Optical/IP Networks

Ciena Follows the Incumbents

After Ciena Corp. (Nasdaq: CIEN) announced disappointing third-quarter earnings this morning before the market opened (see Ciena Reports Q3, OKs Financials), it became apparent that a turnaround is long and slow in the making

Indeed, serious change is afoot, as the company reconfigures itself to focus on RBOCs (regional Bell operating companies) and international incumbents. But this strategy has no quick fix, as it requires significant investments in the Telcordia Technologies Inc. software certification process and even changes to its current product line.

“The pivotal issue for us is how quickly we can get into larger incumbent networks around the world,” says CEO Gary Smith. “The bad news is, we don’t have much market share there. But the good news is... it’s a big opportunity for us. If we can make inroads with large incumbents, we can get significant increases without the entire market turning around.”

The company posted a net loss of $160 million on revenues of $50 million. Analysts were expecting revenues of $68.1 million in the quarter, according to First Call.

While Ciena has made some progress with international incumbent carriers recently, winning business with Mexico’s leading service provider Teléfonos de México, the company has made little progress with the RBOCs here in the U.S. (see Ciena's Optical Switch Fiesta).

So far, the company has only managed to sell long-haul transport gear to RBOCs, including BellSouth Corp. (NYSE: BLS), Qwest Communications International Inc. (NYSE: Q), and Verizon Communications Inc. (NYSE: VZ).

But it's Ciena’s CoreDirector core switches, not its transport products, that are key to profitability. The product is being retrofitted for the RBOCs, which involves the addition of features and a crucial review process at Telcordia, the company that must approve interoperability of the product with RBOC networks.

Ciena cautions that these sales won’t happen anytime soon. ”With RBOCs the issue really has to do with the adoption of a new architecture,” says Steve Chaddick, Ciena’s chief strategy officer. “What we’re offering is quite different from the classic Sonet ADM model. It will take awhile for them to move in that direction. We don’t expect a great deal of business from them until well into next year at the earliest.”

Still, it looks as though Ciena may be overcoming several hurdles that have stood in its way with U.S. incumbents. Beth Perry, senior VP of core switching for the company, told Light Reading in an interview earlier this week at the Opticon trade show in San Jose, Calif., that CoreDirector will be Telcordia-compliant before year end, meeting the standards for Osmine management databases that the RBOCs traditionally have required for product adoption. Perry said Ciena is spending about $5 million on the process.

"If you're going to get in the RBOC space, you have to do it,” she says.

Perry also says Ciena plans to market CoreDirector to RBOCs as a broadband crossconnect. This would put Ciena in the crossconnect market against vendors such as Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) and Alcatel SA (NYSE: ALA; Paris: CGEP:PA).

On this morning's call, Steve Chaddick also alluded to some feature changes on the CoreDirector in his discussion of the product.

“There will have to be some feature development,” he says. “There’s a lot more than Osmine to winning RBOC business. That allows you to talk to management systems, but there are other feature and architectural pieces that are the driving force.”

Qwest Communications International Inc. (NYSE: Q) is probably the company’s best RBOC target for CoreDirector in the short term. The carrier is already using the product in the unregulated portion of its network, and it is actively looking for a product in the regulated portion, the old US West network. But financial constraints could prevent any major deployments anytime soon.

At least one source thinks there's another consideration: "Dick Notebaert [Qwest's CEO] came from Tellabs. That could make things interesting for Ciena," says Sam Greenholtz, senior analyst at Communications Industry Researchers Inc. (CIR). Notebaert, he thinks, could be instrumental in convincing Qwest to keep hold of its existing Tellabs gear instead of taking a chance on changing to Ciena.

So what about Ciena’s other product lines? Long-haul DWDM isn’t expected to bring in much business from RBOCs. Although revenues from it were up slightly from the previous quarter, Smith cautions analysts that this could be the result of "lumpy" deployments from customers such as Verizon, which deployed $1.5 million worth of its gear around Philadelphia in July. The carrier is also currently deploying WaveStar from Lucent Technologies Inc. (NYSE: LU) throughout the rest of Pennsylvania.

Ciena might win some DWDM business from RBOCs with its metro product from ONI Systems, which recently completed its Osmine certification last quarter. But once again, Ciena will be battling Lucent and others for this business. Lucent has already won an exclusive three-year contract with Verizon.

As for the K2 metro switch, experts say that none of the RBOCs have seriously considered the product. Simon Leopold from Merrill Lynch & Co. Inc. says he hasn’t seen the product on any RBOC’s short list of candidates. David Jackson of Morgan Stanley Dean Witter & Co. wrote in a research note earlier this week that the product has technical problems, which have resulted in one customer, COLT Telecom Group plc (Nasdaq: COLT; London: CTM.L), returning the product to Ciena. COLT has also supposedly reopened its request for proposal, according to the note.

For the most part, Fujitsu Ltd. (KLS: FUJI.KL), and Nortel Networks Corp. (NYSE/Toronto: NT) still dominate in this lucrative product category. Verizon’s three-year contract with these players is estimated at around $200 million, in contrast to Verizon’s contract for Lucent’s metro DWDM, estimated at only $10 million.

Management didn’t give guidance for the fourth quarter, but CEO Gary Smith says he expects revenues to be flat or slightly above this quarter’s revenue. Smith also says he's "guardedly optimistic" that stability and growth will return next year.

The company had prepared investors for the shortfall back in June when it said revenues, including those from recently acquired ONI Systems Inc., would be "down meaningfully" from its $87 million sales in the second quarter of 2002 (see Ciena to Merge, Shrink).

The company also announced that Rusty Cumpston, formerly ONI’s chief operating officer, who was in charge of Ciena’s metropolitan transport and switching efforts, is leaving the company to pursue other interests.

On a conference call with financial analysts this morning, management re-emphasized the importance of focusing on incumbent carriers' business as Ciena struggles to meet its $300 million quarterly breakeven point (see Ciena Looking to Merge Away Misery).

Ciena’s stock was trading down $0.09 (2%) to $4.40 today.

— Marguerite Reardon, Senior Editor and R. Scott Raynovich, US Editor, Light Reading

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