Ciena Corp (CIEN) 2004 Q3 法說會逐字稿

Good day everyone and welcome to the CIENA Corporation third quarter fiscal year 2004 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, ma'am.

Thanks, Pam, and good morning everyone.

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

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

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

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

In the interest of time and to insure we answer as many questions from as many callers as possible, we ask that sell-siders limit themselves to one question during the Q&A period.

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

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

Such statements are based on current expectations, forecasts, and assumptions of the company that include risk and uncertainties that could cause actual results to differ materially from the statements discussed today.

These statements should be viewed in the context of the risk factors detailed in our 10-Q, which in keeping with CIENA's long-standing practice of filing the same day we report, we expect to file with the SEC today.

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

Gary?

Thanks, Suzanne, and good morning everyone.

As we reported in our preliminary results release, despite lower than anticipated revenue in the quarter, we were able to achieve our bottom line guidance as a result of our successful cost reduction programs and we're making progress in other important areas.

For instance, we closed both the Internet Photonics and Catena acquisitions and in the Broadband space, we won three new customers for the new CN 1000, next generation Broadband Access platform and we're in trial with an RBOC.

We also secured agreement for multiple RBOC trials for the CNX-100, to the modular broadband loop carrier and this enables broadband capabilities on the installed base of legacy DLC systems.

In addition, we're building good momentum with an international distribution partner in support of telco gigabit ethernet applications.

In the core of the network, our Long-Haul products have been selected for deployment by a new PTT.

And in Multiservice head switching, we recognized our first Verizon revenue on DN deployments in support of multiple data-driven applications.

I'll discuss the quarter in more detail and our business outlook after Joe reviews the quarter's financials.

Joe?

Thanks Gary and good morning everyone.

This morning we reported third quarter revenue totaling $75.6 million.

This is a slight sequential increase and roughly a 10% increase from the same period a year ago.

We had two 10% plus customers in the quarter, representing 27% of total sales.

Both were U.S. customers.

One is a Long-Haul customer, the other purchased across three business units in the quarter, Long-Haul, Data Networking, and Broadband Access.

This compares to Q2 when one 10%-plus customer accounted for 32.2% of the quarter's total revenue.

As you'd expect, given the two 10 percenters in the U.S., domestic sales represented 81% of the quarter's revenue, consistent with Q2 when they represented 78% of the total.

Revenue from our core networking group, which includes CoreDirector, and Long-Haul transport, decreased sequentially after a relatively strong second quarter, and contributed about 27% of the quarter's total revenue.

Revenue from our Metro and Enterprise Solution group includes Metro transport and switching, the CN 2000 storage are networking extension platform, and for the first quarter Multiservice Access transport and switching products from the acquisition of Internet Photonics.

Revenue from this group also increased sequentially representing roughly 29% of total revenue.

Revenue from our Data Networking group more than doubled sequentially reflecting our initial Verizon revenue for the DN series.

Revenue from DNG represented just under 10% of total revenue in Q3.

Revenue from our Broadband Access group, formed by Catena, represented approximately 20% of total revenue.

Service and support-related revenue represented approximately 15% of the quarter's total revenue, compared to 16% in Q2.

We'll no longer be discussing revenue from Solutions separately, as revenue from software sales has been included with the corresponding business unit sales.

Turning to our quarterly 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 the GAAP results and to what the results would have been if we excluded those items detailed in the press release.

With that background, let's start with the operating results.

Gross margin in the quarter improved significantly over Q2, but was slightly lower than expected as a result of product mix.

You'll recall when we reported our preliminary results, we noted that two of the factors for our lower than expected revenue were a delayed CoreDirector deployment and lower than expected sales from our Broadband Access group.

Both of which had a negative effect on our expected gross margin.

This was balanced by lower than expected Long-Haul transport sales in the quarter which had a positive effect on expected gross margin.

Product gross margin increased from 9.8% in Q2, to 25.3% in Q3.

Services gross margin continued to improve, moving from 17% last quarter to 22.4% this quarter.

This quarter's services margin reflects better than the top end of what we expect will be a 10 to 20% range for services margin over time.

Our overall gross margin for the quarter was 24.9%.

