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Executives

Suzanne DuLong - Chief Communications Officer

Gary Smith - CEO and President

Jim Moylan – CFO

Steve Alexander - Chief Technology Officer

Analysts

Scott Coleman – Morgan Stanley

George Notter – Jeffries

Ehud Geldblum – JP Morgan

Paul Silverstein – Credit Suisse

Nikos Theodosopoulos – UBS

Mark Sue – RBC Capital Markets

Vivek Arya – Merrill Lynch

Samuel Wilson – JMP Securities

Simon Leopold – Morgan Keegan

John Marchetti – Cowen and Company

Todd Koffman – Raymond James

Subu Subrahmanyan – Sanders Morris

Ciena Corporation (CIEN) F4Q08 Earnings Call December 11, 2008 8:30 AM ET

Operator

(Operator Instructions) Welcome to the Ciena Corporation Fourth Quarter 2008 Results Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to the Chief Communications Officer, Ms. Suzanne DuLong.

Suzanne DuLong

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

Our call this morning will be presented in four segments. Gary will provide some brief introductory comments, Jim will review the financial results for the fourth quarter; Gary will then review our progress and discuss our outlook and strategy, Jim will conclude our prepared remarks with guidance for Q1. We will then open the call for questions from the sell side analysts. This morning’s press release is available on National Business Wire and First Call and also on Ciena's website at www.Ciena.com.

Before I turn the call over to Gary, I’ll remind you that during this call we will be making some forward looking statements. Such statements are based on current expectations, forecasts, and assumptions of the company that include risks and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed in our 10-Q filed with the SEC on September 5, 2008.

We have until December 31st to file our 10-K for the year end and we expect to do so by then or before. Ciena assumes no obligation to update the information discussed in this conference call, whether as a result of new information, future events or otherwise.

Gary Smith

Despite the disappointing Q4 with 16% annual revenue growth and significant investments in our business fiscal 2008 illustrates our continued strategic and financial progress in spite of an increasingly difficult macro environment. Our achievement is a direct result of continued capacity demands and our customers need to transition to more efficient service driven networks, both of which are key drivers for a longer term network investment cycle.

We are currently operating the business under the assumption that while the environment could get more difficult in 2009 it will not worsen significantly for the markets that we address. While we expect to make strategic investments for the long term during this period of uncertainty our goal is to balance this with managing our business to be profitable on an as adjusted basis in fiscal 2009. We intend to do so by prioritizing R&D and sales related investments to maintain or improve our competitive position, while carefully managing other operating expenses.

If we get indications that our current assumptions about the industry environment are incorrect then we are prepared to pursue additional alternatives to reduce costs. Either way we’re confident that our differentiation in the market positions us as a key strategic partner to our customers during what is likely to be a critical transition period.

I’ll review our progress in more detail and discuss our outlook following Jim’s review of the quarterly results.

Jim Moylan

I’ll start by repeating Gary’s comment that we have made meaningful financial and strategic progress in fiscal 2008. As he noted, however, the past few months have been challenging. This morning we reported fourth quarter revenue of $179.7 million. This represents a decrease of 29% sequentially and 17% year over year. We had three 10% plus customers in the quarter that combined to represent 50% of total sales. Two of the 10% customers are North American based and one is international. All three were 10% customers in Q3 as well.

For the fiscal year AT&T and BT were 10% customers representing 25% and 13% of total revenue respectively. Combined they represented 38% of the fiscal years total revenue. Sales from international customers represented 47% of total revenue in the quarter up from 38% in Q3. We break out our revenue by three major product groups.

As part of a re-branding effort we’ve renamed our converged Ethernet infrastructure group. It is now our Optical Service Delivery product group. The components of the group remain the same. It includes transport and switching products as well as Legacy data networking products and related software. Optical Service Delivery accounted for $137 million in revenue representing 76% of total revenue for the quarter.

Within Optical Service Delivery revenue from our CN 4200 Advanced Services Platform increased 42% sequentially and was the largest single contributor to the quarter at $59 million. Our CN 4200 progress was offset by sequential declines in other areas. Core switching contributed $38 million in revenue in the quarter. Long haul transport added $28 million.

Our second product group Carrier Ethernet Service Delivery includes service delivery and aggregation switches acquired from World Wide Packets as well as Ethernet access products, broadband access products and the related software. For Q4 Carrier Ethernet Service Delivery contributed $12 million in revenue or 7% of our total. Revenue from products gained through the acquisition of World Wide Packets contributed $4 million of the group’s total revenue.

Finally, our Global Network Services group which includes all of our services related offerings was $30 million in revenue or 17% of the total for the quarter.

In the remainder of my comments today I’ll speak both to the GAAP results and to what the results would have been if we excluded those items detailed in the press release. Turning to gross margin, Q4 GAAP gross margin was 45% adjusted for share based compensation and amortization of intangibles Q4 gross margin was 46%. Our GAAP product gross margin for the quarter was 49%. Our services gross margin was 24% just slightly below our target mid 20s range as a result of the mix of service revenue in the quarter.

