Ciena Corp (CIEN) 2006 Q1 法說會逐字稿

Good day, everyone.

Welcome to the Ciena Corporation first quarter 2006 results conference call.

Today's conference is being recorded.

At this time for opening remarks and introductions i would like to turn the call over to Chief Communications Officer, Ms. Suzanne DuLong.

Please go ahead.

Thanks, Gwen.

Good morning, and welcome everyone.

I am 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 our fiscal second quarter and Joe will wrap up our prepared remarks with guidance for Q2.

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

To ensure we answer as many questions as possible during the time allotted for this call, we ask that sell-siders limit themselves to one question.

This morning's press release is available on National Business Wire and FirstCall, and also on Ciena's website at ciena.com.

Before I turn the call over to Gary, I will remind you 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-K filed with the SEC on January 12.

We have until Thursday, March 9 to file our 10-Q for our first fiscal quarter, and we expect to do so by then or before.

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.

With our Q1 results, we again demonstrated evidence of our execution and focus on driving operating performance improvements.

In addition to our eighth sequential quarter of revenue growth we again delivered gross margin improvement and lowered our ongoing operating expenses.

Overall, we're tracking to plan, and we continue to see signs of improving market strength across our portfolio and solutions set.

And we believe that our strategy, our investments, and the resulting changes in our business have positioned us to take advantage of a market opportunity that, for the first time in many years, is growing as a result of fundamental demand drivers.

I will discuss our business in the quarter, and our progress towards profitability and earnings growth in more detail after Joe reviews the quarterly results.

Joe.

Thanks, Gary, and good morning, everyone.

This morning we reported first quarter revenue totaling $120.4 million.

This represents an increase of 1.9% sequentially and 27.1% year-over-year.

There were three 10% plus customers in the first quarter that combined represented 45.3% of total sales.

All three customers purchased access gear, long distance and metropolitan optical transport solutions.

One also purchases our DN multi-service switching product, and another was the single 10% customer in the fourth quarter.

U.S. sales represented 85% of total revenue for the first quarter up slightly from the 78% level in the fourth quarter.

Moving now to talk about quarterly revenue contribution from our business units, revenue from our transport and switching group, or TSG, increased slightly sequentially, from $74.1 million in the fourth quarter, to $74.9 million in our first quarter, representing 62% of the quarter's total revenue consistent with fourth quarter.

This group consists of core transport and core switching, multi-service access, metro transport and switching, and storage extension solutions.

Long-haul optical transport and core switching both increased sequentially, and were the largest contributors to TSG's revenue in the quarter, representing roughly 47% and 19% of the group's total revenue respectively.

Metro optical transport ran a close third, representing roughly 16% of the group's revenue.

For the third quarter since its launching the third quarter of '05, we also took revenue from our CN 4200 advanced services platform.

And while it is not yet a meaningful contributor to overall revenue, we're pleased with the traction and ramp of this product which broke through the $2 million mark in the quarterly revenue and shipping into all of our customer segments as well as through several channel partners.

Revenue from our data networking group was flat at $6 million in the first quarter representing 5% of the total revenue.

Revenue from our Broadband Access Group increased slightly as expected from $22.3 million in the fourth quarter to $25 million in the first quarter representing 21% of total revenue.

Revenue from our global networking services business unit decreased slightly quarter to quarter, from $15.3 million in the fourth quarter to $14.5 million in the first quarter and represented 12% of total revenue.

Turning to our quarterly operating results, the press release includes a GAAP-only presentation of our results as well as detailed information about the adjustments that, as management, we made to Ciena's GAAP earnings in our analysis of Ciena's ongoing business.

In general, these adjustments which are identified in the table in the press release share one or more of the following characteristics: they are unusual, and we do not expect them to recur in the ordinary course of business, they do not involve the expenditure of cash, they are unrelated to the ongoing operation of the business in the ordinary course, or their magnitude and timing is largely outside of our control.

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.

The first quarter's gross margin of 41.9% improved 200 basis points from the fourth quarter's level of 39.9% as a result of our ongoing product and manufacturing related cost reduction efforts as well as product mix in the quarter.

The first quarter's gross margin includes a charge of $300,000 for 123-R related equity based compensation expense.

Product gross margin increased from 42.2% in the fourth quarter to 43% in the first quarter.

Our services gross margin also increased from 24.5% in the fourth quarter to 33.9%.

Service gross profit benefited from an unusually favorable mix of deployment service engagement with higher than normal margins as well as higher margin related training related revenue.

We expect our global networking services related to business to generally track closer to the 20 to 25% gross margin range.

Turning to operating expenses, on a GAAP basis our operating expenses in the first quarter totaled $65.6 million.

In addition to the first time FAS 123-R related equity based compensation expenses of $3.5 million, the quarter's GAAP operating expenses reflect non-operating related or non-cash charges for the following: amortization of intangible assets, restructuring costs, a credit on long lived asset impairments, a recovery of doubtful accounts and a gain on a lease settlement.

