Ciena Corp (CIEN) 2003 Q4 法說會逐字稿

Good day, everyone, and welcome to the CIENA fourth quarter earnings results conference call.

Today's a call is being recorded.

At this time for opening remarks and introductions, I will turn the call over to Vice President of Investor Relations Miss Suzanne DuLong.

Thanks, Steve, and welcome, everyone.

I'm pleased to have with me Gary Smith,our CEO and President and Joe Chinnicci, our CFO.

In addition Steve Chaddick, our Chief Strategy Officer will be joining us for the Q&A portion of today's call.

Gary will provide brief summary comments, Joe will review the quarter's financial results.

Garry will then discuss the business of the quarter and our business outlook.

Joe will wrap up our prepared remarks with guidance for Q1.

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

This morning's release is available on Business [Warrant] and FirstCall, and also on our website at ciena.com.

Before I turn the call over to Gary, I remind you that during this call it is likely that we will be making forward-looking statements.

Such statements are based on 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 risks factors detailed in our 10-K which in keeping with Ciena's long standing practice of filing the same day we report, will be filed with the SEC today.

In addition, the company assumes no obligation to update information discussed in today's call, whether as a result of new information, future events or otherwise.

Gary?

Thanks Suzanne and good morning, everyone.

In our fourth quarter we made continued progress toward restoring growth and sustained profitability to our business.

We delivered sequential revenue growth toward the top end of over guidance range, 7 point sequential gross margin and lower than expected operating expenses.

In addition, we demonstrated continued customer growth and revenue diversity.

Strategically, we completed the acquisition of Akara and we're pleased to see initial revenue from the Cien platform sales of the quarter.

We also entered two new markets with partnerships and worldwide reseller agreements with Laurel and Luminous networks.

I'll talk more about the performance and our outlook after Joe reviews the quarter and year end results.

Thanks, Gary.

Good morning, everyone.

This morning we recorded fourth quarter revenue totaling $70.6 million.

This is a 3% sequential increase and 14% increase from the fourth quarter of FY '02.

For the year, our revenue totalled $283 million.

The number of customers contributing revenue in the quarter increased sequentially from 72 last quarter to 99 in Q4.

For the year we recorded revenue from sales to a total of 110 customers representing an increase of more than 42% over 2002's customer base of 77.

Of the 99 total customers in the fourth quarter, 16 were new customers gained from the acquisition of Akara.

Another six were first-time revenue generators including as expected, BT, as well as revenues resulting from one of our recently introduced reseller agreements.

We had two 10% plus customers in the quarter, one North American and one European.

Combined they accounted for 26% of the quarter's total revenue.

This compares to the third quarter when two ten percenter's accounted for 23% of revenue.

For the year, AT&T and Qwest each represented more 10% of our total revenue in combined contributed 24.9% of total revenue.

This compares to fiscal 2002 when Sprint and AT&T each represented more 10% of total revenue contributed to 36.8% of total revenue.

The domestic/international revenue split in Q4 was in line with Q3.

Domestic sales represented 59.7% of the quarter's revenue versus Q3s 60.4%.

For the year, domestic sales represented 63.1% of total revenue, fairly consistent with 64.4% in fiscal 2002.

Turning to our products.

Revenue from core networking which includes core director and long haul transport increased and contributed approximately 40% of the quarter's total revenue.

Core Director was the quarter's largest single distributor at approximately 26% of total revenue.

Revenue from our metro networking products which includes Metro Transport, Online Edge, the CN platform and Metro Director K 2 was down sequentially after a strong showing in Q3.

Combined our metro networking products contributed 24% of total revenue in the quarter.

As Gary mentioned, we saw initial revenue contribution from the CN platform.

Revenue from our multi-service net working DM platform increased sequentially contributing 10% of the quarter's total revenue.

Service and support related revenue represented approximately 20% of the quarter's total revenue.

The remaining revenue in the quarter came from our solutions group which includes sales of on-center management software.

For the year core networking represented 41% of total revenue while metro networking represented 36%.

A significant diversification from the previous year when core networking was 65% of the total revenue and metro networking was 17% of the total.

The dramatic diversification in revenue was even more striking when compared to 2001 when core networking was 90% of total revenue.

Year over year the percentage contribution from support and services was relatively flat at 15.7% in 2002 and 14.9% in 2003.

The balance of the year's revenue came from DN or multi-service networking revenue or solution sales.

Turning to our quarterly operating results.

The press release presents a GAAP only presentation as well as detailed operation as management we made to Ciena's GAAP earnings in our analysis of ongoing business.

In general we exclude items not usual 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.

Product gross margin improved sequentially from 30.8% in Q3 to 37.5% in Q4.

A more significant improvement is evident in services gross margin.

We realized meaningful benefit from the outsourcing actions we've taken and saw a sequential increase in services revenue.

The combination of which fuels sequential improvement from Q3s negative 30.8 services gross margin to Q4s negative margin of 2.%.