On a GAAP basis Q4 operating expenses totaled $112 million. Included in these expenses is a restructuring charge of approximately $1.1 million principally associated with severance costs following a targeted headcount reduction of approximately 60 employees during Q4. Adjusted for the non-operating and/or non-recurring charges detailed in our press release issued earlier today our operating expenses totaled $96.2 million resulting in an as adjusted operating margin of -7%. Q4 as adjusted G&A operating expenses also include roughly $2 million of non-recurring one time charges.

Our Q4 GAAP net loss was $25.4 million or a loss of $0.28 per share. Adjusted for the unusual and/or non-operating items discussed previously our fourth quarter net loss would have been $9.2 million or a loss of $0.10 per share.

Turning now to cash flow and the balance sheet, with respect to cash we were slightly cash flow negative in the quarter using $4.6 million in cash from operations. During the quarter we repurchased $2 million in principal amount of our outstanding 0.25% convertible senior notes in an open market transaction. We used about $1 million of our cash to affect this repurchase which resulted in a gain of approximately $0.9 million.

Our balance sheet remains strong. We have $1.1 billion in cash, short term and long term investments at the end of the fourth quarter. For Q4 our accounts receivable balance was $138 million which is flat with Q3. Day sales outstanding were 69 days, up from Q3 49 days, as a result of product acceptances by customers that were weighted toward the back end of the quarter. We continue to expect our DSO range to normalize between 55 and 65 days going forward.

Given revenue uncertainty we are closely managing our inventory position which resulted in a 14% sequential reduction to $93 million in Q4 compared to $106 million in Q3. Product inventory turns were 3.2 times in the quarter down from 4.1 times in Q3. The inventory breakdown for the quarter was as follows: Raw materials $19 million, work in progress $2 million, finished goods $96 million and a reserve for excess and obsolescence of $23 million.

Before I close, a quick update on taxes and our $1.2 billion deferred tax asset. As discussed in previous quarters we have accumulated substantial tax deductions from our operations and acquisitions which can be used to offset future tax payments. We continue to regularly evaluate this asset which as you all know we have fully reserved against in the past due to our GAAP loss for the quarter we did not release any portion of the valuation allowance in Q4.

Finally, as of October 31, 2008, our worldwide headcount was 2,203. This is down from Q3, 2,210 reflecting the net affect of the headcount reduction I mentioned previously as well as some strategic hiring.

Now I’ll turn the call back to Gary.

Gary Smith

When we addressed you at this time last year we made a commitment that 2008 would be both a year of focus and leverage for Ciena. Despite the unforeseen economic challenges I think we progressed on our goals throughout the year predominantly in three key areas. While we’ll have to wait for the December results to come in, it’s likely that at 16% annual growth we continued to grow faster than the market.

We also made significant improvements in our operating model ensuring that we maintain the financial strength and flexibility to perform as an agile global enterprise and we continue the evolution of our service delivery portfolio.

I understand that the challenge ahead is very different from where we’ve just come. Still I think the fact that we delivered on several important financial and strategic metrics in fiscal 2008 and before means that our business is well positioned to weather a tough environment.

To recap on some of those we expanded our global footprint, increasing our international contribution to roughly 35% of sales. We attained an annual overall gross margin of 51%. We maintained an as adjusted income from operations of 11% of revenue while investing in our R&D and sales activities. We generated $117 million in cash from operations.

On a global basis we made significant progress in further penetrating our customer base and forging new relationships across multiple segments. In the service provider space we established strategic partnerships with three Tier 1 global carriers for our Carrier Ethernet Service Delivery platforms. We landed key contracts in the US, Europe and Asia for our Core Director Mesh Software platform. We drove considerable momentum in the MSO space globally and we reinforced our position in mobile backhaul with a high profile 4G WiMAX network build.

In Enterprise and Managed Services we increased penetration of our Carrier managed services solution with large incumbent and competitive carriers across the globe. We strengthened our involvement in the government space as well as in the global research and education community. We scored several wins in the financial services and healthcare verticles.

Our product portfolio at the end of 2008 is also much deeper and broader. We successfully completed the acquisition of World Wide Packets, expanding our Carrier Ethernet Service Delivery portfolio. We also entered the emerging Packet Optical Transport space with our G10 modules for the CN 4200 platform. These enable layer two Ethernet aggregation switching and transport. Above and beyond that we progressed on software enhancements to our service aware operating system and made significant progress on the further development of 100G technologies.

As we move forward in 2009 however, I’d like to address the concern that some have expressed that today’s conditions are in fact similar to those that we faced in 2001 and 2002. Today’s industry landscape is in our view profoundly different from that period. At that time, demand was driven by speculation, driving excessive network builds and overcapacity and with a disregard for economic fundamentals. At that point in time I think we faced a multi-year recovery.