Now turning to operating expenses.

On a GAAP basis, our operating expenses in the third quarter totaled $158.3 million.

As noted in the GAAP P&L, this included 76.8 million in unusual non-operating-related or non-cash charges for the following items: Deferred stock compensation, amortization of intangible assets, in-process R&D, accelerated amortization of San Jose leasehold improvements, restructuring costs, long-lived asset impairments, and a benefit for sales, export, and use tax settlement, and a loss on equity investments.

Exclusive of these charges and benefits, our ongoing operating expenses for the quarter would have been $81.7 million, representing a slight increase from Q2 as a result of the addition of Catena and Internet Photonics-related expenses.

I'll review the charges and benefits briefly now.

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, the amortization expense related to deferred stock compensation amounted to $3.9 million.

Amortization of intangible assets is a non-cash expense unrelated to normal operations arising from the amortization of intangible assets acquired in our various acquisitions.

During Q3 this expense totaled $12.7 million.

In-process R&D charges of $30.2 million relate to technology acquired from Catena and Internet Photonics that had not reached technological feasibility and had no alternative future use.

We also recorded a $12.5 million charge related to accelerated amortization of leasehold improvements related to the planned exit of our San Jose facility.

This charge is included on the P&L as part of R&D expenses.

We also recorded a $13.5 million charge in Q3 for restructuring costs which breaks down as follows: 12.4 million related to a workforce reduction of 321 employees associated with the closing of our San Jose facility, $.3 million dollars related to an adjustment of previously restructured facilities, $.8 million related to an equipment relocation activities resulting from actions associated with our closing of the San Jose facilities, and approximately 13.2 million of the total 13.5 million of restructuring charges will be paid out in cash near-term.

We also recorded a charge of 7.2 million for long-lived asset impairments as a result of excess research and development equipment classified as held for sale, which is part of our cost reduction programs.

And finally we recognized a $3.5 million credit related to various settlements of sales, export, and use tax liabilities.

Ongoing op ex was significantly below our guidance going into the quarter, as a result of our successful cost reduction programs, and reflecting the timing of our actions related to closing our San Jose facility which is on-track for our target of September 30.

The third quarter's ongoing op ex of 81.7 million was higher than Q2 by only 5.8 million or about 7.6%, due to the addition of the Catena and Internet Photonics-related expenses.

R&D exclusive of the 12.5 million accelerated amortization costs, increased by only 1% from 44.8 million in Q2 to 45.3 million in Q3, reflecting the addition of Catena and Internet Photonics-related expenses and offset by cost reductions associated with exiting San Jose.

Sales and marketing increased 17.5%, from 25.1 million in Q2 to 29.5 million in Q3, due to the addition of Catena and Internet Photonics-related expenses.

G&A increased 16.3%, from 6 million in Q2 to 7 million in Q3, also due to the addition of Catena and Internet Photonics.

Our GAAP net loss for the third quarter was $141.5 million, or a loss of 25 cents per share.

Exclusive of the unusual or non-operating items I discussed earlier, our loss for the third quarter would have been $64.4 million, or 41.9 million if tax-affected, or a loss of 7 cents per share, which despite the quarter's lower than expected revenue was in line with our guidance range.

Turning to the balance sheet, we continue to work to preserve the strength of our balance sheet.

Cash, short-term and long-term investments at the end of the third quarter totaled $1.36 billion, a decrease of 112.1 million from the second quarter.

This was slightly higher than our guidance of roughly $90 million as a result of the following: 13 million in additional working capital required, 5.5 million in private company investments, and a $2.7 million mark-to-market reduction on our investments.

Our accounts receivable balance at the end of the quarter increased to $49.8 million from 38.6 million at the end of Q2, putting days sales outstanding at 59, up from 46 in Q2.

Inventory levels at the end of the third quarter at 49.8 million, up from the second quarter's $34.5 million.

The inventory breakdown for the quarter was as follows: Raw materials, $18.2 million, work in process, $3.5 million, finished goods, $49.5 million, and a reserve for excess obsolescence of $21.3 million.

Product inventory turns were 3.9 in Q3, compared to 6.5 in Q2.

Finally, headcount.

