Ciena Corp (CIEN) 2003 Q1 法說會逐字稿

Good day, everyone, and welcome to the CIENA Corporation first quarter fiscal year 2003 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 DuLong. Please go ahead, ma'am.

Thanks, Sylvester, and good morning, everyone.

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 provide some brief summary comments, Joe will review the quarters' financial results, Gary then will discuss business in the quarter and CIENA's business outlook and Joe will wrap up our prepared remarks with guidance for Q2. We'll then open the call for questions from outside analysts.

This morning's press release is available on Business Wire and First Call and also on our website at CIENA.com. If you're unable to obtain the press release or if you'd like to be added to our e-mail distribution list, please call CIENA's IR department at (888) 243-6223.

Before I turn the call over to Gary, I'll remind you that 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 risks and uncertainties that could cause actual results to differ materially from the statements discussed today. These statements should be viewed in the context of the risk factors detailed in our 10-Q filed with the S.E.C. 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.

Gary?

Thanks, Suzanne, and good morning to everyone.

Overall we're very encouraged by continued progress in the right direction. We're pleased to see sequential revenue growth in the quarter and solid progress on other operating and financial performance metrics. For the second quarter in a row gross margin came in better than expected as a result of a favorable product mix and the cost reductions we've made in our manufacturing operations. Ongoing operating expenses were also lower than anticipated, reflecting the results of our ongoing company wide cost control and resource prioritization efforts. In our cash position, exclusive of debt buyback, which Joe will discuss in greater detail, was also considerably stronger than anticipated. I will talk more about the business in Q1 and our outlook for Q2 after Joe reviews the quarter's financials in more detail.

Joe?

Thanks, Gary, and good morning, everyone.

As noted in the press release, we reported Q1 revenue totaling $70.5 million, representing a sequential increase of 14%. The quarter included revenue contribution from a total of 64 customers compared to 58 in Q4. Of the 64 customers contributing revenue in the quarter, nine were new to CIENA.

We had three 10%-plus customers in the quarter, two of which were North American and one which was a mix of domestic and international deployments. Combined, the three 10%-plus customers accounted for approximately 51% of total revenue in the quarter. This compares to Q4 when two 10 percenters accounted for approximately 53% of revenue.

In the quarter the domestic / international split of sales swung toward North America, as expected. Domestic sales represented 63.4% of revenue versus last quarter's 44.8%. Although at these revenue levels it is difficult to draw any sort of meaningful conclusions, from quarter to quarter variations in revenues by product I will provide some details.

For the second quarter in a row, Core Director was the largest contributor to the quarter's revenues at nearly 40% of total sales. Revenue from Core Networking, which includes Core Director and long hall transport, was roughly flat in real dollars quarter to quarter but down slightly as a percentage of revenue. Revenue from our Metro networking products increased sequentially and contributed more than 30% of total revenue in the quarter. Service and support-related revenue represented approximately 13% of the quarter's total revenues.

Turning to our quarterly operating results, 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 first 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 and/or not related to ongoing operations.

In my comments today I'll speak to both the GAAP results and to what the results would have been if we excluded those items detailed in the press release. Now that I reviewed our approach let's move on to the numbers.

Our gross margin of 23.1% was stronger than anticipated as a result of favorable product mix and cost reductions we've made in our manufacturing operations. Gross margins were also favorably affected by a benefit for excess inventory reserves of $2.7 million primarily related to the unexpected sales of previously reserved inventory. Excluded in the effect of this benefit, our gross margin was still stronger than expected at 19.3%.

Just to clarify, as there's been some speculation surrounding other companies in our sector, this was not inventory that had been previously scrapped, but inventory we had reserved against because we thought a sale was unlikely. Because we were able to sell this inventory, the corresponding reserve was no longer required and we reserved -- reversed that portion of our excess obsolete inventory reserve by recording a credit to the income statement and debit to our inventory reserve account on the balance sheet.

On a GAAP basis our operating expenses for the first quarter totalled $103.5 million. As noted in the GAAP P&L this included non-cash charges for deferred stock compensation and costs associated with our Nortel settlement. I'll discuss each of these next.

Deferred stock compensation charges. As part of our previous acquisitions we recorded unamortized deferred stock compensation costs relating to the unvested stock options and restricted stock assumed in the acquisition. During the quarter, the amortization expense related to deferred stock compensation amounted to $4.9 million. Deferred stock compensation is presented as a reduction of stockholders' equity and is amortized over the remaining vesting period of the applicable options. As of January 31st, 2003 the balance of the unamortized deferred stock compensation was $18.5 million.