Let me add some color on some of the larger of these items.

Of the $2 million in restructuring costs in the quarter, roughly 1.5 million was attributable to work force reductions we discussed last quarter.

The $6 million gain on the lease settlement came as a result of our early lease termination of an unused facility in Fremont, California.

The $2.6 million recovery of doubtful accounts was related to a single customer.

Adjusted for these and other non-operating or non-recurring charge detailed in the press release our R&D, sales and marketing and G&A expenses for the quarter, exclusive of the stock compensation, costs would have been $62.4 million.

This is down 8% from the fourth quarter's total of $67.5 million.

The first quarter's $6.3 million GAAP net loss or, a loss of $0.01 per share, also reflects a $733,000 loss on equity investments and a $6.7 million gain on extinguishment of debt.

The gain on the extinguishment of debt came as a result of our debt repurchase which I will review in more detail shortly.

This compares to a GAAP net loss of $57 million or a loss of $0.10 per share in the same year ago period.

Prior periods' GAAP results do not include the impact of FAS 123-R but do include share based compensation expense recognized in accordance with APB 25 as interpreted by FASB interpretation No. 44.

Exclusive of the $3.8 million 123-R related compensation expense, our GAAP results for first quarter of '06 would have reflected a loss of $2 million or break even on a per share basis.

Adjusted for the unusual or non-operating items I discussed earlier including 123-R related compensation expense as well as APB 25 related share based compensation expense, our loss for the first quarter would have been $8.7 million or $5.5 million if tax affected or a loss of $0.01 per share.

This is better than the per share guidance range we offered and compares to an adjusted loss of $0.05 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 fourth quarter totaled $961.6 million representing a quarter to quarter change of $131.9 million, of which roughly $32 million was used for operating purposes.

Of that $32 million operating cash, roughly $18 million was associated with increased inventory to support our future demand, $12 million was associated with the early lease termination of our unused Fremont, California, facility, and $11.5 million was used for our semi-annual interest payment.

The balance of the cash in-flows and out-flows were associated with other general operating activities.

In addition, we used $98.8 million to repurchase $106.5 million par value of our outstanding 3 and 3.75 convertible notes due in February of 2008.

With this purchase, we reduced our outstanding principal on these convertible notes to $542.3 million.

Our accounts receivable balance at the end of the quarter increased to $81.1 million from $72.8 million at the end of the fourth quarter in part as a result of orders shipped toward the latter part of the quarter.

Day sales outstanding in the first quarter were 61, up from the 55 level in the fourth quarter.

We expect our DSOs to increase in the second quarter and during 2006 a result of what we anticipate will be a larger percentage contribution from our customers outside of the United States who generally have longer payment terms.

We expect our DSOs going forward will be in the range of 65 to 70 days.

Inventory levels ended the first quarter at $64.4 million, up as expected from fourth quarter's $49.3 million as a result of purchases made to support demand.

The inventory break down for the quarter was as follows: raw materials, $24.3 million, work in process $3.5 million, finished goods, $58.8 million and a reserve for excess and obsolescence of $22.2 million.

The largest increase came in finished goods, which was up roughly 23% from the fourth quarter.

Product inventory turns were 3.7 in the first quarter down from 4.8 in the fourth quarter; as expected given the anticipated and actual increase in inventory.

As a reminder, finished goods inventory for us generally represents equipment awaiting revenue recognition as opposed to equipment awaiting shipment.

We expect the second quarter's inventory levels to increase from the first quarter as a result of purchases we'll be making to support demand and as a result of shipments on which revenue recognition will likely be pending.

Finally, head count.

Our worldwide head count at the end of the first quarter totaled 1,442, a decrease of 55 from the fourth quarter.

And now I will turn the call back over to Gary.

Thanks, Joe.

We continue to execute on a plan that has us simultaneously driving revenue growth, gross margin improvement and operating cost reductions.

As I noted previously during Q1, we delivered our eighth sequential quarter revenue growth and our fourth sequential quarter of gross margin improvement as well as meaningfully lower ongoing operating expenses.

In addition to improvements in our financial performance we continue to see evidence of improving market strength as carriers look to converge disparate networks and offer bundled video, voice and data services, as enterprises look for enhanced network reliability and security and the ability to address industry-specific applications, and as more and more networks look to packet friendly carrier Ethernet as converged enabler.

We're gaining increasing confidence overall that our network specialist strategy and our vision for network transition has positioned us to capitalize on these trends.

With our FlexSelect architectural vision we're showing both service provider and enterprise customers how to get unprecedented network flexibility, manageability and lower costs, as they transition to packet based networks.

We're also taking an aggressive position in defining how to optimally deliver Ethernet and layer 2 services.

