Ciena Corp (CIEN) 2005 Q3 法說會逐字稿

Good day, everyone and welcome to the Ciena Corporation third 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, Philip.

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 with 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 fourth quarter 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 ensure we answer questions from as many analysts as possible, we ask that the sell-siders limit themselves to one question.

This morning'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'll 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.

In general with our Q3 results, I think you see evidence of our execution on a number of strategic comparatives.

In addition to releasing two new products in Q3, the CN4200 Advanced Services platform and our CoreStream regional optical transport platform, we continue to make solid progress toward a more normalized business model and operating performance.

In particular, we delivered significant gross margin improvement as a result of product mix and our ongoing efforts to lower product costs.

This progress should provide some measure of our ability to achieve our goal of a 40% or better gross margin.

I'll discuss our business in the quarter and our progress toward profitability in more detail after Joe reviews the quarter's results.

Joe?

Thanks, Gary, and good morning, everyone.

This morning we reported a third quarter revenue totaling $110.5 million.

This represents an increase of 6.4% sequentially and 46.2% year-over-year.

We had two 10% plus customers in the quarter that combined represented 26% of total sales for the quarter.

This compares to the second quarter when four customers represented 49% of total sales.

Both of the third quarter's 10% customers were U.S. customers.

One is a long haul customer.

The other purchases broadband access and aggregation solutions from us.

Domestic sales represented 81% of total revenue in the third quarter, in line with the 77% in the second quarter.

Moving now to talk about revenue contribution from our business units, revenue from our transport and switching group, or TSG, was down slightly from 68 million in Q2 to 65 million in Q3, representing 59% of the quarter's total revenue.

This group consists of core transport and core switching, multiservice access, metro transport and switching, and storage extension products.

Long Haul Optical Transport, Metropolitan Optical Transport and CoreDirector sales were the largest contributors to TSG's revenue in the quarter.

Within TSG, we saw a mix shift from last quarter, with lower long haul transport sales offset by higher core switching and Metropolitan Optical Transport sales.

Revenue from our data networking group, or DNG, increased slightly sequentially as expected.

DNG's contribution went from 5 million in Q2 to 7 million in Q3, representing 6% of total revenue in Q3, versus 5% in Q2.

Revenue from our broadband access group increased 37% sequentially from 19 million in Q2 to 26 million in Q3, representing 24% of total revenue in Q3 versus 18% in Q2.

We saw strong demand from our broadband DSL upgrade platform, the CNX 5, which continues to represent the majority of BBG's revenue.

Revenue from our global networking services business unit was roughly flat quarter to quarter at 13 million in Q3 versus 12.2 million in Q2.

Now turning to our operating results, the press release represents 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 will 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 get started.

Q3's gross margin of 34.1% was an improvement of nearly 800 basis points from Q2's 26.2%, as a result of product mix in the quarter, as well as our ongoing product cost reduction efforts.

Product gross margin increased from 28.1% in Q2 to 35.6% in Q3.

Q3's services gross margin of 22.5% was up from Q2's 11.4% and more in line with past services gross margin as a result of the mix of services revenue in the quarter.

On a GAAP basis, our operating expenses in the third quarter totaled $91.1 million.

As noted in the press release, this included 20 million of the unusual non-operating-related, or non-cash charges for the following items.

Stock compensation, amortization of intangible assets, restructuring costs, and a provision for doubtful accounts.

Let me add some color on the restructuring costs and the provision for doubtful accounts.

Of the roughly 4 million in restructuring costs in the quarter, 2.3 million was related to a work force reduction of 96 people, mostly from our Ottawa facility, the remainder of the restructuring costs results from adjustments to previously restructured facilities.

The 2.6 million provision for doubtful accounts in the quarter is related to a customer whose financial condition has changed significantly.

Adjusted for these and other non-operating, or non -recurring 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 $71.2 million.

This is flat with Q2's 71 million adjusted operating expenses, and represents a 24% decrease from the 94.2 million adjusted operating expenses in the same period last year.

It is also slightly higher than our guidance as a result of 3.8 million in accelerated depreciation expense.

This expense resulted from our ongoing efforts to reduce costs and increase our operating efficiency, as part of those efforts we have abandoned and disposed of certain idle assets that we determined had no future value.

Our GAAP net loss for the third quarter was $51 million, or a loss of $0.09 per share.

This compares to a GAAP net loss of $0.25 per share in the same period a year ago.

As adjusted for the unusual or non-operating items I discussed earlier as well as for a $1.7 million net loss on equity investments and a $3.9 million gain on extinguishment of debt our loss for the third quarter would have been 33.3 million, or 21.6 million if tax effected, or a loss of $0.04 per share.

This is at the top end of our per share guidance range we offered and compares to an as adjusted loss of $0.07 per share in the same period a year ago.

Now turning to the balance sheet, cash, short-term, and long-term investments at the end of the third quarter totaled $1.12 billion, a decrease of 73.9 million from the second quarter.

There were a number of things that effected the balance sheet this quarter, so I'll take a few minutes to walk through them.