Turning to the Nortel settlement. In late January we announced a settlement to our pending litigation with Nortel in which we agreed to a one-time payment of $25 million in exchange for a license under certain patents. We accounted for the payment by recording an expense of $2.5 million in the first quarter of fiscal 2003 related to the settlement of the litigation. The remaining $22.5 million was recorded as an intangible asset and will be amortized over eight years based on the expected life of the patent rights we acquired in the settlement. Those unusual items aside, we are pleased with our ongoing efforts to lower operating expenses.

Ongoing Op Ex was $92.5 million in the quarter, down 13%, or $14 million sequentially. R&D decreased 12%, from $61.4 million in Q4 to $53.7 million in Q1. Sales and marketing decreased 17% from $32 million in Q4 to $26.6 million in Q1. G & A decreased 7% from $13.1 million in Q4 to $12.2 million in Q1.

Other items on the quarterly income statement that warrant comment include the loss on extinguishment of debt. In January we improved our long-term cash position by executing a tender offer to repurchase the remaining outstanding ONI 5% convertable subordinated notes. Following our $97.1 million dollar market repurchases made during Q4, we repurchased, in the tender offer, another $154.7 million of the remaining $202.9 million notes outstanding. The difference between the purchase price and the accreted book value over the notes resulted in a loss on early extinguishment of debt of $20.6 million.

To recap, on June 21st, 2002 CIENA assumed the outstanding ONI 5% convertible subordinated notes in an aggregate principal amount of $300 million due October 15th, 2005. We initially recorded these notes at a value of $218 million as required by accounting rules based upon their fair market value at the time of the acquisition. We are accreting on a straight line basis over the remaining period to October 15, 2005 the difference between the fair market value and the principal value of the notes at the time of the acquisition so that the carrying value of the outstanding notes equals the principal value at the time the notes become due. In the tender offer we paid $139.2 million for notes with a cumulative accreted book value of $154.7 million at the time of the purchase. Partly as a result of the effect of the items I've just reviewed, our GAAP net loss for the first quarter was $107.1 million, or a loss of 25 cents per share. Exclusive of unusual or non-operating items listed in the press release, our loss for the first quarter would have been $75.1 million, or $48.8 million if tax affected or a loss of 11 cents per share.

Turning to the balance sheet, 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 totalled $1.9 billion, a decrease of $182 million from Q4. This includes $139.2 million used to repurchase the 5% convertible notes. Exclusive of the debt repurchase, our cash usage was $43 million during the quarter, meaningfully below our expectations as a result of lower than anticipated working capital needs and a $17 million tax refund we originally expected in Q2. Our accounts receivable balance at the end of the quarter was $23.5 million. Days sales outstanding were 30 at the end of the quarter. This is down from the 42 days of last quarter and substantially below where we expected DSOs to be on an ongoing basis. Our DSOs will increase but will likely be below our target range of 70 to 90 days in Q2. Despite the industry wide financial difficulties experienced by service providers, we continue to believe that CIENA's remaining receivables balance carries relatively low risk due to the size and relative stability of most of our customers.

Inventory levels ended the first quarter at approximately $40 million, down from Q4's $47 million level. The inventory breakdown for the first quarter is as follows: raw materials totalled $25.1 million; Work in process came in at $11.5 million; Finished goods totalled $40.1 million; And the reserve for excess, obsolete inventory totalled $36.6 million. Raw materials have declined in large part due to our ongoing efforts to increase the amount of outsourcing we do to third party manufacturers. Inventory turns were 5.4 in Q1 compared to Q4's 4.5.

Finally, head count. Our worldwide head count at the end of the first quarter totalled 2,061, a decrease of 57 from October.

And now I will turn the call over to Gary.

Thanks, Joe.

I'd like to take just a few minutes to review the business in the quarter and offer our thoughts about the future. Firstly, from an operational perspective, the vast majority of our California-based activities are now consolidated in our San Jose campus and we are enjoying increased efficiencies from that move.

From a market perspective, worldwide carriers are beginning to recognize the operating savings that Core Director can bring them and that the evolution to next generation networks can provide. In addition to the switching opportunities we're pursuing, as we mentioned last quarter, we have several customers and potential customers' evaluating plans for long haul capacity adds, and we expect there will be trial activity and indeed purchase decisions made over the next several months.

We continue to believe that our efforts to integrate long haul transport functionality with Core Director will provide CIENA with a significant cost advantage and operational benefits to our customers as their plans progress. Like the overall market, spending in Metro networking remains volatile, though we are pleased with the increased customer and revenue diversity the on-line family has brought to CIENA. And as Joe noted, Metro networking constituted more than 30% of the quarters' revenues and we saw the strongest contribution from the on-line products since completing the acquisition.

In terms of the bigger picture, we continue to pursue three strategic goals for 2003. Number 1 is to focus on and win incumbent carriers. Number 2 is to expand our revenue and market opportunities. And number 3 is to continue to manage our costs carefully, balancing strategic investment with very prudent expense management. I'm pleased to report we continue to make progress in all three areas.