The initial traction we're seeing for our CN 4200 FlexSelect Advanced Services platform provides tangible evidence, we believe, that our vision is resonating.

Not only is this product part of BT's 21st Century Network but it halls also been deployed by Swisscom, and during Q1 we also announced its selection by Slovenia'sT-2 for a new nationwide next generation VDSL network and by ProgressTelecom in the United States for 10G DWDN metro and regional transport.

Ciena's key differentiator has always been the practical application of technology and an appreciation of the business needs of our customers, and this continues to be a fundamental part of our approach to the market.

We expect a significant portion of our 2006 revenue growth will come from existing customers, where we're leveraging our incumbency and proving our value as a strategic partner to them.

With service providers, our recent announcement with Telmex is an excellent example of this.

As many of you may remember, we started selling our CoreDirector multi-service optical switch to Telmex several years ago.

As a strategic vendor to Telmex, we're now providing the value of our FlexSelect architecture including CoreStream agility long haul optical transport for scalable capacity, design flexibility and network automation across the Telmex network.

Touching briefly on our other customer segments in the government space, specifically, over the last year we have worked to enhance our support for government customers with a government-dedicated subsidiary and advisory board.

As a result of our actions and high profile government activity like GIG-BE, we've begun to build significant brand awareness in this important market, and this quarter we announced we expanded our involvement with the U.S.

Department of Energy, with product deployment at both Oak Ridge National Laboratory and the Fermi National Accelorator Laboratory.

Finally, in the enterprise market, capacity demands for bandwidth-intensive applications and business continuity concerns are driving forces behind enterprise activity.

And while still a small overall percentage of our business, enterprise users are more and more demanding extreme network reliability and are turning to carrier class solutions, like Ciena's, to address general business continuity applications as well as a variety of industry-specific applications.

This is particularly true, I think, in the financial, health care and retail verticals, where we're getting involved with enterprise build through our service provider partners, as well as through channel partners like EMC.

For instance, in healthcare: Ciena's adaptive LAN solution enables HIPAA compliance, remote storage extension and picture archiving communications systems.

Recently announced healthcare users include UC Davis Medical Center, Trinity Health and the Children's Hospital in Denver.

Whilst we are seeing signs that the overall market is improving, we clearly still have work to do to continue to drive operating performance, and I will spend the remainder of my prepared remark addressing this topic.

Firstly let's focus on gross margin, and as Joe noted we delivered gross margin improvement for the fourth straight quarter.

I think we've consistently stated our goal to return Ciena's business to one that operates with a gross margin of 40% or better.

Delivering a first quarter better than 40% gross margin is clearly a big achievement, but we can't stop there.

Much of our gross margin improvement to date has come as a result of our efforts to reduce product and manufacturing related costs and we'll continue with our efforts on this front.

In addition, our gross margin improvement is evidence of the results of our efforts to diversify our portfolio over the last two years, both through acquisition and through internal development.

On a quarter to quarter basis, we continue to see the potential for certain amount of gross margin volatility based on product mix, customer mix and volume, but at this point we feel strongly that we've established a new gross margin baseline of 40%.

Joe will speak to our Q1 expectations in more detail during the guidance portion of our prepared remarks later.

In addition to gross margin improvement, we're also focused on driving continued operating expense reductions and as Joe noted our as adjusted operating expenses in Q1 was down some 8% from Q4, further evidence we're continuing to execute on a plan that drives towards a more normalized operating model.

In addition to prioritizing our forward investments, focusing our dollars on the most significant opportunities where we have the highest probability of executing successfully, we've also been working to fully optimize and leverage each dollar spent.

For instance, over the last twelve months we've been moving away from our traditional product-based R&D organization to a model of one of core competency-based R&D, where we're able to leverage our engineering resources and expertise across a broader range of products and solutions sets.

Convergence in the network is driving convergence in traditional product lines and functionality cross over.

Going forward we believe these lines will only blur further.

Thinking about our R&D resources and our technology expertise as a pallet, we can apply across our solution sets versus as product specific will we believe stimulate and encourage that convergence.

For instance, we're already applying the Ethernet-based competency and functionality gained from the development of our CN4200 FlexSelect Advanced Services platform to our core switching and multi-service switching development efforts.

In addition to better leveraging our R&D model, we also believe we can get more leverage from our overall business model.

We can and will get more efficiency gains; in part by improving our processes and systems to enable us to scale our business without necessarily scaling our head count at the same rate.

We'll also look to augment our partnership programs to enable us to expand our portfolio and sales reach without adding incremental relative costs.

In summary, we continue to make good progress on a number of fronts.

Revenue growth is coming from improved market strength and as a result of our role as the network specialist and our vision for network transition.

Gross margin improvement will come from our evolving product mix as well as from additional product and manufacturing related cost reductions.

