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Executives

Suzanne DuLong - Chief Communications Officer

Gary Smith - CEO and President

Jim Moylan – CFO

Steve Alexander - Chief Technology Officer

Tom Mock – Senior Vice President of Strategic Planning

Analysts

Kevin Dennean – Citi

Paul Silverstein – Credit Suisse

George Notter – Jefferies

Jeff Kvaal – Barclays Capital

Vivek Arya – Bank of America/Merrill Lynch

Blair King – Avondale Partners

Mike Genovese – Soleil Securities

Alex Henderson - Miller Tabak

Samuel Wilson – JMP Securities

John Marchetti – Cowen and Company

Simon Leopold – Morgan Keegan

Todd Koffman – Raymond James

Sanjiv Wadhwani – Stifel Nicolaus

Ciena Corporation (CIEN) F4Q09 Earnings Call December 10, 2009 8:30 AM ET

Operator

(Operator Instructions) Welcome to the Ciena Corporation Unaudited Fiscal Fourth Quarter 2009 and Year End Results Conference Call. At this time for opening remarks and introductions, I would like to turn the conference over to the Ciena’s 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 and Tom Mock, our Senior Vice President of Strategic Planning will be with us for the Q&A portion of today’s call.

This morning’s prepared remarks will be presented in two segments. Gary will review our fourth quarter performance and discuss our outlook, including commentary on our pending Nortel MEN transaction; Jim will review the financial results for the fourth quarter and provide our guidance for Q1. We will then open the call to questions from the sell side analysts. This morning’s press release is available on National Business Wire and on Ciena's website at 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 3, 2009.

We have until December 30th to file our 10-K 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. Today’s discussion includes certain adjusted or non-GAAP measures of Ciena’s results of operations. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today’s earnings release available on our website at www.Ciena.com.

Lastly, as a reminder this call is being recorded and will be available for replay from the investors portion of our website.

Gary Smith

It’s been an eventful several months since we last spoke to you about our Q3 results. From Ciena’s perspective we delivered a solid fourth quarter with stronger than expected revenue growth. We also launched significant products such as our CoreDirector FS and 5400 family. In addition, we’ve made considerable progress in connection with our pending acquisition of the optical networking and carrier Ethernet assets of Nortel MEN business unit.

From an industry perspective we continue to see some signs of stability though it’s unclear yet the extent to which our customers 2010 CapEx budgets will increase from 2009. We do believe, however, that the percentage of CapEx allocated to next generation platforms will increase year on year. I’ll talk to each of these topics in my remarks this morning, before turning the call over to Jim to discuss the details of our fiscal Q4 results and our guidance for Q1 2010.

Firstly, we’re pleased to deliver strong sequential revenue growth in the quarter, outperforming our expectations that revenue would be roughly flat with Q3. Our 7% sequential revenue increase was driven by growth from our Carrier Ethernet Service Delivery or CESD portfolio, our CN 4200 platform, as well as the sequential increase in Core Switching related revenues.

CESD revenue increased more than 30% sequentially contributing $30 million or 17% of the quarter’s total revenue. In this product group we’re starting to see solid traction with our Ethernet Service Delivery and Aggregation products, with nearly 100% of this quarters CESD revenue coming from these platforms.

In addition to business Ethernet service applications, as we mentioned last quarter, we’re also seeing demand for these platforms in support of wireless backhaul. Of particular note this quarter, we recognized initial revenue from wireless backhaul related deployments at AT&T. While this marks an important milestone with this customers, the majority of this quarters CESD revenue came from deployments in support of other customers; including but not limited to a different 4G WiMax related build as well as from a Tier 1 US MSO.

Revenue from our CN 4200 platform was also up sequentially 15% and revenue from our Core Switching platforms also increased 9%. At 45% our non-GAAP gross margin in Q4 was down slightly from Q3 but within our mid to high 40’s target gross margin range. Q4 non-GAAP gross margin was affected by charges of $2.7 million related to modules approaching the end of their lifecycle. Our non-GAAP operating expenses were approximately $90 million. The sequential increase comes on the heals of Q3 8% sequential decline and is up only slightly from Q2 $87 million.

The increase was due almost equally to a combination of; increased commission related expenses due to a strong order flow in the quarter, as well as higher prototype related expenses largely associated with a market introduction of our 5400 family. Overall, we continue to carefully prioritize the investments we believe are critical to our future.

We know there’s a lot of interest about our progress with the Nortel transaction and ultimate integration of those assets. I want to be sure that I address that. First on our progress, last Wednesday at the final sale hearing we received approval on our agreement with Nortel from the United States Bankruptcy Court for the District of Delaware and the Ontario Superior Court of Justice. At this point the transaction only requires one additional regional regulatory clearance and is subject to customary closing conditions.

We believe we are on track to close the transaction as planned in the first calendar quarter of 2010 and at this point we continue to expect the transaction to be significantly accretive as we get into 2011. Most importantly, I’m also pleased to say that customer response thus far has been overwhelmingly positive. While we acknowledge that the parts of Nortel’s business we’re acquiring have been subject to uncertainty for some time now, customers are telling us they feel many of their major concerns are alleviated with Ciena taking these assets. They truly feel, as do we, that we provide the best home for Nortel’s people and technology.