Firstly, winning incumbents is one of those things that's very difficult to talk about until you've actually got a deal to announce. But I'm very pleased with the progress we're making both here and in the States and internationally with large carriers. We understand that these incumbents won't be quick or easy wins for us and in a few cases it appears as though internal changes may have delayed some of these decisions. But at this point it appears that unlike the dynamics we saw so often during the last year, these decisions have only been delayed and not postponed indefinitely. Time will tell if we're correct with this.

We believe CIENA offers a unique and compelling value proposition and more and more often we're hearing that echoed by our service provider customers. The key to winning these incumbents is not only industry-leading technology and innovation, but also global service and support capabilities and the critical mass that we have. Our demonstrated ability to build and support nationwide networks both domestically and internationally is clearly another strong positive for CIENA. Our up, out and across product strategy is evolving and it is absolutely necessary to expand our addressable market. We have several product enhancements already available, including 10-100 gigabit E and Ethernet switching on Metro Director K2, as well as 10 gigabit E on the online product range and we continue to get positive feed back from customers about our strategic partnerships.

The final leg of our strategy calls for continued pursuit of balance between investing in our business and carefully managing our costs. We'll continue to pursue a measured approach to managing our expenses, attempting to carefully balance strategic investment with expense prioritization. And I think you're seeing that flow through to the financials.

Our commitment to continued R&D spending is reassuring, we believe, to customers and potential customers as they contemplate which vendor to trust the future of their networks with. Innovation, we believe, is still critically important in terms of helping our customers get to a more substantive business model that they can progress with further. We continue to work to prioritize our R&D efforts, to align our investment and our cost with future opportunities and our efforts are paying off with operating expenses in the quarter below our initial expectations, This is a clear measure of the expense and cost management happening throughout CIENA.

We are also very focused on conserving cash, as well, and I'm very pleased with our low cash burn in the quarter, although I recognize that we benefited from some timing coincidences. The changes in the market environment and the diversity in our product line has brought significant product and revenue diversification to CIENA.

While positive overall and a necessary part of our evolution, the diversity has also brought challenges associated with processing more, smaller orders, and we're taking steps to adapt our internal business systems and processes to better deal with these new business patterns. We believe that long-term this diversity will bring our business better visibility and greater predictability. Short-term it means that quarterly revenues depend on a greater number of smaller customers. It's a new dynamic and one I'm confident we'll manage. But because it's new, I believe it warrants mentioning.

CIENA's forward progress in this turbulent environment will be measured best, I believe, by our progress with incumbent carriers and by our improving overall financial performance. Carriers are still facing the challenge of managing the growing demand on networks that were principally designed for voice, and not for data. They still have business and operating models that need to be fixed. And CIENA is still one of the only equipment vendors able to offer them solutions that enable them to address these challenges.

With that I'd like to hand over to Joe, who will walk us through the guidance.

Thanks, Gary.

Before I begin to offer our guidance for Q1, I'll 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, depending on the timing of orders, revenues in Q2 will be flat to up slightly from Q1 levels. As Gary noted, we are seeing increased diversity in our revenues and expect that trend to continue. While long-term a more diverse customer base should make it easier to forecast revenues, short-term there is increased uncertainty associated with having the quarter's revenue dependent on more revenue sources in a given time frame.

As we've mentioned previously, a portion of this quarter's better than expected gross margin resulted from the inventory reserve benefit. As a result, we believe gross margins in Q2 could be down from the quarter's 23.1%, but likely still better than Q1's if you eliminate the effect of the inventory benefit. We expect overall operating expenses, exclusive of any unusual or non-operating items, may increase slightly from Q1 as a result of the timing of certain expenditures. We expect other income/expense will be between $1 and $2 million. We estimate Q2's share count at approximately 433 million shares in total. As a result, we expect that exclusive of unusual or non-operating items, our net loss for Q2 will be in a range of between 11 and 13 cents per share.

We expect that our cash use in Q2 will increase from the unusually low levels we saw in Q1, but generally exclusive of one-time events, such as our Q2 payment to Nortel, we expect to continue to move towards the range of $50 to $70 million.

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

Thank you sir. If you would like to ask a question on today's call, you may do so by pressing star 1 on your touchtone telephone. Again, that is star 1 to signal for a question and if you're on a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star 1 to ask a question. We'll pause a moment to assemble our roster.

We'll take our first question from Nikos Theodosopoulos with UBS Warburg.

Okay. Thank you. Let's see here. Okay.

Wwell, let me ask on the revenue trends in the quarter, just playing with some numbers, it looked like the Metro area was up meaningfully sequentially and, you know, Core Director actually looked like it went down a little bit sequentially. And first of all, I wanted to confirm that.

