Has Ciena Finally Turned The Corner?

Includes: CIEN, FNSR
by: Stone Fox Capital

Ciena (NASDAQ:CIEN) soared after reporting an EPS beat and non-GAAP profits for the first time in several quarters. CIEN had a impressive mix of improved revenue combined with a reduction in operation expenses. The real question is whether this combination can last in the competitive environment.

Ciena has long been a leading optical and networking equipment provider back to the internet bust in 2000. Since the bust, CIEN has had some good periods, but it has never been able to flourish. The company continues to make lower highs every 4 or so years with peaks around 2004, 2007 and 2011.

The biggest issue facing CIEN is a carrier customer base that continues to struggle. While advanced networking equipment is needed for network modernization due to cloud computing and advanced video, the customer base just doesn't have the balance sheets and pricing power to support massive network buildouts.

Negative Operating Cash Flow
One of the biggest concerns when reviewing the financials is that CIEN had massive net cash used in operating activities over the last nine months. For a company with large needs for equipment expenses, it must have positive cash flow from operations in order to re-invest in new equipment. For the nine months ended July 31st, CIEN used $132M in operations.

A major part of the negativity was a $72M increase in accounts receivable (AR) and $81M reduction in accounts payable (AP). A company struggling with profits appears to be getting squeezed by suppliers and customers.

Per the conference call, the CFO expects to reach positive cash flow from operations in Q4. This must be part of the future to definitively turn the corner.

The revenue guidance wasn't as robust as some wanted with a midpoint around $450M below the $466M estimate. The company hopes to optimize operational leverage going forward. A big concern remains whether the cost reductions will eventually impact growth.

Finisar (NASDAQ:FNSR) reported earnings that generally beat estimates and at best beat very low estimates. One needs to understand that the $.21 reported was 50% below the estimate just 90 days ago. Revenue did grow nearly 10% over last year. While lower than the previous quarter, it was still growth from 2010.

Their results suggest that the worst is over for the sector, but it doesn't exactly give confidence the sector will see a robust rebound.

For the market in general, it should be encouraging that this sector has bottomed even as the fears of global recession have roiled the markets. Unfortunately this could all take a turn for the worst, but clearly this is another data point that flies in the face of people fearing a global recession.

FNSR actually has one of the more impressive bottoms put in place. The stock essentially hit a bottom in mid June with just a slightly lower low in Auguts. Now the 20ema is about to cross above the 50ema. The stock popped above the 200ema on Friday, but closed below and will likely fill the gap back to $19.

While FNSR bottomed with the markets around the 8th of August, CIEN hit new lows around the end of August. The stock failed to take out the 50ema and likely will need more time.

Clearly CIEN has made huge strides by growing revenue and reducing costs. Keeping this going in this environment is a tough task. The communications equipment sector continues to struggle from charging too little and spending too much, based on future demand that never pays up. By the time that demand comes around carriers charge less, creating a never ending loop of more demand at lower prices.

Neither CIEN or FNSR spins a story that is compelling as the sector muddles along. The bottoming in this sector suggests one should have less fear over the network equipment companies more tuned into cloud computing, network optimization, and wireless network access like Aruba Networks (NASDAQ:ARUN), F5 Networks (NASDAQ:FFIV), and Riverbed Tech (NASDAQ:RVBD) though one must admit that FNSR has a more impressive chart.

Maybe one can't read that much into the other networking stocks, but if one of the weakest sectors can hit bottom then the non stop fear of falling off a cliff can be taken off the table.

Disclosure: I am long RVBD.

Additional disclosure: All data is provided for informative purposes only. Before making any investment decisions, one should consult and investment advisor.