On integration, we recognized the scale of this integration and the scope of work we face in the coming months. Of course, we’re aware of and are taking steps to mitigate the associated risks. While I believe it’s fair to expect a few bumps along the way, we are confident in our ability to conduct our integration activities decisively and with clarity. We’ve been intensely engaged with Nortel in connection with these assets for more than a year, an elongated process that provided us with the opportunity to do extensive due diligence from which to develop a comprehensive and aggressive integration plan.

That plan is now being executed by dedicated and experienced team comprised of internal resources from both Ciena and Nortel and augmented by experts with experience in integrations of this nature and size. This integration team is being led by Arthur Smith in a dedicated role as chief integration officer. I think Arthur is ideally suited to lead these efforts. In addition to his 12 years of Ciena experience in a variety of roles, he is also a former Nortel employee.

We intend to provide a specific integration framework and an associated timeline once we get to closure on the deal. I can tell you today, however, that at closing we expect to have achieved several important milestones including; identifying the leadership team of our combined entity, setting our long term combined portfolio vision with short term priorities, establishing our go to market strategy, and confirming our revised target operating model. In addition, we expect to have all Nortel employees up and running on Ciena systems including such things as payroll and email on day one after closing.

The bottom line is that we firmly believe Ciena is the best fit for these assets. We know the customers, we know the technology, and we share a common expertise amongst our teams. While that natural alignment doesn’t alleviate every risk I think it certainly positions us well for successful integration. In addition, given the carve out nature of this acquisition, Nortel will be providing some transition services in the near term.

We believe the structure of these transition service agreements have enabled us to substantially mitigate many of the more significant risks generally associated with an acquisition, including continuity of supply and service for our customers. Our complimentary portfolios, strong support from the combined customer base, and enthusiasm of our employees will advance us along the successful integration path even faster and more effectively.

Finally, before I ask Jim to review the details of the quarter and our guidance for Q1, let me spend a few minutes discussing the environment and what we’re seeing and hearing from our customers. While we’d of course welcome it, we’re not operating with the belief that we will see any budget flush as it were as we approach the end of calendar 2009. As I mentioned earlier it is unclear yet the extent to which our customers 2010 CapEx budgets will increase from 2009.

We continue to believe that current depressed levels of spending are unsustainable over time, particularly given the combination of traffic growth and new service demands on the networks. In general, we continue to see signs that customers intend to prioritize next generation spend and those are the definitive issues for Ciena. Particularly the spend that is directly tied to new revenue generation or which can be directly tied to enhancing network and operations efficiently.

More so than even a year ago, many of our customers are facing multiple critical network and business priorities, from capacity crunches in the core and wireless backhaul to the need to deliver more cost effective high bandwidth enterprise services. We believe Ciena as a stand alone company is well positioned to address these demands. However, we believe the combination of Ciena and Nortel MEN assets have the leading global equipment provider exclusively focused on converged Ethernet is even better positioned to meet these customer requirements.

In summary, out goal remains as it has for the last 12 months, balancing strategic and sustainable operating performance over time with the disciplined approach to strategic investment longer term. The Nortel transaction presents a meaningful integration challenge. It’s not a challenge that we take lightly but we have made significant preparations and we’ll be focused on executing our plan and ensuring customer engagement and satisfaction throughout the integration process.

Overall I believe we are seeing the early signs of market recovery but I won’t attempt to predict the shape or timeline of that recovery.

Jim, will you talk to the details of our Q4 results please?

Jim Moylan

We reported fourth quarter revenue of $176.3 million representing a 7% sequential improvement. For the year, our revenues totaled $652.6 million. We had one 10% plus customer in the quarter that represented 19% of total sales. That same North American based customers was also our only 10% plus customer for the year, representing 20% of annual sales. Sales from international customers represented 29% of total revenue in the quarter and 36% for the year.

I’ll focus the majority of my remaining comments on our fiscal fourth quarter results, as described in our press release. We break out our revenue by three major product groups. The first group, Optical Service Delivery, which includes transport and switching platforms as well as legacy data networking products and related software, accounted for $120 million in revenue, representing 68% of total revenue for the quarter.

Within Optical Service Delivery our CN 4200 Advanced Services Platform was the largest contributor in the quarter at $50 million up 15% from $43 million in Q3. Core Switching contributed $41 million in the quarter up 9% from $38 million in the last quarter. Long Haul Transport added $21 million down sequentially from $27 million in Q3.

Our second product group, Carrier Ethernet Service Delivery, or CESD includes Service Delivery and aggregation switches, broadband access products, and the related software. As Gary noted, CESD had a strong quarter, increasing more than 30% sequentially in Q3, contributed $30 million or 17% of total revenue. Almost all of this quarters CESD revenue came from our Ethernet Service Delivery aggregation and access platforms. Finally, our Ciena Specialists Services Group which includes all of our Services related offerings was $27 million in revenue, up slightly from $25 million in Q3.

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 our press release. With respect to gross margin, Q4 GAAP gross margin was 44%. Adjusted for share based compensation and amortization of intangibles, Q4 gross margin was 45% which is generally consistent with the last several quarters normalized gross margin.

As Gary noted, that 45% is after a $2.7 million charge related to modules approaching the end of their product lifecycle. That represented 1.5 points of gross margin. Our GAAP product gross margin for the quarter was 45%. Our Services gross margin was 37%, once again, better then our target mid 20’s range as a result of the mix of services revenue in the quarter.

On a GAAP basis Q4 operating expenses totaled $104.2 million and includes stock based compensation as well as $6 million in amortization of intangibles. It also includes $1 million in restructuring related costs. Excluding those items, our adjusted operating expenses totaled $90 million. While this is up sequentially from the last quarter it is down 6% from the same period a year ago.