First, as noted in the press release, during the quarter, we reduced our long-term debt with the purchase on the open market of 41.2 million par value of our 690 million outstanding 3.75 convertible notes due in 2008 for $36.9 million.

We have saved 4.3 million in future principle payments as a result of the repurchase and reduced our outstanding principle of the 3.75% converts to $648.8 million.

In addition, we recorded the 3.9 million gain on extinguishment of debt I mentioned previously, which is net of 0.4 million associated with debt issuance costs.

Our cash burn from operations was better than expected in the quarter at $39.3 million and was roughly flat with Q2's $36.6 million.

This is inclusive of our scheduled $12.9 million semi annual interest payment in the third quarter.

In addition, we had a $1.7 million net loss on equity investments in the quarter, which is the net of a loss of one equity investment offset by a gain of another.

As we said before, we are comfortable with our current cash levels and confident that we will continue to lower our operating cash burn and move toward positive operating cash flow.

Our accounts receivable balance at the end of the quarter increased to $70.6 million from the 66.5 million at the end of Q2, reflecting the timing of shipments and revenue recognition in the quarter.

Day sales outstanding in Q3 were flat with Q2 at 58.

Inventory levels ended the quarter at 51.4 million, up from the second quarter's $45.5 million.

The inventory breakdown for the quarter was as follows.

Raw materials, 21.5 million; work in process, 3.3 million; finished goods, 48.6 million; and the reserve for excess obsolescence of $22 million.

Product inventory turns were 4.9 in Q3 compared to 5.8 in Q2.

Finally, head count, our worldwide head count at the end of the third quarter totaled 1497, a decrease of 119 from Q2, in large part to the reduction in force at our Ottawa facility I mentioned earlier.

Now I will turn the call back over to Gary.

Thanks, Joe.

As I said earlier, in Q3, you saw evidence of our execution on a number of fronts.

In addition to releasing two new products in the quarter, we made solid progress towards a more normalized business and operating model.

In particular, our nearly 800 basis points gross margin improvement provides I think, summary assurance of our ability to achieve our goal of a 40% or better gross margin moving forward.

While our gross margin improvement by itself is clearly not enough, our gross margin progress combined with our continued revenue growth and our commitment to further reduce our operating expenses should provide investors with some confidence that on an adjusted basis, profitability and positive cash flow are within sight.

Apart from our business model progress, which I'll discuss further in a few minutes, we're also encouraged by initial reception to our FlexSelect architecture.

This is our vision of how the network infrastructure adapts to accommodate and facilitate the move to IP.

FlexSelect is a next generation networking blueprint for service providers.

With it, we're showing customers how they can meet their demands to network flexibility, manageability, and lower costs as they transition to packet-based networks and we're taking an aggressive position in defining how to optimally deliver ethernet and specifically layer to services.

We believe we're ideally placed in this transition with the infrastructure, experience, technology expertise, and customer base that we have.

Following, the remainder of my discussion around our three execution focus points of revenue, profitability, and costs.

Firstly starting with costs, and as Joe mentioned, our adjusted operating expenses were slightly higher than expected in Q3 and roughly flat with our Q2 adjusted OpEx as a result of 3.8 million in accelerated depreciation expenses.

Outside of that expense, adjusted operating expenses would have been down slightly sequentially and in line with our guidance.

We will continue to execute on a plan that drives towards a normalized operating model and we will reduce our OpEx going forward.

Part of that plan entails further focusing and prioritizing our investments in line with opportunity.

As we approach the end of our fiscal year and into 2006, we are prioritizing our forward investments, focusing our dollars on the most significant opportunities where we have the highest probability of executing successfully.

In addition to prioritizing our investments, we continue to pursue partnership alternatives that enable us to expand our portfolio and sales reach without adding incremental costs.

You'll hear more about our partnership efforts throughout the remainder of my comments today, as we have a number of examples in the quarter that I think point to the success of this partnership strategy.

Finally, on our operating expense reduction efforts, we will offshore resources to further reduce our costs, improve our R&D capacity, and strengthen our global market presence.

As I mentioned last quarter, we have begun now taking steps to establish a Ciena site in India and we've moved towards this with our plans during Q3.

It will of course take several quarter's transition time before these efforts begin to benefit our operating expenses, but establishing an India-based development center to augment our U.S. efforts will help us cost effectively drive continued technology and product innovations.

Beyond additional operating expense reductions, we're also very focused on driving profitability at the gross margin line.

Despite an obviously competitive environment, we were able to deliver significant sequential improvement in our gross margin in Q3 and I know there's been some question of how we would get from gross margins in the 20s to our goal of 40% plus.

And while I suspect that our progress this quarter will help allay concerns, it's probably worth spending a few minutes discussing the components of the margin improvement strategy we embarked on some two years ago.

First, of course, we're targeting new portfolio acquisitions that would carry attractive gross margin that were sustainable over time and in markets where we believed we could compete effectively.

The benefits of our actions and approach are becoming evident as product mix is increasingly driving gross margin improvement.

