Ciena Corp (CIEN) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the Ciena Corporation second-quarter fiscal year 2005 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 Chief Communications Officer, Ms. Suzanne DuLong.

Please go ahead.

Thanks, Steve, and good morning and welcome, everyone.

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

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

Gary will provide some brief introductory comments.

Joe will review the quarter's financial results.

Gary will then discuss the business in the quarter and our outlook for the third quarter, and Joe will wrap up prepared remarks with guidance for Q3.

We will then open up the call to questions from the sell-side analysts.

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

This month's press release is available on National Business Wire and First Call and also on our website at Ciena.com.

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

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

These statements should be viewed in the context of the risk factors detailed in our 10-Q, which we expect to file with the SEC today.

Ciena 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.

We are pleased to have delivered solid revenue growth for the fifth sequential quarter, as well as improved gross margin and lowered our cash burn.

As I've said previously, there's more work to be done and we continue to make meaningful progress in a number of areas.

It's particularly encouraging to see growth and opportunities emerging as a result of the steps we've taken to diversify our revenue and customer base.

I will be discussing our progress in more detail after Joe reviews the quarter's results.

Joe?

Thanks, Gary, and good morning, everyone.

This morning, we reported second-quarter revenue totaling $103.8 million.

This represents an increase of 9.6% sequentially and 39% year-over-year.

We had four 10%-plus customers in the quarter that, combined, represented 49% of total sales.

This compares to Q1 when two customers represented about 32% of total sales.

Three of the second quarter's 10% customers were U.S. customers.

Of those three, two are long-haul customers.

The third U.S. customer purchases across several product categories and business units, but revenue this quarter was predominantly associated with our Broadband DSL upgrade platform, the CNX 5.

The fourth 10% customer is an international customer and is not APCT (ph).

This customer purchased for core transport, core switching, and intelligent optical multiservice switching applications.

This customer also has been a 10% customer in the past.

International sales increased as a percentage of total sales, as you might expect, given the addition of an international 10% customer.

International sales represented 22.8% of total revenue in Q2, versus 17% in Q1.

Moving now to talk about revenue contribution from our business units, revenue from our Transport and Switching Group, or TSG, increased 34% sequentially.

This group consists of core transport and core switching, multiservice access, Metro transport and switching, and storage extension product.

In Q2, TSG contributed 67.6 million in revenue compared to 50.4 million in Q1.

TSG's percentage of overall revenue also increased sequentially from 53% in Q1 to 65% in Q2.

Long-haul transport and CoreDirector sales drove the majority of TSG's growth in the quarter.

Revenue from our Data Networking Group, or DNG, decreased sequentially, as expected, given an exceptionally strong Q1.

DNG's contribution went from 16.6 million in Q1 to 5 million in Q2, representing 5% of total revenue in Q2 versus 17.5% in Q1.

Revenue from our Broadband Access Group, or BBG, increased 26% sequentially from 15.2 million in Q1 to 19.1 million in Q2, representing 18.4% of total revenue in the second quarter.

BBD's growth was driven by strong demand for our broadband DSL upgrade platform, the CNX 5.

Revenue from our Global Networking Services business unit of roughly flat quarter-to-quarter at 12.2 million in Q2 versus 12.4 million in Q1.

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 managers, we make to (indiscernible) as 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 had excluded those items detailed in the press release.

With that background, we will get going.

Q2's gross margin of 26.2% was better than our guidance of flat to down from Q1's 25.6% as a result of product mix in the quarter, as well as our ongoing product cost-reduction efforts.

This despite the fact that core transport represented a larger percentage of revenue than in Q1.

Product gross margin increased from 26.1 in Q1 to 28.1 in Q2.

Q2 services gross margin of 11.4% was down from Q1's 22.3% as a result of the mix of services revenue in the quarter.

On a GAAP basis, our operating expenses in the second quarter totaled $94.1 million.

As noted in the press release, this included 23.4 million of unusual nonoperating-related or non-cash charges for stock compensation, amortization of intangible assets, restructuring costs, and long-lived asset impairments.

Roughly 10 million in restructuring costs in the quarter relates to adjustments to previously-restructured facilities due to the continued excess supply of commercial property and the recent workforce reductions at our North Carolina facility.

Adjusted for these and other nonoperating or nonrecurring charges detailed in the press release, our R&D, sales and marketing and G&A expenses for the quarter, exclusive of stock-compensation costs, would have been $70.6 million.

This represents a slight sequential increase in OpEx, which is in line with our guidance, and a 7% decrease from the 75.9 million in adjusted operating expenses for the same period last year.

Our GAAP net loss for the second quarter was 74.8 million or a loss of $0.13 per share.

Adjusted for the unusual or nonoperating items I discussed earlier, as well as for a $7.3 million loss on equity investments, our loss for the second quarter would have been 43.6 million, or 28.4 million if tax-effected, or a loss of $0.05 per share.

This is the top end of our per-share guidance range that we offered and compares to an as-adjusted loss of $0.10 per share in the same period a year ago.

Turning to the balance sheet, cash, short-term and long-term investments at the end of the second quarter totaled 1.19 billion, a decrease of 39 million from the first quarter.

We reduced our cash burn from operations by 15.5% sequentially from 43.3 million in the first quarter of 2005 to 36.6 million in the second quarter.

Cash burn was negatively affected in the quarter by higher-than-anticipated working capital needs, which are offset by a payment received from Broadwing as a result of our settlement with them.

We are comfortable with our cash levels and confident that, if business goes according to plan in FY '05, we will continue to lower our operating cash burn over the course of the year.

Our Accounts Receivable balance at the end of the quarter increased to 66.5 million from 52.1 million at the end of Q1 as a result of a back end-weighted quarter for revenue recognition.

Days of Sales Outstanding increased from 50 in Q1 to 58 as of the end of Q2.

Inventory levels ended the second quarter at $45.5 million, down slightly from the first quarter's $46.3 million.