Our Q4 GAAP net loss was $26.6 million representing $0.29 per share. Adjusted for the unusual and/or non-operating items discussed previously, our fourth quarter net loss would have been $10.7 million which represents $0.12 per share.

Turning now to cash flow and the balance sheet, we have been focused on our working capital management and the disciplined approach we’ve taken has yielded good results. We generated $1.9 million in cash from operations in the quarter and successfully achieved our goal of being cash flow positive for the year. For Q4 our accounts receivable balance was $118 million, down slightly, from $120 million in Q3. Day sales outstanding were 60 days, down from 66 days at the end of Q3.

Given ongoing revenue uncertainties, we continue to closely manage our inventory position. Inventories totaled $88 million in Q4, down from $90 million in Q3. Product inventory turns improved, were up to 3.7 times in the quarter up from 3.2 times in Q3.

The revenue breakdown for the quarter was similar to Q3 as well. Raw materials represented $20 million in inventory, work in progress $1.5 million and finished goods were $91 million. After that we have a balance in the reserve for excess and obsolescence of $24 million.

With respect to headcount, at October 31, 2009, our worldwide headcount was 2,163 an increase of 53 over fiscal Q3.

I’ll conclude our prepared remarks today by talking to guidance for Q1 of 2010. As we noted in the press release, our guidance comments today are limited to our expectations of Ciena’s performance as a stand alone company. They do not reflect the addition of any revenue or expense associated with the acquisition of Nortel’s optical networking and carrier Ethernet assets.

We currently expect a sequential increase in our fiscal first quarter revenue of up to 5%. We also believe based on current expectations about product mix that gross margin will be in our mid to high 40’s target range. We believe our Q1 non-GAAP operating expenses will be roughly flat with Q4. We expect other income expense net in the first quarter will be an expense of roughly $1 million. As for taxes, we expect our tax obligation for Q1 will be solely related to foreign taxes.

Depending upon your assumptions, you may need either our diluted share count or our basic share count. We estimate Q1 diluted share count at approximately 113 million total shares. We estimate Q1 basic share at approximately 92 million total shares.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kevin Dennean – Citi

Kevin Dennean – Citi

I was wondering if you could talk a little bit about the increase in OpEx this quarter. If I recall correctly I think you had guided OpEx in the quarter to come in the low to mid $80 million range. It looks like you came in higher. I was wondering if you could talk about were there any NREs in R&D that we should think about or just a little bit more color on that front.

Jim Moylan

We did guide operating expenses up from last quarter. They actually came in at the high end of our range. The biggest single chunk of that related to the fact that commissions were up significantly from Q3. Since we accrue and pay commissions on orders, that actually is a good new story, it represents the fact that we did have a very strong order flow in the quarter.

Another piece of the increase relates to prototype expenses. Again, that’s a good news story. As we bring products to market, as we ready products to go into customers laps we do tend to spend more on prototypes. This relates to our 5400 family, to some extent our 100 gig program. We did spend more; we think we spent it for the right reasons. As we’re seeing a bit of turn up in the market we want to be prepared to meet that market on both the sell side and our R&D side.

Kevin Dennean – Citi

If you could talk a little bit about your conversations with carriers. Maybe give us a sense for, are you seeing a big variance of sentiments towards 2010 across geographies or across the different types of carriers, Tier 1 versus non-Tier 1.

Gary Smith

Certainly as you talk to the Tier 1 and I guess some of the larger Tier 2 as well, I think I describe it as when we first went into this economic downturn, folks generally just put on the brakes across the board. That was the quickest way they could address their capital expenditures. I think as we’ve seen things in the economy generally stabilize a little I think as they reflect on 2010, what I’m hearing from the major Tier 1 and to your point around is there different geographic spread or whatever.

As I think about that I really don’t think there is, we’re getting a very consistent view around European, Latin America, and some of the Asian large carriers similar to North America. They’re looking, I think, to prioritize their spend and I think we’ll see a shift towards next generation spending rather than legacy because I think they’ve now got some time to adapt to that and carefully prioritize their spending.

From a Ciena perspective you look at our portfolio, the defining issue for us, the much more critical issue of does CapEx overall go up or not is really what they’re spending it on. We’re encouraged by what we’re hearing around the 2010 priorities because I think it fits from a portfolio alignment with us.

Operator

Your next question comes from Paul Silverstein – Credit Suisse

Paul Silverstein – Credit Suisse

With respect to the OpEx if I could revisit the issue, your guidance was roughly flat, your revenues ended up being up $11.5 million, and your OpEx was up relative to your guidance by $5 to $8 million depending upon how one interprets the guidance you gave last quarter. The prototypes I assume were a known issue, can you help us understand relative to the commissions it seems like OpEx was about 50% of that revenue increase; it seems like an awfully high number. Again, I trust the prototypes were a known issue going into the quarter.

Gary Smith

The prototypes we knew that it was going to be up for the quarter and we guided on the operating expenses, we thought it would come in to the mid 80’s. We knew it was down last quarter sequentially so we anticipated some of the timing of the prototypes but we were able in fact to be slightly ahead of plan on some of that. Depending on which way your perspective is that’s good news.

