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Ciena F4Q07 (Qtr End 10/31/07) Earnings Call Transcript

posted on: December 13, 2007 | about stocks: CIEN

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Ciena Corporation (CIEN)

F4Q07 Earnings Call

December 13, 2007 8:30 am ET

Executives

Suzanne Dulong - Chief Communications Officer

Gary B. Smith - President, Chief Executive Officer, Director

Joseph R. Chinnici - Chief Financial Officer, Senior Vice President-Finance

Stephen B. Alexander - Senior Vice President, Products & Technology , Chief Technology Officer

Analysts

Cobb Sadler - Deutsche Bank

Nikos Theodosopoulos - UBS Warburg

Marcus Kupferschmidt - Lehman Brothers

Simon Leopold - Morgan Keegan

Mark Sue - RBC Capital Markets

Tim Savageaux - Merriman Curhan Ford

Tim Long - Bank of America Securities

Paul Silverstein - Credit Suisse

Jonathan Cues - Bear Stearns

Brantley Thompson - Goldman Sachs

Ian Khan - JP Morgan

Hasan Imam - Thomas Weisel Partners

Natarajan 'Subu' Subrahmanyan - Sanders Morris Harris

Presentation

Operator

Good day, everyone and welcome to the Ciena Corporation fourth quarter 2007 results conference call. Today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Chief Communications Officer, Ms. Suzanne Dulong. Please go ahead.

Suzanne Dulong

Thanks, Steve. Good morning and welcome, everyone. I am pleased to have with me Gary Smith, Ciena's CEO and President; and Joe Chinnici, 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 three segments. Gary will provide some brief introductory comments, Joe will review the financial results for the fourth quarter, Gary will then discuss the business in the quarter and our outlook for Q1. We’ll then open the call to questions from the sell side analysts. To ensure we answer questions from as many participants as possible, we ask that the sell siders limit themselves to one question.

This morning’s press release is available on National Businesswire and First Call.

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 August 31, 2007.

The results we are discussing today are unaudited results. We continue to work through the process of our year-end audit and completing the 10-K. Given our desire to be as forthcoming and timely as possible with our disclosure, we made the decision to present today’s unaudited results to you.

We have until January 2nd to file our 10-K for our fiscal 2007 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.

Gary B. Smith

Thanks, Suzanne and good morning to everyone. Consistent execution of our network specialist strategy and the well-timed introduction of our FlexSelect architecture have enabled us to benefit from both pure network capacity related growth, as well as the trend towards ethernet IP based network infrastructures. As a result, for fiscal 2007, we were able to deliver above industry average revenue growth, gross margin improvement, and operating margin expansion.

And our commitment to drive actions across the company to improve our financial performance has helped us gain significant operating leverage, driving Q4’s as adjusted operating profit to better than 15%.

We believe that sustained execution of our strategy positions us for continued, measurable progress in growing the company and delivering shareholder value. I’ll talk to our business in the fourth quarter and our outlook after Joe reviews the quarter’s results. Joe.

Joseph R. Chinnici

Thanks, Gary and good morning, everyone and happy holidays, of course. In the interest of time this morning, I’m going to focus the majority of my comments on the quarter’s results as opposed to talking about all the annual results, so getting started, this morning we reported fourth quarter revenue totaling $216.2 million. This represents an increase of 5.5% sequentially and 35.2% year over year.

We had two 10%-plus customers in the quarter that combined to represent 46.5% of total sales in the fourth quarter. One was a North American based customer; the other is an international customer. For the year, we had two 10%-plus customers, AT&T and Sprint. Combined, AT&T and Sprint contributed 38.1% of the total revenue for 2007.

Sales from international customers remained steady for the quarter, with international sales representing 31.1% of total revenue.

Moving now to talk about quarterly revenue contribution across our portfolio, our converged ethernet infrastructure group, which incorporates all products previously in our optical networking and data networking groups increased to $180.9 million, representing 83.7% of total revenue.

Ethernet access, which incorporates all of our access products, was $12.8 million, representing 5.9% of total revenue, and global network services, which encompasses all of our services related offerings, was $22.5 million, representing 10.4% of total revenue.

Within the converged ethernet infrastructure group, core switching was the largest contributor at $72.5 million. Our CN 4200 advanced services platform contributed $39.2 million in revenue, roughly on par with core transport, which contributed $41.4 million.

On the gross margin front, Q4’s overall gross margin was 50.5%, up sequentially from the third quarter’s 47.7%. This is better than our targeted mid-40s range, primarily as a result of a favorable product and customer mix and our ongoing product cost reduction efforts.

Our product gross margin was strong at 55% and, reflecting our efforts during the last several quarters, our services gross margin improved to 11.9% of revenue in Q4, up from roughly break-even in the third quarter.

In the remainder of my comments today, I’ll speak to both the GAAP results and to what the results would have been if we excluded those items detailed in the press release.

On a GAAP basis, our operating expenses in the fourth quarter totaled $82 million. Adjusted for non-operating and/or non-recurring charges detailed in the press release, our operating expenses totaled $75.9 million. Our as-adjusted R&D, sales and marketing, and G&A expenses for the quarter came in higher than initially expected due to the timing of certain expenses associated with prototypes, consulting fees, and higher sales commissions, among other things.

