Ciena Corp (CIEN) 2009 Q2 法說會逐字稿

Good day, everyone and welcome to the Ciena Corporation second quarter 2009 results conference call.

Today's call is being recorded.

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

Suzanne DuLong.

Please go ahead, ma'am.

Thanks, Stephanie.

Good morning and welcome everyone.

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

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

This morning's prepared remarks will be presented in two segments.

Gary will review our Q2 performance and discuss our outlook.

Jim will review the financial results for the second quarter and provide some limited guidance for Q3.

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

This morning's press release is available on national business wire and first call and also on Ciena's website at Ciena.com.

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

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

These statements should be viewed in the context of the risk factors detailed in our 10-Q filed with the SEC on March 5th, 2009.

We have until June 11th to file our 10-Q for this 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.

Today's discussion includes certain adjusted or non-GAAP measures of Ciena's results.

A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today's earnings release available on our website at Ciena.com.

Lastly, as a reminder, this call is being recorded and will be available for replay from the investor's portion of our website.

Gary?

Thanks, Suzanne and good morning everyone.

Firstly I'll talk to our Q2 performance as well as the overall environment before turning the call over to Jim to discuss the details of our Q2 results.

Any way you look at it, Q2 was a tough quarter.

In addition to the ongoing challenges of the macroeconomic environment, and continued cautious spending by customers, we experienced delays in revenue recognition in the quarter.

These delays, combined with the effects of the initial pricing strategies associated with two new optical transport wins, negatively impacted the quarter's revenue and gross margin.

Let me spend a few minutes talking about the second quarter's key metrics and how we're approaching the third quarter.

Firstly, revenue was down in the quarter but for no one single reason.

We continued to see customer project and deployment delays and push-outs but have not seen any project cancellations.

Given our concentration amongst a relatively small number of large Tier 1 Service Provider customers, even under the best of circumstances, our quarter-to-quarter revenue can be lumpy.

Unfortunately, a difficult macroeconomic environment and cautious spending by customers only exacerbates that challenge.

The good news is, despite some ongoing customer specific challenges, we did see increased order flow in the quarter and in general activity levels are up.

Turning to gross margin.

At 43% non-GAAP, Q2's gross margin was disappointing.

However, we believe it improves in Q3 for the following reasons.

We mentioned last quarter that we were seeing opportunities to claim footprint and that capitalizing on those opportunities might lead to short-term gross margin pressure.

That was the case in Q2.

During the quarter, we successfully captured footprint, securing future optical transport revenue potential with two non-US Tier 1 service providers.

One of which is in an entirely new region for Ciena.

Q2's gross margin was adversely affected by charges of $5.8 million related to lost contracts associated with the initial phases of deployments for these customers.

While we opted to pursue a pricing strategy that enabled us to secure a strategic footprint with these two customers, we do not envision an ongoing pattern of customer loss contracts in our business.

In fact, exclusive of these two lost contracts, our Q2 gross margin would have been within our mid to high 40s target range.

And I think it's fair to say we're not seeing a notable increase in pricing pressure outside of the usual rough and tumble of the long haul transport business.

And based on our current product mix expectations, we expect we will be able to return to the mid to high 40s range in Q3.

Turning lastly to operating expenses.

At $87 million, our non-GAAP operating expenses were up slightly from Q1's normalized roughly $8.6 million.

Q2's operating expenses reflected the already implemented portion of the headcount reductions we announced in early March.

Offset by higher than expected R&D expenses.

The good news is our core switching and 100G developments are going well.

However, as a result, prototype costs are running higher than anticipated with some early deployments.

We are on track to close our Acton, Massachusetts facility on plan as of June the 30th, and expect cost savings associated with the facility closure and final associated head count reductions in the last month of of our fiscal Q3.

We continue to work towards our goal of balance, carefully managing our balance sheet while prioritizing the investments we believe are critical to our future.

We'll continue to monitor in the environment and our customer's needs in assessing our operating expense levels going forward.

Before I ask Jim to review the details of the quarter, as I did last quarter, let me spend a few minutes discussing the environment and what we're seeing and hearing from customers.

Without glossing over the difficulties in the quarter, there were some indicators that lead us to be slightly more optimistic about the second half of the year.

As I mentioned previously, order flow improved in the quarter.

And while we continue to see push-outs and delays, we're not seeing cancellations.

We're also encouraged that recent public commentary indicates a sense that things are not getting worse for our customers.

According to carrier CapEx estimates we believe our top service provider customers spent at historically low CapEx to revenue ratios in 2008.

While it's unclear exactly how much CapEx will be spend in 2009, based on what we've heard thus far this year, it's unlikely to be greater than 2008.

There's no question that underlying traffic demand continues to grow, and traffic demand remains the fundamental CapEx driver for our customers.

So given the combination of traffic growth and new service demands on networks, it seems unrealistic to believe current spending levels are in fact sustainable.