Although we added approximately 380 employees from Catena and Internet Photonics during the quarter, our worldwide headcount at the end of the quarter totaled 1,743, an increase of only 41 from Q2, reflecting net of the new employees and headcount reductions primarily related to our San Jose facility closing.

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

Thanks, Joe.

As I have for the last several quarters, I'll orient my review of the quarter around our three strategic focus points of revenue, profitability and costs.

Let's start with costs.

While we were disappointed with the revenue for the quarter, we were pleased with the significant progress we're making on our cost reduction goals.

And as Joe mentioned, our ongoing operating expenses in the quarter came in significantly below where we anticipated as a result of company-wide cost-cutting programs and the timing of actions taken in the process of exiting our San Jose facility.

We expect that there will, we will be on target to meet a 65 to $70 million run rate for ongoing operating expenses as we exit our fiscal Q4.

And we'll continue to actively evaluate our cost structure relative to our evolving market opportunities going forward.

Shifting to profitability.

We'd caution that short-term our gross margin will be volatile depending upon the product mix.

This quarter we saw a meaningful improvement over last quarter, due to a higher mix of DN revenue and the addition of revenue from Broadband Access.

We continue to work toward what we believe is an attainable overall gross margin goal of better than 40%.

And we believe we'll get there as a result of a continuing shift in product mix towards higher gross margin revenues, ongoing product cost reductions, and continued strong margin contribution from our service businesses.

In addition to the actions we're taking at the ongoing operating expense level, we continue to work to improve costs through consolidating our contract manufacturers.

However, cutting our costs and improving profitability are just two pieces of the puzzle.

We also have to accelerate our revenue growth and thus far have fallen short with our efforts to do so.

Last quarter I noted four things as key to CIENA's revenues in the shorter term.

One was translating the deals we've already won into revenue, two was maintaining momentum for the acquired platforms, three was accelerating portfolio-wide sales through partnerships and channels, and lastly was supplementing our DN 7000 series wins at Verizon and SBC with new application wins and/or another major win for the platform.

Let's review our progress on each one.

Firstly translating the deals we've already won into revenue.

As of the third quarter we were finally recognizing revenue from three of the most prominent deals we've won in the last year, DB, MCI and Verizon.

However, as we discussed during our preliminary results call, two significant revenue contributors moved out of the third quarter.

The first, a delayed Long-Haul order and the second, a delayed CoreDirector deployment.

We're obviously making progress but customer shifting timing continues to plague revenue predictability.

Our broader product offering and the increasing number of customer engagements that have resulted from this will help us combat this dynamic longer term.

The second short-term revenue key I mentioned last quarter was maintaining the momentum of the acquired platforms.

And I believe the integrations of Catena and Internet Photonics went very well indeed.

And the teams particularly did a good job of maintaining momentum despite some very adverse market conditions.

Internet Photonics as part of our Metro and Enterprise Solutions group contributed as expected to the quarter.

As we discussed in our earlier results call, Catena's initial contribution was adversely affected by a noticeable slowdown in North American DSL deployments.

Press and analyst's speculation at this time is that DSL port deployments exceeded take-up rates and the market is expected to find a balance over the next several quarters.

But to be clear, we do not believe competitors are gaining traction here nor are we seeing a wholesale change in architecture.

And DSL, we believe, continues to represent a growth application for us.

We're certain of the competitive strength of the CNX-5 and the soon to be shipping CNX-100.

These platforms enable DSL at POTS economics, matching Cap Ex to revenue, and making them therefore low to no-risk choices for carriers looking to DSL-enable legacy DLCs.

And while the timing of DSL deployments will fluctuate, DSL will remain a key carrier service offering.

The third key to short-term revenue I noted was accelerating portfolio-wide sales through partnerships and channels.

On this one I believe we've made very good progress.

As I mentioned earlier, we've had good traction with an international distribution partner, initially for the Multiservice Access transport and switching products from Internet Photonics in support of telco gigabit ethernet applications.

We recognized revenue from this channel in Q3.

Additionally, we've secured a partnership with a major player in the storage arena.

Channels and partnerships will become an increasing important part of our strategy as they are one of the critical components to accelerating revenue growth longer term.

