Ciena Corp (CIEN) 2003 Q3 法說會逐字稿

Good day everyone and welcome to the CIENA Corporation third 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, Miss Suzanne DuLong.

Please go ahead.

Thanks Pam and welcome everyone to CIENAs' third 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 this mornings call.

Gary will provide brief summary comments, Joe will review the quarters financial results, Gary will then discuss the business in the quarter and CIENAs' business outlook, and Joe will wrap up our prepared remarks with guidance for Q4.

We'll then open the call for questions from the sales side analysts.

This morning's press release is available on Business Wire and First Call and also on our Web site at www.ciena.com.

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

Before I turn the call over to Gary I will 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 today with the SEC.

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 the third quarter we continued to make good progress in our efforts to transform CIENA from a core optical focused provider to a more comprehensive networking solutions provider.

This progress is evident not only in the expanding breadth of our product lines but also in our customer diversification.

We completed our acquisition of WaveSmith in June and integration is going very well with WaveSmith DN platform contributing meaningful revenue in its first quarter as part of CIENA.

As you saw separate from our results released this morning we're entering another adjacent growth market with our acquisition of Akara.

Based in Ottawa, Akara compliments the extended SAN applications served by ONLINE Edge, giving us entry into the SONET/SDH space extended San applications market.

I'll talk more about Akara and how it fits into our plans in my comments later on this morning.

From a business perspective we continue to make progress towards profitability.

Revenue came in near the midpoint of our guidance, yet we still delivered improved gross margins and lower than expected operating expenses.

Clearly we continue to strive for a balance between what we firmly believe is the opportunity to invest strategically in our business, claiming market share in the process, and further reducing ongoing op ex.

In this morning's press release we announced our intent to further lower our operating expenses.

Let me be clear, this does not signal a change in our strategy, and in fact is entirely consistent with our stated strategy.

We remain committed to investing in our business.

We are also committed to transforming CIENA and doing so means ensuring our resources are correctly aligned with our opportunities as we perceive them.

We'll talk more about this in our outlook for Q4 after Joe reviews the quarter's financials.

Joe?

Thanks, Gary, and good morning everyone.

This morning we reported third quarter revenue totaling $68.5 million representing a slight sequential decrease and a year-over-year increase of 37%.

The number of customers contributing revenue in the quarter increased 11% sequentially as we recognized revenue from a total of 72 customers compared to 65 last quarter.

Of the 72 customer contributing revenue in the quarter 7 were new customers and 5 are yet to be announced customers.

We had two 10% plus customers in the quarter.

One North America and one that while predominantly international had a mix of both international and domestic deployments.

Combined, the two 10% plus customers accounted for just 23% of total revenue.

This compares to the second quarter when 3-10 percenters accounted for approximately 43% of the revenue and is by far the lowest percentage of quarterly revenue contributed from 10% customers in our history, demonstrating the significant diversification occurring in our customer and revenue base.

Domestic sales represented 60.4% of the quarter's revenue versus last quarter's 68.5%.

On the product front, metro transport, which includes both ONLINE Metro and MultiWave Metro was up sequentially and was the largest revenue contributor in the quarter at roughly 32% of total sales.

CoreDirector was the second largest contributor at 21% of total sales.

Revenue from core networking, which includes CoreDirector and long haul transport, contributed approximately 35% of total revenue.

Revenue from our metro networking products increased sequentially across the board with the exception of MetroDirector K2 which was coming off a very strong second quarter.

Sales of ONLINE Edge increased 45% sequentially, albeit off a relatively small base in the second quarter.

Combined, our Metro networking products contributed 41% of total revenue in the quarter.

As Gary mentioned, we also saw a strong initial revenue contribution from WaveSmith, our data networking group, at approximately 8% of total sales.

Service and support related revenue represented approximately 13% of the quarter's total revenue.

The remaining revenue in the quarter came from our Solutions group which includes sales of On-Center network management and software.

Turning to our operating results, the press release presents a GAAP only presentation of our results, as well as detailed information about the adjustments that, 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 GAAP results and to what the results would have been if we excluded those items detailed in the press release.

As part of our efforts to provide greater transparency into our business this quarter for the first time we've broken out not only our product and services revenues but also the corresponding cost of goods sold.

Despite growing competition in the last year product gross margin of 33.8% was an improvement over the same period a year ago when it was 8.7%.

Service gross margin of negative 38.8% also showed meaningful improvement over the same period a year ago when it was a negative 50.1%.

Gary will discuss later some of the steps we've taken and plan to take to get to profitability in our services business.

Despite the slightly lower sequential revenues our overall gross margin of 24.1% was an improvement over Q2's 22.8% excluding the positive effect of Q2's reserve reversal for inventory.

On a GAAP basis, our operating expenses in the third quarter totaled $105.9 million.

As noted in the GAAP P&L this included non-cash charges for deferred stock compensation, amortization of intangible assess, in-process R&D and restructuring costs.

As a result of our closing of WaveSmith acquisition some of these charges will be greater than they had been in the past, and I will discuss each of these.

First, deferred stock compensation.

As a part of our acquisitions we've 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 $3.9 million.

Deferred stock compensation is presented as a reduction of stockholders' equity and is amortized over the remaining vesting period of the applicable options.

Amortization of intangibles.

The charge for amortization of intangible assets during the quarter represents an accumulation of the amortized intangible assets resulting from our acquisitions.

During the quarter this charge totaled $4.5 million.

In-process R&D.

As a result of our WaveSmith acquisition we also recorded a charge of $1.5 million for in-process R&D.

This represents the estimated value of purchased in-process technology related to WaveSmith product development that had not yet reached technological feasibility and had no alternative future use at the time of the acquisition.

Restructuring costs.

During the quarter we recorded a restructuring charge of $15.5 million.

The majority of this charge was associated with the write-down of test equipment, though a small portion was associated with headcount reductions of roughly 90 employees.