In addition to the external actions we took to diversify our product portfolio, much of the R&D dollars we've spent in the last 18 months has been directed at internal development efforts designed to do two things.

Number one, reduce product-related costs through reengineering and design, and secondly, drive additional changes in product mix resulting in improved gross margins, again, over time.

Firstly on our product-related cost reduction efforts, in an industry that moves as fast as ours did certainly in the late '90s, early 2000's, product lifecycles moved so quickly that companies were not always rewarded for proactively managing product lifecycles and working continually to cost reduce development efforts.

That's changed.

As a result over the last few years, we've put significantly more emphasis on engineering through a product's full lifecycle, including working closely with our contract manufacturers.

The result has been cost savings that have generated significant gross margin benefit over the last several quarters.

In addition to our product cost reduction efforts, we've also dedicated R&D dollars to internally develop and bring to market new products that we believe will help drive overall gross margin improvement, such as the two I mentioned previously.

Our CN 4200 Advanced Services platform and our CoreStream regional optical transport system.

We expect a certain amount of gross margin volatility quarter to quarter, based on product mix and volume, but we continue to drive to and plan for a business that operates with a 40% gross margin.

And in fact early indications are that our Q4 gross margin could show additional improvement from that that we've just reported in Q3.

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

Continued revenue growth is the third critical execution variable.

Similar to the last several quarters, our revenue growth in Q3 was not driven by any single customer, product, or application.

While we understand that the quarter to quarter variation we routinely experience at the product level can be frustrating from Wall Street's perspective, we're actually seeing precisely the dynamic we'd worked to create when we began to take steps to diversify and expand our product portfolio and customer base.

Our business now reflects multiple market dynamics and we believe over time this will bring a better balance to the business overall and will enable us to better anticipate and predict revenues.

In general, we've seen demand in core and metro infrastructure driven by broadband applications and the shift towards packet-based traffic.

I mentioned previously the initial positive reaction we've seen to our introduction of our FlexSelect architecture, a standards-based service oriented network architecture that facilitates flexible and adaptable managements of network services.

We believe network adaptability is emerging as a key concern for enterprises and is a competitive differentiator for service providers, as both look to evolve their networks to support and deliver new service offerings.

And we firmly believe that Ciena is ideally positioned to capitalize on this market transition.

I'll talk further about our revenue growth and opportunity across our full customer segments and enterprise, cable, government, and teleco.

Firstly on the enterprise side, Ciena's play in the enterprise market emerged as a result of a change in enterprise market demands.

Two dynamics were critical to this demand change.

Firstly, more cost effective equipment and a heightened awareness and focus on business continuity and the competitive advantages that could be driven by more powerful enterprise networks.

As a result, a growing percentage of large enterprises are looking to build their own networks and they are doing so with the desire and demand for carrier-grade service and reliability.

These enterprise networks can be as large as or in several cases larger than, some of the carrier networks that we've built.

In most cases, the enterprise opportunities we pursue result from a channel partner such as ENC, or one of our carrier channels partners.

And we continue to see opportunities emerging in some key vertical markets, including financial, retail, healthcare, and pharmaceutical.

For example, last quarter, I mentioned that the CN 4200 Advanced Services platform was in trials with major financial institutions and retailers.

I'm pleased to announce that we've recognized initial revenue on that platform during Q3 and it has been selected for deployment in the network of one of the nation's largest retailers.

Turning to our business with cable providers, while sales to cable providers represent a relatively small percentage of our overall revenue, we continue to pursue and win opportunities with this increasingly competitive customer segment, both in the U.S. and elsewhere.

During the quarter we announced our first customer win with a major international cable operator for video applications.

J:COM, that's Japan's largest cable operator, is adopting Ciena's optical ethernet platforms for the transport of Video on Demand services.

The J:COM win is a case that emphasizes the success of our partnership strategy as it came as a result of a relationship with a Japanese network solutions provider.

In addition, we're beginning to see initial traction from CN 4200 in cable applications where the need for high speed data is also driving demand for high reliability ethernet transport and the transition from Sonic and proprietary networks to packet-based networks.

We're also pleased with the progress we've made with our government business.

Beyond our ongoing deployment with DISA and the GIG-BE project, during the quarter we highlighted our commitment to government customers with the formal announcement of Ciena Government Solutions, Inc., a subsidiary with dedicated resources and networking expertise to address the evolving communication requirements of the government marketplace.

During the quarter, we also announced that we'd established a Government Advisory Board and a partnership with the Presidio Corporation.

Presidio is a leading network solutions provider to enterprises, including United States government agencies and large businesses and our partnership with them has already resulted in new government deployments.

In our traditional service provider customer base, we're positioned to benefit from the next significant shift in network infrastructure as carriers look to optimize network for packet-based traffic and services and we're seeing a number of demand drivers from carriers.

Increased access traffic volume and growing broadband demands are driving bandwidth demands particularly in Europe.

We're also seeing indications that bandwidth in North America may be constrained in some spots, as we've had two quarters now where we've seen capacity-related orders from customers who have been quiet for sometime.

