Ciena Corporation - Well Positioned To Grow Future Revenue As Profitability Remains An Issue

| About: Ciena Corporation (CIEN)

Shares of Ciena Corporation (NASDAQ:CIEN) saw a decent jump in Thursday's trading session following the release of its second-quarter results.

Investors and analysts are pleasantly surprised by the strong second-quarter and the even stronger outlook for the current third quarter. Ciena is well positioned to take advantage as Tier 1 carriers are investing in their new networks.

Second-Quarter Results

Ciena generated second-quarter revenues of $507.7 million, up 6.3% on the year before. Even more impressive, revenues were up by 12.1% compared to the first quarter. Revenues comfortably beat consensus estimates of $483.6 million.

Net losses came in at $27.8 million or $0.28 per share, as losses increased by a penny compared to last year.

Non-GAAP earnings came in at $2.2 million, or $0.02 per share. This compares to earnings of $0.04 per share last year. On average analysts were looking for adjusted losses of $0.01 per share.

CEO Gary B. Smith commented on the second quarter performance, "We have designed Ciena to take advantage of the fundamental shift in network architecture driven by changing end-user demands, and our strong quarterly and first half of 2013 performance are a direct result of that strategy. Our unique ability to provide customers convergence, automation, openness and software intelligence positions us to lead the industry in this shift."

Looking Into The Results

While revenue growth was impressive, especially compared to the first quarter, it brought little improvement to the bottom line.

Gross margins were up a solid 300 basis points compared to last year, but actually fell by 190 basis points on the quarter. While margins were on the rise compared to last year, operating expenses were increasing as well. Total operating expenses were up by 260 basis points to 43.3% of total revenues on greater research and development investments and an increase in selling and marketing expenses.

Consequently, Ciena was forced to report negative operating margins of 2.1% over the past quarter. This compares to modest losses in the first quarter of this year and the second quarter of last year.

Third-Quarter Outlook

Ciena is looking to the future with confidence. Third-quarter revenues are expected to come in between $515 and $545 million. Non-GAAP gross margins are expected in the low 40s range, while non-GAAP operating expenses are expected to come in the mid $190 million.

On average, analysts were looking for a guidance of third-quarter revenues around $509.5 million.

Continued revenue growth accompanied by solid gross margins and stabilizing operating expenses should provide a boost to earnings.


Ciena ended its second quarter with $692.5 million in cash, equivalents and short-term investments. The company operates with $1.44 billion in short- and long-term convertible notes outstanding, which could dilute shareholder's interest going forward.

Some $700 million worth of debt can be converted at $20 per share in the coming years, potentially diluting the current shareholder base by a third.

Revenues for the first six months of the year came in at $960.8 million, up 7.4% on the year. Net losses came in essentially unchanged at $74.4 million, or $0.73 per diluted share.

Factoring in Thursday's jump, shares are exchanging hands around $19 per share. This values the firm around $1.9 billion, or roughly 1.0 times this year's expected annual revenues.

Ciena does not pay a dividend at the moment.

Some Historical Perspective

Over the past decade shareholders have seen dramatic returns. Shares traded around $50 at the start of 2004 and fell to lows of $5 in the aftermath of the financial crisis. Shares bounced back towards $27 per share in 2011, to trade in a $15-$20 trading range over the past two years.

Between 2009 and 2012, Ciena has managed to almost triple its annual revenues towards $1.83 billion. Ciena has managed to narrow its $581 million loss in 2009 towards $144 million over the past year.

Investment Thesis

Ciena has completely turned around its business in preparation for a fundamental shift in network architecture. Since 2009 the company has nearly tripled its revenues. While it has managed to reduce its losses it is still not profitable. Quite possibly, a renewed jump in revenue growth in the coming periods could lead the path to profits.

Ciena's devices, which allow wireless communications at great speed and ease, are very popular with telecommunication carriers. Top tier 1 carries like AT&T (NYSE:T) and Verizon Communications (NYSE:VZ) are among Ciena's top clients for its 100G optics solutions. The rapid growth implies that Ciena is gaining market share from its competitors Cisco Systems (NASDAQ:CSCO) and Juniper Networks (NYSE:JNPR), among others, which recently have seen some strength as well.

As telecommunication carriers are continuing to invest in their future networks Ciena is well-positioned to take advantage of these emerging and accelerating trends. Its growing backlog during the quarter is only a testament to this claim. On the back of these favorable trends, Ciena is expecting gross margins to improve to their mid-forties in the medium to long term.

The improvements come as a surprise given the general weakness in capex spending, but indicate that Ciena is well positioned to supply future generation infrastructure networks, an area in which carriers are actually boosting capex. Ciena's Ethernet solutions are the way forward, sending a 100 billion bits of information per second.

At its current rate, Ciena is generating over $2 billion in annual revenues, and could report break-even results. Still the company's valuation at little below 1 times annual revenues is understandable given the lack of profitability. Even when I factor in gross margin expansion and positive sales leverage, profitability will be limited.

While I applaud management with the great positioning of the company it is not just revenue growth which counts. A structural profitability improvement is needed to boost the valuation. Still there is a potential added bonus for investors, the interesting technologies and market leading segments might attract a large competitor in making an offer for the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.