The inventory breakdown for the quarter is as follows -- raw materials, 19.5 million; work in-process, 2.9 million; finished goods, 45.2 million; and a reserve for excess obsolescence of $22.1 million.

Product inventory turns were 5.8 in Q2 compared to 5.3 in Q1.

Finally, headcount -- our worldwide headcount at the end of the second quarter totaled 1,616, a decrease of 52 from Q1.

Now, I will turn it back to Gary.

Thanks, Joe.

Q2 was an eventful quarter on a number of fronts for us.

During last quarter's conference call, I mentioned that we would be seeing heightened activity around metro Ethernet transport and switching.

Though it was technically after our Q2 closed on May 16, we announced our new FlexSelect architecture, and the first product to be introduced under this architecture, the CN 4200 Advanced Services Platform.

Our advances here are meant to capitalize on the growing global demand for Ethernet in the network infrastructure, demand we're seeing across our customer segments from telco and cable to enterprise and government.

The adoption of Ethernet as the ubiquitous transport protocol has gained tremendous momentum, fueled by the lower associated costs and widespread enterprise deployment.

Our FlexSelect architecture is an extension of our LightWorks architecture and represents a new way of provisioning, deploying and managing network services.

Whereas LightWorks was designed to provide a managed bandwidth in what was then an excessively bandwidth-hungry world, FlexSelect is designed to use that bandwidth to address the critical needs of customers as they transition to packet-based networks.

The CN 4200 is a flexible, multiservice transport and aggregation platform that delivers the industry's first truly any-service on any-port at anytime by a software programmable hardware that operates down to the port level.

Based on initial customer interest and traction, we expect FlexSelect and the CN 4200 to quickly become meaningful revenue drivers.

Also this morning, in a release separate from the quarterly reports, we introduced our CoreStream Regional platform.

CoreStream Regional is an extension of our CoreStream Agility optical transmission system designed to bring our market-leading DWDM technology to metro and regional core networks with moderate capacity and distance requirements.

It is based on the same platform as our widely deployed CoreStream agility.

This platform is ideally suited for some of the emerging transport demands specifically that we're seeing in Europe.

I will orient the remainder of my discussion of the quarter and outlook around our three strategic focus points of revenue, profitability and costs.

Starting with costs, adjusted operating expenses increased slightly sequentially in Q2, in line with our expectations and our guidance.

The increase was driven by Sarbanes-Oxley-related costs and some costs associated with additional customer demos.

However, for the second half of the year and into our fiscal '06, we expect to resume our aggressive downward push on operating expenses.

We've taken a number of actions that will drive significant reductions in future periods and will continue to execute on a plan that drives towards an overall normalized operating model.

In addition, we are also looking towards alternatives, like partnerships and offshoring resources, to lower OpEx, improve our R&D capacity, and strengthen our global market presence.

In fact, we are in the process of establishing a Ciena site in India.

But OpEx is only a piece of what we're targeting.

We are also very focused on driving profitability.

Given the declining gross margin we've seen nearly across the board in our peers' and competitors' year-end results, gross margin is an obvious concern across the industry.

Despite the competitive environment, we were able to deliver sequential improvements in our gross margins in Q2.

As Joe said, this was primarily due to product mix but also due in part to the realization of our ongoing product cost reduction efforts, particularly relating to our long-haul products.

There's no question that pricing remains competitive, particularly for traditional telecom business, but this is no different than it has been in the past.

We've traditionally not been the lowest-cost provider, and I do not expect that to change.

We will continue to differentiate Ciena and our solutions based on the value we're bringing to our customers, value like our field-proven performance and reliability, that continues to be validated in the marketplace, and also new and differentiated solutions that meaningfully impact ongoing operating expenses, like the any-port/anywhere capabilities of the CN 4200.

In spite of the environment, we continue to believe that Ciena can and should operate with an overall gross margin of better than 40%.

As part of our larger plan to drive towards a normalized operating model, we are also improving gross margin with a combination of ongoing product cost reductions and an evolving product mix.

Cutting our costs and improving gross margin are two pieces of getting to sustained profitability.

One of the most exciting aspects of our revenue growth over the last several quarters is the fact that it has not been driven by any single customer, product or application.

Where optical transport and broadband aggregation drove growth in Q1, Q2's growth came from a combination of broadband DSL, core switching and core transport.

Q3's growth looks likely to come from a mix of metro, DSL and core switching applications.

We continue to look for opportunity to leverage incumbency and existing footprint and expect that our new CN 4200 Advanced Services Platform will be an appealing cross-sell into many of our existing customers.

I will talk about our revenue growth and opportunity now across our four customer segments of enterprise, cable, government and telco.

Firstly, on enterprise and our channel business, our solutions for storage extension applications have proven to be a significant door-opener for us, both in terms of attracting channel partners and enterprise business.

As we begin to strengthen our value proposition with our key channel partners, we are seeing increasing opportunities to supply a broader set of solutions to customers in our key target vertical markets.

For instance, our recently announced CN 4200 sale is already in trials with major financial institutions and retailers.

We're seeing increasing demand for tightly integrated DWDM platforms to address emerging network needs in the enterprise market.

We are also optimistic that we will continue to make progress with an international partner relationship which we've been working on for some time.

Our announced CN 4200 deployment with Swisscom actually emerged as a result of this partnership and is an excellent example of how we will leverage partnerships to augment our direct sales efforts going forward.

Turning to cable, while initial traction has been with telco customers, we also expect the CN 4200 will play well in cable applications as well, where the need for high-speed data is also driving demand for high reliability Ethernet transport.

Triple-play, Voice-over-IP and video-on-demand remain the driving applications in the cable space, where subscriber growth is driving network expansion.

Ciena-powered networks have driven success for our cable customers outside of direct consumer markets as well, including within the educational community.

Another revenue driver is our government business.

In addition to our Edisa (ph) deployment, we see continued demand from the Department of Energy and the research and education markets.

