Ciena Corp (CIEN) 2012 Q3 法說會逐字稿

Good day, everyone, and welcome to the Ciena Corporation fiscal third-quarter 2012 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, Mr. Gregg Lampf. Mr. Lampf, please go ahead.

Thank you, Ally. Good morning and welcome to Ciena's third quarter 2012 review. With me today is Gary Smith, CEO and President; Jim Moylan, CFO; and Tom Mock, Senior Vice President Corporate Communications. This morning's press release is available on National Business Wire and Ciena.com.

In our prepared remarks Gary will discuss management's view on the quarter and Jim will offer some color on our Q3 results and provide guidance for Q4. We will then open the call to questions from sell side analysts taking one question per person with follow-ups as time allows.

Before turning the call over to Gary I'll 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-Q is required to be filed with the SEC by September 6 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. This call is being recorded and will be available for replay in the Investor section of our website. Gary?

Thanks, Gregg, and good morning, everyone. This morning we announced solid third-quarter results that were in line with expectations. With revenue of $474 million and positive operating margin, we continue to generate cash from operations and achieved positive free cash flow.

We believe that our performance in Q3 represents good progress executing against our strategy and our long-term goals for gaining operating leverage, especially in a challenging economic environment. There are a number areas where we believe we are executing particularly well.

Firstly, we continue to drive packet optical convergence across the entire portfolio by uniting platforms by control plane and by sharing more software centric functionality across those platforms.

Secondly, we are beginning to deploy some of our recent design wins while also winning new business. Both of these will help drive future growth.

And thirdly, we are driving balanced investment in our industry leading portfolio and market strategies while also managing expenses carefully.

Our execution in each of these areas helped us make important strides across all parts of our business in the third quarter. We are expanding our presence in the important packet optical metro market, as evidenced by a major Tier 1 win in North America this quarter for the 6500 platform.

We also shipped 100 gig to two new global Tier 1's which, when combined with other new deployments in the quarter, expands the total number of customers using our WaveLogic technology to over 120.

In switching, although we are still in the early stages of the 5400 product lifecycle, we are seeing broader and faster market adoption from the 5400 than we saw for CoreDirector. We are now beginning deployments of the top three major North American carriers and we are seeing a robust global pipeline for 5400 opportunities including several large international networks.

And in our Carrier-Ethernet Solutions portfolio, Heavy Reading again named us as the North American market leader for the first half of 2012. We have completely refreshed the portfolio and now we are focused on expanding Carrier-Ethernet beyond access and into aggregation as well as integrating our packet capabilities across the rest of the portfolio.

I'm also pleased with the market response to our OPn architecture launch. As many of you may recall from Analyst Day, OPn is both a Network Vision and a deliverable architecture that we are using to guide our product development and our overall market approach.

It combines multiple facets of optical and packet networking with software and open interfaces. And these are areas where Ciena offers industry-leading expertise to help our customers simplify and dramatically shift the cost curve of performance on demand networking.

Broadly OPn aims to do three things -- first, use intelligence to create economical exponential scale; secondly, to apply advance control plane software to make the network as a whole programmable, not just individual ports or systems; and then use network level applications to direct the behavior of that programmable network as a single platform infrastructure while using open interfaces to orchestrate network resources alongside those of computing and storage in a virtualized environment.

It's a very powerful concept that not only creates value obviously for our customers but also for Ciena by enabling more strategic customer relationships, broadening our market opportunity and delivering the alternative to expensive router everywhere networking.

The convergence of the portfolio over the last several years has built a solid foundation for making this architecture a reality for our customers. In fact, we are already beginning to see customers worldwide adopt elements of the open architecture.

Now I'd like to take a couple of moments to discuss the operating environment and the tone of the global economy has clearly grown increasingly more cautious over the past couple of months. Europe continues to be the weakest market and in fact it deteriorated somewhat in this period.

North America, where we have a very strong market position, has largely held steady, but customers are exercising a little more caution here as well. In an increasingly difficult macro environment it has taken longer than expected to operationalize some of our major design wins in North America and internationally.

I would say that despite these headwinds next-generation architectural decisions are being made and we are winning certainly more than we are losing and customers are beginning their rollouts, though not as quickly as we would have anticipated.