And our operating cost reductions will come as a result of our working towards additional efficiencies.

Going forward, the challenges we're facing will be substantially different than those we've faced for the last several years.

Going forward I believe more of our challenges will be tied to growing and scaling the business.

For instance, last quarter we talked about the onset of what seemed to be a trend towards larger order sizes for many of our service provider customers.

The good news is we're seeing this trend continue.

But in addition to driving fluctuations in cash use, as was the case with our increased inventory this quarter, larger order sizes can introduce the potential for quarter-to-quarter revenue fluctuation on top of what is otherwise a steadily growing business.

We're not saying this will happen -- we're just reminding you that it could.

In addition for the first time in many years we're facing challenges associated with ramping to meet demand.

These are challenges we faced before and we're working through them, but it does require working closely with our supply chain including contract manufacturers and component suppliers.

To recap on our expectations for 2006 overall, we expect our specialist positioning will enable us to continue to grow faster than the market.

New bandwidth demands and the need for network transition are fueling what seems to be the onset of a new spending cycle and Ciena is well positioned to benefit from this.

During 2005 Ciena grew faster than the market because the areas we chose to focus on, our specialties are growing faster than the overall market and because we were able to take share from competitors.

At the highest level our sales plan for 2006 is to keep doing exactly that, focus on our specialties and continue to take share.

As a result of our revenue growth and steps we're taking to improve our financial performance, I would like to reiterate what I said last quarter.

Though we're not willing to provide an estimate on the quarterly timing today, if we execute on plan, we do expect to achieve profitability on an as adjusted basis during the quarter prior to the end of fiscal 2006.

With that, Joe, will you walk us through the guidance for Q2, please?

Definitely, Gary; thanks very much.

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

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

As stated in the press release depending on the timing of revenue recognition associated with orders from several larger customers, we expect our fiscal second quarter revenue could increase by as much as 7% sequentially from our fiscal first quarter revenue.

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

That said, we expect the second quarter's gross margin will be roughly flat with the first quarter's at 42.1%.

We also expect overall operating expenses in the second quarter exclusive of any unusual or non-operating items will be roughly flat with first quarter's, reflecting our ongoing efforts to gain operating efficiencies.

We expect other income expense in the second quarter will be income of approximately $4 million.

We estimate the second quarter share count at approximately 584 million total shares.

As a result we expect that exclusive of unusual or non-operating items and exclusive of share based payment related 123-R values our adjusted net loss for the second quarter will be a loss of approximately $0.01per share.

Finally on cash, while we will not be making our semi-annual interest payment in the second quarter, we expect overall operating cash needs will be roughly flat with the first quarter's at $32 million, as a result of increased working capital needs.

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

Thank you. [OPERATOR INSTRUCTIONS.] We'll go first to Ehud Gelblum with J.P. Morgan.

Thank you -- you caught me off-guard on that one.

A couple things.

First of all, if you can actually talk a little bit about the market that you're saying is expanding and is continuing to grow with these large order sizes.

Two things I am wondering.

One, you said you would grow faster than the market.

Can you pinpoint the areas you think you're growing faster, why, aside from the 4200 which seems to be a separate piece if you look more at your optical business.

What areas are growing the fastest within optical and where are you taking share, who are you taking it from and why do you think that you're being successful as you are there?

Let me answer that Ehud.

I think if you were to summarize it, it is getting more difficult to talk about the segments because they are in fact converging.

It is an overused word.

I think it is happening.

I think if you summarize it as really anything requiring Ethernet transport, if you were to keep it simple, we see that market growing faster than the overall market, and really that's where we've invested over the last few years specifically 4200 is one articulation of that.

In the metro space you probably say that you know you're seeing stronger growth there than elsewhere, and I think that's fair to say, but I really characterize it as the Ethernet transport space.

In this quarter you said long haul acrually grew faster than metro and in the past you said that metro is growing faster than long haul.

From quarter to quarter you are going to get product fluctuations.

That's really my point, Ehud -- calling it metro and long haul is really blurred.

You have a lot of capabilities on the regional line system you can classify as Metro.

You have a lot of reach on the 4200 you could classify as regional or long haul.

If I look it the some of the applications, that's why the more traditional segments that grew in the late 90's and early 2000 I think are being blurred now and you're really looking at the edge demand driving the Metro and the core.

And as we look at our product families, there is a blur across them.

You have capabilities for long haul in the Metro and Metro in the long haul.

I think you're going to continue to see that.

And do you think you will continue to gain share over the next couple of years, or this is just out of the starting gate as the market begins to go?

I think we've refreshed our portfolio and we've invested to make sure that we've got the right kind of value propositions to what we thought the market would do, and that's certainly our goal.

We think we're well positioned for it.

But we've got to execute well.

Okay.

Thanks.

We'll go next to Cobb Sadler with Deutsche Bank.

Thanks a lot.

