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Edited Transcript of ADV.DE earnings conference call or presentation 20-Feb-20 2:00pm GMT

Q4 2019 ADVA Optical Networking SE Earnings Call

Martineried Mar 4, 2020 (Thomson StreetEvents) -- Edited Transcript of Adva Optical Networking SE earnings conference call or presentation Thursday, February 20, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian L. Protiva

ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board

* Stephan Rettenberger

ADVA Optical Networking SE - SVP of Marketing & IR

* Ulrich Dopfer

ADVA Optical Networking SE - President, CFO & Member of Management Board

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Conference Call Participants

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* Lars Friedrich

Dürr Aktiengesellschaft - CEO of Division Application Technology

* Paul de Froment

Kepler Cheuvreux, Research Division - Equity Research Analyst

* Robert Duncan Cobban Sanders

Deutsche Bank AG, Research Division - Director

* Simon Scholes

First Berlin Equity Research GmbH - Senior Analyst of Technology, Biotech, Medtech, and Resource

* Stephan Klepp

Commerzbank AG, Research Division - Head of Small and Mid Cap Research

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Dear, ladies and gentlemen, welcome to the conference call of ADVA Optical Networking for the full year 2019 IFRS financial results. This call is being recorded. (Operator Instructions) May I now hand you over to Mr. Stephan Rettenberger, ADVA Optical Networking's Senior Vice President, Marketing and Investor Relations. Please go ahead, sir.

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Stephan Rettenberger, ADVA Optical Networking SE - SVP of Marketing & IR [2]

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Thank you, and welcome from my side. This earnings call builds on a presentation, which is available for download in PDF format from our homepage under www.adva.com, in the About Us/Investors section. Should you not have the presentation in front of you, you may want to access it on the conference call's page in the Financial Results section of the Investors section of our website.

Before we will lead you through the presentation, as always, please be informed that this presentation contains forward-looking statements with words such as believes, anticipates and expects to describe expected revenues and earnings, anticipated demand for optical networking solutions, internal estimates and liquidity. These factors are discussed in greater detail in the Risk Reports section of our annual report 2019, which we published today.

Please also be reminded that we provide consolidated pro forma financial results in this presentation solely as supplemental financial information to help the financial community make meaningful comparisons of our operating results from one financial period to another. This pro forma information is not prepared in accordance with IFRS, and should not be considered a substitute for historical information presented in accordance with IFRS.

Pro forma operating income or loss is calculated prior to noncash charges, related to the stock compensation programs and amortization and impairment of goodwill and acquisition-related intangible assets. Nonrecurring expenses related to restructuring measures are not included. Unless stated otherwise, all numbers are presented in euro. We will target to limit this conference call to 60 minutes. As usual, Brian will start to provide a business update and outlook, then Uli will talk us through our Q4 and full year 2019 financials. And finally, we will have sufficient time for your questions, which we'll be happy to answer.

Brian, please go ahead with the business update.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [3]

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Thank you, Stephan. So Page 4 of the presentation, Q4 2019 in review. We finished the year strong. Our Q4 revenues reached EUR 151.1 million, up nicely by 14.9% year-over-year from EUR 131.5 million in Q4 2019. This also represents nice sequential quarterly growth. Our Q4 pro forma operating income was at EUR 10.3 million or 6.8% of revenues. Both key performance indicators are at the top end of our guidance corridor provided on October 24, 2019.

On an annualized basis, our revenue grew by more than 10% and excellent results that even exceeded our communicated annual goal and was supported by us meeting the lower end of our targeted profitability -- the lower end of profitability due to dollar and trade-related cost pressures. Furthermore, we continue to see solid demand from all regions and customer groups. We have a good order backlog, and we are pleased with the level of order entry across the portfolio. Our newer products are enabling us to expand into new markets. While the demand for our solutions is very healthy, the challenges around a strengthening U.S. dollar and the U.S.-China trade tensions, with related costs, continue to put pressures on our margins. Thus, we are committed to continue our tight control of OpEx throughout 2020. Our Q4 results and 2019 achievements further underscore our momentum and our confidence in the market for 2020.

Slide 5, industry macro-environment. The industry growth drivers, which we have described in the previous earnings calls, continue to be fully intact. Multi-cloud concepts for enterprises, edge computing solutions for network operators, IoT and 5G all require a robust and scalable telecommunications infrastructure with more optical data transmission, new models for the provisioning of communication services and more precise network synchronization. Our investments in recent years address precisely these aspects.

We are technologically well positioned for the new opportunities of this network transformation, a transformation based on openness, virtualization and security. As we've positioned ourselves over the last years, digitization is changing networks and bringing the investment focus to the edge of the network. The edge is where you need to combine infrastructure knowledge with end-customer application know-how. It is where ADVA performs best and is most differentiated.

This positive backdrop around the demand for our networking solutions is unfortunately overshadowed by geopolitical tensions and the U.S. tariffs on goods coming out of China, both of which have had an impact on our 2019 margins. More recently, we have started facing new topics, creating uncertainty caused by COVID-19 or the coronavirus. The city of Wuhan is an important center of photonic components and subsystems, and the isolation of the region is causing delays in the global supply chain and, more specifically, will start impacting our ability to supply products in the coming weeks. More detail on these last 2 aspects will be covered on my next slide. But even within this context, I want to reiterate, our industry growth drivers are fully intact and our strategy and portfolio are well aligned. Orders are healthy, and we even had record bookings in Q4 2019. Most importantly, our 3 core competencies are strategically relevant and important for evolving network architectures.

