Ciena Corp (CIEN) 2002 Q3 法說會逐字稿

Good day, everyone.

And welcome to the CIENA Corporation third quarter fiscal year 2002 earnings results conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the call over to Vice President of Investor Relations, Ms. Suzanne DuLong.

Please go ahead.

Thanks, Steve.

And welcome, everyone, to CIENA's quarterly earnings conference call.

Our thanks to all who are joining us this morning to review our Q3 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 for the Q & A portion of the call.

Gary will start this morning's call with a brief introduction.

Joe will review the quarter's financial results.

Gary will then discuss the business in the quarter and CIENA's business outlook.

Joe will wrap up our prepared remarks with guidance for Q4.

We'll then open the call to questions from the cell side analysts.

This morning's press release is available on National Business Wire and First Call, and also on CIENA's website at www.ciena.com.

If you are unable to obtain the press release or if you would like to be added to our email distribution list, please call CIENA's IR department at 888-243-6223.

Before I turn the call over to Gary, I'll remind that you during this call, it's likely that we'll 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 10-Q filed with the SEC 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.

In addition, as noted in the press release, in accordance with SEC order 4-460 and section 906 of the Sarbanes-Oxley Act CIENA will also submit to the SEC today signed personal certifications from both Gary and Joe affirming the accuracy of CIENA's current and historic financial reports.

Gary?

Thanks, Suzanne, and good morning, everyone.

Firstly, I'd like to say that we're disappointed with the quarter's revenue of $50 million which, frankly, towards the low end of the range we thought possible.

As we discussed when we last spoke with you on June 18th, in addition to general continued uncertainty from our customers, we had one sizable deployment under way with a new customer for which acceptance was not scheduled until the end of July.

As we cautioned was possible, formal acceptance for this deployment stretched beyond the end of the third quarter.

This affected a lower-than-anticipated revenue in the quarter and in particular lower-than-anticipated core director revenue.

However, the customer is very pleased with the deployment progress and we expect that acceptance will occur within the next several weeks.

That fact combined with our traction of progress with incumbents worldwide and the general level of activity going into Q4 leads us to be guardedly optimistic about our Q4 revenues.

I'll talk more about this later but first, Joe, can you review the results of the quarter?

Okay, Gary.

Thanks very much.

Good morning, everyone.

As noted in the press release, and as Gary mentioned, we reported Q3 revenue totaling approximately $50 million.

The quarter included revenue contribution of a total of 57 customers compared to a total of 38 that we recognized revenue from in the second quarter.

Of the 57, 14 are new customers to CIENA and came to us via our acquisition of ONI.

All of the ONI customers were existing ONI customers.

In addition to the 14 ONI customers, the quarter included revenue from five customers who had not previously been either a CIENA or ONI customer.

Of these five, four have not been announced as customers.

Our customer base now totals more than 80.

We had two 10 percent customers in the quarter, one North American, and one which has a mix of domestic and international deployments.

Combined, the two 10 percent customers accounted for approximately 32 percent of our total revenue.

The domestic/international split of sales remained relatively even with last quarter's results, with international sales representing 41.2 percent of revenue versus last quarter's 43 percent.

From a product contribution perspective, given the overall revenue decline, we saw sequential declines across all of our products with the exception of long haul transport, which was up ever so slightly sequentially and represented approximately 30 percent of the quarter's total revenues.

Service-related revenue represented approximately 18 percent of total revenues.

Now turning to the bottom line.

As was the case last quarter, the press release presents a GAAP-only presentation of our results as well as detailed information about the adjustments in the third quarter that, as management, we made to CIENA's GAAP earnings in our analysis of CIENA's ongoing business.

In general, we exclude items that are unusual, non-recurring and/or not related to the ongoing operations.

In my comments today I will speak to both the GAAP results and to what the results would have been if we excluded the items detailed above.

Now that I reviewed our approach, let's move on to the numbers.

Our GAAP net loss for the third quarter was $160 million, or a loss of 42 cents per share.

If we were to exclude the unusual non-recurring, non-operating items listed in the press release, our loss for the third quarter would have been $88.2 million, or a loss of 23 cents per share.

This includes the effect of the quarter's inventory-related charge which totaled approximately $41.2 million.

This inventory charge was related to primarily to long haul transport products.

Exclusive of the after-tax per share effect of the inventory-related charge, our loss per share for the third quarter would have been 16 cents.

On a GAAP basis, our operating expenses in the third quarter totaled $120.2 million.

As noted in the GAAP P&L, this excludes restructuring charges of $18.6 million.

Deferred stock compensation charges of approximately $5 million, amortization of intangible assets of $2.3 million, and a credit provision for doubtful accounts of $1.2 million.

Approximately $11 million of the $18.6 million restructuring charge is associated with the consolidation of our metro switching efforts that were based in Fremont, California, with our metro transport efforts housed in ONI's south San Jose offices.

The remaining approximately $7.6 million of the $18.6 million restructuring charge was taken to increase the estimated cost of the net lease expense for previously restructured facilities.

In the quarter, we recovered $3.3 million related to a gross outstanding accounts receivable balance that was previously written off.

We also took a small provision for doubtful accounts of about $2.1 million, related to estimated losses from three customers, each of whom filed for bankruptcy protection during nine months ended July 31, 2002.

The result was a credit of doubtful accounts of $1.2 million.

Our efforts to carefully manage expenses and prioritize projects continued to pay off as we lowered ongoing operating expenses on a quarter-to-quarter basis.

Excluding deferred compensation and payroll tax on stock options and including the addition of approximately 6 weeks of ONI-associated expenses, R&D decreased 9.4 percent sequentially from $59.6 million in Q2 to $54 million in Q3.

Sales and marketing increased slightly from $29.8 million in Q2 to $30.8 million in Q3.

And G&A decreased 18.7 percent sequentially from $13.3 million in Q2 to $10.8 million in Q3.