Those items aside, we continued to work to lower operating expenses.

Ongoing op ex was $80.5 million in the quarter, down 7% or $5.4 million sequentially, and at the low end of the low to mid-80 target we set for ourselves last September despite the addition of the WaveSmith related expenses.

R&D decreased 8% from $52.2 million in Q2 to $48.0 million in Q3.

Sales and marketing expenses decreased 4% from $25.7 million in Q2 to $24.5 million in Q3.

After a significant decrease, Q1 to Q2, G&A was relatively flat in Q3 declining from $8.1 million in Q2 to $8.0 million.

Our GAAP net loss for the third quarter was $88.9 million for a loss of 20 cents per share.

Exclusive of unusual or non-operating items listed in the press release, our loss for the third quarter would have been $63.0 million, or $41.0 million if tax affected, or a loss of 9 cents per share.

Now turning to the balance sheet.

We continue to work to lower our quarterly cash burn and preserve the strength of our balance sheet.

In fact, we lowered cash burn 13% sequentially.

Cash, short-term and long-term investments at the end of quarter totaled $1.75 billion, a decrease of $68.2 million from the second quarter.

The cash used in the quarter was primarily used towards operations, including accounts receivable.

Our accounts receivable balance at the end of the quarter was up slightly to $42.0 million, from $32.4 million, putting day sales outstanding at 56, up as expected from 40 in Q2.

Our ongoing efforts to manage inventory resulted in an inventory decrease for the 8th sequential quarter.

Inventory levels ended the third quarter at $27.0 million, down 15% from the prior quarter's level of $31.9 million.

The inventory breakdown for the quarter is as follows: raw materials, $18.5 million, work in process, $5.0 million, finished goods, $31.2 million, and a reserve for excess obsolescence of $27.9 million.

Given that we've begun to present product-only revenue, we'll also discuss product-only inventory turns.

Product inventory turns were 4.8 in Q3 compared to 4.2 in Q2.

Inventory is likely to increase in Q4 as a result of us building trial systems to pursue a potentially significant long haul build.

I highlight this only because there is a risk that we will not be chosen to participate in the trial, and if so, depending on market conditions, we may have to write off a portion of this inventory in a subsequent period.

And now, finally, headcount.

Our worldwide headcount at the end of the third quarter totaled 2024, including approximately 78 employees from WaveSmith which represent an increase of 19 from April.

And now I will turn it over to Gary.

Thanks, Joe.

In my remarks today I will discuss our strategy in progress including our acquisition of Akara.

We continue to pursue a strategy designed to restore growth and profitability to our business despite what we expect to be flat to down overall market.

Our actions are focused simultaneously on revenue, gross margin, and cost, and I will talk to each of those in turn.

Firstly, revenue.

We continue to focus on growing and diversifying revenue, and we're doing this in several ways.

First, we're winning new customers.

As Joe said, we added seven new revenue contributing customers in the quarter.

In addition, we also secured wins that I'm confident will lead to meaningful revenues in future quarters.

Our focus on incumbents to some extent increases the probability of larger lumpier quarter-to-quarter revenue contributions.

As with incumbents, we're often talking larger deals across a broader scope of products.

Our efforts to expand our addressable market here have at the same time resulted in a growing number of smaller contributing customers.

On the incumbent side in Q3 Tier 1 accounts contributed 57% of overall revenues, including our first ever revenue from SBC as well as revenue from another yet-to-be announced incumbent carrier.

We're progressing through certification of British Telecom and continue to expect initial BT revenue in our fiscal Q4.

In addition we believe we're well positioned for follow-on revenue at Talmax.

Now turning towards the edge, non-incumbent customers made up 43% of revenues in Q3.

And as Joe noted we had 72 customers in the quarter, and if you exclude the two 2% customers, the remaining 70 contributed an average of $752,000 each.

And I say this because it's a good measure of our revenue diversification and perhaps one of the most demonstrable pieces of evidence of our transformation.

In addition to winning new customers we're also working to sell a larger set of products to existing customers.

And while, due to the logistics of finalizing contracts, we are not positioned to announce them at this point, we are confident that several new product wins with existing incumbent customers will begin to positively impact revenues during the first half of fiscal '04.

Finally, we're also working to expand our revenue and market opportunities through a combination of internal and external efforts designed to enable us to enter growth markets adjacent to our traditional core space.

Our up, out, and across LightWorks service strategy aims to identify and tap into the applications carriers are targeting for spending in their quest to support new services and efforts to reduce operating expenses.

We continue to believe that the majority of these applications and therefore potential growth market will be towards the edge of the network.

Partly because many of the innovations we've brought to the core have moved the bottleneck to the network edge.

Internally we've been steadily adding more data centric features to our products, such as the Ethernet capability for ONLINE Edge which we announced last week.

Externally by way of acquisitions we've added ONI, WaveSmith, and today we've announced Akara.

And despite an industry climate that seems to be reluctant to pursue M&A activity generally, acquisitions and partnerships will continue to be a driving force in CIENA's market expansion strategy.

And as Joe noted, we were very pleased with WaveSmith's contribution in Q3 and believe that revenue from our new Data Networking group is also going to be strong in Q4.

Let me spend a few minutes now talking about Akara.

First, the deal is a mix of stock and cash with an aggregate value of $45 million.

The boards of both Akara and CIENA have approved the transaction as have the stockholders of Akara.

The deal does not require CIENA shareholder approval.

We expect the transaction to close during our fiscal fourth quarter.

Akara is an emerging leader in the growing market of Sonet/SDH-based extended storage area networking, or SAN market for storage over distant solutions for enterprises and carriers.

They are focused on leveraging the existing Sonet/SDH infrastructure to deliver new data services.

And according to Infra Net's research the SAN interconnection market exceeds $1 billion today and is an end user spending growth area.

