Ciena's Plunge Is No Optical Illusion

Clobbered by the telecom spending crunch, Ciena (CIEN) showed its upstart mettle Thursday, vowing that its technological advantage will help it bounce back. But the company offered little evidence that it will get off the floor anytime soon.

The optical-equipment maker reported an even bleaker than expected third quarter Thursday morning, posting a 42% sequential sales decline and a stunning 88% plunge from year-ago levels. The company also posted a third-quarter loss that was more than three times the size of its pitiful $50 million top line.

Executives on a call with analysts doggedly insisted that the company is "guardedly optimistic" about the current quarter. But investors can hardly be expected to take heart in those remarks, considering that the big telcos that do most of the industry's spending continue to tighten their belts. Ciena dropped 20 cents, to $4.29.

Go Telmex on the Mountain

Part of Ciena's professed enthusiasm stems from revenue the company expects to book from a large optical switching contract previously signed with Telmex ( TMX). But even including the Telmex sale, the company expects fourth-quarter revenue to remain flat with third-quarter levels. Citing the continued deterioration and flux among its telco customers, Ciena declined to provide any projections beyond the current quarter.

Observers note that the fourth-quarter projection falls far below the company's stated quarterly break-even point. Company executives told analysts on the call that their previous guidance for break-even levels of around $280 million to $300 million in quarterly revenue may have to be adjusted.

Given the ill winds in the industry, the company's minuscule gross margins and its revenue far south of the estimated break-even mark, analysts had a little trouble feeling confident about Ciena's ability to deliver.

CEO Gary Smith tried to address those anxieties on the call. Smith told analysts that recent cost cuts and the strength of Ciena's optical switching technology could give it an edge the industry.

Some analysts agree with the logic and note that with such a small revenue level, any new business will have a major impact.

"When you are a relatively small player, gaining small market share can make a big difference," says Lehman Brothers analyst Steve Levy.

In an interview after the conference call, Smith said that it wouldn't be "appropriate to structure a cost base" on the industry's extremely low and presumably temporary demand levels.

Smith says his hope rides with the large phone companies that have yet to buy Ciena gear.

"We sell nothing to the large incumbents right now," says Smith. "If we can get a share of that revenue, we can make some progress."

Road Less Traveled

Smith says he's not inclined to cut his way to profitability the way larger rivals such as Nortel ( NT) and Lucent ( LU) have been trying. He says spending has to shift to Ciena's next-generation gear at some point, so cutting development in those areas would be destructive.

Investors were handsomely rewarded for believing that story during the bubble era, and they've been singed for hanging on to that belief during the collapse.

It's certainly understandable if investors wait until Ciena can prove the theory again.

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