We've secured additional wins in Europe and the U.S., including first-quarter (indiscernible) installations in this market.

In addition, storage and business-recovery services are also demand-driving applications for this particular customer segment.

In our traditional telco customer base, we're seeing a number of applications driving growth.

First, as evidenced by strength of the long-haul and core switching revenue growth for the second quarter in a row, increased access traffic volume is driving bandwidth demands, particularly in Europe, and a renewed focus on reducing escalating network operating expenses are generating new interest in core networking.

As I said earlier, we believe our new CoreStream regional platform is well-suited to address growing transport demand in metro and regional networks.

On the customer side, we were very pleased to be named as one of BT's preferred supplies for their Century 21 Network.

This extension of our existing relationship with BT is an enormous validation of our specialist approach and is a clear indicator that Ciena has what it takes to establish and maintain strategic relationships with the largest carriers in the world.

In addition to core switching and long haul applications, BT also chose Ciena to provide optical Ethernet, again with our new CN 4200.

In addition to our announced win at BT, we've recently begun deployments at Sejutel (ph) and TELMEX, and expect to begin deployments at another PTT in our third quarter.

While capacity demands on the transport side are definitely driving demand, we've also seen clear signs of renewed interest in mesh networking, as service providers facing high traffic volumes contemplate current network resiliency, security and escalating operating costs.

We believe the packet-friendly nature of our FlexSelect architecture and the demonstrated capabilities of products like CoreDirector give us a significant competitive advantage to address this trend.

In data networking, while revenue from our DN series declined sequentially in Q2, as expected, given deployment cycles and a very strong Q1, we continue to see good demand for the product in support of new service aggregation and in support of broadband deployments at both SBC and Verizon.

We also expect to be able to announce a new wireless back-haul customer shortly.

Taking a closer look at our broadband opportunities, we are pleased this quarter to see an obvious uptick in DSL demand and a corresponding increase in our CNX 5 shipments.

It appears as though the economic realities of operationalizing IPTV by driving many carriers to more aggressively roll out existing DSL services in the interim.

As a result, we expect continued shipment and revenue growth from this product set, and we are continuing to explore ways of leveraging the strong installed base and/or extending the capabilities of this platform.

In summary, as we've said for the past several quarters, there is clearly more work to do but we're making good progress, both in identifying and capitalizing on revenue growth opportunities and managing our operating expenses and cash use.

I think one of the hardest things to grasp about Ciena's story at this point is that there is no one thing that will make a difference.

There is no single customer or product that will drive revenue growth, no one change we can make to improve gross margins, no single large operating expense or development effort we can eliminate to alter our cost model.

Instead, it is really the combination of the efforts we've had underway for some time that are coming together to drive overall improvement.

We are clearly demonstrating significant progress in revenue growth, gross margin improvement and operating model improvement.

By executing simultaneously against all of these key variables, we are driving more meaningful, sustained improvement and we are absolutely closing the gap on profitability.

One final note before I hand the call back to Joe for guidance -- in his more than 11 years at Ciena, many of you have had the opportunity to meet and get to know Steve Chaddick.

Steve was one of the founding team members of Ciena and over the years, he has had a number of different roles in the Company.

Most recently, he has been our Chief Strategy Officer, but early on, he was responsible for the whole of our R&D efforts.

As the Company grew, he went where he was needed, including managing our CoreDirector develop efforts and bringing that product to market successfully.

In his time here, Steve has been instrumental in setting not only the strategy and direction for Ciena, but also for setting the tone for the get-it-done culture that we've cultivated and nurtured.

So, why am I tell you all of this?

Well, Steve has decided there is actually more to life than telecom and will be transitioning to a consulting role at Ciena, which will give him more time to pursue his other interest, including his family and personal a commitment to technology transfer and economic development in the Atlanta area and specifically with Georgia Tech.

I want to take this opportunity to thank Steve for his many contributions and to let him know we wish him all the best.

Steve will be with us at SuperCom, and I urge everyone to stop by and wish him well.

Joe, with that, will you walk us through the guidance for Q3, please?

Certainly.

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

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

As stated in the press release, we expect that revenue in the third quarter will increase by 5% sequentially, which would translate into year-on-year revenue growth of roughly 44%.

Based on the orders on-hand for the quarter and current visibility, we expect gross margin in Q3 to improve, potentially reaching 30%.

We expect overall operating expenses in Q3, exclusive of any unusual or non-operating items, will be down from Q2 levels as we continue to execute on our plan to return Ciena to a normalized operating model.

We expect to continue to drive down OpEx through the remainder of '05 and into '06.

We expect other income and expense will be an expense of approximately $1.1 million.

We estimate Q3 share count at approximately 576 million total shares.

As a result, we expect that, exclusive of unusual or non-operating items, our adjusted net loss for Q3 will be in the range of $0.04 to $0.06 per share.

Finally, on cash, we expect our working capital needs in Q3 to be roughly flat with Q2.

As a result of our $13 million semi-annual interest payment, however, we expect our cash use in Q3 to increase sequentially.

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

Thank you.

Today's question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS).

Vivek Arya, Merrill Lynch.

Good morning.

I have two questions.

First is, as we look at RBOC networks, we seem them trending more towards IP deployments and they seem to prefer IP boxes like the Diametra (ph) and Vivacci (ph).

Can you discuss the prospects for the DN platform, which has been more of an ATM aggregator in these applications?

I will let Steve take that.

So, they do have an IP flavor to them all.

I think that's essentially how services are delivered.

The DN actually plays quite well in that migration.

The DN is built as a general-purpose packet processor.

It doesn't have ATM switch chips in it, for example; it has a load that processes ATM, and so it can make the migration over to IPMTLS (ph) just like any other general-purpose packet processor.

The other thing I would add, Vivek, is we've got a pretty good installed base now with both SBC and Verizon, and you know, we think we're pretty well positioned with the extensions that we've got planned on that platform to be able to take advantage of that.

I see.