These are encouraging data points and lead us to believe that our customer spending patterns will improve over time.

However, we don't feel as though we have enough information to make a broader conclusion about spending expectations or patterns beyond Q3.

To that end, as you would expect, the current environment has caused us to take a hard look at where we believe our development spend needs to be in order to meet customer deliverables.

We've worked hard to prioritize our spend, so that we remain on track and aligned with evolving market opportunities and customer market plans.

Right now we remain focused on four significant ongoing development efforts, including bringing to market our data optimized switching solutions which can also be described as the evolution of our CoreDirector family.

Filling out our converged optical service delivery portfolio including 100-G technologies and capabilities.

Expanding our ethernet service delivery portfolio and extending the the value of software in unified network and service management across our portfolio.

Recently, there's been some speculation about the status of our next generation of CoreDirector, our family of intelligent optical core switches.

It's no secret that we focused a lot of resources on this development effort and while we're not ready to launch anything today, I'd like to spend a few minutes to help you understand where we're headed.

Near term we're focused on a future release, 7.0, that adds OTN capability to allow fundamentally more types of network traffic to be more easily managed.

There is significant development, however, beyond this upcoming feature release.

Our CoreDirector platforms currently lead the market in mash network deployments and continue to support critical application requirements of our customer base.

To maintain that lead, and offer customers a broader solution set, we are expanding significantly the family, creating richer, more multi-dimensional solutions.

I think it's important to note we are not working on a product replacement.

We're working on extensions of the current CoreDirector family.

To that end, we've been working closely with current CoreDirector customers throughout the development process.

As you would expect, they are the initial target customers for the extended family and functionality.

We expect the new platforms to be in customers' hands by fall of this year.

And, we expect to formally launch the extended family and functionality later this year.

I don't mean to suggest by highlighting our core switching efforts that that is the only or even the most important development work ongoing.

We feel strongly that we are on the cusp of several important product cycles including the expansion of our Carrier Ethernet Service Delivery portfolio and the addition of meaningful feature and functionality enhancements to our CN4200 family.

Our recently announced 100-G win at the New York Stock Exchange is a great example of the work we've been doing on CN4200.

In summary, our goal remains finding the balance between preserving and enhancing our strategic capabilities longer term, while preserving our balance sheet now.

And as we've said before, if we get indications that our current assumptions are incorrect, then we are prepared to pursue additional alternatives to reduce costs.

Despite the short-term challenges we're facing, I continue to believe Ciena is in fact in an enviable position.

We've proven our ability to successfully execute our network specialist strategy globally and we've proven it's a strategy that resonates with customers.

In addition to establishing a recognized position as a market leader, we've got a broad customer base and portfolio with incumbency at many of the world's largest service providers.

We're capitalizing on opportunities to expand our footprint and take share.

And we continue to bring new products to market, having already made significant investments over the past few years, we are in a strong position, we believe, for future cycles.

And we have substantial operational flexibility, including a very strong balance sheet.

The combination of these elements give us the confidence that we can strike the balance required to navigate today's difficult environment and to emerge stronger as things improve.

With that, I'll hand over to Jim, who will talk through the details of our Q2 results.

Thanks, Gary.

Good morning everyone.

We reported second quarter revenue of $144.2 million.

We had one 10% plus customer in the quarter, who represented 28% of total sales.

This customer is North American-based and was also a greater than 10% customer in Q1.

Sales from international customers represented 36% of total revenue in the quarter, down from 41% in Q1.

As you know, we break out revenue by three major product groups.

The first, Optical Service Delivery, which includes transport and switching products as well as legacy data networking products and relating software, accounted for $105 million in revenue, representing 73% of total revenue for the quarter.

Within Optical Service Delivery, core switching was the largest contributor in the quarter at $43 million, down slightly from $45 million in Q1 but above Q4's $38 million.

Our CN4200 Advanced Services Platform contributed $32 million in the quarter.

Long haul transport added $23 million.

Our second product group, Carrier Ethernet Service Delivery, includes service delivery and aggregation switches as well as ethernet access products, Broadband Access products, and related software.

For Q2, Carrier Ethernet Service Delivery contributed $13 million or 9% of total revenue.

Finally, our Ciena Specialist Services Group which includes all of our services related offerings, was $25 million in revenue or 18% of total revenue in the quarter.

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

With respect to gross margin, our GAAP gross margin in Q2 was 42%.

Adjusted for share based compensation and amortization of intangibles, Q2's gross margin was 43%.

As Gary noted, Q2's gross margin was adversely affected by $5.8 million in charges related to lost contracts.

These charges were associated with wins at two non-US Tier 1 service providers.

Exclusive of these charges, our gross margin would have been in the mid to high 40s range.

Our GAAP product gross margin for the quarter was 45%, consistent with Q1, despite the effect of the lost contracts which was reported through product gross margin.

Our services gross margin was 29%, once again better than our target mid 20s range, as a result of the mix of services revenue in the quarter.