Based in Ottawa, Akara specifically focused on the growing application for extended storage, and this has emerged really as a medium to large businesses look to higher data storage standards to ensure business continuity and disaster recovery, such as the Canadian and East Coast power outage that occurred last week, is probably a good example of that.

We believe Akara has developed one of the most advanced storage extension solutions on the market with unsurpassed price performance characteristics.

They've also established relationships and qualified their solution with all of the major storage and SAN suppliers in the market.

And with this acquisition, SAN or expands our enterprise and channel partnerships and also I think opens opportunities for new relationships in addition to those already established by Akara themselves.

We also believe there will be sales synergies with CIENA's service provider customer base as carriers continue to look to offer new revenue-generating, storage-related services to their enterprise customers.

Architecturally, Akara's OUSP platform is a logical addition to CIENA's WDM-based offerings in the extended storage market, enabling CIENA to provide enterprise and carrier customers with solutions to meet the full range of extended storage applications.

Upon close of the acquisition, Akara will form the core of CIENA's new enterprise services group led by Akara President and CEO Ed Ugonic.

This group will focus on storage and data center applications to enterprise and channel partners, including potential resale through CIENA's carrier customers, as I mentioned earlier.

The enterprise solutions group will operate from Ottawa as well as from CIENA's worldwide sales offices.

We're excited about the combination and I will take this opportunity to welcome the Akara team.

It's clear that carrier spending in the core is likely to stay flat at best for some time.

Restoring growth and profitability to our business then, means that we must look outside of our traditional markets to identify growing markets and appropriate partners.

It really will enable us to leverage our existing customer base and market presence.

We've done so with success thus far and as a result CIENA looks different than it did just a year ago.

ONI and WaveSmith combined contributed almost 40% of Q3's revenue, and we believe Akara will begin to contribute to revenue in fiscal '04 and will continue to look for other opportunities to either partner or acquire from market expansion penetration.

So let's move to profitability.

And let's move from what we've been doing to improve revenue and restore top-line growth to profitability starting with gross margins.

In the last year and a half we've moved from nearly 100% in-house manufacturing to nearly 100% outsourced manufacturing.

As a result, our overall gross margin will continue to improve as volumes also improve.

Over and above volume improvements, however, as we work to expand our market opportunity we're also working to improve gross margins by adding more profitable product platforms, and we expect WaveSmith and Akara for instance to carry better gross margins than our historical transport business margins have been.

As Joe noted this quarter for the first time we've broken out services revenue and associated cost of goods sold.

Now there's good news and bad news here.

The good news is I suspect that many of you are surprised by our higher than expected product gross margins of 33.8%.

The bad news however, is that our services margins are lower than expected, and as far as I'm concerned, significantly below what I believe are acceptable levels.

The good news again is that this is something we've been focused on for some time and are in the process of fixing.

Over the last several quarters we have begun a transition from a fixed cost services model to a variable cost model, and that transition will continue.

For instance, a large portion of the restructuring cost in Q3 was the write-down of test equipment, as Joe said.

And this is a result of the change in our business and that we no longer need.

In addition, as we age, if you will, as a company, we have a growing number of customers migrating to service contracts from their initial warranty periods.

So we're also selling new service offerings.

As a result of this combination, we expect to see marked steps towards services profitability during the next several quarters.

Now turning to costs.

We continue to believe we cannot simply cost cut our way back to sustainable profitability.

The recovery for CIENA must come from a combination of revenue growth and careful cost management.

Unlike others in the industry who were forced to take a slash and burn approach to cost cutting, from the start we've used cost reduction holistically as a programmatic, deliberate, long-term process leading ultimately towards a different CIENA and to sustain profitability.

For instance, the realignment of our engineering organization discussed a quarter ago was just one of a series of precursors that will enable us to achieve even lower op ex goals.

In part we've taken this step by step approach to ensure our customers understand our commitment to them and in part we've done it to the ensure we have the products and features needed to win the business that's out there.

Last September we set a goal of lowering operating expenses to the low to mid-$80 million range as we exited Q3.

By getting to $80 million in ongoing op ex in Q3 we achieved that goal a quarter ahead of plan in spite of adding WaveSmith related expenses.

We've now reduced ongoing operating expenses by about 37% from net peak in Q4 '01 and we've added two acquisitions in the process.

Over the next 12 months our goal is to reduce expenses further by between 10 to 20% exclusive of the possible effects of any additional acquisitions.

And we expect the majority of these reductions will take effect in the first half of fiscal '04.

So in summary, let's review our progress towards our three strategic goals.

Number one, focusing on winning incumbent carriers, number two, expanding our revenue and market opportunities, and number three, managing our costs carefully, balancing strategic investment with careful expense management.

In terms of incumbent carriers we added SBC as a customer in Q3 and feel good about the progress we're making in both securing new incumbent customers and expanding our opportunities within our existing incumbent customers.

The addition of WaveSmith expanded our market opportunity to include multiservice switching today and MPLS migration in the future.

The addition of Akara enables us to pursue a broader set of extended SAN solutions and further that channel distribution strategy.

We achieved our cost cutting goals a quarter ahead of plan and have set even more aggressive goals near term.

Overall I believe we continue to make significant progress in all three areas, although there's clearly more work to be done.

From a general business tone, we have seen noticeable increase in RFP activity during the last quarter.

In addition, our pipeline activity level combined with business and revenues we already know to be in process and our efforts to augment our base revenues with new opportunities like Akara, leads us to feel somewhat optimistic about future growth.

As is often the case with bigger carriers however, the specific timing around revenue recognition, in particular revenues expected on new product wins, at existing incumbent customers, remain uncertain, which is why we've articulated a broad potential range for Q4 revenues.

And certainly there are some large deals out there to be won.

The potential impact of which we've not factored into our thinking at this point.

In the meantime we will continue to make deliberate steps towards achieving our operating expense targets and in preserving our cash balances.