Today, demand is real and driven by innovations in both services and applications. We’ve seen a return to market fundamentals and most top Tier 1 services providers are in fact financially healthy. For several years now services providers have been adding capacity to their networks when and where they need it so there is in fact not overcapacity for them to leverage. As a result, we believe we are facing a multi-quarter recovery is how we would characterize it.

Notwithstanding recent industry reports about technology by groups and the reality of volatility for at least the next year, traffic demand remains the fundamental CapEx driver in our business and that demand curve has not taken a dramatic turn for the worse. By our analysis we are roughly $8 to $12 billion into what is forecast to be a $70 to $90 billion infrastructure spend targeted at the transition towards efficient Ethernet based multi-service networks. That is expected to last for the next decade at least.

I’ve talked to why we’re well positioned and we’ve proven our ability to execute. The question is how will we address this period of uncertainty and volatility in 2009? As I said in my introductory remarks we’re operating the business with the assumption that while the environment could get more difficult in 2009 it will not worsen significantly. If we get indications that our current assumptions about the industry environment are incorrect then we are prepared to pursue additional alternatives to reduce costs.

In the meantime our focus is on managing to profitability and positive cash flow for the year while preserving our competitive advantage, to do that we need to make progress from Q4.

Let’s review where we are and what we’re seeing. Firstly, we continue to see push outs and project delays not cancellations and perhaps more importantly we maintain solid relationships with our customers who are telling us that we are in fact closely aligned with their strategic focus and business priorities.

Secondly, we continue to experience carrier specific issues that will take some time work through. Thirdly, we believe we have a portfolio and business model that will enable us to maintain gross margins in the mid to high 40s. Fourthly, we’ve already taken actions to reduce our operating expenses and we’ll continue to scrutinize and tighten spending, prioritizing as the environment dictates.

There’s no question that we’re working to strike a balance here and in a volatile environment and we acknowledge that that will not be easy. However, we’ve worked hard to establish a solid business model and we’re focused on preserving that model going forward. Ciena is in a very different position today than we were in 2001 with proven experience and successfully executing our network specialist strategy we are stronger and more mature with an established market position and a broader customer base and portfolio.

As a result of the progress we’ve made in strengthening our business model we also have substantially more operational flexibility. That gives us the ability to make different decisions than we did back in 2001. We will continue to think and act for the long term but in the past we were faced with bet the farm kind of scenario that is not the case today and we will make decisions accordingly.

Jim Moylan

I’ll conclude our prepared remarks today by speaking to guidance for Q1. I’ll remind everyone that the statements we’ve just made and those than I am about to make are forward looking and its important to understand them in the context of the risk factors detailed in our SEC filings.

As we said in the press release at this time our best estimate is that our fiscal first quarter 2009 revenue will be in a range of $170 to $185 million. On gross margin, as we’ve said previously, gross margin is difficult for us to predict with accuracy and we expect it will continue to fluctuate from quarter to quarter due to product mix.

Based on our visibility and to expected order flow and product mix we believe our Q1 gross margin will be above Q4 and within a mid to high 40s range. Given the actions we took in Q4 and our approach to managing toward profitability we expect Q1 operating expenses to be down in absolute dollars from Q4. Reflecting declining interest rates we expect other income and expense net in the first quarter will be around $2 million.

Touching briefly on our tax position, as I mentioned previously we did not reverse any portion of our deferred tax asset during the quarter. Finally, we estimate Q1 diluted share count at approximately 112 million total shares. On an as adjusted basis we estimate our EPS break even is roughly at the mid point of the revenue range guidance we provided.

We’ll now take questions from the sell side analysts.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Scott Coleman – Morgan Stanley

Scott Coleman – Morgan Stanley

If we could just start with your comments about not expecting the environment to worsen significantly from here, obviously the visibility is very low, I think you said that yourself. What gives you the confidence to say that at this point in the cycle as carriers are just starting to set their CapEx budgets?

Gary Smith

What we’re seeing out there right now is mixed signals. I think amongst the larger Tier 1 carriers who are in good financial health they are very focused on their strategic investments and I think we’re well aligned with those. I think they are certainly at this stage committing to roll those out because I think that’s their strategic direction in terms of new service creation and in terms of reducing their operating costs by moving to a more efficient way of carrying bandwidth.

We’re seeing amongst Tier 2, Tier 3 a more perhaps negative scenario around that. They are, I think some of them focusing on using their legacy infrastructure more than shifting to next gen architecture. We’re seeing a mixed environment. Clearly there’s the potential for the market to get worse. I would say that we’re not particularly seeing that right now, it’s bad enough, thank you very much. We’re certainly seeing the decline in the environment like everybody else.

Scott Coleman – Morgan Stanley

If I could follow up on your gross margin guidance, product gross margin is down four points, service, gross margin is down about 1,000 basis points, 10 points this quarter. Do you expect both of them to improve in Q1?

