Ciena Corp (CIEN) 2012 Q4 法說會逐字稿

Good day, everyone, and welcome to the Ciena Corporation fiscal fourth-quarter 2012 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, Mr. Gregg Lampf. Mr. Lampf, please begin.

Thank you, Stephanie. Good morning and welcome to Ciena's fourth-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 the year, and Jim will offer some color on our Q4 results and provide guidance for Q1. We will then open the call to questions from the sell-side analysts, taking one question per person with follow-ups as time allows.

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 January 2, 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 include 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 from the Investors section of our website.

Also, as a reminder, our next IR Chalk Talk is scheduled for Tuesday, December 18 at 12.30 p.m. Eastern. The topic is Ciena's focus on packet networking. Please visit the Investors section of our website to register. Gary?

Thank you, Gregg, and good morning, everyone. This morning we announced fourth-quarter results in line with our expectations, including revenue of $466 million, and a strong overall performance for the fiscal year relative to the market. As you know, macroeconomic challenges weighed on the packet-optical equipment market, which declined by approximately 7% in 2012. However, we grew our annual revenues by 5% year-over-year, indicating that Ciena continues to take significant share from the other players in our space.

In fact, it was a milestone year for Ciena in many ways. We had a record orders quarter in Q4, contributing to the more than $2 billion in orders for the fiscal year, a first for Ciena. We continued to strengthen our balance sheet in 2012, increasing our cash position by more than $100 million. And with multiple Tier 1 wins across the globe, we widened the distance between Ciena and our competitors in the next-gen network infrastructure market.

We continue to hold number-one market share in North America and we are now an even stronger number two globally. We also had a particularly good year in newer vertical markets such as financial services, utilities, research and education, and state and local government. And when you combine these successes with gains we've made in the carrier managed services and Internet content provider markets, it's all further evidence of the progress we're making in diversifying the business and expanding the role we play with a broader base of customers.

Overall, in fact, non-telco markets now constitute more than a quarter of our overall business. Furthermore, specifically to the submarine market, we continue to take share and in fact have 25% this year, up from 0% just two years ago.

Turning to the broader market dynamics, I would characterize the near-term macro and regional trends as largely unchanged. Our fiscal results reflect continued cautious customer spending in North America; however, operators have largely worked through the operational challenges of implementing new network architectures and they are beginning the initial rollouts of those design decisions. But as we've discussed, it does take time for major network plans to be implemented and to be reflected in our results.

Both APAC and CALA were strong order growth regions for us in 2012. We continue to be encouraged by the opportunity presented in these geographies.

Because of the macro environment, Europe obviously remains our most challenging region, but it has not deteriorated further in the last few months. Overall, our view of the market remains positive, and we are seeing ramping demand for the network specialist capabilities that we have been developing over the last several years.

Specifically, demand for capacity continues to increase, with widespread adoption of 100-gig having begun in 2012. Customers are also increasingly demanding convergence of both network functions and layers, particularly the integration of transport OTN switching and packet switching, with widespread adoption of OTN and Ethernet infrastructure finally now getting underway.

Convergence is happening first in the metro, where there is a strong need to aggregate and manage multiple types of services. I think that illustrates the point that it is not just about capacity, but the need to intelligently allocate and manage capacity. So we are also seeing increasing demand for software-based programmability of network infrastructure, with market momentum gaining for concepts like OpenFlow and SDN.

Frankly all of these dynamics play right to our OPn network architecture for building next-generation networks today. OPn combines optical and packet networking with software programmability and open interfaces, all areas where Ciena offers industry-leading expertise and technology.

This approach leverages convergence to create exponential network scale whilst reducing costs. Then it applies advanced control plane software across multiple platforms to make the network programmable as a whole. It also uses network level apps to direct the behavior of that programmable network area, while leveraging open interfaces to orchestrate network resources alongside computing and storage resources in a virtualized environment.

OPn directly aligns with the needs of both service providers and nontraditional Ciena customers like enterprises and cloud service providers. Consequently, our portfolio developments in 2012 and going forward directly support this architecture.

With WaveLogic 3 now shipping we are delivering the industry's most advanced coherent optical processing engine and the only truly programmable 100-gig transport solution for use in applications ranging from transoceanic distances to lower-cost metro applications. Ciena is clearly the global leader in coherent optical deployments, now with more than 50 100-gig customers and about 130 total coherent customers carrying real commercial traffic today.