And second of all, the question is, as you look out to the next quarter, the guidance that you're providing of flat to slightly up and then the comment about the timing of orders, what are you -- When you say the timing of orders, are you looking at some new major customers that you're potentially looking to add during the quarter, or is it more of a, you know, just a -- like this quarter you added nine customers and you're looking for smaller customers? Can you comment on what you mean by the timing of orders? Thank you.

Okay, Nikos. I'll start off with the first part of that, okay? In terms of the question on Metro up sequentially, the answer to that question is yes, I can confirm that. Okay? And then the second part of that had to do with Core Director sequentially quarter to quarter. In absolute dollars it was relatively flat. But since the total went up, the percentage then of Core Director went down slightly, if at all. Okay?

Nikos, in terms of the timing of the orders, it's really, you know, there's no one particular large order that's encompassed in that. There's a number of smaller orders, and it's really just a view right now of when they will come in and when we can ship them out. So, you know, we see in broad terms, you know, good -- reasonable demand that can support the kind of numbers we're talking about here. But it's really just the timing of them coming in so that we can ship them out. But it's not one large order, which I think was behind your question. It's not one or two large orders.

Okay. So, it's not likely that you're expecting some new major 10% customer to kick in next quarter?

No.

Okay. And just a followup, Joe. On the Metro side, I mean, playing with the numbers it looked like it was up the largest sequentially of all the product categories. Was that also -- was that primarily in the WDM product portfolio, or are you starting to see growth again in the Metro Director product category?

I'd say it's the former versus the latter.

Okay. Thank you.

Yes, sir.

We'll take our next question from Rick Shafer with CIBC.

Hi, this is Chris Disrenko for Rick.

Could you guys talk a little bit about the dollar size of the addressable market for switching and transport that you kind of alluded to during the comments, how you're trying to expand that? What dollar ranges are you looking at for '03?

Chris, this is Steve Chaddick.

Obviously it depends on how you count various segments. Right now we believe in sort of the optical states where we currently play, the worldwide addressable market is somewhere around $7 to $9 billion. Of that, for us to capture a larger piece of that we've got to expand the product portfolio, particularly in packet awareness at the edge and things like that, which is sort of behind our strategy that Gary alluded to. So, when we do the internal announcements, we are very careful to understand which pieces we can and we can't go after. And the way we craft our product strategy is really to chip away at those places we can't reach because of either channel or product features.

Okay. Could you talk a little bit about how the competitive landscape has changed from, say, a quarter ago to now?

Yeah. [INAUDIBLE] answer that Chris. I mean, I think the competitive landscape is still pretty painful in terms of, you know, what business is out there. You're seeing an awful lot of competition for. And I think in certain segments you're seeing some very, very aggressive pricing by some desperate competitors, particularly in the larger accounts where, you know, they are the incumbent suppliers. They're clearly wanting to hang on, do everything possible to hang onto that customer piece. But I think that, you know, the landscape from our perspective, I would describe it as being a little more stable from our perspective.

You know, overall we think the Cap Ex for the year is still going to go down, but we think our opportunity is going up because, you know, we're rolling out new products, continuing to invest and spread out our addressable market. And also, you know, if you look at it on a, just a large customer basis, the bad news is we're not in with the majority of the large carriers around the world. The good news is that's an opportunity for us. And so, really, as long as we execute and are able to penetrate those accounts, you know, that's an increased addressable market for us.

So, I'd describe the environment that we're seeing -- I mean, you've seen our revenues go up sequentially. You know it's not where we want to be from a business model perspective, but it's encouraging. And I think our value proposition is playing very well in the large accounts, you know, and I think in terms of both the product line, we've got to critical mass. It addresses the capital savings, the operating savings and helps the carriers create new services. And I think that value proposition is playing very well. And because we're continuing to invest and innovate in this area when many of our competitors are not, you know, I think that we're beginning to see signs of that strategy, you know, yielding real results.

Okay. One final question. Could you talk a little bit about the guidance for Q2 at all, about what percent of the sales you expect to come from new customers?

Chris, I don't think we're giving guidance on that. And I don't think we would given, you know, the increased diversity, you know, as Joe was alluding to, of the customer base makes it kind of difficult to, you know, predict that. It's still a volatile, you know, still a volatile marketplace. But I think, you know, the fact that we can win nine new customers in this kind of an environment I think, you know, says an awful lot for the strength of the company.

Thanks.

We'll take our next question. We'll take our next question from Christin Armacost with S G Cowan.

Thank you. Good morning.

The opportunities in long haul capacity additions, can you give us some more color on that, either quantify the potential number or at least give us some color on how you're looking at those of the existing installed base versus opportunities that may be more competitive?

Yeah. I think we're -- you know, if I split it into those two segments Christin, the existing base that we have, and clearly, I think, the ongoing sustainable spend, if you like, given our footprint out there, you know, was a lot lower than we thought. But I think we're beginning to see some activity now where we're starting to get channel cards back, et cetera. So, I think that bodes well for the future.