In total, ongoing operating expenses decreased 7 percent sequentially despite the addition of approximately 6 weeks of additional ONI-related expenses in Q3.

CIENA has successfully reduced ongoing operating expenses by more than 25 percent since their peak in Q4 of FY '01.

Turning to the balance sheet.

In an attempt to provide even greater transparency into our business this quarter, we have provided additional detail to our balance sheet.

In general, most of the changes you'll see from Q2 to Q3 reflect the effect of the acquisition of ONI.

The acquisition was accounted for in accordance with FAS 141 which means items were recorded to CIENA's balance sheet at fair market value.

We believe our balance sheet remains among the strongest in the industry.

Cash, short-term and long-term investments at the end of the quarter totaled approximately $2.2 billion, an increase of approximately $500 million from Q2's $1.7 billion, reflecting the addition of the ONI cash and its investments.

As a result of our ongoing cash conservation efforts, cash burn in the quarter was $87.7 million, significantly below the $120 to $130 million range we previously discussed with you.

Some of the difference between our cash burn expectations and the cash we actually used in the quarter occurred because payments we expected to make in Q3 will likely happen in Q4.

Our accounts receivable balance at the end of the quarter net of allowances for doubtful accounts of $16.3 million totaled $43.3 million.

Days sales outstanding were 78 at the end of the quarter.

This is up from the 63 days over the last quarter but is within our target range of 70 to 90 days.

Our DSOs are likely to continue to fluctuate and over the next several quarters may come in above our range due to the ongoing uncertainty in the market and our customers' desire to conserve cash.

Despite the industry wide financial difficulty experienced by service providers, we continue to believe that CIENA's remaining receivables balances carry relatively low risk due to the size and relative stability of most of our customers.

On the inventory front.

After the inventory-related charge I described earlier, inventory levels ended the third quarter at approximately $65.5 million.

The inventory breakdown for the quarters is as follows: Raw materials, $80.6 million, work in process, $30.9 million; finished goods, $72.3 million; and the reserve for excess and obsolete goods totaled $118.3 million.

Inventory turns during the quarter were 5.3 and this compares to the 4.6 we reported in Q2.

We noted last quarter that we had implemented a disposal plan for inventory we had written off.

For the year, approximately $186.3 million has already been scrapped.

This is a change of approximately $49 million compared to the $137.6 million we had scrapped by the end of Q2.

We expect to be able to dispose of the remainder of the Q2 write-off and the whole of Q3's write-off over the next six months, which is according to plan.

Goodwill increased from $178.9 million at the end of Q2 to $765.9 million at the end of Q3, as a result of the ONI acquisition.

Under liabilities, you'll note that we have broken out the impact of unfavorable lease commitments.

As part of the liabilities we acquired from ONI and in compliance with FAS 141, we recorded $78.6 million of unfavorable lease commitments.

This value was determined based on the present value of the lease obligations versus current rental rates at the time of the acquisition.

We further detailed this item in current and long-term liabilities.

The convertible notes payable line now includes the addition of ONI's outstanding convert.

In compliance with FAS 141, the notes were recorded on our balance sheet at $218 million, their present trading value at the time of the acquisition, versus the $300 million maturity value.

CIENA is acreeting the $82 million difference between the present value of the notes and the principal value over the remaining period to October 15th, 2005, such that the carrying value of the notes equals the principal value at the time the notes become due.

On the head count front.

Our worldwide head count at the end of the third quarter totaled 2,638.

An increase of 403 from the April quarter, reflecting the effects of the addition of ONI's head count, CIENA's workforce reduction implemented in June, as a result of the acquisition, as well as normal attrition and some selective hiring.

Now I'll turn the call over to Gary.

Thanks, Joe.

I'd like to take a few minutes just to review the business in the quarter and then offer some thoughts about the future.

Firstly on the organizational front, we closed the ONI merger on June 21st and as a result, in order to focus our R&D efforts specifically and streamline decision-making in July, we also announced an organizational realignment encompassing all of CIENA's R&D efforts.

Under the proven leadership of Jesus Leon, we combined our metro transport and switching R&D efforts into a single metro networking products group and our core switching and transport R&D efforts into a single core networking products group.

In addition, we created a light works solution team whose job will be to ensure consistency in unity across all of CIENA's platforms.

Improving on our ability to deliver true end-to-end network solutions as well as to engineer customer-driven solutions that in some cases will integrate both CIENA and non-CIENA solutions.

Effective immediately, Pamela Adams, who has been with ONI for about two years, most recently leading development efforts for the Online 2500 will assume leadership of the Metropolitan Networking Group as Rusty Kumpston will be leaving CIENA to pursue other interests.

Pam is a telecom industry veteran and I'm confident in her ability to lead CIENA's efforts in the metro space.

I'd like at this time to thank Rusty for his help during the critical integration and transition period and wish him well for the future.

In part, due to the combination of Rusty's operational efforts and Jesus's leadership the integration of ONI and the combination of our metro switching and transport efforts have proceeded very well and our metro group is already well on the way to operating as a cohesive unit by team to the point where we saw meaningful revenue contribution from ONI and the combined metro organization during the quarter.

From a product integration perspective, work is also well under way to successfully integrate ONI's planning tools and network management into CIENA's on-center management platform.

In general, though metro revenues were down sequentially from Q2 it appears that metro spending may less affected than core spending by the slowdown overall in carrier spending.

During the quarter, the Online 79 and 1100 platform achieved full Osmine certification, a critical hurdle in the path towards RBOC-related revenues.

We continue to believe that the online products are well positioned with the RBOC but we fully expect that the decision in deployment process will of course be a lengthy one.

We have been very pleased with the customer interest we're seeing in Online 2500, with trial activity for this product busier than it's ever been.

Metro direct to K2 also continues to gain market acceptance as during the quarter we recognized revenue from two new metro switching customers.

Also during the quarter, we delivered SDH capability for Metro Director, a feature that was instrumental in securing some of our current business.