Joe, can you talk us through the guidance, please?

Sure thing, Gary.

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

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

Our guidance is inclusive of Akara, which we expect to close during our fiscal fourth quarter.

At this point we believe that revenues in the fourth quarter will be within 5% up or down from third quarter, depending on the timing of some significant orders.

We believe gross margins in the fourth quarter will show improvement from the third quarter as a result of customer and product mix and our efforts to improve our services margin.

We expect overall operating expenses exclusive of any unusual or non-operating items will increase slightly in the fourth quarter as a result of the addition of Akara-related expenses and the first full quarter of WaveSmith related expenses.

However, we do expect to see the effect of the ongoing cost reduction efforts starting in the first quarter of fiscal '04.

We expect other income and expense will be flat and expense of $500,000 will be between flat and an expense of $500,000.

We estimate Q4 share count at approximately 470 million total shares.

As a result, we expect that exclusive of unusual or non-operating items our net loss for Q4 will be in a range of 8 to 10 cents per share.

Finally, on cash.

We expect our cash use in Q4, exclusive of any unusual or non-operating items, will be at the high end of our 50 to $70 million cash burn target range, in part as a result of the inventory commitments for the customer trial that I discussed earlier.

In addition to operating cash, we expect to use $31 million in cash for the Akara acquisition as well as some cash associated with restructuring costs.

Also, since the end of Q3, we have invested or agreed in principal to invest up to $15 million in private companies, and we anticipate that we will complete these transactions in the fourth quarter.

Operator, we will now take questions from the sales-side analysts.

Thank you.

The question and answer session will be conducted electronically.

If you would like to ask a question, please press the star key followed by 1 on your keypad.

Please bee sure your mute function is turned off to allow your signal to reach our equipment.

Once again, that's star 1 to ask a question.

We'll take our first question from Paul Silversteen with Needham and Company.

Thank you.

Couple of totally unrelated questions, if I might.

Of the seven new customers were any of them meaningful or were they collectively meaningful?

Well, this is Joe.

Of the seven new customers that we had in the quarter that contributed revenue, I would say that collectively they were meaningful, and I would leave it at that.

There was one that was several million dollars in total.

Can you give us the WaveSmith customer account or any additional insight in terms of how that's shaping up?

Paul, let me also add, first of all to, your first question, I would say that one of those customers was a new incumbent carrier that is unannounced.

In terms of your second question, around the WaveSmith piece, clearly, you know, SBC was a significant contributor to that, but there were several more than just SBC in that.

Can I push it, Gary, and ask for a number?

You can push, but I don't think we're divulging at this time.

Can you talk a little bit about pricing and competitive landscape, especially with what you're seeing out there?

Looks like Core Director actually went down.

I think that the Core Director piece really talks to sort of the lumpy nature of the larger incumbent carrier piece, Paul.

I don't think we're overly concerned strategically at this time.

I think over the course of the next couple quarters, come back up again with what we're seeing from some of the larger carriers.

So I think pricing pressure on Core Director remains pretty stable.

We've still got a very big head start on a lot of our competition there.

It's a very mature software offering now, which is going to take a long time for the competition to catch up.

Outside of that, you know, we're seeing aggressive -- it's an aggressive pricing environment, particularly on things like sort of long-haul and some of the other transport pieces, even in some of the metro space.

And I don't think it's overtly different this quarter from previous quarters.

I wouldn’t characterize it as anything significantly different.

Gary, one last question, on that particular point.

With respect to the WaveSmith market and Multiservice, can you characterize the pricing?

I know it's early days, but can you give us insight into pricing environment there?

It's somewhat of a unique offering from the WaveSmith side.

Therefore, the price performance of that particular product, because it's, you know, a new platform, you know, compared to most of the competition there, you know, the price performance on it is incredibly compelling, and it's really hard for the legacy guys to compete.

Thanks a lot.

We'll take our next question from Tim Batter (ph) with Legg Mason.

John, just wondering if you could maybe explain to me who qualifies as a potential acquisition candidate at this point.

I'm curious if I P routing, ethernet switching, what types of companies are interesting to you at this point and why.

Steve, perhaps you can answer that.

Sure.

I think the -- there are several key things.

First of all, it needs to be consistent with our philosophy and strategy from a network perspective which has to do with convergence in an evolutionary way of the service model, helping our customers both lower op ex and improve their ability to offer new value-added services.

The SAN market is an example of that.

Second, hat to be something where we can offer value and feel we have a competitive advantage.

So it needs to be probably closely adjacent to where we are, close to revenue, if not already generating revenue, something we can offered from a burn rate, culturally, the things that fit better from a cultural point of view more attractive.

So a lot of different factors but all aimed around really improving our ability to add services at the edge, specifically data adaptation service for carriers in their large customers.

So at this point our -- are private companies pretty much the only ones you would be looking at given the criteria near revenues?

Not exclusively but there are more that fit that criteria than private companies.

There are some public ones, but we put that into a different category if I would say.

Is it safe to assume that as far as size of any acquisition there's kind of a lid on that that you couldn't go above in terms of what you would have to pay because of the cash flow requirement or restriction that you said?

I wouldn't be quite that deterministic about it.

Obviously a public company that's accretive and generating positive revenue would be in a different category than a private company that's two years away from revenue and is burning two or three million dollars a month.

In aggregate there probably is a realistic one that Joe will impose, but I don't think we have a set of rules that you could put on a spreadsheet and say yes or no to.

Last one on this same line of thinking.

Do you guys have any interest in the fiber of the home, fiber of the premise market?

Certainly.

All right.

Thank you.

I'll let somebody else jump in.

Shoe we'll go next to Alex Henderson, Smith Barney.

Thank you very much.

This is actually Darrell for Alex this morning.

Just wanted to get a clarification on the revenue guidance, where you talked about the potential for a couple of large orders to fall in or fall out during the quarter.