We've got a very, very large installed base out of there that has a lot of [schatzes] that can be filled economically.

I think the second part of it, we're also seeing, and this is fairly early days and not large numbers, but we are seeing one and two large carriers look to grow to RFP, et cetera, for some long haul capacity of new builds, both domestically and internationally. And I think, you know, that's encouraging. And I think we're pretty well placed there as we continue to invest and with the integration with Core Director. So, you know, Christin, I hesitate to put any numbers on that. I think it's early days. But I think we are seeing some signs of life in the long haul market.

And would it be fair to say that the majority of the line cards ads in the long haul are still OC 48 speeds?

I think that -- I'm just trying to think. We used to analyze it by minute detail every quarter. You know, we haven't got enough numbers to analyze that right now, to be frank. But I think that OC 48 is still higher than OC 192.

All right. Thank you.

We'll take our next question from Jim Parmelee with Credit Suisse First Boston.

Thank you. A couple questions. I guess a follow-up on your comments about the on-line business improving.

Are you seeing just capacity adds within the installed base, Gary, or are you benefiting from, let's say, some new product, you know, just the success of, let's say, the 2500 platform or the Edge platform within that category? And if you can comment on Metro Director K2, you indicated that wasn't an area you where saw much benefit. Is this something you think will turn more positively in the next three months or so? And if so, why or why not? Thanks.

Okay, Jim.

You know, the overall, the Metro marketplace I think we're seeing some good signs of life from. And it's held up better than the long haul market during the course of the last 18 months or so. But I think what we're seeing is new builds with some of the existing customers, some with new customers and channel adds. So, it's a mix of both.

I think some of the new customers we garnered in this last quarter were in the on-line product range. So, I think, you know, that's encouraging from an overall market direction. And I think people are beginning to, you know, try and get people ramped on to the networks. And it's success-based capital because they can garner new services from it fairly quickly.

Regarding the Metro Director K2, I think what we're seeing there is it's doing very well in Asia particularly and in certain applications, but we're not seeing the wholesale adoption of it in North America. And I think that's holding back the -- you know, some of the adoption.

Just a follow-up on that. Is it a function of, you know, just going through the lab process still, or is it certain feature additions you need to add to the system?

I think it's the timing in the marketplace. You know, we expect K2 sales to probably go up in Q2.

Great. Thank you.

Let's take our next question from Ehud Geldblum with JP Morgan.

Hi. Thank you. Good morning. Joe, first a question on gross margin.

When you were talking about guidance for next quarter being below the 23% but above last quarter's, how would that relate to the normalized 19.3% that you were talking about for this quarter? Would it be below or above that? And if you can give a few, kind of, the moving parts of that and how we look at that as more a product mix or how we should look at it?

Sure. It would effectively, the script was trying to convey that it would be above the 19%, which is the Q1 number if you eliminated the impact of the reversal of the reserve.

Okay. So, if you start off with the 19 and we use essentially the 59, 60% incremental gross margin that you did this quarter, that's pretty much generally a good run rate to work off of for additional revenue that we use in our model?

I can't go there too specifically. It can be; it can't be. It depends on what we ultimately ship in the quarter 'cuz we get different margins on different products lines in different regions. So, again, if you go back to the revenue guidance, there are a lot of orders, there are a lot of moving parts. This particular quarter I'd say it's going to be dependent upon what we're able to ship and what we're not able to ship.

Okay. Thanks.

And then, Gary, if I could ask you, was there any revenue from either Equip or WaveSmith in the quarter and are you anticipating any of that being part of what you're looking for at the next quarter coming forward?

I don't believe there was any revenue in the last quarter and I don't think we've -- you know, we've not divulged publicly whether we believe any is going to be in Q2. I wouldn't want to do that at this stage, to be honest.

If I could just squeeze one more in if possible?

Sure.

You said that in -- you said that in Asia you were seeing some more strength in the K2, overall you're seeing more strength in long haul. Could you give a little color on the geographic -- kind of fill in a little bit in the matrix between products, long haul, Metro and geographics between Asia, America and northern Europe?

Sure. From a Core Director piece you're seeing demand globally for that, you know, both in Europe, Latin America, North America. On the long haul side clearly I think, you know, you'd characterize it as probably North America built ahead of itself more than you know, other parts of the world as a real generalization. And I think, you know, consequently we're seeing the biggest hangover there in terms of capacity. So, we're not seeing as much activity in North America on the long haul side.

Europe, which generally did not participate in some of those very, very large builds the last few years, there are some signs that, you know, they're looking to have long haul build out there. You saw it fairly consistently in Asia. I mean, principally in China they did their long haul builds and built a lot of capacity out about two years ago. So, you're still seeing that as being fairly quiet. And then Japan, where we've been for a while, we have quite a large installed base, we are seeing some channel adds and other activity there.