On a GAAP basis, Q2's operating expenses reflect the $456 million non-cash impairment of goodwill, we talked about that previously, as well as $6 million in amortization of intangibles and $6 million in restructuring related costs.

Excluding those items, our adjusted operating expenses totaled $87 million.

This is up from Q1, primarily as a result of higher R&D related costs.

As Gary noted, this was largely the result of higher than anticipated prototype costs associated with our 100 gig and CoreDirector development efforts.

Our Q2 GAAP net loss was $503.2 million, or a loss of $5.53 per share.

Adjusted for the unusual and/or non-operating items discussed previously, our second quarter net loss would have been $22.5 million, which is a loss of $0.25 per share.

Turning now to cash flow and the balance sheet.

Notwithstanding the challenges we faced in the quarter, we are pleased with cash management.

Despite the loss, we generated $2.9 million in cash from operations.

So our balance sheet remains strong with $1.1 billion in cash, short-term and long-term investments at the end of the second quarter.

For Q2, our accounts receivable balance was $117 million, down from Q1's $130 million.

Days sales outstanding were 73, up slightly from Q1's 70 days.

Given the ongoing revenue uncertainties and lack of visibility, we pay a lot of attention to our inventory position and manage it very closely.

Inventories totaled $91 million in Q2 which was flat with Q1.

Product inventory turns were 2.9 times in the quarter, down from 3.3 times in Q1.

The inventory breakdown for the quarter was as follows.

Raw materials, $21 million.

Work in progress, $1 million.

Finished goods, $92 million.

Plus a reserve for excess and obsolescence of $22 million.

On headcount, as of April 30th, our worldwide headcount was 2,104.

This is down 134 from Q1, reflecting a portion of the headcount reductions we announced in early March as well as normal attrition, offset by some strategic hiring.

Finally, an update on the restructuring costs in Q2 and those we expect in Q3.

We recorded severance and other employee related costs of approximately $3.5 million in Q2.

We expect to incur an additional $0.5 of employee related restructuring charges in our fiscal third quarter.

In addition, we expect to take facility restructuring charges in a range of 2 to $4 million during Q3.

Associated with the closure of our Acton, Massachusetts facility.

Let me conclude our prepared remarks today by talking to guidance for Q3.

Before doing so, however, I would like to caution that although we are providing some limited guidance for the upcoming quarter, our visibility remains extremely limited.

Based on direct conversations with customers and supported by trends we are seeing currently in the business including improved order flow, we expect to deliver sequential revenue growth in our fiscal third quarter.

We also believe based on current expectations about product mix that gross margin will be in our mid to high 40s target range.

We continue to work toward our goal of balance, carefully managing our balance sheet, while prioritizing the investments we believe are critical to our future.

The higher than expected prototype costs that affected Q2's operating expenses are also likely to affect Q3's operating expenses.

As a result, we believe our Q3 non-GAAP operating expenses will be in the low $80 million range.

We expect other income expense, net, in the third quarter will net to roughly zero.

As for taxes, as we discussed for the last couple of quarters, because we are unprofitable on a GAAP basis in Q2 we did not reverse any portion of our deferred tax asset.

And as has been the case recently, we expect our tax obligation for Q3 will be mostly related to non-US taxes.

Depending upon your assumptions, you may need either our diluted share count or our basic share count.

We estimate Q3's diluted share count at approximately 112 million total shares.

We estimate Q3's basic share count at approximately 91 million total shares.

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

Thank you.

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

(Operator Instructions).

Our first question today will come from Mr.

Mark Sue of RBC.

Thank you.

Gary, direct conversations with customers, does that mean there's a verbal agreement on purchase orders?

Does it mean you have been designed into new networks?

Or does it mean it's as good as a done deal?

If you could just give us some more granular thoughts there.

It's probably a combination of them all.

We've actually seen the physical, I guess the most important thing is the physical order flow, which we're seeing increased activity on so I guess that would fall into your sort of done deal category.

I would also say that, in engagements with the customers across the board, I think the sentiment has been somewhat improved.

I would say that goes back to the sort of March type time frame which I think coincides with the sort of general macro environment as well.

So I think it's a combination of all of those, Mark.

And the sequential revenue guidance, that's based on the order growth and not just the recognition of the push-outs?

Correct.

Is that how we should look at it?

Correct.

Otherwise, we wouldn't be as confident about that.

So it's orders and the other things that we're seeing as well.

I mean, we're seeing increased activity up across the board and that's somewhat encouraging.

I think it's too early to tell around connecting -- we haven't got enough data points yet to connect that to draw a broader conclusion so that's why we're taking it one quarter at a time right now.

Got it.

And Jim, if you -- you must have various scenarios of when you might be able to kind of break even from an operating income point of view.

Any thoughts on when that might be?

Is its two quarters?

Three quarters?

Or kind of like a base case scenario.

It all depends on what our revenue does and where our margins go, Mark, so it's hard for me to answer that question.