Even so, our 15.7% as-adjusted operating profit is slightly above our 15% target and represents a meaningful improvement versus third quarter’s level of 13.8%. And with the exception of G&A on an as-adjusted basis, our OpEx was in line with the target percent to revenue ranges discussed at our October analyst day.

Our fourth quarter GAAP net income of $30.4 million, or $0.30 per diluted share compares to a GAAP net income of $28.3 million, or $0.29 per diluted share in the third quarter. Adjusted for the unusual and/or non-operating items detailed in our press release, including 123R related compensation expense, our fourth quarter net income would have been $50.3 million, or as adjusted net income of $0.48 per diluted share.

Now let’s turn to the balance sheet. We were cash flow positive for the third straight quarter, generating $14.8 million in cash from operations. This is in spite of the cash payment of $53 million in connection with the settlement of our lease obligations associated with our unused facilities in San Jose.

For fiscal 2007, we generated $112.2 million in cash from operating activities. Cash, short-term, and long-term investments at the end of the fourth quarter totaled $1.7 billion.

You’ll note an increase in our short-term investments as we prepare to repay the $542.3 million of three-and-three-quarter convertible notes due in February 2008. You’ll also note in our GAAP results we’ve taken a $13 million loss on marketable debt investments, so let me spend a few minutes on this.

The $13 million loss represents less than 1% of our total cash position. The loss stems from a $45.9 million investment in commercial paper issued by two structured investment vehicles, or SIVs, as you know them, that entered into receivership and failed to make payments at maturity. The initial investment accreted up to $46.9 million during the quarter.

This commercial paper was issued by SIV Portfolio PLC, formerly known as Cheyne Finance PLC, and Rhinebridge LLC. At the time of the purchase, each investment had a rating of A1-plus by Standard & Poor’s, and P1 by Moody’s, their highest ratings respectively.

We have reviewed current investment gradings, third party valuation analysis, company specific news and events, as well as the general economic conditions in determining the fair value of these investments. After giving effect to this loss, our investment portfolio at year-end included investments with an estimated fair value of $33.9 million related to these two SIVs.

To the extent we determine that a further decline in fair value is other than temporary, we may incur additional realized losses in fiscal 2008 up to the aggregate amount of these investments.

We have canvassed our investment portfolio and at this point, we believe our SIV related exposure is limited to these two specific investments. While these two items are a small portion of our overall cash position and understand this is a timely topic, I wanted to spend some time on this this morning to ensure our position was clear.

Our accounts receivable balance decreased from $117.8 million at the end of the third quarter to $104.1 million at the end of the fourth quarter. Days sales outstanding also improved from 52 in the third quarter to 43 in the fourth quarter. Going forward, we expect our DSO range to be between 65 and 75 days.

On the inventory front, reflecting early results from our ongoing optimization efforts, our inventory levels ended the fourth quarter down slightly at $102.6 million from $105.1 million in the third quarter.

The inventory breakdown for the quarter was as follows: raw materials, $28.6 million; work in process, $4.1 million; finished goods, $96.6 million; and a reserve for excess obsolescence of $26.2 million.

Product inventory turns improved from 3.2 in the third quarter to 3.4 in the fourth quarter.

Finally, on headcount, we added 27 employees in the quarter, bringing our worldwide headcount to 1,797.

And now I’ll turn the call back over to Gary.

Gary B. Smith

Thanks, Joe. Before I begin to talk about the business outlook, as many of you know, this is Joe’s last conference call with us and I have to say thank you to Joe for 13 years of outstanding dedication to Ciena. He’s been instrumental in building Ciena's solid financial foundation and he’s helped navigate us through some tumultuous industry dynamics and I know I speak for everyone at Ciena when I say we wish him all the best.

As we announced in this morning’s press release, following an extensive interview and diligence process, we’ve appointed Jim Moylan to succeed Joe. I am confident that Jim has both the skill set and professional acumen to meet the requirements of our growing business and I welcome him to the team.

Joe will officially turn things over to Jim after we file our 10-K and as Suzanne noted in the introductory remarks, we have until January the second to file the K and we expect to do so by then, if not before.

In the remainder of my comments today, I’ll highlight our fiscal 2007 accomplishments and I’ll offer insight on our plans to build on that success in fiscal 2008.

At this time last year, we made a commitment to remain focused on the execution of our strategic plan, to continue growing faster than the overall market and to improve our financial performance. With four consecutive profitable quarters in fiscal 2007, we delivered on that promise.

In summary, we achieved revenue growth of 38%. We surpassed the 10% operating profit on an as-adjusted basis for the year, and ended the year with a better than 15% operating profit and we generated meaningful cash from operations.

To get there, we implemented several actions to reengineer our business model and globalize our company. At the end of last year, we also said we would leverage our market momentum to go on the offensive and further advance our technology leadership. We achieved this goal in several ways, including expanding the breadth and depth of our customer base with significant growth in our international business, launching our FlexSelect architecture for ethernet solutions, and increasing our R&D capacity by more than 40% during the year. And we accomplished this while improving key financial performance metrics.

