past is that as you grow your topline you will -- we believe, that we will have to add sales expense because you have to increase coverage globally to grow your topline. We think that on the G&A line, that is going to be mainly driven by transaction volume and as we get more efficient and improve our processes, we can probably constrain that growth as well.

So just to clarify, what I have said without again giving guidance for this year is that overall for the year, our planning point is that OpEx for 2012 will be essentially flat to 2011.

Okay, and Jim, can you -- just on that sales and marketing point, can you say anything about how many sales and marketing people you've got or how many headcounts you've got in that category and what you intend to do with that number over time? I guess it is growing but by how much? Are we talking 5% or 10% headcount growth there? Are we talking more?

It is really hard to answer that question, Rod. I would say that we have 400 or so around the world today, plus or minus in the field, and that doesn't include some people back in home offices, but that is what we have today and we will grow it as we need to increase coverage.

Okay, and then on coherent pricing?

Yes, you know, clearly as we have talked before, we do expect prices to decline as more people enter the market. That has been the history of the Transport business over all. But I would say as we have talked about on prior calls as well, we have got aggressive programs in place for cost reduction. We are currently on our second generation and getting ready to move into our third generation of coherent product and we think that it's going to allow us to remain competitive regardless of the -- either based or other coherent solutions that are coming to market.

We have also paid particular attention to what we can do in the metro area to be competitive -- to be price competitive in that space as well.

And the last point I would make on that is I think it is worthy of noting that a lot of the solutions that we are seeing go to market today that are being successful going to market today are those that do a good job of integrating Transport and Switching. As most of our customers are not just looking to increase bandwidth, they are also looking to be able to better manage it and to the extent that you can effectively combine those two technologies and manage them in a combined way, that gives you basically more value that you can sell.

Would you expect pricing pressure to accelerate this year though as some of this new technology hits? Or what are you -- what do you expect the trajectory to look like this year relative to the last year or two?

I don't see it being a lot different than it has been. It has been a tough market for a long time and it's going to continue to be a tough market.

Yes, okay. Okay. Jim, could you clarify the tax point you made too? You said that mostly international sourced. Should we just be assuming about the same tax rate then going forward?

Roughly, yes. Well, tax rate can be difficult. I think the amount of taxes is roughly the same. It has been a couple million dollars a quarter and that is what we expect it will be roughly.

Okay. Great. thanks, guys.

Cobb Sadler, Catamount Advisors.

Thanks for taking the question and congrats on the first good [operating] quarter we've seen in a while. The growth for 2012 -- I realize you don't want to give specific guidance, but historically the -- well, the industry firms -- research firms have talked about kind of high single digits and historically you said you'd been able to grow faster than that and given that you are taking market share now, was just wanting to make sure that is still the case and see what you had to say about it.

Yes, I think the general sort of view around the industry analysts is sort of mid to high single digits and we think that's probably a reasonable view of it. And I think given our position in the marketplace and our momentum and what we are rolling out during 2012, I would be very disappointed if we didn't outpace the market in terms of taking even more share.

I'll go back to one other question that was asked, though, about pricing pressure. People should understand and realize that we are not sitting still with respect to our technology development. We have been the leader in 40G and 100G coherent now for a couple of years. We intend to continue that lead. We are investing to continue that lead. We are investing in cost reduction. So there will always be cost competition or price competition in this business.

But if we can be smart about what we are doing, I think we are going to be fine with respect to margin.

Okay, and then switching to CESD a little bit of a down tick. And you guys have talked about the AT&T business service Ethernet services application that you have been approved at. When will that start impacting CESD? Should we expect it to grow in 2012?

I would -- we are starting to see some of those revenues come through. They are fairly small right now, Cobb, but I would expect them to certainly grow more materially in 2012. And we have had a couple of Tier 1 wins in that space. We are seeing a little bit of revenue from -- and we have announced Comcast and AAPT, etc., but there are a couple of others that we have not announced as well and I would expect the momentum there to start to build during 2012 as well.

Great. Thanks very much.

Todd Koffman, Raymond James.

Thank you very much. I wanted to ask again this issue about where the margin leverage of the business is? You talked about having a large variable sort of people cost and the need to add salespeople, the higher commissions on the bookings. And I am sort of scratching my head as to so where is the real margin leverage that you can capture going forward? Thank you.