All that said Ciena has been experiencing significant market momentum as a result of our highly differentiated approach. While we don't expect the economy to improve dramatically in the near future, our view of our long-term opportunity is absolutely unchanged and we continue to believe that we are incredibly well-positioned to continue to grow faster than the market.

We are winning strategic projects and we believe that as these projects transition from the initial installation stages to volume deployment our overall operating performance will continue to improve. And all along we will stay sharply focused on our execution and we'll continue to manage the things in our control.

Now I would like to hand it over to Jim to provide more detail around Q3 financials as well as guidance for Q4.

Thanks, Gary; good morning, everyone. I'll take a few minutes to provide some 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.

With an adjusted operating margin of 2.5% on revenue of $474 million our Q3 performance was solid in a difficult environment. Just a note, our results of operations for Q3 were positively impacted by an out of period adjustment that increased revenue by approximately $4.5 million.

For the second quarter in a row we generated cash from operations. We also achieved positive free cash flow in the quarter. As you know, we have been growing and diversifying our business and in the third quarter we had no 10% customers. While we still expect to have 10% customers in future quarters, we believe that achieving our revenue target in Q3 without a 10% customer reflects the increasing balance in the business.

Orders were up year over year; they were about the same as revenue in a quarter that is traditionally weaker for us when it comes to orders. Gross margin came in at 39.6%, roughly as expected. As mentioned previously, we have multiple large new builds currently underway which is affecting gross margin in a couple of ways.

First, lower margin in services as a result of having delivered more deployment services in support of these bills. And in addition to the costs associated with the product transition we have had very high start-up costs in some of our new switching projects causing greater fluctuation than normal in our switching margin. This is in addition to lower margin common equipment being installed as is typical in the early phases of deployment.

We expect gross margin on switching and services to improve and continue to be strong contributors to overall gross margin in the future. We believe gross margin will improve over time for all of the reasons we have discussed before, things like -- transitioning design wins from installation to volume deployment; continuing our supply chain optimization and working aggressively on design cost reductions; achieving a greater mix of software intensive solutions; and moving out of the costly early stages of new product introduction cycles.

OpEx came in lower than expected at $176 million. Through ongoing operating efficiencies we are continuing to strengthen the balance sheet. Our cash position was up by $31 million to $667 million at the end of the third quarter. Also, as we disclosed through an 8-K, we recently secured an asset backed loan which we intend to use to more efficiently collateralize performance bonds and similar obligations required by some customers in certain markets.

I will now turn to guidance for the fiscal fourth quarter of 2012. Absent any significant changes in exchange rates our guidance is as follows. We expect revenue to be in the range of $455 million to $480 million. We expected gross margin to be approximately 40%. We expect Q4's adjusted OpEx to be in the low $180 million's.

OpEx has been coming in lower than expected through the first three quarters of this year. However, we don't expect that trend to continue into Q4.

Finally, here are some metrics for those looking to model earnings per share. With regard to other income expense net in the fourth quarter we project an expense of approximately $9.7 million relating to the interest on our notes. We expect our tax obligation for Q4 will continue to be related solely to foreign taxes.

As for share count, we estimate Q4's basic share count at approximately 100 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, we will be taking one question per sell side analyst with follow-ups as time allows. Operator, we will now open up the line for questions.

(Operator Instructions). Mark Sue, RBC Capital Markets.

The CapEx linearity should work towards your favor, yet you are still cutting the outlook for the back half and for your near-term. Can you provide some thoughts on maybe month-to-month order trends and maybe indications as we move to the back half on carrier CapEx and perhaps their inclination to spend? And also, if we can quantify the impact of the macro and the slower rollout of design wins, is there a way we can frame that in terms of what amount we should move from October to potentially into the January quarter?

Here is what I would say about the CapEx. Generally speaking the -- none of the large operators in the US are backing away from their plans to update their networks and they -- overall their spending has been -- is expected to be pretty good. But based on internal decisions that they make and where they are allocating their capital expenditure, there is no question that their allocation decisions inside their overall CapEx envelope can affect our results.

