Ciena Corp (CIEN) 2003 Q2 法說會逐字稿

Good day everyone and welcome to the CIENA Corporation second 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 to the Vice President of Investor Relations, Ms. Suzanne DuLong. Please go ahead, ma'am.

Thanks, Pam and welcome everyone to CIENA's second quarter earnings conference call.

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 quarter's financial results, Gary will then discuss the business in the quarter and CIENA's business outlook and Joe will wrap up our prepared remarks with guidance for Q3. We'll then open the call to questions from the sell-side analysts.

This mornings' press release is available on National Business Wire and FirstCall and also on our website at www.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 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.

Gary?

Thanks Suzanne and good morning everyone.

During Q2, we got some strong confirmations that our strategy of continued balanced investment will pay off. Including BT's selection of CIENA and sullied progress with other target incumbent accounts.

In addition, we delivered continued financial performance improvements with sequential revenue growth, improved gross margin and lower ongoing operating expenses. We also took a big step in executing our up, out and across strategy with our announced acquisition of WaveSmith Networks in addition to recently launching our LightWorks services program.

I'll talk more about the business in Q2 and our outlook for Q3 after Joe reviews the quarter's financials.

Joe?

Thanks, Gary and good morning everyone.

As noted in the press release we reported Q2 revenue totaling $73.5 million, representing a sequential increase of 4%. The quarter included revenue contribution from a total of 65 customers, compared to 64 last quarter.

Of the 65 customers contributing revenue in the quarter, seven were new customers and all seven are unannounced customers.

We had three 10%-plus customers in the quarter. Two of which were North American and one which was international.

Combined, three 10% plus customers accounted for approximately 43% of total revenue in the quarter. This compared to Q1 when three 10%ers, accounted for approximately 51% of revenue.

Domestic sales represented 68.5% of the quarter's revenue, versus last quarter, when it represented 63.4%.

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'll try and provide details.

For the second quarter in a row, CoreDirector was the largest contributor to the quarters revenues and more than 25% of total sales. Sales of Online Metro increased sequentially contributing more than 20% of total sales. Metro Director K2 also increased over last quarter contributing more than 15% of total sales.

Revenue from Core Networking, which includes CoreDirector and Long Haul Transport contributed approximately 40% of the total revenue. Revenue from our Metro Networking products increased sequentially and contributed more than 40% of total revenue in the quarter. Service, and support related revenue represented approximately 14% 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 second quarter that has, as management, we make 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 24.8% was an improvement over last quarter and was stronger than anticipated as a result of favorable product mix and the cost reductions we've made in our manufacturing operations.

As was the case last quarter, gross margin was also favorably affected by a benefit for excess inventory reserves. This quarter's benefit of $1.4 million was primarily represented to the unexpected sales of previously reserved inventory. Excluding the effect of this benefit, our gross margin was still stronger than expected at 22.8%.

On a GAAP basis, our operating expenses in the second quarter totaled $96.5 million, a 7% decrease from Q1's total of $103.5 million. As noted in the GAAP P&L, this included noncash charges for deferred stock compensation, amortization of intangible assets and restructuring costs. I'll discuss each of these.

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 the first stock compensation amounted to $4.4 million. Deferred stock compensation is presented as a reduction of stockholders' equity and is amortized over the remaining vesting period of the applicable options.

Intangibles.

As a part of our acquisition of Cyrus we recorded $47.7 million worth of other intangible assets which is being amortized over a seven-year period. In addition, as part of our ONI acquisition we recorded $15.1 million of other intangible assets which are being amortized over a period ranging from two months to seven years.

In the area of restructuring costs.

During the quarter we recorded a restructuring charge of $4.3 million, associated with a work force reduction, offset by a $1.6 million credit related to the adjustment of previously estimated restructuring charges.

Those unusual items aside, we are pleased with our ongoing efforts to lower operating expenses. Ongoing OPEX was $85.9 million in the quarter, down 7% or $6.6 million sequentially. R&D decreased 3% from $53.7 million in Q1 to $52.2 million in Q2. Sales and marketing expenses decreased 4% from $26.6 million in Q1 to $25.7 million in Q2.

G&A decreased 34% from $12.2 million to $8.1 million in Q2. The significant decrease in G&A is predominantly due to reduced legal fees.

Other income increased in the quarter, due to some pre ONI merger related items. Our GAAP net loss for the second quarter was $75.5 million, or a loss of 17 cents per share.

Exclusive of unusual or nonoperating items listed in the press release, our loss for the second quarter would have been $64.6 million or $42 million if tax affected, or a loss of 10 cents per share.

Turning to the balance sheet.

We continue to work to lower our cash burn and to preserve the strength of our balance sheet. Cash, short-term and long-term investments at the end of the quarter totaled $1.8 billion, a decrease of $78.3 million from Q1, which was below our expectations of roughly $95 million.

Our accounts receivable balance at the end of the quarter was up slightly to $32.4 million, putting day sales outstanding at 40. This is up as expected from the 30 days of the last quarter and below where we expect DSO's to be on an ongoing basis. Our DSO's will increase, but will likely be below our target range of 70 to 90 days in Q3.