With our third-generation coherent solution now in market, we are offering customers the most field-proven technology leadership in the industry. And we continue to converge OTN switching functionality into our transport solutions. In fact for the year, about 10% of our 6500 revenue actually came from switching elements within that platform.

The same can be said about our switching product lines, where more transport functionality and packet switching are being integrated into platforms like 5400. We are increasingly seeing customers use tightly integrated 5400s and 6500s together as a single solution for multiple applications.

Much of this convergence across the portfolio is enabled by software commonality and integrated control plane as well as a shift in how we deliver software features. In keeping with the OPn approach, we have begun delivering applications that function on top of the programmable infrastructure versus being embedded in the hardware, although we admittedly are at the early phases of this transition.

And, leveraging the insights gained from our tight customer engagements, we've developed global specialist capabilities in the form of our network transformation solutions. This is a suite of consulting services to help customers efficiently implement and optimize their strategic network resources.

All of these portfolio themes address real customer needs, and we are beginning to see customers adopt the OPn architecture. When combined with our specialist approach to customer engagement and our global scale, our portfolio has experienced very strong market acceptance.

To capitalize on our position of strength, we will aggressively press our competitive advantages in 2013. While we are not counting on dramatic market improvement in the near term, Ciena is carrying strong momentum into the new year with a platform for continued growth and improved profitability.

We are taking significant market share. Our approach continues to gain mind share. And our portfolio is driving the industry towards the next generation of converged programmable networking.

As a result, we believe we are well positioned to drive operating leverage in the business, and we expect to improve our financial performance in 2013. With those prepared comments, I will turn the call over to Jim.

Thanks, Gary. Good morning, everyone. As we have discussed over the past several quarters and as Gary just mentioned, customers are demanding more convergence and greater network programmability. This shift has been coming for a long time.

At Ciena, we have the pieces in place today to lead this shift in the industry. In fact, we have been able to drive convergence perhaps faster than anyone because we are not encumbered by a significant legacy portfolio.

Because the lines are blurring between transport and switching and between packet and optical, we are changing the way we manage our business. Therefore, we must adjust our reported operating segments beginning in the first quarter of fiscal 2013 to reflect our evolution and to give you greater visibility into the most important drivers of future growth and profitability.

So next quarter, we will present our financial information in the following segments, which are slightly changed from the way we have reported them in the past. Converged Packet-Optical is the first segment. This comprises our switching platforms plus the 6500 platform. As Gary said, currently roughly 10% of the revenue in our 6500 platform comes from switching blades, and this will increase over time as the products continue to converge.

Next segment is Optical Transport, which is our current Transport segment less the 6500 platform. Packet Networking is the next segment; this is the same as our current Carrier Ethernet Solutions portfolio, but it is renamed to better reflect its evolution beyond service delivery and into more metro and service aggregation applications.

And finally, Software Applications and Services, which is our current Software and Services segment, including the network transformation solutions that Gary discussed. As we bring network-level apps to market as part of our OPn architecture, they will be included in this segment as well.

Today, we are reporting based on our previous segmentation of Packet-Optical Transport, Packet-Optical Switching, Carrier Ethernet Solutions, and Software and Services, which is consistent with how we managed our business in 2012.

To help correlate your models we intend to file an 8-K in January that will refer you to segment financial data for fiscal 2011 and 2012 reflecting this new segmentation. Additionally, for a couple of quarters going forward, we intend to provide certain product line information that will help you bridge our current segmentation to that going forward.

Now I'll take a few minutes to provide some detail on the results that we published earlier today. I will be speaking only to non-GAAP results, so please refer to this morning's press release on our website for reconciliations to our GAAP results.

Revenue performance in Q4 was in line with our expectations at $466 million. This figure includes an out-of-period adjustment that increased revenue by approximately $4 million related to deferred revenue that should have been recognized in 2011.

We continue to generate profit from our operations. Gross margin in Q4 came in higher than expected at 42.7% due to a higher proportion of cards recognized in our transport business as well as a strong quarter for CES, software, and services.

At $192 million, OpEx was higher in Q4 primarily due to increased variable sales compensation as a result of the strong order flow we had in the quarter as well as greater prototype activity in support of future business. We generated in $11 million in cash from operations in the quarter, and our cash balance was up by approximately $25 million over Q3. Backlog continued to grow in the fourth quarter, as I will discuss later.

I would like to step back from the quarter for just a minute and comment on our fiscal year as a whole. It was a year in which we showed progress on a number of fronts.