I think the strongest statement that we can make is we think that our OpEx are going to be low mid 80s and if we get sort of the revenue and margin that would get to that level, then we'll be there.

I want to go back to this point that we're really striving to run the Company, balancing, maintaining the strength of our balance sheet, but also making sure that we invest in the strategic priorities of the business.

So that's how I answer that, Mark.

Okay.

Thank you and good luck, gentlemen.

Thanks, Mark.

Thanks.

Our next question comes from Ehud Gelblum of JPMorgan.

Good morning.

Good morning, can you hear me?

Yes, we can hear you.

Okay.

Great.

Thanks.

A couple questions.

First of all, the cash, both in terms of the guidance and what you did now.

Jim, you had had said last quarter that your cash breakeven levels were $170 million, gross margin mid to high 40s.

This quarter, maybe you're there but the guidance sequentially from this number doesn't necessarily mean you get to 170.

How should we be looking at what your cash burn looks like next quarter.

It would imply you don't get to cash burn breakeven.

This quarter you brought in about $60 million from the balance sheet.

Mainly accounts receivable and accounts payable.

Is that replicatable or do those reverse as your revenue goes up.

I'm trying to understand if we're not at 170 with revenue, how should we look at the cash burn analysis for next quarter?

Just to get to the bottom line, we're not not going to have a significant -- at least we don't expect a significant cash burn for the quarter.

If you look at all of the indicators that we've given you but it does depend on the working capital as you rightly point out.

As we grow in revenue, you would expect receivables to grow.

On inventory, it's not as clear because we have -- we do carry a certain amount of off-site inventory related to customer acceptances and the timing of revenue rec.

So we can have movements in the inventory position that would tend to take it down, even though revenue is growing.

So it's not as clear as it is on the receivables side.

There's also this function of the fact that our receivables balance at the end of any given quarter is a function of what -- customer mix and what happens during the quarter, back end loaded quarter or front end loaded quarter, so there's a lot of moving parts.

I can't be as prescriptive as maybe you would like, but I think I can say that we don't expect a significant cash burn in the third quarter, all in.

Okay.

That's helpful.

The 4200 fell pretty hard, went to $32 million, it was in the mid-50s, $56 million prior quarter.

That seemed to be one of the major factors.

Was that due to one or two customers or was that more across the board and how can you -- how do you correlate that with what you're seeing across the carriers?

Is there something that's going on on the Metro side?

Is there share loss that you think happened in the 4200 or is there something maybe core and transport fell off a year ago and now Metro is falling out?

How should we look at that?

That's a good question.

I'd start off to say we had two really good quarters, Q4 and even Q1, with 4200.

It's still lumpy.

We're still getting adoption at the early stages of some large carriers.

I wouldn't draw -- overall, I wouldn't draw too many conclusions around our product lines from the Q2 performance, quite frankly.

We're not seeing anything specific to Metro or long haul.

We're actually seeing good traction with the platform.

We've had some decent size wins.

You saw the one in Austria with Cadillac.

You've seen some of the other announcements with the New York Stock Exchange, et cetera.

So I mean, we're continuing to get broader customer traction with it, and frankly, I would expect it to be a growth platform going forward.

You know, we're also adding a lot of new features and functionality as well.

No one product ahead of those new features.

I don't think there's anything specific that comes to mind with any large customers.

The two new wins, were they competitive wins against an incumbent.

They were both competitive wins against a couple of incumbents.

Did you win them on price, did you win them on features to match the price?

We did not win them on price.

That's not normally how we position the Company.

We have to be aggressive on the initial profile for it.

So it was more a very considered pricing strategy.

We do it from time to time.

We haven't done it for a while.

We had -- I think this environment is throwing up these kinds of opportunities and we made sure that we thought that through but we think it's two very good strategic wins for us and I think they will be profitable going forward as well.

That's the other thing I would say.

Okay.

Thank you very much.

Thanks.

Our next call comes from Alex Henderson.

Hey, guys.

How you doing?

Hey, Alex.

Hello, Alex.

Got a couple questions for you.

The first piece of it, though, I'd like to go back and talk about the prototype costs a little bit and how that progresses over time.

Clearly, you get hit in the quarter that just reported and then you said again in the third quarter.

Presumably if those parts are going into the CoreDirector products that are going out to customers in the fourth quarter, that that would fall off pretty precipitously as a cost element.

Would that also imply a little bit lower margins on the initial CoreDirector shipments in the back half when the newer boxes start to hit?

Can you give us a little sense of you how that -- those pieces fit together?

Yeah, it's a complex picture around the prototype costs.

Let me sort of start at the top and sort of work through.

We've got a number of very large platforms coming to market over the next 18 months.

And some of the prototypes are quite expensive for that and they're very difficult to predict.

Some of the -- particularly with CoreDirector, 100 gig and some of the other things that we're doing, on the ethernet switching side as well, and so it can be quite lumpy.