Now moving to Slide 6. Operating model, adapting to a changing world. As our operational model is an area of uncertainty as seen by our ad-hoc pre-announcement, I thought I would take some time to help you understand our operations strategy. In the areas of manufacturing, logistics and distribution, ADVA has developed a tightly integrated approach with best-in-class global Tier 1 EMS partners and a very strong operations team to manage these strategic relationships. The production process and degree of automation have been optimized over many years to drive operational excellence, quality and cost optimization.

Our global EMS providers manage a large part of the operational value chain from material purchasing to PCB manufacturing and then final hardware assembly, after which they support us with software loading, functional testing and ultimately the distribution logistics. Co-located, ADVA experts monitor the results of the individual production and testing steps using remote shop floor control systems, which we have designed and produced. Ultimately, it is critical to ensure efficient communication between ADVA's development centers and these manufacturing partners. This model allows us to scale quickly and to be flexible in times of challenges.

Our distribution strategy to support global business is built on our own distribution centers in Europe and the U.S. We continue to fine-tune and to strengthen both staging and configuration competencies within our centers. And we are very focused on further improving efficiency in freight and logistics by working closely with our global EMS partners.

On the manufacturing side, we had to make changes to mitigate the impact of U.S. tariffs and goods coming from China. We rapidly transferred finished goods to our distribution centers prior to the October 2019 deadline and have started to transfer production lines out of China to strategically reduce the dependency. These mitigation measures are ongoing and will give us an improved cost base for our U.S. business starting in Q2 2020. Disturbingly, the COVID-19 crisis is adding another dimension of complexity. Again, the city of Wuhan is an important center of photonic components and subsystems and the isolation of the region is leading to delays in the global supply chain. It is currently difficult for us to assess what impact the crisis in China will have on our Q1 2020 results.

We expect that despite the healthy order backlog, some of the order fulfillment and revenue recognition will shift from Q1 2020 to later quarters. Clearly, if the COVID-19 crisis continues for a longer period of time, we'll have to review further changes to our manufacturing EMS partners by moving production to new sites. This is a time-consuming and costly exercise for us, but we've already started a similar process with respect to the trade tariffs last year. So what are the opportunities for growth?

Moving to Slide 7, cloud interconnect growth opportunities. The strategic importance of reliable, global and highly secured communication infrastructure is rapidly increasing. The most important raw material here is fiber. It's the only medium that can satisfy that insatiable demand for more bandwidth. Fiber optic networks are extending their reach into new areas and are of crucial importance for 5G. Our transmission technology, in turn, ensures that this valuable medium is used optimally. Thanks to our FSP 3000, network operators can sustainably cope with the rapid increase -- increasing amounts of data being transmitted.

In 2019, we were able to gain share in the market for Metro WDM. Based on industry analysts' numbers published in November '19, our Q3 results moved us to the #2 position in EMEA, and our market leadership in optical networks for data center interconnect for private companies increased to greater than 50% in EMEA and greater than 30% globally.

In addition, our numerous major carrier customers worldwide began using our technology to expand their networks in preparation for 5G. The trend towards open solutions is disruptive here. Network operators are driven to decouple the individual building blocks in their networks in order to use innovation cycles more flexibly. In addition, in times of geopolitical tensions, they can reduce their dependency on individual large suppliers with open solutions. As a pioneer in the development of open and interoperable solutions for several years, ADVA is benefiting from this trend. Our FSP 3000 sets new standards in open optical transmission technology. The platform delivers highly automated, scalable data transmission that further reduces the cost per bit of transport. The market introduction of the new TeraFlex terminal has been successful and the flexibility of our open line systems, OLSs has the potential to push market dynamics further in our favor. And finally, our efforts towards more vertical integration create additional upside.

Moving to Slide 8, cloud access growth opportunities. For many emerging applications in the digital world, it's important how and where the 3 critical functions of data processing, storage and transfer interact. For the Internet of Things, IoT, and also for the creation and use of artificial intelligence, the efficient collection, processing and provisioning of data is of crucial importance. In this context, edge computing solutions are emerging that require data transmission with low latency and high security -- or I should say, highest security.

The network operators' investment focus is, therefore, moving closer to the network edge and towards our sweet spot, at the edge is where ADVA is best positioned. For many network operators, Carrier Ethernet access technology is a key part of the technology mix at the network edge. We have successfully consolidated this market segment in recent years through the acquisition of Overture and MRV, and are now one of the 2 leading manufacturers in this technology space worldwide.

Network operators are currently upgrading their Carrier Ethernet access networks and increasing data rates from 1 gig to 10 gig. And for this, they need new demarcation and 100-gig aggregation technology. Smaller manufacturers are finding it increasingly difficult to keep up with the high pace of innovation and are falling behind technologically. As a result, new opportunities are emerging to gain market share. In addition, the trend towards virtual provisioning of value-added services is accelerating. Our Ensemble Connector offers flexible and fast provisioning of NFV-based services at the network edge. Several leading network operators as well as system integrators have selected solution as a key component for their universal customer premise equipment. Our win rate over the past year has been impressive and commercial implementation of this software solution will continue to gain momentum in 2020.

Slide 9, network synchronization growth opportunities, and our final part of our tripod. I want to briefly touch on this pillar, network synchronization technology. Network operators worldwide have embarked on a journey of implementing 5G and, therefore, need higher precision time and phase synchronization in their networks. Our Oscilloquartz portfolio is globally recognized as the leading technology architecture. Its range of solutions offers unique features and achieves very high success rates in tenders around the globe. After an already very successful 2018, we were able to increase the revenue contribution of this technology pillar in 2019, with strong margins. In additions to the increasing demand from network operators, the product portfolio now also addresses timing applications in other industries, such as media and energy utilities. The vulnerability of GNSS signals or the timing that comes off of satellites is causing concerns as more and more applications rely on precise timing. Network operators in charge of mission-critical infrastructure are rethinking their synchronization strategies and shift towards network-based timing, rather than exclusively relying on satellites or GPS timing signals.

