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

Dec.13.07 | About: Ciena Corporation (CIEN)

Ciena Corporation (NYSE: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 VicePresident-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

Operator

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

Suzanne Dulong

Thanks, Steve. Good morning and welcome, everyone. I ampleased 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 bewith 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 thefinancial results for the fourth quarter, Gary will then discuss the businessin the quarter and our outlook for Q1. We’ll then open the call to questionsfrom the sell side analysts. To ensure we answer questions from as manyparticipants as possible, we ask that the sell siders limit themselves to onequestion.

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

Before I turn the call over to Gary, I’ll remind you thatduring this call, we will be making some forward-looking statements. Suchstatements are based on current expectations, forecasts and assumptions of thecompany that include risks and uncertainties that could cause actual results todiffer materially from the statements discussed today. These statements shouldbe viewed in the context of the risk factors detailed in our 10-Q filed withthe 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 completingthe 10-K. Given our desire to be as forthcoming and timely as possible with ourdisclosure, we made the decision to present today’s unaudited results to you.

We have until January 2nd to file our 10-K for our fiscal2007 and we expect to do so by then or before. Ciena assumes no obligation toupdate the information discussed in this conference call, whether as a resultof new information, future events or otherwise. Gary.

Gary B. Smith

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

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

We believe that sustained execution of our strategypositions us for continued, measurable progress in growing the company anddelivering shareholder value. I’ll talk to our business in the fourth quarterand 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 themajority of my comments on the quarter’s results as opposed to talking aboutall the annual results, so getting started, this morning we reported fourth quarterrevenue 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 combinedto represent 46.5% of total sales in the fourth quarter. One was a NorthAmerican based customer; the other is an international customer. For the year,we had two 10%-plus customers, AT&T and Sprint. Combined, AT&T andSprint contributed 38.1% of the total revenue for 2007.

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

Moving now to talk about quarterly revenue contributionacross our portfolio, our converged ethernet infrastructure group, whichincorporates all products previously in our optical networking and datanetworking groups increased to $180.9 million, representing 83.7% of totalrevenue.

Ethernet access, which incorporates all of our accessproducts, was $12.8 million, representing 5.9% of total revenue, and globalnetwork 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, coreswitching was the largest contributor at $72.5 million. Our CN 4200 advancedservices platform contributed $39.2 million in revenue, roughly on par withcore 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 ourtargeted mid-40s range, primarily as a result of a favorable product andcustomer mix and our ongoing product cost reduction efforts.

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

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

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

Even so, our 15.7% as-adjusted operating profit is slightlyabove our 15% target and represents a meaningful improvement versus thirdquarter’s level of 13.8%. And with the exception of G&A on an as-adjustedbasis, our OpEx was in line with the target percent to revenue ranges discussedat 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/ornon-operating items detailed in our press release, including 123R relatedcompensation expense, our fourth quarter net income would have been $50.3million, or as adjusted net income of $0.48 per diluted share.

Now let’s turn to the balance sheet. We were cash flowpositive for the third straight quarter, generating $14.8 million in cash fromoperations. This is in spite of the cash payment of $53 million in connectionwith the settlement of our lease obligations associated with our unusedfacilities in San Jose.

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

You’ll note an increase in our short-term investments as weprepare to repay the $542.3 million of three-and-three-quarter convertiblenotes 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 minuteson this.

The $13 million loss represents less than 1% of our totalcash position. The loss stems from a $45.9 million investment in commercialpaper issued by two structured investment vehicles, or SIVs, as you know them,that entered into receivership and failed to make payments at maturity. Theinitial 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 thepurchase, each investment had a rating of A1-plus by Standard & Poor’s, andP1 by Moody’s, their highest ratings respectively.

We have reviewed current investment gradings, third partyvaluation analysis, company specific news and events, as well as the generaleconomic conditions in determining the fair value of these investments. Aftergiving effect to this loss, our investment portfolio at year-end includedinvestments with an estimated fair value of $33.9 million related to these twoSIVs.