To follow up, drilling down just on gross margin, do you expect gross margin's improvement to come from cost redesign or volume improvements, or product mix?

Can you rank these drivers as to which you expect to have the best or least impact?

Well, I think it's, if you looked at the two major contributors to it at a high level, it's cost reductions, particularly on the transport element, so obviously the higher the revenue and the cost reductions you get on that particular platform, the more affecting it is, so that varies from quarter to quarter.

But certainly there's significant cost reductions coming through on the core transport platforms.

The other thing is overall mix of the products, you know, particularly with relation to transport relative to the other products, and also within transporters.

We discussed on the last call, you know, that there is a mix between chassis and cards as well, so there's multiple layers to this thing and we are focused on cost-reduction on the transport side.

As some of these larger deployments we're getting mature, they tend to use more cards than chassis once we've done the initial deployment, and a better overall product mix.

I think one last question, Gary -- the BT network, you have announced the win.

When do you expect that contract to impact your topline results?

I think that's still in discussion with BT.

We're still working on the details of that with them, as are the other vendors.

Do you expect it to be an '06 event, not a late '05 event?

It's hard to say right now, to be honest.

Ehud Gelblum, JP Morgan.

A couple of quick questions, if I could?

First of all, on the gross margin that, Joe, you said could hit 30% next quarter, as you look at the different pieces, I guess what happens -- you said that Metro DSL and CoreDirector would be stronger.

Can you help us just rank again the gross margins of your different businesses?

It sounds like obviously DM probably is one of the higher ones, as well as the CNX 5.

What kind of legs do you think the CNX 5 has going forward in terms of how much longer that can survive?

It sounded like DSL was something that is somewhat of an interim gap deployment, while the RBOCs are (indiscernible) IPTV and fiber business.

How much longer do you think the CNX 5 can continue?

How does that impact your gross margin as you go (indiscernible) and higher from there?

Ehud, why don't I take that?

There were a number of questions there.

I mean, first of all, I think we've given sort of broad indications around the gross margin piece.

I wouldn't get into too much detail of that, I don't want to give away all the family secrets.

But I think the core transport piece clearly is a more challenging gross margin profile, particularly as you're in the early stages of some of the large builds on the chassis, and the gross margin is not very attractive down there.

Specifically on the CNX 5, we are encouraged by what we're seeing on the DSL side.

I think some of the realities of the operational and the economic issues associated with IPTV, which are somewhat unproven right now, I think are causing a lot of the RBOCs to focus on the weapons that they have right now, which clearly is DSL.

I think you're beginning to see that in the announcements that are being made, because that's the product they can actually ship out the door and know how to deploy right now and have a good economic handle on it.

So, in answer to your question, I think we are encouraged by CNX 5.

We are doing a number of things to extend the platform and the capabilities of it as well, so you know, we actually see a pretty good lifecycle for this kind of technology.

Overall, you know, as we said, a normalized business model for Ciena really requires a gross margin beginning with a 4, and I think the products, all of the product sets that we are focused on to try and get us blended up there should help in the mix as we improve our overall business model.

I've actually seen gross margin in the long-haul transport area by itself get better.

Are you seeing the overall -- the gross margin in the CNX 5 area in itself get better, or is it only -- (multiple speakers)?

I think the CNX 5 is pretty stable, given the nature of the product.

On the core transport, our gross margin is improving, principally out of -- right now, the improvement in gross margin is recognition of our cost reduction.

Okay, so that maybe can have some more (indiscernible) but just what we see in the outside is that there's a lot of long-haul transport revenue that comes in and that's always, to me, seemed to be some of the lower margin business but I guess -- (multiple speakers).

Yes, and I think that's -- Joe, do you want to -- (multiple speakers)?

Good morning, this is Joe.

You are right; it typically is, but a lot of the long-haul business that we've bid on, we've done with the ultralong-haul product, which is, by the nature of the name, going after a really, really long haul.

A lot of the -- some of the characteristics of the long-haul business that are going on right now are not really, really long.

They are shorter; they are more regional.

Hence a lot of the work that's been going on for the past year in the Steve shop have come out with a lower cost basis platform, which we announced the regional long-haul systems.

So in terms of improving the margin on that long-haul business and getting the overall gross margin to go up, the regional system is a key ingredient to that whole process.

Okay, so maybe there's long-haul and then there's long-haul. (LAUGHTER).

Exactly.

Joe, one thing that I -- while I have you, for the cash burn, can you just help me parse through that a little bit?

Because obviously the interest payment last quarter that wasn't this quarter -- was that in that 43 million that was the cash burn last quarter, so did cash burn actually go up or down?

Because there was also the Broadwing payment that was in here. (indiscernible) -- (multiple speakers) -- apples-to-apples comparison.

It was in last quarter, so therefore, if you do it on a -- if you exploit it, it did go up and there was a comment that I made in the prepared remarks about the working capital requirements going up and predominantly driven by the ARPs, because the DSOs went up.

That normalizes next quarter, because they won't be so back-end loaded?

Yes.

Put it this way -- as we go into the quarter with the backlog that we have, the revenue recognition isn't such as the way -- the same characteristics as the way it was in Q2, so we should be in better shape.

Great.

One last thing, if I could?

JDSU announced yesterday a win with BellSouth, which shocked me.

As far as I know, JDSU supplies yourself and a lot of your other competitors with components.

Now, it seems that they are bidding with your customers, the carriers, on DWDM and other types of systems.

Is that a change in the relationship that you have with some of your component suppliers, especially JDSU?

Was that something you expected?

I think -- I don't know too much about that, but I do know that they've had a sort of a metro broadband sort of DWDM piece that they've had for quite a while, that they've had a relationship with BellSouth, so I'm not surprised by that.

Tim Long, Banc of America.

Just two quick ones, if I could?

First, Gary, could you just give us a sense of -- nice win with BT.

I know it just happened recently, but can you talk a little bit about what some of your other customers, particularly in the European Theatre, are saying and this resulted in any change in activity or change in tone from your customer base over there?