If you look on the Metro side, you know, which includes the Metro Director, the on-line products and, you know, the Metro Edge, which is a 2500, you see pretty consistent demand in most of the regions there, as well. You know, North America is strong. Europe, parts of Latin America and Asia is still strong for the Metro portfolio. That's kind of walking through the major, you know, product offerings by geography.

Right. So, the part that surprised you most on the upside it sounds like more would be Japan was more activity and Europe with some more activity in long haul transport?

Yeah. I think if you take one thing away from this quarter, I think, you know, hopefully you can tell from the comments we've made is that we think that the long haul piece, you know, there seems to be some increased activity there.

Great. Thank you.

We'll take our next question from Alex Henderson with Salomon Smith Barney.

Great. Thanks.

I was wondering if you could talk a little bit more about the competitive landscape. Have you seen downsizing in programs at your competitors that is resulting in them falling out of the competitive mix a little bit more than they had been in the past as a result of their own downsizing programs?

You know, I think what we're seeing, Alex, is you know most of our competitors into the major carriers are the incumbent legacy vendors. And clearly they've got very, very broad product portfolios. And as they've downsized, you know, it's been very difficult for them to maintain critical mass. And I think, you know, one example of this that we've seen very clearly is in the various, you know, switching Core Director competitive offerings. You know, it appears to us that, you know, the whole optical switching piece got caught in the downsizings and, you know, got cut.

I mean, it's very difficult for these legacy vendors given the ability of product that they've got, very broad portfolio and a lot of, you know, legacy maintenance and support issues that they're trying to deal with. And so, they're spread very, very thin. So, Alex, you know, one of the examples we are seeing that in is the Core Director where we're not seeing the kind of feature sets and competitive response that they were talking about maybe two years ago. It's just not coming to fruition because it takes a large investment over a concerted period of time.

Similarly I would assume that you're seeing virtually no private companies at this point? They've pretty much fallen out of the competitive mix, as well?

Yeah. I think one of the real changes is that the major carriers around the world are not as willing to take on, you know, the smaller private companies, not without a big brother kind of approach.

Second question. On the seasonality side of it, we heard from other vendors in the space that did see pickup in their optical business, whether it was Cisco, Lucent or Nortel. All three of them sort of implied that there would be some seasonality to their optical business falling off sequentially into the upcoming quarter. Yet your guidance doesn't suggest that. Can you talk a little bit about why there's a difference in the pattern there?

It's difficult to understand that. I mean, we don't see that much seasonality. We really don't.

And I think, you know, as we talked about this morning, we've got a lot of diversity now, both geographically and amongst the customer base. And that, I think, is helping. But, you know, we talked about this internally.

Even historically I don't think we've ever really seen any great seasonality. I mean, we have the end of year, you know, occasionally people wanting to spend their budget, and then a little bit quieter in the January-February time frame, but never to the point where we've really, you know, been tangible - been able to tangibly measure that. So, we haven't really seen that, Alex.

Okay. Another question. Today being such an interesting day in Washington, do you think there will be any changes in spending as a result of the change in the [INAUDIBLE] rules? Could that help you?

Well, I think it certainly could. I think the devil's in the detail of all of this. And you know, clearly I think we'd have to understand exactly what the rollout was and the timing of it as to really kind of forecast whether it was a win or a loss for us.

Let me rephrase it.

In talking to your customers, have your customers indicated that if the rules are favorable to them that there would be a change in their spending that might impact you? Has anybody actually indicated that to you?

In macro terms, yes. In macro terms, depending on which camp you're talking to.

Well, clearly. And one last question.

You mentioned some comments about network capacity utilization in passing. I was wondering if you could give us a little bit more clarity on that? Are you seeing some of the long haul networks starting to get tight on capacity forcing next generation deployment decisions?

I think that, you know, you're still seek a lot of capacity available in North America, Alex. And I think there's one or two opportunities elsewhere in the world where they haven't built out as much. But I wouldn't want to overstate that. I think we're seeing some channel adds to it.

It's still reasonable to conclude that there's lots of capacity out there and it's very selective, route-specific kind of --

Exactly. I wouldn't want to overstate the opportunity we're seeing there. I mean, I think we're focused on integrating that into the Core Director and in fact we've organized ourselves from an R&D point of view around that. So, really a lot of that functionality will be subhummed within the Core Director.

And then a real easy last one, what was the head count again?

2,063, I think.

Thanks.

We'll take our next question from Steven Koffler with Wachovia Securities.

Hi, there, everybody. Gary, you - when you talked about delays in incumbents, you mentioned reorganizations as one of the reasons. We hadn't heard much about that.

