The worldwide components crunch has caught up with Ciena. Analysts agree the optical equipment maker has done a better job than most of keeping its supply lines flowing, but it is not immune to the crisis. CEO Gary Smith puts the cost in sales terms, reckoning Ciena would otherwise be "low tens of millions" better off in its fiscal second half.

Demand for its products is picking up after a Covid lull, when new builds were put on hold. But the fiscal caution is starting to ameliorate, Smith told Light Reading, as Ciena reported a 1.2% increase in revenues for its third quarter, to $988.1 million. While growth was driven by sales of software and services, and product revenues dipped, Ciena's order book gives Smith confidence about the current quarter. "Absolutely," he responds, when asked if he expects product sales to rise.

In fact, despite the supply chain problems, Smith expects second-half sales to be 26% higher than first-half sales. This would imply revenues in the final quarter of about $1.017 billion, a 23% year-on-year improvement. With growth on that scale, investors may be able to overlook any components shortage.

Why is Smith so bullish? Partly, it seems, because of the sharp recovery in demand he sees for the various products that Ciena provides. Industry and economic conditions have improved, service provider spending is on the up and network investments are normalizing, he told analysts on a call earlier today.

Figure 1: Ciena CEO Gary Smith says demand for optical networking products is booming.

On top of that, Ciena is widely acknowledged as a market leader, with some of the best technology in the business, in critical areas. In the nascent market for advanced 800G systems, Smith boasts a massive head start on competitors. "We are basically the only player in the market and have been there for 18 months," he says. Over that period, it has already sold about 20,000 modems to 106 customers. "Once opportunities are seeded, it is difficult for other entrants," says Smith.

Ciena's capabilities owe much to its substantial investment in research and development. Its costs in that area rose 11% in the third quarter, to about $146 million, which partly explained why operating profits took such a hit, dropping 21%, to about $149 million. It was thanks only to an income tax gain that Ciena's net profit grew – and by 67% compared with the year-earlier quarter, to roughly $238 million.

But revenues are still growing faster than operating expenses, Smith insists. "We'll overperform on the bottom line with EPS [earnings per share] greater than anticipated," he says. Depending on the exact mix of products, software and services, Ciena is also guiding for a gross margin of between 45% and 47% for the fourth quarter, compared with 48% for the third. If it hits the sales target, this would mean a gross profit of at least $458 million, up 13% year-on-year.

Buying Vyatta

Ciena has just bolstered its product line with the acquisition of Vyatta, a routing and switching business previously owned by AT&T, which bought it from Brocade back in 2017. Tweeting about the divestment, Gabriel Brown, a principal analyst with Heavy Reading (a Light Reading sister company), sees it as "the next stage of AT&T unravelling its in-house network technology development work" following its decision to move its network cloud to Microsoft.

For Ciena, which has not disclosed the terms of the deal, it is about adding expertise and expanding the work it does for AT&T, although Smith does not expect the takeover to have much impact on sales. "It is significant for us in terms of getting talent and technology for the routing and switching roadmap," he says. "They are focused on metro and edge use cases, virtualizing 5G and cloud environments and this will accelerate our adaptive IP [Internet Protocol] capabilities."

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Vyatta looks important simply because its platform was linked by AT&T to the company goal of virtualizing 75% of network functions by 2020. AT&T expects to continue making use of Vyatta in the future, which essentially means Ciena will be looking after virtualized functions on the Vyatta platform. It gains 60 former AT&T staff as part of the deal, along with a development center in the UK.

Components drought

Geopolitics is providing a helpful tailwind, too, as governments and service providers outside China turn against Huawei. "It is mainly European carriers who went heavily in and are looking to migrate away over time," says Smith. In India, where there has been greater urgency about replacing Huawei in telecom networks, Ciena is also benefiting.

Yet Ciena's share price is hardly performing as one might expect after such a bullish update. At the time of writing, it was up just 1% on the Nasdaq, where it has gained about 12% so far this year. One possible explanation is concern that a components crunch will be drawn out and painful.

Figure 2: Ciena's share price ($) Source: Google Finance

"In our own view, it will be with us for a couple of quarters," says Smith. "These are structural things and won't get solved overnight." Fixing it, he says, will mean providing new capacity and replacing some components with others that are more easily obtainable. He attributes Ciena's resilience until now to its global scale and vertically integrated business. "Because of scale and financial capability and lots of capacity, we have been able to navigate through it."

Dave Kang, an analyst at B Riley, was cautious in his initial assessment, while noting that Ciena beat consensus expectations. "Although management didn't provide FY22 outlook, we believe FY22 could once again be backend-loaded as the supply chain issues are expected to persist into 1HFY22," he said in a research note. If Ciena can limit the pain to "low tens of millions" in lost sales, it will be doing well.

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— Iain Morris, International Editor, Light Reading