Ciena Corp (CIEN) 2002 Q2 法說會逐字稿

Good day everyone and welcome to the Ciena Corporation's second quarter fiscal year 2002 earnings results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Ms. Suzanne DeLong, please go ahead.

Thanks Steve and welcome everyone to Ciena's quarterly conference call. Our thanks to all that are joining us this morning to review our Q2 results. I'm pleased to have with me Gary Smith, Ciena's CEO and President and Joe Chinnici, our CFO. In addition, Steve Chaddick, our Chief Strategy Officer will be joining us in the Q&A portion of the call. Joe will begin this morning with a review of our results.

Gary will discuss the business in the quarter and Ciena's business outlook. Joe will wrap-up our prepared remarks and guidance for Q3. We'll then open the call to questions from outside analysts. This morning's release is available on national business wire and first call and also on Ciena's web site at Ciena.com.

If you are unable to obtain a press release or if you would like to be added to our e-mail distribution list, please call Ciena's IR Department at 888-243-1623. Before I turn the call over to Joe, I'll remind you that during the call it is likely that we will be making some forward looking statements.

Such statements are based on current expectations, forecasts and assumptions of the company that include risk and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed in our 10Q filed with the FCC today.

In addition, the company assumes no obligation to update the information discussed in this conference call whether as a result of new information, future events or otherwise. Joe?

Thanks Suzanne and good morning everyone. As noted in the press release, we reported second quarter revenue totalling 87.1 million dollars.

The second quarter included revenue contributions from a total of 38 optical networking equipment customers. Our optical networking customer base now totals 66. We recognized revenue from four new customers during the quarter

and we had four 10 percent customers in this quarter; two in North America and two internationally. Combined the four 10 percent customers accounted for approximately 60 percent of total revenue. International sales were up significantly as a percentage of revenue representing 43 percent of revenue versus last quarter's total of 22.4 percent.

This sequential increase was driven by strong revenue growth from the Asia Pack region, particularly China.

On the product front, for the first time core director, our intelligence optical core switch, was the largest contributor to the quarter's revenues and combined core switching and metro switching

contributed more than 50 percent of the total revenues for the first time. As expected we saw continued sequential declines in long distance optical transport with this product family contributing less than 20 percent of the quarter's revenues. Despite the overall total revenue decline, metro director K2,

our metro switching product, continued into revenue ramp representing more than 10 percent of the quarter's total revenues and increasing sequentially by more than 80 percent albeit based on what was still a relatively small base. Our service related revenue represented approximately 15 percent of total revenues.

Turning to net income. Like many other public companies, we find ourselves faced with a dilemma. While regulatory bodies are insisting on a gap only presentation of our results, many of our shareholders in Alice also want us to report results that exclude items which are non-recurring and/or non-operating related so as to

better obtain a sense of the company's ongoing business results and have a meaningful basis of comparison to historic and future results. In order to strike a balance among these constituencies, in our press release today we've provided detailed information about the adjustments in the second quarter that as management

we made to Ciena's gap earnings in our analysis of Ciena's ongoing business. In general, we excluded things that are unusual, non-recurring and/or not related to ongoing operations.

In Appendix A to the press release, we have also articulated the reasoning behind excluding each item on the list.

In my comments today, I will speak to both the gap results and to what the results would have been if we excluded the items detailed. Now that I've qualified our approach, let's move on to the numbers. Our gap net loss for the second quarter was 612 million dollars or a loss of $1.86 per share.

If we were to exclude the non-recurring, non-operating items listed in the press release, our loss for the second quarter would have been 208 million dollars or a loss of 63 cents per share. This includes the effect of the quarter's inventory related charge, which was significant. You will recall on March 26th

we disclosed in a press release that we expected to record a charge of approximately 200 to 225 million dollars primarily related to excess inventory associated with our long haul transport products and purchase commitments with suppliers.

In the quarter, we recorded a charge of 223.2

million dollars which hit our cost of goods sold line and it dramatically affected gross margins in the quarter. If this inventory related charge had been in the range that we've experienced historically, our loss per share for the second quarter would have been between 19 and 23 cents per share, which is roughly in

line with the first call consensus expectations of a loss of 21 cents per share. To a lesser extent, the quarter's gross margin also reflects the significant under absorbs manufacturing capacity we were carrying for approximately two months on the quarter, a situation we've taken steps to alleviate

with the workforce and cost reductions announced on February 5th and March 26th. With regard to operating expenses, on a gap basis, our operating expenses in the second quarter totalled 246.4 million dollars.

As noted in the P&L, this includes restructuring charges of 121.4 million dollars and an income tax provision of 148 million dollars. This income tax provision consisted of an income tax benefit of 157.8 million dollars on the net loss for the quarter offset by a 305.8 million dollar

non-cash charge to establish a valuation allowance against our gross deferred tax assets.

The second quarter's ongoing operating expenses reflected only one month's benefit of the cost cutting efforts we announced at the end of March.