Let’s drill down a little bit further on the progress we made with our customers and detail some of the new business we secured in the year. At the highest level, we grew our business across the globe. Sales in North America were up more than 30% year over year and international sales rose 55%, with business won in 10 new countries for Ciena. And notably, our partner sales worldwide increased more than 45% in 2007. ‘

In our traditional customer segment, the highly competitive service provider market, we added 12 new customers and we sold new products into 14 of our existing accounts.

Furthermore, our non-Telco business contributed more than 15% of our overall revenue. We penetrated 19 additional customers in the government and research and education communities and demonstrated a significant level of success in our ability to serve the enterprise market, with 85 new customer wins in that space.

On the portfolio, we made several moves to advance our leadership in converged ethernet infrastructure. In February, we extended our FlexSelect architecture with a comprehensive strategy to make ethernet a carrier class performance grade convergence vehicle from the access network to the core.

With that, we committed to adding new products and capabilities to enable flexible converged ethernet based networks for the delivery of any type of service with unparalleled resiliency, service quality, and management control.

In line with that during fiscal 2007, we announced our CN 3000 ethernet access series and the CN 5060 multi-service carrier ethernet platform, both of which are gaining interest in the market. In fact, we announced this morning that BT has selected the CN 3000 series for its 21st century network. This agreement extends our expertise beyond the 21 CN transmission domain to provide BT with ethernet access solutions that will support the rollout of new 21 CN services and applications.

Looking ahead, we believe we can build upon our accomplishments in 2007 to continue growing faster than the market in 2008. As I’ve said previously, 2008 will be a year of focus and leverage for Ciena.

First, we remain dedicated to improving our operations to ensure we perform as a fast and agile global enterprise. Secondly, we are committed to attacking high growth market opportunities to deliver faster than market growth. And lastly, we will continue to carry out our FlexSelect architecture vision to advance our market, technology, and thought leadership in performance grade ethernet.

On the operations side, we will leverage the strength of our business model to scale the company for future growth. Our team is hard at work identifying areas where we can further improve the efficiency of our business. Paramount among these activities is process and system improvements. We’ve already made tremendous progress in this area with the successful reimplementation of Oracle, which we’ve completed last month. With that, we ensure ourselves a solid platform on which to scale and automate the entire business going forward.

We are also highly focused on streamlining our supply chain for greater efficiency, as well as improving overall product lifecycle management.

Moving to the growth of our business, we’re entering 2008 with an acute focus on driving continued adoption of our FlexSelect architecture. Our expertise in transitioning networks to next generation ethernet based architectures combined with the ethernet optimized portfolio we’ve assembled enables us to meet the total cost of ownership and service delivery needs of our customers.

Because of that, we are confident in our ability to build upon our progress in securing more customers, as well as extending our value into existing accounts with new products and features.

We also continue to see opportunity to apply our expertise in simple and highly reliable networks to a wide range of enterprise applications, particularly in helping our customers deliver higher value carrier managed services.

We will continue to strategically pursue high growth market opportunities like wireless backhaul, where we can bring scale in evolving existing networks to better and more efficiently support higher capacity, higher value services.

Given our overall position heading into 2008, we are optimistic about our potential for a number of reasons. We’re seeing a healthy level of RFP activity, including a number of opportunities in the ethernet transport space, which is a sweet spot for our network specialist position.

Our global account activity with service providers, enterprises, and partners is on the rise and we are seizing more opportunities to sell across our portfolio.

And finally, the architectural debate is in our favor. The ethernet driven intelligence and automation we bring with FlexSelect is helping alleviate customers’ concerns about network complexity, ease of management, and total cost of ownership.

In summary, we came a long way in 2007 towards growing the company and stabilizing our business model. You will see us capitalize on that energy and momentum and continue aggressively pursuing high growth market opportunities where we can help customers align their network architectures with the business values of their customers.

You will also see us working to leverage the strength in our operating model and I’d like to give you three concepts to focus on in 2008. Firstly, innovation, globalization, and velocity. These will be pillars in the continued execution of our strategy and key to our consistent goal of striking the right balance between investing strategically in our business to fuel longer term revenue growth and maximizing short-term operating profit and net income.

With that, let me conclude our prepared remarks today by talking to our guidance, and I’ll remind everyone that the statements I’ve just made and those that I’m about to make are forward-looking and it’s important to understand them in the context of the risk factors detailed in our most recent 10-Q.

As stated in the press release, we expect to deliver sequential revenue growth of up to 5% for Q1 2008. For the year, we believe that we are well positioned to continue to outperform the market and we believe that we can deliver 20% annual revenue growth. And as we said at analyst day, we’ve still got a lot of ground to cover between now and the end of 2008. So do I think there could be upside to the 20%? Of course, but there is also risk associated with achieving 20%.

On gross margins, as we’ve said in the past, gross margin is difficult for us to predict with accuracy and we expect it will continue to fluctuate from quarter to quarter. Our gross margin ultimately depends on a combination of factors, including product and customer mix. It can also be influenced by services revenue mix as well as volume, pricing, and the effects of our ongoing product cost reductions.

Based on the orders we have to date and other contributors to visibility, we expect Q1 gross margin will be in the high 40s. Beyond Q1, however, we continue to believe that a mid-40s gross margin range is realistic for our business.