Then secondly, to Joe I guess, if you come at this gross margin question a different way, the goal is to get to 40%, so if we assume we are in the high 20s right now, just give us a sense on how we get there, relative to both mix and efficiency.

So is it -- you know, it's obviously a combination of the two, but is it more mix, more efficiency?

Any clarity you can give on how we get to that 40% goal, that would be great.

Thanks.

Why don't I take the first one?

I think we've been seeing, for a little while in Europe -- first of all, I think that they did not deploy as aggressively the capacity that we deployed in North America during the bubble.

They've also overall been more aggressive on deploying access and DSL, so in addition to that, they've got 3G wireless back-haul, which is becoming pretty significant as well.

So you put all of that together and I think you've got a situation where they are beginning to run out of capacity.

I don't want to overstate that, but you're seeing signs of hot spots on their networks generally amongst the European PTTs.

I also think that one of its capacity issue, the second issue is they're all beginning to look at how do they reduce their operating expenses and put a different next generation architecture out there.

They are all at sort of different stages of that but I think, you know, BT's influence on Ciena and its perception with other customers I think is clearly helpful.

I think it's an enormous validation of the expansion of the relationship.

But I also think that Ciena has been in Europe for quite awhile; we are beginning to make inroads into some new PTTs, one of which we haven't announced yet and we are beginning deployment with them as well.

So I think, overall, Tim, we're encouraged by what we're seeing in Europe.

It fits very much this architecture of the mesh.

I think the regional alliance system that we've got coming in and also the adoption of Ethernet seems to be more advanced there generally than it is in North America as well.

So I think if you look at the product set that we have, it's particularly well-suited into the European arena.

Tim, this is Joe.

In terms of trying to continue the dialogue of gross margin, which I'm sure we will do throughout most of the day, I would say it's going to be a combination first and foremost of mix and volume, and mix and volume, volume and mix.

But kind of a close second is going to be the continued efforts on the cost reduction, much akin to the way we did -- again, not to be redundant -- with the regional long-haul system as opposed to a ultralong-haul system.

The introduction of the 4200 is going to be a key ingredient to this as well, because that offers a completely different pricing algorithm with it, where both the customer gets a lot of benefit from it and we get a little bit too, just because it helps the overall picture.

So, that's about the best I can do at this time.

Paul Silverstein, Credit Suisse First Boston.

If you strip out the interest payment, the 13 million, from an operating cash flow perspective, would cash flow improve?

Would the burn go down for this coming quarter?

For the quarter coming up?

For this quarter you are in, the July quarter.

The quarter that we are in, no; that's not -- no, it wouldn't, Paul.

So it's not just the interest payments?

No, we are going to be (indiscernible) working capital because the business is growing.

Okay.

Second, the (indiscernible) 1000 platform in terms of your DSL comments, any traction there or the same old --?

I will let Gary take that one, Paul.

Paul, we are continuing to develop the CN 1000 platform really around the UNEP, UNEL opportunities we see in North America and some international opportunities.

You know, we still think this thing is at fairly early days in terms of what's really going to be adopted here.

Okay.

Finally, I know you made some comments a moment ago about your Europe, but if you speak about visibility generally, can you quantify or give us some metrics in terms of your visibility today relative to this time last quarter?

I mean, I would say, overall, that our visibility is getting better and it's better than it was last quarter.

I don't know if I would like to put any real metrics on it, Paul, but I think, given the sales pipeline we are seeing and the backlog, etc., and the combination of all of that, I think we've got improving visibility.

Okay, thanks, guys.

Samuel Wilson, JMP Securities.

Good morning, gentlemen.

I promise no questions on gross margin!

Just two things real quick -- what was the settlement?

How much was the settlement with Broadwing?

Is that a one-time payment or is there anything in the future coming from them?

Secondly, Gary, from your prepared remarks, it sounds like the enterprise business is going a little bit better than you expected.

Just some color there and are you continuing to invest in the channel?

Are you trying to sign up more resellers?

Kind of what are you doing there to broaden the appeal to the enterprises?

Thank you.

Sam, I'm really disappointed you didn't ask the gross margin question -- but anyway!

The settlement with Broadwing was $35 million and it's spread out over three years.

The first payment was 11.7.

The second payment will be 11.7, and the third one will be the difference that makes it up.

That's an annual payment?

They are annual payments, that's correct.

They can use those payments towards the purchase of products, or a portion of that payment towards the purchase of products.

Samuel, on the enterprise side, I think we're ramping up with our EMC relationship, which we're very pleased with, with -- they are bringing us a lot of opportunities, both directly into some larger enterprises and also into their channels.

We are ramping up our resources here both in terms of marketing and sales in there.

We see some good applicability of some of the technologies that we've got.

We are looking at how do we take some of those technologies and bundle them together around the sort of storage extension and the metro transport space.

So I think we're pleased with what we've seen there.

It's early days, but we think that's potentially a nice, profitable segment for us.

Steve Kamman, CIBC World Markets.

Yet again no questions on gross margin!

That horse is well dead!

I do actually, though, have a question on the R&D side.

It looks like you guys had it run at about 130, 140, maybe 150 million this year, supporting about 400 million in resin (ph), a pretty broad product line.

We've got optics; we've got some ATM; we've got some broadband aggregation; we've got an OMT out there.

I'm just trying -- I'm getting a little nervous about you being spent a little thin across there.

Are we going to cut back on some of the products?

Do we have some phenomenally productive people in India?

You know, by contrast, Juniper is spending 300 million;

Cisco spends something in the 3.4 billion range.

I'm just a little nervous about how much can we keep the gas going on everything here.

Do you end up refocusing back on a few core platforms that may be seeing some more future?

Okay, Steve, why don't I let Steve do that first?

I think you're right; we want to avoid what you might call the peanut butter principle, right, where you spread it out way too thin.

The way you have to approach this essentially is you look at where the customer traction and the customer needs are, and you're making your investments in line with those.