Overall, our gross margin improved to 31.6% from 24.1%.

This included a benefit of $1.1 million million in Q4 due to selling previously reserved inventory whereas Q3 included a benefit of $55,000.

Operating expenses.

On a GAAP basis, our operating expenses in the fourth quarter totalled $133.6 million.

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

I'll discuss each of these.

First the stock compensation charges.

As part of our acquisitions, we have recorded unamortized stock compensation costs relating to the unvested stock options and restricted stock assumed in the acquisitions.

During the quarter, amortization expense-related to deferred stock compensation amounted to $3.5 million.

Amortization of intangible assets.

This is a non-cash expense unrelated to normal operations arising from acquisitions of intangible assets, principally developed technology acquired in Cyrus, LNI, Waysmith, and Akara acquisitions which we are required to amortize over its expected useful life.

During Q4 this charge totalled $6.4 million.

Next in process R&D.

A result of our Akara acquisition we recorded a charge of $1.3 million for in process R&D.

This represents the estimated value of purchased in process technology relating to Akara's product development and 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 $12.9 million associated with a work force reduction of approximately 230 employees.

Lease terminations, noncancellable lease costs and the write down of certain property equipment and lease holds improvements.

Intangible asset repair.

As part of our review of our fiscal 2003 results and according to FAS 144, we performed an assessment of the value of our long lived assets including other intangible assets.

As a result of this review, we recorded a charge of $29.6 million related to the impairment of technology acquired in our Cyrus transaction.

The charge was based on the amount by which the carrying amount of the technology exceeded fair market value.

Although there is not much to do to effect these expenses quarter to quarter, we continue to work to lower ongoing operating expenses.

Despite the addition of a full quarter of Waysmith related expenses and the addition of Akara-related expenses for a portion of the quarter, ongoing OpEx was lower than expected at $79.9 million in Q4, down slightly from Q3's total of $80.5 million.

R&D decreased 4% from $48 million in Q3 to $45.8 million in Q4.

Sales and marketing increased 8% from $24.5 million in Q3 to $26.4 million in Q4, reflecting higher costs associated with associated sales resources and trade show participation.

G&A decreased 3%, from $8 million in Q3 to $7.7 million in Q4.

Just the last four quarters we reduced R&D sales and markets and G&A expenses by 25%.

Our GAAP loss fourth quarter was $115 million where a loss of 24 cents per share.

Exclusive of unusual or non-operating items I discussed earlier, our loss in the fourth quarter would have been 56.3 million or 36.6 million if tax affected or a loss of 8 cents per share.

For the year, our GAAP net loss was $386.5 million or a loss of 87 cents per share.

Exclusive of unusual or non-operating items, our loss for the year would have been $260.2 million or $168.5 million if tax affected or a loss of 38 cents per share.

Turning to the balance sheet.

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

Cash, short-term and long-term from in investments at the end of the fourth quarter totalled $1.63 billion, a decrease of $123 million from the third quarter.

The cash activity during the quarter included $74.4 million used toward operations including inventory as well as $33.8 million used in the Akara transaction and $15 million invested in private companies.

Our accounts receivable balance at the end of the quarter was up slightly from $42 million putting day sales outstanding at 56, up slightly as expected from the 55 total in Q3.

Inventory levels ended the fourth quarter at $45 million, an increase as expected from the prior quarter's level of $27 million.

The inventory breakdown for the quarter was as follows: Raw materials totalled $16.1 million.

Work in process $5.9 million.

Finished goods, $46.1 million, and a reserve for excess obsolete inventories $23.1 million.

By far the largest increase came in finished goods, which was up 47%.

As we mentioned during our August conference call, this increase was expected as a result of trial systems built to pursue a potentially significant long haul build.

Product inventory turns were 3.1 in Q4 compared to 5.8 in Q3.

Now let me think about the debt for a couple seconds.

On November 18 after the quarter closed, we committed a redemption or remaining 5% convertible notes.

Based on the spread between the interest payments on the notes and income generated from the principal of current rates, we expect the early redemption should result in a net cash savings of $2 million over the remaining two-year life of the notes.

Upon completion of this redemption, we will have reduced our long-term debt to just the 609 -- $690 million 3 3/4% Ciena converts due in 2008.

Finally head count.

Our world wide head count totalled 1816, a decrease of 208 from Q3 reflecting the net of adding roughly 50 employees from the Akara acquisition and work force reduction effecting 230 employees.

Now I'll turn the call over to Gary.

Thanks, Joe.

In my remarks today I'll discuss that strategy in progress keeping to the format that we used last quarter, discussing revenue, profitability and cost as our actions are focused simultaneously on each of these three levers.

First revenue.

We continue to take steps to grow and diversify revenues.

First we continue to win new customers and as Joe noted, we added a total of 22 new revenue contributing customers in the quarter, 16 of which came as a result of Akara.