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

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

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

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

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

Product inventory turns improved from 3.2 in the thirdquarter 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 businessoutlook, as many of you know, this is Joe’s last conference call with us and Ihave 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’shelped navigate us through some tumultuous industry dynamics and I know I speakfor everyone at Ciena when I say we wish him all the best.

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

Joe will officially turn things over to Jim after we fileour 10-K and as Suzanne noted in the introductory remarks, we have untilJanuary 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 ourfiscal 2007 accomplishments and I’ll offer insight on our plans to build onthat success in fiscal 2008.

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

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

To get there, we implemented several actions to reengineerour business model and globalize our company. At the end of last year, we alsosaid we would leverage our market momentum to go on the offensive and furtheradvance our technology leadership. We achieved this goal in several ways,including expanding the breadth and depth of our customer base with significantgrowth in our international business, launching our FlexSelect architecture forethernet solutions, and increasing our R&D capacity by more than 40% duringthe year. And we accomplished this while improving key financial performancemetrics.

Let’s drill down a little bit further on the progress wemade with our customers and detail some of the new business we secured in theyear. At the highest level, we grew our business across the globe. Sales inNorth America were up more than 30% year over year and international sales rose55%, with business won in 10 new countries for Ciena. And notably, our partnersales worldwide increased more than 45% in 2007. ‘

In our traditional customer segment, the highly competitiveservice provider market, we added 12 new customers and we sold new productsinto 14 of our existing accounts.

Furthermore, our non-Telco business contributed more than15% of our overall revenue. We penetrated 19 additional customers in thegovernment and research and education communities and demonstrated asignificant 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 ourleadership in converged ethernet infrastructure. In February, we extended ourFlexSelect architecture with a comprehensive strategy to make ethernet acarrier class performance grade convergence vehicle from the access network tothe core.

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

In line with that during fiscal 2007, we announced our CN3000 ethernet access series and the CN 5060 multi-service carrier ethernetplatform, both of which are gaining interest in the market. In fact, weannounced this morning that BT has selected the CN 3000 series for its 21stcentury network. This agreement extends our expertise beyond the 21 CNtransmission domain to provide BT with ethernet access solutions that willsupport the rollout of new 21 CN services and applications.

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

First, we remain dedicated to improving our operations toensure we perform as a fast and agile global enterprise. Secondly, we arecommitted to attacking high growth market opportunities to deliver faster thanmarket growth. And lastly, we will continue to carry out our FlexSelectarchitecture vision to advance our market, technology, and thought leadershipin performance grade ethernet.

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

We are also highly focused on streamlining our supply chainfor greater efficiency, as well as improving overall product lifecyclemanagement.

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

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

We also continue to see opportunity to apply our expertisein simple and highly reliable networks to a wide range of enterpriseapplications, particularly in helping our customers deliver higher valuecarrier managed services.

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

Given our overall position heading into 2008, we areoptimistic about our potential for a number of reasons. We’re seeing a healthylevel of RFP activity, including a number of opportunities in the ethernettransport 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 opportunitiesto sell across our portfolio.

And finally, the architectural debate is in our favor. Theethernet driven intelligence and automation we bring with FlexSelect is helpingalleviate customers’ concerns about network complexity, ease of management, andtotal cost of ownership.

In summary, we came a long way in 2007 towards growing thecompany and stabilizing our business model. You will see us capitalize on thatenergy and momentum and continue aggressively pursuing high growth marketopportunities where we can help customers align their network architectureswith the business values of their customers.

You will also see us working to leverage the strength in ouroperating 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 thecontinued execution of our strategy and key to our consistent goal of strikingthe right balance between investing strategically in our business to fuellonger term revenue growth and maximizing short-term operating profit and netincome.

With that, let me conclude our prepared remarks today bytalking to our guidance, and I’ll remind everyone that the statements I’ve justmade and those that I’m about to make are forward-looking and it’s important tounderstand them in the context of the risk factors detailed in our most recent10-Q.

As stated in the press release, we expect to deliversequential revenue growth of up to 5% for Q1 2008. For the year, we believethat we are well positioned to continue to outperform the market and we believethat 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 doI think there could be upside to the 20%? Of course, but there is also riskassociated with achieving 20%.