Inventory levels ended the second quarter at approximately $31.9 million, down from Q1's level of $40 million. The inventory breakdown for the quarter is as follows: Raw materials totaled $21.8 million; work in process $5.3 million; finished goods, $36.3 million; and our reserve for excess and obsolescence inventories totaled $31.5 million. Inventory turns were 6.9 in Q2 compared to 5.4 in Q1.

Finally, head count.

Our worldwide head count at the end of the second quarter totaled 2,005, a decrease of 56 from January.

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

Thanks, Joe.

In the past, I've articulated three strategic goals for CIENA. Number 1, to focusing on and winning incumbent carriers. Number 2, is expanding our revenue and market opportunities and thirdly, managing our costs carefully, balancing strategic investment with careful expense management. We continue to make significant progress in all three areas.

From an incumbent perspective, we made very good strides and we're very pleased to announce our British Telecom win. This win was a long time in the making and the result of literally years of persistence and we're very excited about the opportunity to work with a leader like BT.

We are not at liberty to discuss BT's specific intentions, however, if all goes according to the current plan, I expect BT will begin contributing revenues in our fiscal Q4 and will provide some of the fuel necessary to enable us to close in on our break even and profitability moving forward.

This win is exciting on a number of counts. First, we've been able to establish a foot hold in a customer where there has been very strong incumbent vendor relationships.

Second, BT, one of the world's largest and most established carriers has intentions of actually deploying a next generation network.

Third, they will be deploying network solutions that span our entire LightWorks product portfolio because they understand the potential OPEX and CAPEX saving and the need to evolve to a data services friendly converged architecture.

Finally, we expect that our selection by BT will encourage other incumbent carriers to evaluate the benefits of using LightWorks to evolve their network architectures in spite of their existing vendor relationships.

In addition to BT, we continue to be pleased with the traction we're seeing at other incumbents as well, both internationally and domestically in the United States. And I suggest that in addition to watching for new incumbent wins as a sign that our strategy is paying off, you should also look for evidence of our ability to expand the products and applications with selling to our existing large customers.

Our up, out and across product strategy is evolving as evidenced by last week's LightWorks Services announcement. And we believe it is absolutely necessary to expand our addressable market and to fuel revenue growth.

The addition of the online family to our product offerings and in particular the Online Edge products, which was formerly the 2500, continues to open new opportunities for us at the edge of the network.

In addition to the developments we've been pursuing internally to add features like 10-100, Gigabit E and ethernet switching on MetroDirector and 10 GigB on Online, our announced acquisition of WaveSmith is designed to open an estimated 2 billion incremental data market opportunity. Including opportunity of incumbents such as SBC and others.

We're excited short term about opportunities such as DSL deployments that are likely to bring for ATM and frame reapplications of this product. Longer term we expect it will provide a solid foundation for our MPLS offerings.

WaveSmith shareholder meeting has been set for June the 11th and we expect the transaction will close shortly thereafter. In the meantime, we're working on integration activities.

Jesus Leon, who many of you know lead our ONI integration, is heading up WaveSmith integration efforts as well and will oversee operations there on an interim basis. In general, integration in the strict sense of the word will be limited, as our goal will be to allow WaveSmith to stay on track and focused on the product and customer deliverables at hand.

We are taking steps, however, to see that we have all of the necessary business systems integrated and up and running on day 1. Following the transaction close, we'll refer to WaveSmith as CIENA's Data Networking Group.

The final leg of our strategy calls for continued pursuit of a balance between strategic investing in our business and managing our costs. We understand we're facing the environment that is much changed and that success requires significant change in response. But for us, this change implies more than simply restructuring and cost-cutting.

We are in many ways, reinventing our business in light of our changed market opportunities. In part, this results from executing our up, out and across initiative. We're, after all, no longer simply an optical transport company.

In short, we are transforming ourselves into a networking solutions provider and the completion of that transformation will take some time, particularly in this environment.

It is also requiring that we examine our infrastructure and specifically how we do things. As an example, during the quarter, we have realigned our R&D resources, previously R&D was structured in product orientated groups. At this point, we've moved to a functional alignment so as to enable us to better prioritize and allocate resources.

Another example of change is the evolution of our internal processes to more efficiently handle a significantly larger number of smaller orders as opposed to the fewer tens of million dollar orders we processed in the past.

These are not changes that can be achieved in one fell swoop and they are not always changes that are immediately evident to the outside world. Some of these changes are required to set the stage for future changes of the company. But I can assure you that change is happening, and it's happening in a careful, deliberate fashion that we believe will enable us to capitalize on opportunity and return us to profitability.

We are on target to achieve our goal of exiting Q3 with quarterly OPEX in the low to mid $80 million range. Exclusive of the incremental 4 to 5 million quarterly operating expenses we expect WaveSmith to add. And we'll continue to look to optimize our business model from there.

I've said previously that CIENA's forward progress in this turbulent environment will be measured best by our progress with incumbent carriers and by our improving financial performance. The BT win is clearly a sign that our strategic investment strategy can and will pay dividends.

Our improving financials are beginning to show the benefits of the restructuring efforts already taken. And we will continue to look for opportunities to move the levers we have at our disposal, revenues, gross margin, operating expenses, to get to profitability faster.