I have a quick question on the DSL business.

Can you tell us kind of where you are in the upgrade cycle, so what portion of the business is line card adds in existing DLCs that you upgraded and then what is new footprint expansion?

Also, could you tell us roughly what the mix is between the Lucent upgrades versus Marconi/Fujitsu?

Cobb, that's sort of detailed information, it isn't, we don't think appropriate to divulge.

I understand the question.

What we are seeing is that the CNX5 platform sells into all of the R box, and most of it is replacement of line cards, and that's a mix in any quarter between cards and new chassis and I think it is fair to say we've seen a fair mix of both new footprints and cards going into it the existing chassis.

OK, great.

And then just a follow up on British Telecom, I know you don't want to talk about how big the deal is.

Could you tell us if you're chasing or maybe if you won business at BT outside of the 21CN deal?

And then also, could you give us the relative contribution for the three products within the 21CN deal if you can't give us the overall?

Okay.

[Laughter] That was pretty good, Cobb.

Thanks a lot.

Let me try and answer what we're prepared to answer of that.

I think it is fair to say we've received our first orders from BT.

The second part of your question is have we got any orders outside of Century 21.

I think we can confirm that as well.

We are broadening our reach within BT and the various operating activities as well, so it is so far so good.

Okay.

Thanks.

We'll go next to Tim Daubenspeck with Pacific Crest Securities.

The three top 10, how many international, how many domestic?

Tim, this is Joe.

Let me take that one.

They're all domestic according to Suzanne.

Great.

And I know there is the product lines are blurring, But what's your expectation for the traditional long haul transport market as we move into calendar '06?

We had a solid '05.

Are you seeing indications at least with your customers that the traditional long haul market is seeing pockets of strength and some of this is sustainable?

Let me answer that.

To follow from what Gary said, as you drive demand in at the edge of the network, that drives bandwidth demands back into most Metro and what you call inter-city core.

The real issue is you're seeing blurring of the definitions of what is long haul and what is Metro application space.

The overall bandwidth demands on the network are increasing and moving from SONET/SDH based services to 10 gig Ethernet based services.

And so all of the platforms we've got now provide that kind of a service suite and they do it over varying distances.

It is a very flexible platform architecture that we've put together.

Okay.

Thank you.

We'll go next to Nikos Theodosopoulos with UBS.

Yes, thank you.

I had a clarification first, and then a question.

You gave the break downs with within TSG this quarter.

Do you have the break downs for last quarter specifically as well?

Nikos, this is Joe.

No, I do not but we can get that to you later.

Well, my question then is on BT.

How do you expect this contract to ramp over the next couple of quarters now that you have initial orders?

Do you expect like a gradual revenue ramp over the next two to three quarters or would you expect you know, a big one-time pop in orders that would be recurring, whatever that number is on a quarterly basis and what is that, what does the BT contract do if anything to your margin profile?

Nickos, let me take that.

I think my overall comment is it's very early days.

It wouldn't be appropriate to guess as to how this is going to roll out.

I don't think based on what I am seeing now, I don't expect it to be a huge initial pop and then go down.

I think from what I can tell right now, I think it is going to be a fairly steady ramp as we roll out this network.

One of the benefits is we've got three of our portfolio platforms out there, so it gives us a little bit of balance when they're building the core and the building the edge out in the Metro.

We're participating in a lot of that, so I can -- that should help balance it out.

But I think we're at the fairly early stages of it.

I would say that we do expect to recognize the initial, some initial revenues in Q2.

I think you can tell from the margin guidance, I think Joe was talking about fairly flat with Q1, so I think that you can draw some conclusion from that, but I don't think it is appropriate to be more specific than that.

Okay.

Just one last one on BT.

Your comments earlier, Joe, on DSO, the mix going international, does BT fall in that commentary?

Is that an example of an international customer that's going to have longer payment terms?

As relates to DSOs, yes, but I would caution you don't be real focused on BT as a part of that issue.

It is just as you go more and more internationally, Nikos.

They want longer payment terms.

The revenue recognition cycles are a little bit longer as well.

A lot of the growth and stuff Gary was talking about earlier right now from what we see, there is probably more in the European arena than there is in the United States arena.

So that's why we said that.

Okay.

Thank you.

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

Thank you.

I would like to get a clarification in and then the question.

On the -- Joe, when you ran down the TSG break down, you talked about long haul switching and metro, I think the percentages were 47, 19, 16.

What's missing?

What's the other part?

To get us to 100%?

I do believe it was the Ethernet storage, CN4200, those three lines.

We haven't given you the detail on each of those three, Simon.

I just want to make sure I had apples and apples.

Yes, sir.

Great.