Since H2 2019, our investments in synchronization technologies are now starting to return invested euros as this segment is growing faster than 20% per annum. We are on the verge of annual profitability in 2020 in this market segment. And finally, in addition to accelerating 5G rollouts, we see additional opportunities for growth and profitability in new industry verticals.

Slide 10, and my last one, a summary of why we win and why we are growing in a world driven by cloud and mobility. We are committed to our brand promise of open networking, operational excellence and being a partner who is easy to do business with. We were the first of the optical networking vendors to push open solutions, alien wavelength support, open optical line systems, and we have moved beyond this to offer open universal CPE solutions and DCSG software. So that's the access -- same cell site gate access routers at the edge of the network. Our commitment to operational excellence will help us not only continue to lead in sustainability, but also solve our latest challenge with the COVID-19 supply chain chaos. While for our customers, we'll remain a leader in open transparent communication and products. However, and most importantly, it is our passion to remain focused on our customers' needs and easiest -- be the easiest company in our industry to work with.

With this, I pass off to Uli to cover our financials.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [4]

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Thank you, Brian. Welcome, everybody, and thank you for joining us on our Q4 and full year 2019 conference call. I will review our results, followed by our outlook for 2020. All numbers are presented in euros.

We executed the financial year 2019 successfully with revenues of EUR 556.8 million, 10.9% up from EUR 502 million in 2018. The positive development was due to solid demand from all customer groups across all technology areas. Our pro forma operating margin was at 4.5% and on a similar level with 2018. Our margins in 2019 were heavily impacted by the U.S. dollar development and the effects resulting from the U.S. trade policy. The strong U.S. dollar compared to 2018 contributed negative EUR 3.2 million. Costs related to extra tariffs and additional freight costs resulting from transfer of materials and components to U.S. locations amounted to EUR 5 million. We were able to offset these costs, these effects due to our cost discipline within OpEx. I will discuss the current status of our improvement measures at a later stage. Due to the first-time adoption of IFRS 16, net debt increased significantly to EUR 61.1 million. This includes EUR 34.4 million lease liabilities. Excluding IFRS 16, net debt was EUR 26.7 million and at a similar level compared to the EUR 26.8 million at the end of 2018. We met or exceeded all our expectations for the financial year 2019.

Next slide, please. Q4 key financials. As Brian stated in the beginning of this call, revenues in Q4 2019 amounted to EUR 151.1 million, and were significantly up by 14.9% from EUR 131.5 million in Q4 2018. This result was at the upper end of our guidance corridor of between EUR 142 million and EUR 152 million. Pro forma gross profit contribution increased to EUR 54.6 million, up from EUR 48.7 million in the year ago quarter. Our pro forma operating income margin was at 6.8% of revenues, up from 6.2% in Q4 2018. This result also came in towards the upper end of our guidance of between 5% and 7% of revenues. Net income was EUR 2.5 million compared to EUR 3.6 million in the year ago quarter. Please note that our Q4 net income was impacted by EUR 3.2 million one-off restructuring expenses. Consequently, earnings per share decreased from $0.07 to $0.05. Net debt was at EUR 61.1 million, as already discussed on the previous slide.

Next slide, please. Q4 revenues per region. Looking at our revenues geographically, EMEA revenues increased by an impressive 22.5% year-over-year, now representing 53.9% of total revenues. This is attributable to a very good demand from network operators as well as strong business from enterprise customers. We also saw solid demand in North America. Similar to EMEA, we had strong business with all customer groups. North America revenues increased significantly by 11.4% compared to Q4 2018, now contributing 38.3% of total revenues. Asia Pacific represents 7.8% of total revenues. The region is predominated by project-based business, leading to greater fluctuations in individual quarters. In addition, regulatory uncertainties affected one large customer, which led to a decline in revenues with that particular customer.

Next slide, please. Quarterly revenue and pro forma profitability. Except for Q1 2019, our revenues grew sequentially throughout the year. In Q4, we were able to convert successfully the strong order pipeline into revenues. Based on a more favorable customer mix, pro forma gross margin increased to 36.1%, up from 34% in the previous quarter. With EUR 10.3 million or 6.8% of revenues, our pro forma operating income improved strongly when compared to the EUR 7.4 million or 5.1% in Q3 2019. Compared to the year ago quarter, pro forma operating income increased by EUR 2.2 million.

Next slide, please. Improvement measures, status update. We are pleased to see that our improvement measures are showing the expected results. The transfer of tariff-effected production lines from China to Southeast Asia will be completed within Q2. To limit the negative impact of further increasing import duties, we expedited the transfer of materials and components to U.S. locations. This resulted in before-mentioned increased freight costs and high inventory levels in the second half of the year. We are making good progress with our product road map, which allows us to streamline our R&D efforts without jeopardizing our competitiveness. Our targeted cost savings of EUR 8 million in 2019 have been achieved and will lead to run rate savings of up to EUR 22 million. This supports our aim to keep OpEx flat on an annual basis.