We continue to believe, however, that simply cost-cutting our way to profitability, while perhaps effective in the short term, would be futilely detrimental to our longer-term strategic and competitive positioning. We believe recovery for CIENA will come from a combination of new and existing revenue opportunities and careful expense management.

In part, we believe our new revenue opportunities will come from helping our customers generate new revenues. Carriers needs have moved beyond simply box solutions.

Most have cut CAPEX to the point where it appears to be unsustainable and while more are focussed on the benefits to be gained from achievable OPEX savings as they emerge from their spending hibernation, all are coming to grips with the problems they face creating services for and generating revenue from the demand for data. And more and more, are looking to their vendors or guidance and assistance concerning cost savings and revenue generation.

Our LightWorks services initiative launched, last week, is the next step in CIENA's efforts to help carriers migrate to more efficient data revenue generating business models.

LightWorks services is the next step beyond the CAPEX and OPEX savings you've been hearing us and others talk about. LightWorks services is about providing existing services more efficiently and thereby improving service margins.

It's also about providing new and differentiated revenue generating data services without completely rebuilding or overbuilding the existing network architecture. So it's a combination of actions that will lead to CIENA's recovery.

New wins, broader product offerings, new services, and careful expense management. The one thing we are not counting on, however, is a rebound in carrier spending.

Recently there has been some optimism regarding expected carrier spending patterns for the remainder of the year. I can tell you that from our perspective the environment is a whole remains challenging and spending remains difficult to predict with any degree of certainty.

The way to counter that uncertainty is to multiply the opportunities which is where we focussed our efforts and why we're continuing to pursue new incumbent carrier wins and incremental revenue opportunities in adjacent spaces.

We believe several of those incremental opportunities will begin to contribute and will fuel sequential growth as we exit our fiscal year.

Joe, can you talk us through the guidance?

Sure thing.

Before I begin to offer our guidance for Q3, I'll remind everyone that the statements Gary just made and those that I'm about to make are forward-looking. It is important to review the risk factors detailed in our 10-Q in order to understand the factors that may cause actual results to differ materially from this guidance.

At this point, we believe that revenues in Q3 will be in the range of between $65 to $75 million. I realize that this is a fairly broad range. But current visibility makes it impossible to narrate further at this time.

As Gary noted, we are seeing increased diversity in our revenues and expect that trend to continue. While a more diverse customer base should make it easier to forecast revenues long term, in the short term, there is increased uncertainty associated with having the quarter's revenue dependent on more revenue sources in the given time frame.

As we mentioned previously, a portion of this quarter's better than expected gross margin resulted from the inventory reserve benefits. As a result, we believe gross margins in Q3 could be down from this quarter's 24.8%, but likely still better than Q2's, if you eliminate the effect of the inventory benefit.

We expect overall operating expenses, exclusive of any unusual or non-operating items, will increase slightly in Q3, as a result of the expected addition of WaveSmith related expenses.

We expect other income or expense will be between $1 to $2 million, we estimate Q3's share count at approximately 458 million total shares and reflects the closing of the WaveSmith transaction. As a result, we expect that, exclusive of unusual or nonoperating other items, our net loss for Q3 will be in a range of between 9 and 11 cents per share.

We expect that our cash use in Q3, exclusive of unusual or nonoperating items, will be flat to slightly down from what we used in Q2. And we'll continue to work to lower it to the bottom end of our $50 to $70 million target range.

Pam, we'll now take questions from the sell-side analysts.

Thank you.

The question-and-answer session will be conducted electronically.

If you would like to ask a question, please do so by pressing the star or asterisk key followed by the digit one on your telephone keypad. If you are on a speakerphone, please be sure your mute function is turned off to allow your signal to reach our equipment. Once again, press "star 1" to ask a question.

We'll take our first question from Rick Schafer with CIBC.

Hi, thanks guys.

I've got a couple of questions. I guess the first just is a broader question on what's going on in the industry right now. In terms of maybe a status update on other potentially, sort of, large builds out there. We all - everybody's talking about the government defense contract, the AT&T opportunity out there. Are we going to see a defense RFP out finally this week? Just kind of a rough update of what we see there and then I've got a follow-up.

Rick, why don't I take that.

I think there are opportunities out there. I mean, clearly, you know the RFP activity, there are specific things going on with the government, there's been considerable speculation around, I think we're all involved in those. But I think overall, we're not seeing dramatic change in terms of an uptick in RFP activity, et cetera. You've just got to win the ones that are out there.

Okay. So nothing, I guess, much new there.

The other thing I had a question on was really on K2. I know you talked about it being roughly 15% plus the sales in the quarter. Are there any 10% K2 customers out there? Is there any way to break that out by customer type and region, your K2 customers?

Rick, this is Joe, good morning.

The answer on the 10% K2 customers is a definite yes. And in guess in terms of region, it's not North America, it's international.

So you have a single 10% K2 customer out there?

Yes, there's one outfit that's been - has been buying large quantities of the boxes for quite a few quarters now.

Okay. All right.

And then just one fast question, I can't resist on cash burn. I guess it's a little higher than expected this quarter. I know you're trying to get that 50 to 70 million target rate, but what are you saying for the end of the year, where your going to finish the year in terms of cash?

Rick, again, this is Joe.