So if you're seeing, you know, additional take in the enterprise space and you look and you say, okay, the combination of things like the CN 2000 and the CN 4200 play well in there, what you do is you introduce features into the roadmaps that funnel directly into the enterprise market.

So what you're finding is we are leveraging some key developments, 4200 being one, CN 2000 additions of package capability onto CoreDirector, the ability to transport Gigabit Ethernet and 10 Gigabit Ethernet long distances over the CoreStream product line, the additions on FlexiPort on for the product line.

That really drives the features and the opportunities up, and you just want to align your R&D resources with that.

We do expect to benefit from the India R&D center.

It gets us a capability that is aligned with some of the lower-cost development opportunities and also puts us smack in the middle of one of the fastest-growing markets in the world, you know, adjacent to the other fast-growing market, right?

So we do expect to get additional engineering leverage that way.

But what you'll find and that we're focusing now are R&D dollars on the platforms where we think there's the highest leverage cost what's an expanding customer base.

Then if I could follow onto that, because I sense a bit of a Back to the Future tone which -- not necessarily one I disagree with -- the new Ethernet optical stuff, some nice win at BT.

Is it fair and would you characterize it as the expansion into other areas, maybe (indiscernible) hit its course and maybe a refocus back in that sort of core transport optical area with a lot more packet thrown in?

Do you see more M&A in the future kind of along those same lines, or is that over?

Then, kind of the broadest question, the things worrying me most about the last two years is we've actually had a really nice rebound in optics; you guys have had some good contracts, but we still don't seem to be able to make money.

Not you guys alone; nobody seems to be able to, except maybe the Chinese.

So I'm just trying to figure out how we take this forward and can you ramp this over the next couple of quarters?

Well, I'm not sure I would describe it so much as Back to the Future as much as I think you're beginning to see the convergence technologies start to really pay off and take old.

The fact that Ethernet -- you know, you have to be careful when you talk Ethernet with people, because it exists as a transport capability as well as a switching capability, but that's one of the first true convergence technologies that you are seeing taking serious hold in the customer base.

It needs to be expanded from the kind of LAN technology that it was originally developed around to be one that is more suitable for, you know, the Wide Area Networking applications.

So, I think it's really the first emergence of convergence is what we're talking about here.

I think that's why, by the end of this year when you look at our portfolio, with only a couple of exceptions, every product is going to Ethernet capabilities on it.

Those are going to exist at both kind of layer 0, layer 1 Ethernet, which is the fly (ph) level right.

You can move Ethernet packets around, right?

Or it's going to have true layer 2. 2.5 even some layer 3 capabilities in there, which is more of the conventional packet processing ability.

So again, I'm not sure so much Back to the Future as much as it is the first arrival of true convergence.

Steve, let me take the last question you have, which is about acquisitions.

You know, just to Steve Alexander's point, I think we've certainly not ruled it out, but we've got a lot of things on our plate right now that are beginning to come together and we're still very focused on that.

We think we've got a lot of the stable of technologies required to take advantage of this kind of TDM-to-packet convergence, so we think we've got a lot of the parts already onboard.

Wojtek Uzdelewicz, Bear Stearns.

Close enough -- good morning.

I just want to ask a couple of clarifying questions.

One, your deferred revenues jumped very nicely, core-over-core.

Any color sort of what's that was driven in (sic) and will that be recognized in a coming quarter, at least a significant portion of that?

Second, there was a little higher loss of investments.

Has (indiscernible) been realized and can you give us a sense?

Was that sort of related to some investments in some of the private companies, or was some due to the stock market movement?

The third thing that, if you could just give a comment, I talked recently to some of the -- an Asian supplier, and they were indicating that you guys are moving significantly more -- your components purchases to optical components purchases to someone like ZTE away from some of the U.S. or Vocamore (ph) or guys like JDSU.

Kind of interesting sort of situation here -- as we've seen a little bit more and more in this sort shift towards some of the Asian vendors, are you seeing the same thing happening on the higher-level systems, where the North American or European carriers, as we saw with Huawei since -- (technical difficulty) -- moving more business towards the Huaweis of the world,.

How do you see the Asian competitors end suppliers putting competitive pricing pressure?

How do you kind of evolve that system down the road versus the competition from Asia?

Okay, Wojtek.

Good morning.

It's Joe.

I will do one and two, and then I will hand off to either Gary or Steve to do number three.

On the deferred revenue front, this links back to the dialogue we touched on previously with regards to Broadwing.

So the first of those three installment payments gets geographically placed in deferred revenue on the balance sheet until one of two things happens.

The first part could be if they take some kit and then as they take it, we move it to revenue and get gross margin from it, or if they don't purchase kit within the first 12 months, all of it just goes straight to revenue and you get 100% gross margin.

But moving onto the second question, which had to do with the investment write-off, one of the companies, the private companies in our portfolio, had a triggering event, which was they're going through another round of financing, which is a down round and we're not participating.

Correspondingly, we have to value it based upon the way we see it, and that's the reason why we took the write-down in that particular company.

Then I will pass the baton for the third question.

Wojtek, I think the issue you are talking about with the Asian vendors, I would kind of describe it as, you know, you're seeing the global market and clearly you're seeing some Asian vendors, both at the systems side and the components side, who are very ambitious, very aggressive and are going to be here to stay.

You know, from our perspective at a systems level, we do see Huawei and others, particularly in the European market.

We are very focused on the value that we drive, which is different than people like Huawei.

On the components side, as Joe talked about, our cost reductions -- it's engineering-based, it's manufacturing-based, and it's getting components at lower cost, too.

We will also take advantage of the global market to source that as required.

An indication of that is on the R&D side with the announcement of our India -- establishing an India center as well.

That's just the nature of the market if you're going to play in this industry right now.

How -- just again to clarify, I mean, I'm just curious.

I'm hearing (indiscernible) Alcatel loosen a lot of the vendors are complaining about Huawei just being predatory with pricing, and they have the big government checkbook, $10 billion and so on.