On the incumbent side on Q4, revenues from incumbents world wide made up roughly 60% of revenue in Q4 and as expected we recognized our existing revenue from British Telecom and look forward to working with them as a strategic supplier for the 21st Century Network.

We are increasingly more confident about our acquisition at several other carriers.

We are in the process of several new contract negotiations with two existing incumbent customers with employments we anticipate beginning during the first half of fiscal '04.

Towards the edge, in just the last year we've grown the percentage from the edge and data markets of less than 1% of total revenue to roughly 7% and I expect that trend to continue going forward.

Our goal is to expand our edge in data revenues to over 30% of total revenue even in 2004.

Thus far our efforts to enhance that data have been very well received by our customers.

We've been very pleased with customer's acceptance of the DN platform from Waysmith.

In addition to completing the acquisition of Akara in the quarter and as I mentioned earlier, we also announced strategic partnerships in world wide reseller agreements with both Laurel and Luminous networks.

We have already responded to several RFPs with these new partners and we're encouraged by customer reaction to the relationships and these new solution offerings.

In addition to winning new customers, we are working to sell a larger set of products to our existing customers.

Including our reseller partnerships, we added nine new products to the portfolio in fiscal '03, and at least partly result of these new additions, we had 15 new product wins in what we consider to be Tier One customers and we estimate we cross sold multiple products to 40% more customers in '03 versus FY '02.

We're also taking steps to expand our addressable market overall and in just the last two quarters we entered four new markets expanding our addressable market we estimate up to $3.8 billion.

And we believe there are other segments where we could leverage our strength and experience either through partnership or acquisition.

We also continue to evaluate and explore entres into new geographies.

For instance, we've embarked on establishing a small R&D center in China to further our sales and partnership efforts in that region.

Finally, we've also significantly expanded our channels during the year, adding 22 new world channel partners enabling us to address new geographic regions and market segments.

Let me turn to profitability.

We expect that our overall gross margin will continue to improve as volumes improve.

Although short term our gross margin is likely to fluctuate depending heavily on the product mix in any given quarter.

In addition to improvements we expect from overall volume increases, we are working to increase gross margin in several ways: By adding more profitable product platforms to the portfolio, by improving the profitability of our services business and by continuing to focus on product cost reductions.

Last quarter we highlighted targeted improvements in our services business and this quarter we've improved our services gross margin from a negative 38.8 to a negative 2.9%.

This improvement was primarily the result of the cost-cutting efforts we discussed last quarter.

We are also starting to see the effect of the introduction of new service offerings.

And from this point service gross margin improvements will be less attributable to additional outsourcing or cost-cutting and more dependent upon the mix of the service revenue within any given quarter.

We continue to expect we can bring the services portion of our business to a sustainable break even run rate by mid-2004.

Now turning to costs.

We lowered ongoing operating expenses sequentially despite the addition of a full quarter of Waysmith related expenses and the addition of Akara related expenses.

We'll continue to be vigilant with expenses, taking steps to lower our ongoing operating expenses and also assuring our costs are aligned with our opportunities.

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

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

We've reduced ongoing operating expenses by 37% from their peak in Q4 2001, adding three new acquisitions and we'll continue to work toward our goal of further reduced ongoing operating expenses.

Overall, we believe we've made good progress positioning CIENA for future growth.

There are two more things that I want to cover before Joe reviews our Q1 guidance.

Some thoughts on vision, where we've been and where we are going.

Finally comments on the general business climate.

CIENA's transformation from an optical pure play to a compressive network solutions provider is well underway.

This transformation is evident in our substantially broader solution offerings, in our growing customer base and in our revenue diversity.

We may have started life as an optical company but we are now much more.

The new markets we've entered in the last year, our direction, has been largely driven by our vision of where our customer networks and therefore our/their spending is going.

Carriers have reduced their Cap Ex to more traditional levels in part due to the application of new technologies.

But they continue to face a more serious longer term challenge.

How to reduce the ongoing cost of operating and managing the network which means tackling the Op Ex problem and that means collapsing what is currently desperate networks into a single data and packet friendly network.

We believe our solution for network evolution and service convergence is substantially different from many of our competitors.

Compared to the approach offered by route vendors, we continue to offer a compelling economic and resilient network to deliver converged IP/MPLS services.

Let's face it, every vendor out there is talking about how they are the one that is finally going to enable the Holy Grail of a converged network so why do we think CIENA is any different?

For the same reasons we were able to revolutionize optical transport.

For the same reasons we were able to deliver what is arguably the industry's leading and only widely deployed core switch.

We don't have legacy product revenue to protect, and we don't have religion about technology.

We do have religion about network economics and we have a track record of delivering the high standards of carrier network reliability, and it's those two things, economics and network reliability that will redefine data networking.

Redefine it as a profitable revenue generator for service providers as a flexible available full service network for enterprises.

CIENA has a proven track record of harnessing and doing so in a way that minimizing risk to customers and their networks.

We are bringing together the best parts of optical and data networking into an integrated solution to maximize reliability, efficiency and service at that adaptability.