We grew annual revenue 5% in a market that declined. With a record orders quarter in Q4 we received more than $2 billion in orders for fiscal 2012. Our backlog of approximately $900 million at fiscal year-end was up by about 25% compared to year-end 2011.

And we continued to strengthen the balance sheet. As we said, we increased our cash balance for the year by $100 million.

I will now turn to guidance for the fiscal first quarter of 2013. Absent any significant changes in exchange rates, our guidance is as follows.

We expect Q1 revenue to be in the range of $435 million to $460 million. In the past, we have spoken to you about the seasonality of our Q1. We typically have experienced reductions in order volume and deployment activity toward the end of the calendar year and again early in the next calendar year due to the holidays. This period, as you know, encompasses our fiscal Q1.

So we do anticipate and our guidance reflects that our Q1 revenue will be impacted by this seasonal impact on our customers' procurement and deployment cycles. We expect Q1 gross margin to be in the low 40%s. However, we do expect it to be somewhat lower than the gross margin we reported in Q4.

We expect adjusted OpEx to be in the high $180 millions. With regard to other income and expense net in the first quarter, we project an expense of approximately $10 million related to the interest on our convertible 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 102 million total shares. Diluted share count will vary depending upon your projections about our profitability.

While we won't be providing guidance per se for the full fiscal year, I would like to offer some general comments on 2013. Due to the progress we have made with our portfolio, our continued market share gains, and customers' adoption of our OPn architecture, we feel very good about our market position heading into 2013. We expect to continue to grow revenue faster than the market this year.

We believe that product mix, cost reductions, and other factors that influence gross margin are trending in the right direction. However, as you know, it is difficult to predict gross margin with precision and we expect that there will be quarterly fluctuations.

We do believe that our gross margin will improve over time. However, many of our new wins in 2012, particularly certain international transport wins, will begin rolling out and being recognized in revenue in 2013. As a result, we don't expect to see significant improvement in gross margin this year. Just to be clear, this comment refers to the overall gross margin for the year as compared to that for 2012.

With respect to operating expense we are planning to average in the high $180 millions in 2013. We expect OpEx to be higher than 2012 primarily as a result of increased resource allocation to support our global go-to-market coverage model as well as the need to maintain competitive compensation for all employees.

However, we are continuing to take the necessary steps to control our costs and drive additional operating leverage from the business. As an example, to improve the efficiency and to focus and strengthen the contribution of our global R&D operations, we are restructuring and reallocating certain engineering resources to better align with portfolio and market opportunities.

We are consolidating and clarifying the mandate of our development sites. As a result, we expect to take a restructuring charge in Q1 in the range of $3 million to $5 million related to these activities.

In addition, we are in the process of reallocating some of our sales and services resources to our stronger-performing geographies. And we have recently taken steps in other areas to increase efficiency.

All of these actions are intended to ensure that our workforce transforms as our business transforms. We are committed to managing our business so that OpEx as a percentage of revenue continues to decline going forward.

I would just like to say in conclusion, as Gary said, we do expect improved financial performance in 2013. That concludes our prepared remarks, so with that we will move to Q&A. As a reminder, we will be taking one question per sell-side analyst, with follow-ups as time allows. Stephanie, we will now open up the line for questions.

(Operator Instructions) Kevin Dennean, Citi.

Great, thank you very much. Thanks for taking my question. Jim or Gary, a question for either one of you. You mentioned that you will aggressively press your advantage in '13. You talked about some restructuring actions to align your resources where you want to be.

How should we think about that aggressively pressing your advantage? Should we expect to see another episode of a land-grab for footprint that can sometimes be a headwind to margins in the near term?

Kevin, this is Gary. Yes, that's a good question. I think we have laid a lot of the groundwork for that already in terms of our footprint, so the term aggressive was really more of a strategic term around where we are going to focus our attention. We are very focused on our operating leverage, and I think we have made a lot of those investments from a geographic point of view and a portfolio point of view.

And as Jim said, we expect our margin overall to continue to improve over time, and we are very focused on that. So we are managing our OpEx very carefully and we expect our gross margins to be better for the year overall. So it is within the context of that.

And, Gary, just a quick follow-up if I may. Understanding your comments about '13 and we still have continued macro headwinds and Europe is still a problem; but how are you balancing that internally against -- you should start to see Verizon come on with their metro deployment. AT&T lifted CapEx by 15%. Your WaveLogic 3 is out in the market now. How should we balance those headwinds when we think about '13?

Yes, I mean the thing we can't control is obviously the macro. Our view is, the thinking as we approach the year, is we are not expecting an appreciable improvement in the macro.

