Ciena: What Slowdown?

Like a beacon lancing the darkness of recent earnings reports, Ciena Corp. (Nasdaq: CIEN) today announced strong earnings and no slowdown in carrier demand, particularly in the long-haul space (see Ciena Chalks Up $352M First Quarter). And to underscore the point, it revised its revenue expectations for the remainder of the fiscal year upward -- bucking a marked trend in the opposite direction.

"Legacy suppliers are reporting spending slowdowns. Our numbers speak to the growth of this market," CEO Patrick H. Nettles said in an exclusive interview with Light Reading following today's announcement.

Nettles says carriers worldwide, under pressure to make money from broadband services quickly, are accelerating their buildout of next-generation optical switches that replace Sonet add/drop multiplexers and crossconnects.

Nettles has no truck with those who claim carriers are unwilling to make the shift. "That ten customers have decided to replace their Sonet gear with [Ciena's] CoreDirector -- a radical change in architecture -- shows that they're not only willing to change to next-generation equipment, they're openly embracing the change," he says. "The combination of runaway [expenses] and diminishing revenues [from existing infrastructure] is driving them to use new solutions."

Installing next-generation optical gear is a no-brainer for these carriers, he says. "We're not talking about 5 to 10 percent savings on capital expenditure, but 50 percent savings compared to legacy equipment," he asserts. He says next-generation kit, once installed, can provide 50 percent more savings in operational expenses for carriers -- while substantially increasing revenue.

Nettles criticizes market researchers who've failed to recognize or publicize the shift he describes, largely because they glom together new DWDM switches with Sonet gear in making their counts. "Legacy suppliers list everything they make as optical networking," he says. "If all the data is stirred together, it's very hard to separate out [the next-generation gear]." It's a complaint Ciena's reiterated before to suppliers and market research firms (see Nortel Spins Past Ciena).

Here are the highlights of today's announcement:

• Revenues were $352 million for the first fiscal quarter of 2001 -- growth of 22 percent over fiscal fourth quarter 2000 and more than 130 percent over last year's figures.
• For the first time ever, sales of Ciena's high-capacity CoreDirector switch surpassed 10 percent of revenues.
• Four CoreDirector customers were added this quarter, Broadwing Communications (NYSE: BRW), Genuity Inc. (Nasdaq: GENU), Level 3 Communications Inc. (Nasdaq: LVLT) (see Ciena Closes in on Level 3 ), and McLeod USA (Nasdaq: MCLD) (see Ciena Lands $200M Deal With McLeod), bringing total customer count to 43, 30 of which contributed to revenues in Q1 2001.
• Five of Ciena's long-haul customers have adopted its OC192 (10 Gbit/s) interfaces, and the company expects OC192 channel connections to "predominate" in product sales of long-haul gear in 2001.
• Adjusted net income was $54.1 million, or 18 cents earnings per diluted share, compared with $41.3 million or 14 cents per share the previous quarter.
• Gross margins were 45.5 percent for the quarter. And while inventory levels were slightly higher than those of the previous quarter, Ciena said it's all because of a backlog related to stronger demand, particularly in North America.
  
  

All of this, Ciena says, has encouraged the company to revise its earnings guidance upward for the remainder of the fiscal year. Instead of expecting to see earnings per share (EPS) of about 67 cents for 2001, it expects to see EPS closer to 75 cents. And for fiscal 2002, the company says it expects revenues to grow in a range from 45 to 65 percent above 2001 levels, versus previous expectations of 35 to 65 percent.

The lion's share of growth, Nettles says, should come from sales of long-haul CoreDirector gear. In contrast, business in the metropolitan area networking market, which some other companies and industry sources emphasize as key to the optical segment, will represent a much smaller opportunity. "The metro market is smaller in scale than long haul," Nettles says. "We expect it to be $900 million in 2001, and we expect to get our fair share of that." Indeed, Nettles thinks the metro market is shaping up to be "a three-horse race" between Ciena, Nortel Networks Corp. (NYSE/Toronto: NT), and ONI Systems Inc. (Nasdaq: ONIS).

In contrast, Nettles says he expects Ciena to dominate the market for long-haul DWDM gear, which Ciena predicts will be close to $4 billion in 2001. Chief competition in this space will come from Nortel, which according to Nettles has linked its optical solutions too closely to its existing Sonet kit. "They're a tough competitor, but they're going to be hamstrung by not having the right products at the right time."

Ciena says its acquisition of Cyras Systems Inc. (see Ciena To Buy Cyras for $2.6 Billion) will help its penetration in the metro space, since customers reportedly are looking to use Cyras gear to aggregate links at the network edge for delivery to the CoreDirector. That merger is on track and expected to be finalized shortly, executives said this morning.

While analysts universally applauded Ciena's news, the main question seems to be whether it can continue as planned. What happens, for instance, when the big North American buildouts that represent the bulk of Ciena's revenues, are built out?

Not to worry, Nettles told Light Reading. Demand is going to continue to be fueled by the growth of Internet traffic. "The fact that the dotcom bubble has burst doesn't mean e-commerce is dead by any means. More and more applications of e-commerce are going to become mainstream."

-- Mary Jander, senior editor, Light Reading http://www.lightreading.com