If we successfully execute and are able to expand our product portfolio to include higher value platforms and functionality, we may be in a position to talk about our higher gross margin range in the future.

We expect our Q1 operating expenses will be within the percent to revenue ranges we discussed at our analyst day in October, and to recap on that, we talked about an as-adjusted R&D and sales and marketing both being in a 12.5% to 15.5% range to revenue, and G&A in a 4.5% to 5% range.

We expect our Q1 as adjusted operating profit will be roughly flat with Q4’s.

We expect other income expenses net in the first quarter will be income of approximately $8 million.

We expect our first quarter income tax expense will represent primarily foreign taxes, which we expect will be approximately $1.2 million.

We estimate Q1’s diluted share count at approximately $109 million total shares.

Finally, on cash, we expect we will be cash flow positive in Q1.

With those comments, Operator, we’ll now take questions from the sell side analysts. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go to Cobb Sadler with Deutsche Bank.

Cobb Sadler - Deutsche Bank

Thanks a lot, guys, and I want to thank Joe for the many years with Ciena. A question on services gross margin; it was 13%, 12% or 13% for the quarter. It’s been as high as 35%. Where do you see that going and what were the dynamics during the quarter to pull it up 1200 basis points? Thanks a lot.

Gary B. Smith

As I think you are aware, we had some particular challenges with our service business during the middle of the year, if you will. We identified certain improvements and actions that were underway and they are beginning to kick in so I think we signaled that you’d see a linear improvement in the services business and I think we’ve demonstrated that in Q4.

I would expect it to be in the high teens range and maybe early 20s over time as we move forward but in that kind of a range. You are going to get some fluctuations. I think it’s unlikely to be as high as 30, 35 and we’re targeting in the high teens range for now.

Cobb Sadler - Deutsche Bank

Sounds great, and next question, you do have some financial services exposure. I guess it’s probably small but could you just tell us what you are seeing there with your enterprise customers? Thanks a lot.

Gary B. Smith

We’re actually from -- the enterprise business, whilst important to us is I think about 15% of our business but growing nicely. I think we have a fairly very small exposure to it. We are actually seeing increased activity in that area, frankly. We’re a new entrant to it and I think we continue to see expanding opportunity there.

We are reading the newspapers and we understand what’s going on in that sector but I still think there is a lot of data needing to be moved around by these enterprises and I think with the advent of video and things like that, which they see as a cost saving measure, I think that’s going to continue to push their requirements for data up.

So I think we’ll continue to look at it carefully but we actually feel pretty good about that sector from Ciena's perspective.

Cobb Sadler - Deutsche Bank

Okay. Thanks very much.

Operator

We’ll go next to Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Warburg

I had two questions. The first one is on AT&T was probably your largest customer this year. Do you have -- do you know if you look at AT&T on a pro forma basis including the BellSouth acquisition what kind of growth you saw in fiscal ’07 over fiscal ’06?

And then the second question is on gross margin, why do you think past the first quarter it goes back down to the mid 40s? It would seem to me the RFP activity is in ethernet platforms, core director is doing well. What would cause a product mix shift away from those areas back to the lower margin products past Q1? Thank you.

Gary B. Smith

Let me take the AT&T one first. I wouldn’t get into that degree of specificity around a customer but I will offer you this; clearly before the merger, both SBC, AT&T, and BellSouth were all large customers of Ciena so I think it is natural that they continue to be a large customer as they have converged.

I would also say that we are seeing an expanding role for core director as helping integrate all of those networks as well, so we are pleased with our expansion within AT&T.

In terms of the gross margin, it is the most difficult thing for us to predict with accuracy. There is a lot of moving parts that go to contribute up these numbers. We continue to look at that very carefully. I think we’ve signaled that Q1 is likely, as best we can tell, to be in the high 40s and it really is a mix not just of the main product platforms but also a mix within those product platforms most classically represented in the transport space as cards versus chassis, but as we get into the converged ethernet space there’s even a lot more complexity within that mix around software and cards and the kind of expansion, whether it’s access, metro, et cetera.

A lot of moving parts to it. We do expect if we execute well over time, as we get into 2009, that we may be able to sustain an increased range. But right now, we still feel that as best we can tell, a range in the mid-40s is about right for our business dynamics that we see. That withstanding, Q1 we are forecasting a mix that would give us in the high 40s.

Nikos Theodosopoulos - UBS Warburg

Just a quick follow-up on the AT&T, I realize you don’t want to get into too many details on one customer. Could you comment at least whether on a pro forma basis that customer grew above or below the overall revenue of the company in ’07?

Gary B. Smith

I think they did grow. I wouldn’t say it was over and above. I wouldn’t want to comment on specifics.

Nikos Theodosopoulos - UBS Warburg

Okay. Thank you.

Operator

We’ll go next to Marcus Kupferschmidt with Lehman Brothers.

Marcus Kupferschmidt - Lehman Brothers

I just want to clarify; what was the guidance for other income?

Joseph R. Chinnici

It’s about $8 million.

Marcus Kupferschmidt - Lehman Brothers

And that’s a dramatic change from what we saw in October, if I’m doing my math right.

Joseph R. Chinnici

That is correct. Because don’t forget, we have to pay down the 542 and then we also moved some of our investments around into pure cash. And we’ve seen also a decrease in some of the rates and the money that we are getting.