I think specific to our industry, I think the view that we are getting is that the sentiment is improving within our industry. I think we've got -- we feel better about that than we did at this point last quarter in terms of our engagement with the customers.

We've got through a lot of the operationalization of some of these key strategic wins that we've had. So on balance we feel better about '13 than we did about '12, and we do expect that to translate into an improving financial performance.

Terrific. Thanks very much. I will drop in the queue.

Mark Sue, RBC Capital Markets.

Thank you. Good morning, gentlemen. If I look at the timing of procurement, that seems to be the primary reason behind the delta between your backlog growth and your lower revenue guidance. However, we have seen this in prior quarters; so I'm just wondering what has really changed.

Are the carriers rethinking the urgency of their upgrades? If you could give us a sense of the composition of your backlog, if it is still mostly transport or are you seeing switching and CES grow into the backlog as well?

Let me address the backlog and activities of the customers. What I would say is there is no change in the urgency of anybody's desire to build out their network. It has taken somewhat longer than we would have thought because of the complications of changing to a new architecture, but the fact that our backlog has grown so strongly is a sign of how strong we are in terms of our product portfolio and the customer engagements.

What I'd say about the backlog is that we do have within our backlog some multiyear service arrangements. That is not going to come into revenue immediately.

We also -- much of our backlog is a result of the fact that we are growing in geographies which just take a longer time to get to revenue. That is particularly in APAC and CALA; we have long deployment cycles and in many cases we are building out complete networks, which means we have to wait until the network is complete, lit up, and accepted by the customers before we get to revenue.

So clearly there has been a change in the speed at which our orders overall get converted into revenue. It is not really a function of individual customer's change; it is a function of the mix within our backlog.

As far as the makeup of the backlog, it is really very mixed in all of the areas. I would say it has grown particularly in transport but also in CESD and in switching.

That's helpful, Jim. Then -- so if we think about the growth of backlog, the near-term seasonality, and the macro, and the architectural wins, after the January quarter should we intuitively expect the revenues actually to grow sharply sequentially?

What I would say is that it is hard for us to pinpoint the exact timing of when we start to see this backlog start to empty out, you might say. But it is just hard to predict how our customers are going to behave.

We do think that because of this backlog and how it is now scheduled throughout the year, and because of the fact that we continue to gain in the marketplace, that we will have a stronger 2013. But it is hard to pinpoint.

Now, we do say, as we said earlier, that seasonality is impacting Q1. So if -- hopefully we won't see seasonality in Q2 and we would see some improvement; but it is hard to say how much.

Okay. That's helpful. Thank you.

Kent Schofield, Goldman Sachs.

Great, thank you. Looking at optical switching, can you talk a little bit about the underlying dynamics between CoreDirector and the 5400?

Yes, Kent; it is Tom Mock talking. We are -- one of the things that was tough for the switching market overall in the year is the fact that switching as a market declined. I think that was a headwind that all of us faced, particularly as we looked to make the transition from SONET/SDH to OTN.

Most of the people that are deploying switching stuff today in new greenfield applications from Ciena are using our new 5400 platforms as opposed to our CoreDirector platforms. That said, we are still seeing significant card adds in existing CoreDirector platforms, and we are also seeing CoreDirectors added to existing CoreDirector networks.

One of the other things I would point out on the switching market broadly is we are also starting to see switching show up in other places in the network, not just in standalone switching platforms. As we talked about earlier, it is showing up in some of our transport platforms. And we are also seeing packet switching become a more important part of the mix, both as standalone packet switching platforms as well as packet switching embedded in the actual products themselves.

As we have talked about in the past, 100-G is one of the things that is driving people to shift toward OTN. And as we are seeing now the 100-G deployments are now just beginning to hit in the market in a big way, and as a result of that we think the deployment of the OTN switching in support of that are likely to follow that. So broadly we expect our switching business to be stronger in 2013 than it was in 2012, largely on the back of this transition to OTN switching.

Okay, and so -- okay, thank you.

Tal Liani, Bank of America Merrill Lynch.

I have a question about two things. Number one, you -- the Packet-Optical Switching was down 45%, 46% sequentially. Is this a subject -- I think in prior quarters you spoke about OSS and BSS integration that needs to take time. Is this the explanation of the decline? Or could you explain the decline in Packet-Optical Switching?

And then I want to also speak about the CSD, the sustainability of the growth. It grew 53% sequentially after a few weak quarters. Does it mean that it is a multi-quarter deployment cycle, or was there a one-off nature to the recognition?