I would also say that the platforms that we’re rolling out now are very large platforms. You look at the 5400, six times the capacity of the existing platforms, great deal of density, these A6 are expensive. We’ve got a lot of customer interest that we’re putting into their labs. You’ve got the 100g components which are also expensive. I’d add that by way of a bit of color as well. It did come in hotter then we anticipated.

The other part of the operating expenses principally, and as you say, probably about 50/50 in terms of the up was related to sales commissions. We had a stronger order quarter then we’d anticipated in Q4. That bodes well for the future and that resulted in the increased commissions.

Paul Silverstein – Credit Suisse

Going forward, if your revenues were to come in $5 to $10 million higher relative to the guidance should we similarly expect about half of that amount to end up in a higher OpEx?

Gary Smith

No. We would expect operating leverage; I think it’s particularly a function of, first of all most of the commission payments are related to orders so it’s the future growth to that. There’s not necessarily a linear relationship there. I think we’ve been very disciplined about our operating expenses in the downturn, we’ve reduced our operating expenses overall considerably. We have been constrained by what we want to spend on and now we’re seeing signs of stability and opportunity and we want to make sure that we fund that accordingly, particularly on the sales side and off R&D side.

We’re also able to spend more in R&D then we did last year as well. We do have operating leverage in the model so we would anticipate as things recovery and as revenues go up, we would anticipate some of that dropping to the bottom line, obviously.

Paul Silverstein – Credit Suisse

The $180 million projection you gave on restructuring costs I think a couple months back in connection with the MEN deal, the cash restructuring item. What’s the potential upside and potential risk to that number?

Jim Moylan

I don’t believe there’s a lot of upside to the number. We took a very disciplined and conservative approach to developing that number. We went about it from a bottoms up bi-function approach. We tried to cover every single item that we could think of. I don’t believe there’s going to be a great opportunity to overspend that. We are working with MEN developing another look at that and we’ll see where it comes out but I don’t expect it to go up from where we had estimated it.

Paul Silverstein – Credit Suisse

Is there opportunity for it to be lower?

Jim Moylan

We’re going to make that estimate and we’ll be able to tell you a better number soon.

Operator

Your next question comes from George Notter – Jefferies

George Notter – Jefferies

I was hoping to get an update on CoreDirector and the transition to the next generation platform, the CoreDirector 2. Were you guys able to deliver the CoreDirector 2 to carriers, specifically AT&T this quarter?

Steve Alexander

We’re making very good progress with it. It’s in trials both where people are coming into our labs to see it as well as beginnings of getting the chassis and the modules out into the individual customer sites. We’re on track with that, we’ve seen very good customer interest in the transition that it represents, away from the TDM SONET SDH world over to OTN and the FlexSelect and Ethernet. We’re very happy with the results.

George Notter – Jefferies

When could we expect that customers could deploy that commercially and then thinking ahead, when do you think you could get that through initially for revenue recognition?

Steve Alexander

The spectrum of acceptance cycles out there is quite broad. We’re going to have some customers that would be looking to put that out into the network sort of in the middle of the year. We’ve got others that would be putting it through an acceptance cycle that may take up to nine months to a year. It’s quite a broad spectrum of opportunities for it.

George Notter – Jefferies

Rev rec would that follow immediately or would there be a lag from commercial deployment to you guys taking it for revenue?

Gary Smith

It depends on the customer. I wouldn’t anticipate meaningful revenues given the acceptance cycle, its a very large switch, you’re talking very large Tier 1, by the time it gets through as Steve was saying those various cycles. We would clearly expect to recognize revenues in 2010 for this platform.

George Notter – Jefferies

The margin structure as you transition from CoreDirector to CoreDirector 2 how would that look, would it be same, better, equal to, lower, what’s the thought there?

Gary Smith

It’d be very similar; it’s a very software intensive platform.

Operator

Your next question comes from Jeff Kvaal – Barclays Capital

Jeff Kvaal – Barclays Capital

I was wondering if you could talk a little bit more about the end of life charges in the gross margin, which products those were for and if we should be on the watch for further?

Jim Moylan

We don’t plan to get into the details. We have had some modules that are limited in their customer coverage and are nearing the end of their life given that they’ve been in market for a while. We look at this every quarter; it just happened that we had a little higher amount in this quarter. As I said, I don’t want to get into the specifics of that.

Going forward I guess we will have decisions to take with respect to our portfolio. We’re not prepared to talk about that now. You’ll hear about that within the next couple of quarters.

Jeff Kvaal – Barclays Capital

If orders were particularly good this quarter and it makes sense to spend on the commissions, of course. One might expect that the operating leverage would come relatively quickly on the basis of that or would we not?

Gary Smith

The commissions are normally aligned to our plan for the year. That starts out from Q1; I think we had a particular mix and very strong end to the financial year which is good news. As we go forward, we start with a new plan and we have, I think it’s fair to say, more ambitious plan for 2010 then we had for 2009. The targets and payments are commensurate with that. If you look back to 2007 and 2009 in more normalized environments you can see a more linear dropping of the operating leverage to the bottom line.

Jeff Kvaal – Barclays Capital

How long until the order received in the prior quarter, that you’re paying OpEx for translate to revenues?

Gary Smith

It varies. You’ve got some customers where it takes longer for revenue recognition so some can be in the quarter, some can be the following quarter, some can actually be 12 months from that as we build up backlog or put offsite inventory, as we put some of these large networks in place pending full recognition of the system. It varies.