Marcus Kupferschmidt - Lehman Brothers

Are you moving your investments to cash because you are trying to be more conservative where you park it or because you need quick liquidity with what you are doing with the company and --

Joseph R. Chinnici

It’s both. It’s because we have to pay down the 542 on the first of February and just given what’s going on in the environment.

Marcus Kupferschmidt - Lehman Brothers

Right. Okay, and then going into the business, talking a bit more about the visibility in the business, I think your point is you are seeing things looking now versus six months, do you have more visibility in what you’ve won and kind of a better pipeline now than maybe six months ago? Where are you in terms of how you look at the business you’ve won as opposed to all the opportunities and RFPs that you are looking at?

Gary B. Smith

I would say overall, Marcus, I would say visibility is about the same as it was probably at analyst day, going back a few months. We are seeing good activity, seeing good RFP activity and interest. I think we are seeing in our conversations with our customers both two dynamics; one, the demand for more capacity, particularly in the metro type areas and also a desire to carry it more efficiently and a desire to move towards carrier ethernet.

So I would say it’s been pretty good now for a few months.

Marcus Kupferschmidt - Lehman Brothers

And my last clarification, the fact that 4200 goes up, long haul goes down, should we start thinking that your customer base is starting to spend more money on metro and less on long haul? Or is the 4200 also being used in long haul applications and we shouldn’t be thinking about market dynamics changing around? Thank you.

Stephen B. Alexander

What you see with all these builds is an effect whereas you build a lot of capacity in the core, then you tend to go back and build it in the metro side. If you are building in the metro, you tend to load your core, so it flows back and forth.

We are, as the portfolio evolves, converging 4200 and core stream together, and so you are going to see a natural transition over the customer base to the 4000 series.

Operator

We’ll go next to Simon Leopold with Morgan Keegan.

Simon Leopold - Morgan Keegan

Thank you very much. I wanted to see if we could drill down a couple of things. One, I wanted to see what the trends are in some of these legacy products that you don’t talk about too much, particularly the maturing long haul products and the metro products that I believe are still contributing. If you could just give us a little bit more color there.

And I also want to throw in the data networking products, those legacy -- a little color on those.

Stephen B. Alexander

Back to my earlier comment, we are converging the -- call it the raw transmission products. So core stream evolved as a product and now is hundreds of channels over mega-meters, right? And we are adding that feature set over time to the 4200, so that’s a consolidation play, if you will, on the portfolio side.

With regard to the metro platforms, these go back to some of the online platforms and such, they continue to sell well to the customers where there is a substantial installed base. We are adding the required features to again migrate those over to the 4000. We brought our feature set to market that we call FlexiShelf, that basically lets a 4000 series shelf be a channel shelf into the online products and such as one way to facilitate that.

Simon Leopold - Morgan Keegan

And I just wanted to go back to I think a topic many of us are trying to figure out, is that the trending on overall gross margin of what’s driving a step down after next quarter or in the back half of the year. And really I think it’s a choice of are you being conservative, is it about product mix or is it about the competitive environment or is it about how the products are evolving that a given platform like core director may have a lower gross margin later in the year because of something. So a little bit of help understanding what’s driving this guidance.

Gary B. Smith

Some if it is clearly as we look at Q1, we’ve got better visibility of that than we have of Q4 and so we’ve got orders on hand and other contributors to visibility and we call it how we call it. But we do see overall a mid 40s range for the mix of products. Now, we may be incorrect on that and it can fluctuate quarter to quarter and I go back to Q2 of 2007 when we went down to 42%, 43% as a gross margin. So you are going to see some fluctuation there.

Joseph R. Chinnici

You have to also remember there still are a lot of suppliers in the market in which we play and like Gary said, we’ve got really good visibility into Q1 and Q2. The second half of the year, you don’t know what it has in store and everybody is going to be looking for growth. Based upon the way the economy is headed, it could be a tough time.

So I think part of the guidance on the margin front is the mid-40s looks and feels reasonably comfortable. We just don’t know yet.

Simon Leopold - Morgan Keegan

Right, but I guess what I’m trying to get at is more about your sense of your shifting mix or a stable mix assumption and changes in the gross margin within that mix.

Gary B. Smith

Frankly, it’s all of the above would go into our consideration on it. The other thing that I would add is we are expanding into new markets, new countries, new markets for Ciena, things like wireless back haul with some new customers. And you know, typically when you do that, it is at a lower entry point from a margin point of view and we are also being thoughtful about that as well and putting that into the mix.

We’ve got a lot of new products coming out as well that are working their way into the marketplace and so we AE also mindful of that.

Simon Leopold - Morgan Keegan

Thank you very much.

Operator

We’ll go next to Mark Sue, RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you. Gary, any further thoughts on the deceleration in your top line growth for the new fiscal year, considering you just did 38%? Is a large component of that related to the wind-down of major projects at AT&T and BT? Is it the new deals that are being slower to ramp or are you just being conservative so crazy analysts like myself don’t raise numbers?

