Ciena Corp (CIEN) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to the Ciena Corporation third quarter 2006 results conference call. [OPERATOR INSTRUCTIONS] 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, ma'am.

Thanks, Cecilia.

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.

Our call this morning will be presented in four segments.

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 fourth quarter.

Joe will wrap up our prepared remarks with guidance for Q4.

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

To ensure we answer questions from as many participants as possible, we ask that 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.

Separately from our results announcement today, Ciena announced that its Board of Directors has approved a one-for-seven reverse split of its common stock to be effective as of 5:00 p.m.

Eastern on September 22, 2006.

The Q3 results presented in our press release and in this conference call do not take into account the effect of that forthcoming reverse split.

Before we turn the call over to Gary, I'll remind you that during this call, we will be making 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 filed with the SEC on June 1.

We have until September 7 to file our 10-Q for our fiscal third 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.

We're very pleased this morning to report our 10th sequential quarter of revenue growth, which we believe is a result of our focused market positioning.

In addition, this quarter's results point to continued progress towards our goal of normalizing our business model.

We're pleased with our progress thus far and we continue to focus on driving operating performance improvements and future earnings growth over the long-term.

Overall, we remain encouraged by current market dynamics and the emerging trends.

And we're confident that our portfolio is aligned to benefit from these improving conditions.

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

Joe?

Thanks, Gary, and good morning, everyone.

This morning we reported third quarter revenue totaling $152.5 million.

This represents an increase of 16.3% sequentially and 38% year-over-year.

There were three 10% plus customers in the third quarter that, combined, represented 51.6% of total sales.

All three 10 percenters are North American customers.

Two were also 10% customers in the second quarter.

The third is a long time Ciena customer, purchasing primarily long haul capacity additions and has not contributed to the 10% category or more of revenue since our fiscal 2002 year.

International sales decreased sequentially as expected from 27.3% in the second quarter to 23.7% in the third quarter.

For the second straight quarter, we did recognize revenue from BT for both the 21 CN project as well as non-21 CN related deployments, though BT was not a 10% customer in the quarter.

Moving now to talk about quarterly revenue contribution across our portfolio.

Revenue from our transport and switching products increased sequentially from 83.8 million in the second quarter to 104.3 million in the third quarter, representing 68% of the quarter's total revenue.

Our transport and switching products consist of core transport and switching, multiservice access, metro transport and switching, ethernet transport and switching, and storage extension solutions.

Long haul optical transport-related revenue grew sequentially and was the largest contributor within transport and switching.

Long haul transport revenue increased from 19.7 million in the second quarter to 52.1 million in the third quarter, primarily as a result of channel card adds to a particular customer's core network.

Core switching related revenue decreased slightly sequentially from $22.8 million in the second quarter to $17.9 million in the third quarter.

Revenue from our metro optical transport products increased sequentially from 12.3 million in the second quarter to 17.2 million in the third quarter.

Revenue from our CN 4200 FlexSelect Advanced Services Platform of $11.5 million was roughly flat sequentially, although shipments of this product continue to ramp aggressively, with the third quarter shipments of more than two times revenue in the quarter.

Revenue from our data networking products also improved slightly on a sequential basis, growing from $11 million in the second quarter to $12.8 million in the third quarter.

Revenue from our broadband access products decreased slightly from 22.4 million in the second quarter to 20.7 million in the third quarter.

Finally, revenue from our global networking services increased slightly from 14 million in the second quarter to 14.7 million in the third quarter.

Now, let's turn 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 make to Ciena's GAAP earnings in our analysis of Ciena's ongoing business.

In my comments today, I'll speak to both the GAAP results and to what the results would have been if we excluded those items detailed in the press release.

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

The third quarter's gross margin of 47% came in as expected, slightly below the second quarter's level of 48%.

Our strong gross margin, again this quarter, was the result of our ongoing product and manufacturing related cost reduction efforts, as well as product mix in the quarter, including a favorable chassis to channel card mix within our long haul transport revenue.

Product gross margin decreased slightly from 49.7% in the second quarter to 48.9% in the third quarter, as a result of product mix in the quarter.

Services gross margin also decreased, as expected, from the second quarter's level of 33.3% to 28.7% in the third quarter as a result of services related revenue mix in the quarter.

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

On a GAAP basis, our operating expenses in the third quarter totalled $84.5 million.

The quarter's GAAP operating expenses reflect nonoperating related or noncash charges for FAS 123R related equity-based compensation expenses, contingent legal and consulting fees upon litigation settlement, amortization of intangible assets, restructuring costs, and a recovery of doubtful accounts.

Let me add some color on a few of the larger items.

We had $2.4 million in 123R related equity-based compensation expense.

We also incurred $5.7 million in contingent legal and consulting fees upon litigation settlement.

These were legal expenses, specifically contingent fees, paid to outside counsel and advisers connected with the settlement of our patent litigation with Nortel Networks.

There was no money paid to Nortel as a result of the settlement.

Of the $11 million in restructuring costs incurred in the quarter, roughly $10 million was a charge associated with a reduction in estimated future sublease payments associated with our previously restructured unused facilities located in south San Jose.

The small remainder of the restructuring related costs were associated with other activities, including workforce reductions, associated with the second quarter's closing of our Shrewsbury, New Jersey, location.

