The last couple of months have been pretty difficult for Ciena (NYSE:CIEN). Shares are down almost 15% since late October, driven by industry bellwether Cisco's (NASDAQ:CSCO) weak guidance in November and Ciena's own fourth-quarter earnings "debacle" earlier this month.
Ciena failed to satisfy the Street's bottom line expectations, reporting adjusted earnings of $18.3 million (or $0.16 per share) while analysts were expecting $0.24 per share. In addition, its outlook for the ongoing quarter also failed to satisfy expectations. Ciena expects revenue between $515 million and $545 million in the current quarter, below the consensus estimate of $537.6 million at the mid-point.
Ciena saw an accelerated roll out at one of its key international customers, leading to a blowout on the top line. However, the company's operating expenses were higher than expected. Higher orders led to an increase in performance-based variable compensation, along with an increase in research and development spending.
Additionally, Ciena's gross margin dropped 280 basis points from last year as a result of faster than expected deployments at certain customers. This led to higher start-up costs and ultimately pressurized its bottom line.
Not as gloomy as it seems
So, it looks like it couldn't have been much worse for Ciena. A big earnings miss and a below-par outlook led investors and analysts to ignore Ciena's terrific growth in the previous quarter. The company's revenue was up 25% from last year, while it reduced its net loss to $9.8 million from $38.8 million in the year-ago period. Also, if Ciena achieves the mid-point of its revenue outlook in the first quarter, it would be reporting year-over-year growth of around 18%.
However, recent industry trends haven't been favorable for Ciena, especially after networking giant Cisco reduced its revenue growth guidance. Cisco expects its top line to grow at 3% to 6% per year over the next three to five years, down from an earlier forecast of 5% to 7%. This led to fears of a slowdown in its telecom and network spending.
However, the problem at Cisco seems to be company-centric. Cisco is facing weakness in its emerging markets due to the recent surveillance allegations. Since Cisco's equipment routes most of the data, it is quite possible the company is now finding it difficult to sell its products. As such, this should be good news for Ciena since it is a Cisco competitor and is finding traction in the emerging markets.
Ciena management is optimistic about its prospects in markets such as Brazil and India, where it has landed Tier 1 design wins. Recently, it also won a contract from Cablevision Argentina, which is a leading cable TV and Internet services provider in Argentina, to enhance its broadband network countrywide.
The company has also entered into a global partnership with Vodafone and expects this account to grow further in 2014. Ciena is seeing strong business in North America, which led to a solid growth of 73% in packet networking revenue over the previous fiscal year. Hence, it is not surprising to see Ciena's year-end backlog grew 12% on the back of such customer wins, exceeding the $1 billion mark. This means that the company is seeing strong order patterns, which should translate into better top line performance.
Ciena investors should also take heart from the fact that optical networking spending is strong in North America, according to Ovum Research. In addition, Ciena is a dominant player in the wavelength division multiplexing or WDM market in North America, according to the Dell'Oro Group. The WDM equipment market in North America has grown 20% in the last three quarters, which bodes well for Ciena since it is a key player in this space.
Ciena is also working to improve its margins in fiscal 2014. Operating expenses are expected to be lower in the current fiscal year. Management expects operating expenses to grow at a slower rate than revenue, resulting in an adjusted operating margin in the range of 7% to 10%, up from 6% in the just-concluded fiscal year.
All in all, Ciena might be facing some weakness, but its financial performance has been strong. The company is rapidly reducing its losses, and the earnings growth outlook for the next five years is also quite promising. According to Yahoo! Finance, investors can expect Ciena's earnings to improve at an annual rate of 16.7% for the next five years.
Also, considering Ciena's impressive growth, the stock doesn't look too expensive with a forward P/E of 16. Thus, investors looking to initiate a long position in Ciena should consider its recent pullback as an opportunity. Quite frankly, its long-term prospects look good.
Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. 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.