We believe we can and will bring the experience we gained to revolutionize these carriers core networks to bear on their data services markets.

Finally a few comments on general business term before I hand off to Joe.

Last quarter we commented on a noticeable uptick on RFP activity.

It appears that the activity level has remained fairly steady.

In general I believe we are moving in the right direction on a number of fronts.

We are also getting encouraging signs that the environment is stabilizing.

That combined with our pipeline activity, in processed business, and new opportunities arising from our expanding portfolio, lead us to feel optimistic going into fiscal 2004.

With that, Joe, will you walk through the guidance, please.

Definitely.

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

It is important to review the risk factors detailed in our 10-K that may cause actual results to differ materially from this guidance.

At this point, we believe that revenue in first quarter will be flat to up as much as 10% from Q4 depending on the timing as well as acceptance of some significant orders.

As always, while our customer and revenue base is growing and has diversified significantly, a meaningful portion of our first quarter revenue expectations are dependent upon a small number of key customers.

As Gary noted, short-term we expect gross margin volatility quarter to quarter depending largely on product mix.

We believe overall gross margin in the first quarter will be closer to third quarter of fiscal year 2003's overall gross margin and Q4s gross margin predominantly due to product mix.

We expect overall operating expenses in Q1 exclusive of any unusual or non-operating items will remain roughly flat to Q4 as the full impact of the addition of Akara and some customer-specific development costs are likely to offset the cost reduction actions taken in Q4.

In connection with the redemption of the LNI notes, we expect to record a loss of $8.2 million.

Exclusive of the loss of the redemption, we expect other income expense will be an expense of approximately $500,000.

We estimate Q4 share count at approximately 473 million total shares.

As a result, we expect that exclusive of unusual or non-operating items such as the loss on the LNI debt redemption, our net loss for Q1will be in the range of 8-10 cents per share.

Finally on cash, we expect our operating cash use in Q1, exclusive of unusual or non-operating items, such as the announced redemption of the ONI 5% notes will be approximately $75 million, roughly flat with Q4.

We expect the note redemption to use an additional $49 million in cash during Q1.

Operator, we'll now take questions from the [sell-side] analysts.

Today's Q&A will be conducted electronically.

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

Please make sure your mute function is turned off to your question will register in the cue.

Again, star one, to ask a question.

Our first question Brant Thompson, Goldman Sachs.

This is actually Angelo, on behalf of Brantley.

A couple questions regarding the acquisition strategies.

In terms of Laurel, the relationship they have with Marcony, does that help or hinder your relationship with Laurel and the if you could also talk about your relationship with Marcony, particularly with the British Telecom account.

And secondly, as you make investments with start-ups, what are the catalysts and milestones to trigger an outright acquisition, is it a certain revenue level or number of customers or anything specific you are looking at?

Thank you.

This is Steve.

Let me start at the end of your questions and go back to the beginning.

We have a certain set of criteria about targets both from partnership and acquisition perspective that are consistent with the convergence vision and Op Ex economic vision Gary alluded to.

Generally folks that we're interested in are adjacent to where we are currently in terms of the customer or product space, they have growing market potential.

They will be cash flow neutral, relatively soon and they have compelling technology we believe we can help integrate as we mentioned in an innovative way and a risk mitigative way into certain networks.

Without going into specific commentary with any particular folks, that's a framework for how we look at things.

In terms of our relationship at BT with Marcony, we actually are quite cooperative with them, we're working with them in a way to ensure the customer can get the benefits of the control playing advantages of core director throughout the network and so we have begun discussions with Marcony to make that happen over the next couple years and working well together.

In terms of the relationship with Marcony, with respect to Laurel, we haven't seen any conflict yet and other than that I don't think we should comment on that other than something Gary may want to add.

Marcony's had a relationship with Laurel for a while and much focused on the U.S. federal government and that's -- we knew that going into the relationship with Laurel so that's really not an issue for us.

Thanks, guys.

Anything on the revenue front from Laurel that you can talk about?

I think it's early days for that.

We only just launched it, really, for the sales force.

We are encouraged by some of the opportunities we are seeing there and involved in a number of RFPs at a number of larger carriers.

Thanks a lot, guys.

Next question from Hasan Imam, Thomas Weisel Partners

Hi guys, actually Mike DeMichele for Hasan.

You talked about opportunities for growth next year, you talked about two customers that you are working on, signing new deals with.

Wondering what product segment you are seeing or expect it to come from.

Long haul transport or switching or more on the metro side and then, kind of as a corollary to that, what kind of features and functionality are customers asking for on these products and what sort of additional R&D or acquisitions might be necessary to meet those conditions.

Thanks.

Why don't I take the first part of that and Steve will take the second part of it.

I think we are seeing opportunities for us that the larger carriers across the board in the portfolio, we are seeing them one or two opportunities in the long haul space, certainly at the high end, where you are looking at wave selective switching and higher end channel count and distance with the next generation core stream.