Adjusted for these and other nonoperating or nonrecurring charges detailed in the press release, our R&D, sales and marketing, and G&A expenses for the quarter, exclusive of stock compensation costs, would have been $59.2 million.

This is down 6.6% from the second quarter's $63.4 million as adjusted OpEx.

Despite the fact that it includes costs of approximately $2.9 million associated with reinstituting our short term performance based employee bonus plan during the fiscal third quarter.

This marks the first time since the first quarter of our fiscal year 2002 that we paid employee bonuses.

Our third quarter GAAP net loss of $4.3 million or a loss of $0.01 per share, compares to a GAAP net loss of $51 million or a loss of $0.09 per share in the same year-ago period.

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

Adjusted for the unusual or nonoperating items I discussed earlier, including 123R-related comp expense and a gain on equity investments, our third quarter net income would have been $20.6 million or 13.6 million if tax affected or as adjusted net income of $0.02 per share.

This assumes, of course, due to the transition from as-adjusted net loss to as-adjusted net income, you used the higher, fully diluted shares outstanding of 650.7 million versus the basic share count of 589.4 million.

This is better than the per share guidance range we offered and compares to an as-adjusted loss of $0.04 per share in the same period a year ago.

Turning to the balance sheet.

Cash, short-term, and long-term investments at the end of the quarter totalled $1.2 billion.

We used roughly 18.8 million in operating cash during the quarter, which is up as expected due to increased working capital needs.

Turning to some other balance sheet items.

Our accounts receivable balance at the end of the quarter increased as expected from 76.6 million at the end of the second quarter to 89.6 million in the third quarter.

Days sales outstanding in the third quarter remained at 53, below our expected 65 to 70 day range.

Inventory levels ended the third quarter at $95.8 million, up as expected from the second quarter's level of $79.1 million, as a result of purchases made to support anticipated demand.

The inventory for the quarter was as follows.

Raw materials, 29.4 million.

Work in process, 5.5 million.

Finished goods, 81.5 million.

And a reserve for excess obsolescence of $20.5 million.

The largest increase came in the area of finished goods, which was up 19.4% from the second quarter.

Product inventory turns were 2.9 in the third quarter, down slightly from 3.0 in the second quarter, as expected, given the increase in inventory.

We expect the fourth quarter's inventory levels to increase from the third quarter as a result of additional purchases we'll be making to support demand as a result of shipments on which RevRec will likely be waiting for customer acceptance beyond Q4.

Deferred revenue decreased in the quarter from 58.8 million in the second quarter to 42.6 million in the third quarter.

Deferred revenue for Ciena generally consists of service related revenue for which we've been prepaid.

However, occasionally, it will also contain equipment related to revenue from a customer who has paid us but for whom we have not done -- excuse me let's start over.

However, occasionally, will also contain equipment related to revenue from a customer who has paid us, but from whom we do not yet have acceptance to trigger revenue recognition.

This was the case in both the second quarter and the third quarter.

And this quarter, like past, we were able to recognize a substantial portion of equipment related deferred revenue due to timing of product acceptance and associated revenue recognition.

Finally, head count.

Our worldwide head count at the end of the quarter totalled 1,422, an increase of 34 from the second quarter, reflecting normal hiring and attrition, as well as ramping our R&D facility in India, where we now have roughly 80 employees.

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

Thanks, Joe.

Continued progress in the focused execution of our strategy is helping align our business model and enabling us to capitalize on the available market opportunity.

At the macro level, consumers and, in part, the enterprise market are driving business to our traditional telco customers at an accelerated pace from the last several years.

It's no secret that following the protracted lull in significant capital expenditure on our network infrastructure, our customers, particularly telco carriers, are opening up spending again to support the increase in demand on their networks.

We're finding that these capacity requirements are being generated both by broadband subscriber growth and an increased uptake in higher bandwidth optical services and end user applications, which is expected to continue.

In addition to near-term success based spending trends, we've also recently had conversations with customers, again the telcos in particular, about next generation network builds.

And as Steve Alexander, our Chief Technology Officer, discussed with you last quarter, all network operators today have some mix of legacy WDM, PDM, as well as new packet based networks.

Our service providers face an increasingly competitive landscape and mounting end-user demands for new high bandwidth applications.

They are also realizing that they must respond, not just with the right services but at a much faster pace.

So as they begin to change what they sell, they are increasingly looking to next generation solutions to help them do it faster and more efficiently.

We're hearing from customers that as demand grows for broadband and IP services, Ethernet combined with WDM for transport, along with packet aggregation and switching, are emerging as the most economical and efficient technologies for delivering and transporting services.

In other words, our FlexSelect vision and architecture is resonating.

And in many of these conversations with customers, we find ourselves revisiting several of the innovative technologies we talked about prior to the industry turndown, like 40 gig, gigabit Ethernet, intelligent control planes, among others.

Of course, we are cautious in our optimism about these conversations and recognize that these preliminary talks do not imply imminent business opportunities.

We do, however, view these conversations as a positive indicator that the industry is focused on overall growth versus simply on cost reduction.

Again, we stress that our customers are still spending carefully and are only beginning to interpret the necessity of these next generation technologies in serving real customer needs.

We're encouraged, though, by our conversations with these customers, as well as commentary from industry observers.

Several industry analyst firms report anticipation of a healthy next generation solutions market moving forward.