Gary B. Smith

Clearly keeping up growth rates of 30% to 40% gets more challenging as the numbers get bigger. We still see our ability to outstrip the market that we play in, depending on which numbers you look at. We are exposed to the higher growth markets and they are classically sort of 10% to 15% and we are confident we can grow higher than that. I don’t think it’s particularly project based. We feel pretty good about the outlook. We’re seeing a good pipeline, particularly in the adoption of our architecture with core director and MASH and a number of new platforms that we are releasing, particularly mid-year and towards the end of the year.

But I think a 20% growth on balance is a pretty good performance in this marketplace.

Mark Sue - RBC Capital Markets

Lastly, if you could just give us your thoughts on your win rate when it comes to architecture deals, what that might be and what that might increase to?

Gary B. Smith

Well, I think because we are a specialist focus player, when we engage in terms of our FlexSelect architecture and folks really want to move towards converged ethernet, I would say that win rate is very high. When you are just looking at moving bits around, pure transport, that can vary because there is a number of other players in the market space there.

So you know, it does vary. When it gets into our sweet spot, which is around converged ethernet, our hit rate as you’d expect goes up pretty dramatically.

Mark Sue - RBC Capital Markets

Thank you, gentlemen and good luck, Joe.

Operator

We’ll go next to Tim Savageaux with Merriman.

Tim Savageaux - Merriman Curhan Ford

Good morning. Nice quarter and Joe, congratulations and good luck. I have a question -- I mean, we’re talking a lot about guidance and gross margins and I think you guys are actually implicitly signaling something through your operating expense spending. So you’ve brought it up to a new plateau. The last time you did that, we all got kind of concerned about it and you delivered a lot of top line growth and a lot of margin expansion.

So at this point, you appear to feel confident enough to breach by some measure the $70 million per quarter operating expense level and yet are continuing to talk conservatively on the top line in the gross margin side, which is why we find ourselves in this annual disconnect discussion. I’m a little disappointed I didn’t get to ask the 20% growth question because I normally get to every year but as you look at how you are managing your business and the operating expense levels that you are comfortable with, what should we take out of that with regard to your views on potential gross margins and top line growth?

And the fact that we plateaued at 60, moved to $70 million a quarter a little while ago and that was accompanied by a great deal of expansion, you mentioned a balance between investing in the business and delivering short-term operating profitability. For the moment, you seem a little out of balance, at least between what you are doing and what you are saying. I wonder if you could address that issue.

Gary B. Smith

Why don’t I do that, Tim? I think to the balance, we’re focused on I think at this stage in the company’s evolution, we’ve got to what we sincerely hope is a stabilized business model and we’ve indicated that one of the milestones for that is operating profit of around 15% and in fact, we exceeded that in Q4. So we are focused on two things, essentially; one, continuing to deliver to the bottom line and around that 15% kind of range as we talked on analyst day is where we are targeted. We are investing in new platforms and extensions to make sure that we continue to outperform the market and we are focused on ’09 and 2010 in terms of many of those platforms. A lot of that investment takes two to three years to bring out in terms of new platforms.

If we are successful with those, then clearly that will help drive both the top line and potentially in the future improve our gross margins as well. So it is a balance. I would encourage you to focus on our overall operating profit as opposed to fluctuations in our OpEx from quarter to quarter. But I can understand you drawing some parallels to that and if that happens to be true in 2007, then that will be great.

Tim Savageaux - Merriman Curhan Ford

Okay. Thank you.

Operator

We’ll go next to Tim Long, Bank of America Securities.

Tim Long - Bank of America Securities

Thank you and congrats, Joe, as well and good luck. Another one, just a different way of looking at the top line growth for the year, I understand the 20%, tougher to grow off a big number. Just looking at the sequentials though, obviously looking at a pull-back from what’s been several quarters in a row of 5% sequential, so just curious about that, particularly in the context of concentration of your customer base. I think at the analyst day you talked about two or three customers in a given quarter generally being about 50% of revenues. Is the concentration something that might be causing a hiccup in that sequential growth rate going forward? How do you think we’ll look as far as 10% or meaningful customers next year? Will we see a swap out with some new ones in there or do you expect more concentration?

Gary B. Smith

If we look at it quarter to quarter, there’s a number of customers that come in and out on a quarterly basis of being 10% contributors and I think all of you are familiar with our larger accounts, which include people like British Telecom, Telmax, et cetera. So in any one given quarter, we’ve got a number of those accounts that can rotate through. At any one time, you can say that we’ve got concentration within particular accounts. The trick is to get enough of them so that when one is digesting a build, you’ve got others that are rolling stuff out.

The other thing I would say around risk and diversification is even within those larger accounts, those big tier-one accounts, people like Verizon, we’re actually selling more platforms to them, so you are not just dependent upon a single build-out as we were traditionally for example in the long-haul space.

So we are very mindful of it. It’s still concentrated around some large carriers. The good news is there’s more of them. The other good news is we’re selling more things to those same accounts.

The other thing I would also bring into play is we are also looking to getting to new international markets. You saw a pretty significant expansion this year. Also outside of our traditional space, 15% of our business came from the enterprise and government space as well and I would expect that to continue to grow this year as well. So that gives you more balanced business.

Tim Long - Bank of America Securities

Okay, so we shouldn’t read into the sequential slowing of growth in your Q2 or Q3 to mean that one of the larger carriers is slowing significantly?