On gross margins, as we’ve said in the past, gross margin isdifficult for us to predict with accuracy and we expect it will continue tofluctuate from quarter to quarter. Our gross margin ultimately depends on acombination of factors, including product and customer mix. It can also beinfluenced by services revenue mix as well as volume, pricing, and the effectsof our ongoing product cost reductions.

Based on the orders we have to date and other contributorsto 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 realisticfor our business.

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

We expect our Q1 operating expenses will be within thepercent to revenue ranges we discussed at our analyst day in October, and torecap on that, we talked about an as-adjusted R&D and sales and marketingboth 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 beroughly flat with Q4’s.

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

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

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

Finally, on cash, we expect we will be cash flow positive inQ1.

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

Question-and-AnswerSession

Operator

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

Cobb Sadler -Deutsche Bank

Thanks a lot, guys, and I want to thank Joe for the manyyears 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 whatwere the dynamics during the quarter to pull it up 1200 basis points? Thanks alot.

Gary B. Smith

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

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

Cobb Sadler -Deutsche Bank

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

Gary B. Smith

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

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

So I think we’ll continue to look at it carefully but weactually 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 wasprobably your largest customer this year. Do you have -- do you know if youlook at AT&T on a pro forma basis including the BellSouth acquisition whatkind of growth you saw in fiscal ’07 over fiscal ’06?

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

Gary B. Smith

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

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

In terms of the gross margin, it is the most difficult thingfor us to predict with accuracy. There is a lot of moving parts that go tocontribute up these numbers. We continue to look at that very carefully. Ithink we’ve signaled that Q1 is likely, as best we can tell, to be in the high40s and it really is a mix not just of the main product platforms but also amix within those product platforms most classically represented in thetransport space as cards versus chassis, but as we get into the convergedethernet space there’s even a lot more complexity within that mix aroundsoftware and cards and the kind of expansion, whether it’s access, metro, etcetera.

A lot of moving parts to it. We do expect if we execute wellover time, as we get into 2009, that we may be able to sustain an increasedrange. But right now, we still feel that as best we can tell, a range in themid-40s is about right for our business dynamics that we see. Thatwithstanding, 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’twant to get into too many details on one customer. Could you comment at leastwhether on a pro forma basis that customer grew above or below the overallrevenue 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 otherincome?

Joseph R. Chinnici

It’s about $8 million.

Marcus Kupferschmidt- Lehman Brothers

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

Joseph R. Chinnici

That is correct. Because don’t forget, we have to pay downthe 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 aregetting.

Marcus Kupferschmidt- Lehman Brothers

Are you moving your investments to cash because you aretrying to be more conservative where you park it or because you need quickliquidity 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 thefirst 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 bitmore about the visibility in the business, I think your point is you are seeingthings looking now versus six months, do you have more visibility in whatyou’ve won and kind of a better pipeline now than maybe six months ago? Whereare you in terms of how you look at the business you’ve won as opposed to allthe opportunities and RFPs that you are looking at?

Gary B. Smith

I would say overall, Marcus, I would say visibility is aboutthe same as it was probably at analyst day, going back a few months. We areseeing good activity, seeing good RFP activity and interest. I think we areseeing in our conversations with our customers both two dynamics; one, thedemand for more capacity, particularly in the metro type areas and also adesire 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, longhaul goes down, should we start thinking that your customer base is starting tospend more money on metro and less on long haul? Or is the 4200 also being usedin long haul applications and we shouldn’t be thinking about market dynamicschanging around? Thank you.

Stephen B. Alexander

What you see with all these builds is an effect whereas youbuild a lot of capacity in the core, then you tend to go back and build it inthe 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 corestream together, and so you are going to see a natural transition over thecustomer 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 downa couple of things. One, I wanted to see what the trends are in some of theselegacy products that you don’t talk about too much, particularly the maturinglong haul products and the metro products that I believe are stillcontributing. 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 itthe raw transmission products. So core stream evolved as a product and now ishundreds of channels over mega-meters, right? And we are adding that featureset over time to the 4200, so that’s a consolidation play, if you will, on theportfolio side.