I assume that you are not referencing British Telecom, that there are other service providers.

Yeah?

Darrell, let me answer that.

I think, you know, as we said, there's a number of incumbent customers that we have, you know, and, you know, every quarter has a lot of moving parts to it, and it's difficult to predict how they'll all fall out, but it's better to say there are a number of incumbent carriers that are looking to get -- we're looking to get to revenue in Q4 and beyond.

Then as a follow-up on different subjects, are there any reference customers, either enterprises or service providers, that you could provide for Akara?

Not at this stage.

We will be talking more about that after the actual acquisition closes.

Okay.

And one, last one.

In terms of the fourth quarter, would you expect revenues for the WaveSmith products to be up sequentially?

You know, I think consistent, Darrell, my piece about the moving parts, the -- potentially, yes.

Thank you very much.

We'll go next to Steve Levy with Lehman Brothers.

Thanks.

Just wanted to confirm that, one thing, you really only had one month [inaudible] but you still had a fair amount of [inaudible].

Steve, this is Joe.

We can just barely hear you on this end.

Let me see if I can repeat that.

Tell me if I'm right or wrong.

You were asking about WaveSmith revenues, I believe, and you were trying to confirm that it was only one month?

It was one month of expenses but you got all the revenues?

No.

No, it was a little over a month, about a month and a half of expenses, and the revenue, whatever they shipped in that month and a half, we got that as well.

Okay.

The other question I wanted to ask you, Joe, you made a comment about a potential big contract, and you mentioned long haul, building from inventory.

Does that mean, when you talked long haul, that it was just a long-haul transport opportunity or would that also include perhaps some band wit management inventory you might have?

I think when we talk about the inventory, Steve, we're specifically talking about the long haul inventory.

That includes some of the switching capabilities and multiplex capabilities, but specifically inventory in the long haul, which is -- which historically has been way down.

So we wanted to make sure that people understood that.

Where, you know, in the other areas, our inventory is able to satisfy demand.

Okay.

Thank you.

Thanks, Steve.

Should we'll go next to Sam Wilson, J & P securities.

Couple questions.

First, can you talk a little bit about the U.S.

Federal Government?

We also know there's a big RFP out for a contract, and just how CIENA is trying to play a role in that?

Sam, as you're probably aware, that's subject to an ongoing RFP situation, so we really wouldn't like to comment at this stage.

We did bid on -- or respond to three elements of that, and we feel comfortable with our position.

Great.

And then I want to follow up a little bit on Akara, but kind of a two-pronged question on it.

First, is there any -- I mean, just a general sense of where the product is, is it in beta?

Is it in alpha?

Do they have revenue customers?

Just a sense of where the company is in its lifecycle.

Secondly, Gary, kind of philosophically, from your prepared remarks sounds like it's going to be enterprise sale, directly enterprises.

How do you see CIENA going about trying to target the enterprise market?

Do you see yourself building a direct sales force for that?

Do you see yourself co selling with the carriers into enterprises?

How do you see yourself building distribution into that market?

Okay.

That's a good question, Sam.

In terms of where Akara are at, they have product, they have -- that they've been shipping for a while, they have revenue, and real customers that pay.

So from that point of view, they fall into the classification of what Steve was talking about in terms of potential acquisitions.

So they're mature from that perspective.

In terms of the sales channel piece, really, you know, we're already selling through carriers, you know, the re-sell elements of carriers who were selling both carriers and solutions into the enterprise space, with our on-line product, and specifically the on-line edge products, so it's a good compliment to that from the existing sales channel that we have.

So we see a very good fit from the existing channels that we have.

Now, they also have a lot of other relationships with third parties, integrators, bars, and also some carrier sales pieces as well, so we'll combine those.

I think it leverages our relationships; it also gets us into this particular application space.

I would also add that we do expect some Akara revenue after the deal closes in Q4, so we will be able to talk more about that clearly after the deal closes and when we get through Q4.

So I think in summary, Sam, it's very complimentary, some of the sales channels that we already have.

Thank you very much.

Our next question comes from Michael Gargano with Bear Stearns.

Good morning.

Just a couple of quick questions.

In terms of the revenue guidance for next quarter, it seems as though with the BT contract, you know, most likely starting to ramp, then some additional revenues from SBC with WaveSmith, they're down 5% to up 5%, probably you guys could probably be able to do at least the thinking was you probably would have been able to do a little bit more than that.

Just wondering -- this is somewhat Darrell's question -- what are the specific issues?

Some of the SBC contract was recognized this quarter?

Were there some push-outs?

Was it one or two customers?

And was it anything with the revenue recognition with one or two customers?

Just any more detail on that.

Also, with some of the RFP's that you mentioned this quarter that you've seen the pickup in, is there any particular areas you're seeing more pick up in than others?

Is it with some of the WaveSmith product?

Also, is there any way we can gauge for the next couple of quarters, you mentioned there could be a couple of incumbent wins.

Are you setting any target for yourselves in terms of the number of incumbent wins that we can kind of gauge your success with?

Okay.

Mike, let me take your first one.

You think, overall, with some of the RFP activity and some of the incumbents that we're doing very well and getting traction with, I think it's fair to characterize some of those that it's taking longer than we would have thought to get to revenue with them.

I would specifically, though, say that we do expect to recognize our first revenue from British Telecom in Q4.

However, some of our other incumbent sales are taking longer than we might have anticipated to get to revenue.

We're very confident about them coming to revenue, and potentially could have come to revenue in Q4.

There're no specific issues with them.

It's just the combination of, you know, finishing the contracts, being able to deploy, and to recognize revenue, et cetera, et cetera.

So we feel good about where we're at with the number of incumbent engagements, so it's really just a reflection of timing of all of that.

In terms of RFP activity, you know, I think it's really into some areas around, you know, the edge of the network, the WaveSmith piece, and also things like, you know, Core Director switching new architecture activity as well.

