Highlights From CIEN's Q2 Conference Call; Successful Completion of Critical Integration Milestones Combined with Investments in Our Business

Ciena Corporation (NASDAQ: CIEN) reported Q2 adjusted loss of $0.24, $0.14 worse than the analyst estimate of ($0.10). Revenue for the quarter came in at $417.9 million versus the consensus estimate of $428.1 million. Shares are down over 13% to about $21.

Highlights From CIEN's Q2 Conference Call:

• Sees Q3 2011 revenue of $435-$455 million, versus the consensus of $456.42 million.
  
• (Gary B. Smith, President, CEO and Director) We continue to make good progress in all aspects of our business and operations. We have great momentum as evidenced by our robust customer engagement levels, additional design wins, and strong order flow.
  
• Going forward, we expect the traction we're experiencing in 40G and 100G coherent transport, the industry's transition to OTN and the strong alignment of our solutions to customer priorities to drive future growth and operating leverage.
  
• In fact, in calendar Q1, Ciena gained market share globally in all key optical segments: Switching, Long Core Transport and Metro Transport.
  
• While we have been successfully executing on a large-scale integration, we've also spent the last 15 months investing heavily in major new platforms in each of our four segments.
  
• We've also invested in entering multiple new geographies and vertical segments as well as in expanding our footprint in our traditional customer base.
  
• While we anticipated and planned for these investments, the costs have impacted and are continuing to impact a number of financial and operational metrics, including margin, OpEx and cash flows. However, I would like to stress that even with these dynamics, we have been able to demonstrate solid progress.
  
• Going forward, there are clearly lots of moving parts, so progress may not always be linear and the timing is difficult to predict but we absolutely expect improving financial performance over time as we begin to reap the benefits of these investments.
  
• With our successful completion of critical integration milestones combined with these investments in our business, we've created a solid foundation for growth with multiple positive indicators.
  
• Today people and businesses are using the network in significantly different ways, and they have higher expectations for their network experience...These needs and requirements are being driven by a number of trends including on the mobile front nearly 6 million iPhones have been activated recently in the U.S. alone...At the same time pricing plans are being more aligned with usage, making the expansion of networks more viable and consumer Internet shows no sign of slowing. The most recent example is Netflix's nearly 30% growth in the U.S. since just the fall.
  
• Additionally, enterprises are increasing their dependence on communication services for applications like cloud computing, IT virtualization and data center connectivity.
  
• Ciena's experience with OTN and complementary technologies is uniquely strong. Ciena's OTN switching includes our proven control plan for automated mesh networking, which is the most widely deployed technology of its kind in the world and we have embedded this technology into a range of commercially deployed platforms.
  
• Most notably our CoreDirector switching family has been deployed successfully for many years.
  
• We now have six customers for the 5400 family, two of which were not current CoreDirector customers, and I think this indicates the traction we're getting outside of our current switching customer base.
  
• A number of network operators are emphasizing Ethernet access in their 2011 spending plans for fiber to the home, enterprise connectivity, and backhaul for 3G and 4G LTE wireless networks.
  
• To date we've deployed more than 200,000 CSD network elements, most of which have been used in wireless backhaul applications.
  
• In summary, we are very encouraged about our growth prospects as we enter this next phase of the company's evolution. The market data and our overall progress since the MEN acquisition strongly supports Ciena's strategy and we expect to see our market position continue to improve.
  
• (James E. Moylan, CFO and Senior VP) We reported second quarter revenue of $418 million, which was at the lower end of our guidance range.
  
• These results partly reflect the effects of our ERP system shutdown during the first two weeks of the second quarter in connection with completion of the back office integration of the MEN business. This shutdown reduced our fulfillment and shipping capabilities during the quarter.
  
• Our second quarter results followed higher than anticipated revenue in the first quarter. You will recall we reported Q1 revenue of $433 million. In that quarter, approximately $10 million was pulled in from Q2 as a result of customer requests for accelerated fulfillment in anticipation of our ERP shutdown.
  
• And just to complete our high level revenue review, we had two 10% plus customers in the second quarter contributing 26% of total revenue. Revenue from outside the U.S. represented 45% of total revenue.
  