In addition, we've also seen signs of renewed interested in mesh networking, as service providers facing high traffic volumes contemplate current network resiliency, security, and escalating operating costs look to automate their core networks.

Finally, we're beginning to benefit from the drive towards packet-aware networks and the infrastructure required to support that transition, both in metro and core applications.

For instance, video in the local networks will fundamentally change how those local networks are built and will require a significant transition from the SONET/SDH networks currently deployed.

We're confident that the packet-friendly nature of our FlexSelect architecture and the demonstrated capabilities of products like CoreDirector give us a significant competitive advantage in all of these demand scenarios.

A look at our service provider wins announced in the quarter emphasizes the diversity I think, of our revenue and growth drivers.

In addition to our J:COM win which I mentioned previously, we also announce a Long Haul Optical Transport win at T-Online, our first entree into Deutsche Telekom.

And a DN multi-service EDGE switch win at StarHub in support of their 3G mobile services rollout.

We had an additional service provider win that wasn't formally announced with the press release, but I'm pleased to announce today our deployments at France Telecom.

Ciena's CoreStream Long Haul Optical Transport DWDN solutions were selected by France Telecom in the scope of its July, 2004 top sourcing program tender.

This selection followed initial equipment installation in France Telecom's network in April, 2005.

Wrapping up on the customer-specific comments, I realize many of you are hoping for an update on our selection of one of BT's preferred suppliers for their Century 21 network.

What I can tell you at this point is that negotiations are ongoing and we continue to be optimistic about Ciena's role in 21-CN.

Touching briefly on our broadband opportunities, we were very pleased with another strong quarter of DSL demand in North America and a corresponding increase in our CNX 5 shipments.

I'll caution that we will continue to see some variation quarter to quarter in this business.

But overall, it does appear that carriers see the competitive necessity of leveraging their existing copper infrastructure in addition to their fiber expansion plans.

As a result, our access business is healthy and cash flow positive and we expect it to stay that way.

In summary, as we've said for the past several quarters, there is clearly more work to do, but we are making good progress.

As noted in the press release, we're seeing what we believe is some softness in order patterns as a result of customer summer holidays, but overall, the volume of the opportunities we are pursuing continues to grow.

I'll reiterate what I said on last quarter's conference call.

I think one of the hardest things to grasp about Ciena's story at this point is that the progress we're making is the result of the combination of the efforts we've had underway for some time that are coming together to drive overall improvement.

We absolutely have more work to do, but we are clearly demonstrating significant progress in revenue growth and gross margin improvement.

On revenue, we've established ourselves as an incumbent supplier at some of the largest carriers in the world.

We continue to win new deals and to look to expand our market opportunity through partners who will enable us to tap new markets with minimal added expense.

We're optimistic about the growth trajectory for CN 4200 and we're confident that our FlexSelect vision is resonating very well with customers.

On gross margin, we've taken a number of steps to set the stage for continued gross margin improvement.

We're driving changes in product mix with our product portfolio, and we're focused on reducing product-related costs.

We acknowledge we have some work yet to do on our operating model and as I said earlier, we're committed to further operating expense reductions and we'll continue to execute on a plan that drives towards a more normalized operating model.

By executing simultaneously against all of these key variables, we're driving more meaningful, sustainable improvement and we're closing the gap on profitability.

And I believe you'll see continued evidence of our progress in the coming quarters.

We'll have the opportunity to discuss our progress in more detail at our upcoming analyst day currently planned for October the 11th in New York City.

More information about the event will be made available in the coming weeks, including a detailed agenda.

With that, I'd like to hand over to Joe to walk through the guidance for Q4.

Thank you very much, Gary.

Before I begin to offer our guidance I will remind everyone that the statements Gary just made and those that I am 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.

As stated in the press release, we expect that revenue in the fourth quarter will increase by up to 5% sequentially, which would translate into year-over-year growth of up to 41%.

In terms of Q4's revenue mix, we expect lower DSL upgrade related revenue to be offset by increases from other business units.

While our forecast are susceptible to a certain amount of churn at this point, we expect core and metro optical applications to drive Q4's revenue growth.

Gross margin is difficult for us to predict with any accuracy as it ultimately depends on the combination of volume, product mix, and the effects of our ongoing product cost reductions.

That said, we expect Q4's gross margin will be flat with just slightly better than Q3's 34.1%.

We expect overall operating expenses in Q4 exclusive of any unusual or non operating items will be down from Q3 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 into '06.

We expect other income expense in Q4 will be income of approximately $1.1 million.

We estimate Q4's share count at approximately 578 million total shares.

As a result, we expect that exclusive of unusual or non-operating items, our adjusted net loss for Q4 will be in the range of $0.03 to $0.05 per share.

Finally on cash, we expect our working capital needs will increase in Q4 primarily due to an expected increase in accounts receivable.

However, given we will not be required to make an interest payment in Q4, we expect our operating cash use in Q4 to decrease sequentially.

Now, operator, we'll take questions from the sell-side analysts.