Tal, it's Tom. First, on the Packet-Optical Switching piece, one of the things that we have been talking about on that segment for a while now is it does tend to be a lumpy segment. And as we mentioned before we have also had some operational issues in terms -- not operational issues, but operationalization issues, where our customers are doing the things it takes to get this kind of equipment deployed in their network.

Now, as we mentioned early, we think we are largely behind that -- we think that is largely behind us. We have gotten that operationalized at top North American carriers, and we think the investment they have made in that speaks well to the commitment they have to deploying that kind of a technology moving forward.

When I look at the CESD and the sustainability of the growth in that sector, we are beginning to see an uptick in carrier Ethernet business services, which is in the area for growth.

That said, we are also seeing strength in wireless backhaul. We have actually begun to look at it as that a lot of the growth we are seeing is really more in Ethernet infrastructure, because in a lot of our bigger service provider customers they are actually using that infrastructure to support both wireless backhaul as well as Ethernet business services.

But as we have talked about on prior calls we are beginning to see the Ethernet business services portion of that business increase, and we are beginning to see continued interest in their customer base in terms of deploying the infrastructure required to support those new services.

Just a follow-up on that, Tom, one thing I would say is that sequential movements in any of our segments can be somewhat misleading because of the fact that we do have this lumpiness aspect of our revenue recognition. But overall, we expect a good year for CES as well as a good year for switching.

Right. So just on that, as of the backlog, as of the orders, do you -- is the mix between the Packet-Optical Transport and the Switching and the CSD -- how is the mix? What can you say about the mix? Is it more towards the lower margin stuff or is it more towards the higher-margin stuff?

Tal, this is Gary. I would say overall our margin mix, and you saw at in this quarter, is improving. Now there are, as Jim said in his prepared comments, some international business that we are rolling out that are initial deployments that will weigh down on that. But I do see the mix improving, the software content improving. We have got Control Plane playing on the 6500. We are putting more switching applications on that as well.

To the point about sustainability on the packet side, we broadened our capability there, which should point to more sustainable and a broader opportunity of revenues. And as Tom said, a number of the applications there continue to increase. So part of our thinking around our whole portfolio strategy is really around the convergence of these platforms, which I think plays to where the market's going and the blended margin for that overall should improve.

Thanks, Tal.

Thank you.

Paul Silverstein, Credit Suisse.

Jim, I apologize if I missed it; but can you comment on the pricing environment and the competitive landscape? And obviously, Gary same question for you.

Yes, I would say, Paul, it hasn't changed significantly. As we said in the past, there has been an intention on the part of several of the players in this market to try to grab or retain market share. And that is reflected in a price environment, particularly on the new, big transport opportunities at 40- and 100-gig, that has caused prices to go down.

But that has all been the case for really at least a year, probably longer. It has not changed.

What -- the reference that I made to margins next year is that we won a lot of deals in 2012, and as you win new deals you're in early stages of deployment with more heavy commons content, with startup costs, with lab equipment, all those things which are going to influence margin in 2013.

But the other thing I would say is with the convergence of the platforms and as we move switching onto transport, that is going to, to some extent, counteract the pricing environment. We think that our portfolio as converged really is the most competitive.

And we have made some substantial efforts towards cost reduction, probably the most notable of which recently is WaveLogic 3 beginning to ship.

Yes. And Jim, I thought I recalled your friends over at Infinera making a comment this past quarter that the rate of price erosion had stabilized for 100-gig in particular. Obviously, they were one of the aggressors in bombing 10-gig pricing, which was also impacting 100-gig.

But are you not seeing any of that? I understand it is still an aggressive environment. Are you not seeing any stabilization in 100-gig?

I would describe it, Paul, as I think the world is shifting to a converged architecture, where you can talk about 100-gig, etc. but it's really around packet integration, it is around switching integration. So the game is really shifting to convergence and I think that plays to a different dimension, as Jim was saying.

I think as a point product these things can be measured, and it is a tough environment. As you get towards the more and more convergence that you are getting and with the other things that we are wrapping around in terms of software, control plane, functionality, that's really takes it to a different game. And I think we are beginning to see that, and I think that is what gives us confidence around our longer-term growth in our gross margins.

If I could ask one more question on this line, and I apologize again if I missed it in your prepared remarks. But in the past, you have commented about the need to gain footprint and pricing aggressively to get the footprint, and then you get much better margins as you roll out the blades downstream. Is there visibility as to a point in time where you start to see a meaningful crossover to the blades versus the chassis?

