Crumbling Ciena Fumbles for Core Values

Updated from 9:12 a.m. EST

Frosted by the industrywide spending freeze, Ciena (CIEN) is whittling its business down to the core.

The maker of optical telecom gear Tuesday laid plans to focus its business more closely on its highly successful CoreDirector optical switch. Alas, the idea didn't exactly visit Ciena CEO Gary Smith in a dream: The company arrived at the decision as its customers, big telcos such as Qwest and Sprint, continue to trim back on spending for optical transport gear, which they bought by the warehouseful last year.

Evidence of the pain felt across the telecom industry was served up Tuesday in Ciena's preopen earnings warning. The onetime Wall Street favorite projected a steep loss, undercut analysts' first-quarter revenue expectations for the second time in three months and said it would cut 400 jobs, or 12% of its staff. Its stock, down 90% over a year, dropped 7% to $9.43, steepening a 16% plunge that started Monday.

Sustaining

Despite cutting its staff for the second time in six months, Ciena said it remains committed to spending on the research-and-development efforts that put it in the lead in the optical switching market. "We are sticking with sustained investment strategy in key areas of research and development and key areas of sales," said CEO Gary Smith on a conference call with analysts Tuesday.

But the continued spending on innovation is coming at a steep cost. Ciena says it expects to report a first-quarter operating loss of 19 to 22 cents a share, reversing a year-earlier profit of 18 cents a share. Revenue will plunge more than 50% from a year ago, to around $160 million. In December Ciena projected that first-quarter revenue would fall 30% to 40% from the year-ago $352 million. Analysts expected Ciena to lose 11 cents a share on revenue of $227 million.

Without offering any specific guidance, Ciena also said it expects second-quarter revenue to be flat with or below first-quarter levels. Analysts had projected second-quarter revenue of $222 million, down from the year-ago $425 million.

The Overhang

It wasn't always this way in the telecom industry. In the late 1990s telecom stocks rocketed skyward on the thinking that the Internet would represent the greatest business advance, and the best investment opportunity, in a generation. Wall Street raised billions of dollars to build new networks, creating a whole new class of highly speculative companies. Ciena, once a supplier to many of these now-failed telcos, was among the favorites of the fast-growing networking industry.

But when the bubble popped, the industry stopped spending, forcing shops like Ciena and its bigger peers, such as Lucent, Nortel and Cisco, to cut costs and pull out of some businesses altogether. Nearly 300 of the jobs Ciena is cutting involve long-haul optical transport gear production. The industry is sitting on a surplus of this gear, since new network construction screeched to a halt last year.

Ciena will take about $10 million in charges to cut jobs and close its Marlborough, Mass., plant. The company also said it was reviewing it current inventory supply and measuring it against expected revenues. It wouldn't be a big surprise if the company figured in some additional charges related to excess inventory in the coming quarters.

Bright Spot

At least the glut of parts won't be coming from its optical switch production. CoreDirector has long been the center of Ciena's plan to offset the shift in buying trends away from long-distance network construction and toward more efficient traffic management and local network expansion, or metro, projects.

CoreDirector, the industry's favorite optical switch last year, is expected to represent 50% of revenues by the June quarter, up from 20% last quarter, say Ciena executives.

The optical switch remains a must-buy even for cash-strapped telcos, because it enables them to direct more traffic more efficiently over their networks. Ciena said Tuesday that CoreDirector added another big customer during the first quarter, presumably AT&T, but neither company would confirm that.

If this stock's going to revive, Ciena's going to need more CoreDirector business, and fast.

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