Ciena

(CIEN) - Get Report

offered more evidence Thursday that the networking business is dying a death of a thousand spending cuts.

The Linthicum, Md., optical networker posted a stunning 80% year-over-year sales decline for its second quarter, en route to a $612 million loss. Moreover, Ciena predicted third-quarter revenue would be flat to down from the second quarter's paltry $87 million, well short of the nearly $100 million consensus.

As sorry as those numbers are, Ciena executives sounded an optimistic note in a postearnings conference call, saying that demand can't go much lower. But some observers point out that the company was late to the spending slowdown that has rent the telecom industry asunder in the last two years -- and perhaps as a result it's a bit behind on the learning curve.

"There's no traditional metric you can use to know how low spending can go as long as the telcos can use capex as a magic wand to reduce their financial pressure," says Lehman Brothers analyst Steve Levy.

Ciena shares dropped 42 cents to $6.02. The stock has lost 90% of its value in the last year.

Sour and Low

Ciena executives told analysts on a conference call that they are seeing their customers go to extremes to conserve cash. That means forgoing purchases by shifting existing gear around to meet network traffic demands. While that creates pain now, Ciena says, it means that demand will inevitably bounce back once the big telcos resume their normal patterns of maintenance and upgrade spending.

"This suggests we are seeing unsustainably low spending levels," says Ciena CEO Gary Smith.

But while Smith's observations may play well with the optimistic crowd still clinging to hope of a rebound this year, others see little encouragement. They note that what was taken in some quarters as normal spending patterns were in fact inflated expectations that grew out of the late 1990s Internet building boom. Now, with big phone carriers suffering financially and slashing capital spending in a bid to hold onto scarce cash, the spending landscape is different altogether, these people say.

"I think spending has bottomed, but I don't think you can say its unsustainably low," says Levy, who has a neutral rating on Ciena. Lehman has no underwriting ties to the company.

Collectively the top seven U.S. phone companies have cut their network equipment budgets by 40% from peak spending levels in 2000. And extremely cash-strapped, debt-saddled phone companies like

WorldCom

(WCOM)

,

Sprint

(FON)

and

Qwest

(Q)

continue to cut their spending by half or more from last year's totals as they fend off onerous loan expenses and sales declines.

Cutbacks

Evidence is building that Ciena is just now seeing the depths of demand weakness that its gearmaking rivals

Nortel

(NT)

and

Lucent

(LU)

suffered through last year. Tellingly, the latest period saw Ciena's gross margin, minus restructuring and inventory charges, hit 0%. The company expects margins to widen to between 5% and 10% this quarter. Notably, both Nortel and Lucent hit their lowest margins in the September 2001 quarter; Nortel dropped to 0% and Lucent came in at 12.5%.

Since the boom peaked in late 2000, Lucent and Nortel have cut the size of their operations by half. For its part, Ciena has cut its staff to 2,235, a 43% decrease from its peak last autumn. The company says it doesn't expect to make large additional cuts.

Ciena expects to close its merger with metro optical networker

ONI

(ONIS)

shortly after shareholder votes on June 18. One slightly positive aspect of the deal, as Lehman's Levy notes, is that Ciena is acquiring the company for roughly the equivalent of ONI's $600 million cash value and its $300 million convertible debt. That means the business ?- technology, talent and coveted customer ties -- come along mostly for free.

That's the kind of news Ciena shareholders can use nowadays.