The actual question, looking it some of the post merger environment of the old SBC buying the old AT&T and us getting used to calling it AT&T and now Verizon merging into MCI, if you could talk about your exposure, your outlook, your sense of what the implications are for your business, the role you can play and your confidence in those expectations, and maybe put it in commentary related to the sense that maybe these carriers try to reduce their number of suppliers and how you end up in that race.

Thank you.

Good question, Simon.

I think it is too soon to say overall.

Things are still shaking out.

I think from the early indications I am happy to share those with you.

I think we feel pretty positive about it from what we can see so far.

I think we're fortunate in that we're predominantly providing different set of products to the various merged companies before they got together, so the good news from our point of view is that we're now providing multiple products to these new merged carriers, and I think we feel that we're pretty well positioned to leverage that and work with them.

There is always some uncertainty there as these things happen, but I think generally speaking from what we've seen so far we view it pretty positively, and it leverages off a lot of the solution sets that we've got across multiple products, and I think as they look to transition their networks we can help them put that together with our FlexSelect architecture and our vision I think is pretty well suited to what they're trying to do.

You're always cautious when these things happen and historically in the late 90s, early 2000, I think we'd have concluded it was definitely bad news for everybody.

I think we have to pick through the details of each of them to conclude whether it is good or bad us for us, and I think so far we feel pretty positive about it.

Is it your assessment that because of some of the regulatory issues related to 271 that AT&T may move slowly where Verizon may move more quickly?

Is that what you're seeing as well?

I really think that's too early.

I am not dodging the question completely, Simon.

I think it really is too early to tell.

We're seeing the new AT&T be pretty aggressive about its architecture plans.

They're certainly going to go be to be moving similar kind of pace is my take on it.

Okay.

Thank you.

We'll go next to Paul Silverstein with Credit Suisse.

Joe, Gary, can you hear me?

Yes.

Great.

If you already answered these questions I apologize and skip it and I will take it off line.

Can you talk about 4200 trial activity in perhaps some relative terms, what you're seeing today versus quarter ago, how that's tracking and also if you could talk about non-BT international demand, and if you already answered these questions I will take it off line.

I think we covered part of them but I don't think we've talked to those explicitly.

4200 demand across those platforms -- generally we've just seen it grow quarter to quarter.

We're very pleased with it.

That's gone nicely, Steve, and I don't know whether you want it talk about any specific application growth you've seen.

I think one of the things to realize with that platform is it is plays into so many applications spaces out there.

It works in healthcare.

It works into the financials.

It works into the carrier space.

It works into data center extension and such.

The use of the all the flexi-ports where you can define them to be any type of service port you want and change it in the future, that makes it a very widely attractive platform through a number of spaces.

We're seeing generally a very broad base of interest in it.

Before you go on to the next question, the non-BT international demand question, can you give us any metrics in terms of percentage and percentage increase in trial activity and customer activity, my metrics you can throw our way in tracking the progress of this platform and also in terms of the gross margins on that box, as volume increases, I assume you're seeing a positive impact on the gross margin line as well.

Let me answer that, Paul.

I think from -- it is from a fairly small base.

It is growing exponentially if you want a statistic, I would say we have more trials going on now and more activity than we had last quarter, and you could say it is double, to pick a thing that gives you some idea about the kind of activity we've got.

It is very, very positive.

In terms of the European or international growth, and I think by my comment there you can tell what I think it is coming from, outside of BT we're seeing good opportunities throughout Europe both in eastern Europe, and in other countries outside of the U.K., continental Europe.

We've got a pretty good user base now.

You've got Neuf Cegetel, France Telecom, Swisscom -- they're all looking to do things.

We have a number of channel partners addressing eastern Europe and the Enterprise Markets in Europe as well, so I think we're seeing it across the board in all segments, and also in the government and research areas in Europe as well as we've seen in North America.

Gary, has there been any change in the competitive landscape? [Wame lass] seems like it is more of a force.

Have you seen any of your traditional competitors become more competitive, less competitive, anybody dropping shorts and pricing et cetera.

It has been a competitive landscape for awhile.

I think those of you will know, and we're still seeing particularly in Europe, you know, you're still seeing Alcatel, particularly.

You're seeing a number of other vendors.

You're seeing some of the more traditional players.

I think not focused as much on this space, and I describe somewhat at trophied out of it, and that's helping a little bit.

There is plenty of other competitors to take their place.

I describe it about the same.

I will pass it on.

Thank you.

We'll go next to Joe Chiasson with Susquehanna.

Thanks.

Good morning.

Gary, I wonder if you can talk about a trend that has been alluded to by Cisco and others with respect to the fact that optics are increasingly being integrated into things like routing platforms, how you guys sort of see that trend progressing and what specifically any moves you might be making to reconcile your product portfolio with that trend.

Thanks.

Sure, we've seen an emergence of what you call the small form factor pluggable markets for quite a while.

That's one of the big global market trends we've identified early and hooked our product designs onto.