Thank you, sir. [OPERATOR INSTRUCTIONS] We'll take our first question from Ehud Gelblum with JP Morgan.

Hi, good morning.

Just a couple of very quick questions.

Just to confirm, Joe, in the cash burn analysis that you have gone over before, the 39.3 million, that includes the interest payments, so if we were to exclude the interest payment this quarter, you would be in the 20s?

Just about, not quite, but, yes it, did include the interest payment.

Awesome.

When you gave guidance last quarter, did you expect the revenue breakdown to be -- you basically hit the guidance fairly well. 6.4%, you were guiding to -- up to 5%.

Were you expecting the optical to be down the way it was and the DSL to be as strong as it was, or were you expecting a slightly different mix?

I'm trying to get a sense as to how lumpy DSL is with respect to how you can forecast it?

This is Joe.

It was pretty close to what we had thought about.

The margin is up because of that, so it's a little bit hard to tell.

There is a fair amount of movement.

It's a function of rev rec and what's out there to be recognized as rev rec.

You can go in with a reasonable amount of being able to branch that margin number, if that's where you're going, but, again, it comes right down to the rev rec at the end of the quarter and what you get and what you don't get.

We go next to Brantley Thompson with Goldman Sachs.

Hi, guys.

Hi, Brantley.

I was wondering if you could -- you've got a number of products that you've introduced over the last couple of years, and a number of initiatives.

I was wondering if you could just go through and remind us what the kind of potential annual run rate and revenues in some of these businesses are so we can get a sense, a sense of the potential revenue growth opportunities that are going to be out there?

Thanks.

I thin it's a little too soon on some of the newer platforms, but I think if you look at the FlexSelect architecture, that addresses certainly the first articulation of that, the 4200 addresses sort of converged metro ethernet space and I think we're seeing that market go very, very quickly now, both in terms of the traditional metro and I think moving towards the ethernet piece.

We've already won Swisscom, a number of enterprise customers, and we've got some potential with some very, very large carriers.

So I think in overall terms, Brant, I think the opportunity on the FlexSelect is hundreds of millions in terms of the market opportunity there.

Steve, any other?

Want to summarize any other--?

I think the way you can look into it, Brant, is you want to look into where the applications that the boxes are selling to and pretty much all the carriers are faced with a transition plan from today's kind of TDM centric networks over to the packet-centric ones that they have to get to and that really means transitions to ethernet services and such and that's really the target market and that's FlexiPort, the 4200, some of the changes that we've made that CoreDirector and CoreStream all really address.

We think we're positioning all of the products right into the sweet spot of where the carriers are having to migrate.

We go next to Paul Silverstein with Credit Suisse First Boston.

A couple of housekeeping questions before some real questions.

Can you tell us how many new customers and how many total customers in the quarter?

Paul this, is Joe.

We've kind of stopped doing that kind of stuff, so since we have stopped, the answer is not right now.

But with the enterprise business, it gets really, really difficult because it goes up and down and it's all over the place.

Okay.

Mostly it's going up.

Joe, can you tell us either in percentage or dollar terms what government and enterprise are?

Not at my fingertips, no.

Okay.

On the gross margin outlook, if I understood your comments correctly, the CNX 5, which has very healthy gross margins, you're expecting to be down in terms of contribution.

And yet you're expecting gross margins to be flat or better.

It would seem somewhat counter intuitive.

Is the strength coming from the new 4200 product?

What accounts for your outlook that gross margins would be flat or better if CNX 5 is down?

Paul, this is Gary.

I think what you're seeing is cost reductions on the transport side, on the metro side, the new 4200 coming in.

I think it's back to what we're talking about on the call.

We've got a more balanced portfolio now and now we've got the cost reductions beginning to kick in, particularly on the transport and metro side.

We're less susceptible to changes in the product mix.

You are still susceptible to it, you're just less susceptible to it.

I think this quarter is a good example of that and the other element is, even within the transport side, the mix within there of channels versus chassis so I think you're starting to see a more balanced view going forward, which even with the product mix profile of DSL being down, we can still get the sequential growth in our gross margins.

We go next to Michael Genovese with Citigroup.

Great, thank you.

Congratulations on the France Telecom win and the gross margin in the quarter.

Thank you, Michael.

When I look at the model and look at the various lines to play around with, the most sensitive line or certainly one of the most sensitive lines is it's still the OpEx line, in many cases more so than the revenue and gross margin at this point.

So I mean you gave us some talk about efficiencies and plans to further reduce costs, but we don't have any concrete targets to model to or to think about or measure your progress against.

I mean can OpEx get to 65?

Can it get to 60?

How should we think about this?

Michael, I mean I think you can understand the sensitivity of that particular area, so that's why we're not talking about particular timings and numbers around that, Mike.

I understand that's a variable that would be very helpful to you.

We've tried to articulate that we will continue to reduce their operating expenses and articulate the initiatives that we've got in place to do that, but we're not going to be specific at this stage.

We go next to Nikos Theodosopoulos with UBS.

Yes, thank you.

Just a couple of quick questions.

You mentioned that the receivables, DSL's will go up next quarter.