Finally, I said a key driver would be supplementing our current DN 7000 series wins with new application wins and/or another major win for the platform.

Since winning deals at both SBC and Verizon, the DN has expanded beyond the application for which it was originally chosen and is now being deployed in support of multiple applications at both carriers.

The DN series supports data services such as DSL.

It also offers a safe migration path to IP and MPLS for legacy services such as ATM and frame relay.

We'll continue to work to secure another major win for the platform but in the meantime, customers' willingness to expand the scope of applications addressed by the product is just as significant.

Our challenge remains the same as I articulated last quarter.

For the most part we've won the deals, we now need to drive revenue growth and we need to translate those deals into revenue and we need to drive momentum for the new platforms like the CN 1000 Broadband Loop Carrier platform.

As I mentioned earlier, we secured three new customers for the CN 1000 platform.

Given that it now appears the installed copper plant will play a much bigger role than previously anticipated in involving access plans, the flexibility of the CN 1000 should cast it as an ideal platform, capable of handling the various FTTX access architectures and the multitude of emerging broadband access applications such as IPTV.

In addition, the capabilities of the CN 1000, combined with the suite of access, switching, and transport products from Internet Photonics, uniquely positions us to effectively and economically address triple play delivery.

In summary, our strategy does not involve being all things to all customers, and the goal of our expanded Solutions portfolio is not only to get more product to sell.

Our portfolio expansion is targeted at specific network challenges faced by our customers, and is very focused on enabling the most sought-after applications in the most cost-effective way.

With the addition and integration of Catena and Internet Photonics, we are finally in the position to target the part of the network customers are most focused on, that being access.

And while we'll continue to aggressively pursue cross-selling and pull-through opportunities across our product portfolio, we're focused on addressing specific applications in each of the vertical markets we address.

In some cases this will mean working with partners.

But in all cases, it will mean doing what CIENA has always done best, solving real-world networking problems with innovative solutions.

So in closing my comments here, we've taken a number of important steps, I believe, towards restoring health and profitability to our business, and we're encouraged by many aspects of our transformation.

Over the next several quarters, focus and execution will be crucial to our success.

We know we have more work to do and we also know this is work in process.

And we understand the ultimate validation of our strategy and our ability to execute comes in the form of real revenue growth and that is what every employee although CIENA is focused on.

Joe.

With that, will you please walk us through the guidance?

Sure thing, Gary.

Thanks.

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

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

We expect that revenue in the fourth quarter will be roughly flat with Q3.

As we've mentioned previously we continue to anticipate gross margin fluctuation quarter-to-quarter, depending largely on product mix.

We believe overall gross margin in Q4 will increase slightly from Q3 levels due to anticipated product and customer mix.

We expect overall operating expenses in Q4, exclusive of any unusual or non-operating items, will decrease slightly from Q3 and as a result of our ongoing cost reduction programs.

Looking beyond Q4, we had previously told you we anticipated our cost reduction efforts in fiscal 2004 to result in cost savings on the order of 30%.

As a result, we expect to be on target for our goal of exiting the fiscal year with a 65 to $70 million operating expense run rate.

We expect other income and expense of approximately $1.9 million.

We estimate Q4's share count at approximately 570 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 6 to 8 cents per share.

Finally, on cash.

We expect 65 to 70 million of our expected approximately 90 million total cash use in Q4 will be related to ongoing operating activities.

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

Thank you.

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

If you'd like to ask a question, please press the star key followed by the digit one on your telephone at this time.

We do ask that in the interest of time you please limit yourself to one question.

Once again, it's star one to ask a question.

Our first question comes from Samuel Wilson, JMP Securities.

Good afternoon, gentlemen.

A couple of questions and I'll stretch the one-per rule here for a second.

Gary, just want to get a sense for, as you look across your broad product line that you're building now, where do you think you'll continue to cut costs and where are you kind of reducing R&D and where are you potentially ramping up R&D spending?

And then Joe, two questions for you.

One is, first on Catena.

Is there an earn-out on the transaction that potentially could be a cost savings since it seems like revenues at Catena are not coming in when probably what you were thinking when paid 500 million for them?