So let me have it go at that, Todd. I think if you take the go-to-market piece, we have established a very solid go-to-market operation globally. We can do more with the same -- let me keep it real simple. We can do more revenues with the same cost base that we have with the salesforce currently. And in addition to that, we are looking at evolving some of the partnerships that we have developed over the last 18 months or so. From a go-to-market, we will start to receive some of the benefits for that.

So that's operating leverage at the front end of the business. As Jim said, we may add a little bit here and there in terms of the salesforce for coverage but frankly, we think we've got a good infrastructure in place there that can actually do more so very simply, we've got leverage there.

And then at the operating level, there are three or four different levers there that we are now pulling on as we have got through the integration phase. We are now focused on these. They are cost reductions on the platform, they are rationalization and reengineering of the supply chain. In addition to the business process reengineering that Jim talked about, i.e., more efficiencies, being able to do more with the same amount or less.

So you combine all of those things and that is how we look at this sort of next phase of evolution of the business has been one of optimizing on the foundation that we have built.

So that is why -- and you're beginning to see in the business. You know, last couple of quarters we have got to as adjusted operating profit. We have started to generate cash, so you're beginning to see the levers that we are pulling in terms of that showing up into the numbers. And I think that is what we are talking about when we talk this longer-term operating goals for 10% to 12%.

And I might've confused people. Let me try one more time because I think the confusion might be around timing here. The first point is we believe, strongly believe, that there is a lot of operating leverage in this business. As evidenced by the second point, which is again not giving guidance, we believe that we can hold our OpEx relatively flat this year as compared to last year and on top line will grow. So that in and of itself by definition is operating leverage.

In response to the question about when do we get to 10% to 12%, I was making comments about where OpEx might move in future years, and we can certainly not commit to holding OpEx flat in dollar terms forever. That is not the case. We will have to increase OpEx over time.

But we think that there is a lot of operating leverage here and the number one thing that we have to do to increase our operating margin is grow our top line. We will also get margin improvement as we get a better mix, but the number one thing is to grow our top line which we think we will do.

Thank you very much. Good luck.

Thanks, Todd.

Subu Subrahmanyan, Sanders Morris.

Thank you. I had two questions on Transport. First, given the slight sequential downtick at the midpoint of your guidance range and expectation that CESD and Optical Switching grow, would you expect Transport to be down a little bit in first quarter?

And then on the gross margin side, your product gross margins declined only slightly despite a significant shift -- mix shift toward Transport. And I am wondering if there was a mix within Transport line cards or just a cost improvement that allowed that?

Let me take the last question first. I think there is -- as we say, a mix within the mix, the mix in Transport was a little bit better in Q4. So you had a little bit better margins as you -- essentially to simplify more cards than chassis because we've had a number of wins that we are now beginning to populate with chassis. That can change quarter-to-quarter, but that is following a trajectory that we'd kind of expected.

Depending on the overall product mix, the Transport, depending on where we finish overall might be slightly down in Q1 but again I think that is just the lumpy nature of sort of some of these larger deployments and more talk into the earlier point of seasonality than anything else and the particular projects that you are working on. We would expect Transport to grow during 2012 as we would expect Switching and CESD as well.

Yes, one of the things I would add to Gary's comments on the Transport side is we added over 10 new customers on 42 coherent in the quarter, and four on 100G. So we still see that business continuing to grow.

Understood. And when you combine the Switching capability into Transport, is that first of all, Switching ordered separately still as a separate bucket or do you see more and more of the deployments where Optical Switching is combined into a Transport platform rather than as a stand-alone (inaudible) product?

That's a very good question. We are actually seeing more and more opportunities for convergence which plays to our value proposition. When you think about it, we've got leadership -- global leadership in coherent. We are going to be bringing out our third-generation of that this year and on optical switching and control plane integration, we pioneered all of that as well, so we are clearly the market leader and then as the two together, that really puts us in a very strong position. We are seeing more and more of that and I think we are putting switching capabilities onto the 6500. We are putting transport capabilities onto the 5400 and packet capabilities.

So I think this issue of which bucket we include them all in is going to get a challenging one as we go forward.

The buckets that we are currently using really are based on an historical perspective and I think going forward, convergence is really beginning to happen in the marketplace and we need to think through carefully how we get people insight into our business but really reflect what is going on in the customer solutions.

Thanks, Subu. That's going to be our last question for today. We appreciate everybody taking the time to speak with us. Don't forget to join us next Thursday at 12.30 p.m. Eastern for OTN discussion. Enjoy the day. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.