We support that notion.

As networks are upgraded for today's pure capacity needs and the service providers increasingly realize the inherent value and flexibility in next generation, largely Ethernet-based, infrastructures.

We're confident that our specialist role positions us to benefit from this trend as customers start to make the transition.

In particular, we are encouraged by customer response to our FlexSelect vision, our approach to converged Ethernet architectures, and how the value of our product portfolio, notably the CN 4200 family, is resonating in the market.

And while my comments thus far have been primarily telco centric, we're seeing this sentiment across our customer segments; from telco to cable to government and also in some specific enterprise verticals like financial services.

We're also seeing new fits for some of our solutions in nontraditional applications.

For instance, this quarter, we secured two new MSO customers for our core director platform.

And we're engaged with a number of U.S. and European organizations in the research and education community, where our innovation and technologies are congruent with advanced network research.

Turning to how these market dynamics are affecting our business.

As I mentioned earlier, this marks our 10th straight quarter of revenue growth and significant progress towards sustained profitability and an improving operating model.

And we're confident that, despite some expected variability in gross margin based on the timing and magnitude of our ongoing product and manufacturing related cost reductions, product mix, customer mix, and volume, we can sustain a gross margin range in the mid-40's.

In addition, this quarter's results also point to continued focus on driving efficiencies across the Company.

On the operations side, we continue growing our India R&D facility where, by this fall, we should have more than 100 engineers on board.

At the cost of goods sold level, we've extended our work in Asia with suppliers and contract manufacturers to continue improvement of our supply chain model.

And we have teams dedicated to improving back office systems and rationalizing associated processes.

All of these efforts are designed to enable us to scale our business, without necessarily incremental costs, and provide the underpinning for the growth of our business.

As Suzanne noted, we've also announced today that our Board of Directors has approved a one-for-seven reverse stock split to be effective 5:00 p.m.

Eastern on September 22.

We believe that effecting the reverse split will enhance the stock's appeal to a broader range of investors and permit a more meaningful comparison of our results of operations in the future.

In summary, our fiscal third quarter illustrates continued progress in the execution of our plan.

We're driving sequential revenue growth as a result of sustained market strength and our position as a specialist for network transition.

While we continue to expect quarter to quarter variation in our gross margin, driven in large part by product and customer mix, again, we're increasingly confident that our business can sustain gross margins in the mid-40 range.

Our focus on operating expenses remains persistent, as we continue to implement efficiencies across the Company to improve and normalize our business model.

We've talked before about the challenges we face in growing and scaling our business, which are markedly different than those we endured during the industry's slump.

We're making steady progress but we're not underestimating the scope of the changes we've yet to make.

For example, we continue to work to streamline many of our back office operations to improve the efficiency of those systems and processes.

And to enable us to more efficiently deal with projects that can range from wholesale network upgrades to spot capacity related additions.

Positive sign towards renewed network investment, fueled by growing demand for capacity, as a result of greater broadband usage and wider mix of services and applications, have us encouraged about the future.

We expect our role as a network specialist will continue to provide us momentum and enable growth in our business, as the need proliferates to transition networks for improved service delivery.

We'll have the opportunity to discuss our progress and outlook in more detail at our upcoming analysts' day planned for October 10 in New York City.

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

With those comments, Joe will you walk us through the guidance for Q4 please?

Certainly.

Thanks, Gary.

Before I begin to offer guidance, I will remind everyone that the comments 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 our fiscal fourth quarter revenue will trend up sequentially by as much as 5% from our fiscal third quarter revenue.

As we said previously, 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.

While we continue to pursue additional product and manufacturing related cost reductions, we expect quarter to quarter variability in gross margin; in large part depending upon product mix.

Based on anticipated product mix, we expect the fourth quarter's gross margin will be down from the third quarter's.

And as we stated last quarter, we expect that overall the next several quarters, our gross margin will settle in the mid-40's.

We expect as-adjusted operating expenses in the fourth quarter, exclusive of any unusual or nonoperating items, will increase moderately from the third quarter reflecting the timing of some R&D related expenses.

We expect the other income expense in the fourth quarter will be flat to up slightly as a result of improving interest rates.

We expect other income net of approximately $9 million.

Adjusting for the one-for-seven reverse split announced today, we estimate Q4's basic share count at approximately 84.7 million total shares.

Again, adjusting for the one-for-seven reverse stock split announced today, we estimate Q4's fully diluted share count at 93.4 million total shares.

On our tax rate.

As we stated last quarter, we have NOL's in excess of $2 billion.

And as a result, are not likely to pay U.S. federal taxes for some time after we achieve GAAP profitability.

However, to this point, we've been using a 35% tax rate in the presentation of our as-adjusted results.

And we expect to continue to do so through the remainder of fiscal 2006, effectively one more quarter.

We acknowledge that this presentation may not reflect what is likely to be our actual tax obligation near term.

And as such, we expect to amend our as-adjusted presentation to reflect a substantially lower tax obligation as we move into FY '07.

Adjusting for the one-for-seven reverse split announced today, we expect that exclusive of unusual or nonoperating items and exclusive of share-based payment expenses related to 123R, our adjusted Q4 net income will be in a range of $0.10 to $0.12 per share.

Finally on cash, we expect overall operating cash needs will increase slightly from the third quarter's $18.8 million, as a result of general working capital needs, including inventory and accounts receivable.