When we look at our expectations for Q4 today against where they were earlier in the year, there is no question that Europe is a fair amount weaker than we expected it to be. As we move into next year it is hard to say what is going to happen. I think we are well positioned depending up on the CapEx amounts that the operators choose to spend. But the macroeconomic environment is going to inform their decisions.

Mark, let me come at it from the aspect of the overall order piece we have used. I think there are sort of two dynamics that we are -- that are weighing on the business. One is the overall macro environment I mean obviously most obviously manifested as Europe. The issue around Q3 particularly is it's a big vacation time as well, so how much of that is vacation, et cetera. It is typically a weaker quarter for us.

But our borders more actually reasonable in the quarter. We achieved about a 1 to 1 to revenue order intake. North America, whilst I am sure is showing some impact from the overall macro, it is sort of difficult to really pick out and discern any tangible things you can point to there. The other thing that is weighing on us is some of the operationalization of the many wins that we've had are clearly taking longer.

I actually don't think that is terribly much to do with the macro in -- they're going as quickly as they can, they're big strategic moves, they are fundamentally a changing infrastructure for many of these major carriers and I think it is just taking longer in terms of the back office and all the rest of it to get in place.

I would say encouragingly I think we are through the majority of that and some of the large ones and we're actually beginning to see some deployments won't materially impact Q4, but I think it is encouraging that we are actually starting to get some of that stuff out there. And order flows for Q4 are forecast to be pretty reasonable and we are off to a pretty good start even in August.

Gary, with that being said, would the order trends and the design wins all add to your comfort that backlog is actually continuing to grow on a quarter to quarter basis since your record backlog back in October?

I would think that we would leave the quarter with a higher backlog than we went in, yes.

Thank you, Mark.

Kent Schofield, Goldman Sachs.

If you look at the last two quarters of software and services revenues, they very nicely beat the $80 million to $90 million range of the seven quarters before that. Could you talk a little bit about the strength there and if this is sort of a new run rate base or if there has been anything going on the last couple of quarters that we should think of as more temporary?

Yes, Kent, I think certainly the increase in the services piece talks to the overall picture around increased initial deployments and typically the margin on that is lower. You can also look to the lower margin that has come out of that segment as well. And I think as we get through that I think we should see margin improvement as we get into 2013. But I also think we are seeing growth in some of the software aspects of that as well. So I think that is sustainable as we get through 2013.

Yes, we do expect to grow our services business. As in everything in our business, there are large project spends that can cause quarter to quarter movements to vary slightly. But we are making a concerted effort in several areas of our software and services business. And, yes, I do think that this level that we see now, generally speaking, we are going to grow from here.

Thank you.

Tal Liani, Bank of America-Merrill Lynch.

On one hand you started the call with a very positive overview of the wins in the environment. And on the other hand your guidance for next quarter calls for a sequential decline. And I think, Gary, you just related to it in your reply.

The issue is that this has been the case for the past few quarters; this is not just a hiccup in the fourth quarter. We are in a kind of wait mode for many quarters. And the question is as time progresses and the contracts are not being deployed or the projects are not being deployed, what happens to pricing? What happens to the competitive landscape? Does it give time for the competitors to catch up, et cetera? Thank you.

I think that is a very good question. I would say that these design wins -- part of the reason it's taken us longer to get to operationalize these is there is a lot of intimacy and a lot of things required in terms of the back office, et cetera, to operationalize these. So they are very big commitments on behalf of our customers and for us to get those operationalizing.

That also in many ways creates a barrier to entry and also these are beginning to be rolled out now. We are starting deployments in switching at all of the major carriers in North America for example.

The second thing I would say is from an operating pricing margin point of view we are not standing still either. We are continuing to develop our portfolio aggressively in a lot of those things that are also coming to market. There are actually things like cost reductions, et cetera, and we are improving our operating performance.

So I think the pieces, whilst taking longer to come together, I think we are showing progress. Not as much as we clearly would have envisioned, but I think against a backdrop of macro uncertainty I think we are continuing to take market share. We are continuing to win. Our revenues last quarter were up 9% year on year. So I think overall the competitive environment is one that we continue to do well in.

While we can't be dismissive of your question, one thing I would say is that many decisions have already been taken here around the world. And so, that gives us some measure of protection against the concern that you have.