It is difficult to predict with accuracy, Paul, but you saw some favorability to that even this quarter, where we invested pretty heavily over the last 18 months in footprint and also took a while to operationalize some of those. We are now on some of those beginning to see the cards, in its simplest form, come in; and that helped our gross margins.

I think you will see both of those going forward. You will still see newer footprints at lower margins, but you get a better blend. And together with convergence and software, I think that will help our overall margin.

All right, I will pass it on. Appreciate it. Thanks.

Simon Leopold, Raymond James.

Great, thank you very much. Jim, I know in your prepared remarks you talked about the higher operating expense forecast, and this quarter was a bit higher than expected. If you could, just clarify the drivers there.

And then in terms of the first pass on 2013, it sounds like a higher operating expense level is going to stay with us, high $180 millions. So I guess I want to understand the trajectory towards the comments you provided in the past on operating margin. I think you have talked about an objective of getting to high single digits, if I am correct, a 10%, 12% range.

I am just wondering how you were thinking about your trajectory on operating margin for the full view of 2013. Will it be a profitable year? Thank you.

Yes, one thing I would say about the OpEx overall, Simon, is that we said really all year that we thought our 2012 OpEx would be about that of 2011. And, that is about what happened. We had some quarterly movements; prototypes come in and out of the quarters depending upon the timing of programs; third-party services the same.

But we actually ended up the year just a little below 2011 OpEx. And I think I have said -- I know I have said many times that we can't expect to hold OpEx flat forever, that we have to attend to certain needs.

As we go into 2013 there are two things in particular that we addressed. One is that we felt we needed to add some people in the field because we are expanding our go-to-market model, and we have got to put guys and gals out into the world in order to get our growth. Second thing is, we have to provide for competitive compensation for all of our employees. Those are the two movements that go from 2012 to 2013.

As far as our R&D spend, there will be some movement; but it's really not -- we're not increasing the scope of our R&D effort. In fact, we are restructuring pieces of that in order to more focus and align it.

We think that this OpEx plan is very much in keeping with how we see the growth of our revenue. And as we said, we expect to improve our operating performance, our profitability performance, in 2013.

Now, as far as the long-term goals that we set out for ourselves, we are still committed to them. We are not going to make a comment today about achievability or when we are going to achieve them. But we do expect to achieve them at some point going forward. The timing of it is difficult to predict.

Do you have a sense of, on a pro forma basis, whether the full year '13 -- your confidence that it will be a profitable year in terms of earnings per share?

In terms of earnings per share? Now, I am not going to be able to give that guidance today, Simon. It will be better than last year, but I can't give that guidance today.

Thank you for the clarification.

Brian Modoff, Deutsche Bank.

Yes, guys, a couple things. First, on the gross margins, saying that they're really not going to improve materially from last year, you would think that with the mix shift more favorably towards OTN and carrier Ethernet as well as the WaveLogic 3 shipments starting, that you would see some improvement. So is it really the competitive environment that is keeping you from seeing that? Or can you just give us a little more granularity around why you wouldn't see some improvement in your margins given the mix shift you should see?

Yes, Brian, that's absolutely logical. I think the three pieces to it are, first of all, it is one of the most difficult things for us to predict. There's a lot of moving parts to it.

Second of all, if you look at the portfolio and the shape that that's in now, you would absolutely conclude that we are going to get a better mix going forward and absolutely conclude that. Whether that all flows through into 2013 I think is the issue.

The third issue is -- so those are all very positive movements, and you saw some evidence of that in the Q4 margin. The other thing that is weighing on the other side of that, if you like, is that some of the rollouts internationally that we've got during -- that we have already won during 2013, our initial rollouts will temper some of that margin growth on balance as well.

So you look at all those three elements together and that is why we are talking around the kind of margin that we are seeing right now. I would describe it as the underlying margin of the portfolio mix we expect to improve.

And as we talk about our longer-term operating goals it will absolutely play into that. It is just difficult to predict in terms of timing during 2013.

Thanks, Brian.

Just on the --

Go, Brian. Brian, you have another question?

Rod Hall, JPMorgan.

Yes, good morning, guys. Thanks for taking my question. I just wanted to talk a little bit more about what you are seeing on OpEx and what that implies for revenues; and also, just understand the short-term drivers of this OpEx. So the OpEx-to-sales levels are jumping up above 40% here in this just-reported quarter and the next quarter from 36% to 37%. Yet you guys are saying OpEx-to-sales numbers are going to come down in 2013.