Can you provide a little detail as to, not which customers, but sort of why and what areas? What's going on there?

Well, I think, you know, in broad terms certainly amongst some of the large PTTs around the world you've got some pretty significant change of leadership at the top of the company and that takes time to filter down in terms of, you know, their revision of their strategy, et cetera. So, I think we're seeing some of that generally. That kind of happens from time to time. And I think that's certainly been, you know, one factor in it.

And I think the carriers around the world are trying to adjust to, you know, the new environments that they're in. And I think, you know, they're thoughtful about what they're doing. They're very thoughtful about how they're spending their money. And, I think, that's leading to some delays in some of the awards of the RFPs, et cetera. And I think we've seen that for a while and we're continuing to see it.

Did it change materially at all relative to what you saw in the October quarter?

I don't think it has changed materially, no.

Thanks.

Thanks, Steve.

Due to time constraints, we ask that you limit yourself to one question.

And we'll take our next question from Steve Levy with Lehman Brothers.

Tnaks. Just a question here on the operating expenses, which obviously came in less than expected. Joe, I just want to be clear, you said that -- it sounds like there were some timing issues that might have helped out this last quarter, which are going to increase it in next quarter. I wanted to confirm that.

And then the question is, in the past you've had a goal of getting those operating expenses, I believe, down to around the $80 million level from this $92.5 million. I want to know if that was still the goal and whether your break even has changed from that $175 to $200 million in revenues. Thanks.

Steve, okay. A couple of questions there.

First of all, it is timing. It is specifically in the area of R&D, and it relates to some prototypes and some testing monies that you've got to spend, which are one offs. So, it might go up and it will come back down.

In terms of the guidance, it still stays the same. In terms of the operating expenses, we're still targeted to bring it down and trend it down. We have been trending it down and everything has been put into place to continue that progress and those efforts. And that would then translate into there's no change in the break even guidance at this point in time.

We'll take our next question from Andy Shelpek with Nutmeg Securities.

Thank you and good morning. Joe, I'd just like to try to clarify a couple numbers here. I'm trying to make everything add up to 100%.

When you initially spoke I think you said Core Director was about 40% of revenue, Metro network was in excess of 30% and that service and other was 13%. Roughly that adds up 83+ percent. Is the other component of this in other switching and transport?

It would be the other portion of Core networking, which is long haul.

Okay. Thanks there.

And also, Joe, with respect to the Nortel settlement, if I understood you correctly, why you took a settlement charge of $2.5 million in this quarter, the balance of $22.5 million, which you're recording as an intangible asset, will be amortized over how many years?

Eight, sir.

Eight years?

Yes, sir.

And just from a financial reporting perspective, will you treat that more or less as, you know, a kind of -- you don't like to use the word pro forma -- [ laughter ] I think you know where I'm going. The amortization of intangible assets, would it be - would that cost then be thrown in that category? No, sir. It would not?

No, sir. It will show up as cost of goods sold and classified as a royalty expense.

Okay. Thank you very much.

We'll take our next question from Simon Leopold with Merrill Lynch.

Great. Thank you very much. I'll ask a couple, but I'll make them easy so they're quick.

Within your Metro WDM, could you give us a little sense of how much of that business was Enterprise and how that compares to your previous quarter?

Also, deferred revenue looks like it went up 5 million. If you could give us a little color on where that came from?

And the last one, in the previous quarter press release you talked about '03 sales could be up from '02. I'm wondering if you still feel the same way. Thanks.

Okay. Let me take the first one there, Simon. Enterprise sales is still very, very small, you know, for the company. I would estimate it at being, you know, 1% or 2% kind of area, say probably about 2% to 4%. So, it's still very, very small. You know Joe, in terms of --

Deferred revenue? Deferred revenue, the reason it's up is it has to do a little bit with some products that we shipped and people have paid for it but we haven't really gotten revenue acceptance. And then there are certain customers that are continuing to buy, let's say, some services over and above the warranty pieces, the normal warranty. And they pay for multiple years. So, it's a combination of both of those. More of it is the former rather than the latter, Simon. Okay on that one?

The third question you had, which was last quarter we talked about an opportunity for year on year growth. I think the opportunity still exists there are a lot of moving parts to this, but at this point this time we have not changed that guidance.

We'll take our next question from Hasan Imam with Thomas Weisel Partners.

Yeah, thank you. Two quick questions. First, Gary, on the nine new customers you spoke about, could you characterize them by size and what type of business we're talking about? Is it essentially one-time, fully-loaded box sales or more repeat business possible?

And then on the switching side, could you talk about the competitive landscape more specifically on Nortel's win with the Chinese carrier they announced earlier? Thank you.

Sure. Let me talk about the nine new customers. You know, it's a very varied, diverse group, some of which were customers that, you know, we can certainly build on and they were, you know, initial networks. So, we would certainly get repeat business on them. Some were, you know, fairly small in terms of size and potential. So, a fairly mixed bag there, to be honest.