Can you elaborate on that?

Hi, Nikos, this is Joe.

It's just the way the shipments are scheduled.

It's predominantly what it's all about, Nikos.

Other than that, nothing more.

We go next to Marcus Cooper Smith with Lehman Brothers.

Good morning, guys.

Good morning, Marcus.

In terms of the comment about the orders for the July quarter I just want a little bit the comment about the summer seasonality likely being the driver there.

Can you give us some sense, is that across all geographies or more U.S. in nature and what products would you say were most effected?

I think it's pretty clear you talked about DSL likely will be down in the October quarter, but should we assume it's also more than that?

I think it's a general comment that we've seen in August.

I wouldn't say it's particularly attributed to geography.

Our fourth quarter visibility is strong.

It's just that we're seeing some softness in orders currently that we believe just attributed to customers basically being on holiday.

It's too early to say what effect, if any, this softness will have on future periods revenue and as I said, our fourth quarter visibility is strong.

I think you're seeing cycles on the DSL side anyway that we've seen during the last year and I think that's what we're seeing now from a seasonal perspective.

We go next to Tim Daubenspeck with Pacific Crest Securities.

Just to clarify, I have two questions.

The first one just to clarify, so the softness commentary is just normal summer seasonal softness, something you kind of expected going into the quarter?

I think, yes, I would describe it as we're attributing that right now just to the holidays, just people not being around in terms of the customer piece.

We don't see any more than that.

We see our pipeline connectivity continuing to grow.

All right.

Then you talk about the head count reduction in Ottawa.

Talked about kind of CNX 5 doing well.

Can you give us an update on the broadband load carrier, does the head count reduction indicate any kind of future for the broadband load carrier or are you still confident that there is an opportunity there?

We're still confident that there's absolutely an opportunity there, Tim.

We're just aligning the resources to some of the opportunities that we see right now.

We go next to Samuel Wilson with JMP Securities.

Good morning.

Just a generic broad macro question for Gary.

It sounds like with J:COM, BT, and FT, the international business is somewhat picking up, but it's still a relatively low percentage of revenues, so I wanted to get a sense, were you winning business there on kind of a trial basis, a field deployment basis, are you at the front end of maybe some larger deployments, just a sense of what's going on there and what you expect in the future?

I think our international business, I'll describe it as we're not getting our rightful amount of revenues from that.

I think what you're seeing is we're having the customer wins.

It takes a while to get to meaningful deployments with some of the larger carriers and I think that's exactly what you're seeing.

The important thing is that we're winning.

I think I would characterize it as we're at the front end of that, Sam.

Certainly with the likes of Deutsche Telekom, France Telecom, BT, et cetera, we're at the front end of that.

We've done well to get the wins, but that's got to translate into revenues and large scale deployments.

We go next to Simon Leopold with Morgan Keegan.

Thank you.

There are two things I wanted to ask about.

One was going back to the Ottawa facility closing, could you clarify, was that a business related to the Catena or the Akara acquisitions, and if it is Akara, maybe you could touch on what the trends are there, and then the second thing I wanted to ask about is we talked a lot today about the 4200 products.

Obviously the outlook is upbeat.

Could you help us understand where you are today in this quarter and maybe a little bit about the very near term outlook of what the October quarter looks like.

What's the baseline of how much revenue, some kind of ball park, of where we're starting?

Thank you.

Simon, let me just correct one thing.

We did not close the Ottawa facility.

We did have a reduction in head count.

It was predominantly on the broadband folks, from the Catena acquisition, focused on one of the product line.

We've still got a lot of strategic capability up there on the broadband side and also on the storage side with the CN 2000, both of which feature in our plans moving forward very strongly.

On the 4200, we recognized -- we've just launched the product, we recognized our first revenues in Q3.

We think that clearly will sequentially go up in Q4 and continue to grow, but we're at the early stages of that product availability.

We go next to Cobb Sadler with Deutsche Bank.

Thanks a lot.

I had a couple questions.

First off on partnerships, so you've got enterprise partners now.

Would you consider for the DN product line pursuing any European partners on the wireless side?

And then second question is on BT.

Looks like you have good guidance going into Q -- or good visibility going into Q4 and then we've got a quarter after that that you're seeing maybe some softness now, but when do you think BT might actually start contributing revenue given your history with the Company and they were a 10% quarter a couple quarters last year?

Hi, Cobb.

First of all, on the DN side and for those kind of application, the answer to that question is yes.

I think it's looking for certainly solution providers that can encompass some of the point technologies that we've got into broader solutions as well, particularly international and into segments that we're -- that we're currently not addressing.

Specifically regarding the BT, they have asked us not to comment on timing or dollars, so unfortunately, I have to, I have to honor that.

We go next to Timm Bechter with Legg Mason.

Thank you.

Guys, you mentioned the changes to networks to support TV traffic.

I guess you're talking about triple play there.

Can you talk about how Ciena can benefit from those network changes and how the various last mile approaches, fiber to the prem, fiber to the network, or to the node, excuse me, can impact those opportunities or do they have any bearing at all?