Our efforts to carefully manage expenses and prioritize spending are paying off as we successfully focused R&D, sales and marketing, and G&A expenses on a quarter-to-quarter basis. Excluding deferred compensation and payroll tax on stock options, R&D decreased 8 percent sequentially from 64.8

million dollars in Q1 to 59.6 million dollars in Q2. Sales and marketing decreased 20 percent sequentially from 37.6 million dollars in Q1 to 29.8 million dollars in Q2. And G&A decreased 2 percent sequentially from 13.7

million dollars in Q1 to 13.3 million dollars in Q2. Turning briefly to the balance sheet. Our balance sheet remains among the strongest in the industry. Cash, short term and long term investments at the end of the quarter totalled approximately 1.7 billion dollars, a decrease of approximately 200 million from Q1 primarily

reflecting the April payment of all of the outstanding Cirrus notes totalling approximately 178.4 million dollars. Exclusive on the repayment of the Cirrus debt, our cash earned in the quarter was approximately 44 million dollars. With regard to receivables.

During the second quarter, we took a 16.1 million dollar provision for doubtful accounts, a rare occurrence for Ciena. Despite the difficult telecom environment, the last time we took a provision for bad debt was back in October 2000. The provision was taken to reflect receivables currently owed by two customers whose financial condition

suggests that they might not be able to make required payments. We will not disclose the identities of these customers however during our second quarter, one filed for bankruptcy protection, the other's financial condition has deteriorated to an extent that their ability to meet

agreed upon payment terms is not reasonably assured. Day sales outstanding were 63 at the end of the quarter. This is down from the 83 days of last quarter primarily as a result of lower revenues and the provision taken for doubtful accounts as it is slightly below our target range of 70 to 90 days.

Our DSA's are likely to continue to fluctuate and over the next several quarters, may come in above our target range due to the ongoing uncertainty in the market and our customer's desire to conserve cash.

Despite the industry's large financial difficulties, experience by service providers, we continue to believe that Ciena's remaining receivables balance carries a relatively low risk due to the

size and relative stabilities of many of our customers. With regard to inventory. After recording the charge I described during the gross margins session, inventory levels ended the second quarter at approximately 75.6 million dollars. The inventory breakdown for the quarter is as follows.

Raw materials totalled 101.3 million dollars. Work in process totalled 27.6 million dollars. Finished goods totalled 73.1 million dollars and the reserve for excess obsolescence totalled 126.4 million dollars.

Inventory turn excluding the charges for excess inventories were 4.6 in the second quarter compared to Q1's turns of 2.2. As for the inventory that we have written off, we will implement a disposal plan. Approximately 137.6 million dollars has already been scraped

and we expect to be able to dispose of the remainder over the next six months. With regard to head count, our worldwide head count at the end of the second quarter totalled 2,235, a decrease of 1,059 from January 31, 2002 reflecting the workforce reductions implemented on February 5th and on March 26th.

And now I'll turn the call over to Gary.

Thanks Joe and good morning everyone. To begin with, I would like to spend a few minutes on a brief update on the status of the O&I merger. The SCC declared our S4 effective last week and as a result we announced shareholder meeting dates for June 18th. Provided we receive the requisite shareholder approvals,

we expect the transaction will close shortly after the meeting. Integration planning generally is going very well. We're well into the process of identifying areas for cost synergies and determining what the combined organization will look like. We've yet to begin any of the real product integration efforts.

Those will have to wait until the deal closes. But the technology folks from both companies have been in detailed discussions.

In general, I think the teams are anxious to begin working together officially and both are looking forward to the deal closing.

And now briefly I'll review the quarter's business reading through the discussion of Ciena's product lines and first of all, long-haul transport and as expected, the long haul transport product sales in the quarter were down sequentially more than 70 percent for the second quarter in a row.

Unlike last quarter however, long haul system sales outpaced channel card sales though given the low volume in the quarter it's really difficult to draw any meaningful conclusion from this. Given our customer's capital expense cuts and cash conservation efforts,

it has thus far been impossible to really determine what sort of maintenance level really should be achievable on an ongoing basis.

We are seeing our customers going to extreme measures to conserve cash and I'll describe this in a couple of phases.

Initially their cash conservation efforts consisted of spending little, obviously, and working through inventory. We are now seeing them spend even less and some are even going so far as to ask for our assistance in redeploying systems on alternate routes and in

some cases even exchanging channel cards between systems. Evidence such as these extreme efforts combined with our ongoing analysis of traffic growth and recent and historic band width deployment in several customer's networks, suggests we're currently seeing unsustainably low spending levels, below what

could be considered normal maintenance levels. Combined revenue from metro transport and metro switching was about flat with Q1 and as Joe noted, revenues from metro direct or our metro switching product increased sequentially offsetting down sequential revenues from metro transport.

We're encouraged, as Joe said, by the group progress we're seeing in metro switching and we recognize revenue from five metro switching customers this quarter, up from two in Q1. We also have a number of trials underway with a similar number of potential buyers. In addition during the quarter, our metro switching

group delivered SDH capability from metro direct, which we believe will open up additional opportunities for the product internationally. Core director continues to gain market presence and we continue to add new core direct to customers. We've now shipped this platform, which includes core director and

core director CI, the smaller version, to more than 35 customers worldwide. And as Joe mentioned for the first time ever, core director revenues were the largest contributor to the quarter's overall revenues.

Previously we've talked about core director trials underway in the labs of several incumbent carriers internationally. These trials are continuing and we believe they are progressing very well.

Core director's widespread acceptance by incumbents we believe will be a significant benchmark in this product's life cycle and a meaningful telltale sign in the progress of adoption by the incumbent carriers of the whole next generation technologies.

We're not there yet but we believe that we're making very good progress in this area. So that really brings us to what's next for Ciena and how that you as investors determine whether or not we're making any forward progress in this kind of turbulent environment.