What happens to the scope of the projects over time? Do you think that because of the environment the scope is getting narrower or smaller? Or is the plan now similar to the plan that you expected to have a year ago, let's say?

I think if you look at -- just thinking about most of the deployments, I think it is similar to the scope that we saw before. I don't think any major changes to that.

Thanks, Tal.

Kevin Dennean, Citi.

Just wanted to dive into the optical switch opportunity for a minute and first a quick housekeeping question. Gary, can you give us a customer count on the 5400 series?

On the 5400 in total, I think it's about 19 or 20 approximately.

Okay, so I think that is relatively unchanged quarter to quarter?

Yes, I believe so. I think we took some revenues from new customers, but I don't think we actually took new orders from any customers. I think I am right in saying that, even though the pipeline increased.

Now for the question. You mentioned that you will be rolling out the 5400 with US carriers. Can you help us understand the size of the opportunity that we are talking about here on an annual basis? And what sort of revenue trajectory we should be thinking about for optical switching going forward?

Kevin, this is Tom. We've typically talked about the optical switching opportunity as being larger than CoreDirector because it covers a wider range of opportunities and we've talked about it as being kind of a high hundreds of millions to a $1 billion market today and moving to a $1.5 billion to $2 billion market as some of the OTN features allow us to capture greater -- wider range of applications between now and 2015.

So we see the trajectory of that as being positive. We also see most of our Tier 1 and Tier 2 customers being pretty bullish on their adoption of OTN as a technology.

So in terms of trajectory, I mean should we think about it being kind of flattish for a quarter or two because of macro headwinds and the difficulty and operationalizing these new deployments and then some sort of a step function increase? Or is it more of a kind of slow and steady gradual decrease?

Yes, I think we have talked about the ramp on 5400 in particular beginning to happen in next year. But one of the things I would remind everybody about too when we talk about that opportunity is that we are also putting OTN switching across our product line, particularly in our transport products. And that represents an additional opportunity.

Great, thank you very much.

Thanks, Kevin.

Paul Silverstein, Credit Suisse.

A housekeeping then a question. What -- you said the 40 plus 100 customer count, I think you said 120, Jim. What is the 100 gig customer count this quarter? And then I have got a question.

Let me get that -- we have that.

Yes, the 100 gig customer count, Paul, is 13 new in the quarter for a total of 44.

13 new ones. All right, here is the question. It's similar to what has been asked a couple of times, but narrower. The question being, what have your customers communicated to you in terms of both these optical switching deployments and the 100 gig deployments?

So if we look at those 44 wins in 100 gig, we look at the 19 architectural wins in optical switching, one question is how much of the revenue opportunity lies in front of you? I assume optical switching is virtually all in front of you. But if you could give me some insight on that.

And then more specifically, what have your customers in each case with respect to both of those opportunities communicated to you in terms of the planned deployment, the size and how that translates into revenue? If they've communicated to you at all.

So if I split into two sort of switching and 100 gig, the high-level answer to it, I don't think we've seen any appreciable change. This is the challenge around the discernment of the macro environment and impact on these rollouts.

There is no backing off in terms of their perspective around wanting to deploy either the 100 gig or the switching. And we are seeing that from pipeline point of view, you are seeing it from wins on 100 gig. We had 13 new 100 gig customers in the quarter. And they are all -- they are all looking to deploy.

I would say that the majority of sort of the OTN switching revenues are most certainly in front of us. You know, I think -- and I would say that on at the OTN convergence within transport as well.

Gary, can I push you in terms of have your customers communicated to you the expected size, either in units or revenues or both, in terms of these deployments? I understand the messaging hasn't changed from your customers, but can you quantify it for us in terms of what if any visibility they have given you?

It varies customer to customer. And I think particularly the piece that we are excited about is moving into the metro because that is a much larger opportunity for us. I mean I think we have got some clear visibility as we go through what their priorities are around next year in terms of some of their core elements to report.

So I think in some customers we've got very, very good visibility into that. I think the piece that frankly I am encouraged by in the last few months is really the metro deployments out there because that is much denser and has a much larger opportunity be it on 100 gig or the switching elements to it.

Thank you, Paul.