Sure, they have tremendous impact because what that really translates into is increasing command for capacity moving right back into the networks.

And so what you you'll see is the way that we're positioning the access portfolio, the CNX 5, the DN for aggregation, as well as additional capacity on ethernet services and such is all tailored into that application space.

We have a product, a 4350, which is the real first purpose-built package streaming ethernet switch.

It's really optimized for the delivery of video over ethernet effectively and so we think that's going to have a major impact into our business.

It's a certainly effective feature that we're putting onto the products today.

We go next to John Marchetti with Morgan Stanley.

Thanks.

Hey, Joe, just wondering if you could talk a little bit about the repurchase of the debt.

It's not really due until '08.

Just curious as to why that amount and why now in terms of what you were doing there, and then, Gary, if you could just elaborate on your comment a little bit about the fact that you're seeing some bandwidth constraints.

Is that just with those couple of customers that have been quiet for a while?

Do you think that's a little bit more widespread, just if you can add anything there, that would be helpful.

Hey, John, this is Joe.

On the debt side, it's just a question of opportunity.

The prices were nice and it was a good deal for both sides.

So we took advantage of it, other than that, there's nothing else behind it.

It's pretty simple.

On the bandwidth issue, John, I think we started to see it in Europe.

I think before the U.S. and I think that's largely the large part of 3G that's being deployed and the access networks in Europe and also they didn't build out I don't think as aggressively as we did in the bubble as it were on the transport side.

We began to see that in Europe, sort of a few months ago and I think we're beginning to see that a little bit in the U.S.

It's spotty.

I wouldn't want to overstate it.

I think it's -- as Steve talked about, people are deploying more broadband and clearly that's beginning to have an impact in the core of the network.

Folks have not really spent much on the core of the network, as we're painfully aware over the last few years.

I think you're beginning to see some pressure on the core of the network.

I'd describe it as spotty.

We're seen it in two or three larger customers that we've not really done a lot of business with over the last few years.

So it's encouraging, but we don't want to get too carried away yet.

We go next to Robert Tango with Lazard.

Thank you, good morning.

Gary, just based on some of our discussions this summer with some of the regional bells, they are thinking about looking at some new architectures for optical eye drop moxes, reconfigurable eye drop moxes, and they haven't stated too much about what their plans would be or how they may integrate these systems into their networks in the future, but our sense is they are at least thinking about it.

I would assume obviously with your relationship, the technology, the systems level, the certain pathways here you could take with regional bells, are there any signs, I guess just from a macro level, can you comment at all in terms of what some of the regional bells are thinking about, how Ciena may be playing a role in some of the developments?

Steve, do you want to--?

Sure.

The rodum (ph) is an interesting approach to the way they want to build networks.

What a rodum really allows a carrier to do is avoid a lot of the complexity of planning for capacity.

The reconfiguration is in there not so much because you're going to be redirecting 10 gigabit channels every five minutes or so.

It's really in there so that you can put a network in place, have it auto configure, have it understand the connectivity patterns and such and it really simplifies the provisioning cycles quite dramatically.

The rodum in the Ciena portfolio was actually developed originally under CoreStream as what we call select optical edge op.

We actually had the first shippable rodum in the industry and this goes back several years now.

We're moving some of those technologies into the metro space as well, 4200, for example, will have rodum capabilities.

We actually can do the feature of automatic connectivity and avoid the planning cycles today with 4200.

We implement it using electronic switching.

It turns out to be a very cost effective way to start these network builds and that's one of the key features, if you will, that the carriers are finding attractive.

We're going to be adding a lot more of that kind of flexibility into the portfolio going forward because what it really is is a way for them to avoid having to spend planning cycles up front it's that cost reduction feature for them.

We go next to Vivek Arya with Merrill Lynch.

I have I two questions perhaps related.

The first one is what would be the impact on your top line and gross margins when the big RBOCs start going to fiber to the home and fiber to the node, that is away from the CNX side and perhaps related to that is Gary, from what you see and what you've been told today, do you expect cash flow and EPS break even in fiscal '06 or do you expect that to be a fiscal '07 event?

Thanks.

Vivek, let me take the first question.

I think that you described it correctly as a transition.

What we're seeing is strong DSL right now will be somewhat cyclical because that's the weapon that they have got in hand right now to get market share and customers and we're engaged with all the RBOCs, bear in mind we provide a lot of the aggregation through DN, et cetera and the transport to a lot of those RBOCs, so all access traffic is good traffic as far as we're particularly concerned.

Also with the CNX 5, you've got some significant architectural extensions that we're able to do on that platform to allow it to participate from an IP perspective and a high capacity perspective at the edge of the network as well.

So don't presuppose just because it's fiber to the node, IPTV that CNX 5 goes away.

On the cash flow one, Joe, do you want to--?

Vivek, this is Joe, how are you?

On the cash flow front, for the past year or so that question has been one that's been very popular, but we have avoided answering it and despite the fact that we are now getting close, I'm going to continue to avoid to answer it, but I got to point to a couple things.