What also -- if you want to sort of spin it in a positive light, I mean, particularly around some of the 100G, you've got people wanting to deploy even the early sort of prototype type versions of it and that's causing us to accelerate some of those.

But we've got a lot of these platforms coming out over the next 18 months.

So frankly, I would expect it to be somewhat lumpy.

A number of those came together in this quarter, unfortunately.

I was just trying to get a handle on the trajectory.

Does it start to fall off, prototype costs start to fall back off and normalize R&D into the fourth quarter, first half or does it continue to stay high because of the continuing high level of new products that cusp?

I don't think it will fall off, per se.

But I think normally you wouldn't see such a high spike as we saw in Q3.

It's on an ongoing basis.

Normally it's included in our normal operating expenses so it wouldn't show quite the spike that it showed in Q2.

Okay.

Second question, as you talked about the new customers, two new wins, sounded like you had some initial pricing that was fairly low but does that normalize over a period of time to more reasonable price levels?

Or is that a contract pricing level that will stay at that level through the course of the next X number of contract years?

Yeah, it's a mixed bag.

Generally, they will both go up.

But in one case, clearly, it will go up and in the other case, what really happens is it opens up a new region with a set of customers related to this first deal.

Which will be, we think, at significantly higher margins.

So the general shape of it is margins will go up on both those deals or follow-on deals.

One more question on the business model.

The comment about the interest costs or interest income cost lines being net to zero.

Is that what I heard you say?

Yes, we did say that.

That's a little bit of a step down.

Is there something other than the restructuring costs driving that down?

No, I'm really referring to that without restructuring costs.

Absorption of cash.

Conservative statement, but we have over the past really several quarters moved all of our cash into very conservative positions, not that it wasn't conservative before but essentially we're entirely in Treasury bills of relatively short duration.

So because generally interest rates have trended down and we have really conservatized our portfolio over several quarters, that's why I think net interest expense will be roughly zero.

Great.

Thank you.

Alex, just to follow up on one question on the prototype thing you talked about.

I wouldn't extrapolate it out to sort of CoreDirector margins.

As we extend the CoreDirector family a lot of that is with very intensive software architecture that I would actually say would preserve if not enhance CoreDirector margins going forward.

Great.

Thank you very much.

Our next question is from Todd Koffman of Raymond James.

Thank you.

As it relates to the visibility, and you highlighted some improved order flow, can you give any granularity with regard to geography, US versus outside the US?

Thank you.

Yeah, Todd.

I mean, I wish I could give you some sort of insightful regional aspects to that.

I think it's fair to say it's across the board.

You know, we've seen it in Europe, as I said, some of our recent wins in Europe and Austria, Cadillac deal and things like that.

We've seen some new wins in North America as well.

So I mean, I think it's across the board.

Thank you.

Our next question is from Simon Leopold of Morgan Keegan.

Thank you very much.

I wanted to get a couple of quick clarifications, then some questions.

In terms of clarification, I think you mentioned that CoreDirector this quarter was up from $38 million just looking at last quarter's transcript, I thought it was $45 million.

Was there some restatement of the January quarter's segments?

No, there was no restatement.

I'll just have to follow up on that, Simon.

There's been no restatement of any of these numbers, no.

Just if we could follow up later on that one.

Looking at transcript, it's a little bit different than what I thought.

That's okay.

Moving along.

In terms of the wins you talked about affecting gross margin, I think that was all long haul.

Can you give us a little bit more color in terms of what the revenue contribution was in that particular business that hit the gross margin?

Actually, in neither case was there significant revenue in the quarter, Simon.

It was the function of taking orders for the contracts that resulted in the losses.

So you're recognizing the expenses up front?

Precisely.

Yep.

Yes.

The expense associated with the loss, estimated loss.

Okay.

Great.

Just two more things I wanted to touch on.

One was in terms of the competitive environment, do you have any ability to quantify what you may be gaining due to Nortel's bankruptcy and carriers perhaps showing some hesitancy of doing business with a bankrupt vendor and how that's maybe hitting your business?

It's difficult to quantify that.

I would say, Simon, it's more around -- we've got multitude of engagements right now.

These things take a time to filter through to market share and orders and -- orders first of all.

I think we're probably getting a little benefit from that but I wouldn't characterize it as large, frankly.

Right now.

I think, it's a function of time over this, if this continues for a long period of time then I think it will clearly have a more positive impact for us.

How about the wins that you highlighted today?

Were they Nortel incumbent accounts that you're winning or others?

Actually, both of those were not against Nortel.

Okay.

Great.

And last thing, if you can just drill down and give us a bit of an update of what's going on with the former Worldwide Packets business in terms of where it is versus your expectations and how you see that particular business trending through the year in terms of applications, customer types, drivers, size.

Yes.

I think it's fair to say, to characterize it as it's the adoption has not been as -- we were either over-optimistic around that market space or the impact of the overall economic downturn has affected it adversely.

It's difficult to separate the two.