So I just want to understand what is driving that short-term jump. Is it related to installation of -- getting the operational issues worked out on some of these deals you've talked about? Or what is causing that jump up?

Then if I think about OpEx-to-sales coming down in 2013 and the absolute levels of OpEx you are talking about, then that is starting to imply midteens revenue growth, which is pretty impressive actually. I just wondered if you would talk about what you think market growth levels are going to be in 2013, so we can get an idea of what you are thinking there.

And then clarification on this $4 million revenue adjustment would be nice, too. What segment was that in? What kind of margins? That sort of thing.

Yes. I will deal with the last question. The out-of-period adjustment was $4 million. The impact on revenue was an increase of $4 million. It didn't have an appreciable impact on margins, gross margin, overall.

Then the way it comes about is we have many complications in the way we do commercial arrangements with customers. We attempt to make sure that we account for all these correctly. Sometimes we miss a couple of things, and that's what happened. We should have recognized that revenue in 2011, and that's it.

Now as far as the overall growth, right now, if you talk to the industry analysts, they predict growth rates of perhaps higher than we expect, but maybe sort of mid to high single digit. As we all know, they were wrong about that last year. They predicted sort of 10% and the market overall shrunk.

So we always take a cautious view about what analysts are saying about our industry. And although we expect to grow in 2013, we are not talking about the growth rate of the market today as we believe it or our growth rate because of the uncertainty. We are confident we're going to grow faster than the market.

As far as the OpEx percentage, fourth quarter was higher than you might have expected, as we said, mainly because we had a record orders flow; we had very high variable sales comp as a result of that. At the end of the year, sales people get to their quotas, get to accelerators, and we get very high sales comp typically in the fourth quarter.

Okay. And what about Q1, Jim? Because it's over 40% there, too. So is it different drivers for that?

Well, that just reflects the fact that we have a seasonally affected revenue, and we do plan our OpEx at high $180 millions for the year.

Okay.

Thanks, Rod.

Okay, thank you.

Scott Thompson, FBR Capital.

Hi, guys, a little color on the macro environment, if you would. There is others in the market, maybe a little further up the stack, that are reporting service providers coming on fairly strong. Other service providers have raised CapEx estimates.

Is that going to include additional optical deployment soon? Or is it more favored toward wireless and those sorts of things? Can you give us a little insight in what you are hearing there?

Yes. From an industry point of view, Scott, I would describe it as, I think, certainly within the North American theater, and frankly with a lot of Tier Ones in CALA and Asia-Pacific too, and the Middle East, I think the sentiment is better than we have seen in 2012. I think you are finally seeing some movement towards these next-generation networks.

Their legacy spending I think dropped off considerably during 2012, and they are able to focus their attention on these next-generation architectures. So I think we absolutely feel better than we did at this point last year, given that sentiment.

In terms of split between wireline and wireless, I think the real pertinent piece is really more between legacy and next-generation. What they are looking to build is converged networks that provide multiservice including wireless backhaul throughout the networking.

Now, those are big strategic decisions that have taken longer than we would have all expected. Some of that is the macro as well.

So, I think you've seen some of the announcements that they have come out with. I think they are planning to over the next few years roll out these next-gen networks. So in summary I would describe the sentiment as improved.

Okay, so how would you help us reconcile others seeing the service provider industry strong, but you are saying there is no material improvement in first quarter -- or in the near term, I guess you said.

Well, I would just say our first quarter -- specific to us, you can understand our first quarter straddles November, December, and January. And what happens in the major carriers is they basically go on lockdown in their networks for about half of that period. So over that holiday period -- in terms of deployments, etc., and it is very difficult to get to revenues if you can't install it in the network.

So I think that is really an artifact of the industry and our particular peculiarities around our quarterly fiscal quarters. So, I mean I think if you look at all the indicators, from our perspective they are positive. We have had multiple new wins. Our backlog has increased 25% during the year. We are beginning to deploy these next-generation architectures, a number of these Tier Ones.

So -- and we actually think we will do better in 2013 than 2012. So Scott, I think that does reflect our perspective on that.

Okay.

Thanks, Scott.

Ehud Gelblum, Morgan Stanley.

Hi, thanks, guys. Just a few clarifications and some questions. First of all, on the switching side, can you give us a breakdown as to how much of that was 5400 versus CoreDirector?