And secondly, Gary made the comment about the deals being won and the execution being the key and I want to reconcile that with flat revenue guidance.

Is this a matter of customers delaying deployments and this revenue just keeps getting pushed out indefinitely or is this a cost issue?

I want to try to reconcile those two issues.

Thank you very much.

Just some color there.

Thank you.

Sam, why don't we allocate your three questions like this.

I'll answer the first one and the last one, and Joe will take the middle one.

In terms of where we're investing our R&D dollars, I think we've said for a time we're going to realign our operating costs appropriate with the market opportunity.

And I think in simple terms that means that we will be, and we've announced with the San Jose closure, reducing in absolute terms the amount of R&D we're spending in the core of the network.

Now, that being said, we still view this as a strategic part of our business and we'll continue to invest in the core of the network and we've just come out with a new transport platform.

We've got a good number of enhancements that we're continuing to make on CoreDirector, so we're absolutely committed to that space.

But in aggregate terms across our portfolio now, we've got in the access and data side areas where we need to nurture these newer platforms and so as an absolute percentage more of our revenue, more of our R&D dollars will be spent nurturing the access and data platforms.

On the last question, Samuel, on the guidance, I think, given the volatility of the market right now I think, you know, it is proving very challenging to forecast and so I think, you know, our best view right now is flat revenues which we're trying to give guidance on.

Before Joe answers the next one can I just have some clarification?

And I guess I didn't ask it very well.

Is it a revenue recognition issue, i.e. accounting, or is it a actual shift of product issue for some of the timing involved?

I think it's a market issue, Samuel.

Got it.

I think it's the second element that you talked to there.

In some cases it is revenue recognition and timing of it, but I think given what we've seen in the last couple of quarters and the general market conditions, I think it's just beyond predictability of orders, timing, projects, even of the stuff that we've won, so I think that's why we come into the guidance that we're coming to.

Thank you.

Sam, this is Joe.

I'll answer your other one question.

As it relates to the Catena acquisition, there was no earn-out.

To give you a little color, just one quarter under our belt and with these guys and their performance, you know, it's nothing you can gauge the acquisition on.

We're still very excited about what they're doing, what they bring to the family here of CIENA.

The acquisition is really the thing we're interested in it's the CN 1000.

And as Gary alluded to in his prepared remarks, we think it's making great progress and we're very, very excited about it.

Thank you very much, gentlemen.

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

Good morning.

It's Vivek Kire for Tal Liani.

I'll try and limit myself to one two-part question which is, really it's a clarification.

Joe, as I look at this 12.5 million for amortization of leasehold improvement, if I assume that it's included in your in-process R&D, then the non-GAAP adjustment only totaled 87.1 million.

That is you have, from what I can see, you have included this 12.5 million as a separate line item in your non-GAAP adjustments but it is excluded from the GAAP P&L.

And the second question is, the San Jose facility.

When you announced the closure of that you were expecting a hit of 75 to 85 million on the P&L, and I just wanted to see how much of that has already been accounted for and how much do you expect to hit the P&L in Q4?

Thank you.

This is Joe.

Good morning.

In terms of the 12.5 of accelerated amortized leasehold improvements, that is in R&D expense.

So I'm a little bit confused by your question, or maybe we confused you in the way we presented our remarks.

But, you know, if you want to, we can go over that.

You can give us a call and we'll go through the details if there's some confusion there.

With regard to the other part of your one question, we have, most of the 75 to 85 has been realized where somewhere between a little more than, almost half, 40 to 50 to go, but most of it's already there.

Most of the activity which is important that has been kicked into place is going to get us there.

Okay.

And new products were about 20 to 25% of revenue I believe in this quarter, and as you give your guidance for the next quarter do you expect this number to go up dramatically or to stay at this level?

I think, Vivek in terms of our, you know, we're not into that specificity of guidance given the puts and takes of it all.

Okay.

Thank you.

Thank you.

We'll take our next question from Tim Daubenspeck, Pacific Crest Securities.

Thank you.

You talked before on some quarters about a cash flow and EPS breakeven level of say, 140 million or so.

Seeing that you're at roughly half of that, can you kind of give us an idea of whether you need to take [inaudible] further to accelerate that breakeven level in a cash or an EPS, and just kind of give us an update if that is still the kind of guidance?