Gary B. Smith

No, no, I think it’s more a general comment from us around things that we can’t quite see yet. We’ve got more -- it’s simple as that, really. We’ve got more visibility into Q1 and Q2 and we’ve got good sequential growth -- I think we were over 5% growth from Q3 to Q4. We’ve signaled it could be as high as 5% from Q4 to Q1 and then we’ll clearly look at that as we go through the year.

Tim Long - Bank of America Securities

Thank you.

Operator

We’ll go next to Paul Silverstein with Credit Suisse.

Paul Silverstein - Credit Suisse

Gary, I hate to bring this up again and I certainly don’t want to make a speech -- I’ll let others do that -- but I guess I’m still trying to understand the 20%. Can you just refresh my memory -- how long have you been talking about 20% growth for? This isn’t the first time you’ve referenced that number. Is that correct?

Gary B. Smith

We talked about it in our Q3 analyst call, I believe, and then we amplified on it in the analyst day.

Paul Silverstein - Credit Suisse

So is it just a function that you have strong near-term visibility and things get more uncertain as you go out in time? Or is it really grounded in hard information and things have to happen for it to be much better than 20%?

Gary B. Smith

I would say yes to both of those things. We’ve got better visibility in Q1 and Q2 and I think it’s just a function of the further out you go, you have less visibility to it. And I would say that we are seeing good activity. We are not seeing anything that would give us undue cause for concern in that. It’s just it is a general perspective that we are offering up, which is we’ve only just completed our FY07.

Paul Silverstein - Credit Suisse

One other related question, if I might; in terms of the RFP activity you referenced, among the RFPs that are out there, are there any that are extraordinary in size and scope that I recognize you haven’t necessarily won but that could potentially drive significant growth?

Gary B. Smith

We see a number of RFP activities and there are some decent size ones out there, Paul. I don’t think there are any that are sort of world changing, from that perspective. We were pleased to secure the BT one, which we announced today. That’s our first real big win in the ethernet access space. There are some others out there like that and those are ones that we are going hard after but I don’t think there’s anything in there that would be game changing.

The other thing I would say is RFPs are not the only measure that we are seeing and in fact, from an industry wide perspective, folks, their purchasing models are not as based around RFPs as perhaps they were sort of 10 years ago and we’ve kind of seen that trend but it is certainly something that we look at in our pipeline.

Paul Silverstein - Credit Suisse

Thanks a lot.

Operator

We’ll go next to Phil Cusick with Bear Stearns.

Jonathan Cues - Bear Stearns

This is Jonathan [Cues] for Phil Cusick. Thanks for taking my question. Great quarter, guys. I just want to start with housekeeping first. You had said that the 4200 was $39.2 million for the quarter. Last quarter it was $23 million and I guess I’m wondering, is this apples-to-apples? Because there was a DNS and metro was separate at 24 and now you have 4200 at 39 and no mention of DNS separately. I’m just wondering if on an historical basis, this is an apples-to-apples comparison?

Gary B. Smith

The answer to your question is yes, it’s absolutely apples-to-apples which is why we’ve split that out.

Joseph R. Chinnici

It’s a function of the great progress the sales team has made in getting that thing rolled out. The customer base keeps expanding every single quarter, pretty much every single month, and what you had happen is in the fourth quarter, a lot of it was triggered by the rev-rec aspects of the individual contracts that we’ve signed up for the product.

Gary B. Smith

I would also add that I think when we launched the product, I think we talked publicly around what kind of run-rate can we get up to in ’07 and we talked about $40 million. I actually think it took us longer than we thought to actually get there because of revenue recognition, et cetera.

Jonathan Cues - Bear Stearns

So if I’m adding up the numbers correctly here, then with the long haul stuff, then the -- okay. So then DNS and the other metro stuff would be about 20-ish then for -- in order to get up to --

Gary B. Smith

That’s about right, yes.

Jonathan Cues - Bear Stearns

All right. Thank you for clarifying that. And then the bigger question I had was I wanted to I guess talk some more about operating margin. There has been a lot of discussion on the call about gross margin and about top line. I wanted to spend some more time on the operating margin. Obviously you are still reaffirming the ranges that you gave during the analyst day and you had also said during the analyst day that 15% would be a target in fiscal year ’08. You reached it in fiscal year ’07. Is there potentially a new target? Is there a potential range?

I mean, if you are sticking with the ranges for the OpEx, obviously then dollars that you are spending in OpEx are going up throughout the year, so are you going to be sticking pretty closely to that? Are you going to -- is there more play for operating margin just as much as you have for gross margins? If you could elaborate on that, that would be great.

Gary B. Smith

I would say that yes, we are sticking with the ranges, which will be around about that sort of -- we gave 15 as a milestone and we hit that a little sooner than we’d thought in Q4. But generally how we think about the business, I think the challenge as we go through into 2008 is making sure that we can sustain a 15% operating profit and clearly we are going to try and do better than that, if we can.

But the ranges that we talked about or the way we are going to frame our thinking about the business and how we are going to manage it during FY08, and that’s the balance between long-term investment and making sure that we deliver good growth and deliver to the bottom line as well.

Jonathan Cues - Bear Stearns

So would you say that there’s as much upside or downside potential for the operating margin as you would have for the gross margin?