We continue also to secure trials with new potential customers both domestically and internationally.

As they look for ways to restore health to their businesses, carriers are growing increasingly focused on the local loop and on providing enhanced services and creating new revenues.

As a result, it's possible that spending in the metropolitan area could rebound before spending in the core.

Applications like storage area networking and disaster recovery are clearly driving carrier interest in edge products such as the 2500.

In addition, carriers are becoming increasingly aware that a networking model that distributes intelligence from the core through to the edge will give them the ability to create, deploy, and manage more new data-friendly services more quickly.

With the addition and integration of ONI's online family, we believe CIENA is the equipment vendor best positioned to deliver networks that not only save money on OP-X and CAP-X but also make money for our customers.

Moving on to core network, as Joe noted, revenue from long haul transport was up slightly sequentially in the quarter.

While certainly a positive occurrence, I think it's too soon to say whether or not it's representative of a change in momentum for this particular space.

We do have several customers and potential customers currently evaluating plans for long haul capacity adds and we continue to believe that our efforts to integrate long haul transport functionality with Core Director will provide CIENA with a significant cost advantage as our customers' plans progress.

We continue to see in-network equipment and channel card redeployments.

Evidence that our customers continue to take extreme measures to conserve cash.

Core Director revenues were down sequentially in part due to the pending acceptance I discussed earlier.

Core Director continues to gain market presence particularly with incumbent carriers, and we continue to expect that it will be the largest revenue contributor for CIENA this fiscal year.

We have received feedback from customers and potential customers that indicate Core Director continues to hold a significant technological lead over any potential competition.

In fact, we are the only vendor who today has customers operating large dynamic networks based on distributed intelligence which Core Director and our other products provide.

That time to market and technology lead combined with CIENA's real world large-scale network deployments and Core Director's proven software stability and optical signalling and routing performance make it the only choice for carriers looking for next gen switching solutions today.

We continue to add features and invest significantly into the functionality of the product, as well.

For instance, in a recent software release, we added functionality that allows to us more efficiently aggregate more rings on to Core Director.

We believe this is a key application specifically for ILEC's and PTTs as it will enable them to eliminate the cost associated with co-located ADMs.

In addition, we have already demonstrated Core Director's integrated optics to many customers and we're working towards an early '03 commercial availability of this particular functionality.

The product innovations CIENA is pursuing in both metro and the core are key to helping service providers find ways to make data profitable and migrate from existing voice networks to more data-friendly architectures.

The years of Legacy infrastructure builds caused by vice equipment vendors are making it impossible for carriers today to capitalize on the fast-growing demand for data and adding new data services without addressing the network's inability to cost effectively deliver them only worsens carriers' business models.

CIENA is squarely focused on fixing the data service model.

Our unique approach of distributing software intelligence from the core to the edge enables all service networks, networks that are automated, scalable, and dynamically responsive to the needs of data, voice, storage, and other bandwidth-intensive services over a common architecture.

CIENA's ability to create an all-service environment can help restore order to data profit margins today and we believe will open the door to new customized revenue-generating services in the future.

Switching focus now to the 2000 foot level, our market obviously remains incredibly challenging.

The challenge specifically for CIENA is to take the steps during this market downturn that will position us as a clear industry leader when the market begins to turn.

During our last quarterly conference call, I identified three key areas of execution for CIENA.

Firstly, an increased focus on incumbent carriers.

Secondly, to expand revenue opportunities.

And thirdly, to manage our costs carefully, balancing strategic investment with careful expense management.

I believe we have demonstrated meaningful progress in all of these areas.

We have won Telmex and we continue to strengthen our position to other incumbent carriers worldwide.

And with the addition of ONI we have expanded our product reach, customer base and our revenue opportunities.

But clearly we have got more work to do.

As we see it we have several levers we can use to continually adjust our business.

The first of these levers is clearly revenue.

In addition to winning business of incumbents and pursuing the expanded opportunities ONI brings to CIENA, we need to continue to diversify and expand our customer base.

In addition, we need to be careful that while focused on global top tier accounts, we don't lose sight of other opportunities, including those in non-Telco markets.

I mentioned earlier that there appears to be a growing focus on services at the edge of the network.

To capitalize on this opportunity, we will look to strengthen the perception and recognition of what we believe is our ability to help service providers, capitalize on demand for data and potentially expand beyond our direct sales model.

The use of business and strategic partners could become more important to CIENA as we look to expand our market reach without expanding our costs.

The revenue lever is not entirely obviously within our control.

But how it moves will also affect how we move the other two levers.

The second of which is obviously gross margins.

In the last several quarters, CIENA has made significant changes to our operating structure.

The benefit of which has not been visible because of the continued downward revenue pressure.

However, once revenues stabilize and we begin to show sequential improvement, we believe the operating changes we have made will begin to show visibly in our gross margins.

We continue to believe that gross margins in the 40s are possible as we approach quarterly revenues near the $175 million range.

Finally, the third lever is operating expenses.

Thus far, CIENA's taken a rather measured approach to managing our expenses, attempting to carefully balance strategic investment with expense prioritization.

As a result, unlike most of our competitors, we continue to support development in all of our major product lines, a source of reassurance, we believe, for our customers and potential customers alike.

We continue to work to prioritize our R&D efforts to align our investment and our costs with future opportunities.

And our efforts are paying off.

With operating expenses in the quarter significantly below our initial expectations.

I see this as a clear measure of the expense and cost management happening throughout CIENA.

Returning to profitability remains a major goal and we'll continue to look to balance our costs with our opportunities to get there as soon as possible.

In addition, during the downturn, we'll continue to work to minimize our cash burn.

We continue to believe that we cannot save our way out of this downturn, however.

Recovery for CIENA will have to come from a mix of new revenue opportunities and very careful cost control.

Through the combination of the two, I'm confident we will return to profitability.