With regard to the metro platforms, these go back to some ofthe online platforms and such, they continue to sell well to the customerswhere there is a substantial installed base. We are adding the requiredfeatures to again migrate those over to the 4000. We brought our feature set tomarket that we call FlexiShelf, that basically lets a 4000 series shelf be achannel 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 usare trying to figure out, is that the trending on overall gross margin ofwhat’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 aboutproduct mix or is it about the competitive environment or is it about how theproducts are evolving that a given platform like core director may have a lowergross margin later in the year because of something. So a little bit of helpunderstanding what’s driving this guidance.

Gary B. Smith

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

Joseph R. Chinnici

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

So I think part of the guidance on the margin front is themid-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 aboutyour sense of your shifting mix or a stable mix assumption and changes in thegross margin within that mix.

Gary B. Smith

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

We’ve got a lot of new products coming out as well that areworking 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 - RBCCapital Markets

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

Gary B. Smith

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

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

Mark Sue - RBCCapital Markets

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

Gary B. Smith

Well, I think because we are a specialist focus player, whenwe engage in terms of our FlexSelect architecture and folks really want to movetowards converged ethernet, I would say that win rate is very high. When youare just looking at moving bits around, pure transport, that can vary becausethere 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 prettydramatically.

Mark Sue - RBCCapital 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 goodluck. I have a question -- I mean, we’re talking a lot about guidance and grossmargins and I think you guys are actually implicitly signaling somethingthrough your operating expense spending. So you’ve brought it up to a newplateau. The last time you did that, we all got kind of concerned about it andyou delivered a lot of top line growth and a lot of margin expansion.

So at this point, you appear to feel confident enough tobreach by some measure the $70 million per quarter operating expense level andyet are continuing to talk conservatively on the top line in the gross marginside, which is why we find ourselves in this annual disconnect discussion. I’ma little disappointed I didn’t get to ask the 20% growth question because Inormally get to every year but as you look at how you are managing yourbusiness and the operating expense levels that you are comfortable with, whatshould we take out of that with regard to your views on potential gross marginsand top line growth?

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

Gary B. Smith

Why don’t I do that, Tim? I think to the balance, we’refocused on I think at this stage in the company’s evolution, we’ve got to whatwe sincerely hope is a stabilized business model and we’ve indicated that oneof the milestones for that is operating profit of around 15% and in fact, weexceeded 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 aswe talked on analyst day is where we are targeted. We are investing in newplatforms and extensions to make sure that we continue to outperform the marketand we are focused on ’09 and 2010 in terms of many of those platforms. A lotof that investment takes two to three years to bring out in terms of newplatforms.

If we are successful with those, then clearly that will helpdrive both the top line and potentially in the future improve our gross marginsas well. So it is a balance. I would encourage you to focus on our overalloperating 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 tobe 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 ofAmerica Securities

Thank you and congrats, Joe, as well and good luck. Anotherone, just a different way of looking at the top line growth for the year, Iunderstand the 20%, tougher to grow off a big number. Just looking at thesequentials though, obviously looking at a pull-back from what’s been severalquarters in a row of 5% sequential, so just curious about that, particularly inthe context of concentration of your customer base. I think at the analyst dayyou talked about two or three customers in a given quarter generally beingabout 50% of revenues. Is the concentration something that might be causing ahiccup in that sequential growth rate going forward? How do you think we’lllook as far as 10% or meaningful customers next year? Will we see a swap outwith 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 ofcustomers that come in and out on a quarterly basis of being 10% contributorsand I think all of you are familiar with our larger accounts, which includepeople 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 trickis to get enough of them so that when one is digesting a build, you’ve gotothers that are rolling stuff out.

The other thing I would say around risk and diversificationis even within those larger accounts, those big tier-one accounts, people likeVerizon, we’re actually selling more platforms to them, so you are not justdependent upon a single build-out as we were traditionally for example in thelong-haul space.

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

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

Tim Long - Bank ofAmerica Securities

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

Gary B. Smith

No, no, I think it’s more a general comment from us aroundthings 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 sequentialgrowth -- I think we were over 5% growth from Q3 to Q4. We’ve signaled it couldbe as high as 5% from Q4 to Q1 and then we’ll clearly look at that as we gothrough the year.