We've kind of expected colored optics to say show up in platforms all across the board and from the beginning all of the line systems were designed to handle that exact scenario.

That's how we in fact interwork things like CoreStream and CoreDirector and 4200 is we use that same technology.

We're well positioned for it.

Okay.

Thanks.

Next to John Marchetti with Morgan Stanley.

Just a question for you, Joe, on the India operations, how was do you think those can ramp, where you're looking to go take that to and the impact that that might have on some of your OpEx lines?

John, I am going to hand it over to Steve since that's his responsibility.

He can give you first hand knowledge.

It is a very good question with him here today.

The facility is sized for about 300 people.

We're early in the ramp.

We haven't officially opened the building in some sense.

We are hiring.

We are training people.

At any given time there is probably more people in North America for training than there is in the India facility.

It is going quite well.

We expect to realize the benefits of it ever the next couple of quarters.

Mr. Marchetti do you have another question?

All set.

Thank you.

We'll go next to Subu Subrahmanyan.

Thank you.

Can you talk a little bit more about the DN platform and the CNX5 in terms of revenue and growth it seems like a lot of it continues to be from TSG if you look at 2006.

Do you still expect that to be the trend?

Subu, I think as I was talking about earlier with the developmenting going on with DN, we're taking a lot of that functionality on the Ethernet side and putting that into the other products.

We're also putting some of the transport capabilities into the DN piece.

The product lines are getting blurred from that.

I think we need to look at our segments very carefully and from a reporting point of view, because I think that is one of the challenges we're having.

We see good opportunities for the functionality of DN, be it in that platform or in other platforms that we've got and we're developing.

I think on the CNX side, Steve, do you want to comment on some of the technology things we're doing with that?

Really falls along the same themes.

What you're seeing is really blurring of the product lines and the application spaces.

The model that Gary alluded to earlier of moving towards one of the R&D centers being core competencies, you're going to find the Ethernet up through IP NPLS core competency the DN group represents, those feature sets will show up on more and more platforms.

So you're going to see them and cooperating with the ones that have [TSG things out of BDG, which are things like] the CNX5 and such.

You are going to start to see those integrated into the FlexSelect architecture story with flexi-ports showing up on those platforms as well with the rich variety of services it can create.

And just on the back on the TSG, would you think as a percentage of revenues it is a bigger percentage of revenues in '06 and I am just wondering does that have any implications for kind of a more of a lumpy revenue trend quarter to quarter fluctuations, as more comes from TSG?

I think with how we're currently looking at that, I would say the TSG, you know, covers a multitude of segments.

There is a lot of platforms and technologies in there.

It is a very big bucket which is what I was talking about earlier of trying to articulate what's going on in the business.

As you get the convergence going, amongst those platforms it is more and more difficult to talk about them as home genius segments and so that transport, the TSG segment has a lot of pieces to it, Subu.

It really does.

Thank you very much.

We'll go next to Marcus Kupferschmidt with Lehman Brothers.

Good morning, everyone.

Hi, Marcus.

I want to clarify a couple of things.

We talked about the gross margin outlook for the business and continue to be optimistic about improvement but quarter to quarter volatility.

Can you give us a better sense what are the pressure points that you worry about in terms of what creates that quarter to quarter volatility?

It is a complicated mix of products and customers, you know, and the cost reductions and the timing of those, when you get them on the components, when you get them out there, when you get the revenue recognized.

There is a lot of aspects and dimensions to this.

And that's why it is probably of all the aspects to our business the most difficult to predict with great accuracy on a quarter to quarter basis.

You know, I think you've seen us in the last four quarters improve our gross margin and that activity and focus that we've got there, we're working on more cost reductions.

We have line of sight to how we can get more cost reductions.

We expect a better mix as a result of our overall product portfolio, you know, focused on higher margin products.

As you get to this convergence as well which generally means Ethernet, et cetera, the gross margins tend to be as a general rule somewhat higher you go up the stack.

I think you've got some positive overall trends around improving gross margin, the things that impact that are, you know, quite simply the product mix if we're doing a big build on a transport build where the customer is put in a lot of chassis and not a lot of cards in, that can impact it; as you get to the core of the network with more software, that's generally positive.

So there's a lot of moving parts to that.

But I think we're confident overall given what we've seen in the last four quarters that in pricing pressure generally in the marketplace and that's been tough, but it has been tough for a number of years and our value proposition is not about being the cheapest product company.

It is really about the value we have as a solution.

We think that overall we can improve the margin from where we are.

Okay.

And a couple clarifications you guys kind of thinking near term.

The comment was the operating expenses should be flattish next quarter.

I guess could I understand a little bit more about that given you're emphasizing you plan to take down the R&D going forward.

You know, I think, Marcus, if I can, Steve answered some of that.

You have the ramp up in India which is costing us more but you have efficiencies we're getting elsewhere to balance that.