Thank you.

Tim, in terms of the operating expenses we've given guidance that will be on sort of 65 to 70 million sort of run rate as we leave Q4, that kind of area, and as I think we've seen, we've done pretty well in terms of doing better than our expectations around the cost reduction here.

I think the cost cuts that are underway, you know, will, that have already been announced with the San Jose closure, and we're making good progress there but we've got a ways to go.

That will actually take the numbers down to the 65 to 70 line.

You know, our issue really is around needing to ramp our revenues and needing to improve our gross margin and that's what we're focused on.

We believe that we're, you know, we've got critical mass in terms of the areas that we're focusing on from an operating expense point of view in terms of R&D, but really we've got to grow revenues, Tim.

I understand.

But in terms of, you know, how long do, is there another quarter or another couple of quarters where we kind of keep an eye on revenue and if revenue doesn't come back there's another restructuring or another breakeven level?

You know, and we're always looking at the longer term market opportunities and what our view is of that and we have a lot in process already that needs to get bedded down and we need to understand, you know, some of these market dynamics a little better but really, you know, our strategy is to position ourselves for the longer term to manage our operating expenses carefully, which I think we're doing, but I don't think, you know, whether we achieve one quarter's revenue growth that we're after or not will necessarily impact what we do on the operating expense side.

We've got to take a much broader view.

All right.

Thank you very much.

We'll go next to Simon Leopold with Morgan Keegan.

Thank you.

I'd like to get a little bit more color on how you're adjusting your organization with consideration for the acquisitions as well as the staff you're cutting.

And to be more specific, what I'm trying to understand is, do you have somebody essentially responsible for day-to-day operations who everybody reports to in terms of looking for synergies, commonality of purchasing, and in terms of sales when you've integrated the new organizations, Catena and IPI, how are you maintaining the sales continuity with customers in terms of which people do you get keep and which people are you cutting and how are you managing that specific transition?

Hopefully that makes sense.

Why don't I start with the sort of broad organization Simon, and broadly we're organized in terms of all of our operations that is a single group so that we get the synergies around manufacturing, services, and CRMs, et cetera, so we have a single, what they all come into a single operations group.

And then at the front end of the company we have a single sales organization.

The middle parts of it, if you will, are organized by product line, where we have broad product families that have synergies between them.

For Broadband Access group, which is the Catena folks, Internet Photonics was put in with the Metro and Enterprise group and so we can get some synergies around the products there, and then you've got the core networking group which is CoreDirector and transport, and then you've got the data group which is the, principally the WaveSmith acquisition.

So you've got folks focusing on those applications in the R&D parts of that and then we've got other people focused on any of the integration issues specifically from a practical point of view, and then from a portfolio point of view, all of those folks are responsible, along with Steve Chaddick and Steve Alexander on the, as Chief Technology Officer looking at the right kind of portfolio aspects to it, Simon.

On the sales side, we're very thoughtful as we do the integrations of keeping relationships.

For example, you know, the Internet Photonics had made tremendous inroads into the cable space, and we basically took the cable team that we had in Internet Photonics and they are exactly focused on exactly the same segments and customers as they were, and in fact, we've given them some more resources that were with CIENA.

So that's just one example of trying to be thoughtful around the continuity of the relationships.

Let me just quickly follow up and maybe reading between the lines you can see where I was going with the question.

But what I'm trying to understand, at least in part, is with some of the weakness in the Catena business this quarter, as a result of a disruption in that sales interface to that, basically to major account that has been buying that product.

Simon, you know, I would not characterize as any disruption in the sales relationships that is the impact for that shortfall on the CNX sales.

I think it's specific customer related issues, it's the overall DSL decline, some people are saying it's sort of seasonal et cetera, I wouldn't draw any conclusion personally from that yet, but you know, the same people that were in place selling to those customers are pretty much the same people that are in place now.

It's not a disruption from a sales perspective.

Okay.

Thank you.

Our next question comes from Marcus Kupferschmidt, Lehman Brothers.

Hi, guys.

I had to hop off the call so hopefully I'm not going to ask something that was already discussed.