Tim Long - Bank ofAmerica 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’twant to make a speech -- I’ll let others do that -- but I guess I’m stilltrying to understand the 20%. Can you just refresh my memory -- how long haveyou been talking about 20% growth for? This isn’t the first time you’vereferenced that number. Is that correct?

Gary B. Smith

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

Paul Silverstein -Credit Suisse

So is it just a function that you have strong near-termvisibility and things get more uncertain as you go out in time? Or is it reallygrounded in hard information and things have to happen for it to be much betterthan 20%?

Gary B. Smith

I would say yes to both of those things. We’ve got better visibilityin Q1 and Q2 and I think it’s just a function of the further out you go, youhave 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’veonly just completed our FY07.

Paul Silverstein -Credit Suisse

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

Gary B. Smith

We see a number of RFP activities and there are some decentsize ones out there, Paul. I don’t think there are any that are sort of worldchanging, from that perspective. We were pleased to secure the BT one, which weannounced 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 goinghard after but I don’t think there’s anything in there that would be gamechanging.

The other thing I would say is RFPs are not the only measurethat we are seeing and in fact, from an industry wide perspective, folks, theirpurchasing models are not as based around RFPs as perhaps they were sort of 10years ago and we’ve kind of seen that trend but it is certainly something thatwe 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 - BearStearns

This is Jonathan [Cues] for Phil Cusick. Thanks for takingmy 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 itwas $23 million and I guess I’m wondering, is this apples-to-apples? Becausethere was a DNS and metro was separate at 24 and now you have 4200 at 39 and nomention of DNS separately. I’m just wondering if on an historical basis, thisis an apples-to-apples comparison?

Gary B. Smith

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

Joseph R. Chinnici

It’s a function of the great progress the sales team hasmade in getting that thing rolled out. The customer base keeps expanding everysingle quarter, pretty much every single month, and what you had happen is inthe fourth quarter, a lot of it was triggered by the rev-rec aspects of theindividual 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 ’07and we talked about $40 million. I actually think it took us longer than wethought to actually get there because of revenue recognition, et cetera.

Jonathan Cues - BearStearns

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

Gary B. Smith

That’s about right, yes.

Jonathan Cues - BearStearns

All right. Thank you for clarifying that. And then thebigger question I had was I wanted to I guess talk some more about operatingmargin. There has been a lot of discussion on the call about gross margin andabout 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 analystday and you had also said during the analyst day that 15% would be a target infiscal year ’08. You reached it in fiscal year ’07. Is there potentially a newtarget? 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 throughoutthe year, so are you going to be sticking pretty closely to that? Are you goingto -- is there more play for operating margin just as much as you have forgross 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, whichwill be around about that sort of -- we gave 15 as a milestone and we hit thata little sooner than we’d thought in Q4. But generally how we think about thebusiness, I think the challenge as we go through into 2008 is making sure thatwe can sustain a 15% operating profit and clearly we are going to try and dobetter than that, if we can.

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

Jonathan Cues - BearStearns

So would you say that there’s as much upside or downsidepotential 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 revenueperspective 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 balancedperspective right now.

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

Jonathan Cues - BearStearns

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 aboutyour non-telco business being 15% of revenues. I was wondering if you couldremind us of what it was a year ago so we can get an idea of the growth ratesthat we are seeing in that business and any commentary on the type of marginsthat you see in that business and how they differ from the corporate average.

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

Gary B. Smith

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

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

In terms of margins, tends to be high margin, i.e. generallyover 50% into enterprise and government, et cetera, and I think we are seeingparticularly the 4200 family begin to do very well in some of theseenterprises. As I said on the call, we’ve won about 80 odd new customers duringthe year on the enterprise side and I think that gives us a good base to growfrom.

So we are optimistic about the future of that space. Joe, onthe 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. Ifyou take a look at the fourth quarter or the first quarter, we had to use $50million for that to buy out of that lease and in terms of anything similar tothat, we’ve -- all that stuff has been predominantly dealt with so there are noother big needs there or demands on cash for that.