• First, our Packet-Optical Transport segment, which includes all of our optical transport platforms plus associated operating system software and embedded software features, this segment accounted for $273 million in revenue in Q2, representing 65% of total sales. Our Packet-Optical Switching segment includes CoreDirector, CoreDirector FS, and our 5430 OTN switch, plus associated operating system software and embedded software features. This segment accounted for $31 million in revenue in Q2 or 8% of total sales.
  
• Our third segment, Carrier Ethernet Service Delivery, or CESD, includes our service delivery and aggregation switches and broadband access products plus related operating systems software and embedded software features. Sales of CESD increased 12% sequentially to $31 million, or 8% of total revenue in Q2.
  
• Finally, our Software and Services segment, which includes our integrated network and service management software as well as all of our services-related offerings, was $83 million in Q2.
  
• Q2's overall gross margin was within guidance at 41.3%. OpEx came in at $186 million, which included approximately $3 million of upward FX pressure primarily due to the appreciation of the Canadian dollar against the U.S. dollar.
  
• Moving on to other income and expense, this includes a $2.2 million gain from foreign currency transactions and interest expense of $9.4 million. Our as-adjusted Q2 net loss was 22$.4 million or a loss of $0.024 per common share.
  
• Now on to cash flow and the balance sheet. At April 30, 2011, we had approximately $557 million in cash and liquid investments. Let me update you on a metric that we've talked about in the past. We used $51.8 million in cash from operations during the second quarter. This includes a use of $41.4 million due to an increase in working capital and $13.9 million of integration and restructuring payments.
  
• At the end of Q2, our accounts receivable balance was $391 million from $370 million at the end of Q1. Days sales outstanding were 84 from 77 days in Q1.
  
• The increase in DSO was driven by revenue in the second quarter being back-end loaded, in part due to the temporary ERP shutdown, and of course when you're back-end loaded on revenue, you don't get a chance to collect as much of that receivable balance during the quarter as you might otherwise.
  
• Inventories totaled $286 million in Q2 from $267 million in Q1. Product inventory turns were 2.8 times in the quarter from 3.2 times in Q1. The inventory breakdown for the quarter included raw materials of $40 million, work in progress of $9 million, finished goods of $267 million, and all of this was reduced by an accrued reserve for excess and obsolescence of $30 million.
  
• Finally, on head count as of April 30, 2011, our worldwide head count was 4,301.
  
• (For Q3) We expect revenue to be in the range of $435 million to $455 million. We expect adjusted gross margin to be in the low 40 percentages, and adjusted operating expenses to be below the levels we saw in Q2, in the low to mid $180 million range. We project other income expense net in the second quarter will be an expense of roughly $9.4 million, all of which relates to the interest on our convertible notes.
  
• (Q&A) I just wanted to ask, I guess, just one question. If you could characterize what the demand situation is looking like from carriers regionally and if you can talk to us about what's going on in Europe specifically as well as the U.S. Just trying to get a better handle on why the guidance - your revenue guidance is a little bit weak, below at least what we thought it was going to be in the model. (A) Rod, why don't I talk to it. Overall we're seeing strong demand. And I think from a regional point of view, just thinking about your question here, we're seeing good demand in Europe. Just like some of the macroeconomic uncertainties in certain country also that we don't have exposure too, we're seeing pretty good demand in Europe. Clearly Asia is not a large market for us, but we do have some, you know, strategic countries there. We're seeing good demand in Asia, Latin America, and North America. So I really don't see much changes from region to region, Rod. We see pretty solid demand across the board globally.
  
• Do you think the reason that I mean the revenues are below street estimates for the guidance, I mean do you think the reason for that is the street is just ahead of itself in terms of expectations? How would you, you know, how would you explain the differential there, I guess? (A) Here's what I'd say about that, Rod. We have a lot of wins which are big complicated networks that require a long testing cycle, lab cycle, and are going to take a bit longer to get to revenue than we might have expected. Also we're expanding outside the U.S., and it just is the case that rev rec cycles outside the U.S. are a bit longer than those in the U.S. But I would say that with the projection that we have now given you for Q4, we do have to have a pretty nice uptick in both revenue and in margin to get to the levels that we're talking about. So we do see it coming. For all the reasons that I talked about, it's a little less than we expected to date.

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