So it's in the sort of areas where we would expect, you know, growth.

Okay.

Finally, you mentioned that there were two new incumbent customers.

Could you just, of the one incumbent customer that I don't think you've mentioned the name, is that in the U.S. or international, and could you talk a little bit about the applications that you're selling into them?

It is an international PCP, and it is the edge of the network.

It is on line edge products.

Great.

Thank you very much.

Thanks, Mike.

We'll go next Ehud Gelblum to JP Morgan.

Good morning.

Thank you.

Sorry my voice.

Couple of assorted questions, but I'll ask them one at a time.

First of all, the K2 customer that was so strong last quarter, it has been around for a while, is it over, Joe, or are they going to come back and in and out by quarters?

Sure.

No, it's not over.

They are scheduled to take more products this quarter, just not as much.

From here on out it will be lumpy as they fill out, but it is a very large deployment, so when they do fill it out, there will be some nice adds.

So we could see that bounce back the next quarter or quarter after that?

It’s Possible.

In looking at new customer count of seven, in the prior earnings release -- in the earnings release, I'm sorry, in the prior press release when you acquired WaveSmith they had six customers currently.

Are six of your seven new customers those WaveSmith customers, leaving you with only one new core CIENA customer or am I doing the math wrong?

This is Gary.

No, it's a mix.

I think from -- don't hold me to this but I think there's about two new customers that WaveSmith brought to us.

Others were a combination of CIENA.

Okay.

And again, the two incumbents that are new to you, one is the WaveSmith SBC relationship and the other is an ONI European TTT relationship?

I would say PTT, I would say on line edge.

Absolutely.

But your deduction on that is good.

Okay.

That does clear that up.

Appreciate that.

In terms of the difference, again, kind of going back to the question that's been around a little while now, between your prior guidance of leaving the year on a potential up and now being plus or minus 5%, is it much more of a timing issue than it is a revenue materialization issue, in that the revenue is there, it just may get pushed out a little more into fiscal year '04, and mainly the do with your incumbents, will we see still see the revenue, if you look at first quarters numbers are, is it a matter of pushing the stuff out or is it a matter that some of the stuff isn't coming in right now?

It's characterized as you first said it.

It will come.

It's just we're taking a lot of new product into new customers, and it's taking a while.

So it's really an issue of timing.

We are confident that that revenue will flow through.

Okay.

If I can actually get one last thing in, Talmax, a prior large customer of yours, and you talked about them as well, was there any Talmax revenue this quarter, or do you expect to see any next quarter or after?

I do not believe there's any revenue from Talmax this quarter.

We do expect revenues from them in fiscal '04.

But probably not in the October quarter?

Probably not.

Potentially in the October quarter.

That's some of the moving parts.

And that's probably one of the reasons why the guidance now is a little bit lower than it had been.

Well, I think, stepping back from it, it's overall there's a number of pieces to the jigsaw for it.

I think the overall comment would stay that, you know, we think we're making very good progress with a lot of these opportunities that just taking locker to get to revenue than we would have anticipated.

That would be my overall statement.

We're still very confident that those revenues will come through.

Right.

Okay.

Then if I could ask one last thing.

On Akara can you give us any headlines what the revenue was in the beginning of the year or your expectations through the end of the year?

Maybe what some of their burn rate is or some of the things that will be added.

Joe?

Sure.

Let me do that.

On the revenue side they do have some revenue.

It is small.

A lot of their partnerships are in the early stages of developing, although they have some very, very strong relationships to distribute the product.

So in terms of revenue number, you know, it's definitely low single digits, maybe a million or so, depending upon where the quarter -- when the deal closes within the quarter.

On the expense side, as it relates to the burn, I'd say it's going to be somewhere between a million and $2 million on a full quarter basis.

Okay.

And that will be added in only partially next quarter, then we'll have that going forward?

Right.

Okay.

Terrific.

Thank you.

Thank you.

Next to James Parmelee, C S First Boston.

Thank you, couple of clarifications.

One on the plus 5% type of sequential revenue scenario that could emerge, just to understand what you're -- the orders and the timing, is this a case in which you've kind of deployed or sought of your products in your waiting for customer certification or is it kind of early where it's a situation in which, you know, you are close to closing the sale, you haven't deployed systems yet?

Can you kind of characterize or provide a little bit granularity how we should think about that.

Then the comment that there is a potential that the data networking business would be up sequentially, would that be driven more by kind of increased strength, let's say SBC or some existing customers you've seen, or would it really be more predicated on your ability to kind of glean some new customer on that in the quarter?

Thanks.

Let me answer the first one, James.

I really would say that it covers a whole spectrum of maturity of situations.

Some is shipped, and it's revenue recognition, some is deals that we've already got contractually, and it's issues about timing of deployment, readiness of sites, all those kinds of things, and certification within the incumbent carrier, and then, you know, right away through to we haven't won the deal yet.

So it really covers the whole spectrum of opportunities.

I think on the WaveSmith piece, specifically the D & G, it's really around if it's going to be up, it's going to be new customer wins, would be my view to that.

Now, we are pursuing a number of new opportunities with the D & G product and group.

There's also opportunities within existing accounts of us really getting in and looking at new applications.

It's a very flexible platform.

So if it were to be sequentially up, we'd need to get into some of those application and translate them into revenue.

We're already engaged on a number of those, and I think it's fair 0 say, and I think you can hopefully pick up from, you know, the tone this morning and some of the facts out there that we're clearly very, very pleased with the response to this platform.

Great.

I think the timing of it has been well received from the market, and it's a very robust, mature platform.

Just to follow up on the first question I asked and your response to that, it sounds like we aren't talking about a big revenue Delta in terms of the up side scenario.