In terms of the capital, you might spend a little bit moremoney in terms of investing in the R&D functions in India and somewhereelse. I think the only big thing out there outside of the norm that you aregoing 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 keepin mind is that the 4200 now is a family of products. It started out as afour-slot config. We added a two-slot config. We’ve also added a 17-slot configto it and it’s all the 4200 family. And so that changes your competitivelandscape in the pure transmission space just moving bits from A to B. That’sprobably one of the most fragmented, fluid markets there is in the telco spaceand so as we went to the smaller platforms, we brought in a whole other set ofcompetitors that typically had specialized in small transmission boxes as we’veadded 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 inthat space.

It remains the large suppliers that we’ve always competedwith and you see them distributed throughout the globe. You have some veryclear, highly competitive environments in EMEA and in Asia and again in NorthAmerica and the competitive landscape changes a bit.

But as we add features and functionality and the familygrows, we fully expect the competitive landscape to change, evolve, and growalso.

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 yougo. Just a follow-up to the cash, you gave some annual cash flow numbers at theanalyst day and unless I missed it, you didn’t necessarily reiterate thoseexact 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 ofmagnitude in terms of revenue, what this means for you guys at BT, what mightthe timing of the revenue be? What’s the margin profile for that product? Andthen, does that fall into ethernet access or into [converged ethernet]?

Gary B. Smith

I can answer your last question a little easier. Yes, the answerto your question is yes, if falls into the ethernet access. We just announcedthe deal. I would say we would expect to see that roll out probably the secondhalf of the year. We’ve known about it for a little while so we’ve built itinto our guidance and revenue, et cetera, and then I’d expect to see it rampingup 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 gettowards the edge, even in ethernet access, it’s not too dissimilar from thesort of transmission type analogies. You get closer out to the edge, themargins tend to go down and as you aggregate, you know, when you’ve got moresoftware, 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.

Hasan Imam - ThomasWeisel Partners

Thank you. Joe, good luck at your next job and hopefully youhave more fun. My question, I just wanted to drill down a little bit on theOpEx front. So your OpEx ramp this quarter quite faster than revenues. I’m justwondering where you are spending that money. Is that primarily India, theheadcount ramp? And when does that end?

Joseph R. Chinnici

It was not primarily a headcount. We didn’t add very manypeople in the quarter. It was predominantly on prototypes, some one-off typethings, and although we haven’t talked about it and it took this long to getthere, the order intake in the fourth quarter was strong and I’m not allowed touse the word strong anymore than that, so I can’t -- I have to find some otherword after analyst day.

But it was very -- it was strong and consequently, thattranslated into commissions coming in a lot higher than what we had anticipatedfor the fourth quarter. So they were the biggest single pieces that are I thinkthings to be concerned about and worried about. The prototype things are notongoing. You are not going to have those every quarter and the commission ones,as long as that order rate keeps going up, I’m sure Gary would love to keeppaying those the way they are going.

Hasan Imam - ThomasWeisel Partners

And what about the India headcount ramp? When do you thinkthat tapers off?

Joseph R. Chinnici

We met within a couple of headcount of what our goals werefor 2008 -- 2007. We have plans to continue to grow our R&D capacity into2008 but we are going to do it with a careful eye on what the business modelrequires and what we think is a prudent level of investment.

Hasan Imam - ThomasWeisel Partners

Okay, and then one last question; in terms of the 40Gcontracts that are coming up in AT&T, Verizon, et cetera, I just wanted tohear what your position is there, given that you’ve more heavily bet on 100G.Should we expect you not to be meaningful players in these contracts and thenwait for the 100G upgrade? Thank you.

Stephen B. Alexander

We have a 40-gig solution in the market today. It’s aproduct that we have through the StrataLight relationship that we’ve had forquite a while. That’s actually used by several of the other suppliers in thespace and fulfilling 40-gig needs, so I think we’re competitive in that space.

I do think we are focused internally on a lot of activityaround 100-gig, you know, the next gen switch platforms and transmissionplatforms and such are all focused around that.

But we expect to be able to provide competitive solutions,both at 40-gig and 100-gig.

