Belt-tightening by customers proved a major downer for Ciena last summer. In August, its share price plummeted 30% as CEO Gary Smith warned investors about pandemic-era deployment challenges and a slowdown in orders. But the good times seem to be coming back. On a call with analysts this week, Smith hailed "an improvement of industry and economic conditions overall." Spending by his own clients is returning to "more typical pre-pandemic levels," he said.

It was not immediately apparent in the optical equipment maker's top-line results. Revenues dropped 6.7% for the recently ended second quarter, to $833.9 million, compared with the year-earlier period. Of all the company's units, the only meaningful growth came at the relatively small software bits, buoyed by customer enthusiasm for automation.

Figure 1: Ciena CEO Gary Smith has reasons to look cheerful.

But there was enough positive rhetoric from Smith to enthuse investors and send the company's share price up 7.3% on June 3. Orders in the second quarter were significantly greater than revenues, he told analysts, putting Ciena firmly on track to hit this year's financial targets. It appears relatively unfazed by the semiconductor supply problems that have rattled other parts of the telecom sector. Despite the revenue decline, net profit grew nearly 13%, to $103 million. And geopolitics is working to Ciena's advantage.

That issue, unsurprisingly, received a lot of attention on the call as analysts pondered what the current backlash against China's Huawei could mean for Ciena in future. "It obviously benefits us and other competitors that are not Huawei," said Smith, according to a Seeking Alpha transcript. While a sudden swap-out of optical equipment looks improbable, customers in Europe are slowly reducing their "dependency" on the Chinese vendor, he reckons. In India, moreover, big carriers have already issued requests for proposal to replace Huawei.

Ratcheting up the G force

More immediately, customers are responding favorably to Ciena's launch of 800G technology under the WaveLogic 5 (WL5) brand. So far, the pace of adoption has been quicker than it was for the previous generation of 400G technology, according to Scott McFeely, Ciena's senior vice president of global products and services. Analysts are impressed. "Ciena continues to make progress on WL5, as its customer base has increased to 95, up from 79 in F1Q [the fiscal first quarter]," said Dave Kang, an analyst with B. Riley Securities, in a research note. "It has shipped 5K during F2Q, bringing the total to 11.5K to date."

Kang's estimate is that WL5 accounted for between 20% and 30% of converged packet optical (CPO) sales in the second quarter, or 15% to 20% of total revenues. If there is any concern, it seems to be that WL5's sizeable share implies sales of other CPO products are in a sharper decline than expected. "As such, it remains to be seen how the rise of WL5 and the decline of other CPO will play out over the next two to three years," said Kang.

More encouraging is the boost to profitability that WL5 seems partly to have provided. The gross margin, a closely watched metric within the vendor community, rose 3.3 percentage points year-on-year in the second quarter, to 49.5%, as Ciena benefited from product improvements. "We've taken a lot of costs out of our product," said Jim Moylan, Ciena's chief financial officer. "And we have great technology. All that has contributed to our improvement in gross margins."

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While future product development could exert pressure on the figure, Michael Genovese, an analyst with WestPark Capital, is optimistic about short-term guidance. "A portion of the better GMs [gross margins] is sustainable, driven by growing software mix and excellent supply chain management," he said in a research note. Ciena expects to generate a gross margin of 46% to 47% for the second half of this year.

As for that supply chain, Smith acknowledged there had been "some lengthening of component lead times" but said he did not expect this to have a material impact on sales this year. Besides reaping the benefits of supply chain diversification, Ciena appears to have kept a lot of technology development in-house. "Component shortages are not likely to significantly affect Ciena's ability to achieve its FY21 revenue growth outlook, given Ciena enjoys a considerably higher level of vertical integration than its peers," said Fahad Najam, an analyst with MKM Partners, in a research note.

The market's optimism seems justified. A well-documented consequence of the pandemic is to have made the planet even more heavily reliant on communications technology than it already was. Companies like Ciena that provide the plumbing for this system always stood to profit once their customers made it past the initial shock. With Huawei on the ropes, and the Biden administration now flinging money at infrastructure projects in the latest example of "stimulus," the backdrop could hardly be better.

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— Iain Morris, International Editor, Light Reading