Is there any lobbying or -- I mean, is it sort of the new reality we've got to live with it?

Is there a way to get -- because I think that a lot of the support there is just not only that they have good products but it sounds like they're also getting a lot of extra support.

Are you -- (technical difficulty) -- in the industry trying to do something to address the problem, put some political pressure or this is just the reality you've got to live with?

Our view is that this is the reality that you've got to live with.

I mean, clearly, I think what you're referring to is some people believe this is a strategic government initiative that's backing Huawei and that may or may not be true.

What we're focused on is, if we are providing the value in our solutions to our customers, then, you know, we will compete with Huawei and it's not all just about first prize.

We are very focused on certain specialist areas of the marketplace, and that's where we intend to gain competitive advantage.

I think some of the more broader-based players who are exposed to the pricing challenges, without some of that, the value propositions there are clearly going to have a tougher time with this.

But you know, these guys are here to stay and you've just got to figure out how to live with it and compete with it.

Thank you.

Nikos Theodosopoulos, UBS.

Thanks.

I had a couple of questions.

The first one is on the existing MCI and Disa (ph) buildouts, the contracts you announced I guess several -- way back.

What percent of completions of those two networks do you think you're at at this point?

Nikos, why don't I take that?

Without getting too specific about the customers, the MCI one continues to roll out.

I'm guessing that we're not even halfway on that yet, but you know, that's just a personal view. (indiscernible) some of the chassis, you know, that they are building out their network, will be the initial buildout -- I understand will be largely complete towards the end this year.

Then they will begin to put traffic on it in other channels and cards on it.

Okay.

On the BT contract, just a different question than the one before.

I realize you don't know when the revenues will start, but once they do start, what do you think a two-year period contribution from this contract would be?

Nikos, that would be entire speculation at this stage.

Just one more on that one -- I mean, given the -- what most people perceived was a very aggressive bid, not just in the optical portion but the entire BT contract, do you think that this contract will impede your ability to get to the 40%-plus gross margin, or do you think your mix of business there will support this move to 40% gross margin?

You know, I wouldn't comment specifically on BT, but I would say that we're very careful about the business that we take to make sure we can get to a normalized business model.

The last question I have is on this deferred revenue.

Joe, think what I heard you say with that if Broadwing does not purchase any product over the next year, or whatever they don't purchase of the 11.7 million, that you will record that as revenue and it will flow through at 100% gross margin?

I just want to make sure I understood that.

If that happens, will you be providing us some disclosure on that?

Nikos, this is Joe.

You heard me correctly.

If that does happen, I think we're going to have to give you some color so you don't model that in on a normalized basis, yes.

Marcus Kupferschmidt, Lehman Brothers.

Good morning.

A couple of questions I wanted to explore -- in terms of the new CoreStream product, they announced their availability now.

How long do you think it will take for trials before you can start shipping it for revenues to customers?

Steve, (inaudible).

So, in terms of trials, it varies tremendously on the customer.

Some have a very elaborate trial process, acceptance process, if you will, that can take two to three months.

Others have a much more straightforward approach and they generally identify the worst place in their network, they throw it as a field trial immediately.

It works there, they know it works everywhere.

So, it varies tremendously.

It could be a couple of weeks to several months.

So you wouldn't be surprised, then, to get some revenues on this thing starting this July quarter?

I will take that one, Marcus.

I guess some asked (ph) that, and can you give us a sense, too, Joe, of maybe what percent of your long-haul revenues could this product represent two quarters from now or a year from now, just something to help us better understand, since it seems to address only a subset of what your long-haul opportunity could be, if I'm correct.

Okay, in terms of the current quarter we are in, July, how much of it would be the new regional system, could it be some?

Yes.

Am I expecting to be some?

No.

I think it's more of a Q4/Q1 item, Marcus, to be realistic.

Not just saying you couldn't see a little bit.

Then the second part of that question -- how much do you see?

What percentage of this do you expect to be of long-haul?

Of the total long-haul market, I mean, I'll have a go at that next year.

I mean, CoreStream agility already addresses some of that market, you know, except that the regional line system will do it more economically, both for the customer and for Ciena.

So I would estimate it would be about half of that total market. (multiple speakers).

Okay, great, super.

On a separate subject, if I understand correctly, your expectations for some of the key product drivers for the July quarter does not include a rebound in the WaveSmith DN product?

Yes, I don't think it will be a large rebound.

It's a little bit cyclical based on some projects that are going on.

We do expect it to improve over Q2, I believe, but I don't think it will -- you know, I don't think you would describe it as a rebound.

I think we anticipate more in Q4.

You said largely (ph) you think you did timing issues -- (multiple speakers) -- some of these customers?

Yes, it's just timing issues of over-absorbing the equipment and some specific projects that were going on.

Then just the last of the detail, I was curious about the services gross margin of around 11 or 12%.

It seems to be well below the kind of 20% you guys have been running at.

I mean, is this a one-time blip do you think or is this something that's changing in the profile of the services business?

Marcus, it's really a sort of mix within the services piece.

There are some activities that are lower-margin than others and we just happened to have a mix (indiscernible).

We expect it to return in Q3 to normal levels.

Over 20%?

Yes.

Super, thanks very much.

Todd Koffman, Raymond James.

Thank you very much.

Just following up on an earlier question regarding the CNX 5, this is a fairly definable, finite market as I understand it.

I was just wondering.

Can you quantify how big is the remaining untapped market for that product is?

In absolute terms, it's about another -- in total, I think it's about 17 million lines.

I mean, the available market now in chassis and the rest of it, it's in the hundreds of millions of dollars.

That's remaining, is that correct?

Yes, remaining opportunities.

That doesn't seem to say you're going to get it all.

The other thing I'd also ask you to be cognizant of there, you've got the CN 100, which also aggregates in that space.

That's a new platform as well on a slightly different application but that's -- we are also seeing good interest in that as well.