I want to understand, when you talk about CNX 1000 customer, what does it mean when you say, what is, how do you define customer?

Does this mean that they contract signed, you're shipping product for revenues now?

Then I had kind of one little follow-up to that.

Marcus, do you need the 100 or the 1000?

Because the 100 we've gone into, we're, it's only just beginning to be released.

The 1000 is shipping.

And if you mean the 1000, then you know, our definition is an order.

And revenue and collected the money.

Good.

I guess the question is, is that in your revenues today?

Or, kind of what is the timing of the revenues for kind of mature revenues for this and kind of where, thinking down a couple of quarters, what percent of your Catena revenues you think would come from the 1000 versus the CNX-5 carts?

Marcus, I think there's some revenue for the CN 1000 in the revenue, it's not material.

I think we're at the very early stages of that and I think we're not really ready to sort of project that going forward in terms of guidance, et cetera, but it's a strategic aspect to our future.

But I think we're at the fairly early stages of that right now.

We do not expect that to be materially impactful in the short-term.

And even thinking a couple quarters down the road roughly speaking, could this be 25% of your Catena business?

Marcus, I think that would be bordering on guidance.

Thanks anyway.

Had to ask.

Thank you.

We'll go next to George Notter, Jefferies and Company.

Hi, this is Raj Das for George Notter.

Could you talk a little bit about what you've seen in the DSL market since your pre-announcement in early August?

If you've seen the weakness that existed in Q3 persist in the Catena business in August?

I think that's too small a window for anything to change.

You know, within two weeks, I think, you know, our view really hasn't changed.

We're still trying to understand all of the dynamics around that and the macros around it.

I mean I think the conclusion that where we're at right now is that we believe DSL is still very, very compelling proposition for the carriers, and we believe that that is, you know, the market that they will continue to deploy for the foreseeable future.

Clearly we're seeing somewhat of a lull in sales and it's kind of challenging to put down as to really why that is.

Great.

Thank you.

We'll go next to Susan Kalla, FBR.

If I could just explore the DSL question as well.

In speaking with both Verizon and SBC, they said that they had finished most of the upgrades of their remote terminals to DSL compatible, or with DSL systems.

Over the past year it was really a 2003 sale a little bit flowed over into 2004 but they said they're largely completed.

Are you seeing another area of growth for DSL?

Susan, this is Steve.

I don't think that's accurate.

For example, in the Verizon network we currently only address roughly 500 of 3,000 wire centers.

So the other 2500 haven't even seen the first remote terminal upgrade from us.

Well, they said yesterday to me that they had upgraded their 31,000 remote terminals already, and they said they're largely completed.

There's a misunderstanding someplace because that's not true.

Actually the one that's farthest along in that is Bell South and neither SBC and Verizon are well behind Bell South in that, in that perspective.

So our estimate, for example, just in the area where the CNX-5 plays, which is the SLC-5 upgrades that only about 20% of that market has been addressed so far, potentially, and that doesn't include the markets that are served by other digital loop carriers like the CN 100 which is the Fujitsu and others, which is an additional 30 million lines.

Those haven't been even looked at yet.

So there may be in certain places, certain remotes done, but there are many, many areas in Verizon, for instance, where there's just no DSL footprint at all established, zero.

And could you go through what you are anticipating to help the margins, the gross margins going forward?

Susan, why don't I take that.

There's a number of initiatives on cost reductions of specific platforms, things like the Long-Haul platform, for example, so I think those together with the continued focus on operations to get, you know, more synergies around that, we've got a lot of CRMs, our strategy is to get down to fewer, and I think, but the biggest lever we have is really around product mix.

And as we go forward our kind of view around product mix will get more favorable for us which gets us into improved gross margin.

So it's a combination of product mix of these newer platforms coming online which have good gross margins and cost reduction programs that we've got in place.

And then the higher margin products are?

Well, the higher margin products are basically anything apart from transport, if you were to simplify the thing.

And we're working hard on the transport side but most of the other products enjoy good gross margins.

And then one last question.

Could you just give us an update on the progress at British Telecom?

Susan, I don't think it would be appropriate to talk about specific customers particularly as that customer has a very large RFP out right now and we're right in the middle of that.