Operator

Your next question comes from Vivek Arya – Bank of America/Merrill Lynch

Vivek Arya – Bank of America/Merrill Lynch

On the roughly $90 million non-GAAP OpEx should we assume that is the base OpEx assuming that sales stay flat or go up over the next several quarter on an organic basis?

Jim Moylan

I think that’s a fair assumption. What we said was we expect OpEx will be roughly flat and we got it up on revenue.

Vivek Arya – Bank of America/Merrill Lynch

On the $180 million restructuring or integration expense costs, will that be part of your non-GAAP OpEx or will those only be part of the GAAP and they would be considered one time and we should not model them as part of an ongoing non-GAAP type OpEx?

Jim Moylan

Certain of those costs will clearly be as adjusted out. Some of those costs we are actually trying to figure out the appropriate accounting treatment. Whether or not we break them out for as adjusted we will clearly identify them. If I were modeling the company I would model the company without these integration costs.

The way that at least I think about these costs is it’s a cost of the acquisition. We’re taking on a company that’s more than our size in terms of revenue, it about our size in terms of people. It’s a significant undertaking. We’ve known from the beginning that we were going to have a large integration expense associated with this deal. At least my thinking about it, I’ve thought of it as a cost of the acquisition. We’re going to be very disciplined as we move through this integration. We’re going to be smart about it and we’ve already put in place the team to make it happen. I would consider it part of the acquisition cost.

Vivek Arya – Bank of America/Merrill Lynch

On the product side, you’re CN 4200 platform is doing very well but I assume that’s also where you potentially have a lot of overlap that Nortel’s WDM products. I think you also announced 100g recently and 4200g is also where Nortel has been putting a lot of R&D. My question is, how are your customers responding in terms of what they would like to see in terms of an integrated roadmap, what kind of questions are they asking and how are you thinking about them?

Tom Mock

One of the things that our customers are looking for here is a transition path if one should be required and a transition path that’s graceful. I think one of the things though that’s important to think about here is that when you look at where we’ve positioned 4200 and where we’ve had most of its success it’s largely been in metro and shorter distance regional network.

If you look at where Nortel has had most of their success its really been with longer distance networks, particularly being able to take long distance networks comprised of old fiber and upgrade those very easily to higher capacities. There’s probably a bit less overlap there then you might think. While it’s too early at this point to say exactly how the portfolios are going to architected moving forward it is something that we recognize we have to be pretty decisive about and that’s something that we’re going to be working toward as we said before as we close the deal and move forward.

Operator

Your next question comes from Blair King – Avondale Partners

Blair King – Avondale Partners

You had mentioned the leverage in the model and ultimately that would play out. What I’m trying to figure out is if the OpEx is flat in the first quarter relative to the fourth quarter then that would obviously also imply a fairly strong top line in the second quarter. Can I think of it that way?

Gary Smith

I’d certainly like to think about it that way. I think what we’re seeing is some stability in the marketplace and we’ve been constrained for the last year or so in terms of spending so we’ve been very disciplined around letting some of those additional investments happen now, particularly as we bring these new platforms to market I think its important that we do that properly.

I think that overall we’re dealing with a better environment in 2010 then we’re dealing with in 2009. I think its fair to say that most folks still don’t have great visibility to that and we’d include ourselves in that but I think we feel a little bit better about the world then we did certainly this time last year. We’re behaving in a disciplined way but appropriate with that perspective. We’ve got a lot of platforms coming to market; we’re going to make sure that we do that properly.

We want to make sure that we’ve got enough fuel in the tank because as we step back from this we feel very encouraged around what we see the opportunity going forward once we can work through these broader economic issues. There’s tremendous demand in the overall industry as they move toward wireless and video and we want to make sure we’re well positioned for that.

Jim Moylan

Outside of the two things that we have highlighted today, meaning sales commissions and R&D prototype expenses, we’ve done a very good job of holding OpEx flat. I would say that the focus in terms of controlling OpEx has been on those areas which we’ve done a very good job with. With respect to commissions and prototypes we think that that’s indicative of revenue to come. I would take from that that the areas of OpEx which are steady as you go we’ve done a great job on. Those things which indicate hopefully some revenue on the way we’ve been willing to spend and we think you want us to spend there.

Gary Smith

We beat our own expectations for revenue in Q4. We’re also forecasting, we believe, higher revenues then we’d anticipated in Q1 as well. That’s as far as we’d be prepared to go right now but I think its testament to the environment that Jim’s describing.

Blair King – Avondale Partners

You alluded in your prepared remarks about the integration effort and the milestones of plans you have in place for building the combined company at close. From your view what are the key focus areas that you believe will ultimately determine success on the integration? The second one obviously is your plan for communicating the combined outlook from a financial perspective?

Gary Smith

I think it starts with the customers in making sure that customer experience is first and foremost in all of our thinking both in terms of continuity with them, in terms of their portfolio needs going forward and what kind of organization and resource we need around that. The starting point is the customer and we’re looking to be very decisive around rolling out a day one when we do close, the organization.

I think from a portfolio point of view we will be ready day one to roll out our portfolio, the combined entity of both in terms of the portfolio vision and the short term priorities and the organization around that. Those are the things that we’re focused on. In addition, as Jim said, it’s to all the back office element to that in making sure we’re mitigating all of those integration risks. I think the relationship that we have with the residual Nortel entity is incredibly helpful at mitigating those risks, certainly in the short term.

I think we’re going into this with our eyes open. I would also say that because it’s a business that we’re very familiar with it’s not an adjacent space; I think that also bodes well for our ability to make the right kind of decisions.