But the net result is the same.

But we are encouraged by what we're seeing.

I think it's fair to say in the Tier 1 market where we've seen good wins, it's taken longer than we had anticipated to get that to actual service delivery for our customers.

But I think we should start to see an uptick in the second half of that from an order point of view, it was up sequentially in Q2.

Still a nascent market but very strong interest and we think it's going to be a good growth segment for us going forward.

We launched some new platforms this quarter in that space as well.

So I think with the level of engagement that we have and the broad engagements around number of carriers, we still feel very good about it.

What's the better application here?

Enterprise ethernet or wireless back haul?

We're seeing certainly ethernet services and wireless back haul and we've got customers that are using them for both which is great.

But we've also been able to get into just wireless back haul applications and also into ethernet business services.

The ethernet business services takes a little bit longer because of the integration into all of the OSS and service delivery systems and the software that we're rolling out now helps carriers do that faster.

One more real quick one.

The 10% customer, was it also a 10% customer in the quarter last year.

Yes.

Thank you.

Let me come back to your -- your first question on CoreDirector revenue, this is what I meant to say and if I didn't say it, then we can talk about it later.

Q2 CoreDirector revenues were $43 million.

That compares to Q1, $45 million Q4 of 2008, $38 million.

Okay.

That's exactly what I have.

Thank you.

Okay.

Thank you.

Our next question is from Paul Silverstein of Credit Suisse.

Two questions, if I might.

First off, Gary, on these long haul wins, and I know you've had several questions on this, but can you give us a sense for the scope of the revenue opportunity?

And then I've got a question on the Centaur.

In terms of scope, early days, initial deployments, on one of them is 10s of millions.

Actually both of them is sort of 10s of millions and could scope up from there.

And the 10s of will I millions, do you think that's over the next four quarters or is that over a lengthier period.

Next three or four quarters.

And with the opportunity for more?

Yes.

In one case it's in a new region for us which we think is opening up to us, so it's hard to size it, but we hope that it's going to be very meaningful, Paul.

And having booked the expenses up front, as you realize the revenues in that deployment, are the margins consistent with the rest of your long haul business.

Yes, yes.

And could you tell us where margins are these days for long haul?

Is it still around 45, give or take?

I don't think we separated it out.

But it can be anywhere in sort of 30s to 40s.

Okay.

And on the Centaur, I apologize if you addressed this in your remarks, but can you give us some sense for what -- I know it's a very big box, 5 terabits, it's a huge capacity.

How big is the opportunity?

How many of those can you sell over the next couple of years one it's commercially available?

How big is the opportunity over the next two, three years, given the capacity of the box and where carriers are at these days?

So, Paul, this is Steve Alexander, I think you're pretty much on track in terms of the size of it.

You should be thinking in numbers 6X bigger to get started with, and there's obviously ways to make that larger going forward.

Double-speed backplanes, those sorts of things.

In terms of the traffic demands for a box like that, keep in mind this is going to be a pretty rich extension of the existing family.

Current CoreDirectors have a good set of ethernet services on it, the extensions to it, you can imagine would have that much more ethernet packet capabilities.

A lot of of that goes to what we're just seeing in natural traffic growth.

If you kind of look at what's happened over the last four or five years, what used to be a core switch is now considered a Metro switch so that's a factor of five or so.

They typically start with what you would call the top 10, 20 cities of the country and they expand outward as traffic continues to grow.

Initial deployments would be measured in the dozens and final deployments would be measured in the several hundreds and that kind of goes carrier by carrier, country by country as long as the bandwidth demand keeps growing like it is.

Should the margin profile in Centaur be consistent with CoreDirector one.

Yes, because a lot of the margin is derived off of the software value.

So the margins of boxes that do a lot of traffic management, switching, aggregation, protection, provisioning, service delivery, generally are substantially higher.

Okay.

Finally, one quick housekeeping question.

Gary, did you all break out worldwide packet's contribution for the quarter?

No, we didn't.

But we included it in the ethernet access section so you can see it.

Okay.

Thank you.

Thanks, Paul.

Our next question is from Nikos Theodosopoulos with UBS.

Good morning, Nikos.

Hey, I just had a quick question on these two long haul wins.

So I guess a two-part question.

The first one is, can you kind of explain the accounting rationale of taking the loss up front before revenues were recorded, why not just record the losses as the revenues ship?

I'm just trying to understand how that flows.

And then the second part of that, I'm a little confused when you say it opens up a new region.

That almost suggests that it's a customer that you're dealing with and it opens up a new region with that customer, but you said it's a new customer so I'm trying to understand the terminology opens up a new region.

Thank you.

Yeah.

On the second part, I was referring to a geographic region that we have not yet been in.

One of the loss contracts that we recorded was in this new region, new geographic region with a new customer.

The customer has other opportunities in that region and associated with other companies.

We believe that there is really a lot of opportunity in this new geographic area.