Jeff Kvaal, Barclays.

I've got similar of the when category of questions. And I guess that includes when -- are you including in your October view the return of some of your 10% customers to above that threshold? And if not, when might they get back there?

I would also like to clarify that you had said earlier in the Q&A that you were talking a little bit about a recovery next year for carrier spending. I'm wondering if you were referring to Europe in particular or that was a global commentary. Thanks.

Jeff, it's Jim. On the issue of 10% customers, it is hard for us to comment on any particular customer on a forward basis because they have a plan for the quarter, but their plans might change during the quarter. So I can't give you an answer on whether we expect a 10% customer in Q4. It wouldn't surprise me at all if we did have one. But I just -- I wouldn't want to comment on that.

The one I would say though that I think is a positive for our business is that we have diversified our customer base both geographically and by product. And so, we are no longer as dependent upon the big customers that have been 10% in our numbers. Now they are very important customers to us, absolutely, and yes, we are strategic to many of them. But I think the fact that we hit our target this quarter without a 10% customer is a positive.

Jeff, let me answer the part of the -- part of the question. I mean, yes, I think we are more balanced to the business now. I would characterize not in terms of recovery or not of the carrier spending, it is really what they are spending it on.

And I think the reason that we think that a lot of this lies in front of us is we have had the design wins, they are beginning to roll out and we've got some visibility into those rollouts. So it is more around the shift of this NexGen architecture next year. I don't expect the overall spending to go up from a CapEx point of view.

Yes -- no, I don't think many of us do to be honest, Gary. I think the question really becomes you have spoken in the past about a 10% market growth rate just for optical in particular. Is that something that is on the table for some unspecified point in the future or do you think we should now be thinking about a lower growth rate than that for optical all in?

When you look at the analysts -- the industry analysts have been saying for this year, they have been pointing to an expectation for growth this year of 8% to 10% in what we do. If you look at the overall results of the industry, including the sum of our competitors in this space and ourselves, I don't think you would draw the conclusion that the overall market is growing at 8% to 10%.

But I do it think you would draw the conclusion that we are growing faster than the market. And so, we are going to wait and see what the industry analysts come out with as far as next year's growth in NexGen CapEx. But one thing that we do believe is that given our wins, given where we are positioned, that we will grow faster than whatever rate is inherent in that industry forecast.

Thank you, Jeff.

Okay, thank you.

Brian Modoff, Deutsche Bank.

Vijay Bhagavath on behalf of Brian. I have a two-part question. The first is on the weakness in the revenue guide, was it mostly a couple or two of design wins that got pushed out of Europe?

And then the second part of the question is there was some product mix improvement in the quarter, obviously that didn't translate to gross margin improvement. Any color it's or thoughts behind that?

And then obviously as you look to improve or increase software content in transport and OTN switching, how would that help improve gross margins because obviously we are not seeing that in the guide? Thanks.

Vijay, let me take the first part of that. I think probably -- in Q4 probably a combination of things. Certainly Europe in overall terms lower than we would have anticipated coupled with slower operationalization of a couple of the rollouts in North America amongst the large carriers.

And on the mix question, as you've surmised there, given that our guidance for margin is not up significantly from what we did this quarter, clearly we don't expect a big shift in the mix in Q4. We still expect over time that we are going to sell more switching as a percent of our revenue than we are today. We don't think that will happen in Q4.

And switching is an important piece of our margin increase. It's not the only piece; the whole intelligent network open architecture as we add switching to transport, as we put functionality -- converged functionality across platforms enables us, we think, to be stickier with customers and to improve our margins and that is another piece of the story.

And the third piece of the story is just the fact that we are transitioning products, particularly on the switching and the CESD side. There are start-up costs, early implementation costs which hurt our margin. So those are really the three pieces that we expect over time to improve our margin.

And then a quick follow-up if I may. The WaveLogic 3 chip, hopefully that is starting to ship. Would that or did that have any impact on margins or not yet?

Probably won't have a big impact on margins this year. We will start to ship some of it in this year. We do think next year it is going to help us.

Thanks again.

Rod Hall, JPMorgan.