There are several strategic issues facing us. Some are particular to Ciena, others result from the state of the general telecom industry but clearly we've got to figure out how these two come together in order to identify and execute on the opportunities they create.

We cannot pretend to know when the telecommunications industry will recover or when service providers will resume more

normal levels of spending. However we continue to hear from our customers that enduser demand continues to grow and we're beginning to see some additional signs that validate our belief that the current levels of spending are unsustainably low.

In the last several quarters, we and others in the industry have pushed technology in order to continue to drive down the cost of bandwidth for our customers. Because of technology advancements, our customers are able to deploy a long distance network today for about half of

what it would have cost them a couple of years ago. And further technology enhancement such as the integration of transport and switching and the introduction of more efficient intelligence based products such as our recently announced orbitrail optical ADM

which allows carriers to drop individual channels of wavelengths along a long distance route continue to push that cost curve down.

What that means to Ciena in summary is that we cannot sit patiently by and wait for the long haul market to return to its former glory.

While we obviously believe demand will return, we also firmly believe that as a result of continued technology advancements, the market we serve will look very different in this segment. And as we have in the past, we intend to lead that technology advancement.

So directionally that means a couple of things for Ciena. Firstly, we must continue to deliver the network solutions, not just single product boxed solutions that meaningfully drive down carriers capital and operating costs in both new and existing networks as the near term opportunities are likely to be more brown field than Greenfield applications.

The longer term issue that carriers are coming to grips with is that Capax is only part of the problem. Opex is the ongoing issue that I think will be a ship to address as we go through the next few quarters.

Second, we must grow and nurture a broad base of revenue drivers at Ciena to take place of the formerly dominant long haul revenues.

I believe we're well on the way to executing on both of these fronts. Perhaps more so than other equipment vendor, Ciena has been espousing economic benefits of an integrated network wide solution by our light works vision. We're making good progress towards delivering on this promise as evidenced by this week's announcement of auto

provisioning continuity from a quarterly edge of the network between core director and metro director. As for the future revenue drivers, several of them are already contributing and there are more in the works. For example, we will continue to add features and functionality to core director and we'll continue to look to secure and expend our footprint in the core switching market.

Metro director is getting good traction as I mentioned and we believe the SDH functionality and other forth coming feature sets will greatly enhance this product's appeal.

We believe the combination of O&I and Ciena dramatically strengthen our metro transport offerings and expend our reach further towards the edge of the networks. The combination with O&I gets us closer to the edge of the network than we've ever been. And as we move in that direction, we'll continue to look towards data centric services and platforms.

We're doing this in a number of ways including our strategic investments with Equip.

In summary, I believe there are three key things on which Ciena has to execute moving forward. As we said before, we must focus our sales efforts on incumbent carriers and I would like to specifically mention that by that that I do not mean only the

but also the international incumbents. Our recent report that we've recently won a major international incumbent customer for whom we expect deployment to begin in the Q3, Q4 timeframe. Now obviously this is very encouraging news, a large incumbent carrier actually awarding business and we won it.

However I think it's too Suen to proclaim recoveries around the corner, but we are beginning to see signs of incumbents looking to deploy overlays of next generation technology as a means by which to reduce capital costs and operating costs and

that I believe is critical to Ciena and to the industry moving forward.

Successful execution on the incumbent win that we have and future incumbent wins will be a key benchmark in assessing not only Ciena's recovery but the recovery of the market in general.

For us, Ciena wins incumbent business we'll also be driving the adoption of next generation networking, if you want to view it from a marketing perspective across the chasm, from the early adopters of next generation architecture to the mainstream incumbent market. A critical next step in the shift to the adoption of next generation networking.

The second element of execution for Ciena is we must continue to broaden our product portfolio and with it our revenue opportunities. And this is an ongoing process and as I mentioned previously in my comments about future revenue drivers, we've got a lot of work well underway.

Short term, this will be imperative for smooth integration of O&I is critical, and I believe we're on track.

Teams are working well together and I believe once the deal closes, integration will be relatively straightforward. However we understand that this is a significant undertaking and that making it happen will be more challenging than planning for it. Longer term, we've got to continue to extend light

works and deliver technology advancement and we've got to keep our eyes and minds open for other emerging opportunities along the way. Finally, we must continue to manage our costs prudently balancing expense management with priority investing in the drivers for our business for the future. This also obviously is an ongoing challenge, one that we work on daily,

and the one that will take some time to prove out.

Admittedly, this is the sort of thing that requires making some bets about what technology and adoption will be required by when, but we continue to revisit our plans and our roadmaps with our customers making adjustments when and where necessary. So I think the objectives for Ciena are clear even in this environment.

What remains less clear however is the timing obviously of a larger market recovery. We continue to see positive signals but we also hear continued uncertainty from our customers. We'd like nothing more than to say with absolute certainty that the worst is over, but it's not clear that we're there just yet. What is clear is that in spending returns,

those vendors who are able to offer carrier's clear economic advantages, will be the winners and we think Ciena will be one of those vendors and all our efforts are obviously targeted towards achieving that goal.

With those few comments, I'd like to hand over to Joe. Joe, if you can walk us through the guidance for the Q please.

Sure thing.