In addition, because of the timing of the end of the third quarter, the interest payments for both the 0.25% and our 3.75% convertible notes will fall in our fiscal fourth quarter.

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

[OPERATOR INSTRUCTIONS] And we'll go first to Paul Silverstein at Credit Suisse.

Two question if I might.

First on British Telecom, can you give some more insight in terms of what your expectations are going forward?

It's been less than 10%, so the bulk is still to come.

Can you give us any insight Gary and Joe on the timing, as well as the magnitude?

I know there's sensitivities, particularly to account but --.

Sure, Paul.

We recognized revenue in Q3 from BT for both 21 CN and some non-related 21 CN deployments.

It was not a 10% customer, as we said.

We continue to see orders from BT relating to networks outside of the 21CN build, which from quarter to quarter, could be as much or if not more than some of the 21 CN business.

It generally appears on track.

It's a large program, from our perspective, and it's going to spread out over a couple of years as was originally planned.

So Gary, on the on track comment, you haven't seen any evidence of a slowdown, in particular with respect to the 21st century buildout for optical?

I can't talk for BT and I certainly wouldn't want to.

But from our perspective, it appears on track.

It's a big project and we're beginning to take revenues from it.

It's going to fluctuate quarter from quarter from our perspective, but it appears on track.

And secondly, on the competitive landscape, in particular Infinera but in general, can you give us some commentary what you're seeing out there in both metro and long-haul?

Steve, do you want to give some color on it?

With regard to all of them, you have to take any kind of competition seriously.

I'd say, you see competition coming from the low cost suppliers overseas, in particular from some of the Chinese suppliers.

And you see the folks like Infinera, who are, I think, going after the Tier 2 and Tier 3 carriers, where they kind of focus mostly on some of the short-term CapEx.

In general, we take all competition seriously.

I think fortunately, that the innovations that we've put in with FlexSelect and FlexiPort and the ability to migrate networks from the Sonet SDH TDM world over Ethernet are playing out well in the marketplace.

Gary, have you had to respond via pricing in any situation to any meaningful extent vis-a-vis Infinera, Huawei, etc?

I think our value proposition is different from those guys.

So, I don't think -- we certainly wouldn't compete with the Chinese guys on price.

That's not the market we're after and that's not -- as Steve said with the FlexSelect architecture and the rest of it, that's not really the market we're going after.

And we'll go next to Cobb Sadler with Deutsche Bank.

I just wanted to drill down a little bit on the gross margin.

You got it, if I heard it right, down quarter over quarter.

But it sounds like BT has continued to increase and a lot of that revenue up to half, I understand, is the CN 4200.

So, are you just kind of lowballing margins a little bit, being conservative, or are you seeing something out there in the pricing front?

Cobb --

Cobb [laughter]!

I'm surprised you'd accuse of that but I can understand the perception.

No I don't think -- in all seriousness, there's a lot of moving parts to that gross margin.

There a lot of things that can affect it and we do expect to see some variability.

We had strong gross margins in Q3, primarily, the result of increased cards versus chassis on the long-haul.

BT was not the biggest factor, it was less than a 10% quarter and it's not going to be the biggest factor on product mix on the whole.

Generally, looking at all the moving parts to that, our genuine perspective is that it's going to be in the mid-40's range.

Great.

And Joe, could you give me the raw material number again?

Sure, Cobb, give me a couple of seconds.

Great.

The finished goods, looks like it's up about 13 million quarter over quarter.

And when -- I'm assuming a lot of that is product you've already shipped into a carrier network or about to ship.

But your guidance is only up roughly 5%.

So I'm just wondering, if you've shipped a lot of product, do you expect to recognize that in the out quarter, or how should we look at that?

Okay, Cobb, this is Joe.

You asked for the raw material number, correct?

That's right,

29.4.

Got it.

Now, what you're also asking about is clarification on the finished goods piece.

Like every other quarter, a big piece of that finished goods is sitting off-site, basically waiting for RevRec.

What we've also done is we've started to move some other stuff closer to the customers and that's why you're seeing the finished goods go up as well.

More from a customer service level and being able to shorten lead times for our customers.

Because a lot of this business is success based and you've got to be able to respond very, very quickly.

Thanks a lot.

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

Looking at the earnings guidance that you guys have have, revenue is up and clearly gross margin seem to be coming down a little bit from the shift, I'm guessing, from the long-haul card sales that you're selling.

I'm assuming that's into that third 10 percenter that you've haven't had since 2002.

The EPS number, though, is down from this quarter, $0.10 to $0.12.

I'm looking, you basically did around $0.15 when you adjust for the trajectory -- I'm sorry, for the reverse stock split.

How should we be looking there for -- you've had a bunch of quarters of earnings going up.

How should we be thinking about the earnings and why would it be going next quarter?

Was it really -- was this a one-time nature that you had this kind of a one-time kind of a purchase from this 10% customer that you don't expect to repeat?

Just trying to correlate how we should be thinking about the down earnings guidance for next quarter?

Joe, why don't you take that?

Sure.

Hi, Ehud, this is Joe.

It's a good point, good observation.

I'm glad you hit it head on right up front.

Again, a lot of it is driven by the customer mix.

If you go back to the guidance, I feel like a broken record, but we've talked about how difficult it is to forecast the gross margin, because it is really difficult with regard to channels and chassis.