Just wanted to check on the OpEx, Jim, first of all. I mean, the revenue guidance is for down and yet you are saying OpEx in the low $180 million's again. I know you said that you have been doing well, but you still think it is better to look at the $180 million to --.

Can you just talk us through what would cause OpEx to move up even as revenues decline a little bit? You guys have been doing a pretty good job controlling that. And then also if you guys could give us an update on SEA-ME-WE 3 and what the status of that is and whether it is included in push-outs, that would be helpful as well.

On the OpEx, Rod, one thing that you would have recognized watching our results is that our OpEx can be a bit lumpy depending upon what we are doing with respect to prototypes or big projects within certain platforms. And obviously we are focused on controlling OpEx as tightly as we can.

We have done a good job through the year, but given what we now expect that we will have to spend in R&D in Q4 in support of some platform work that we are doing, I think we will be in the low $180 million's.

The other thing that we have said is that on our sales costs we pay on the basis of orders. And therefore when we have big orders quarters we expect higher OpEx in sales. Typically the fourth quarter is a big orders quarter for us and that is embedded in that as well.

Okay, thanks, Jim.

And on SEA-ME-WE 4, we actually did recognize part of the revenue on the SEA-ME-WE 4 project in Q3, we will recognize the rest of it over time as we finish certain items of that project. We did do a large deployment for SEA-ME-WE 4 in the quarter as well. So there will continue to be some revenue from SEA-ME-WE 4 as we move through time, but not a large amount, unless we get further projects with that customer, which I hope we will.

So you are saying, Jim, just to clarify, the bulk of the revenue has been recognized at the Q3 level here?

A big part of it has, yes.

Okay, thanks.

Thanks, Rod.

Simon Leopold, Raymond James.

Just a quick clarification on that last comment on the SEA-ME-WE 4. I did notice deferred revenue in the quarter was down pretty significantly; if you could just give us a little color on that. And then in terms of the question -- Gary, you alluded to sort of the metro long-haul split.

If you could give us a little bit of context in terms of how much of your revenue typically comes from long-haul versus metro maybe versus submarine, if you could break that out and some color in terms of how you see these trends driving your business. Basically is long-haul better than metro, et cetera? Thank you.

I will deal with the deferred revenue piece. It's a complicated story, Simon, because really there are a couple of pieces inside of deferred revenue. On the services side in some cases we get paid in advance for services and then we perform those services over time.

When we get paid at the beginning we collect the money and that gives rise to deferred revenue, as we perform the services it comes out of deferred revenue and into revenue. So that is a -- frankly the biggest piece of the deferred revenue bucket.

On the other hand, there are some hardware contracts where we do get paid progress payments or other payments during the course of implementing the project. That is the same case basically. When we get paid, we put that up as deferred revenue. When we finish the project and recognize the revenue, the deferred revenue goes down. In the quarter, a big change was on the hardware side.

Simon, let me take the second part of that. I'd characterize it the vast majority of our switching and transport revenues right now come from longhaul backbone networks. And you have seen we've gone into the submarine space. We were new entrants to it a little while ago, and we've taken significant share, but that really again obviously is longhaul.

We do see increasingly a number of our wins into the metro space, and we've done a lot of work on the platform convergence where we are now able to offer really a next-generation architecture into that metro space that is particularly valuable in terms of where the traffic flows are going. It is a much bigger market. It is a market where a lot of the things around convergence of layers zero to 2.5 is happening.

And so consequently overall, it is where there is higher gross margins and it is where we focused a lot of our R&D research resources over the last two to three years. And I think we are beginning to see a shift in that. As we go through 2013, we will be rolling more of those out with many of the Tier 1 carriers. So I think that is a significant opportunity for us going forward.

Is it fair to say, though, Gary, that the longhaul market is one where you've demonstrated more of a competitive advantage, whereas the metro market is probably a more highly fragmented competitive market?

I do think that is fair, Simon, but though I think that fragmented market, some of the major carriers are now collating that spend because they need a more cohesive single architecture in that space. Not all carriers, but I would say a lot of the major Tier 1s are now, as they look to converge their multiple networks, are pulling that together at the metro.

So I think that is becoming much more of a strategic battleground, and I think we are extremely well-equipped for that. But I think your commentary about the existing position I think is absolutely accurate.

