FBR’s Scott Thomspon:

“Ciena is arguably the world’s leader in optical communication innovation and is dependent on carrier spending on optical (think lasers) equipment. We expect Ciena’s revenue to be focused on two near-term themes that are likely to drive a strong revenue growth cycle in the optical equipment space. The near-term themes include a carrier optical network upgrade cycle and continued deployment of fiber-based Ethernet technologies for wireless backhaul.

Ciena appears to be two-plus quarters into an optical upgrade cycle that management has indicated could be longer than past cycles. While we expect Ciena will continue to post strong results on the back of    relatively strong service provider spending patterns, we encourage investors to keep expectations in check as revenue recognition is often lumpy for CIEN (30%-plus of revenues are from two customers).”

Key Points:
■ Converged packet networking, software, and services combine to deliver a more balanced and prolonged upgrade cycle. Past cycles have often been driven by optical transport and a mix of switching, resulting in significant volatility throughout the upgrade cycle. We view this cycle as being different given strong and balanced growth in multiple and higher-margin categories such as packet networking, software, and services balance Ciena’s core product growth. For the July quarter, we expect growth in Ciena’s packet networking segment is likely to remain robust, potentially delivering upside to our above consensus revenue and GM estimates.
■ Margins continue to improve? We expect GMs to remain strong for Ciena for several reasons: (1) several industry participants have made comments recently about pricing pressure abating as carriers continue to deploy significant optical network upgrades, (2) component cost savings associated with WaveLogic 3 could drive additional upside to Gross Margins (GM) through CY13, and (3) Ciena is beginning to work through the initial stages of deployment where lower-margin chassis mute GM expansion. While we are always cautious with regard to GM with Ciena, we expect the July quarter GM result could come in well above our and the consensus 42.6% estimate.
■ Raising July quarter revenue estimates; tempering our enthusiastic EPS slam dunk. We are raising our revenue estimates in expectation of strong 2H13 optical spending patterns. We have revised F3Q13 revenues above the high
end of management’s guide to $549M from $534M, above Street consensus of $532M, and lowered our GM estimate to 43.4% from 44%. For FY13, we expect revenues to come in at $2.05B, up from $2.03B, against a Street consensus of
$2.04B. As a result, our $0.23 EPS estimate declines to $0.22 for F3Q13 but remains well above Street consensus of $0.15, while our FY13E EPS declines to $0.58 from $0.67 to make room for any potential non-linearity in large project
completions, which have been known to concern CIEN investors.

Q &A:

1. Will service providers, especially in the U.S., invest in an optical network upgrade cycle in 2013?
Yes. Carriers seem to invest in optical products in cycles. We expect that Verizon Communications, Inc., AT&T Inc., and Sprint are planning to make material investments in the optical layers of their networks in 2013.

2. Will Cisco s move to integrate optical transport into its routing platform pressure gross margins across the optical network equipment sector?
We believe Cisco only makes a concerted effort to enter a market when it believes it can hold one of the top two market share positions in the category. We expect Cisco s move to integrate optical capabilities into its routing platform creates a more credible and negative threat for Ciena and its ability to maintain and grow its gross margin profile.

3. Could increasing competition from Huawei Technologies Ltd. and Infinera Corporation pressure the gross margin?
Yes, but we are cautiously optimistic that pricing pressure may have subsided a bit. Additionally, lower COGS associated with the WaveLogic 3 product could help to offset competitive margin pressures for the next several quarters. Huawei is an aggressive competitor, but we expect political pressure against Huawei in the U.S. and the EU may prove beneficial for Ciena s margins in 2013.

References (by this author):

Ciena and Research Network Partners Work to Make Carrier WAN-SDN Realizable                  http://viodi.com/2013/08/12/ciena-research-network-partners-work-to-make-carrier-wan-sdn-realizable/

Open Network Foundation & Other Organizations; ONF-Optical Transport WG; Ciena & SDN http://viodi.com/2013/04/24/open-network-foundation-onf-optical-transport-wg-ciena-sdn/

Sprint to Scale Core Network to 40G/100G and later 400G with Ciena’s 6500 Packet-Optical Platform  https://techblog.comsoc.org/2012/06/13/sprint-to-scale-core-network-to-40g100g-and-later-400g-with-cienas-6500-packet-optical-platform

Ciena brings SDN functionality to new network architecture- OPn https://techblog.comsoc.org/2012/06/12/ciena-brings-sdn-functionality-to-new-network-architecture-opn-july-comsocscv-meeting