And we don't know when they're going to want some of this stuff, like we do.

Going forward, again, gross margin will be a big piece.

The OpEx is slightly, some of it has to do with timing, that's impacting your observation on what the earnings are doing.

But going forward, as we move the revenue line consistently upward, the leverage of that will drop through to the bottom line.

It's just that we can't give it to you in this particular quarter.

Okay.

So the main difference -- the discrepancy between the revenue going up next quarter and the earnings going down is primarily the gross margin is not really the OpEx and that has to do with the mix shift coming back?

It's really, if you put it simply, it's gross margin we're forecasting down a little, OpEx, slightly up.

You put those two things together and even with our revenues forecast up, that gets you to the operating performance.

I think the important thing is that we think we've got good operating leverage in the business that's going to continue to improve our operating model.

It's just that even with revenues up, we're looking at it, we think the gross margin will be down a little, OpEx up slightly and that's the end result to it.

All right.

One last thing to add into that, you had said before that your run rate of 4200's you thought was going to get to 40 million a quarter here, 11 second straight quarter.

You said these shipments were double that, so another 11 million, my is that's the increase in finished goods that's sitting out there in the field while you recognize.

Are we still on pace to get to 40 million in revenue, not just shipments, for the quarter by the middle of '07?

Well, let me qualify something.

My $40 million number, that's I've been talking about for the past couple of quarters, was the supply chain, which is stuff here and stuff on the way.

We're very much well on our way to that.

In the case of what we're doing as the shipments are very, very strong in the -- were very very strong in the third quarter and they're expected to be very, very strong again in the fourth quarter.

We're not worried about that.

In fact, we're quite excited an it.

The big piece there to bridge the gap is predominantly nothing but RevRec and getting those acceptance certificates.

And by very, very stong in Q4, you mean even stronger than the 22ish million in Q3?

I can't go there, because we're getting into more qualification of our forward-looking guidance, but we're comfortable with what we see.

And we'll go next to Marcus Kupferschmidt at Lehman Brothers.

A couple odds and ends.

The comment about the 4200 revenue recognition delays versus the big shipment this quarter.

Is that spread across a bunch of customers, or is that highly concentrated into any individual accounts?

And I have a couple of follow-ups.

It's across a number of customers.

I would also point out that it's not delayed, so don't get me wrong here, I don't to close any issues.

It's just the normal sequence of shipping something, installing it, and getting the RevRec.

Understood.

Now, when you think you can support a 40 million a quarter run rate -- or shipment rate, will that be a pretty diverse shipment across many customers, or do you think there'll be any real concentration of those roughly 40 million a quarter shipments.

Well, the design of the supply chain that Arthur has put in place is to basically be able to service any customer.

But if you think about your goal for mid fiscal year '07?

Marcus let me answer it and answer it this way.

We've had very broad customer uptake of the platform; right from the more traditional telcos, right through MSO's into the enterprise space, into the R&E community.

So it's a lot of customers.

There'll be some concentration during that for sure.

But it's a lot of customers making up those numbers.

We had 16 customers in Q3, for example.

That's great.

For shipments?

Or revenues?

That was for actual revenues.

So, that 11 million, we recognized from those amount of customers.

So that gives you some kind of view of how --

Outstanding -- [multiple speakers] A big gold customer of yours returning this quarter for a lot of long-haul.

Do you think that's a near-term shipment blip, or a lot of catch-up, or are they giving you a sense that that kind of activity can continue over the next couple of quarters because they've got some bigger projects?

How should we think about that?

I think our sense, without getting specific about the customer, let me talk sort of in generalities.

I think we're seeing it across the board of ongoing activity.

From time to time, you'll get folks playing sort of catch-up with not having invested over the last few years, but I think that's largely settling down.

I think it's real demand drivers, it's success based, they're putting it on for real customer demand.

And I think you'll see a blend of that going forward but I think we're encouraged by ongoing activity there.

Thank you.

And next we'll go to Nikos Theodosopoulos at UBS.

Hi, this is [Amidac Pase] on behalf of Nikos.

Just a couple of questions.

On the data network business, you had another sequential uptick in the quarter.

Can we expect this trend to continue, or do you think we we might see revenues drop off in the next couple of quarters?

I think you're going to see some fluctuation quarter to quarter across the portfolio.

Steve, do you want to talk about some of the --?

Sure.

Again, one of the trends that we've talked about in the past that we're doing with the portfolio is moving some of the core competencies and their contributions around.

So, a lot that in the past, we'd have just have said, "okay, this only shows up on the DN series," for example; is now moving over to show up on the 4200 series, on the CoreDirector, on the CoreStream.

So, the way we talk about the portfolio has to change as well.

We're moving Ethernet features onto all the platforms now.

In fact, pretty much every platform that we have in market has Ethernet features on it.

And so, you're going to find those technologies are distributed throughout the entire feature office, the whole portfolio feature set.

Okay.

And if I may, just one quick followup question.

Last quarter, one of your international channel partners was quite a significant customer.

Should we consider that to be a one-time event last quarter, or can we expect this customer to again be fairly significant down the road?

Again, I think you're going to see fluctuation there.

It's ongoing business with them, it's going to fluctuate from time to time.

We had a little bit of pent-up RevRec, as we articulated, in Q2.