With respect to the lost contracts, it's just a function of -- a feature of GAAP, that once you have an order in place that you're going to deliver against, that you know that you will have a loss on, you have to book the loss, even though you don't book the associated revenue until you deliver the equipment.

So that's just the way GAAP works.

I don't know if that answers the question, but it's a technical side to GAAP.

Okay.

But then going forward, when you start shipping, what's the gross margin on -- when you ship?

I mean, do you have any costs?

Do you have 100% gross margin?

Well, it's -- it's a little different for each of the two, but in one case, the later orders and shipments will be at a very good margin.

The delivery of the revenue under the initial amount that was recognized in the loss contract will be at a zero margin.

But the net effect of some amount at zero margin, some amount at a very good margin gets us in the sort of long haul transport range.

Got it.

Okay.

And then in terms of the new region, I'm still confused because I thought you guys pretty much shipped to every region of the world.

I gather you're not talking continents, you're talking countries when you say a new region?

Yeah, I mean, I'd say it's a definition of -- it is a new geography for us.

I mean, we've typically been focused on North America and Western Europe.

And this is in a new -- you know, this is in a new region for us.

Okay.

All right.

Thank you.

Thanks, Nikos.

Our next question is from John Marchetti of Cowen.

Good morning, John.

Good morning, how are you?

Good.

Good.

Quick follow-up, Gary.

In terms of the -- kind of the way you've laid out the second half here, you talked about things improving a little bit.

You're winning footprint.

All else being equal, if things stay the way that you're looking at them right now, should we be looking at this April quarter as potentially the sort of trough for your top line business?

That's a good question, John.

I would sincerely hope so.

I think the caution that you're hearing with us right now is we just haven't got enough data points, John.

So that's why we're taking it sort of step by step.

We're seeing improved sentiment.

We're seeing improved order flow but we need some more dots to join up before we sort of make any broader claims.

But we certainly hope so, John.

And then just getting back to the prototype cost just for a second here, given the way that's going to run a little bit hotter for the next little bit, should we just sort of look at where your OpEx is coming out and take it back to the comments you made last quarter when you first set out the $80 million at roughly a breakeven level at sort of the Q1 level, it just sort of scaling those things up maybe a little bit marginally at a sort of mid-80s range or a little bit below that in terms of OpEx for your breakeven level now?

I guess I'd start by saying what we're -- what we're saying right now is prototypes are running hotter than we thought when we last spoke to you and, frankly, that's a good news story, because what it means is that deployments of some of these new development projects are happening faster and in greater quantity than we thought.

So it's a good news story and we can speak to Q3 now.

We know it's going to be low 80s instead of the $80 million that we said last quarter.

I think going forward from here, we're just -- given all of the lack of visibility that we have, we're just not prepared to say anything beyond what we said about Q3.

Thanks very much.

Our next question is from Jeff Kvaal of Barclays Capital.

Thanks very much, Jim.

I did want to dial into that OpEx question a bit more.

I think at one point in the call you had said low to mid-80s.

I just wanted to make sure that low was the way you were thinking of it.

Low is what I said for Q3.

Wouldn't the subsequent quarter be a little bit lower, all else equal, if you have three months of the facilities closure?

Let's see now.

The facilities closure cost will not be in the quarter.

And we did take out sort of 130 people in Q2.

There still remains people in Acton.

Those people will be leaving at the end of June.

So the July quarter will be affected by some costs that will be coming out sort of end of Q3.

So would it be reasonable, then, for us to assume that the subsequent quarter would be lower for OpEx or are there other things going on with higher prototyping?

We're just not prepared to answer that question right now.

We do -- we have seen demand from customers for new generation products.

It's affecting prototypes, as I say.

I think that's a good news story.

I'd like to think that it will continue.

I just don't know.

Okay.

All right.

Thanks very much.

Thanks, Jeff.

Our next question is from Samuel Wilson of JMP Securities.

Hi, two small questions.

One, in most of the RFP activity and the increased orders, can you just give us a sense of who you're seeing in terms of competition these days for that business?

It's a little geographic dependent, Sam.

And obviously and value proposition dependent too, particularly as we get more into the sort of converged ethernet, it can be anybody from Cisco, Alcatel, et cetera.

Alcatel particularly is who we come up with probably most across the board.

Given their broad product portfolio, as we also get a broader platform out there.

We still see Nortel, particularly on the sort of Metro side.

They've got a huge incumbency.

So those are the sort of key players we see.

If it's just transport, you'll see Huawei, particularly outside of North America as well.

You'll see those folks.

But we tend to focus on value propositions that -- it's tough for them to play in because it's very software intensive.

A second question is -- comes more from your sales background than maybe being CEO, but you've now publicly released that you loss leadered two contracts.

What sort of stops your other customers from demanding the same?

I mean, the situations are very specific.

They're in new situations for us, into new customers and markets.

It's not unusual for that kind of profile to take place.

We only do it from time to time and in very specific situations, so it's just a different kind of situation.

