Growth Talk Offers Hope at Ciena

For the first time in more than a year, Ciena's (CIEN) headed in the right direction. The question now is whether it's moving fast enough.

Thursday morning, the optical networking shop became the first major communications gearmaker to not only post sequential revenue growth but to predict more of the same for the current quarter. Ciena shares jumped 18% Thursday afternoon, spurred by the Linthicum, Md., company's surprising top-line strength.

But as always, plenty of caveats were available to balance the telecom market's latest hopeful murmurings. For one thing, Ciena's turnaround milestone comes only after a six-quarter-long sequential sales slide. Tellingly, that plunge ended with latest-quarter sales more than 80% below their mid-2001 peak.

For another, red ink is flowing robustly at Ciena, and the company, though cash rich, continues to burn cash at a rapid rate. And even if the latest quarter's numbers suggest the worst is over for tech-savvy Ciena, company executives and analysts note that the telecom equipment market remains a swamp.

"The industry isn't stabilizing," Ciena CEO Gary Smith told analysts on a morning conference call. "We aren't a barometer for the industry."

James Garner

Because of the popularity of one or two of its products, and the strength of $1.5 billion in cash on its balance sheet, Ciena has been a maverick in the telecom-equipment market. The company has drawn heated criticism for opting to expand its product line even as all its rivals have cut back to better-weather the downturn.

Ciena bought the unprofitable metro optical gearmaker ONI in June to add to its line of local networking products. The move plunged Ciena deeper into red ink and raised the stakes on its aggressive spend-our-way-out strategy.

While Ciena isn't tangled in a liquidity crisis like many of its larger peers such as Lucent ( LU) and Nortel ( NT), the company does have about $1 billion in debt coming due by 2008. On that front, Ciena bought back some of its $300 million in ONI bonds, retiring $97 million last quarter in an effort to reduce its obligations.

"Clearly, we are very early in the bottoming process, but it is good to see improvements on their top line," says Justin McNichol, a money manager with Osborne Partners Capital Management who is long Ciena. "Unfortunately, they're going to need many 10%-plus growth quarters in a row to reach their break-even."

Coming Due

Indeed, Ciena can't spend forever. Despite staff cuts and expense trimming, Ciena burned through $100 million of its cash pile last quarter. At that rate, and with more debt buybacks, Ciena will run its cash level down below its debt levels sometime next year, eroding its creditors' confidence in a cash collateral.

Also muting the enthusiasm was the wide gap between the company's current $62 million quarterly sales level and the $200 million in revenue it needs just to break even.

"Ciena was the last company to feel the spending pinch, so they were late to the cost-cutting process," says money manager McNichol. "The potential problem for them is that if we don't have a strong snapback, it will take them longer than their competitors to rebound."

CEO Smith says he's aware of the fine line he must walk.

"We have reduced our workforce by half, so we have taken a balanced approach to this," Smith said in a midday interview. He says his focus is to emerge successfully from the telecom downturn by offering his phone-company customers more efficient next-generation optical equipment.

"You can only do that by innovating. We have to simplify and automate the network," says Smith. "We might be wrong with that approach, but we aren't unsure."

You can bet investors will be looking for Ciena to win its promised big customers and deliver its 10% sales growth this quarter, to help validate that strategy.

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