We are also seeing core director opportunities and, of course, cross with the DN and the metro portfolio.

So I would say it's fairly well spread in terms of the opportunities that we are seeing.

One of the things I would add to that in terms of our relationships with customers and how they help us influence our partnership and acquisition strategy, it's developed kind of in concert and consistent with the vision we've talked about.

And that is where there are opportunities for new network services, converged network services and next generation technology and we can contribute to that from a perspective of our skills and assets to bring some of this new technology into a broader set of marketplaces.

We go investigate those.

Sometimes those are brought to us by our carrier partners who specifically have brought opportunities for us to look at.

So we consider those carefully and act accordingly.

Many of them as I mentioned in the area of data and converged services layer one and two conversions and layer two and three conversions, so we focus heavily on bringing the network solutions to market in a robust and economic way that preserves a lot of the investment in the ground today as opposed to ripping it out and starting over but that's a general comment.

Our approach is literally that general in terms of finding opportunities.

Any kind of additional development needed on the next gen core stream platform to get some of the long haul deals out there?

We've been working on our platform for quite some time and coming to fruition finishing up the sections of it but in terms of investment to historical levels, it's pretty mature, we think.

Our next question Nikos Theodosopoulos of UBS.

Yes, hi.

A two-part question.

The finished goods inventory went up about $9 million sequentially.

Was all of that tied to product shipment that went to this customer, the new customer you are trying to win, is that an exact reflection of $9 million or is it also a combination of this new customer and shipped to BT that hasn't been recognized yet.

And as an extension to that, now that you started recognizing revenue with BT, what should we see there?

Should we see sales continuing to increase off this level or steady core contribution we should be seeing as we build this network.

I'll do the first one.

You basically are talking about the increase in inventory and was it one item or the other item and a former rather than the latter.

Basically because we shipped a lot of finished goods to a customer and it's sitting there waiting for the acceptance.

It is really two customers.

One we haven't talked about so that's the good news story.

That's all a part of things looking better going forward.

The second part of the question?

In terms of the BT relationship and what we've said publicly, what you expect given the nature of the build out here for the next generation network, I would expect over the next two years a steady roll-out of that network and expansion of product portfolio that we put into that network.

So I would see a sort of steady roll-out.

You're gonna have peaks and troughs over the course of two years but being an ongoing feature hopefully of our revenues.

Joe, just to clarify to make sure I heard it right.

Some of the finished goods inventory does reflect material at BT, it's not just this other customer's?

I didn't say BT.

Okay.

I can't go there.

I can't disclose who it is.

I'm kind of bound.

The majority of it, the increase in finished goods was really 14, not 9 on an absolute basis, and the meat of it went to one customer but there is another new build, another new piece of business we're working on that the rest of it went to.

Thank you.

Our next question from Tal Liani, Merrill Lynch.

Hi, good morning.

I'm wondering how much revenues came from enterprises of service providers and maybe you can discuss the evolution of this ratio.

The second question I have is I don't know if you clarified it in the opening remarks but was BT a 10% customer this quarter and if not, have you had any contributions from BT at all?

Why don't I take those.

In terms of the enterprise channel, I'd say it was small.

Some of, you know, a lot of our enterprise revenue comes through partners that we've developed and so I would expect it to increase over time and when it becomes sort of meaningful within the revenue split, we'll think about breaking that out clearly.

We don't disclose quarterly 10% or whatever customers but I will confirm to you that we did recognize our initial revenue from British Telecom this quarter.

Thank you.

And our next question Paul Silverstein Needham and Company.

Good morning, can you hear me?

Yes, Paul.

We can hear you.

Can you give us more insight on gross margin and pricing environment across the product line?

Joe?

Gross margin?

Sure.

Good morning, Paul.

How are you?

The gross margin analysis we kind of gave in the guidance, not, I don't know how much more to elaborate on that.

Gross margin, we are working on it hard.

The overall gross margin are going in the right direction but it's going to be a function of how much, what the mix is.

Again, if you were to stratify it, we had better margins on the switching the bits and the bytes rather than transporting the bits and the bytes.

Which translates into core director and some of the new product lines are much higher.

Long haul stuff is not as good on the margin front and it's really going to be driven by product mix.

Do you want to talk about price?

I think, the obvious comment to make there, you still see an oversupply in certain segments, certainly in long haul transport.

One could argue too many players, so you are seeing considerable pricing pressure on the transport side as Joe said.

You're going to see the gross margin fluctuate but a general trend over time is going to be up.

You've seen that in the last year, albeit from a very low base.

I think you are going to see fluctuations going forward quarter to quarter as we indicated in our guidance, but overall given the efforts that we're doing on cost reductions, newer product areas we are investing in and as that begins to shake out over time, you will see an overall increasing gross margin for CIENA.

The core director, with respect to metro applications as opposed to traditional long haul applications, has there been progress in terms of LSR, and the other features and functionality you need to make that product competitive?

