Telecom equipment maker Ciena (NYSE:CIEN) soared almost 14% after its third-quarter results and current quarter's guidance trumped analysts' expectations. The company has been on a terrific run this year with revenue, earnings, and stock all moving north. Given the strength that Ciena is seeing in telecom spending, it won't be surprising if the following chart continues its upward trajectory.
Ciena's management stated that order growth in the previous quarter outpaced sequential revenue growth of 6%, leading to a record backlog. This can be expected as Ciena counts major telecom carriers, such as AT&T (NYSE:T) and Verizon (NYSE:VZ), as customers and it has also been entering new markets.
Some good moves
The company recorded design wins at several Tier 1 telecom customers across the globe, including Europe, Brazil, and India. Management is of the opinion that its customers are shifting to a new networking architecture and this will be a multi-year upgrade cycle.
Ciena has also diversified its product lines. Aside from being a leader in Ethernet solutions and packet optical networking, Ciena is witnessing growth in network application software. Revenue from this business was up 50% in the first three quarters of fiscal 2013 as compared to the corresponding nine-month period last year.
Ciena is looking to make the most out of growth in "mobile data, business services and app-driven machine-to-machine connectivity." This is why it is focusing on addressing the needs of the evolving network architecture and diversifying its portfolio to cater to different types of applications.
Benefiting from telco spending
Ciena is witnessing an uptick in carrier spending and that's why its guidance of $550 million to $580 million came in comfortably ahead of the $551 million consensus estimate at mid-point. The order backlog that Ciena has built so far seems to be translating into revenue.
The company expects revenue from multiple international Tier 1 customers during the ongoing quarter. But at the same time, gross margin is expected to decline to the low-40s range from 43.6% in the previous quarter.
Management sees this drop as a short-term phenomenon as Ciena is aggressively looking to capture more international customers. Start-up costs and discounts offered to new customers were cited as the reasons behind the pressure, but Ciena expects the metric to return to normal levels in the long run.
Domestically, Ciena should continue to benefit from its two main customers. AT&T and Verizon together account for around 30% of its revenue, and they are either expanding or looking to make their LTE networks better.
Verizon has completed its initial LTE build-out and is now present in 500 markets, covering close to 300 million people. However, building an LTE network doesn't mean that spending has come to an end, since Verizon will have to make the network more efficient to provide better service. This is where densification, or replacing larger cell sites with a number of smaller cell sites, will come into play.
Densification allows telcos to provide better services, especially in crowded areas. Earlier this year, Big Red stated that it will start deploying small cell sites in the second half of the year. This means that even though Verizon has completed its initial LTE roll out, it will continue to spend to make the network better.
Then there's AT&T, which has been chasing Verizon aggressively and consistently keeps adding to its LTE markets. AT&T has around 350 markets covered by 4G and intends to expand its coverage to 300 million people by next year. Apart from building its LTE infrastructure, AT&T's Project Velocity IP also focuses on adding 40,000 small cells in urban areas.
Ma Bell will be spending a total of $40 billion in 2014 and 2015 to upgrade its wireless and wireline networks, and since Ciena is a supplier, it should benefit from AT&T's capex plans.
With both Verizon and AT&T continuing to invest in their LTE infrastructure and accounting for a major part of Ciena's top line, the equipment provider's performance should strengthen going forward. In addition, Ciena has been aggressively looking to capture more design wins in international markets and it has seen strong order inflows as well, making it a stock worth holding on to.
Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.