Previously, I have suggested that as investors you should determine CIENA's forward progress in this turbulent environment by a progress with incoming carriers.

I still believe that to be the case.

In addition, I believe you should watch as we continually improve our financials.

We also continue to believe that CIENA is far better positioned than our competitors.

We have meaningful technology, time to market, and experienced lead over competitors in building next-generation networks with distributed intelligence.

We have a broader metro portfolio that reaches further than ever before toward the edge of the network and new revenue-generating opportunities for carriers.

We have a strong balance sheet and tight financial controls.

With timing of a resumption in carrier spending - remains uncertain.

We continue to see positive signals but we also hear continued uncertainty from our customers.

We would like nothing more than to say with absolute certainty that the worst is over, but it's not clear we're there just yet.

What is clear is that as incumbents migrate to next generation architectures and search for ways to generate new revenue from data demand, those vendors who are able to offer carriers clear economic advantage will be the winners.

We think CIENA will be one of those vendors and all of our efforts are targeted at delivering undeniable value to our customers.

With those comments, I'd like to hand over to Joe to walk through the guidance for the quarter.

Sure thing, Gary.

Before I begin to offer our guidance for Q4, I will remind everyone that the statements Gary just made and those that I am about to make are forward-looking.

It is important to review the risk factors detailed in our 10-Q in order to understand the factors that might cause actual results to differ materially from this guidance.

At this point, we believe that revenues in Q4 will be flat to slightly up from Q3 levels.

As Gary mentioned, we feel good about our progress with incumbents.

And as a result, we are guardedly optimistic about our short to medium-term revenue opportunities.

However, we lack sufficient visibility beyond Q4 to offer specific revenue expectations beyond then.

Based on product mix assumptions that call for Core Director to improve sequentially, we believe that gross margins will also increase sequentially and will turn positive but will be less than 5 percent.

We also expect that, as a result of having a full quarter of ONI-related expenses excluding any future potential actions to reduce them, operating expenses, exclusive of any unusual or non-recurring items, will increase from Q3, but will be below the $120 to $125 million range we estimated at the time the deal closed.

We expect other income to be a net expense of $3 to $4 million in Q4, primarily due to accretion associated with acquiring the ONI debt.

Q4's share count will show the addition of all of the ONI-related shares approximately 431 in total.

As a result, we expect that our adjusted net loss, exclusive of unusual or non-operating items, will be in a range of 17 to 19 cents per share for Q4.

We expect that our cash burn will peak in Q4 and in the quarter could be as high as $145 to $155 million.

The increase quarter to quarter is primarily the result of cash payments some of which we initially expected to make in Q3 including payments for certain reserved excess inventory purchase commitments, fixed assets, lower accounts receivable, collections, as well as higher operating expenses due to the merger.

We expect to be able to reduce our operating cash burn significantly over the course of fiscal year FY '03 to the point where we return to the $50 to $70 million range we targeted historically.

Operator, we'll now take questions from the cell side analysts.

Thank you.

Today's question an answer session will be conducted electronically.

To ask a question, press the star key followed by the digit 1 on your touch-tone phone.

Again, that's Star 1 for questions.

Our first question from Jeff Lipton, J.P. Morgan.

Thank you.

Good morning.

Could you comment on your Core Director and CI Outlook at the RBOCs.?

What's going on with the timing of their decisions, your relative position, and who you're seeing on a competitive front?

Thank you.

Hi, Jeff.

Steve Chaddick.

I think the issue with the RBOCs and large switches of this kind really have to do with the architectural adoption of something that's quite different than what they've been used to.

The RBOC architecture is primarily in the inner office and excess rings built around classic sonnet 80ms and it will take a while to get that architecture shifted to what we would call next generation version that we have what we believe a very exciting compelling architectural vision for those interoffice networks but it will take a while to get it there for a number of reasons.

One, some future development.

Two, some ability in the tele40 operating systems to support them and three, obviously, the acceptance of that architecture in the RBOCs.

So we don't we don't expect a great deal of RBOC revenue from Core Director until well into next year, at probably the earliest.

I think it's important to note that it's a whole lot more than just Osmine that gets you in the RBOCs.

The Osmine process really just allows to you talk to the management systems that they use.

But the features and architecture really are the driving force there.

And even though it's early on a competitive front, who are you seeing the most right now and do you consider yourselves to be in the lead?

I don't know that there is a great deal of activity in the RBOCs yet other than what we have.

We are generating for this type of switching platform.

Most of the activity there is still around next generation ADM activity in the edge.

Thank you.

Our next question from Subu Subrahmanyan, Goldman Sachs.

Thank you.

Good morning.

Couple of questions.

First, could you talk about revenue mix for the quarter?

I know you broadly talked about long haul being 30 percent but if you could split it between long haul switching, uhm, and services.

And then also, could you talk about current expense run rate, what you think the break-even revenue is going to be?

And Joe, you mentioned cash burn coming down.

Is that based on current structure or is that based on for the restructuring?

Thank you.

Okay, Subu.

I have three questions.

If I can just -- correct me.

First of all, from the case of revenue mix, I think we'll stand behind our posture the way it's been since the very beginning of time where we don't share those types of details with you.

I'll just leave it at that.

In terms of the current operating expenses, can you go over that question again?

Yeah.

Joe, my question was, the current expense run rate, what do you think break-even revenue level would be?

Okay.

At the current levels Subu, assuming you get to this 40 percent gross margin that Gary talked about and we have talked about many times in the past, you're in the vicinity of about $300 million.

Okay.

In terms of the cash burn, I would refer you back to Gary's commentary earlier on that talks about the various levers and what to hit.

And effectively, we'll be -- we are monitoring every one of those and determining which lever we need to pull at which given point in time.

But the -- we feel pretty confident at the moment about the cash burn guidance we have just given you.

Great.

Thank you very much.

Our next question from Nikos Theodopoulos, UBS Warburg.

Yes, hi.