Gary B. Smith

I would say clearly it can fluctuate as the gross margin, but I think overall if we look, we feel pretty good about 2008 from a revenue perspective and the 20% growth and is there opportunity to do more than that, absolutely. Is there risk to it? Yes, so that’s sort of that balanced perspective right now.

Similarly with gross margin, we are talking about a normalized range, if you will, in the mid-40s. That’s our best perspective but we are starting off with a Q1 of late 40s is our best view to it and we think that the operating margin will -- you know, on an as adjusted basis, should be about flat with Q4, which we achieved 15.7.

Jonathan Cues - Bear Stearns

Thanks for elaborating on that and good luck, Joe.

Operator

We’ll go next to Brantley Thompson with Goldman Sachs.

Brantley Thompson - Goldman Sachs

Thank you. A couple of questions; first, you talked about your non-telco business being 15% of revenues. I was wondering if you could remind us of what it was a year ago so we can get an idea of the growth rates that we are seeing in that business and any commentary on the type of margins that you see in that business and how they differ from the corporate average.

The second question is just around any other major cash outlay items in 2008 that we should have on our radar. And then the third is just an update on the competitive environment in the switching and 4200 business in particular in terms of who you compete most against now, given that so much has changed in the landscape. Thanks.

Gary B. Smith

Okay, why don’t I -- I’ll take the first one, Joe can take the cash one, and then Steve will finish up on the 4200 for your single question.

First of all, on the enterprise side, I’m not sure of the exact comparison but I think I’m pretty confident in saying it was below 10% of our business in 2006, so it’s had significant growth last year, albeit off a relatively low number.

In terms of margins, tends to be high margin, i.e. generally over 50% into enterprise and government, et cetera, and I think we are seeing particularly the 4200 family begin to do very well in some of these enterprises. As I said on the call, we’ve won about 80 odd new customers during the year on the enterprise side and I think that gives us a good base to grow from.

So we are optimistic about the future of that space. Joe, on the cash.

Joseph R. Chinnici

In terms of cash, at this point in time as far as I’m aware, there really isn’t anything major, any plans to use -- bake on some money. If you take a look at the fourth quarter or the first quarter, we had to use $50 million for that to buy out of that lease and in terms of anything similar to that, we’ve -- all that stuff has been predominantly dealt with so there are no other big needs there or demands on cash for that.

In terms of the capital, you might spend a little bit more money in terms of investing in the R&D functions in India and somewhere else. I think the only big thing out there outside of the norm that you are going to have is don’t forget we have to repay that debt on February the first, which is 542.

Stephen B. Alexander

And on the competitive side with the 4200, one thing to keep in mind is that the 4200 now is a family of products. It started out as a four-slot config. We added a two-slot config. We’ve also added a 17-slot config to it and it’s all the 4200 family. And so that changes your competitive landscape in the pure transmission space just moving bits from A to B. That’s probably one of the most fragmented, fluid markets there is in the telco space and so as we went to the smaller platforms, we brought in a whole other set of competitors that typically had specialized in small transmission boxes as we’ve added the larger shelf, the 4200 RS, the regional shelf or the [rotem] shelf. For that feature set, we again brought in a whole bunch of other competitors in that space.

It remains the large suppliers that we’ve always competed with and you see them distributed throughout the globe. You have some very clear, highly competitive environments in EMEA and in Asia and again in North America and the competitive landscape changes a bit.

But as we add features and functionality and the family grows, we fully expect the competitive landscape to change, evolve, and grow also.

Brantley Thompson - Goldman Sachs

Great. Thanks and Joe, congrats and good luck.

Operator

We’ll go next to Ehud Geldblum with JP Morgan.

Ian Khan - JP Morgan

This is Ian Khan for Ehud. Congrats, Joe. Sorry to see you go. Just a follow-up to the cash, you gave some annual cash flow numbers at the analyst day and unless I missed it, you didn’t necessarily reiterate those exact figures today. Any change there?

Joseph R. Chinnici

Definitely not.

Ian Khan - JP Morgan

Okay, and then on the contract announced at BT, the CN3000, can you discuss a little bit of the incremental impact to -- as an order of magnitude in terms of revenue, what this means for you guys at BT, what might the timing of the revenue be? What’s the margin profile for that product? And then, does that fall into ethernet access or into [converged ethernet]?

Gary B. Smith

I can answer your last question a little easier. Yes, the answer to your question is yes, if falls into the ethernet access. We just announced the deal. I would say we would expect to see that roll out probably the second half of the year. We’ve known about it for a little while so we’ve built it into our guidance and revenue, et cetera, and then I’d expect to see it ramping up probably even further as we get into 2009.

Ian Khan - JP Morgan

It’s a plus 50% gross margin type of product, or --

Gary B. Smith

That’s not something we’d comment on. Typically as you get towards the edge, even in ethernet access, it’s not too dissimilar from the sort of transmission type analogies. You get closer out to the edge, the margins tend to go down and as you aggregate, you know, when you’ve got more software, the margins tend to go up.

Ian Khan - JP Morgan

Okay. Thanks, guys.

Operator

We’ll go next to Hasan Imam with Thomas Weisel Partners.