Thanks Gary. Before I begin to offer our guidance for the third quarter, I will remind everyone that the statements Gary just made and those that I'm about to make are forward looking. It is important to review the risk factors detailed in our 10Q in order to understand the factors that might cause actual results to

differ materially from this guidance. I'll also note that the guidance I'm about to offer is for Ciena as a standalone entity prior to the combination with O&I. Due to increasing levels of activity and what appears to be good progress with incumbents, we're beginning to feel better about the

medium to long term view however short term visibility, in particular visibility in the Q3 is still poor.

At this point we believe that revenues in the third quarter will be flat to down from the Q2 levels. Based on that

product mix assumption and reflecting the cost cutting efforts we announced during Q2, we believe that gross margins will increase sequentially and will be in the range of between 5 percent and 10 percent. In this uncertain environment, gross margins are especially difficult to forecast

given a number of factors that might influence them such as changes in product mix, potential pricing pressure due to more aggressive competition, inventory obsolescence and component costs. We also expected as a result of our already implemented cost cutting efforts, our operating expenses will decrease slightly from Q2.

We expect other income to be in the two to four million dollar range based on the wide range of revenue guidance we've offered and excluding the valuation allowance for income taxes non-recurring unusual and non-operating related items, we expect a wide range of EPS estimates as well ranging from a loss of 17 cents to a loss of 19

cents per share which is slightly better to inline with current consensus expectations.

As noted in the press release distributed, we have set the shareholder meeting dates for our proposed merger with O&I for Tuesday, June 18th.

Provided we get the requisite shareholder approval, we expect the transition will close shortly after the meeting. If our proposed merger with O&I closes under the current timetable, when we report our Q3 results on August 22nd, we expect to report combined Ciena,

O&I results. We continue to expect significant cost savings as a result of combining the two organizations and I expect it will be in a better position to comment on the integration and our execution on the costs front when we report in August. Operator, we'll now take questions. Thank you.

Thank you. Today's question and answer session will be conducted electronically. To ask a question, press the star key followed by the digit one on your touchtone phone. Again, that's star one for questions. We'll pause a moment to assemble our

. We'll take our first question from Jim

, Credit Suites First Boston.

Thank you. A couple questions. First, Gary, you talked about several customers doing some extreme things to kind of leverage existing plants. At the same time you talked about a real change in the pricing dynamic for new systems

over the last let's say 12 to 24 months. How do you see that kind of evolving in the next quarter to, meaning are you assuming that prices start to stabilize here and that utilization will be the key driver causing, or you know, they can only do so much in the way of extreme measures so they'll have to upgrade?

If you can talk about that dynamic. And then a question on switching in the second half. Is it your sense in terms of the guidance you provided Joe that we'll actually see that continue to increase as a percent of revenue? Thanks.

OK Jim.

I'll take the first part of your question. In terms of the pricing, I think that's really not pricing from competitive pressures especially, it's really, we've driven down our costs from a technology perspective,

things like Ramon, Ultra Long Call, and then moving into integration of optics with core director that still transports, so it's really taking the costs down for the carriers pretty dramatically over the last 18 to 12 months and I think what a number of carriers are now looking at

and this gets to the second part of your question, but when they need capacity now, they can take some of these over bills at much lower costs than they could have 18 months ago or 12 months ago.

So I think it's kind of a good news, bad news

from that perspective. It is a smaller standalone market of transport, that transport will represent. It will be a more integrated market with our other products. But, you know, frankly if we don't capitalize our revenues by driving these technologies, then someone else will.

So that's always the stance that we've taken. We believe that we can push costs further down because of the presence of core director and integrating the products. But then the issue, sort of the first part of your question, is really about where are the carriers,

and this is a very broad question, where are the carriers in terms of needing more capacity? I think we saw it in kind of phases where they first started to switch off the Capax and now we're seeing a phase where they're sort of moving equipment

around and going to sort of extreme measures to extend their runway from what they've got. Clearly, there is an inflection point there as enduser traffic continues to grow and our sort of broad view of that is that probably towards the end of this year,

early next year is our best yet at that. Joe, do you want to...

Sure. Jim, you're right, both switching products did a great job this quarter in terms of the total and they are up significantly. In terms of this Q3,

I would expect that they're going to be, to give ourselves somewhat of a range given what we know today to be either a similar percentage to the total of what they were in Q2 to slightly up and then potentially going up from there in Q4.

OK. Just a quick follow-up for Gary. So Gary it sounds like obviously you're going to continue to drive costs, to drive, improve differentiation for Ciena. It feels like though that utilization driver, they can only do much

in the context of extreme measures that you will see that be the driving force in your mind it's just hard to figure out when. Is it late this year, is it early next year? (Inaudible) think about it.

Yeah, I think when we get more revenue on the transport, that's the driver for that and it's obviously how quickly we get to

this inflection point where obviously it's stating the obvious but where they run out of capacity and enduser demand continues to grow, that's not a sustainable dynamic without putting some more capacity on the network and our sort of broad

view right now is that towards the end of this year, early next year is best we can tell.

Thank you.

Our next question is from Kristin

, SG Cowan.

Thank you.

Two questions. First on your major international customer win, can you give us an idea of the equipment that you will be shipping to them in the Q2, Q3 timeframe? And then also, while I know you won't name the customer, could you tell us who was the incumbent

supplier into that customer today? And when you mentioned there is at least as many trials for the metro switching products as there were customers you recognize revenue from this quarter, can you give us an idea of domestic versus international? Thank you.