I'm sorry.

Okay.

Thank you.

We'll go next to Todd Koffman, Raymond James.

Thank you.

Just a follow-on to the Catena question.

Is it fair to say the CNX-5 will potentially be down sequentially in the current quarter?

Todd, we haven't given guidance to that, you know, we've just given an overall view of the market.

Possibly.

I think it just depends on what happens in the fluctuations of the DSL space.

I think, you know, as we've said, we think that DSL is still very compelling and, you know, our view right now is that it's got a good future going forward.

Just a follow-on to that.

It does seem as though a significant piece of the footprint might already have DSL addressable but you seem to indicate that 80% of that addressable footprint is not available for DSL.

How do you reconcile that difference?

I think if you were to put it simply, if you look at the amount of SLC-5 cabinets that out there, as Steve said, we've only addressed about 20 to 30% of those.

So you still see a large available market that's still there for the SLC-5.

Right.

But with the possibility of that business actually being down sequentially, would you just then draw the conclusion that that footprint is going to remain untapped for some time?

Not necessarily, no.

We just see it as a, you know, lull in deployments right now, and I think there's something around some of the, if you looked at it from a macro point of view, some of the low-hanging fruit in a couple of the carriers being addressed by existing CNX-5 but basically Verizon and SBC are at the fairly early stages of deployment here.

Yeah.

Maybe on a more exciting note with regard to an earlier question on the CN 1000, someone was trying to get some sense of the potential timing of the success and contribution from the product.

Can you just sort of gauge it, you know, how far out do you think that deployment and decision timing would be if successful there?

You have to segment it by market.

I think you've got the Uni-P and the Uni-L sort of deployments which will begin over the next 12 to 18 months.

I think penetration of any of the RBOCs will take longer on that, you know, go back to your earlier point.

DSL won't be deployed on all of the lines, and so, you know, there's an application for CN 1000 there, and also in the Fiber-to-the-X, you know, the node, those kinds of applications.

CN 1000 is very well positioned but I don't think being realistic that's significant revenues in the next 12 months, personally.

I think you've seen a lot of drivers around video, IPTV, et cetera, but I think that will take awhile to actually gain traction.

Thank you very much.

Very helpful.

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

Hi.

This is actually Bobby Sarkar for Hasan Imam.

I had a couple of questions.

First off, can you give us a little bit more color on how the gig BE deployment is proceeding?

And secondly, did you actually say you recognized revenues from MCI again this quarter?

Thanks.

Bobby, the gig BE is really going as expected.

I believe it's on track generally, certainly from our perspective we don't see clearly, the whole project, but it's on track from our perspective.

And the answer to your MCI question I believe was yes.

Bobby, does that --

That's fine.

Thank you.

Thanks.

We'll go next to Ehud Gelblum with J.P. Morgan.

Hi.

This is Scott Eisenberg for Ehud Gelblum.

I just wanted to know really quickly could give us some more color on that approximately $5 million investment in a private company if that is a new product type company you invested in or is it more of a channel partner that you're bolstering?

Just a little more color around that.

Sure, Scott, let me take it.

This is Joe.

We did do an investment, it's in a West Coast organization, you'll be hearing more details about it.

It offers us a similar arrangement that we had with some of the other ones that we did.

We are going to partner with them.

We're going to sell the product for them, and we've got a lot of other clauses in the contract similar to what we've done before but we don't go into those details.

Thanks.

Could you give us a little color on what type of product it is, like what family it would theoretically fall into?

Not at this point, no.

You'll be hearing more about that in the quarters to come.

Okay.

We'll go next to Brant Thompson, Goldman Sachs.

Mr. Thompson, your line is open, sir.

Once again if you would like to ask a question, please press star one on your telephone keypad at this time.

Again, it's star one for questions.

At this time I'd like to turn the conference back over to you, Miss DuLong for any additional or closing comments.

Thank you very much.

This is Gary.

Thanks everyone for your time this morning, and I know there was some conflicting things going on.

We appreciate your attention, and thanks for your continued support.

Thank you.

This does conclude today's conference.

We do appreciate your participation.

You may now disconnect.