Turning to the balance sheet. Q4 2019 credit metrics remain solid with an equity ratio of 47.7%. Gross leverage was 1.2%, indicating a solid investment-grade profile. Liabilities to banks of EUR 81 million and IFRS lease liabilities of EUR 34.4 million add up to our total financial debt of EUR 115.4 million. Year-to-date ROCE was 3.3%. We were able to improve gross cash to EUR 54.3 million, up from EUR 38.4 million in Q3. I will discuss our cash flow development for the financial year 2019 on the next slides. The net working capital for Q4 improved strongly to 21.4% of revenues at the end of Q4 2019 and improved by 2.7 percentage points compared to the previous quarter.

Next slide, please. As already mentioned in the past, our cash -- our operating cash flow is subject to a certain seasonality due to recurring events, in particular, employee-related costs in Q1 and Q3. Operating cash flow improved year-over-year by 8.9%.

Next slide, please. Free cash flow, 2019. We made big steps forward in many areas within the financial year 2019, however, free cash flow generation was not one of them. Our free cash flow decreased by EUR 5.7 million, down to EUR 6.6 million, mainly impacted by the high investments in new products within our technology tripod. Focused investment areas were enhancement to the open optical transport solution, including the development of the new TeraFlex terminal and a new generation of open line systems; a new generation of 100G network edge products, including our NFV software for our cloud access portfolio; and ultra-precise synchronization technologies for 5G mobile networks and other industry verticals.

Next and final slide. We have created a solid basis in all 3 technology areas and see promising growth scenarios as a result of the network transformation that is disrupting our markets. The market introduction of the new FSP 3000 TeraFlex terminal has been successful, and the flexibility of our open line system has the potential to push market dynamics further in our favor. Several leading network operators as well as system integrators have selected our NFV solution as a key component for the universal customer premises equipment. Our win rate over the past year has been impressive, and commercial implementation of the software solution will continue to gain momentum in 2020.

Our investments in synchronization technology are bearing more and more fruit and offer us additional opportunities for growth and profitability. Due to the COVID-19 prices in China, our supply chain is temporarily constrained. We believe that this will most likely lead to a negative pro forma operating income margin in Q1 2020. Whether and to what extent the situation in China will change cannot yet be reliably predicted. However, we assume that some revenue will shift to the following quarters and that the decline in pro forma operating income margin will recover on an annualized basis.

Finally, we stay committed to work diligently on our OpEx to improve margins. We decided to change the revenue and profitability guidance from quarterly to annual period. For the full year 2020, we expect revenues to exceed EUR 500 million (sic) [EUR 580 million] and a pro forma operating income margin above 5% of revenues.

With that, I hand the call back to the operator to open the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we've received the first question. It is from Stephan Plank (sic) [Stephan Klepp] of Commerzbank.

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Stephan Klepp, Commerzbank AG, Research Division - Head of Small and Mid Cap Research [2]

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Stephan Klepp actually, but anyhow. Just a few questions from my side. So okay, Q1 is going to be not good because of the supply side disturbances. Any indication how bad Q1 will be? And any visibility on the improvement? Do you think it's going to be Q2? And last but not least, you said that the bookings in the fourth quarter were at record level. Can you give us more color on that because record level can be anything?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [3]

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So I will take the first point, you take the second point, Uli. The first one is in and around what's happening in China. And it's a moving target. We're getting updates daily, weekly. The latest information is that Wuhan is continuing to shut down the factories, could be all the way into the 10th of March at this point. So it's a moving target day by day. It seems like the numbers that were being said -- looking that things are stabilizing. Having said that, I think it's just a matter of waiting that out. And then as we get information, we will forward that the best we can to our investor base.

I think, at this point, we are truly flying blind, and I think a lot of companies are. I mean looking at some of the car companies, looking at Apple, I think a lot of them are being surprised by the situation. I do think we can catch up pretty quickly, though, as we get going. I would hope to do it in Q2. I think we can't commit to that today just because we don't know how long, how much, but I believe we'll catch up pretty quickly. And usually, the Chinese community and especially manufacturing community is very focused, very committed, willing to work overtime, willing to work in multi-sessions. So I think once we're released and moving forward, we'll be able to recover pretty quickly.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [4]

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Okay. So I'll take the next one, the question regarding the bookings. Usually, we don't disclose booking numbers, but I can tell you that the bookings in Q4 exceeded by far the revenue we posted for Q4. So I don't know if I can give you a percentage, maybe about 20% roughly. So a nice uptick. However, this, of course, also includes some multiyear service contracts. So don't expect that this will translate immediately in revenues in one of the quarters -- the following quarters. So some of the overachievement in bookings was due to multiyear service contracts. Because it makes us sticky and binds us with the customers and shows that we have a longer-term relationship with these customers.

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Stephan Klepp, Commerzbank AG, Research Division - Head of Small and Mid Cap Research [5]

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Can I come back to the first one? So is it right then to assume that your supply was, let's say, disturbed or started to get disturbed 2 weeks ago and since then you were not able to ship anything or more or less in an extreme scenario? Is it right to assume, are you saying that actually because you (inaudible)?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [6]

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No, no. So I think we showed you a slide in our manufacturing strategy. We were not just solely dependent on China. We've already moved some pieces out because of the trade conflict. We also had most of our optical products outside of China. So what we're assuming right now is that there was exposure of about EUR 40 million of products. It could have an impact, but we had a lot of supply chain organized and planned and stuff. The look right now is somewhere between EUR 10 million and EUR 20 million and then depending on orders, how they flow, how big of an impact that is, there are a lot of variables that just -- because of all those variables and because of that range, and it's, again, a best guess right now. It was just too complicated for us to go out there with a massively wide range and then have to update that week by week. And therefore, we decided to pursue the strategy of the annual number. And we do continue to believe that annual number because we ended the year pretty strong. As Uli had indicated, we think we had good new products, things are running well in the markets for us and, therefore, we feel confident, but clearly, lots of uncertainty. And it's just -- it's not something we can quantify for you today. So we will be back and close to you guys over the next weeks and months to try to help you understand that as we understand it. And I think that's really the best we can do, but it's not a black or white. It's that we are exposed to a certain number of our products. Some of the components, though, create complexity because, "Oh, could that have an impact?" A customer doesn't want a partial delivery, et cetera. So lots of moving parts.