Jim Moylan

Yes but we expect both will improve in Q1. As we’ve said in the past we do have a fairly wide range of margins in both our product and services portfolios. We can see these kinds of movements and we expect we will see these kinds of movements.

Operator

Your next question comes from George Notter – Jeffries

George Notter – Jeffries

I’m wondering why you wouldn’t elect to be more aggressive in cutting operating expenses right now. You mentioned that you don’t expect the environment to significantly worsen in ’09 but given the size of the miss here relative to your prior guidance and given where you’re guiding for Q1 I guess I would pose it that maybe the environment has changed for the worse and maybe you’d look more closely at that, any thoughts on that comment?

Gary Smith

Our premise really is that this will not be a multi year downturn. Certainly I don’t think we’ve seen anything so far that would lead us to change that fundamental premise. That being said, I think the environment has deteriorated since we talked about the environment that we saw in Q3 I think for sure. We’re working a balance here, we did reduce our operating expenses in Q4 as Jim said and we’ll continue to look at that carefully moving forward.

George Notter – Jeffries

World Wide Packets it looked like it was at the low end of our expectation here for Q4. What’s your thought on that piece of the business going forward, what kind of revenue expectations do you think you can produce in 2009?

Gary Smith

It was certainly below our expectations in Q4; it came down from a reasonable Q3. A couple of things I’d say about it, one I think its still a nascent market and it’s a new one for us as well. We feel very good about the portfolio development and the traction in the pipeline is in fact increasing for that portfolio. We’ve secured three Tier 1 carriers for the CESD offerings and we feel good about that moving forward, disappointed in the short term revenues. I think that’s also seeing struggling for some of the headwinds from the overall macro space as well.

Operator

Your next question comes from Ehud Geldblum – JP Morgan

Ehud Geldblum – JP Morgan

In the guidance that you will be at least break even or so at the mid point of your new guidance given that you basically on a revenue basis were there this quarter the only way you can do it obviously is like you said higher gross margin, lower OPEX.

Can you give us a sense as to as you close the gap between your negative operating margin this quarter and a break even next quarter at roughly the same revenue run rate, not saying that is the revenue you’ll have, but if you were to do that is it more the gross margin goes up and OPEX is down a little bit or is OPEX going to be down $3 to $5 million from that $96 million and the gross margin up less? Can you give us a sense how much improvement you’re getting from gross margin next quarter versus how much we’re getting from OPEX to get us closer to break even?

Gary Smith

I don’t want to be precise on that because both of those numbers can move around a little. I would say that in our numbers we expect reasonable contribution of similar size from each of those elements. Within our OPEX we do have some variable comp that works depending upon the level of revenue. We have some other things. I would say this; we’re very tightly controlling our OPEX. People are focused on maintaining our strategic investments and competitive position in the R&D space and also maintaining our investments that our customer facing while focusing on every single other element of OPEX.

Ehud Geldblum – JP Morgan

You said acceptances were very back end loaded and that’s what made accounts receivable stay flat on an absolute basis and day sales move up and at the same time you said that you’re not seeing cancellations, you’re seeing push outs. Is there a relation between those where people not accepting things until the end of the quarter because weren’t sure if they could afford them and they wanted to possibly push them into next year?

What can we learn or glean from the acceptances being so back end loaded? How are you comfortable that these projects that seem to be pushed out and delayed and accepted only at the end of the quarter, how do you feel comfortable that they’re not really cancellations?

Gary Smith

Certainly in this environment we’re sure to be paranoid around that. When we looked at the quarter it was always going to be tail end loaded from a perspective of installations being completed so that we could get the acceptances. It’s just an artifact of the rough and tumble and timing of some of these projects. We’ll continue to watch that with great scrutiny but we’re not reading more into that at this stage because some of the chunks that were identified that were recognized later in the quarter were in fact that’s when they were scheduled to be recognized and it wasn’t a function of customer discretion.

Ehud Geldblum – JP Morgan

Do you expect that to reverse next quarter possibly then?

Gary Smith

We would expect our day sales come down next quarter.

Ehud Geldblum – JP Morgan

So you could generate cash next quarter?

Jim Moylan

It depends on our revenue level. I wouldn’t say a big reduction but we think 69 is a number that we’re going to do better on.

Ehud Geldblum – JP Morgan

As you look to see when you have to do what with respect to how things change are you looking more to EPS and profitability on the operating income line or are you looking to break even cash flow as long as you’re not burning cash you’re fine with keeping the current operating model or is it more the EPS.

Gary Smith

Both are pretty tightly aligned. I would say we’re focused on both. I think it’s important that we continue to generate cash as a business, maintain a strong balance sheet even during this period of volatility. I think it’s important that we maintain our business model around profitability on an as adjusted basis, I think that’s key. The things that we look at are order flows, customer dialogue, order pipeline, customer forecasts and all of those things taken into consideration when we look at aligning our operating expenses to the market.