Hasan Imam - ThomasWeisel Partners

On the 40-gig side, would you say you are at par with someof the leaders? I know that I the past, Steve has talked a number of timesabout really putting more of your eggs in the 100G basket.

Stephen B. Alexander

I think what we’ve done is looked at the way we want toapproach the market and again, the 40-gig comes to us through StrataLight.Technically, it’s as good a product offering is available out there today. Weare looking at the 100-gig approach in terms of where 100-gig ethernet is goingto go and what the impacts are going to be on the market there. But we arecomfortable with our position at 40-gig today.

Hasan Imam - ThomasWeisel Partners

Thank you.

Operator

Due to time constraints, we’ll take our final question fromSubu Subrahmanyan with Sanders Morris.

Natarajan 'Subu'Subrahmanyan - Sanders Morris Harris

Thank you and Joe, congratulations and thanks for all thehelp. My question actually is on the -- I just wanted to revisit thenon-operating income point and see if you wanted to just talk about an EPSguidance and also just a trajectory of operating expenses going forward.Because the way I calculate it, you had about $17.5 million in non-operatingincome for October, going down to about $8 million. And I just want tounderstand the impact on EPS and how much of that could be offset by lowerOpEx.

Joseph R. Chinnici

In terms of the -- I’ll do the non-op and I’ll let Gary talkabout the OpEx on a go-forward basis, as well as the operating profit number.

The non-op income, as you’re calling it, is a question ofpositioning the 542 to be paid down and the way the rates moved around and whatkind of investments we had and where we moved it from, so it’s really aquestion of just the mechanics and the actual investment vehicles that we wereinvolved in.

In terms of the big number, we had to take the write-down inthe quarter, which was an unfortunate situation but we had to do what we had todo there.

So in terms of -- I like the eight. Could it be a little bithigher than that? Yes, but it depends on where we end up for the quarter andwhat we do. Aside from that, I don’t feel real comfortable in going a lotfarther into that one right now.

Gary B. Smith

Why don’t I take the second part of it on OpEx -- as wesaid, we gave the ranges out, which we believe are applicable going through toFY08 and what we are focused on is the overall operating profit and deliveringthat. We’ve hit that milestone a little earlier than we’d anticipated butaround that 15% is where we are focused from an operating profit perspectivegoing forward. And we would expect in Q1 for our operating profit to beflattish with Q4, and it was 15.7 in Q4.

Natarajan 'Subu'Subrahmanyan - Sanders Morris Harris

Understood. If I could just follow-up; is that $8 million agood run-rate for the rest of the year on a quarterly basis, Joe? And do youwant to venture an EPS guidance, because obviously you cleared some variance onthe EPS number?

Joseph R. Chinnici

Okay, the eight -- theoretically, if you go back to what wetalked to you about at the analyst day, we could generate as much as or up to$200 million, so the eight in theory should grow depending upon what -- wherethe rates go and what kind of investment vehicles we can get our hands on. Sothe eight could grow.

In terms of the EPS guidance, we don’t typically do that andI’m not going to set a precedent for the new guy coming in here because I don’tthink it’s a proper set-up for him. He and Gary can talk about that and figureout what they want to do during the next quarter.

Natarajan 'Subu'Subrahmanyan - Sanders Morris Harris

Thank you.

Operator

Mr. Smith, I would like to turn the conference over to youfor any additional or closing comments.

Gary B. Smith

Thank you and I would like to thank everyone for their timethis morning and for your continued support. I would like to add a couple ofsummary pieces, if you like. Thank you for your support during 2007. Ashopefully you can tell, we feel good about 2008 and certainly our visibility isgood into the first half of the year and we are very focused on leveraging ouroperating model. We think we are in the sweet spot in the market. We arewell-placed from a product cycle point of view and we are very focused on acontinuing improving financial performance.

With that, I’d like to reiterate my thanks and best wishesto Joe, as many of you have passed on today. I am sure you will have a chanceduring the next few days to do that and we’d like to wish everyone a happy andsafe holiday season. Thank you.

Operator

This does conclude today’s conference. Thank you for yourparticipation. You may now disconnect.

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