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Operator [7]

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The next question we've received is from Tim Savageaux of Northland Capital Markets.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [8]

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A couple of questions. I guess I'd like to try, and if I think I heard you right, it's EUR 10 million to EUR 20 million revenue impact for the year out of the CDs. So you're guiding to I guess 5%-plus type growth for the year with that impact. I wonder if you could kind of relate that guide both to the strength of your performance in the second half, I know you're seeing some slowing there? But the overall levels of market growth, really. And if you could kind of segment commentary on both the optical and enterprise side, if there's any meaningful difference in growth rates both for your Q4 performance and for your 2020 outlook?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [9]

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So the first, it's not a EUR 10 million to EUR 20 million yearly. That was a quarterly comment. Clearly, all the numbers I mentioned in the first thing were quarterly. We are exposed to the Wuhan area. If Wuhan stayed closed for the whole year, we'd start a transfer policy and try to pull things out, get another site for certain key strategic products going as quickly as possible. So this is not a yearly issue at all. We believe that we catch up that EUR 10 million to EUR 20 million rather quickly, unless the scenario is that Wuhan stays shut for 3 to 6 months. In that case, we would most likely go start -- restart some of the pieces in other regions and get that going. And then we'd recover some of that piece in the second half. So we can't come anywhere -- we can't answer the question on Q1. There's no way we can quantify what the actual impact is from an annual level if Wuhan stays shut. It never will happen, but I'm just trying to put that into perspective. So that's the first area.

And again, we think it's temporary, and we think they're going to come back stronger than ever. And yes, we're already in a process of transferring stuff out for -- because of trade tensions. And it means that we continue down that strategy to get really good balance throughout 2020. I also indicated, though, that's not a free lunch. That's a lot of hard work. It means huge focus on our operational teams. And if you reduce volumes and certain things in one region and move to another, you need to manage that well from a cost perspective. So that's that answer.

The second was about market growth. I mean you get that data, Tim, from the markets, and I think people are saying that the market is growing, depending on who you're talking to, anywhere from 3% to 7%. Some of the bigger players are saying it's 4%, 5%, 6% market growth rates out there. Some are saying, not very positive at all, and especially in some of the large players in the core routing segments. So it really depends on who you're talking to. I would say, because of the uncertainty at the start of the year with a couple of these issues, for us, is that we've said, "Okay, we look good, we were growing much faster last year." Clearly, that could have some annual impact for us, and we feel that getting 5% growth and 5% pro forma EBIT is the right strategy and the right forecast for us.

When you look at breaking that down into segments, in uncertain times, the carriers are not good customers from a margin perspective. They put a lot of pressure on their suppliers. But in uncertain times, they're pretty stable. So I guess that's the only comment I can make there. I don't think one market's growing radically faster. And if any area is growing relatively faster, that's the ICP space. I don't think that the enterprise space versus the carrier space in our product segments is growing fundamentally faster. Having said -- a lot of people said that the enterprise segment would start to decline as the ICP and service provider space dominates. I don't see that shift happening either.

And important for ADVA is that we continue to bring market -- products to market that allow us to address all 3 segments efficiently. So in the enterprise space, sync and timing is now becoming an opportunity for us, which is important for us. Universal CPE is an area that we're targeting enterprises with. So there's -- we're building products that are targeting those market segments.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [10]

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Great. And if I could follow up quickly. You mentioned ICPs as perhaps a faster-growing part of the market. As you look at what appeared to be a pretty broadly positive demand environment in Q4 and your strong bookings, can you call out whether cloud providers were a meaningful part of that? And maybe in tandem with that, what you're seeing and what you might have seen in terms of 600-gig or higher type products driving order bookings in the quarter?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [11]

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So high level, I think ICP was a good quarter for us. I mean nothing fundamentally changing where one area is growing. I think Uli precisely said, most of market segments in most regions were doing fine across the board. So not one to call out, but yes, we're doing fine in that ICP space. Remember, that's only high single digits for us to a low single -- double-digit type of a range from exposure perspective. So I think that's the one issue. What was the other question now?

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [12]

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600 gig.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [13]

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600 gig. So yes, I think that continues down the pipeline. We're competing for a number of things. I think the competition seems to have pushed off their introduction of the 800 gig. The products are -- big iron. So it's slowly but surely moving into, let's say, our customer base. And then there are some big opportunities that we continue to pursue there. It's an important product for us, and an important part of our 2020 plan. But we're not forecasting massive growth. We think we're very competitive throughout the year, and we've -- as indicated, we think we have some features and capability in the products that people don't even catch up to with their latest or next-gen products.

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Operator [14]

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Then we'll go to the next question. It's from Simon Scholes of First Berlin.