Blair King – Avondale Partners

You mentioned at closing you’d have, I think you mentioned, you’d have some sort of financial outlook prepared.

Gary Smith

Lessons learned from other integrations and talking to other folks who’ve done things of this scale. I think its important that we communicate our plan as best we can externally as well as internally, with some milestones around that both in terms of the financial model that we’re heading towards, how much we’re spending for example as Jim was saying on the integration costs we want to call those out separately so people can see what we’re doing there and so frankly we can measure our own progress as we work through this integration plan.

We’re moving very quickly and decisively with this but we hope to by the time we get to closure here be able to communicate so you can see a clear roadmap in terms of the overall integration of the business and the financial performance of the business going forward.

Operator

Your next question comes from Mike Genovese – Soleil Securities

Mike Genovese – Soleil Securities

On the gross margin you had this very positive product mix of packets up, CoreDirector up, 4200 up, and long haul down. Give all those factors I think gross margins came in below what a lot of us were expecting. Can you comment on that? Was there any pricing in the quarter or any reasons for the 45% gross margin?

Jim Moylan

The first think I’d point to is we did have about 1.5 points of margin decrement related to the charges to the end of product lifecycle platforms that we talked about. It was really a bit better then we reported. It is all mix. We have a range of margins for our products; we have in some cases a range of products margins within products. We’re comfortable that we have mid 40’s range margin currently. As we said in the past, the Ciena business is headed toward higher margins as we improve the software content of our products. We think that over time that goes up. We’re guiding roughly flat for Q1.

Mike Genovese – Soleil Securities

There’s been a lot of talk about OpEx but I’m not sure if this question was asked. Within that $90 million of OpEx can you identify any piece that was due to maybe lawyers, consultants, and other people around this deal?

Jim Moylan

Actually there’s probably not a lot in there. Most of that cost we have captured separately and we will account for it when we begin to account for the acquisition. I’m sure there is some cost related to the MEN transaction we’re been working hard on this for a year. We’ve had a lot of people flying all over the world, frankly and we didn’t capture all those costs in integration. Yes, there’s probably some upward pressure but not a huge amount.

Operator

Your next question comes from Alex Henderson - Miller Tabak

Alex Henderson - Miller Tabak

If it’s not a mix within the products is there a mix between new boxes and blades that may be accounting for some of that variance?

Gary Smith

That’s certainly, that used to be the case in the old core stream days where you’d have chassis and cards. It’s less the case now. Certainly as you get into the CESD portfolio that’s not particularly profiled like that. It’s more a mix around the kinds of platforms, the kind of applications, how much software intensity is one some applications as opposed to others which is also similar with CoreDirector. As Jim said, there is a mix within a mix.

If you’d just look at it as Mike said you have the three generally higher margin, higher software content platforms do well you would have expected a gross margin perhaps higher then that even 46% or 47% which reflect run off charges it was but really it was just one or two skus within the platforms.

Alex Henderson - Miller Tabak

A clarification on the gross margin. Last question I thought I heard you say that you were guiding to flat gross margin yet your guidance I thought was mid to high 40’s. To clarify whether you meant sequentially flat or whether you meant mid to high 40’s?

Jim Moylan

They’re roughly the same. Remember we reported 45%. We said that that had 1.5 points related to charges. We’re basically saying it’s going to be about flat mid to high 40’s.

Alex Henderson - Miller Tabak

Going into your commentary earlier, you said you were seeing a nice pickup in the wireless backhaul space. Can you give us some sense of what percentage of your revenue base is coming from that segment, generally focusing on stuff that’s more inline then further downstream?

Gary Smith

You can look at a lot of the portfolio being involved in modest backhaul but specifically front and center you’d see virtually all of the CESD revenues that we took, the vast majority for wireless backhaul. If you take AT&T as an example, the initial deployments, and they’re very small this quarter, but the orders are ramping up, they are really primarily all for wireless backhaul. You’re only just starting to receive orders for the Ethernet business services on it. The vast majority of that revenue is wireless backhaul right now.

Alex Henderson - Miller Tabak

The inventory level was down sequentially on up revenues and up sequential guidance. Are you planning to build some inventory over the next couple of quarters to fill in the demand side of the equation? Are you seeing any tightness in supply on components or changes in pricing on components?

Jim Moylan

So far we haven’t really seen any significant tightening or price increases. Our inventory situation is a rather complicated picture. In some cases we ship inventory to customers awaiting acceptance and recognize revenue when they accept the revenue and that sometimes contributes to inventory build, almost independent of the way our revenue trajectory is going.

In some other cases what we have seen frankly is a higher demand then we had expected and so it’s possible that we might build some inventory to make sure that our supply chain is robust enough to handle a better then expected revenue projection. It’s a complicated question; we’re going to go about it in a disciplined manner. We’re going to make sure we make the right decisions and we’re going to hold down inventory increases. On the other hand we’re going to make sure we have the material that we need to support what we expect to be revenue growth.

Alex Henderson - Miller Tabak

Can you give us any commentary on the linearity of orders and particularly linearity of orders relative to what you were expecting? Did it accelerate through the quarter; was it a little bit ahead of target all the way through the quarter, how should we think about the trajectory there?

Gary Smith

I’d describe it as we began in September to see reasonably good flow. That frankly has continued. Q4 is normally very good relative to the other quarter’s order intake for us because our Q4 ends the end of October. We’re actually continuing to see a reasonably steady flow up to today, including the first month of Q1 as well. It’s been fairly regular.