OK Kristin. In terms of the international customer, it is core director. There is opportunities for further products in there as well but the principle lead will be with core director and in terms of the current competitors in the account, it's the normal gang of suspects there, you know, the existing legacy vendors.

In terms of metro switching, it's pretty much split between, you know, in terms of the trials, between international and domestic.

I think the SDH functionality with metro director is obviously going to drive greater international adoption. So I think the predominance going forward in the shorter term will be with international.

Thank you and just to follow-up on the vendors. So the customer that you're referring to has a heterogeneous equipment supplier today so there is multiple vendors supplying into the network today?

There is multiple vendors and there is a couple of, as you would expect, predominant large vendors in there. But without, I really wouldn't want to divulge them on the call really Kristin.

Thank you.

Our next question is from Nikos Theodopolous, UBS Warberg.

Yes, thanks. A couple of questions. Can you comment on China? I think you indicated that was part of the strength in the quarter, Asia Pack, I think last quarter the strength was Japan. So if you could kind of give some additional information on that and what products are doing well in China? And then the second question is, once the merger with

O&I completes in the June timeframe, are you going to have another update in terms of combined guidance of any additional

the combined company would make in terms of cost structure, etc.? Thank you.

Yes Nikos. In terms of

China, we're involved in various degrees of maturity, trials and evaluations with many of the major carriers in China and things are progressing very well there. In terms of the products, principle products on the switching side,

K2 and the core director, as you'd expect, also there is a good opportunity for integrated transport optics there as well. So really the kind of broad product line led by the switches. In terms of an update, I think it's unlikely that we'd do that given the sort of close

that we're still evaluating the timing for potential updates on the combination and the environment being sort of uncertainty, we'd have to look at that, but I think we're unlikely to give updates until really the next scheduled quarterly conference call.

OK. And just back on China, in this particular quarter,

if we looked at international being the 43 percent, was China like a 10 percent, not a customer, but a country if you will, or was it just starting, trickling in into the revenue stream?

It was about 10 percent, as a country, as a region, it was above 10 percent, Nikos -- so significant.

Thanks.

Our next question is from Jeff Lipton, JP Morgan.

Thank you. Question for Gary and then I have a quick follow-up for Joe. Gary, can you tell us about progress at the Arbox with the quarter after NCI,

when you think they may start buying that sort of product broadly? How you're doing in preliminary takeoffs? And who your main competition is there?

You know with the Arbox, I think it's going to take a little while, we're involved in a couple of trials right now with them.

You know, we're working through Augmine and we'll have may constituents about by the end of the year. Our real primary targets are the PTT's internationally. If you look at the incumbents and put them into two broader groupings, one into the PTT's and the other one into the Arbox, I think because of their architecture,

I think the PTT's are a primary target and some of the feature sets that we're working through with the Arbox will be available towards the end of this year which will coincide with some of the Augmine functionality's. So in broad terms Jeff I'd say that the

Arbox is probably going to be till 2003 before we see meaningful traction with them on core director. With the PTT's, I think it's going to be earlier than that. Obviously we've just won one of them and I think we're in various stages in

maturity with others as well. So I characterize it as we'll see earlier wins at the PTT's, continue to work in parallel with the Arbox, but I don't think we'll see meaningful traction at the Arbox until 2003 being realistic.

Are you seeing the same list of competitors at the Arbox that you do in the IXE and PTT market or is there any change there?

Not really different. I think internationally we see more Alcotel and Marcone just because of their incumbency in many of the PTT's.

Domestically it is more Lucent, you now, we have a very large presence into the Arbox and obviously Tel-labs so I think there probably is some delineation in terms of who the primary competitor is in each of those segments.

OK. Quick follow-up for Joe.

Joe, can you comment on the linearity of the revenue pattern in the quarter?

Sure Jeff. I'd say it's been, there really is a linear, I mean that goes without saying, we've hit a trend over the past couple of quarters where a lot of the revenue does get recognized in the third month of the quarter in terms of shipping,

when it would ship, that

there really is no consistency from quarter to quarter.

OK. Thank you.

Our next question is from Paul Silverstein, Robertson Stevens.

Thank you. Could you discuss whether there has been any change in the competitive landscape? You've now got this

unite, this obviously in the quarter records past,

Nortel with HGX, have you all seen any change in terms of the competition?

Hi Paul, it's Steve. I would say with one exception, no. I think, well maybe two exceptions. The HGX seemed to make a flurry of news and disappeared again would be my commentary.

I think Lucent has a decent strategy with land to unite in combining with the next generation ADM and has gotten some interest, although not traction. Other than that, no, I think the landscape has got basically kind of quiet to be honest.

So Steve, Gary's omission of

Nortel in response to the previous question, that was not an oversight, you're not ...

I think they play, you know, one of the things Paul, they play in those places partly where we have been traditionally strong and the market has gotten traditionally weaker.

So they are not particularly enforcing the incumbents in Europe as an example.

OK. On the Q2 side, are all those K2 customers also core director customers?

No.

OK. Thank you.

Our next question from Kevin Slocum, SoundView Technical Group.

Hi guys. Joe, a quick one for you and I think the rest are Gary questions. In terms of the tax actions taken in the quarter, is there anything that they imply in terms of a different sort of pro forma rate that we should be thinking about with our numbers?

No Kevin. In terms of, you're using the one pro forma rate, so no it's still in the 34 percent-35 percent range.

OK. And Gary, just two questions. One is related to the switching commentary and the other versus the international incumbents that you mentioned.