So is it fair to say that the strength you saw in that product category this quarter is likely to be sustainable or it's just way impossible to tell going forward?

I think it's potentially sustainable.

It's going to ebb and flow a little bit quarter-to-quarter.

It's really down to DSL demand.

We are in all four RBOCs now and we are operational in all of them.

It's really down to the approach of the RBOCs around DSL, what they are going to do with that.

You know, the unknown factors are when are they going to really kick in with IPTV, if they're going to continue with all of the projects -- the way that is.

So, the more DSL they sell, the better for CNX.

Thank you very much.

Simon Leopold, Morgan Keegan.

Thank you.

First, I'd like to see if you could clarify, if you categorize TELMEX as a PTT, and the question I'd like to ask about is, on trends in Asia, talking to a number of your system provider competitors, they seem to be backing off of doing as much or business in the Asian market, perhaps because of competition from the local vendors.

If you could give us some color on your thoughts on doing business in that market?

You did mention moving some of your R&D into India, but if you could drill down a little bit on your ability to sell in those markets against the local providers?

Thank you.

Let me take -- the first one is pretty easy, Simon.

TELMEX we would define as a PTT, so we would include it in there.

On the Asian trends, I think some of it goes back to the conversation we were having a little bit earlier on.

It's really about -- you know, Ciena is a specialist within the marketplace, so we are not addressing the whole market.

We are really focusing on certain applications.

So, I don't think we are terribly reflective on some of the broader, all-encompassing larger Western vendors.

We see opportunities, specifically in the larger markets in China.

Particularly for things like CoreDirector, there's really not a competitive product for CoreDirector from the Asian perspective, also within Korea, India and Japan where we've been for a long time, so we're focused on certain market niches there that we can add value to.

We look for local partners there, as well as their helpers (ph).

Setting up a direct operation is not necessarily the right thing to do in all of these spaces.

You know, the Asian system vendors, you know, are certainly going to be here and they are going to be around, and they are going to be coming across Europe into North America as well, so you've got to learn how to compete with them.

We've been able to compete with them successfully in their home markets by focusing on our core competencies and the value that we place.

Certainly some of these players are going to be real global ambitions and they are going to be successful.

Now, to clarify that point, is there a difference between how you pursue business in Asia versus how you pursue business in Europe?

You know, I think, if you were to sort summarize it, Simon, I think you'd say that we tend to be more partner-based in Asia than we would be in Europe.

Great, thank you very much.

George Notter, Jefferies & Company.

A lot of my questions have been asked and answered, but I wanted to ask about CoreDirector.

What's going on in the market for optical switching right now?

I mean, obviously there's 2 kind-of-million applications, there's metro aggregation applications as opposed to long-haul aggregation applications.

You know, if there was a period there where the market seemed to be shifting more towards metro applications and aggregation of sonet rings (ph) was a key and now, in listening to you guys, it sounds like maybe there's more activity around mesh networking.

I mean, give us a better flavor for how you see the market evolving going forward and how Ciena fits into that.

Thanks.

Sure.

I think you have to address this kind of on a regional basis, what is called G.Ason (ph), which is the automatic switched optical network, which is the kind of standards-based, mesh approach is emerging in Asia as kind of the de facto way to build new networks.

I think they've had the luxury to kind of sit back and watch different architectures evolve and have picked what they believe is the best.

In North America, it still seems to be around the metro ring aggregation, the SONET-based.

In Europe, it tends to be a mix.

You've got the BT 21CN, which is more on the mesh intelligent networking side.

You also see some applications which look more metro ring aggregation, so it really -- it's broken into a number of regional markets now.

Great, thanks.

Joe Chiasson, Susquehanna Financial.

Good morning.

Just a couple of quick housekeeping questions if I could, please?

Joe, did you give out the percentage of total revenues this quarter that came from acquired products?

I know, in the past couple of quarters, you've given that number.

I don't think we gave it.

It's 27%.

27%, okay, great.

Then Joe, also, with respect to your prepared remarks there, early on, you threw out a percentage as it relates to the TSG revenues, and I don't recall whether it was the percentage of Q2 TSG revenues that were from core transport specifically, or core transport and core switching, but the number was 65% versus 53% in Q1.

Okay -- (multiple speakers).

Can you go back and tell me what that was?

I will read you exactly what I said.

TSG's percentage of overall revenue also increased sequentially from 53% in Q1 to 65% in Q2.

Okay, great.

Okay, fine.

Thanks very much.

Gina Sockolow, Buckingham Research.

Thank you.

I just want to go back to the question about the long-term contracts.

Of the four large 10% customers this quarter, can you tell us the status of projects that are underway with them and if you have other projects that are underway with large customers that were not 10% customers this quarter but were 10% last quarter?

And (indiscernible) with their buildouts and how this affects your visibility?

Gina, why don't I take that?

You know, we've gotten now, over the course of the last few years, I think we've got all of the RBOCs in North America, all of the major carriers, we've got a lot of the major PTTs in Europe, in addition to some very large government builds as well.

I think sort of the ebbs and flows of all of that, you know, it's difficult to summarize apart from to say, you know, we've got a better visibility than we've had for a long time.

It seems to be improving, certainly, on the last couple of quarters.

We see a lot of opportunities within our incumbent customer base to sell the new products, the cross products; certainly the CN 4200 is a good example of that, where we believe we can sell it into the existing customer base.

So you know, I think we've got an enough large customer base now so that when one is digesting its deployments, as it were, we've got others that are beginning to roll out.

The skill to this is you've got to get as many of them as you can!

So I couldn't really answer any more specifically than that, Gina.

Thank you.

I hope that helps.

Thank you, yes.

Having no further questions, I'd like to turn the conference over to Gary Smith for any additional or closing comments.

Thanks, everyone, for your time this morning and for your continued support.

We are looking forward to see many of you at SuperCom next week.

Thanks very much.

This does conclude today's conference.

Thank you for your participation.

You may now disconnect.