Then Jim, are you still looking at an 8% to 10% long-term operating margin? And if so, can you give us a sense as to what the revenue run rate looks like when you get to that level and what the gross margin looks like, given that you are now looking at a high $180 millions OpEx level?

Then your strength in orders is very impressive this quarter and the backlog is very strong. What I wonder is, given that salespeople seem to get paid more immediately for orders booked in the fourth quarter than they do in any other quarter, how do you get comfortable with order strength going forward and that salespeople didn't perhaps bring orders forward into the fourth quarter, and that we might be looking at lower order quarters for the next couple quarters? How do you get your arms around that and feel comfortable?

Let me start with the CoreDirector versus 5430 situation. Over the course of this year, as we have begun to ramp 5430, we are seeing a number of customers begin to adopt that platform who are currently CoreDirector customers. Now, we are still seeing CoreDirector deployments and we think we will continue to see that, as there are a number of CoreDirector chassis out there that still have cards yet to be deployed.

And there are some applications in which, if you have an existing CoreDirector network, it makes sense to continue to put CoreDirectors in. But that said, the overall trend now is that we are beginning to see the revenue mix tip in favor of 5430 as we look forward, because more customers are beginning to deploy that platform as opposed to traditional CoreDirector in some applications.

And most of our new customers -- and remember that about half of our current 5430 customer base aren't current Core Director customers -- are really deploying exclusively 5430. And we expect that trend to continue.

With respect to the operating model, we are still committed to getting to 7% to 10%, which is the goal we set for ourselves here a couple years ago. It has taken longer to get there than we expected.

We said then that we had to have three things in order to get there. We had to grow our top line, we had to improve our margins, and we had to hold our OpEx tight. I think we have done a very good job of holding our OpEx. We can't hold it flat forever.

We have to attend to resource allocation and competitive compensation and those kinds of things, so we are increasing our OpEx a bit this year. But we don't think that over time that those kinds of increases are going to inhibit us from getting to a 7% to 10%.

That means that we have to see top-line growth and we have to see a bit of margin expansion. We've commented upon that this year already.

But in terms of your third question, in terms of the order flows, Q4 is typically a strong quarter for us for orders just because of the placement of the quarter. But if we step back and look at throughout the year, we actually had strong orders throughout the year. We had over $1 billion in orders -- $2 billion in orders throughout the year.

And also, we are looking at our pipeline for the year, which continues to increase. So we look at all of those factors when we think through in terms of our future performance. So I think we feel pretty positive around what we're seeing on the order side.

Thank you, Gary.

Jeff Kvaal, Barclays.

Yes, thanks very much. Can I ask you about the converts payoff that you are scheduled to make this year? Could you talk about what your plans are for paying that off and how you might fund that? Thank you.

Yes, Jeff. As you know, we can't give you our plans about our balance sheet; but what I would say is that we have improved our balance sheet this year. We have a cash balance of just about -- or just under $700 million. We are in condition to pay it off with cash if we choose to do that.

And the other thing is that as our performance has improved, the range of capital markets opportunities available to us has increased. We did an asset-backed loan this past quarter, which is just an indication of the fact that the capital markets are opening up to us. We don't have to rely on the kind of equity-backed instruments that we have in the past.

So I feel great about our balance sheet. We are going to continue to see it improve through time. And if we choose to pay those converts off with cash we are certainly in a position to do that.

Okay, so all options are on the table then for that payoff this year?

Well, they always are. All of the balance sheet options are always available to us.

We are clearly going to do something that is going to be good for shareholders. That is our intention as we manage our balance sheet going forward.

I think we have done that in the past. We will continue to do so.

Thank you, Jeff. We will take one more question, please.

Amitabh Passi, UBS.

Hi, thank you for squeezing me in. Just a couple brief ones for me. Can we get an updated customer count for your 100-gig and 5400?

And then, Jim, wondering if you had any thoughts on your cash flow outlook for fiscal '13?

Yes, let me -- on the 5400 we had, I think, four new customers in the quarter for 5400.

Yes, total of 23.

Total of 23. And then on the 100-gig, I think we increased that to over 50 customers for our 100-gig coherent carrying live traffic.

As far as our cash flow situation, we do expect to generate cash from our business in 2013, and our cash balance at the end of the year is going to depend upon what we do with respect to 2013.

Okay. Appreciate it. Thank you.

Thank you, everyone. Appreciate your time today. Happy holidays. Don't forget our Chalk Talk next Tuesday the 18th at 12.30 p.m. Eastern. Look forward to seeing everyone there.

Thank you, ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.