Operator

Your next question comes from Paul Silverstein – Credit Suisse

Paul Silverstein – Credit Suisse

Can you give us some sense of the sensitivity to volumes versus mix in terms of how that impacts gross margin? Can you give us any update with respect to the roll out at AT&T World Wide Packets the timing of that as well as the timing of the next generation core director? On the OPEX line can you give us some sense when you say its going to be down what magnitude are we talking about? I assume at this point you have a pretty good idea of where you want OPEX to come out.

At the risk of being unfair if we dial the card back to the 2000, 2001 period when I think the mantra back then was that you guys were going to power through it, it was going to be that longing while everybody else is cutting OPEX you come out the other side in a much better position from a product technology standpoint. Any lessons learned you’re talking now about a multi quarter as opposed to multi year what if it turns out to be more severe than what you’re talking about right now and why shouldn’t we believe that?

I think we all understand the bandwidth growth story etc. but if we go back in time I don’t think anybody was expecting the severity that we ended up with back then as well.

Gary Smith

We absolutely could be wrong, there’s no doubt about that. I think it is a very different environment from a customer market point of view. There’s not the overbuild of capacity, of that I think we’re all very sure. There is real demand for capacity growth in all the applications that we see with increased mobility increased video on the network.

I think those are real things, clearly it’s not immune from some of the dramatic global economic issues that are happening and it may be that the growth of that traffic will slow, a perfectly reasonable scenario. I think it’s incredibly unlikely to stop growing but that’s a premise and we certainly could be wrong with that.

I think the environment is very different; we’re in a very different position than we were then and I’d characterize it simply then we were basically a single product company with a couple of large customers. We really had to bet the farm that the market would turn out to be a converged Ethernet mesh architecture market and we had to basically bet the farm. We also had to restructure the business at the same time. We were 100% manufacturing, we had very little operational flexibility. Then we were taking much longer path to profitability.

As we fast forward now I think over the last three to four years we’ve executed on our strategy. We’ve got to a more normalized business model. We still have customer concentration for sure but we’ve got multiple Tier 1 customers and spreads into broader geographies and markets as well. What that gives us is the ability to be more agile around responding to what the market realities may turn out to be.

Clearly I think this has taken everybody by surprise, the magnitude and the last half of 2008. We’ve been able to respond to that somewhat and we’ll continue to be aligned around what we see is the market reality but I would say that we have more flexibility to manage our operating expenses than we had in 2001 and 2002 as we navigated through that period.

I wouldn’t say it’s easier but I would say that we have more levers and we’re much broader balanced business than we were then which is why our goal now is to focus on profitability. Out goal then was to focus on creating a business model at some point in the long term future. That’s how I would characterize that.

Jim Moylan

Our gross margin is much more dependent upon our mix than it is on volume. As you know, we’ve outsourced most of our manufacturing and so we don’t have big manufacturing overheads that affect margins as our volume comes down. The answer is mix. With respect to OPEX, I would have to say, as I said earlier, that we do have an amount of variable comp that’s in our OPEX that varies per our revenue and profitability. That can move around.

The best way to answer the question is the way I answered Ehud’s question when you look at what combination of things are going to impact the fact that we think we’ll move to a break even at roughly the same revenue range as experienced in Q4 its very much a mix of expected margin improvement and OPEX reductions. We did have, as we said, a couple of run offs in Q4 that won’t recur and that’s about $2 million.

Paul Silverstein – Credit Suisse

On the OPEX issue how much variability could there be through the balance of the quarter relative to what you’re currently projecting?

Jim Moylan

I can’t be specific as to a number. What I’ve said is that, if you run the numbers on what we have to do to get to a break even number you’re talking in the high single digit numbers made up between margin improvement and OPEX decline. We are focusing very tightly on our OPEX, we’re maintaining R&D investment, our customer facing resources and we are going to manage OPEX as tightly as we can.

Paul Silverstein – Credit Suisse

An update on World Wide Packet, is AT&T and the next gen core director?

Gary Smith

It’s on track and progressing well and we expect to have revenues second half towards the end of 2009 that that’s progressing well.

Steve Alexander

As far as the evolution of a core director the next gen that’s coming out comes out in our 5400 series. It’s a large complicated project but it inter works very nicely with the existing core director infrastructure. ASICs are in, boards are being turned up, we’ve got the first of the OTN SNC’s up and running and the only two mesh protection and such.

You’re starting to see couple pieces of the strategy come forth in terms of that box was built for 100 gig kinds of transport infrastructure and it’s a switch fabric that’s designed from the ground up for that kind of an environment. It dovetails in very nicely with some of the improvements we’re making on the transport space expecting the 100 gig transmissions. It’s nominally on track.

Operator

Your next question comes from Nikos Theodosopoulos – UBS

Nikos Theodosopoulos – UBS

On the 4200 and the core director, the 4200 was quite strong this quarter and I’m trying to understand was that one or two customers with big deployments, is it more broad based then how should we think about that going into next year is this just lumpy on the positive side this quarter or is this a more broad based customer base that you could get recurring revenues from?