This is [INAUDIBLE] for Nikos.

My question has to do with your deployment with AT&T.

I think a quarter ago you mentioned that the deployment has been more than 50 percent completed.

And I was just wondering how much -- how much remaining portion that will need to be done going forward?

My second question is, can you give us a little bit more color in your trial activities with Core Director as well as Metro Director in Europe and Asia?

Thanks.

Sure.

I mean, this is Gary.

You know, it's not our policy to get into great detail about specific customers.

But regarding AT&T, you know, I think it's an ongoing relationship there, a strategic level.

They are basing their core new architecture on Core Director and we're well into deployment with them.

I think it's difficult to say how far through we are because it's an ongoing relationship and we're continuing to develop our applications with the customers.

So I wouldn't like to say any more than that.

In terms of Core Director and K2, traction internationally, I think specifically in Europe it's going very well.

I think we're seeing a lot of interest from the incumbent carriers looking to migrate to next generation architecture and clearly Core Director is, you know, very well proven in this area and well validated by some very large incumbent carriers who are using the architecture.

And so I think, you know, we continue to be confident about the traction with Core Director into some of those large incumbents, particularly into Europe and also some in Asia, as well.

So, you know, I think we're certainly encouraged by that.

Thank you.

Our next question from Kevin Slocum, SoundView Technology Group.

Gary, I think the hard thing for people is to kind of assess your opportunity when you talk about a break-even point that's as high as the one you mentioned on the call.

And I'm just wondering if there is any way that you can describe maybe hypothetically the kind of opportunities that you see in, you know, a generic, you know, PTT or ILEC for your product lines, you know, in any given annual period so that, you know, people can get the sense of what a ramp back in business might look like when spending finally turns.

Because otherwise, you know, people are going to be looking at these numbers assuming anemic growth and losses forever and you just, you know, burn away the cash for a couple of years.

Okay.

Let me answer the question like this, Kevin.

I think the -- you know, the issue from our perspective and some of the assumptions that we're making is that, you know, clearly this is not going to be a quick recovery and the faucet is not going to be turned on quickly and then spending returns to the levels that it was.

If that happens, that would be a nice surprise for us all.

You know, our view in terms of how we're managing our financials and specifically our balance sheet and cash burn is that we do not expect a, you know, rapid turnaround in terms of carrier spending.

The pivotal issue for CIENA is as I think you alluded in your question, is how quickly CIENA can get into, you know, some of the larger incumbent carriers around the world.

You know, the bad news is, we don't have much market share in that particular area.

The good news, we don't have much market share in that particular area.

So it's a rare opportunity for us, even if you assume the capital expenditure and the general carrier spending environment remains as it is.

So if CIENA were to make inroads into, you know, some of those large incumbent carriers, you know, we could get sequential revenue increases over a period of time without necessarily the market, you know, turning around.

Now, I think some of our larger customers that we have had have been in a, you know, a severely cash-managed environment where they're clearly managing all of their CAP-X rollouts.

We don't think that will continue forever, either.

We have seen the long haul market completely, you know, decline at a very dramatic rate.

So I think, Kevin, the key to it is us getting into these large incumbent carriers and broadening out our product portfolio there.

We're very focused on minimizing our cash burn, balancing that with, you know, our strategic investments.

Now we've got competitive advantage in a number of product areas.

I think it would be short-sighted of us to give that up by dramatically reducing our investment in those areas.

So I think, you know, we think that we can get back to profitability by penetrating the large incumbent carriers.

We think that market is large enough for us financially and for us to gain viability there.

So long answer to a short question, Kevin.

You know, without getting into any sort of specifics, going back to the levers that we talked about, we are going to look at those very carefully and pull whichever ones we think are the most appropriate at any time.

The cash burn that we have right now, even though it was lower in the quarter than, you know, we forecast for the reasons that Joe talked about, is not acceptable to us moving forward.

We don't think that's an appropriate balance.

And you know, we'll take actions accordingly.

Okay.

Operator: Our next question from Alex Henderson, Salomon Smith Barney.

Hi.

This is Darrell Armstrong for Alex today.

I have a couple of questions.

First, could you tell me what percent average your revenue actually came from incumbent carriers this quarter and where it was last quarter?

Second question, the increase that you talked about in terms of long haul transport, was that a function of a modest broad base improvement in spending from your customers or did you just see a couple of lumpy orders from one or two customers?

And then finally, relative to the purchase commitments that you expect that you'll have to pay out in this current quarter, will that exhaust all of your purchase commitments, or are there still additional commitments that you'll have to fulfill in the future?

Thanks.

Darrell, why don't I take the first two and hand the last one to Joe.

In terms of, you know, we have not split out some of its definitional issues but, you know, percentage of our revenues from incumbents historically, that's something that we might do in the future, you know, if we think that's appropriate.

But I would look for, you know, announced wins as we penetrate, you know, those large incumbents as to how well we're doing.

In terms of the transport, I'd characterize it, you know, albeit small on a relatively, you know, small revenue quarter, I wouldn't say it was across the board.

I'd characterize it, Darrell, as just one or two, you know, customers coming in for a long haul transport.

I don't think we have seen -- that's why, you know, the cautionary notes on the long haul transport, whilst it's encouraging, I don't think we are going to get carried away with that right now.

And the third question, Joe?

Darrell, Joe here.

On the purchase commitment front, if we do what our plans are this particular quarter, that will take care of definitely the lion's share of everything else we have left to do.

Okay.

Great.

Thanks.

Our next question from Steve Levy, Lehman Brothers.

Thanks.

Just two quick ones.

On those new customers, any chance of you giving us an indication of how important they were either percentage-wise or some qualitative point of view to the July quarter revenues?

And were any of them incumbents?

And then the other question has to do with the next quarter.

Given that you're expecting, you know, it sounds like Telmex to be recognized in the quarter, would you say that the two 10 percenters are also from the third quarter are likely to contribute or be as significant in the fourth quarter?