So, it might not be as large as that but it is -- we do have ongoing relationships with a number of partners that you're going to see steady business from.

Okay.

Thanks, Gary.

Next, Brantley Thompson at Goldman Sachs.

Two questions.

Could you give us a little bit more color in terms of what type of tax rate we can expect to see going forward in terms of the Company?

Where is your cash tax now and is that how you're thinking about presenting results going forward?

And then I've got a follow-up.

So brantley, what you're really asking for is some guidance going into '07.

And I would say, let's hold off for that and maybe we can add that to one of the things we can talk about when we get to the analysts day.

Because that's going to be a little complicated and we should leave it for that, rather than go through all of it on this call.

Okay.

But any indication of where your cash taxes have been running on a quarterly basis?

It's very, very, very, very small.

Probably, in a -- for a yearly thing, annually, well less than $1 million.

Well less than $1 million for a year.

Okay.

And then in terms of the gross margin and the mix impact that you're seeing, I know you've given an indication for the next quarter.

But can you talk about the mix, what you see as the predominant mix trends over the next, say, three quarter or so?

And then how we should be thinking about that?

Clearly, 4200 is going to continue to ramp as a percentage of overall sales but what do you see for long-haul in some of the other businesses?

Why don't I try that, Brant?

It's hard to predict the sort of mix to it.

We're encouraged by what we're seeing on the 4200.

I think the core switching and core transport, as well, we're beginning to see a good cadence rate on that.

So, I think we're going to see fluctuations on that and that's what's leading us to -- with all the other moving parts, predict a gross margin in the mid-40's range.

But I think we're encouraged by the DN, what we're seeing there as well.

But to Steve's point, from a portfolio point of view, you're seeing this word "convergence" actually become a reality across the portfolio.

And so you're looking at some of the functionality and applications we're shipping products for and we're shipping 4200 for some Ethernet and transport applications that are really what you'd call sort of regional transports.

So, you're really beginning to see a convergence across the portfolio.

Okay, thanks.

Next, Michael Genovese at Citigroup.

Thanks a lot.

Hi, guys.

So, everyone with a fiber oriented access business -- and I know your access business is more copper oriented.

But practically every vendor that sells access equipment or gear to support fiber to the access projects; has recently seen a weakening of demand and forecasts both in North America and Europe.

So my question to you guys is first of all, what are you seeing there given that you have a copper-oriented access business?

And secondly, what are your thoughts about fiber access as a demand driver for optical capacity in the metro in the core of the network?

Are you worried about some of these slowdowns and delays in fiber access eventually having a follow-on impact in the capacity markets?

Thanks.

Steve, do you want to --?

Sure.

So again, I think it's important, we kind of play right behind the first points of aggregation on the fiber fit side.

As you pointed out, we do a piece on the copper.

And the copper, we expect, is going to fluctuate around with different builds and different demand rates.

In general, the bandwidth demands on the networks continue to increase, especially as some of the first video services and such are starting to turn up and new applications show up on the Internet.

So, we see a continuous increase, if you will, in demand for capacity and bandwidth.

And a lot of that is what is fueling the move from 2.5 gig transport, up to 10 gig transport, up to 40 gig transport.

So, we're very comfortable people are going to continue to use network capacity going forward.

Let me follow-up here.

Do you think the capacity that's being put in today is going to being put in to support today's growing traffic demand?

Say network traffic is growing well in excess of 50%, are they putting it in to support the services that are on the network today, or are you seeing customers prebuilding capacity for their planned video service architecture over the next three to five years?

And sort of saying, "look, we need so much capacity over the next five years that we'd better start putting it in today because video is such huge demand"?

No.

I think as Steve said, that might be the case in some of the access pieces but not where we're sitting, Mike.

It's really kind of -- I'd classify it as success based.

The other drivers, while things like IPTV have got all the publicity, you need to understand that broadband generally is still increasing.

As you said yourself, the copper based stuff continues to roll out.

You've also got enterprises with huge amounts of increasing data requirements driven by compliance and their businesses.

You've got new models that are maturing onto the Internet.

You've got the advent of music and video etc. driving all of that.

So I think at the macro, we're comfortable, as Steve said, about the ongoing drivers of demand, including IPTV.

But Mike, I would say that what we're seeing right now is success based builds.

Thanks, Gary.

Next, Tal Liani with Merrill Lynch.

Thank you.

It's Vivek Arya on Tal's behalf.

In the last few quarters, you have benefited quite a lot from channel card sales.

And I just wanted to understand, typically, what is your visibility into that?

Do you already know how many channel cards you will sell in the next two quarters?

And I'm just trying to basically gauge how sustainable that business is because that has implications on both your top line as well as your gross margins.

Vivek, that's a good question.

Channel card visibility, the answer to that is; probably not a lot of visibility to it.

It tends to be success based.

And I would say that whilst we're pointing to that, clearly, as one of the big factors for the strong gross margin performance in Q3; if you look back at some of the other improving gross margins in Q2, wasn't really channel cards mix in Q2 that got us to 48% gross margin.

It was a mix of other products and other customer mixes there as well.

So I think the whole -- one of the strategies we put in place with rebuilding the Company was to get a broader-based portfolio across a broader customer base.

So, that as one or two trends and fluctuations within a quarter might be negative or positive, they're smoothed out over the broader customer base and product base.