Let me go back and fix something first of all. Our cash burn for this particular quarter was lower than what we talked about on this very same conference call last quarter. So I need to correct that right away.

Okay.

The 78 million -- we had projected somewheres in the 95 to 100, $110 million range when we had this call last time and we came in at 78. So it was about 25-plus odd million lower.

In terms of an absolute cash balance by the end of the year, we've never talked about anything like that. Our goal is to get the burn down to the $50 to $70 million range. And I think that is a very, very reasonable target.

I think what we're now doing is pushing for the lowest end of that range. And that's what we're operating to here.

Okay. Thanks, guys.

And we'll take our next question from Christin Armacost with SG Cowen.

Thank you, I have two questions, first on guidance then on the customers that you mentioned in the quarter.

First on guidance, if you are actually down sequentially, would it be most likely from lack of contribution in North America or outside of the U.S.? Or are these growth opportunities that you had thought could drive growth in fiscal '03 above that of '02, that or just taking longer to happen?

Christin, this is Gary.

I mean, I think given the, you know, still relatively very low revenue base, I think there's a tendency to sort of potentially over analyze it. I think, you know, our international revenues are not where we want them to be.

You can see in this quarter, you know, that 30-odd percent, I would expect them to be 40 odd percent. So I don't think you can attribute to it particular regions. But I think in North America, we're holding up better than we are internationally.

I think that's fair to say, Christin.

Okay. Thank you.

And then on the customers, you said you had seven new unannounced. Any chance of getting a profile of that? And then of the reserve that you had, a reversal on the gross margin, would it be fair to say that's from the same customer from the previous reserve reversal?

Christin, why don't I take the customer piece and then maybe Joe can talk about the reversal.

We've got, you know, seven new customers that are unannounced. It's really a mix of service providers and one or two enterprise customers in there as well. But clearly, you know, we wouldn't want to go further than that until, if and when we get approval from the customers to announce them publicly.

Christin, good morning, this is Joe.

I'm addressing your second question which was the reserve reversal. It was predominantly related to one product line but there was a little bit across all the product lines.

Great, thank you.

And we'll take our next question from Mike Gargano with Bear Stearns.

Hi. Good morning. Just a couple of quick questions.

I guess your comments about the rest of the year are pretty similar to what we've been hearing from several of the vendors, ADC last night.

I was just wondering if you could just give us any more information as to exactly what your customers are telling you about the back half of the year? It seems as though they did spend a very low amount in the first quarter.

You know, do you think there's any chance of you guys let's see losing a little bit of market share, do you just think it's the market in general? Or just any other clarity into why you think the customer's spending patterns are going as they are.

Then just a second question in terms of, you know, pricing, what exactly are you seeing out there in terms of pricing? Are you seeing it being exacerbated right here, getting a lot more aggressive? Maybe in terms of overall like unit numbers, if we look at, say, the units that you guys shipped, you know, in this quarter, if we looked at it three or four quarters ago, what do you think the same revenues would be based off of the units you had this quarter?

Thanks.

Mike, in terms of the general market, I think that we're not really seeing any change, I don't think, from the first half, you know, but I think CIENA's opportunity, you know, we're not banking on an uptick either in the second half or even really into next year.

It's really -- if we're going to be successful, we've got to take market share from other people. And we've go to win incumbent carriers that are not currently our customers, expend our adjustable market, take products such as the WaveSmith acquisition and get those into larger incumbents et cetera and take market share from existing players. That's really our strategy.

I wish I could say something different about the whole environment because clearly that would be, you know, helpful to us and everybody else. But we're certainly not banking on it. And we're not seeing clear signs of it.

I mean, we're seeing, you know, some carriers now moving from, you know, their CAPEX issues and clearly everybody has their hands on the CAPEX lever with white knuckles and I don't think that's going to change in the foreseeable future.

But the issue now with the carriers is moving on to, okay, what do we do about our operating expenses? We have to do something different. That's where, I think, it plays to CIENA's value proposition.

As I talked about earlier, the third step of that is how can we create service that is people will pay for? That's the whole mart of the LightWorks piece. So, you know, we don't see the macro being terribly encouraging from what we can see right now.

In terms of pricing, I think you go hand in hand in that. Pricing has been very competitive. You know, throughout this whole downturn. And I think especially in the metro space.

You know, our view to this is we will continue to price strategically as we always have and not respond to some of these particular issues in terms of taking our gross margin down in ways that don't make a whole lot of sense. So I think the environment, you know, from a pricing point of view, Mike, has been competitive for a while and we don't see any particular change in that. But we are, over the last, I guess, couple of quarters, seeing particular price pressure in parts of the metro space.

Okay.

And just lastly, just in terms of WaveSmith can you give us any kind of estimate of contributions for the back half of the year?

No, Mike, this is Joe, good morning.

We haven't done that.

They've got -- to give you a little color, they announced a deal with SBC and orders are flowing there and more importantly, shipments are going out the door. They've got a handful of other customers that are they're shipping to as well and recognizing revenue and we'll be better positioned to maybe share some more data with you when we have this call at the end of the next quarter.

Suzanne's getting prepared to do that as we speak.

Okay, thank you very much.

And we'll go next to Nikos Theodosopoulos with UBS Warburg.