Thanks.

Steve, let me just process the question a little.

I'll take the first one.

Joe, you think about the second one.

The new customers percent, how important.

You know, we did have -- one of them was, uhm, certainly one of them was a incumbent carrier.

We bought 14 new ones over from ONI, 5 of which are new to the, you know, the combined companies.

So I think it's still, you know, bodes well that we are making traction as we increase our penetration into the incumbent carriers.

And Gary, I guess I was asking about the five new ones.

Yeah.

The five new ones, one particularly was a, you know, larger incumbent carrier.

Okay.

Great.

Which was new to us.

Then the other part of your question, Steve, was, uhm, any of those new ones going to contribute materially in the next quarter, was that your question?

No.

Well, actually, that's a great question. [ Laughter ] But... we'll count that as your question, Gary. [ Laughter ]

All right.

You're allowed one more! [ Laughter ]

But the real question is, you had two 10 percenters in the July quarter.

Is it likely that they will also contribute significantly to the fourth quarter?

Potentially, yes.

Okay.

Great.

Our next question from Rick Schafer, CIBC World Markets.

Hey, thanks, guys.

I just have a quick question on your international mix.

If we get a little more granularity there.

Is there a way you can give us some color on what the shift was?

I know overall international hovered around 40 percent this and last quarter but was there a shift within what you guys sold internationally?

I mean, you know, Asia versus Europe versus, say, international North America?

And so, what do you expect that trend to be like in the fourth quarter?

What do you expect overall international and then overall mix sort of within international if we can get a little bit of granularity there.

I think last quarter, Rick, you know, was strong in Europe.

You know, previous quarter was strong in Asia.

So you know, we're seeing a sort of, you know, a balance.

It's still fairly lumpy, you know, based on some larger deployments.

We expect Latin America to be, you know, strong in Q4.

I think that's a reasonable comment to make.

But I think, you know, we're still seeing it to be fairly lumpy so I wouldn't draw any great kind of trend conclusions from it.

I think, you know, we have a number of opportunities as I look at it in Europe and also in Asia, and continually in Latin America.

So I think you are going to see a sort of fair balance from it.

Over time, you know, my own view is that I would expect international to be 40 to 50 percent of our revenues on a sort of an ongoing basis across sort of FY '03.

Okay.

Thanks.

Our next question, from Voytech with Bear Stearns.

Good morning.

This is actually Mike Gregano for Voytech.

Just a couple of quick questions.

Could you talk about the -- it seems like there is a new item there on long term deferred revenue.

Just talk about where that came from.

Also, could you discuss what's going on with the taxes?

Looks like you had a tax payment there.

Given the losses, was wondering what was going on there.

And then thirdly, if I get this right, you guys have -- you're expecting about a burn of 145 to about 150 in the the coming quarter.

And then you expect that to basically trail down to about $50 to $70 million, which is what your projection is -- by the end of fiscal year '03?

Just want to clarify that.

Okay.

So this is Mike AKA Voytech.

Correct, Mike?

Right.

On the cash burn, let's work our way backwards.

Yes, if you are asking for confirmation on the guidance we gave, you heard it right.

So is that what you were asking before we move off of that one?

Yeah, yeah.

And given the levers that you were talking about, it seems like you are going to try to do some incremental cost-cutting without any more restructuring.

Where would that take your break even?

Uhm...

I can't -- I don't think we can go there at this point in time.

Okay.

Okay?

I don't think that's fair to everybody.

Okay.

Let's go to the second question, which were taxes.

We did accrue some taxes that were predominantly all foreign-related from our foreign subsidiaries and foreign entities.

That's why you saw a bit of an accrual there in the current quarter.

Okay?

Okay.

In the case of a long-term deferred revenue, I -- we'll have to follow up with you on that one.

Okay.

I mean, I didn't -- I don't see it moving much.

A lot of that long-term deferred revenue is tied to maintenance agreements.

Okay.

And the like.

That we've signed up our customers.

The sales guys and the marketing guys have done a very good job selling long-term services over and beyond what we typically do to give people extended warranty, extended spare support, quicker spare support and a lot of what you see in the way of deferred revenue, especially in the long term side, is the fact that we have put up these multi-year contracts.

We have a couple of big incumbent carriers that we're doing business with where we have been able to sign them up for a five-year program.

Depending what portion of that they buy, and then they come back to the well and buy more.

That moves around accordingly.

Great.

Thank you very much.

All right, Mike.

Our next question from John Wilson, RBC Capital Markets.

Yeah, thanks.

Good morning.

Just a couple of question once for Joe, first, I guess.

Joe, if you could just give us if you can the split in the inventory write-off between how much that was supplier commitments on a percentage basis, maybe, versus what was actual inventory?

And then, uhm, Gary, I think last quarter you talked about China being over 10 percent of revenues.

It doesn't sound like that was the case this quarter.

If you could just give us your thoughts on what China looks like for you in the second half of the calendar year?

And then just one last one.

I just want to drill down a little bit on the acceptance that did not happen in July that, you know, caused revenues it be a little lower than you expected.

Sounds like you were saying that's coming in the next several weeks.

That just seems like a pretty big jump from, you know, hoping to get it done in July to being several weeks later.

What sort of drove that?

And, uhm, you know, I guess again, is that why you think you can be flat to slightly up this quarter, that piece of revenue that was supposed to be in Q3 is moving into Q4?

Is that it, John?

That's it.

Sorry.

Okay.

I'll go first.

The question was out of the inventory charge, how much of it was because of commitments versus inventory that's already on hand.

I'd say less than 10 percent of it related to commitments.

Where the inventory had not yet been received in yet.

Okay.

John, take your second one.

You know, on China, I think you know there is a consistent sort of view here I think across most of the sort of equipment vendors that you know, there is a delayed spending in China due to the integration, you know, with China the -- restructuring of China telecom, et cetera, and some of the issues around deregulation in China.