Is that a, on the latter, is that deal with an existing customer or is it a new customer? And as far as the switching question, when you talked about activity in switching, the product development type activity, you said that you'd be doing more in the core,

is that in the sort of realm of collapsing transport into your switch platforms or is that something different?

OK. Let me clarify some of that Kevin. In terms of the customer, it is a brand new customer for Ciena, it is a large international PTP that we have never had revenues ordered from before.

So from a number of perspectives, it's very significant for us and I think the pivotal issue for Ciena, you know frankly going forward is not so much about whether Capax goes down or up, although going up

would be a good thing in the overall carrier environment, but it's pretty straightforward I think in terms of Ciena's path to success, it's really how many of these large incumbent carriers can Ciena penetrate as quickly as possible? And that transcribes to the adoption of next generation architectures by the incumbent

carriers and I think we're seeing now at various stages with incumbent carriers, particularly internationally, they're beginning to look at integrated next generation products as opposed to just DWDM platforms as being a way to address their capital and operating expenses going forward.

And there is a number of them looking at fairly large overlays on their existing architectures and I think this is a very good example of one of those more forward thinking incumbents that are beginning to make those kinds of moves and I think that's really a defining issue for Ciena going forward.

And that really links into the development question and I think as you talk to the incumbents, what they're looking for is complete system solutions as well as lower capital and operating costs. And to achieve that, specifically we've talked about integrating the transport

products into core director and our switching platforms and that takes the cost down even further. But there is also an ongoing development and we're on a number of next generation software releases into core director that really add more and more features and functionality

based on the incumbent's requirements. So it's a combination of physical integration and additional software functionality that they want.

Just as a follow-up to that, do you have a natural advantage, I mean, other people have talked about collapsing

transport into switching platforms and have been moving down that path. That's a more recent discussion for you, at least on an external basis. Do you have an advantage nonetheless because of your existing footprint or are most of these

bids going to be sort of real then full blown compete?

Kevin, it's Steve. I think the fact that we have 435 networks certainly gives us a footprint advantage as overlays get built on top of that switching footprint.

And I think frankly the advantage that we've had in just the technology of transport in general gives us an advantage. We have by much measure in the transport business and the long haul space does as well as anybody

and that by itself I think is advantageous because of the breadth of our solution as deployed there as well. So I think both things are important.

OK. Thank you.

Our next question is from Rick Shaffer, CIBC World Markets.

Great. Thanks. First question I just have is on pricing. Can you talk a little bit about the disparity between switching and transport pricing and kind of what the trends have been there? And then also while we're talking about pricing,

with Asia becoming a bigger piece of the overall revenue pie, what's sort of been the trend there with, you know, can you compare pricing, what you're seeing in Asia versus what you're seeing now in North America and even Europe? And then I've got a quick follow-up for Joe.

Yeah Rick. Let me have a go at that.

I think we're seeing a lot of competitive price pressure at the lower end of this sort of transport platforms, you know, the lower channels, simple functionality. I don't think we're seeing anything specifically really different in the, off the long

haul core stream type platforms, it's been competitive for a while, I don't think we're seeing any appreciable change in that. On the metro side, particularly in Asia and one or two countries in Asia, I think you're seeing very, very competitive pricing competition.

I think on the switch side, really we haven't seen a whole lot of change to that because of the value proposition with core director. So that's holding up pretty well, it's an incredibly software intensive environment particularly as you get into the incumbents. So there is a lot of resources required to provide the functionality that they want.

So you know Rick that's the kind of real quick segmentation by pricing, if that helps prove your point.

Yeah. So it's not a big difference basically is what you're saying, if you're shipping K2 or core director into China versus let's say selling that same box or same solution in the US?

Yeah. I think there is an

appreciation of the features and functionality there. I don't think it's appreciably different in China specifically.

OK. Thanks. And Joe, on cash burn, somebody's got to ask the cash question, do we still expect or are we still looking at something in the sort of 59 dollar a quarter range for operating cash burn? Is that a fair trend to assume?

And then second on that, how much of the restructuring charges that are still out there, how much of those are in cash or are going to be cash? And that's it. Thanks.

OK Rick. In terms of the cash burn, that number was basically prior to, again, this is prior to O&I or doing anything else like that.

The cash burn because of the restructuring and everything else is going to be north of 100 million dollars in the current quarter, probably closer to about 140 to 150 million dollars. And a lot of it is driven to because of the recent

restructuring that we've just announced and the disposal and the things of that nature. OK? In terms of, what was the other part of the question?

I was just curious what a normalized operating cash burn would be for you guys, I guess if you backed out these charges?

I think the guidance that I gave you prior is still apropos.

OK. Thanks.

Our next question is from

from Goldman Sachs.

Thank you. Two questions.

First on 10 percent customers, could you just talk about how many of them were pure core director customers versus mix of core director and transport? And then my next question was just on the split between metro transport and long-haul transport, just curious to see if long haul was larger than metro or not?

Sue, if you could just hold on one second, we're flipping through some notes so that we can get the detail for you.

So your question Sue was, were there any just pure, of the top four, were they just pure core director or a mix?

Yeah, that was the first one.

OK. Hold on a second.

OK. Here it is.

I can handle the second part.

OK. Why don't you handle the second part Joe?

Sue. Metro transport versus long haul transport, you were

specific point?

Yeah.

I have that data in front of me. Sue?