In terms of the competitive landscape for switching, as I said earlier, I don't think we see a whole lot of competition from the legacy vendors for reasons that I talked about earlier. I can't comment specifically on the Nortel win in China. They've been in China for a long time and have invested a lot of money there. But I think in terms of being able to look at a competitor for Core Director, we don't see anybody close to Core Director, frankly. And the more time goes on, the barriers to entry are very, very high.

You know, we've now had that product commercially available for a number of years. The software has matured and the functionality has matured incredibly and we continue to invest heavily in that Core Director switching. So, you know, we are pretty confident about our position in the market place there.

And on switching, how about Lucent and Sycamore?

Don't really see them in the bids that we're involved in.

Thank you.

Once again, that is star 1 if you would like to ask a question.

We'll take our next question from Chris Fischer with Raymond James.

Hi. Real quickly, on the 10% customers, were two of the three the same as in the previous quarter? And could you just maybe describe the types of products that each of those three customers are taking?

Why don't I start with the seconds part of that question while we make sure we've got the right answer to the first part. The types of products that the three 10 percenters are taking, in the case of one of them, they're taking a multiple -- several of the product lines. The other two customers are taking predominantly one, although one of those two is taking more than one product line.

Is it fair to say one is taking a lot of Metro product?

I think that's a fair statement, yeah.

Thank you.

Definitely.

Now, in the case of were two the same as last quarter, only one was.

Thank you very much.

Right.

We'll take our next question from Chet White with RTX Securities.

Hi. Thank you very much. I just had two quick questions, one to clarify, really.

In the competitive landscape for switching, you're saying you really are only seeing the HDX, not any of the Lucent or Sycamore products?

And then the second question, which you spoke out regarding the long haul RFPs, or at least activities, you're starting to see -- and I take it this is for the first time or at least the beginning of a trend, or you could comment is it the beginning of a trend, for some traction with the DWDM integrated and the Core Director and does that really set you apart? And do you expect that to be something that will set you apart for a lengthier period of time as you integrate solutions, whether it's DWDM or go up the stack? If you could comment on that whole progression for you as a company? Thank you.

Chet, in terms of the competitive landscape, I mean, you know, it's not clear to us which product we're actually seeing from Nortel. You know, whether it's their existing, you know, products or it's really the HDX. We have not come head to head with it, yet, I don't think, in terms of actually getting into the lab with a bake-off with it. So, we reserve judgment on that. It seems from our perspective to be continually delayed.

Your other question, about the long haul, we think that by integrating greater functionality into Core Director and leveraging our capabilities and functionalities of Core Director it does give us a unique position in the marketplace in terms of our offering. And we'll continue to differentiate that in terms of increased functionality, and integration of other components of the network, you know, specifically some of the long haul optics, et cetera, as well.

I would say, Chet, that I don't want to overstate what we're seeing in the long haul piece. I think it's just one or two opportunities there. It is not - We're not heralding this as the return of the long haul market because clearly it's not going to come back in the same way it was. And that's not what we're counting on and that's not what we're focused on. We see it as a much more integrated approach with our LightWorks architecture which gets much lower cost for the carriers.

We'll take our next question from Nikos Theodosopoulos.

Hello.

Hey, Nikos.

Hey. A quick question on the -- I'm sorry -- the restructuring. I didn't see any additional restructuring charges taken in the quarter. So, what I'm reading into that and then the guidance that you've given in terms of, you know, the breakeven levels that we had talked about in the last conference call, there's really no change in what you're planning there at this point. Is that fair to say?

That's correct. There were no restructuring charges in the quarter, Nikos.

Okay. And the break even range, I believe it was like 175 to 225, is still the range that you're managing the business towards at the current time?

That's the mathematics of it, that's correct.

Okay. All right. Thank you very much.

And we'll take our final question from Jim Parmelee.

Thanks. Just to follow up on the comments about investing in switching, can you give us a sense more specifically if the 1 or 2 key initiatives in the short-term that are really important, is it higher speeds and feeds? Is it certain features you'd highlight? If you can just put a little more granularity on what you're doing with Core Director. Thanks.

Jim, this is Steve. Density, cost points, data centric features, a whole range of things that we believe will take us really to the next level in terms of the product performance, both in terms of -- in terms of technical performance and also economic performance. And a lot of data centric pieces in that, as well.

Mr. Smith, that was our final questions. Our final question. At this time I would like to turn the call back over to you, sir.

Thanks very much. And thank everyone for your time this morning and for your continued support. We'll be busy with financial conferences over the next several months and look forward to seeing many of you at OSC in Atlanta towards the end of March. Thank you.

This does conclude today's conference call. At this time you may disconnect.