Would it be incorrect to kind of characterize you do have a lot of pipeline things but it's probably going to take two to three-quarters, if not more, and none of them are really big at this point, it might be some incumbents but it's fairly small revenue dollars and it's probably going to take, would it be fair to say, six months plus for them to really gestate and really lead to sequential growth, or am I being too conservative.

I would answer the question like this, Jim.

We think that revenues for next year are going to be higher than this year, and we think they're going to -- why do we think they are going to be higher than this year?

We believe that the number of deals that we've won and we're working on will translate into revenue.

Now, we'd expected some of those to, you know, materialize this year, this quarter that we're in.

Now, we were wrong about the timing, yeah.

But, you know, we're still confident of them coming in.

Now, you know, accentuating the positives here, the diversity of our customer base, as we get out and transform the company and get into different market areas, that should help take some of the lumpiness out of this.

But I think we're a little ways away from getting to a smooth revenue line here.

Thank you.

We'll go next to Andy Schulpak, Nut Meg securities (ph).

Thank you.

Good morning.

I think my questions have been answered, so let me pass it along.

Thanks, Andy.

Sure.

We'll go to Brant Thompson, Goldman Sachs.

Hi, guys.

If we could just switch a bit to the cost side, you've lowered your operating expense target going forward and given a range of 10 to 20% reduction.

Could we get some color in terms of the source of some of these savings, where you're going to be seeing it, and if there's any potential for you to able to change how you're doing your service and support and installation with your customers, in terms of the capability to enter distribution agreements in some of the regions you're servicing?

Brant, what we've tried to do in approaching, you know, the last 18 months are 00 is to do it from a programmatic point of view.

Basically if you're going to take this amount of costs out, you've got to do things differently.

What we've done is a step by step approach to restructuring our business, and I think perhaps the more obvious example is manufacturing outsourcing.

And I think on the service and support side, sort of two elements to it.

You know, one, we've got a lot of customers coming off warranty, and we can now put them into service contracts that we get some revenue for.

And also with the diversification of our customers and our product base, it gives us a little more flexibility to get to a more variable cost model as we approach those kinds of service, and also some of the large, you know, single product deployments, we need a different mix of some of the skill sets within the company.

So, you know, both the service and the manufacturing, you know, are good examples of that, and also we're changing a number of our processes internally to trying to take some costs out.

So, really, those are some of the areas -- some of the things that are facilitating, you know, the reduction in costs, and, you know, just getting more efficient, and I think a lot of it is, if you go back three or four years, we were predominantly a single product focused company that grew very, very quickly, and, you know, transforming the company from that to a more complete network provider, you know, takes a little bit of time, and if you're going to take costs out along the way, then, you know, that takes some thought, and we've been very programmatic about.

So should we look for more in the SG&A lines in terms of headcounts tied to some of the transition of the services contract, or is more of the reduction coming out of the R&D in terms of the programs should focus on there?

I think in terms of the three buckets articulated externally both R&D and G&A, and sales and marketing, and some of the services peace, of course, is in, you know, our above line, which is affecting our gross margin impact.

So really, you know, across the board.

Across the board is answer to your question, over time.

Thank you.

Our next question comes from Nikos Theodosopoulos with UBS.

Just a couple of quick ones.

In terms of the guidance, if I was to look at the high end of the guidance of the plus 5%, is it fair to assume that that does not include any potential revenue from the [GIG] BE contract?

Sounds like you guys aren't factoring that as being a contributor to revenue in the October quarter.

Is that a fair assessment, or is that one of the moving parts as well?

That's a very fair assessment, Nikos.

And the other question I had was, I just want to make sure that all the charges that were in the quarter did not have anything to do with any unannounced or ongoing headcount reduction, they were related to other factors?

That's the sense I got from the commentary during the early part of the call.

Nickos, this is Joe.

If you are referring to the restructuring charge of $15 million, the majority of it was related to writing off some test equipment.

There was a small amount for a facility that we decided to consolidate and get out of, and then the other portion of the charge, the third portion of the charge, represented the costs associated with approximately a 90-person headcount reduction.

Great.

Thank you very much.

We'll go next to Rick Schafer, CIBC.

Hi, just had a couple of quick questions, too.

The first one is asking a carrier question from a different angle.

Can you guys clarify or give any idea how do they impact or what the impact is to your adjustable mark, or what do you think their ear total adjustable market is, what is there's, and just for Joe, the 70 million burn right that you are guiding to for this quarter, does that include Akara or not?

And that's it.

Thanks.

Rick, I'll take the first one.

You know, the market overall SAN space, you know, is certainly a billion plus.

They don't address all of that.

It's probably, you know, a market around three to four hundred million, depending on when you take the photograph and who you talk to.

But about that kind of size relative to the total SAN market.

Probably about a quarter to a third of that market would be applicable.

To give you some kind of view to it.

In terms of the overall market for CIENA, you know, in terms of our addressable market, given the changes that we're making, you know, I think over time, even in an overall flat market, which is certainly what we're assuming, you know, our market will grow into a market of about 3 billion of truly addressable market to us over time.

That's not the total market.

That's what we can address given into account sales channels, incumbent relationships and contracts, et cetera.

So what we're spending our time on is getting into these new growth segments and making sure that we've got the channels to market for it and over time that will, you know, grow to a 3 to 4 billion dollar truly addressable market for us over time.

Rick, this is Joe.

Let me take the second part of your question on the Akara burn.

Being at the high end of the range includes the cash associated with the ongoing Akara operation and not -- does not have anything to do with the actual acquisition or the cost associated with the acquisition.

Okay.

Thanks, guys.

We'll go next to Christin Armacost with SG cowan.

First on the guidance, I know there's a lot of moving parts on what customers come in at on certain quarters but would it be fair to say that deviation of the guidance range, one of the largest contributors to that is the timing of the Talmax revenue?

No, I don't think you could say that, Christin.

I think there's a lot of smaller pieces to it in terms of, you know, the diversity of the customer base.