We reduced our OpEx 8% from Q4 to Q1, and I think you can see the overall trend there.

Again, a lot of moving parts to that.

You have some things we're focused on and investing in to bring up, but we've got some efficiencies that we think are going to continue overall to drive our operating expenses down, not necessarily quarter to quarter, but across the year.

And thinking about the nice sequential growth guidance for next quarter, if you think about it by product types, which product do you think are going to be the biggest contributors to the sequential growth you're looking for for the April quarter and let's say even the fiscal year '06?

Marcus, I think you will see it across the board from the access piece, you know, if you look between now and the end of the year, I think you're going to see it on the Metro transport bit, the 4200.

As I think Joe said we just started taking revenues for it fairly modest right now.

The converged Ethernet space of the FlexSelect 4200 is an area that will grow dramatically for us, where we only recognized a couple million of revenue this quarter for it, and we expect that to increase substantially over the next few quarters.

So you'll see it across the portfolio.

If I were to highlight the specific areas around the converged Ethernet space.

The same would be true for the April quarter?

Yeah, I think you're going to see -- those are the trends for the year.

I think you're borrowing what comes in and out of that quarter, I think you will see the same things in Q4, Q2, sorry.

Okay.

Thanks.

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

Thank you.

A strategic question.

If you go back a little bit, Ciena had been a pretty aggressive acquirer, many times willing to pay a premium price tag.

It has been a couple years since you've, your last sort of notable combination or acquisition and I was wondering what's the latest thinking on this particularly given the rise in your currency.

Thank you.

Todd, I think it's fair to say we're working hard on leveraging the pieces that we put together there.

It was part of a strategy and as Steve said not necessarily focused on the products and the platforms that those acquisitions brought us but really the technology pallet and capability that is very well suited to where receive seen the market go around the converged Ethernet space.

I think those acquisitions are part of our longer term strategy to really build a competency around a broader ray of technologies and that's beginning to work for us.

That being said, never rule out an acquisition in the future.

We're really focused right now on the pieces that we have.

We think we've got a lot of the things we need to address the market pieces that are growing right now.

Thank you.

We'll go next to Gina Sockolow with Buckingham Research.

Thank you.

When you look at your international revenue in this past quarter and your outlook, what do you think the mix of chassis to cards were and what the trend will be and then within that answer, can you just clarify if you think the what the BT revenue recognitions are how long it will take orders in hand to translate to revenue?

Thank you.

Let me have a go at that.

I think you saw our international revenues pretty small this quarter sort of about 15% of the total revenues overall.

As I said, I think we've got good growth potential internationally with BT and outside of BT as well, places like France Telecom, Neuf Cegetel, Swisscom, et cetera, there is a lot of activity in Europe right now that we're seeing.

I think our product profile of Cards and chassis is fairly evenly mixed right now and fairly small revenues and we expect that that will change going forward and international specifically Europe greater part of our revenues.

We do expect initial BT revenue in Q1.

In Q2, sorry.

The quarter that we're in right now initial revenues.

We can't really talk about the size and the scope of it unfortunately publicly.

Clearly, it is a large and meaningful deal for us and we're at the early stages of rolling that out.

That will help, I think, clearly skew the domestic and international revenues to a more favorable mix.

We've got a lot of other activities in addition to BT as well that I think are going to help, Gina.

When you say the mix between cards and chassis is about even, that's what I heard you say, then looking out, would you expect higher traffic level to go drive higher margin card sales so that mix and profitability shifts on the international business?

I think one of the things that we're dealing with, Gina, is the traditional markets where on the transport side where you ship a chassis and then put cards in, that's very true.

We clearly have some of those.

We've also got if you look at the new platforms, the FlexSelect architecture around 4200 family, that really doesn't apply.

You've got a more software based [chassises] and cards that actually come in with that.

You haven't got a lot of capacity for increased cards with it.

It is a different model I guess is what I am trying to say, Gina.

You've got the more traditional space with cards and [chassises] and the more smaller Metro platform that are converged.

Is Ethernet transport picks up in the U.S., would you see this scenario falling with first selling the [chassises] in and then getting a better mix of cards?

Gina, a lot depends on of course the size of the platform that some of the big more core facing transports platforms can handle a couple hundred channels overtime so you have a lot of potential card adds.

Some of the ones out at the edge people put in two and four-slot boxes and some of them buy them full so there isn't a card add business there.

It varies tremendously.

Thank you.

Thanks, Gina.

Thank you.

In the interest of time that concludes our question and answer session.

I would now like the turn the call back over to Mr. Smith for closing remarks.

Thank you, Gwen, and thank everyone for your time this morning and continued supported.

We look forward to seeing many of you at financial conferences during the fiscal second quarter, and at venues like TelecomNext in Las Vegas.

Thank you.

Thanks everyone, that concludes today's conference.

You may now disconnect.