Gary Smith

It’s a broader base of customer and it’s also some of the new functionality that we’re adding to the platform as well.

Nikos Theodosopoulos – UBS

In this quarter it wasn’t driven by one or two customers the sequential increase?

Gary Smith

Not specifically.

Nikos Theodosopoulos – UBS

On BT you had a strong second half there, how do we look into that, is that a new run rate or is it more a reflection of the winding down of that project and finishing it up? How do we look at the BT situation being that they were quite strong in the second half?

Gary Smith

There are two elements really to that business, one is the well publicized 21CN and that can be quite lumpy. There are also other businesses that the non-21CN businesses in the global services and managed services business as well that cadence is a little more consistent as the combination of the two. I wouldn’t read too much into the strong second half I just say it’s a lumpy business. There’s a long way to go in that project yet.

Nikos Theodosopoulos – UBS

On your guidance on the DSOs and gross margin as you have your discussions with your Tier 1 customers has there been any change in the last three to four or five months on aggressiveness on their part in terms of extending payment terms or more than normal price reductions. When I look at your guidance in those areas it doesn’t seem to be changing I just want to make sure you’re not getting beyond the normal pressure that you normally get on payment terms and pricing.

Gary Smith

As you said, our customers are always asking for better terms and we are competing with some tough competitors out there. We don’t see, as we sit here today, a big change with respect to our contract terms nor really our pricing.

Operator

Your next question comes from Mark Sue – RBC Capital Markets

Mark Sue – RBC Capital Markets

If things are not improving with Tier 1 it’s still deteriorating with Tier 2 and 3 was it just it could be at least a year until things get better since the net of it’s still a decline. Could you help us understand those moving dynamics between the two customers?

Gary Smith

Its very volatile situation and volatile market but our view is this is going to be 2009 looks challenging for sure but quite how long and quite what the combination of that is from Tier 1 and Tier 2 its really difficult to predict.

Jim Moylan

To reiterate what Gary said earlier, it is difficult to predict, it is uncertain, we’re managing the business with a certain premise about how the year is expected to turn out. If things get worse we will adjust our OPEX and we do have the levers to do it.

Mark Sue – RBC Capital Markets

Considering the installed base and the current utilization rates at the Tier 1 is it your thoughts that generally things will improve and come back to the Tier 1 but the Tier 2 and 3 its still a piece of business that you have to fight for so its something that you might not necessarily come back in a year.

Gary Smith

I think it’s mixed even amongst what we’d classify as the Tier 2. We’ve got some pretty healthy Tier 2 that have strong balance sheets and are seeing good business. We’ve got others where that’s not the case. We’ve also got some balance into government business, into the enterprise in different parts of the enterprise carrier managed services in different geographies as well that are new to us that are actually performing reasonably.

That helps give us a little bit of ballast for want of a better expression in the business. It’s a mixed bag of things that we’re seeing. The core Tier 1 are at least thus far committed to funding and rolling out their critical path investments and I think we’re pretty well aligned with that, things like global mesh, things like Ethernet business services and things like Ethernet wireless backhaul.

Operator

Your next question comes from Vivek Arya – Merrill Lynch

Vivek Arya – Merrill Lynch

I’m trying to get a sense for how profitable you can be in fiscal ’09. Last year, for instance, you had several large projects including this CN 4200 deployment at BT core director at AT&T, Verizon, long haul at Quest, etc. Next year you will probably not have the recurrence of these large projects. Also I don’t sense any big movement in gross margins or OPEX. How much more profitable can you be relative to your Q4 levels? Is it possible that you’re just around break even EPS for the next two quarters?

Gary Smith

If I knew what we could be in 2009 I’d clearly be trying to articulate that. We haven’t got much visibility in this huge amount of uncertainty which is why we’re only really talking about the next quarter. I will say that I think we can be more profitable that we were in Q4 for sure. That absolutely is the intent. We want to be clear about that. We’re in a very different environment than we were, we’re a different company and we’re going to manage differently.

I think we can get to profitability moving forward in 2009 even if it turns out to be most likely a very challenging year. We have, as Jim said, the levers to do that from an operating expense perspective and we’ll pull which ones we think are appropriate to align ourselves to make sure that we’re profitable. I think our gross margin is holding up pretty well is testament to our value proposition and our customer relationships. Our operating expenses we’ve reduced coming in to Q1 and we’ll continue to pull the appropriate levers.

Vivek Arya – Merrill Lynch

If you look at some of the new products that you’re working on for example the next generation core director how should we think about that? Is that just a replacement of your current core director product or do you think that will help you expand the market also?

Steve Alexander

That will actually dramatically expand the market. It’s not only a bigger switch; it’s coming out in a family format so there are several different sizes. It’s a portion of what we call a full service metro as well as a core mesh infrastructure. It has a flexi ports on it that we have had such success with the 4200. It really lets us bring one family of products into multiple markets simultaneously.