Yeah. The question was, was long haul transport larger than metro transport?

Definitely.

OK. Great.

Sue, in terms of the core director, of the four customers, two were pretty much exclusive core directors. The other two were mixes.

And any characterization between the North American customers and international? Were the North American customers pure core director customers there?

There were two North American and two international, one pure domestic core director, the other one was a mix and the same obviously for the international.

Great. Thank you very much.

Our next question is from Steve Levy, Lehman Brothers.

Thanks. I have two questions that hopefully have short answers. The first one is Gary, when you talk about focusing on network solutions being more important going forward, does that mean you're going to have more emphasis on the services part of the business?

Because that's an area that I think you've been de-emphasizing. And the second question is, as you say that it's more important for incumbent carriers going forward, can you tell us what percentage of your revenues today come from incumbent carriers as you define them?

And where you think it might be a year from now?

OK. In terms of services, Steve, I think that's a critical issue because if you're providing these complete solutions which if your point, you need to be able to support them and I think we've built a infrastructure up over the years,

particularly internationally fairly early on in Europe, etc., that will hold us in good stead to that. And I think what we've moved from in terms of our services profile, is from having a very, very large service organization

focused on installation to one that's really focused on more moving towards these complete solutions, so a higher level of expertise at network integration, program management, etc. And

I think the thing you picked up on, we've been kind of de-emphasizing our basic installation capability, more in favor of some of these higher level services.

You know, I don't think we're there yet in all parts of the planet, but I think we've made good progress in terms of making that transition and that's been consistent.

I mean, you know, the point I would make is, the fact with the incumbents, you know, the top 30, 35 accounts in the world are, were going to be the primary focus for us has not been a recent epiphany, you know, I think most folks could have predicted that and we saw that a while

ago and we've been developing our infrastructure in terms of support and in terms of sales channels to that as well. The second part of your question, if you take the sort of target 30 accounts in the world and you know different people may have some different composition there,

but I think about 20 of them would be common on anybody's list, you know, it's kind of a good news, bad news. We had about 8 percent-9 percent of our particular target market list last year, that's dropped down a little because of

the key accounts that we were dealing with have stopped spending pretty dramatically in 2002.

So the opportunity for us with these incumbents and that's why I go back to my previous point, the real critical path for us

is how many of these incumbents can we win? And we could see a real opportunity over the next couple of years to take 12 percent-15 percent market share of those particular target accounts. And I think the win which we've just talked about is a good

indication that we're following through on that strategy and so that's why I make the comment we are less sensitive in many ways to what goes on in the Capax and more sensitive to how many of these carriers that we don't have right now as customers can we win and take market share from other folks.

So Gary, if I could just follow-up. Your mention of 8 percent-9 percent, I'm not sure I understand what that was. Maybe you could just tell us of the 30 to 35 customers that you consider the critical incumbents, how many are ongoing customers? How many were customers in the quarter?

Or what the percent of revenue was?

We have of those top 30 accounts, we have approximately eight or nine of them as customers right now and we historically have had anywhere between 5 percent - 10 percent of their revenues,

you know, or the total available market to us, we've had about 5 percent or 10 percent.

OK. That's helpful. Thank you.

Our next question is from

, Salomon Smith Barney.

It's actually

for Alex today.

I just wanted to get a clarification on your comment about carriers under investing this year. In terms of the existing RFC's and the commentary that you're getting from the service providers, when they do start spending whether it's at the end of this year or the beginning of next year do you get a

sense of the size of the opportunities? Or are we talking primarily about this route by route upgrades or something a little bit more encouraging as they try to compensate for the under investment that we're seeing in Q2?

I think what we're seeing is, given our particular focus into the major incumbents around the world, we're seeing them look at the adoption of this next generation networking now, they're doing it in different ways. Some of them are looking at

very large scale overlays, you know, which will roll out in the next couple of years, so as they adopt to that architecture, they're lighting up other fibers and putting in overlay network in at much lower costs. Others are going from much more integrated and phased

approach to it and you know there is every kind of flavor in between. But I think the encouraging thing for us is that we're involved in various levels of maturity of conversation with them in terms of their more

brown versus green fields sites obviously because they're large incumbent carriers. But I think the opportunity for us provided that we execute well is very large and it plays directly to the kind of portfolio that we have and the value proposition that we have. So I think we're engaged in a number of those, some of which are very, very large projects.

Great. And one last follow-up. Do you get the sense that any of your customers are deferring purchases waiting until you guys close the

transactions on the transport side?

I don't as a general rule get that impression Darrell. I don't think anybody is waiting to close to wait to see what the roadmap will be

and we will support all of the primary product lines going forward. I don't think there is any confusion amongst the customer base there.

Thank you very much.

Our next question is from John Wilson of RBC Capital Markets.

Yeah, thank you. I guess just two questions. If you could just update us as to the status of the quarter after rollout at AT&T. You talked last quarter about the initial rollout there. And then second I guess for Joe if we could just drill down a little bit more maybe into where you are coming out of

fiscal second quarter, going into third quarter on the restructuring, are you pretty much done? You talked about the third month of the quarter reflecting that cost reduction, does that mean we just, you know, are you going to take that third month and roll it out over the next quarter or are we still going to see the run rate

as you move into the third quarter,

or is there more to still happen?