You know, and I think that, you know, is impacting us like everybody else.

You know if I look through that I still think that we're very well positioned in China for the longer term.

And I think, you know, depending upon some of the issues to do with the restructuring in China, I think, you know, it will be a, you know, significant play for us in '03 and '04 -- providing that we, you know, we execute well.

So I still think we're fairly bullish on China and out opportunities there.

You know, the issue is just one of timing.

In terms of the Q3 acceptance that we talked about, it was a new customer.

It was a large customer.

And really, I'd say it's no more than just the issues of getting formal acceptance with a new large deployment.

I think it's fair to say, though that it does give us additional comfort if that's quite the word in this environment for our Q4 revenues being north of Q3.

But the delay itself was not driven by any changes you guys had to make?

No.

You know, I think I -- I said in a sort of commentary the customer's very, very happy with what we've done for them and, you know, the relationship's going very well.

Just getting, you know, a big customer to get formal acceptance, uhm, you know, in the various processes -- and the various processes that you go through, with a new customer particularly, were a little more challenge than we had envisioned and really no more than that.

Thanks a lot.

We're confident of being able to take revenue for that in Q4.

Great.

Thank you.

Our next question from Simon Leopold, Merrill Lynch.

Great.

Thanks a lot.

Wasn't sure if I was going to sneak in there.

Couple quick ones.

Would love it if you could provide a little bit of color on your 10 percent customers in terms of what they're doing, what kind of architectures, what kind of products they're taking.

Second question, also drilling down on the 2500 product that you brought in from ONI.

I expect that that product has a certain appeal to enterprise type customers but you have not historically had a sales channel for that?

If you could give us some thoughts on your strategy for that product and maybe talk a little bit about the addressable market for that product?

And finally, on the break-even level, I think in the past you talked about 40 percent gross margin and over $300 million in quarterly sales.

With your reduced operating expenses, could you guide us in terms of where you see that going?

Thanks.

Simon, why don't I take the first two and hand over to Joe for the third.

The 10 percent customers in the quarter, uhm, in terms of, you know, more color on that, they were existing customers of CIENA.

They were not new customers to us in the quarter.

Their architecture, uhm, you know, both of them, uhm, are customers for broad product lines within the combined CIENA/ONI.

And you know, without going into more detail of what was deployed, they're both Core Director and Metro customers for us.

You know, and a what a lot of them are doing, you know, particularly with the ONI piece and some of the overlap that we have, we are now able to sell, you know, a broader portfolio to those customers.

And I think certainly one of those is a -- is a good example of that in the quarter.

So the -- you know, the customer reception to the improved portfolio combination of CIENA and ONI I think, you know, has gone very, very well.

It allows us to go from the core to the edge and extend our reach in that.

And specifically, as you talk about the 2500, I think, you know, you make a couple of good points there.

The market that we see for the 2500 is basically a, you know, customer premise type product.

But many of the carriers are interested in deploying.

So even though it would go into an enterprise, the predominant channel for it is as a carrier provide CPE tall shiny building type product.

So you know, that's a sales channel that we already have.

We're also looking at and have done for a while some enterprise channels through some partners, that is, you know, in the process of maturing.

I don't want to say too much more about that. -- right now.

From an architectural point of view, Steve, any other comments from your perspective on the 2500?

One of the things that the 2500 brings that we haven't had in earlier product lines, Simon, is the storage area networking capability and in particular the ability to extend certain types of storage area networks beyond the local network which has a great deal of appeal.

So -- so we're just now beginning to really uncover the opportunities for that product, particularly in the combined enterprise and enterprise access space.

And as Gary mentioned, some of that will be direct to carrier, some of it will be for channels.

Just to follow up, though, on the 2500, could you catch us up on Osmine status for that?

Have been through turps for parts of it, continue to go through the rest of the [INAUDIBLE] suite this year.

Great.

And break even question?

Sure, Simon.

This is Joe.

Our OP-X is lower, you're right.

And we're continuing to work on bringing it down.

So correspondingly, the conversation that we had previously about a 300 break even, it is lower.

I wouldn't say it's significantly lower.

But I would say you are in the 280 to 300 range given where we are today without doing anything else.

But we're continuing to work on it.

And we will continue to work on it as Gary said.

You naturally -- that number will come down correspondingly.

You guys are pretty bright.

If we're going to make some pretty significant changes in the cash burn then correspondingly the break even is going to come down, as well.

Great.

Thank you.

Right.

Our next question from George Knoter with Deutsche Banc.

Hi, guys.

Thanks very much.

Just a quick clarification on the guidance.

You said flat to slightly up in Q4.

You are going to get another 7 or 8 weeks of revenue out of ONI.

Obviously, the push on the Core Director business at Telmex.

So the question then, is: Is there some dose of conservatism in that guidance, or should we look at the organic business still deteriorating into Q4?

Thanks.

Joe, do you want to comment on your presumption on the Telmex piece?

But I think that the Q4 guidance is flat to slightly up.

You know, it includes all of ONI.

Whether it's a dose of conservatism or not, I think, you know, given the environment and what we have gone through in the last 12 months, you know, I think we can, you know, be forgiven for being a little punch-drunk from that in terms of our guidance.

We are trying to be as realistic as we possibly can in getting a handle on this environment.

So, you know, I honestly wouldn't, you know, describe it as either conservative or, you know, optimistic.

I think what we're trying to be is as realistic as possible based on the data that we have right now.

You know, things change.

But I wouldn't describe it as conservative.

I think we believe that we can, you know, get sequential growth in the quarter.

And that's, you know, what we've tried to reflect in our guidance.

I think we are, you know, if I put the short-term piece to one side, I think we're encouraged by our traction and progress into some of these large incumbents.

And the adoption of our architecture that we have been espousing for a long time.

I think, you know, the issue with that George, is really how quickly will that translate into revenues?

And that's really why we're not giving guidance, you know, beyond the quarter that we're currently in.