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Simon Scholes, First Berlin Equity Research GmbH - Senior Analyst of Technology, Biotech, Medtech, and Resource [15]

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I have two questions, if I may. The first is on 2020. It looks if it's going to be another busy year in terms of tariff saving initiatives and cost control measures. I mean I noticed you had about nearly EUR 6 million in restructuring costs in the 2019 numbers. I wonder if you could give us a rough idea of where you currently budget 2020 restructuring costs to come in. And secondly, and I know there's a great deal of uncertainty surrounding the situation in Wuhan. But presumably, I'd be correct in assuming that if Wuhan does stay in quarantine into Q2 of this year, I mean then the current guidance that you've given would be vulnerable.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [16]

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I'll take definitely the first one. So we plan restructuring of about EUR 1 million to EUR 2 million. So not quite as high as last year. As I said, we follow through on our road map, and we make good progress on our development road map, and we continue to streamline some of our R&D efforts, but the majority has been already done last year.

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Simon Scholes, First Berlin Equity Research GmbH - Senior Analyst of Technology, Biotech, Medtech, and Resource [17]

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Okay. But I mean the actual impact, it looks like it's going to be higher this year.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [18]

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No, I think the savings impact is because you roll forward the (technical difficulty), right? Because you have a full year impact.

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Simon Scholes, First Berlin Equity Research GmbH - Senior Analyst of Technology, Biotech, Medtech, and Resource [19]

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Yes, okay. Understood.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [20]

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And I guess from -- I mean yes, if Wuhan goes on for 6 months, we will still struggle then with our annuals. But on the other side of the coin, Shenzhen is up and running now with 20%, 30% capacity, was shut down, it's running now. And discussions are in place is how do they get Wuhan up and running. That's one aspect. So we don't see it lasting that long. That's not our information at this point.

Second is, yes, we would start to transfer second leg for any key products that we have in Wuhan where we have suppliers or supply chain challenges out. And we're already actually started that process, nonetheless. So we're on it, and I think we'd be able to manage that. Now do we recover everything? We could recover everything, even if we're down for 3 months or 4 months by having a seller-focused approach in the H2, the real question there is, do we have any areas where we challenge customers to the point where they -- we lose demand? As long as I think the industry runs into some similar challenges, then it's not a nonissue at all. If others say, I don't have any exposure at all to Wuhan, which I can't imagine because there are some key optical components coming out of there and subcomponents and, therefore, we really need to look at the details on that. But yes, our guidance is contact with Wuhan, at some point, opens up in Q1 or first half of Q2, kind of an area. And I think then we can regroup accordingly and meet all the needs of our customers and also our guidance.

But again, they're moving parts. We've got multiple plan in place. I think we managed the trade challenge really, really well. I mean you guys don't see all the things that happen in the background. We would've been highly exposed to that. By the end, we've really managed that well. And by Q2 2020 now, we will be in a really good shape to kind of stabilize most of those extra costs. We'll do the same thing on this. We'll manage it accordingly.

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Simon Scholes, First Berlin Equity Research GmbH - Senior Analyst of Technology, Biotech, Medtech, and Resource [21]

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Okay. And just a quick follow-up. You mentioned Shenzhen. I mean how important is Shenzhen for you relative to Wuhan? And how serious was the virus outbreak in Shenzhen?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [22]

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So Shenzhen, if you look at the numbers, it's like 415 people have been impacted, only one death versus Wuhan, where you're in 40,000, 50,000 people and 1,500 deaths. So I think it's much more isolated. I think things are under control. We have our team up and working in Shenzhen. Yes, there are very strict regulations, who can come in, when they can come in, masks, all sorts of -- not travel or public transfer, et cetera, et cetera. So it's really amazing how controlled things are in China, but I think it's the right approach for the situation. So we feel that Shenzhen is in decent shape. Like I said, they're up to now 20%, probably more like 30% capacity and growing step-by-step up. So I feel comfortable there. Shenzhen's even more probably important to us than Wuhan because a lot of our Carrier Ethernet products are there. But I think -- so that comes up and takes away some of the risks that we had and some of the numbers that I had mentioned. But let's see how that evolves. Positive right now. We'll see step by step.

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Operator [23]

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The next question is from [John Lopez] of (inaudible).

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Unidentified Analyst, [24]

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I'm sorry, I just wanted to come at the inventory situation a little differently or maybe to help my own understanding. Your inventory balance in calendar Q4 increased high single digits and by our math, you're sort of like 98 inventory days, which is like maybe 15 or so above what you historically carry. So as far as my question here is, #1, why did inventory go up in calendar Q4? And how is that not helping you mitigate the issue in Q1 a little bit better?

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [25]

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So inventory in Q4 went up for multiple reasons. One reason was the Brexit. So also here, we -- due to the uncertainty, we decided to increase inventory levels for the U.K. Second one is, and in early this year, you have always the Chinese New Year, where we traditionally increase inventory levels to bridge the period during the Chinese New Year. And then we have -- again, we saw strong order flow in Q4 already or bookings, and we wanted to be ready to ship these orders and that's why, essentially, we purchased inventory to fulfill the customer demand in Q1.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [26]

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And we shipped quite a bit in January.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [27]

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We did already ship a lot in Q1 in January.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [28]

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So it is helping to mitigate some. We just don't know how, again, the problem with that is, how big is it for us? It's just such a moving target and you've got -- you can sit there now and say, "oh, let's -- they should have better grasp." If Apple, with their thousands of people, give us guidance in end of January and take it back 3 weeks later, you can imagine there are a lot of moving parts. It is complex because of one little part in the supply chain, what it means to somebody as a supplier to us. It is really challenging for us. But again, I think we'll get it under control. We have lots of people working it. We're looking at analyzing all the different pieces. We're looking at where the problem sets are, how do we address it, where do we source the products differently? Usually, we are dual sourced.