Yes, hi. This is Norm for Nikos.

Could you just share some insight into the potential revenue opportunities at British Telecom, given your recent contract wins? And at first sight, you know, this contract covers a whole range of your product portfolio. That's an encouraging win.

But on the other hand, the incumbent vendor at British Telecom seemed to suggest that only a limited portion of the total optical networking spending by BT has been assigned to -- to their competitor. So could you share some further insight on that? Thanks.

Yeah, Norm why don't I take that.

You know, the contract we announced with BT is a three-year global agreement for all of our products. You know, unfortunately, we're not at liberty to discuss the sort of details of structured agreement, that's really -- time will tell for that.

However, you know, considering the agreement is the result of an extensive RFP, it's a three-year global deal, which includes all of our product line, we're very pleased with our position there. And how much we expect to provide to BT over the long-term will depend on a number of variables, including, not least of which, how we execute their deployment timing, et cetera. So I think, you know, time will tell for this, but, you know, I don't think BT would have gone through this extensive RFP process for it to be a small amount of business over the longer term.

Okay. Thanks.

We'll take our next question from Tal Liani with Merrill Lynch.

Hi good morning. Two questions.

The first one, it seems like this quarter CoreDirector declined by about 10 million sequentially and Metro and K2 went up. What is the product mix that you baked into the next quarter guidance?

Tal, this is Joe, good morning, good to hear from you.

I guess what I would say is it's up in the air. It's going to be a function of what we ship and what we're able to get revenue recognition on. It could stay the same SKU we had this quarter or shift more towards CoreDirector.

There are some deployments where we will be doing the installation that are going out in the month of June that we're kind of on the edge of whether we'll get revenue recognition or not by the end of the quarter. We're assuming we don't at this particular point in time, that's why we gave you the guidance that we did.

But I guess, you know, the short answer is here, it could stay the way it was this quarter or it could go up, depending upon where we recognize the revenue. And if it does go up and the SHU changes it will be back more towards the CoreDirector.

The other question I had is more general about the market for 40 gigs, what size of applications do you see there, what's the size of the opportunity and what's, sort of, your position in this market?

Tal, this is Steve.

40 gig remains a technology demonstration application at the moment without -- with rare exception, without real economic validation in most areas. The one thing that's been talked about has been high band with router interconnects, but I actual expect those to be 4X10 G, not really 40 G in their early -- so I think the opportunity in the short term is actually pretty much nil.

Okay. Thank you.

We'll go next to Jim Parmelee with Credit Suisse First Boston.

Thank you.

A follow-up on the question regarding BT. Gary, if you could talk a little bit about, kind of, of the portfolio, what products do you think will be toward the front end in terms of interest level and deployment by BT? Would it be, kind of, switching in Metro first followed bid Long Haul? If you characterize the revenue recognition process, will it be like some of the other larger deployments you've seen with TeleMex or AT&T where you see a step function increase in revenue recognition initially?

And then the second question is more about the data strategy longer term. How broad do you need to be to be competitive, do you need an edge and core capability in data? If you can talk about that, thanks.

Okay, Jim. I'll talk the first part and then Steve will talk to the strategy piece with data.

I think it's fair to say that, you know, probably the Switching Metro piece initially, and then broadening out, with transport, with integrated optics, et cetera. But I wouldn't want to get too further involved, you know, in their specific plans.

Jim, this is Steve.

Let me talk just a bit about what up, out and across means in terms of our data strategy. We are seeing a trend in the industry driven, I think, by business application users of data that are suggesting on architecture different from what folks have thought about for the last few years.

That as an amalgam of finding ways to transport existing data services like framing ATM effectively, but also transitioning to new services like IPBPN's over ethernet and so forth. That requires a couple things that we intend to be involved in.

One is edge dating a addition. Some of our current products like Online Edge are beginning to show those features. The WaveSmith products do that at the next level up in the ATM reframing space.

We also believe that the next layer of aggregation in the -- I would say the edge of the core will involve adaptation of multiple layer two protocols into, in our world, an MPLS layer 2 core with switched STSTDM wrapping around it. So we're involved in understanding that space a bit and we'll be very active in doing it.

So what I will tell you in our migration, is we will go up to layer 2 1/2, I'll call it, sort of at the edge of the core. The core of the core, the big core MPLS piece we're going to leave to our friends at Cisco and Juniper.

Great. Thanks. A quick call for Gary.

So, Gary, you think revenue recognition at BT will be, you know, more gradual or could follow kind of that step function type of increase you've seen at some of your other large installs?

Sorry, I missed that part of the question.

You know, I think you'll see, you know, typically until we get the initial piece in and recognized, and we haven't recognized any revenue yet, I think we said that we, you know, we expect the first -- the initial parts of that to be within Q4. I think then we'd have to -- you know, we're in the process now sitting down with them, and going through, and planning out their networks.

I would expect it to be somewhat lumpy going forward, which is the classic sort of rollout until you get to a reasonable install base. Then you start to get to, you know, a more regular revenue pattern. So I would expect it to be somewhat lumpy, Jim, from what I can tell right now.

Great, thank you.

Well go next to Stephen Koffler with Wachovia Securities.