But I think we are encouraged by the amount of activity we see on RFPs, et cetera, and trial activity, you know, across the product range.

Great.

Thank you.

Thank you.

Our next question, from Kristin Armacost, S.G.

Cowen

Thank you.

Good morning.

A couple of things.

One, you keep mentioning throughout the commentary for the next quarter, uhm, barring -- excluding any restructuring or one-time costs.

Can you help us understand what events that you are looking for that is ultimately going to drive the restructuring that people are expecting?

And then the second, with Rusty leaving, can you give us any idea if you expect any more management changes to be made?

Thank you.

Kristin, why don't I take the first one.

I'd go back to the sort of levers that we have, you know, that we have talked about, dependence upon revenues, gross margin and managing of our operating expenses.

I think we've -- you know, I think we said in the commentary, we have taken our operating expenses down, you know, about 25 percent so far, you know, uhm, and we'll continue to -- to look at that, depending upon the revenue and the gross margin projection that we have.

I wouldn't like to get drawn further on that at this time.

In terms of, uhm, the management in the combined metro piece, I think, you know, you make any of these acquisitions, some of the leadership do not always stay.

I think Rusty did a great job in terms of helping us with all of the integration, and I think Pamela, you know, who has been with ONI for about two years, basically has led all of the 2500 team, you know, is very well placed to lead, you know, the combined metro which also includes the metro director and CIENA's historical metro piece.

You know, we don't envision, uhm, any, you know, further, uhm, losses in terms of the, uhm, leadership there.

Thank you.

Our next question from Steven Koffler with Wachovia Securities.

Hey there.

For Steve, uhm, last time I don't know if it was your commentary but on the conference call, there was some fair amount of qualitative comments on, uhm, the competition.

Specifically Lucent and Nortel in switching, core switching.

And just wonder if you could update us.

The flavor last time was that, uhm, Lucent may be making a little more progress than Nortel.

Is that still the case?

I think that's probably a fair state of assessment.

Nortel, I think, has disappeared a little bit in the last quarter in that space and Lucent has -- as we talked about last time, began to make some noises [INAUDIBLE].

So I think it is a fair comment, Steve.

Okay, thanks.

Our next question, from Hasan Amman, Thomas Weisel Partners.

Hi, guys.

It's actually Mike DeRochelle for Hasan.

Just two quick questions.

You know, ONI had had some traction with some of the RBOCs.

Just wondering if we could get an update there in terms of what you expect from them on metro deployment, et cetera.

And then also, there were some momentum from some of your competitors in optical.

In China, in the quarter, just kind of wondering, you know, what's going on there, what you guys are seeing, you know, from your perspective both on the competition and with your own progress there.

Thanks.

Okay, Mike.

Why don't I take the first one.

I think, you know, ONI -- had already commented that they are shipping to one RBOC.

You know, prior to the merger with CIENA.

So I think, you know, we have one customer there and I think we're , you know, good traction with the -- we're making, you know, good traction with the others.

In terms of China, you know, I think it's across the board in terms of some of the delays impacting the -- due to the restructuring in China.

I think there has been one or two customer regurgitation of announcements.

I would describe it thus.

I don't think anybody is particularly, uhm, you know, gaining tremendous amounts of traction in China right now in our particular space given the restructuring that's going on.

You know, the comments that I made earlier, I think, were, you know, well positioned there.

And there is business to be won in China within the next, you know, 12 months.

So, you know, there is still plenty to play for there and you know, we're leading with Core Director and K2 and the ONI platforms.

And I think we're -- you not sure I think we're pretty well placed.

Great.

Thanks.

Due to time constraints, we'll take our final question from David Tong, McDonald Investments.

Thank you.

Some of the IXC incumbents have been making noises about taking advantage of the competitive situation vis-a-vis bankruptcies of the competitors.

They have shown, if not increase in CAP-X, at least holding the line.

You know, given the opportunity that they are trying to do, have you seen any of this reflected in your activities with these IXCs, both of which have been, I guess, major customers of yours?

Yes.

It's a good question, David.

I think, uhm, you know, we should be fairly well placed for that.

I'd describe it as, you know, it's a little too early for us to see any of the benefits of that right now.

You know, we're in conversations with them as you would expect, and I think, you know, we should benefit from that, you know, if they're successful and if they, uhm, you know, have gone on some of the customer base, you know, from the carriers that have some uncertainty around them.

But I think it's fair to say, you know, it's going to take a little while to translate into, you know, orders for us.

And I think, you know, it's still a time of, you know, great confusion.

Well, some of them talked about, uhm, better pricing environments which could lead to a better return.

So I mean, that would certainly drive some of their purchase decisions, uhm, I mean, does that come up in the conversations?

I think it's -- you know, I think it's early days for them.

I think we're all hopeful that, you know, from a customer carrier perspective, their pricing, you know, the carrier pricing is stabilized and that, you know, our -- it's always good when your customers can be, you know, profitable.

You know, the challenge that I think many of the carriers have is not just getting traffic but getting profitable traffic.

You know?

As we talked about the issue is not the data growth is not there.

It's how can you make money out of it?

And I think many of these incumbent IXCs are migrating towards architectures that are much lower cost and I think if we were to see a more stabilized supply and consequent pricing model in North America, I think that would be good news certainly for, you know, certainly for us.

And I think for the industry, you know, where you can get carriers that are making money.

Okay.

Thank you.

You know, I guess, David, I just think it's too early in the play right now to draw any conclusions from that.

Well, I just wanted to hear your -- you know, what you had to say.

Okay.

Thank you.

At this time, Mr. Smith, I'd like to turn the call back over to you for any additional or closing comments.

Thank you.

And thanks, everyone, for joining us this morning.

And for your continued support.

And we look forward to seeing many of you in Dallas at NFOEC.

Thank you very much.

This does conclude today's conference.

Thank you for your participation.

You may now disconnect.