With most things, we are dual sourced. But even there, churning up demand when everybody is going out to the same demand is also not an easy, it's a complex situation. So there's just a lot going on. And I think you guys have to trust us. We're going to get our hands around it. We've done -- had multiple challenges like this. In fact, even last year, that we managed pretty well. I trust our team. It's an excellent team, and we have strong internationally, globally scaled EMS partners, which would allow us to move as well with the strategy of readjusting and moving dependencies away from regional dependencies that we have right now in some areas. I know it's a hard one for you guys because we can't give you more data, but we're going to do our best. And like I said, we -- the strong Q4 moving into this year where we look fine, demand is there, positioning is there, great new products, all the things that we showed, we show that we could grow in a year organically, nicely, should continue down this path as long as this issue is solved. And my tracking of it, we get really good data is that it's getting better already and that the Chinese government is doing the right things in order to contain this very quickly.

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Unidentified Analyst, [29]

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Helpful. Sorry, I had 2 quick follow-ups on that, if you don't mind. The first one is, just related to share, I suppose -- and I know you hit on this, but how comfortable are you that this isn't shifting share to competitors over the, say, the first half of the calendar year? And then just sort of resident in your annual guidance, is your assumption here that whatever you are not able to get done in the first quarter does come back? Or is your assumption that you have some headwind that you carry through the balance of the calendar year?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [30]

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So I think we're saying 5% growth and 5% pro forma EBIT. So maybe some headwind because we just don't know. I mean you could just make the assessment, "Hey, we're growing at that rate, let's just keep that rate before. That's how we forecast, let's go-go-go." so there's some analysis of numbers and whatever else. So it's not a situation where you say, "Hey, this happens. Let me turn it over, we'll solve within a few weeks." That's not what we're thinking. We're thinking, "Hey, we've got these challenges, we still don't know how it's going to be solved, by what time?" Therefore, you have to put into perspective, from a global perspective, like I said, our ability to recover, we think, is pretty good.

And then ship to competitors? Sure. I mean is there a worry there? I don't think there's any short-term worry. To qualify products in our space takes months. The complexity of integrating into OSSs and management platforms takes half a year. These are not things that shipped shortly. So we're very, very close to our customer base, looking at that. Can we miss a new opportunity? Be it if someone wants -- has a new opportunity, wants orders right away and we're not able to deliver that product. Again, it's not affecting all of our products. It's only affecting certain selected products and, therefore, there's going to be a lot of stuff that we still ship. This is not a black or white scenario in any way or form. But yes, it could impact us. I can't sit here today and say, it's not going to impact us if you look at odds and likelihoods, et cetera. We don't see any tendency to all from our customers to say, "Oh, we got to do something else now if there's any risk." And again, we do believe that most players are going to be exposed in some way or form throughout the next weeks.

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Operator [31]

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The next question is from Lars Friedrich, Dürr Aktiengesellschaft.

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Lars Friedrich, Dürr Aktiengesellschaft - CEO of Division Application Technology [32]

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I have a more general one. Bad news just keep coming. We were talking about strong U.S. dollar, then it was Brexit and trade war, now it's the virus. And even moving production lines doesn't really seem to help that much. Do you think that it's just bad luck during last quarters or is there a kind of special weakness, vulnerability, exposure, whatever you want to call it in ADVA and its business, which you and shareholders will always have to deal with because it's maybe just the nature of the business?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [33]

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Well, I guess I'd have to ask you that question. Do you believe that trade wars and coronaviruses are not pretty, let's say, surprising, and not very standard events? I would tend to say, they're very once in a lifetime or once in a decade or once in a presidency or something. I -- could we have a world that's moving to a more chaotic standard and having these issues come up regularly? Sure, but that's going to impact the world. We grew 10% last year. We had 2 major problems, and we grew 10% last year. That's -- I'd say, we adjusted very well. So I'll make the statement that I think as -- if the global world is moving to chaos, is what you're inferring to, is always going to be surprising events because these events are pretty one-off, I think ADVA is going to do extremely well there. We're incredibly fast. We have dedicated people. We understand our business really well. That will help us compared to competitors.

Will that continue to happen? I'm going to tell you, my belief is no. I've been in the business now for, what, 25 years. And I've had years where there are surprises, then we've had stability over a number of years. We're in a mode right now where there's more surprises than stability. But again, let's put that in context, we grew 10% last year. And yes, we didn't hit the profitability that we had wanted to, but we hit it in the range that we had guided for the year. So let's put it into perspective. And what we're telling you this year is we're growing 5%, and we're going to be profitable 5%. We were pretty close to last year, overachieved in one area, slightly underachieved, if you were to say, mid of our guidance. I would give us the benefit of the doubt that we, more than most companies, are going to be able to handle the situation. So I guess we can look at it as the glass is half full or that glass is half empty. I'm going to go for the half full because I do believe that we, as a company, are incredibly fast adjusting to surprises.

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Operator [34]

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The next question is from Paul de Froment of Kepler Cheuvreux.

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Paul de Froment, Kepler Cheuvreux, Research Division - Equity Research Analyst [35]

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Two very quick questions for me. The first one is, will the current situation in China affect equally all your divisions? I mean will cloud access, for example, suffer as much as optical transport from other delays? And the second question is, can you give us some feedbacks and the ramp-up of the FSP 3000 TeraFlex, especially regarding your ICP customers?

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [36]

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Wait one second, please. So we were just trying to make sure that we understood the question set equally. So I think more from a finished goods perspective, maybe the cloud access piece is a little bit more impacted from a supply chain components and module area, the optical space is impacted. And from a sync and timing also from a -- more from a product side, it's impacted. Hard question to be answered today. I'm going to take a rain check on that. We're analyzing those things and putting that together. We have a lot of data. I just -- I honestly don't have that at my fingertips right now. It does impact, though, each of our business units. And I said in that EUR 10 million to EUR 20 million, there's going to be impact in all 3 of those business units.