I don't think you could say it's dependent upon Talmax specifically, no.

We're still operating in an environment that's challenging.

You haven't got huge visibility, and there’re a lot of pieces moving around to it.

I don't think it would be realistic particular to blame it on one particular lumpy piece.

Sure.

Okay.

Then two additional questions.

In British Telecom you said you have initial revenue recognized in the October quarter.

Since it seemed to be a pretty extensive deployment and installation, can you help us understand how you expect the revenue to be recognized for that over a couple of quarters, or will the biggest piece be recognized in the October quarter?

We're making very good progress with it.

You know, what we will recognize in Q4 is really just the initial deployments, which is sort of the first office application stuff.

Would that be the largest piece?

No.

Typically in a build-out, you know, with a carrier like this, where we're moving to help them to me great them to a new architecture, this is just the initial first office application where you come out and you get certified in the lab and they put it out in the field, and once they're comfortable and go through all of the extensive tests that they go through, that just really gives you certification for the first office application.

It's going to be lumpy, but this is, you know, really just the small first part of it.

Okay.

Then just to make sure I understood the comments to the last question on the 70 customers average deal size was 752,000 each, that would suggest that the two incumbents contributed about 16 million to revenue with some of it being the WaveSmith revenue which you called out.

I just wanted to make sure that that's directionally accurate.

I think that's direction alley.

Let me figure out the math, Kristin.

I think that's about right, yeah.

Thank you.

We'll go next to Simon Leopold with Merrill Lynch.

Handful of hopefully quick questions.

First, you did mention the inventory build associated with positioning yourself for a large project, but when you talked about your increased op ex you didn't note the large project would be -- or positioning yourself for this large project would drive your R&D up.

I'm just wondering if some of the increase in op ex would be associated with your efforts to win this business and if you could quantify that.

Second question, in terms of your restructuring, have you done some headcount since the end of the quarter, and if you can give us an update on where you've been making cuts more recently, and finally, on the Akara product, if you could tell us a little bit about who you see as the primary competitors there and how you're going to -- or where you're going to include the revenue in terms of your segment discussions.

Thanks.

Okay.

Let me take the first one, Simon.

In terms of R & D, we've spent significantly on R & D, particularly into transport platform, so we don't envision a need to increase the R & D as a result of this opportunity.

You know, we have a well-developed new platform there that we've just recently launched.

So we really don't see a need to increase the R & D in that.

In terms of headcount, we have not made any changes, significant changes, since the -- or material changes since the end of the quarter.

And your third question was really the competition for Akara.

That's an interesting one.

You know, Steve, do you want to address that?

I think, you know, generally the people who do storage extension and storage transport don't do the same sort of thing as the Akara product does, which is migrate the protocols from native SAN protocols into SONET and actually do some long-distance travel, so there's not really a direct competitor right now.

Obviously the other people in the SAN business compete one way or other with it but less directly.

Cisco, for instance, has some stuff that's specifically IP, storage over IP, but it hasn't been great traction.

The nice thing about the Akara product in this context is that it's quite consistent with our philosophy in allowing the carriers who use the existing infrastructure to carry new service, and that's why it's appealing to us, and we think it's going to be appealing to a broad set of enterprise customers.

Just to check my understanding of your answer, it sounds like the way enterprises are -- or carriers are addressing that problem is to map the traffic onto maybe a metro WDM solution.

Correct.

And that the Akara is just a more efficient way of solving that problem.

Yeah, that's a good way to put it.

Rather than adding a whole WDM panel, it allows you to use a fractional.

Thank you.

Simon, you had one further question, which would be how are we going to show or represent or kind of communicate the Akara revenue, and at this point in time it's a little early.

We'll wait until we close the deal to decide, but at the moment I think we would talk about it the same way we talk about the rest of the new product.

Would you create a new segment for it or include it with your metro transport?

We would probably include with it the metro transport, Simon, but to be honest, we haven't thought that through yet, what's the right thing to do.

We'll go next to Stephen Koffler with Wachovia Securities.

Joe, I think general one is going to take a crack at the break-even, based on what you've communicated, but we might as well ask it on the call.

If you assume some improvement in product growth margin, significant improvement in service gross margin, you're looking at, I think if you grow 10 to 20%, it decreases in operating expenses, what would a reasonable target be for quarterly revenue break-even?

Steve, if you take the guidance we gave and, say, the 10 to 20% range, and you picked the 20% reduction in op ex off an 80 base, you come down to about a $64 million number for operating expenses.

Then, you know, you guys have to make an assumption about what you want to do on the margins, but if the margins begin with a four, it puts you in the range of 150 and lower.

150 annual.

No, 150 million quarterly.

I'm sorry, I don't have any numbers in front of me.

150 million a quarter, if you follow Joe's logic there.

Okay.

Thanks.

Thanks, Steven.

And we'll take our final question today from Hasan Imam from Thomas Weisel Partners.

This is actually Bobby Sarkar be talking for Hasan.

All my questions have been answered.

Just a quick question.

You mentioned some investments in private companies in the fourth quarter.

Could you give us more color on that?

Sure.

This is Joe.

As we try and proceed with the transformation we're making investments in companies that have some products as Steve said that fit specific criteria we have.

We've done one, we're about to do a second one, and what we're doing is, we are -- our engineers are working with there's in terms of the inter-operability side and we've even gone so far as to bid on some of the RFP's, on several RFP's with each of them, and I guess when there's something to announce, if we win something, then we will be a little more public about where that is, but at this point that's where we are.

Thanks.

And at this time that does conclude the question-and-answer session.

I will turn the conference back over to you gentlemen for any additional closing comments.

I'd like to thank everyone for their time this morning, for your continued support, and we will be busy with financial conferences over the next several months so hope to see many of you soon.

Thanks very much.

And this does conclude today's conference.

We do appreciate your participation.

You may now disconnect.