Thank you, Simon.

Thank you.

Amitabh Passi, UBS.

I had a question and a follow-up. Gary, the question for you is just again going back to the macro commentary. I think you talked about weakness in Europe. Last quarter I believe you said you had limited exposure to Southern Europe. I'm just trying to understand, are you starting to see the weakness in Europe spread into other territories, particularly Northern Europe?

And then related to that question, in North America again we saw quite a bit of weak performance in your third fiscal quarter. I don't see how these macro issues really resolve in the next three to four months, yet operators have kept their budgets steady. Do you think there is some risk as we move into the calendar fourth quarter that we don't see the typical budget plus this year?

Let me take the European one first. I think it is fair to say that we are seeing the European macro issues certainly in the last quarter creep into Western or Northern Europe, however you want to characterize it. Again, I would caution a little bit around that because it is typically a very weak quarter in Europe anyway with long vacations, et cetera. So I don't want to over-rotate on that, but we certainly saw a step-down in the quarter in Europe.

From a North American perspective, I don't think we are assuming a lot of change in the macro environment. Our confidence is really built upon specific wins that we have had that will come to revenue that will give us that growth. Despite the environment we have been in, we have continued to take market share in revenue terms.

And if you look at our Q3 performance, I mean frankly it's appreciably much better than any of our competitors. It is not where we thought it would be at the beginning of the year, I think that is a fair characterization. But I think the two dimensions particularly around the European macro and the slower operationalization of some of these wins are really probably the two major factors.

In the dialog that we are having with our major customers in North America I would say that none of them are backing off from their strategic deployments and adoption of their infrastructure. That is not I think what is affecting the rollout of those new networks. I think it is more around the ability to operationalize those wins. Our assumption going into 2013 is the macro doesn't get appreciably any better.

Got it. Thank you, I appreciate that color. And just as a quick follow up for Jim. Jim, if we were to just maybe make an exemption for fiscal 2013 you can grow topline 5% to 10%, how do we think about the OpEx? Can you hold it into low $180 million's. Would you see some level of OpEx creep? Maybe just some guidance in terms of the leverage in the model if we assumed some modest growth in fiscal 2013?

Amitabh, I appreciate the question. We are just now sort of working into our view about 2013. And so, I can't comment specifically on what we are going to see in OpEx in 2013. I will say that what we have said in the past about OpEx is that we believe that we will be able to hold our OpEx relatively tightly as we move through time; it's going to have to increase somewhat because of all the things that go up in cost.

But as far as the scope of our OpEx, whether it is R&D, whether it is sales, whether it is G&A, I don't see a significant increase in the scope in any of those functions. So you wouldn't expect to see a big increase. But having said that, I will reserve on what the numbers are going to be until we actually finish our 2013 plan.

Thank you.

Tim Long, BMO Capital Markets.

Thank you. Jim, I wanted to dig a little bit more into one of your comments about hitting the numbers without the 10% customers. Just doing some math here it looks like to me there are two parts. First, on the North America side, if I were to back out the 10% customers it looks like we have seen north of 20% sequential growth there from Tier 2, Tier 3. So curious what is driving that? Were there some big projects?

And then looking at your international business growing close to 6% sequential but obviously Europe was down. So maybe we saw 10% or so growth outside of Europe, same question, it sounds to me like you've got a few weak carriers in Europe but pretty robust everywhere else. If you could just let us know were there kind of one-time deals in there or is it pretty broad-based outside of those clearly weak areas? Thanks.

Yes, I would say that we've made a conscious effort to put more balance into our business by virtue of increasing our focus on areas where we think we have particular platform advantages. And that is strongly in the US in Tier 2 and in the enterprise space, we have gone after that, we put sales and marketing focus on that and we have had a lot of success in those areas and we feel great about it.

One thing I would say though is that you have to be careful, as we have always said, about looking at sequential movements and applying too much importance to them. So, yes, we feel great about what we have been able to do in the US overall and whether it is the big Tier 1's or below that, and also outside of the US same sort of picture.

I don't think that in the quarter there were any really, really large projects, I think it was just general -- with the exception I should say of SEA-ME-WE 4. But I would say that the international growth is a pretty balanced picture as well.