Steve alluded, one of the questions around control plane integration, we're having a number of conversations driven primarily by large customers, you know, helping us get integration with other ADMs, et cetera, so we are making good progress there.

Clearly we've got by far the largest market share in the core networking piece and that allows us to network into the metro and data space which we are now focusing attention on.

Thanks a lot.

Our next question Sam Wilson, J&P Securities.

Good morning.

Just a couple of quick questions.

I wanted to give further clarification on the channel strategy.

You are adding a number of channel partners.

Is that more focused toward the enterprise segment or international partners?

Or give clarity and do you expect to continue to add channel partners?

Are you focused on any really large national resellers, color on that.

And then just a question on cash flows, what do you expect your Cap Ex guidance to be for the next fiscal year?

Let me take the first part of that and Joe will talk about the Cap Ex.

The channel partners, now we've got products in our portfolio that are well suited to channel partners into the enterprise into the metro space and the acquisition of Akara that actually brought a number of channels with them, we've now got product that's highly appropriate with some of the enterprise channel and most of the additional channels we've talked about last quarter were really focused on the enterprise space.

Predominantly domestically but some international as well, so we will continue to look at appropriate channels for that.

We are at the fairly early stages of it, to be candid.

Internationally, we will continue to use channels particularly into geographies where we are not going to go to the expense of building an infrastructure up direct so it's really a mix between the two.

This last quarter was certainly skewed more towards of the new partners we took on board, more skewed toward the enterprise channel.

Great.

This is Joe.

Good morning.

I'll do the Cap Ex one.

For the FY '03, we spent about$30 million in Cap Ex and lease hold improvements and the like and you'll see that in the K in a few minutes as soon as we push the button.

FY '04, I would expect to spend in that same range possibly up a few million depending upon how many of these new partners and what not we are able to establish relationships with.

Every one of them will take equipment to be used for demos and the like in test systems.

Great.

Thank you.

And our next question Michael Genevicci, Smith Barney.

Thank you.

Good morning.

My question is when you look at over the installed base of core stream customers, what kind of trends are you seeing on a monthly/quarterly basis for channel card orders and can you characterize that in terms of any trends on customer inventory or capacity of supply and demand in the market?

Mike, I think, we're clearly got a very large installed base of various platforms on the transport side.

I think the channel adds we're beginning to see more activity on the channel add side.

I wouldn't characterize it as more than a little activity.

What we are seeing is some of the larger carriers look to new builds where they can significantly reduce their costs and have optical, all optical switching in there, et cetera.

A number of those builds come out.

There's not huge amounts of them but they are fairly large by their nature so it's the larger Tier One-type carriers.

We would expect over the course of FY '04 to see more channel add activity occurring.

We are aware that some of our install base is beginning to fill up in terms of the channels already deployed.

I would not describe it or we're not assuming that's going to be significant in 2004.

Let's just say that, Mike.

Thanks.

And our next question with Ehud Gelblum with JP Morgan.

Thank you.

I have two quick questions.

The first, on this customer that you have been building inventory for, can you give us a sense of the timing of when you might know about that and is that the timing that determines the difference between a flat next quarter and up 10% next quarter?

And my second question is when you look out, and you start talking about your gross margins, we previously had been talking about break even rates for gross margin in the 45% range.

Is that still there and what we are looking at and what kind of time frame?

Why don't I take that.

The trial customer in terms of timing I believe is Q1 of this year, and, you know, certainly if that customer gets to revenue, that would be helpful for the quarter.

It's not entirely a piece of Q1 so it's certainly a significant contributor to Q1 but not just Q1.

In terms of the gross margin, our target is more in the 40% gross margin area or in the range, and the time frame for that we would expect certainly over time our gross margin to improve.

I wouldn't like to get nailed to a specific time frame but clearly as we get to an area of sustained profitability, you need to be talking in excess of 40% gross margin.

Okay.

Again just to follow up quickly on the first point.

If this customer does not come through in Q1, would we be looking at a flat Q1 or are there other deals that you think could continue to come in and get to the 10% range?

When we give our guidance, there's a number of moving parts to it and not all completely binary.

We take a mixed view of probability and risk when we give our guidance.

Thank you.

Our next question Steve Levy with Lehman Brothers.

Good morning.

A few clarifications.

When you talk about new customers, I believe you said one of the six new customers that were non-Ankara were from resellers so I would assume that's a new customer that you got because of the reseller agreements with Laurel and Luminous?

Is that the right read or no?

Steve, that's correct.

Okay.

And in terms of the one international 10% customer, would you say that's a first time customer as well?

Steve, this is Joe.

We haven't gone, given you that much indication so that you could figure that out yet.

All right.

Well, I was just trying.

Good try.

You can ask it a different way.

Yeah, it was European

And it wasn't -- forget it.

Bigger than a bread box.