Vivek Arya – Merrill Lynch

Recently Bell Labs won a deal in the British Telecom 21CN network I realize that its obviously not the same application that you are selling, the CN 4200 into. How do you see competition in some of your key accounts? For example, Fujitsu coming in at Verizon, Bell Labs coming in at BT. Do you sense any change in competitive dynamics?

Gary Smith

It continues to be challenging but in the areas that we’re focused on in the specialty areas that we’re positioning in and the value propositions that we have I don’t think we’ve seen any appreciable change. We have great relationships in the spaces that we’re in. We continue to see very good traction with Verizon, AT&T, BT, France Telecom moving forward in spaces, Telemax, etc.

We feel confident about the relationships and with the fact that we’ve been able to invest in the last few years we’ve got a lot of new platforms and features functionality rolling out over the next 18 months that I think will help us. In fact, expand our footprint as other people didn’t put that investment in and are struggling to roll out new platforms and offerings. We feel we’re pretty well positioned.

Vivek Arya – Merrill Lynch

Do you expect spending to resume first at the US carriers or at European carriers?

Gary Smith

It’s tough to tell. This is a global phenomenon for sure. We first saw it in North America and it spread pretty quickly. I described it then as I think I would describe it now as just increased scrutiny of CapEx. They’re not canceling projects they’re just postponing, delaying and pushing them off. It’s really across the board and I think what carriers are clearly struggling with as we all are is very fast unfolding economic implosion and really how they manage that.

I will tell you that in all of the conversations with key executives in our large customers they are all continuing to see traffic grow, strong traffic growth both in terms of mobile, in terms of backhaul, in terms of video. What they are doing is focusing on prioritizing their spending. Amongst the bigger guys it’s less focused on the legacy stuff, how quickly can they transition their networks to Ethernet, IP, and global mesh type architecture.

You could certainly be accused of accentuating the positives you could even say that this environment could speed up the movement towards those kinds of architectures. I think that’s balanced with a number of the smaller players who don’t have that ability who probably will stay in the legacy world for perhaps longer.

Operator

Your next question comes from Samuel Wilson – JMP Securities

Samuel Wilson – JMP Securities

Of your $150 million in product revenue this last quarter how much of that just roughly do you think is maintenance break fix type of product and how much do you think is going into continued capacity build out?

Gary Smith

It’s a tough question to really answer given the nature of the platforms. Most of it is aligned with capacity, I would say that. An awful lot of it is success based, its not lets go build this infrastructure. Build it and they will come I guess that’s a good analogy back to 2001 we don’t have much revenue tied to that. There’s a little bit of it where folks are making strategic decisions to shift across things. Most of it I would say is predominantly driven by the desire for capacity and to create new services.

Operator

Your next question comes from Simon Leopold – Morgan Keegan

Simon Leopold – Morgan Keegan

If you could talk about your expectations for your CapEx spending in fiscal ’09? In the past you’ve talked about not necessarily buying back your own debt given where it’s trading if you could give us an update on that? In terms of product mix this was a pretty dramatic mix shift this quarter I know you tend to have lumpiness but this seemed to be a bit more so. If you could speak to your mix assumptions and the guidance for the January quarter and what kind of trends are underlying that.

On the Carrier CapEx budget release I’m wondering how much of your guidance reflects a concern that there’s a delay in budgets being released in January given a lot of the trend here, how much of that is incorporated into your forecast.

Gary Smith

Its variable but most of the big Tier 1 have got reasonable visibility into their CapEx for the year, I know it can change for the year as they manage it quarter to quarter but we’ve got reasonable visibility amongst our big partners around there. In terms of the product mix shift we’ve gone through this in some detail, clearly internally don’t read too much into that.

For example it’s likely that core director will be back up again in Q1 from Q4, 4200 ought to expect to be strong as well in Q1. The product mix shift even though as you said it was dramatic in the quarter I can point to other quarters even during the year where you’ve had a pretty big shift as well. I again wouldn’t read too much into that it’s just lumpy.

Jim Moylan

On the debt buy back as we said we did buy back $2 million of face amount in the quarter for roughly $1 million. We’ve taken a very measured approach toward that decision and I think we will continue to do so. With respect to CapEx, we spent just at $30 million in fiscal year ’08. We expect it will be at or about that level in the fiscal ’09.

Simon Leopold – Morgan Keegan

I want to go back and get some clarification on the first question, the carrier budgets, I’m not really asking about the full year trends but more about the timing of when they start spending their budgets simply put I’m concerned that there could be a bit of a delay in the month of January money not getting freed up during that month.

Gary Smith

Sorry, I went down a different path. I think that’s a possibility. Clearly people are scrutinizing that, we’ve seen that in one or two instances.

Simon Leopold – Morgan Keegan

That’s baked into your forecast or not?

Gary Smith

That’s baked into our numbers.