Good morning. Quick question on DSO.

It did jump a pretty good amount, granted still way below the target range. What are the main things driving that, including the increase you're calling for this quarter? Is it longer payment terms that your entering into? Are the revenues more back-end loaded? What's really driving it?

Good morning, Steve, this is Joe.

It's pretty simple. In the previous quarter, we recognized revenue when we received the cash, so it drives into our DSO's because of the type of customer mix that we had and the type of customers we were shipping to.

And it's just purely a function of customer mix in Q3 we did not have as many of those customers where the -- calls for you can give them terms and recognized revenue when you ship it and you have DSO. So, the simple answer is, it was artificially driven down in Q2 because of revenue recognition based upon collection of cash.

Okay. And just quickly, head count and the change, please?

Sure. This is Joe again. The head count was 2005, and it was down 56.

Thanks a lot.

We'll go next to Hasan Imam with Thomas Weisel Partners.

Yes. Thank you, a couple of questions.

First of all in terms of the broad guidance range and your comments afterwards during the call, it would appear there's no good visibility even a quarter out. Is that a function of the large number of customers contributing to the 60% of revs or is it more due to the lumpiness in the other 40% coming from 2 to 3 customers?

Hasan, I think, you know, the broad guidance is still, you know, relatively low revenues, you know, we've said from 65 to 75. It's really due to timing of a whole, sort of, mixture of things.

Yes, we've got a lot more smaller customers, and that can be a little more unpredictable in terms of exact timing. But, you know, even some of the larger customers can be lumpy as we talked about before. So I mean, it's just the mix of that as we perceive it.

When we look at it, we take the snapshot now before this call, we try and give the best possible guidance that we can based on it. We've also said that based on what we know, we expect to go out of the year with, you know, an incrementally increasing revenues for Q4.

So, you know, we've tried to give you some indication of our visibility there as well. And that's based on some of the, you know, larger deals that we've won that we believe will come to revenue at that time.

On that, Gary, would you say the visibility just remains the same compared to prior quarters? Has it tightened?

I think it's probably about the same. It's probably about the same. I mean, the more wins that you get, you know, with the larger carriers, you know we've got sort of SBC, and BT now to add to the list of incumbents, you know you get a little more visibility with those folks, depending on what projects they're working on.

Great.

And the second question on Metro, it sounds like you had good sequential growth. Could you talk about the large RBOC deployments that have been expected for some time, what's the timing on that from your chair and where are you in all of this? Thanks.

Hasan, this is Steve.

I think what shifted in the RBOC space in terms of Metro Transport and related stuff is that the opportunity for really large pure transport WDM in the core has really diminished, it's just never come to pass. What has happened is more interest in, what I'll call, service aware transport closer to the edge than our Online Edge product addresses.

So for a few channels of course WDM with both ADM or GigE or ethernet or low-speed TDM functionality incorporated in, is really where the WDM action is, I think in the RBOCs over the next year or so, much less so than interoffice fiber-constrained relief.

And Steve, on that, will CIENA be a part of those deals or because of ONI's (INAUDIBLE) compliance issues, you may miss this round?

No, we will not miss this round.

Thank you.

We'll take our next question from John Wilson with RBC Capital Markets.

Hi. Thanks very much. I guess just two questions if I could.

Number 1, on the cost side, you continue to make some, I guess, better than expected progress on the operating expenses with the head count ticking down every quarter. Better than I guess what we've talked about. Is that something we should continue to look for?

I mean, you just continue to tweak away and get 30 to 50 heads a quarter? How should we look at that over the next three to four quarters? As part of that, I guess, is it fair to say that the quarterly break even right now is around $200 million a quarter?

And then, maybe a quick one, Gary, you guys talked about, even as recently as last quarter, the opportunity to grow in fiscal '03 over fiscal '02, that obviously's going to look difficult here. Can you talk about what is it that's really changed in terms of being able to do that this fiscal year? Is it stuff that you already had that's shifted out or stuff that you're hoping to announce that hasn't yet come to pass?

Okay. Why don't I take both of those questions, John.

First of all, from an operating expense point of view, I'd encourage folks to look at it in terms of us transforming the company and doing things differently.

And, you know, to be able to really take costs out, you have to do things differently. You can't just cut costs. Because that just impairs your strategic ability. And what we're in the process of doing is transforming the company from it's, you know, traditional transport business into a full systems supply, as Steve was saying, into both the edge of the network and also into the layer 2.

So to be able to do that, you have to restructure, pretty fundamentally, what you're doing internally. Until you've restructured, that really doesn't give you the opportunity to take some of the costs out. So, I know, from an external perspective, it looks like we're, you know, steadily going down, but we're taking - it's really enabling us to take cost out as we restructure our business.

And I would say that, you know, we can realize some more of those cost savings as we -- which are enabled through the restructuring efforts that we've both done and are currently underway. So I would expect our operating expenses over, you know, a trend not necessarily quarter-to-quarter, but over a trend of a period of time to continue to go down.

In terms of fiscal '03, I think the issue has been clearly throughout the year some delays in some of the larger decisions. You know, perhaps we were somewhat optimistic on the timing of some of those decisions on the growth plan in expanding our market opportunity.