Operating expenses, you talk about Q1 I believe a couple quarters ago, you talked about cutting your operating expenses, you had a certain target, would those targets still be in place and therefore, would we expect after Q1 when we absorb the full quarter related to a customer, would you expect the Op Ex to continue to move downward after Q1?

The answer to that is yes.

The simple answer to it.

We are going to continue to manage our operating expenses carefully and continue to reduce them over time..

This is Joe.

We gave the target of 10-20 over the next twelve months because of the Akara acquisition.

We have to even that out and absorb full quarter of Q1 and you'll start to see the adjustments kick in.

That target is still holding.

Definitely.

If there was a read, you are slightly ahead of where you thought you were in this fourth quarter considering Akara.

This is usually our behavior.

Thank you very much.

Our next question, Tim Vestor with Legg Mason.

Thank you.

A couple of housekeeping questions then I want to follow up on the gross margin question.

First of all, the 99 customers that contributed revenues in the quarter, what does that represent as a fraction of the whole active customers you have out there?

Also like to know what the revenue contribution was from Akara and I'll ask a gross margin follow-up.

In the 99 customers, how many are active?

Certainly a large portion of that.

Assuming over 100 customers have taken revenue at any one point in time.

I don't know exactly.

I think it's about 110 we've taken over time.

For the year, we've taken revenue from 110 different customers.

It's stronger.

Akara, we've not broken out; however, it contributed for the first time.

It was not as we classify sort of meaningful in the quarter.

It was a nice contribution and a very good start.

We're encouraged by the growing prospect base for the Akara piece.

Now as far as gross margin, one of the answers you gave is it sounds like from the 40% plus in the context of break even, I'm more interested in the context of getting better and getting past break even, whenever that might be.

How high can the gross margins get in the products business?

Why don't I take that.

It goes back to the conversations you and I have had before.

It's a function of, sounds like a broken record but it's real.

It's product mix.

If we do nothing but core director and DN, your product gross margins not to mention overall gross margin could be in the upper 40s or higher than that.

When you throw in transport it brings it back down.

Steve, you want to --?

This is Steve.

Part of our strategic part here.

The economics got to work on both sides of the equation.

As someone noted, the outlook both from an economic perspective and margin perspective and the pure optical business is somewhat dour.

Part of our strategy is to make sure as we do new partnerships, new acquisitions, new products, that those are heavily, those are good contributors and good contributors are ones that contribute economics of our customers as well.

So part of our strategic, we haven't made it obvious, but it should be, our strategic plan is to make sure it moves in the right direction over the next couple years.

Joe, you have another comment?

The other piece of our transformation that Gary alluded will involve us and something Steve once knew about expanding our existing product portfolio.

As we make strategic investments elsewhere, they will all be with types of products or types of solutions that will again yield margins that are more akin towards the managing the bits and the bytes rather than transporting rather than the higher end of the range rather than the lower end.

And our next question Subu Subrahmanyan with Sanders Millers.

Thank you, good morning.

A quick question on the RFPS that you had talked about.

Can you characterize it in terms of long haul you made comments between core director and multi-service.

Where are you seeing more near term opportunity and how that is playing out?

I think we are seeing activity in the long haul space but it's just a high end.

Wouldn't characterize it as very high end of the long haul space.

And also I think it's clearly a function of us responding to more RFP activity because we've got more products in our portfolio.

We are probably not the best overall barometer of what's happening in the industry because we've got more products than we used to have, so therefore a much greater exposure to newer opportunities.

Does that answer your question?

And just wondering on the multi-service side and the metro side, if there's anything specific going on?

I think on the DN side and multi-service side, you're seeing generally a acknowledgement that as people move toward MPLS and you want to migrate towards it and the larger carriers, clearly there's a large opportunity for DN type platform which allows you to make that convergence and evolve it in a way that's not, you know, it's an open architecture, it's not bespoke or customized but allows you to stay with standards and attack your existing investments and architectures and service revenues as well.

As frame relay and ATM ATM services are still one of the profitable highlights of one of the major carriers.

And follow-up on an earlier question that was asked on inventory, the finished goods inventory which, Joe you'd mentioned, a lot of it went to one customer trial, depending on the stage in which that trial is, is there a possibility that some of those test systems turned into revenues and in the near term or is that a longer term opportunity?

No, it is near term and they would all turn into revenue.

Thank you, very much.

Thank you.

Our next question Wojtek Uzdelewicz with Bear Stearns.

Thank you and good morning.

A few questions.

One is just on the currency as DT starts ramping up and some of the European sales come in, would you expect that could start helping a little bit topline and what you do -- do you see your exposure to Euro over the next few quarters.

Second, on the competitive front, if you could comment how do you guys approach or differentiate, there's just, for example, MCI, you got a nice business there but looks like Sieman's walked in and also got some business.

A lot of loose end, a lot of Lucent, Marcony, and BT, a lot of people are starting -- we were assuming they would exit the core business and putting a lot of pricing pressure, how do you go back to that?