And I think that's what we're beginning to see.

So, whilst I think the Q3 gross margins we've pointed to the channel cards in Q2, it was a different mix of products and customers.

Got it.

And when you look at the question on operating expenses, as you look into the next few quarters, do you see plans in place, do you have the levers in place to lower OpEx or do you expect it to remain steady?

Or do you think there is a way to perhaps get it down to the low to mid-50's?

I wouldn't go with a number of to it but I'd say clearly, that we've got more room to continue to drive efficiencies and to work leverage across our operating model.

And that includes all aspects to it.

I wouldn't necessarily point to just the OpEx line.

As we talked in the commentary, we've got India ramping up and that will help drive operating efficiencies as well.

So, we've got some engineering expenses that we're likely to take in Q3, which is why we're forecasting the OpEx slightly up, but it is going to fluctuate.

I would not say that it would continue to go down.

One last question.

The broadband access group, do you still view it as a growth opportunity, or is that just going to be stable in this 20 to 25 million range for the next few quarters, at least?

Well, we do see it as a growth opportunity.

We're looking at other developments and investments that we've made during the last few years and new features that are driving that.

We still see both copper deployments as being a good tool and the carrier's armory of getting broadband out there can can be very, very cost effective.

We'll continue to invest in that space and we have some new platforms coming out there.

So, we think that it will be a growth opportunity over time.

Okay, thank you.

We'll go next to Sam Wilson from JMP Securities.

This is Jonathan Curtis for Sam.

Just a quick question, how would you characterize the performance in the quarter X obviously the strong growth and shipments in 4200 and what looks like good sales to possibly AT&T?

If you looked at the Company's performance outside of those two areas, how would you characterize it quarter on quarter?

I think -- I'd classify -- if you look across the portfolio, I would say it was strong.

I'd also say across the diversified customer base, it was strong as well.

Okay.

And then when you do win against a Huawei in the marketplace, obviously, they use price as a competitive advantage; what is the reasons that customers go with you beyond installed base, especially in a new build?

Well we don't see Huawei that much because we really don't focus on the low-cost commodity areas where they're playing, quite frankly.

We see them from time to time in some European builds.

Where we went against them is where the customer really values the value proposition that we have, which is not about just being the cheapest point to point piece of transport.

So, we don't see them that often.

Sometimes they're included in RFP's somewhat as a strategic stalking horse by the purchasing departments.

But when you really get down to it and the application requires real innovation and they're looking at the total life cost of the products and they're looking at operating expenses, etc., we more often than not, we will win.

And then when you look at how your head count breakdown will look over the next maybe four quarters, obviously you're continuing to add head count in India.

U.S. versus international head count in R&D, how will that look over the next four quarters?

Steve do you want to --?

So, the North American head count in R&D will be roughly flat and the growth will be offshore.

We sized the India facility to handle a total of 300 staff.

Got it, thank you.

We'll go next to Tim Savageaux at Merriman.

Good morning.

Congratulations on a lovely quarter.

A couple of questions.

First, regarding your guidance and this kind of follows on to the channel card and visibility question.

To what degree does that guidance include or not include any assumptions regarding seasonality of capital spending among your customers or kind of typical late-year upticks that we've seen?

I'm looking at last year when things weren't nearly as wonderful for you guys and you were up 7% sequentially.

So, I would imagine with limited visibility, it wouldn't include much in terms of assumptions of a broad seasonal uptick.

But that's question number one.

And then question number two is; there's been a lot of comments about sort of slightly kind of moderately on OpEx.

I'm wondering if we can get just a tad more granular on that?

You did 59, which is great.

You got below the $60 million level, I think, for the first time.

I assume you're going to come up back above that but maybe not too much.

You're sort of in the 62ish area the first couple of quarters.

Can you give us a little more specificity with that?

Okay.

Tim, why I don't take the first question and Joe will address your OpEx question.

Typically, we have not, as a business, seen too much seasonality.

We did make the comment last August where we saw particularly low order intake and at the time of the call, we wanted to articulate that because that's what we were seeing.

We're really not seeing that this year.

And I think we're making our judgements and our overall visibility based on backlog and customer interactions.

There are some assumptions about some run rate cadence of channels and things but I wouldn't say that plays a large part in it.

We're certainly not counting on some end of year uptick in it.

So, I think we have pretty good solid visibility, Tim, into the forecast certainly for the next quarter or so.

Joe, do you want to --?

Sure.

Tim, before I answer your question, let me qualify my answer a little bit.

A lot of what this is, is driven by the R&D side and the projects that Steve's working on.

It's a lot of variable spending related stuff like an OSMINE or a prototype or stuff like that, it's big.

There are big numbers because we haven't been very public about it but Steve's working on a quite a few new new things.

In terms of innovation, those guys are really cranking and they've really got the machine going.

So, as it relates to that, I'd say it could possibly go up a few million dollars on the mac side.

Okay, thanks very much.

And we'll go next to Simon Leopold at Morgan Keegan.

Thanks.

I wanted to ask you maybe a bit more of a philosophical question.

If you could talk to two different scenarios, one is Alcatel and Lucent agree to merge, how that affects the competitive landscape for you?

And then the second scenario is, if their merger gets voted down, what that does to the competitive environment for Ciena?

Thanks.