You know, we absolutely believe they're there and I think things like the British Telecom win and the SBC piece is testament to that. So, I think if you were to summarize it, I would say it's still all out there, we've got some of it, but the timing has moved.

Okay. Sorry, just on the 200 million per quarter, is that roughly where you guys see your break even right now?

John, this is Joe.

In terms of the break even, it's a question of whatever your estimates are for gross margin.

We've basically left that up to each one of you folks that are asking the questions on the call today. But it's in the range of -- I've seen some models and had dialogue with people that it's somewheres between 175 and 225 depending upon what your gross margin assumptions are and how low you bring down the OPEX.

Okay. Thanks a lot.

Well take our next question from Timm Bechter with Legg Mason.

Thank you. This question is for Gary.

My question is concerning the catalyst effect of the BT announcement. Have you found increased interest from (INAUDIBLE) service providers because of that win, and how is your meeting schedule shaping up for SuperCom?

That's top secret, Timm, I can't share that with you.

Sure.

I think, you know, we've seen certainly we're engaged with most of the large carriers worldwide and I wouldn't say, you know, we're getting more phone calls for them than we did before then, but I think it certainly helps, you know, validate the opportunity that we have with those players. So, you know, it's certainly incredibly helpful.

Now, you know, we've got AT&T's call-back bond network and with the BT announcement, and also with the SBC announcement with WaveSmith, I think folks -- and TeleMex, I think folks are certainly paying attention to us and it gives us more credibility to be able to get attention from them in terms of our LightWorks story.

Do you think some of other service providers out there maybe need to understand better what it is that BT's planning to do before they'll make a move?

I think it's a fairly close-knit community, Timm, and I think most of the players would understand what they're going to do. And I do have a full agenda for SuperCom.

Okay, thank you.

Thanks.

We'll take our next question from George Notter with Deutsche Banc.

Hi guys, thanks very much. I wanted to ask about the long haul transport. It looked like it was up nicely on a sequential basis.

Is there anything particularly new going on there that's creating the lift in that business? And then what do you think about the outlook for long haul transport? Thanks.

George, you know, I think it may be up, you know, slight up sequentially in the quarter.

I think, you know, that's really because, you know, my own view is that it's at unsustainable levels. But I've been saying that for two years. So I think we're seeing a little more activity and opportunity in there, but I don't think, you know, it's going to be a substantial prayer in the short or the medium term.

Got it.

Are there are any new kind of routes or long-haul builds going on? I assume the answer there is no and most of the business you're experiencing now is line-card sales and on the existing installed base?

There are some new builds out there. You know, they're not large numbered, certainly as we've been used to historically, largely because the pricing and the costs and the technology have driven the costs down and things like CoreDirector mean that you don't need as much capacity there, but we are, George, seeing some new routes. It's a combination of, you know, existing card fills and some new routes.

Thanks.

We'll take our next question from Ehud Geldblum with JP Morgan.

Hi. Good morning. First a clarification and then a broader question.

On the clarification, I just want to make sure the revenue guidance for next quarter, does that include WaveSmith and what kind of contribution would that include from there? Then I'll ask the question after.

This is Joe.

Good morning. The revenue guidance for Q3 does include a very, very little bit of WaveSmith.

So only maybe 1 or 2 million at most?

Yeah, that's safe to say.

Okay. Thanks.

On the question. Can you just give us a little insight into matching up the product sets with the three large customers? First of all, are those three 10% customers the same as you had last quarter, just making sure of that, and then if you can give us a little sense in the grid of CoreDirector, K2, Online et cetera, how that matches up with what the 10% customers are buying and how that's kind of changed from last quarter?

Ehud two are the same as the previous quarter. You had 1 K2 customer there, which I think we talked about a little bit earlier.

Yeah, we did.

The rest, you know, was a mixture of product.

Okay. So nothing in particular that --

No.

That stands out?

No, no, if you look at sort of the matrix, it's still a mix.

Okay. One last thing.

You mentioned that in the G&A, Joe, you said that the G&A came down to 8 million this quarter based on reduced legal fees. Is that primarily from the Nortel settlement that got out of the way and you took care of that in Q1 and it's Q2. And could we see that come up with any legal fees you may incur with the WaveSmith transaction or is that going to stay down at that level?

No, you shouldn't have much because of the WaveSmith transaction, Hudi. I'd say even more so than the legal guys being able to resolve a portion of the Nortel stuff, I think it's more related to our friends at CORBIS (phonetic).

Okay. Thank you very much.

Next to Steve Levy with Lehman Brothers.

Good morning, it's Marcus Kupferschmidt for Steve Levy. A quick one for Gary and then a follow up after that.

Gary, in the past, you've talked to us about benchmarking CIENA's progress through incumbent wins. Can you tell us if any of the new seven unannounced revenue-generating customers this quarter are in that category? And maybe you could quantify that for us?

Marcus, that's a very good question, unfortunately, I'm not going to answer it at this time. We'll hopefully have more for you on the next conference call call.

Okay.

And then in terms of the sequential uptick in revenues that you're expecting for the October quarter, you made references to BT and BT's focus on Metro builds, but could you help us understand, are you looking for a pickup also from existing customers to help generate that increased sales and would you expect it from any specific products or geographies?