Alex Henderson - Miller Tabak

Is it reasonable to think that you are on a track, excluding the acquisition of Nortel, to hit profitability during FY2010? We’re trying to get a handle on what base think about the accretion on?

Gary Smith

Clearly we don’t have a huge amount of visibility coming out from where we are. I would personally been disappointed if we weren’t showing operating leverage and profitability certainly in the second half of the year.

Operator

Your next question comes from Samuel Wilson – JMP Securities

Samuel Wilson – JMP Securities

Can you give us what you think the balance sheet will look like in the capital structure of the company post-transaction? How you think about that over FY2010 and 2011.

Jim Moylan

The immediate, at close, we will pay $530 million in cash. We will, for the deal, issue a convert for $239 million. What will happen during ’10 is likely we will spend a significant chunk of the integration money. Some of that is capital in nature and we may do some leasing and things like that with that regard. I’ve said in the past that about a third of the integration expense is capital. We expect to be for the outside of the integration expenses then we should not be burning cash, we should be generating some amount of cash.

Operator

Your next question comes from John Marchetti – Cowen and Company

John Marchetti – Cowen and Company

On the CESD side you mentioned obviously the majority of the business right now still coming from wireless backhaul. Can you give us your view as we’re going into 2010 of maybe the business services side? As a follow up to Sam’s last question, as you look the numbers you just laid out there on the cash side do you feel comfortable as you’re going through 2010 then with that kind of an expected cash balance on the balance sheet or do you envision maybe having to come back to the capital markets next year in some fashion to raise a little bit more cash?

Gary Smith

CESD side of things my perspective, but I think you’ll continue to see wireless backhaul be strong, some of the new platforms we’ve begun to deliver there are very targeted in that area. I would expect that to continue to ramp. We’ve got some large Tier 1 that we’ve secured and I would expect that to continue to ramp. We’re also seeing good take up in some of the Tier 2 now, although it’s very small from a revenue right now I think that will continue to escalate.

On the Ethernet business services, as I said, at AT&T we haven’t really started yet so I’m very encouraged by the potential upside that we’re going to see through that. We’d actually anticipated frankly the Ethernet business services starting before wireless so I think we’ve got that to come. We’re engaged with a number of Tier 1 and Tier 2 carriers where we’ve secured the platform and they’re just beginning to roll out the Ethernet business services.

I think some of that is also linked into the Enterprise part of the economy so I think those business services, as you see improvement in the general economy, I think you’ll see some pull through on those services as well. I think we’re well placed for that.

Jim Moylan

With respect to capital position, as you can imagine, we look very hard at the cash requirements for this transaction. It’s been a focus for all of us. I’m comfortable with where we are now and with respect to future capital market activity you know I can’t comment on that but we have the right and the ability to affect such transactions at any time that we want to do it and we’ll watch to see what the terms of such a deal could be and make decisions appropriately.

Operator

Your next question comes from Simon Leopold – Morgan Keegan

Simon Leopold – Morgan Keegan

I wanted to revisit one aspect of the gross margin profile. I think the services gross margin was pretty good this quarter relative to history and if you could drill down a little bit of what might have contributed this quarter and how to think about that within the overall model going forward.

Jim Moylan

We’ve had very good margins in our services business now for several quarters. That is frankly an area that we focused on in terms of trying to get higher value added services to customers and in terms of focusing on areas where we had less than good results in that business. We’re not prepared to change our target at this time but we’re very encouraged by the fact that we’ve done very well on services margin.

The other thing I’d say, as I’ve said before, just as we do in products we have a range of services in terms of their gross margin. The less value added services tend to be lower margin. The higher valued, more professional services or consulting in nature tend to be higher margin. We’ve intentionally focused on trying to move toward the higher end of that scale and you can see the results.

Simon Leopold – Morgan Keegan

What’s sort of your target for services gross margin?

Jim Moylan

What we said is mid to high 20’s and not prepared to change it at this time.

Simon Leopold – Morgan Keegan

I think you may have made a comment earlier regarding some of what’s driven the higher R&D than expected included in that list, spending on 100g. In light of the fact that it looks like you’re going to get the Nortel assets and their 100g technology do you lighten up on that investment, particularly in terms of what’s contributing to the January quarter expenses?

Steve Alexander

What you’ve touched on is one of the areas we potentially could see some synergies going forward. We’ve done a very good job getting 100 gig out in what you might call the enterprise side, data center extensions and such and I think Nortel has done an exceedingly good job with 100 gig for long haul, ultra long haul and the upgrade of existing fiber plant. There’s clearly opportunity as we combine these two.

As Gary alluded to earlier, a lot of customer interest in that as a going forward position but clearly you combine arguably the best solution, kind of the metro, and you combine that with the best solution long haul I think we can have an excellent position in the marketplace as a result.

Simon Leopold – Morgan Keegan

A couple quarters ago you highlighted a couple of long haul wins; with European carriers, one in Europe, one outside Europe. Were those contributing yet?

Jim Moylan

One is maybe a small contributor to the quarter; the other is not yet contributing.

Simon Leopold – Morgan Keegan

When you first talked about the MEN acquisition and the $180 million of integration charges it seemed pretty clear at that point that you looked at it as these are investments in the business and should be included when one thinks about the expenses. Then in your response to Vivek’s question earlier it sounds like you’re changing that and suggesting we’re backing out most of it in terms of pro-forma. I want to clarify first of all, is that change in your view? If you could give us a little bit deeper explanation of what led you to change your thinking.