Operator

Your next question comes from John Marchetti – Cowen and Company

John Marchetti – Cowen and Company

When you’re having discussions with the Tier 1 carriers and obviously their scrutinizing these dollars do you get the sense that it is more on their side of either being afraid to spend the dollars or is it also that their customers are not coming in with the demand that they’d seen earlier in the year?

On the cash obviously you’ve got a pretty good horde, I know that you’re trying to make sure that you maintain that but how much do you think in normalized times that you need to have on the books? Are we in a situation like we were back in 2001 and 2002 where you needed the very strong balance sheet to reassure customers that you could still service products or is there an opportunity to get a little bit more aggressive with the cash that you have on the books.

Gary Smith

What you’re seeing if I were to characterize multiple conversations with the carrier executives I think they’re really trying to prioritize their spending. Given the economy and the rest of it they’re giving tremendous amount of thought to what they want to invest in and what they don’t want to invest in. I would characterize it at the large Tier 1 they’re very committed and focused on their strategic investments things like wireless backhaul, things like global mesh, and things like Ethernet business services.

They’re committed and focused on those things because that’s what they see is the future both in terms of new service generation and reduced operating expenses for them. They are trying to get off the legacy systems faster. I don’t think, at least I’m really not seeing a sense that they’re scared to spend on those things as all. What they’re seeing from their customers, I think this is fairly well commented on, they are continuing to see incredible traffic growth really driven by increase in mobile, increase in video and just the whole new applications that are coming on.

What they are seeing is a faster decrease in domestic wireline parts type connections I don’t think that’s a surprise at all. What they’re trying to do is now monetize new services and that’s what they’re focused on.

Jim Moylan

With respect to the cash, as we’ve said we intend to manage through this slow down at break even or better and without using cash. That’s our intent. Having said that it’s an uncertain world and things could get worse. Having some amount of cash on our balance sheet is a very nice insurance policy. With the lack of visibility that we have we like having that cash.

We have done some things with the cash in this past year. We did make an acquisition and we used about $200 million of cash. We did buy a small amount of convertibles back. I would say that we are going to be very measured in our approach to using that cash. I’d hope that some day we could get to the point where we could use it to our advantage strategically.

Operator

Your next question comes from Todd Koffman – Raymond James

Todd Koffman – Raymond James

I wanted to get a little more color on the weakness you’re experiencing in the World Wide Packet business it was a relatively recent acquisition that you paid a fair amount and you were pretty excited about it. It seems like that business is coming in slower than you might have thought.

Gary Smith

I would characterize it as we’re very pleased with what we’re seeing in terms of the technology, the people, and the customer engagements. It is not translating to revenues as fast as we would like that’s for sure. It’s been very spotty during the three quarters that we’ve had them in. I will say that customer traction continues to improve and we’ve had some successes there with some pretty significant wins that have not yet translated to revenue.

There are a couple of things around that; one, it is a nascent market where people are looking to create Ethernet business services and its taking longer to get those services to market in some carriers than anticipated. I also think it’s affected clearly by the overall headwinds in the environment as well. I think we’re pleased with what we’ve seen from a technology point of view, we’re continuing to integrate some of that technology across the portfolio. We’ll continue to do so during 2009.

We see a lot of new applications where this can be applicable in places like wireless backhaul, in 4G WiMAX, etc. We are not seeing the revenues that we’d anticipated I think that’s largely a function of the headwinds in the overall industry but also some of the nascent characteristics of this market.

Operator

Your next question comes from Subu Subrahmanyan – Sanders Morris

Subu Subrahmanyan – Sanders Morris

On core director and product mix the down tick in core director was that in any way linked to some of the functionality being absorbed into the 4200 and any other functionality that was absorbed into the 4200 which made that number go up? I realize there’s not much visibility in terms of forecast revenues but as you plan your business for break even or better for the next few quarter is there implicit assumption that revenues do not get worse from current levels, am I reading that right in terms of your commentary earlier?

Steve Alexander

There is no cannibalization between the two product lines, 4200 and core director are now interoperable in the sense that the 4200 can feed to the core director. They actually complement each other and can accelerate each individual platforms acceptance into the markets. They don’t cannibalize each other.

Gary Smith

The way I would address the question is that we haven’t really given guidance beyond the first quarter. We have given a range for revenue and we’ve said that sort of at the mid point of the range which is about what we reported in the fourth quarter we’re at break even. We’ve also said that if we see things deteriorate below this that we can and will take action to try to maintain both profitability and positive cash flow. It’s hard to say the direction of revenue as we sit here today.

Operator

At this time I would like to turn the conference back over to Mr. Smith for any additional or closing comments.

Gary Smith

I’d like to thank everybody for their time this morning and for your continued support in what is clearly a tough environment for everybody. I’d like to wish everybody a happy and safe holiday season.

Operator

This concludes today’s conference we appreciate your participation you may now disconnect.

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Source: Ciena Corporation F4Q08 (Qtr End 10/31/08) Earnings Call Transcript
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