Tim, let me answer Jim's balance comment around A-PAC and [CALA] I think have been particularly strong for us. And order flows and opportunities and pipeline looks good there, as has I would single out the Middle East as well as a place where they are looking to build next-generation architectures from scratch. So I think the challenges that we are having and everybody is having in Europe is offset by the balance around some of the other international markets that we have.

Okay, thank you very much.

Ehud Gelblum, Morgan Stanley.

A couple of quick confirmations or just clarifications. Of the $37.8 million switching, can you give us a sense how much of that was 5400? And also, can you go over that $4.5 million of out-of-period revenue, what the margin on that was and what that came from? I don't -- I think you may have spoken about it before but I don't recall details around that.

And then I wanted to understand two issues -- one is the comments that you made on some of the -- your gross margin being impacted by some -- I think it was some install types of things that I guess you had guaranteed and promised. I'm wondering are those civil engineering types of things that you got involved with that you aren't usually involved with that work more expensive than you thought.

And how do we kind of put a bread box around what types of things that you had to guarantee and what types of customers those are and why? And if there is any time left, Gary, I would love to hear some more comments about order flow, because it sounded like you said that July was weak but August picked up. I just wanted to understand the dynamic if I got that right.

Okay, let's see if we can run through the eight questions. Let me try on the -- I don't have the exact numbers, but 5400 family was close to $30 million I think of the $38 million of the total of switching.

So that was up very large from last quarter, I think last quarter it was (multiple speakers).

Yes, it was pretty strong. I mean it is going to fluctuate. I mean, CoreDirector is still, we've got a lot of opportunities for CoreDirector with existing customers. And actually some new customers as well and that is going to fluctuate quarter to quarter. But it is pretty strong on some of the new 5400 footprints as it rolls out.

And just to the eliminate any uncertainty, yes, a big chunk of that was SEA-ME-WE 4. On the $4.5 million, we have a lot of different commercial arrangements with our customers, some of which include credits that we give as part of the deal. This $4.5 million reversal into revenue represents a set of credits that expired over a period of time in the past and we should have recognized it in earlier periods, we corrected that mistake and $4.5 million -- it is all revenue and all margin.

I'm sorry, so this was a contra revenue that you had to apply this quarter?

No, it's a revenue increase.

It's a revenue increase.

It's a revenue increase. It's contra revenue in the quarters in which the credits were recognized. And then -- I am sorry, when we actually delivered the first part of a project there were potentially some credits that arose at that period of time. So we lowered revenue in that period by the amount of the credit. Now over a period of time the customer then earns those credits and we should have recognized those in previous periods -- over the past 18 months really.

And did you know that ahead when you gave guidance this quarter?

No.

Okay. And that was 100% gross margin?

Yes.

Okay. The others were just the comments about what you are doing with customers that caused the lower gross margin, was that it -- or no, that wasn't it.

The gross margin, I think one of the things that impacted it was we were rolling out some of these networks and increasing services. So if you look at the increase -- the services margin was lower and that is becoming an impactful part of the business. We do think we are going to get a better mix there --.

I think there was some specific comments -- specific comments that, I may have gotten this wrong, that you were agreeing to do certain things, it sounded like civil engineering, but I'm not sure if it was or not.

No.

No, no. Here is what we said. What we said is -- let me back up and go even a little further back. When you look at our services business we have two to three different businesses, the two big businesses are a deployment piece and a maintenance piece. Deployment is the -- frankly the lowest value add and we tend to get lower margins on deployment than we get on maintenance and other higher end services.

We had a particularly high amount of deployment revenue in the quarter and, to be honest, we had a surprise on a contract and we expensed more money on that contract to get that piece of equipment deployed. So our services margin, as you will see, is a lot lower than our trend, we expect that to come back up. We don't expect to have that kind of experience on any more services deployments.

But it is not civil engineering. No, it is standard deployment. It can be very complicated depending upon the part of the world and all those sorts of things, but it is not really civil engineering.

Okay, that is actually very, very helpful.

And with that we are at the end of our call. So we will end it here. Thank you, everyone, for joining us this morning. Have a good day. We look forward to speaking with you soon.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.