I'm going to take the first part without getting into too many specifics on a particular customer, I mean, the rollout with AT&T of core direct is going well. I think we're more than half way through their initial rollout in terms of installation and adoption and things are going on plan.

And so, if you say you're more than half way through, you've done revenue recognitions for being more than halfway through or you just sort of shift to being more than halfway through?

You know, I can't comment on the details of the revenue recognition, but we've certainly shifted and installed more than half of their sort of first phase rollout.

OK. And then on the restructure?

Sure John. This is Joe. Good morning. In terms of restructuring, it's basically, all of the plans have been announced and I'd say with the exception of a few miscellaneous cats and dogs, it all has been executed, there are some small things left to go that will take

place in this particular quarter. But I think your statement about is a go forward run rate comparable to just extrapolating out the third month of the quarter? I think that's a reasonably good statement. You could probably look for Opax to decrease, you know, at least by probably another five

million dollars for Ciena, this is on a standalone basis now, going from Q2 to Q3.

All right. Thanks very much.

Our next question is from

with Bear Stearns.

Hi, this is actually Mike Gregano for Voy Tack. Good morning. What's so funny over there? Just a quick question. In terms of, could you just talk a little bit about the trends that you've seen particularly within the US, if you wanted to segment the market between

Arbox and IXE's, and particularly going into the third quarter, can you expect some of the Arbox, maybe quarter over quarter revenues, has that been stabilizing or could that even be flat or do you still expect that to be down also in the third quarter?

And then in terms of breakout of your revenues from international going into the next quarter, what kind of increases do you think we could expect, it's from somewhere around 22 percent to I think 43 percent this quarter, could we expect that to be around 60 percent next quarter?

Do you care to take any kind of guess at that? And then lastly, could you just refresh us in terms of what we see for break-even?

OK Mike, I'm going to take the first part and then Joe will take the other two questions. I touched on some of the trends that we're seeing, obviously we've got a lot of Arbox customers from the transport side and that's been

pretty flat and we don't expect that to change in the short term. Similarly with the IXE's from a transport perspective, so I think the US market has declined as we step back from it in general terms,

the US market has declined more than Europe and certainly more than Asia. And in fact if you take those sort of target 30 accounts that we're sort of looking at, target 30, 35 accounts,

the Asian market could be larger than North America and in fact there were one or two studies from a couple of analysts and some stuff that we've done suggests that the optical market will be larger in Asia than potentially North America next year which is pretty dramatic.

Mike, this is Joe, how are you?

Good. How are you doing?

Good. Good. The North American/international split for Q3 I'd say with today's snapshot picture, it's tough to call, but with today's snapshot picture, I'd say it would be relatively close to where it was this particular quarter, maybe slightly greater.

OK.

OK? Now in terms for a break-even point, knowing that we're going to close the deal with O&I in the end of June-ish timeframe, I'd say let's hold off that question until we talk about it at that point in time because that will have more meaning and I think would represent a better number, a better picture.

OK. Just in terms of the clarification since the business is moving more to Asia, I'd like to ask the question about pricing in Asia and I think there was three or four quarters ago when O&I was talking about their margins coming down because more of their business shifting to

Asia or it's basically in Asia only look at price as kind of the main factor. Can you just, and I know you're

is a little more differentiated on the switching side, but could you just talk a little bit about in order of magnitude how aggressive this pricing is in Asia relative to say North America, any way to kind of quantify that?

Mike, I think we talked about this a little earlier on. I mean, I think there are certain countries in Asia that I think, you know, when you get to the lower end of metro and some of the lower end of the transport piece, that are just very challenging from a pricing perspective.

That's not really where we're focused. You know, we're focused on the larger systems opportunities into the major carriers. And so while pricing is competitive, it's not appreciably different than we've seen in other parts of the world and that's really where our focus is.

That's great. Thank you very much.

Due to time constraints, we will take our final question from

with Wachovia Securities.

OK. Hi there. The P&L is kind of complicated, so I just want to try to

in the following way.

Looking at the gross margin, when you back out the inventory charge and you do that on the statement, basically show revenue at 87 million, cost of goods sold at 87 million, basically gross margin zero.

So I don't think anyone was going into the quarter thinking about pro forma gross margins being that low. I'm trying to figure out how we get, what's the key factor that gets us to that loss of 19 cents? Is it this change in the tax treatment? Is that it Joe?

It's a combination of the change in the tax treatment in conjunction with everything else that we outlined in the press release Steve.

OK. So, I mean, I guess we'll go through all those

. But basically, I mean, what was the, how much was the tax benefit on the first share basis?

The tax benefit has a 35 percent tax rate, using a 35 percent tax rate.

All right. And so then, going into the quarter, not thinking about a pro forma or gross margin quite that low and without O&I,

have you gone through the exercise of just thinking about what the break-even gross margin would be, not the whole break-even on the company, but where you'd need gross margins to be to break even?

You're confusing me Steve. At the gross margin line or at the bottom line?

At the gross margin, in other words, you know, basically, we're going to go to something like, you know, let's pick a number, 80 million. What gross margin would you need to break even at that revenue?

In the case of the guidance that we gave you today, standalone Ciena, you could do probably the 5 percent-10 percent and break even and probably do a little bit better I think.

OK. Thanks.

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

OK. I would like to thank everyone for your time this morning and for your continued support and we look forward to seeing many of you in Atlanta

in the next couple of weeks. Thank you very much.

This does conclude today's conference. Thank you for your participation. You may now disconnect.