Then going forward, ICPs and -- I mean that's one of our target areas, both for open line systems and for the TeraFlex product range. We're working seriously hard to win business in that ICP space and hope to win some of the projects that we're working on to drive volumes. I think that there has been somewhat of a lockdown on big decisions in the industry due to competitors pushing 800 gig, but they're still going through the process. And as the 800-gig stuff has -- looks to be pushed off, at least that's what we're getting back from customer discussions that we're having, that hopefully helps our positioning and competing for those next-gen decisions. So again, back to the TeraFlex, we expect to continue evolve that and it's moving into other customers, but the big wins that fundamentally transform our business are in the ICP space.

But as we said last year, our 10% growth model was not based on ICP wins and big TeraFlex. The 5% model this year is not based on big wins in TeraFlex. Those are breakout scenarios where we go get ourselves double-digit millions with one of the large ICPs because others are struggling, or because our product is the best, or because we can deliver in a timely fashion, et cetera, et cetera. All of which is to be defined. I can't comment on that just now, but I do believe, again, we have a very competitive product.

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Operator [37]

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The next question is from Robert Sanders of Deutsche Bank.

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Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [38]

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Just a few questions. If Europe went with a cap on Huawei of 50%, is there an opportunity for you? Or do you not really compete with them directly, especially in your portfolio? Second question was, are you ramping up Inphi in DSPs? There's been a lot of uncertainty around the Cisco/Acacia deal and whether it's going to close or get blocked? I was just wondering if you sort of risk-mitigating on that. Third question was, which components are you actually specifically seeing shortages of? Is it like generic stuff like passive components? You mentioned optical-specific components. Is it like lasers? Just a bit more detail would be great.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [39]

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Part one, Huawei, I mean the limitation right now is trending towards a mobile core discussion. And clearly, we're not in the mobile core. In general, though, because of that, people are looking more and more open. How do we get less dependencies on one vendor because a lot of these companies were very dependent on Huawei? So the concept of changing the model definitely opens up the market, point one. But we're not right there in that first initiation of making decisions because we're not core players. Having said that, it opens up ability in the backhaul and fronthaul areas. And we are positioned well in a couple of the Tier 1 accounts in Europe, and we hope to leverage that. But it's not an immediate change, but we see 5G is very interesting. We've won a lot of sync and timing opportunities there and leveraging those 2 initiatives. Sync and timing wins plus Huawei, transformational change, allowing for business for us going forward.

Second, just add on to that. I think the U.S. government, at least, isn't pushing us hard on the European governments for transport exclusion. It's a first, it's a 5G discussion. But that is tending to have those sets of discussions as well, but it's not the same political environment. Point two, from a passives and components and lasers, yes, it's passives. It's some active components. It's some of the real cheap stuff that people just got out of, and it's pretty much some of the stuff is centered in Wuhan. And so it's affecting our pipelines there. It's some builds. We have some of our EMS guys in factories there, building certain parts of our product solutions base. So it's mostly really optical components and some assemblies that are impacted in the Wuhan area, where in the Shenzhen area, it's mostly box builds, Carrier Ethernet and sync and timing. And again, there, we're starting to already build products and get those out the door as we speak. So that's coming back online. So it's more of that risk mitigation around the optical side.

And the third one was, Inphi risk management on the DSP piece and that is, yes. We told you last time, we'd already moved before that announcement was ever made to get balanced. We have -- we are moving to always trying to pull 2 or 3 suppliers into each segment. So that's been a process that's been in play for 2.5 years, probably already now. We have some opportunities already with other, let's say, DSP designs. And going forward, we have a number of projects that allow us to be a lot less dependent on any one provider. What was being told by Cisco and committed in -- going to be committed in writing as we want, essentially. They're going to stay an open supplier of components. That is absolutely in their cookbooks in the future. You saw that with the One Silicon.

So even the new stuff that's coming out for their router-based stuff, they're opening up and saying, "We're open for business." So they're moving down that pipeline because that's how they're approaching the ICPs and some of their other customers as piece-part selling. So I think that's not going to change if it does get closed. They can be of 1 or 2 or 3 suppliers. And if it doesn't get closed, then it's business as usual with Acacia. And probably better for the industry, it doesn't get closed. If it does get closed, though, Cisco is staying committed to that, it's fine. And I think it's not really going to change much of the Acacia strategy at all for the next 2, 3, probably even 4 years for us as a company. So I don't see that as the biggest risk. The biggest risk for us right now are this -- now the supply chain challenges, this trade war challenges, road maps, getting products out the door, et cetera. Staying competitive and differentiated, innovative are more important probably to us on a level of risk management than the DSP issue.

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Operator [40]

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We have no further questions for the moment. Ladies and gentlemen, thank you for your attendance. I would like to hand back to the speakers for some closing remarks.

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Stephan Rettenberger, ADVA Optical Networking SE - SVP of Marketing & IR [41]

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All right then. Thank you very much for the interesting debate and active Q&A session. We are closing today's call. Thank you for participation, and we'll be back with our Q1 financials in April. Thank you.

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Brian L. Protiva, ADVA Optical Networking SE - Co-Founder, CEO & Member of Management Board [42]

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Thank you very much.

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Ulrich Dopfer, ADVA Optical Networking SE - President, CFO & Member of Management Board [43]

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Thank you.

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Operator [44]

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Ladies and gentlemen, this call now has been concluded. You may disconnect.