Thanks.

It's, you know, some of it Marcus is the result of things like BT, also some of the WaveSmith opportunities as we forecast out there. One or two projects with existing customers and some new ones. So again, it's a blend. You know, but based on our visibility right now, we expect the quarter to be up.

All right. Super. Thank you.

We'll take our next question from Subu Subrahmanyan with Sanders, Morris Harris.

Mr. Subrahmanyan, your line is open, sir.

Thank you, good morning. Just a couple of quick questions.

Joe, could you confirm for us your share count guidance and then Gary, could you talk about your R&D restructuring in terms of functional groups, where that's going and also maybe some comments on the integration of the transport and switching platforms you talked about?

Good morning, Subu, this is Joe. Share count that we alluded to was 458 million.

Okay. Gary?

Subu, we basically, you know, had R&D into four product lines. What we've done is to rationalize that by function so we've really now got software, hardware and network management LightWorks, which is making sure we get consistency.

You know, one of the things that drove us to that was clearly efficiencies but the other one was consistency so that we make sure we have the LightWorks architecture across all of the products. Clearly, you know, there's some efficiencies from being able to do that.

You know, and we're constantly looking at, you know, what's the optimization of that so we get the most bang for our buck. But making sure that we continue to invest in the right things and in new platforms as well. So that restructuring took place during the last quarter.

And anything specific that does to your cost structure?

Well specifically, you know you can optimize things and it's helped contribute to some of the cost reduction this quarter.

Thank you very much.

We'll go next to Todd Costman with Raymond James.

Yeah. Just a follow-up with regard to the cost structure comments, I think you're quite a ways away from profitability. You made a comment earlier on that you can't take cost out or something with regard to doing things differently. Could you explain what you're talking about and do what things differently?

Todd, if we take some examples of this, two years ago, we manufactured pretty much all the products that were in the company. Now we only manufacture about 15%, the rest is outsourced.

Another example, I just talked about, we were organized from an R&D perspective into four different product line divisions. We're now in functionally. You know, I can give you a lot more examples internally of what we've had to change and that allows to us take cost out.

Just a follow-up to that.

Is there enough of those opportunities out there to say, you know, reduce the break even level by taking cost out by, I don't know 50% or so? How much cushion or opportunity is left with those types of cost-cutting initiatives?

Todd, I think that we have some opportunities to take further cost out. I would not want to quantify them and get into further detail at this time, I don't think it's appropriate. Thank you.

We'll take our final question today from Gina Sockolow with Buckingham Research.

Thank you. I've got three questions. First, can you tell us what the CAPEX was for the quarter and what your guidance is?

Are you going to do them one at a time, Gina?

Yeah -- yes, please.

This is Joe.

We typically don't talk about that. We definitely don't talk about the guidance.

You'll see the CAPEX in the Q within a few moments when we press the button. I'll give that to you. It was between 8 and $9 million.

Thank you. Okay. Hopefully the next question will be easier.

Well, that was pretty easy.

Yes, this will be easier.

Our indications are that the DOD contracts and the DSA (phonetic) contracts are favoring the incumbents. Once the RFP's go out.

Could you discuss where and to what extent you have an installed base with the DOD, other Fed and State agencies, and what types of products and their systems are deployed?

Gina, why don't I answer that.

We don't have a large installed base currently with the DOD or the government. You know, our view is that if the DOD, DSA (phonetic) opportunity, if they really want to go with a next generation network, then we have a compelling value proposition there, you know, as part of that complete solution.

You know, I think time will tell who's right about that and which way they're going. If they clearly want to continue laying out the network they've got right now, then I would agree with you they would continue with the incumbent players. But we would have a different view of that if they really want to go to a next-generation network.

Okay. Thanks.

And the last question is: What other interfaces will WaveSmith -- what other interfaces does WaveSmith support now, besides ATM frame rely, what are your plans and benchmark dates for future interfaces particularly given the Juniper/Lucent announcement of upgrading ATM switches to IP with MPLS? Thank you.

Hi, Gina. This is Steve, I'll close the day on a positive note.

The WaveSmith platform at the, sort of, the edge of the core is we expect to translate relatively rapidly into an MPLS gateway at the back end. I won't give you time frames, but they are on the road map.

The WaveSmith guys are going to be very busy delivering what they already promised for the next six to nine months in the ATM frame space to some customers that we have talked and not talked about. But we're clearly going to move in a direction that pushes us into the lock (INAUDIBLE) two number of space which is MPLS in the edge of the core or in the core.

Is that a separate platform?

No.

On the same -- in the same box, will it be on the card or on the back plane that you're going to do.

You're getting into the technical details that are beyond my feeble little brain, Gina.

HA-HA.

But it will be in the same box.

Okay. And do you have a date for that?

Yes, but you don't.

HA HA HA. Thank you.

Good day.

Buy.

Bye.

And this does conclude today's question-and-answer session, I'll turn the conference back over to you for additional comments.

Thanks very much, Pamela and thanks everyone for their time this morning and for your continued support.

We'll be busy with financial conferences over the next several months and we also look forward to seeing many of you at SuperCom in Atlanta in early June. Thank you very much.

This does conclude today's conference. We do appreciate your participation. You may now disconnect.