That's an interesting philosophical question, Simon.

I think generally speaking, I think it's good for the industry, the consolidation there.

I think that certainly, it's going to be a challenging integration for them.

And I think if you were to summarize it, any confusion is good for us and both the -- if they were to merge, there's certainly probably going to be a good degree of confusion going on with the best laid plans.

And if they don't, that's going to be confusing too because rightly enough, folks will be started planning on the basis on the merger.

So, all confusion amongst our competitors is a good thing for us to grab market share.

And I think you've got a lot of customers saying, if the merger does happen, this potentially opens up a landing slot, to use an airline parlance, where they want some diversification of the customer base.

But is it fair to say what's in Ciena's best interest is for the merger to complete?

Simon, I wouldn't conclude that.

I'd say, genuinely in the big picture of things, not hugely impactful either way.

Though, ongoing consolidation I think is generally good for the industry.

Having said that, if you want to really get philosophical about it, I think it's a good thing.

Okay, thank you very much.

And we'll take our next question from Subu Subrahmanyan with Sanders Morris.

My question is regarding deferred revenue.

Joe had talked about CN 4200 shipments being very strong but some revenue recognition from previous channel cards and so on.

Can you give us a sense of overall what's going on with deferred revenues given the pieces that are coming in and out?

And is that CN 4200 higher shipment all in the current deferred revenue?

No.

Subu, let me start at the back and work my way forward on your question.

In terms of deferred revenue, there isn't a lot of 4200 in that classification per se.

So, the 4200 is more tied to off-site inventory than it is deferred revenue.

The deferred revenue, we've got some older contracts with a bunch of stuff that's tied to services, where, A) people have the right to do some -- what's a good word -- a soak or a -- which is different than an FOA application, but they pay you for it.

In the case of 4200, it's newer, it's more success-based, it's kind of a new business paradigm where you've got to get it installed and they won't pay you until after that happens.

Got it.

So, just line card and channel card business and the customer that came back, was that the piece that led to a significant revenue recognition and lower deferred revenues this quarter?

That's hard to say, Subu.

Got it, all right, thank you.

Next, Gina Sockolow at Urchin Partners.

I wanted to go over the deferred revenue a different way.

Can you differentiate for us how much of that deferred revenue was longer type builds that are now getting recognized, as opposed to product that has to -- systems that have to be reconfigured for specific specifications of the customer or changes in the specification?

And also, in the finished goods inventory, has there been a change demo units, per se in the finished goods?

Or is some of that buildup related to a change in shipping methods from airplane to shipping overseas by boat?

Okay.

So let me try to -- those are complex ones, Gina.

How are you?

Deferred revenue, none of it has to do with changing -- a customer's changing specs.

I don't ever recall getting -- having to deal with anything like that since I've been here.

So hopefully, that nails that question.

On the finished good side, I guess your question is more oriented to; as we change our supply chain and move it to cheaper cost locations A) do we have al of stuff on a boat instead of a plane?

The answer is no.

So, that wouldn't account for any growth in finished goods inventory.

As it relates to the demos, we've had no change in what we do or how we do it on that front as well.

Okay.

So then, as your success with metro optical switches, as I understand, it has been very strong in overseas markets.

And as you move into the U.S. markets with the new products, does that affect your mix between chassis and line card and is that a factor in your different guidance for next -- for the fourth quarter for gross margin?

Simplistically, I'd have to say no.

Again, the mix driven by channels and line cards impacts the margins, sometimes we do know about it and sometimes we don't.

In case of the 4200, it gets shipped out as a box and it's very different than the days of old with the Century or the Agility in that you don't have a whole lot of channel card adds to the 4200, because the product wasn't constructed that way.

The 4200 right now is more a product that is growing feverishly in Europe, as opposed to North America.

Although, North America is doing very well in the enterprise space and the MSO space.

But it's going crazy in Europe.

Okay, so is there -- has there been a change in the ratio of filled slots over just as a broad view in your products between the metro Ethernet products and the bigger switches and between that ratio of filled slots in European sales versus U.S. sales?

So in other words, do you -- is there more room in the boxes to be filled with interface -- with cards as your -- as you seed the market in the U.S.?

Gina, this is Gary.

Let me try and help you there.

The 4200 basically is preconfigured, so it doesn't -- it's not the same dynamic, as Joe was saying, from a channel line card.

Now, as that business continues to ramp and becomes a bigger percentage of our business, overall, the dynamic around the channel card filled becomes less of a relevant one over a period of time for us.

That said, we've still got a lot of chassis out there, both within the optical switching space and within the CoreStream Agility space as well.

Steve.

So, Gina, just so you get the full picture.

One of the innovations around the 4200 platform is that you can stack them.

And so, it's a little bit of a different model.

In the past, you sold the large chassis that would you add channel cards to.

The 4200, again, one of the innovations in the way it was architected was that you can actually stack them up.

Great.

Thank you.

That concludes the question-and-answer session today, ladies and gentlemen.

At this time, Mr. Smith, I will turn the conference back over to you for any additional or closing remarks.

Thank you.

And thanks everyone for your time and for your continued support.

We look forward to seeing many of you at the upcoming financial conferences during the next several weeks and at our analysts day on October 10.

Thank you.

That does conclude today's conference, ladies and gentlemen.

We thank you for your participation and everyone may now disconnect.