One is, we are getting closer, we are starting to make strides.

The revenue lines moving and the gross margin line is moving and we feel really good about that.

Now we've started to get the OpEx line going down again, as the prepared comments said we're going to make reductions into '06.

In all probability we'll continue to make them in '06.

You just got to take that kind of information.

We've tried to demonstrate what we're doing by the words that we're using and I think we have been, so you just got to hang in there and stay tuned.

We go next to Joe Chiasson with Susquehanna Financial.

Good morning.

Two questions, if I could, please.

Joe in, terms of the revenue this quarter, did you give the percentage of the revenues from acquired products?

Joe, this is Joe.

No, we did not.

We don't -- we haven't done that in quite a while.

It was somewheres in the mid-30s off the top of my head.

Okay, and then, Gary, I'm wondering if you could comment a little bit on the trends that we're seeing with respect to the access group there and specifically the revenue pattern for the CNX 5.

I guess I'm not of the philosophy that the DSL stuff is going to just tank as soon as the fiber and the loop stuff starts to move further along, but I'm just wondering here, we saw the CNX 5 revenue pattern in the mid teens there for three quarters, then it bumped up to around 20 million last quarter and then 26 million this quarter.

I'm just trying to reconcile that with the macro DSL environment here in North America.

I guess what I found surprising about this quarter was the strength kind of came in Q2, which is a seasonally down quarter.

So I'm just looking for some better understanding as to what's going on there.

Yes, I think what's gearing some of these things is the various promotions and how aggressive the various RBOCs get with their DSL promotions and the timing of that on our revenues because they tend to carry some stock on that, is not always directly connected.

So I think that's why you're seeing some lumpiness in it as well.

So I think it's classically, you've got to view that over a period of quarters I think to get a more holistic view of what's going on.

I would agree with you Joe, we're also of that opinion as well.

I think DSL will be around for a long time.

It's a very cost effective way of customer capture and one that's, from an architectural point of view is very well defined and they can execute on, but I think also as I mentioned, I think in one of the previous questions, there's a lot of things we can do with that CNX 5 in terms of upgrading the capability of it to be able to participate in the fiber to the node and the IPTV type applications as well.

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

Yes, thanks.

I just had a couple of questions really on the margins.

In terms of the product gross margin expansion, would you give us a sense of how much of that was due to the government-related GIG-BE product maybe being weak in the quarter and related to that, are we substantially done with the GIG-BE buildout now?

Secondly, maybe you could give us some more color on what drove the services margin expansion.

Thanks.

Hasan, why don't I take that.

On the product side, we continue to roll out the GIG-BE network.

I think the main -- it's difficult to tell because it's a top secret network, so difficult to tell the exact timing of it, but we're continuing to roll out that network.

I think the gross margin improvements really around combination of product mix within transport, cards versus chassis.

I think it's also about the product mix, things like CNX 5, et cetera, it's also around cost reductions coming through on the transport and metro side.

It's a combination of all of those things.

Services, the margin improvement, I'd describe it as not improvement.

Go back for where we expect it to normally be.

It was unusually low last quarter, is how I would describe it.

So we expect this to be a sort of normalized margin for our services.

It's in line where it's been in the past.

We just had an unusual services mix last quarter, it was more than that than anything else, Hasan.

We go next to George Notter with Jefferies & Company.

Hi, thanks, guys.

Wanted to ask about the MCI deal.

I think last quarter you guys mentioned that we weren't even halfway through that rollout.

Is that still the case, are we farther along?

Where are we on that front?

Then also on France Telecom, I assume -- I believe you took revenues last quarter on that.

I assume you did as well this quarter.

If you could confirm that, that would be great.

Thanks.

MCI's progressing and think there's opportunity for other products and platforms as we start to roll that out as well.

I think that's going well and continuing.

On the France Telecom side, yes, we did recognize some revenue in Q3.

We go next to Tim Long with Banc of American Securities.

Hi.

This is Chinis Liu calling in for Tim Long.

Actually I have a question regarding your DN group and then in the July and April quarter was actually seasonal weak.

Do you still anticipate that your October and January quarter will be strong?

And can you also comment a little bit about the gross margin?

Are they strong or are they relative weak?

Let me try and answer that, Chin.

I wouldn't describe the DN specifically as being seasonally weak and I don't want to overplay that.

We've not seen seasonal stuff in our business before.

All we're saying is that we haven't seen many orders in the August period and we think that's because a lot of people are away on vacation.

I really don't want to overplay that.

As I said, I think our fourth quarter visibility is strong.

Our gross margins were up significantly this quarter and I think as Joe guided to they are going to be flat to up next quarter as well.

So I mean I think that addresses the -- I think that addresses the issue.

That concludes our question and answer session.

At this time, I would like to turn the call over to senior management for any additional or closing comments.

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

As I mentioned earlier, we'll be in New York next week at a financial conference and we're looking forward to seeing many of you then and at our analyst day in New York on October the 11th.

Thank you.

That concludes today's conference call.

Thank you for your participation.

You may now disconnect.