And somewhat related to that, one of the customers which is testing now and one of the reasons inventory went up, is that customer, the other one obviously as they start deploying the equipment, this customer tends to be more generous in terms of gross margin and ability and not as price sensitive?

Would we expect that to be a meaningful benefit or competitive environment that's not going to help as much.

Finally with Laurel, there is a lot of MPLS RFPs going on with AT&T and Verizon and so on, your competitors would be Juniper and Cisco, what is the differentiation against those two major competitors?

This is Joe.

Good to hear from you.

Haven't heard from you in a while.

You heard from Mike usually introducing me.

I'll do the first and hand off the middle two to Gary and Steve will do the fourth.

How is that?

Perfect.

On the currency exposure, if we have any it is unbelievably minimal.

The contracts we enter into, these are partnerships and we work with both of us and share whatever there is in terms of good things and painful things.

In terms of currency exposure, I'm, you know, none to very, very low.

On the others, in terms of competition, I think I alluded to earlier from an overall industry structure, precious little consolidation.

While some players, the larger players have backed out of certain segments, they've really continued to sell even though they haven't backed off their R&D so they are spread thinly across broad product areas.

The benefit we have is where even though we are broadening our portfolio, it's still very, very focused compared to some of the broader based players.

That allows us to target our R&D and really have a differentiated product, which is why we are figuring very well on these larger RFPs and the larger Tier One carriers.

So we feel confident, we are uniquely placed coming out of the optical space of the layer two and three and this whole convergence given our position in the core of the network, we think we are uniquely placed to help carriers converge carriers and reduce Op Ex and really that is the value proposition around that we are focused on and seems to be playing extremely well.

In terms of the particular trial, I wouldn't like to get involved in that specifically, but the word "generous" in some large customers is difficult to include in the same sentence.

It's a very competitive environment still and these deals are tough to win.

I will say these Tier One carriers do appreciate some of the longer term strategic value CIENA brings.

In terms of Laurel.

Just a comment on being able to deploy in that space in general and Laurel specifically.

We don't compete with Cisco and Juniper in the carrier space and big core routers.

That's not the Laurel platform strength.

That is a service creator edge router and giving people a run for the money in that space.

In general, in building cost-effective resilient big IP networks, we have an architecture that we probably don't have time to go into here, that we believe will provide significantly lower price points and higher resilience than that proposed by some of the purely router-centric vendors and takes an hour to explain all that but it's getting great traction.

We are confident in our ability to move into that space directly with the DN platform eventually and with our partner platforms and we're getting a lot of resonance with our customers about that.

I'm sorry.

What would be the timing when they will make the decision?

Are we still three months?

Those are big opportunities.

Three months, six months?

What will be the timing of that?

I don't know the specific timing on many of them.

Very often some of these RFps coming on, come and go, it happened with Verizon so I don't think we can comment about the specific timing too accurately.

Thank you.

Our next question Christin Armacost with SG Cowen.

I had one clarification on the gross margin guidance.

Joe, did you say it would be similar to the October quarter?

No, ma'am.

Similar to Q3.

Okay.

And then on the question of inventory, when you characterize two customers and the latter one was a new build, was that a new build for existing long haul customer or a new customer?

The former rather than the latter.

Thank you.

And our next question from Ben Kadlec, Buckingham Research.

A quick question.

Sorry to beat the gross margin horse but looking for clarification.

When you say gross margin closer to Q3, you expect the product margin to be closer to Q3 and service margin to be closer to the October quarter, is that correct?

No, we were talking about the overall margin.

Overall margin falling back down to the mid-20s?

That's what Q3 is.

Okay.

And then another question, wondering on MCI, just generally speaking, have you seen any spending from them coming back and do you think possible they could be a significant contributor in '04?

Ben, this is Gary.

It's not our policy to talk about specific customers unless we've done a public announcement.

Sorry.

Okay.

Can you comment on generally if you see -- if they are coming back into the fold now that they are coming out of bankruptcy and all that?

You know, just personal hypothesizing, I think if they're coming back out of Chapter 11, what all the major carriers are looking at as we said in our earlier conversations is how do they all reduce their operating expenses and use new technology to do that and create new services.

I would expect most of the major carriers are beginning to engage at looking how do they converge their architecture and reduce operating expenses and I can't imagine that MCI would be different than that.

Okay.

Thanks.

Our next question Gabriel Lowy, Blaylock Partners.

Thank you.

It's already been answered.

And our next question Steven Koffler of Wachovia Securities.

Sorry if I missed this before.

Joe, did you explicitly break out the DN revenue contributions this quarter?

Yes, in the vicinity of slightly more than 10% of overall revenue.

Thank you.

And this will conclude our question and answer session.

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

Thank you very much and thank everybody for their time this morning and also for your continued support.

We'll be busy with financial conferences over several months and I hope to see many of you and take this opportunity to wish everybody a happy holiday.

Thank you.

This does include today's conference.

Thank you for your participation.

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