Jim Moylan

I’m not sure what you’re referring to in terms of my past comments. We have always through that this $180 million is a cost of the deal. In terms of the investment entailed in getting to the integrated company I’ve always thought of it as money that we have to spend to bring the companies together.

Let’s get to the accounting issue. Some of these things let me back up and say that the $180 million is really an all in number. It includes transaction costs, it includes the integration costs, it includes capital to upgrade and strengthen our IT infrastructure so it’s really an all in cost related to the transaction. The accounting for it clearly some of those items by virtue of their very nature we would exclude from as adjusted results. Some of them it’s less clear exactly how to handle them.

We have talked about that internally, we have not reached a final decision on how to handle it in an accounting sense. We will make it clear to you that what the spend is and where it’s being afforded. We’re not going to, in any way; force you to look hard for these things. We’ll show you the numbers and you can deal with them the way that you think is appropriate. My feeling is this is a cost of the transaction, not a part of ongoing business.

Simon Leopold – Morgan Keegan

If we just sort of step back without hard and fast numbers and I understand the fiscal ’11 accretive potential but if we look at fiscal ’10 it sounds like there some in, some out. Is the deal dilutive or accretive to fiscal ’10?

Jim Moylan

The deal, if you could ignore all of the integration costs, the deal is slightly accretive to ’10. If you include those integration costs as part of your reported results then the deal is dilutive in 2010.

Simon Leopold – Morgan Keegan

Reality is somewhere in between.

Jim Moylan

We’re talking about accounting here not economics. I think that it’s a cost of the deal.

Gary Smith

We’re going to serve this up in a way that you can decide how you want to treat that. Clearly we’re going to treat it how we have to from an accounting point of view and that’s what we’re going to do. We’ve going to serve it up in a way that you can make the decision how you want to play that.

Simon Leopold – Morgan Keegan

My concern is I’m not the only one making that decision, it will be wide range of interested parties making judgments and therefore I think it could create some confusion up until the point you’re able to clarify it.

Gary Smith

We will attempt to clarify and be decisive around that and we will serve it up in a way that we think it’s appropriate. We’ll serve it up in the way that the accounting is appropriate to it and in a very disciplined way so that you’ll get to see what our view of it is, the accounting and then clearly as you say, people will then make their own interpretations of that. I think we’ll provide the information.

Operator

Your next question comes from Todd Koffman – Raymond James

Todd Koffman – Raymond James

The one area on this call you haven’t spoken about too much is the long haul transport area, its continuing to hit a new low watermark. As Simon mentioned, you had called out some customer wins a couple quarters ago. What’s the outlook for that segment? I think you said its doing $21 million in the just reported quarter as you look forward.

Steve Alexander

We have had some wins in the long haul space. I think it’s important to realize, depending upon geography, one person’s long haul is another person’s ultra long haul, is another persons region, that sort of thing. I’d go back to some of the points Tom made earlier when you look, going forward, what the 4200 has been focused on has been the metro space predominantly. You look at the opportunity presented to us with the MEN assets which has been focused on long haul through ultra long haul. In particular the 40 and 100 gig upgrades.

Then you factor in the fact all the core stream routes, all the routes going back to multi-wave, our original product, are now available to us to go back and upgrade to 40 and 100 gig over the next few years. That’s where we see the real opportunity in terms of the long haul point to point transport market.

Todd Koffman – Raymond James

That all said, coming of the $21 million new quarterly low watermark would you say that likely would be a new low and its steady to rising from these levels or its impossible to tell?

Steve Alexander

The bandwidth demands it’s an ebb and a flow right, the traffic patterns in networks are shifting a little bit to metro aggregation side. As that fills up it will put demands back onto the core. It’s been that way for the last 15 or 20 years or so. I would hate to say this is the low watermark. I think you’re going to see variations, you’ll see regional variations as different carriers build out.

The thing you want to keep in mind is there’s a tremendous amount of demand for capacity and a lot of the infrastructure is in need of an upgrade and the technologies that we’re bringing to market allow that to be transitioned over to a carrier Ethernet and transition to both 40 and ultimately 100 gig Ethernet.

Operator

Your next question comes from Sanjiv Wadhwani – Stifel Nicolaus

Sanjiv Wadhwani – Stifel Nicolaus

Looking at the guidance for the January quarter should we expect the growth to continue to come from Ethernet and CN 4200? In terms of the OpEx guidance for January flat sequentially should be assume that the elements remain sort of flattish or maybe there’s growth in R&D but sales commissions coming down slightly?

Gary Smith

I would anticipate that the carrier Ethernet would certainly be robust in Q1. I would also anticipate that 4200 with all of its various applications including long haul, as Steve said, would actually be up in Q1 as well.

Jim Moylan

I wouldn’t make any major shifts in the mix. I’m sure there’s going to be some movement plus or minus in some of the categories but I wouldn’t make any major changes.

Operator

That concludes our question and answer session. I’d like to turn the conference back over to our speakers for any additional or closing remarks.

Gary Smith

Thank you everyone for your time this morning, I appreciate it and for your continued support. We wish everyone a Happy Holiday Season.

Operator

This concludes today’s conference. We appreciate your participation. You may now disconnect.

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Source: Ciena Corporation F4Q09 (Qtr End 10/31/09) Earnings Call Transcript
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