Got it.

It's a different kind of challenge.

And then lastly, stock option expense looked like it was up noticeably quarter on quarter.

Just wanted to know if there was anything there?

No, no.

Nothing that I can think of, Sam.

All right.

Perfect.

Thank you.

Our next is from Tal Liani of Banc of America.

Thank you.

It's Vivek Arya on Tal's behalf.

Good morning.

Good morning, Vivek.

Just a couple of questions and one clarification.

First on the clarification, I think Jim, you mentioned share count would be 112 million.

At what net income do we start including the shares associated with your converts?

Really, it's just slightly above breakeven, Vivek.

Below breakeven the converts would be accretive rather than dilutive so you don't use that share count.

You don't add back the convertible interest below breakeven.

Slightly above breakeven and I can't give you a precise number but you can sort of consider breakeven as the dividing point.

Got it.

Next thing, Gary, if CapEx visibility is low, how do you know when and if carriers will start adopting your new platforms, I'm especially curious to see what kind of discussions you have had had about the timing and the magnitude of adoption of your new CoreDirector by the largest customer you have had so far for that platform.

I think as Steve said, most of the initial engagements are clearly with our existing customers and I think given the benefits that the extensions bring to them, both in terms of some of the capacity stuff, but just as importantly I think the features and functionality and the convergence that that provides, that really is very much in the sort of next generation target architecture for a lot of these Tier 1 carriers, so they are very keen to get that tested in their labs and deployed and out and we're at various stages of engagement with a number of Tier 1s around that, because both from a capacity point of view and economics point of view and new service creation, it's going to be impactful for their business so we're seeing very good engagement with them, Vivek.

And then Q3 sales in the last two years have grown about 4 to 5%, in that range, sequentially.

Is conceptually that the kind of range you're looking at this year?

I think to be honest, we have some seasonal trends that are more on the order side than necessarily on the revenue.

But I would also say that in this environment, I wouldn't look to seasonal trends, given the macroeconomics.

I think you can -- it's not much of a sign post, unfortunately.

And just one final one.

On this, the loss that you had to book initially, I think you mentioned about $5.8 million or so or $6 million or so --

5.8, yes.

Is that 100% off the cost of goods for that particular deployment?

No, it's just the loss associated on the two.

Okay.

So when you do start recognizing a revenue, I think maybe you had answered that question before, but if you could clarify that.

When you start, let's assume you recognize $10 million of revenue and let's assume it's at, say, 40% gross margin when you do recognize it in a normalized situation.

What really would be the revenue end margins you start recognizing when it starts?

What I said was that in the one case, the pricing strategy on the deal is such that depending upon the mix of the product which is delivered or which is ordered, you can have a very low margin on some types of orders and a very high margin on other types of orders.

We just so happened in this case to get the lower margin orders, kind of grouped together in this quarter.

So what we did was we booked the loss on that contract.

When we get later orders, what will happen is, they presumably should be more heavily weighted toward the higher margin piece of the business.

So for that piece of the business, whatever the revenue is, we'll book a very significant margin, a very comfortable margin.

However, let's assume that we then deliver some amount of the material which is associated with the loss contract that we booked this quarter.

Those would go out at a zero margin.

You would book the revenue and costs at zero and then the other piece of the order would be at a very nice margin.

And I think somebody asked this before.

The net result of all of that is that later on you'll get margins that are equal to or maybe even a little better than our sort of average margins on particular types of equipment.

Okay.

Thank you and good luck.

Thanks, Vivek.

Due to time constraints we have time for one last question.

That question will be from Blair King of Avondale Partners.

Thanks for taking my question.

Appreciate your time.

Just one quick one.

If you could give some clarification on one of the -- on the development of the 40G interface relative to the 100G interface and to the extent you can put some timing around that would be kind of helpful, if you can.

Thanks.

Sure.

Sure, Blair.

So 40 gig is available today.

That's kind of the -- I don't know, the high end that people are deploying.

The 100 gig is generally considered the next gen.

I think if anything, we've always looked at it as the real high ground with 40 gig as kind of a stepping stone to it.

40 gig is important but obviously 100 gig will be more so once it gets into market.

We're fortunate to have arguably the first deployable 100 gig solution.

One quick follow-up then.

I realize the 40 gig is available today.

I was under the impression that there was some development effort internal to Ciena that perhaps there was a 40G interface being created internally.

Is there anything you can say about that?

Well, so we do 40 gig interfaces for all the products that should support 40 gig and it's kind of a make versus buy.

Whether you build it or you buy it as a module that's kind of the designer's choice.

You can assume that all the products will have 10 gigs, 40 gigs, 100 gigs if that's what appropriate to their applications.

Thank you very much.

This concludes today's question-and-answer session.

At this time I would like to turn the conference back over to Mr.

Gary Smith for any additional comments.

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

Very much appreciate it.

Thank you.

This concludes today's conference.

Thank you for your participation.