Ciena Slashes, Stock Burns

Telecom equipment maker Ciena (NASDAQ:CIEN) had some good news for investors yesterday -- and some bad news, too. Good news first: Revenues in the fiscal first quarter of 2005 grew 43%, losses declined by 26%, and losses per diluted share declined by 37% (the larger per-share decrease was owing to stock dilution, which spread the total loss across a greater number of shares).

In reaction, Wall Street deducted 13% from Ciena's already diminished market capitalization -- from which it's safe to infer that the bad news was pretty bad. It came in two parts: First, the company's gross margins declined by 390 basis points to 25.6%. Second, of the nearly $20 million that Ciena saved from the net-loss line entry this quarter, roughly two-thirds came out of the company's research and development budget.

Now, there may well be a good business reason for a high technology firm that operates in a world in which one must constantly innovate just to remain competitive in the marketplace -- much less pull into the lead -- to reduce spending on R&D by 29%. But as you can probably tell from the way I phrased that hypothesis, I don't know what that might conceivably be. Especially when the president of the company in question asserts that it sold a lot of low-margin products in quarter A, so that in some future quarter its customers will buy a bunch of high-margin products from it.

As a general rule, a company can't charge high margins on a product unless the product in question has a discernible technological advantage over competing products. And the way to achieve and maintain that technological advantage is -- you guessed it -- to invest in R&D to ensure that your widget is better than the other guy's. So why, pray tell, is Ciena cutting the very R&D that its future depends upon?

I can only venture a guess: Ciena may have decided that the competition has given it enough cover to permit the cuts. Last quarter, Lucent (NYSE:LU) cut R&D expenses by 4.5% year on year. Cisco (NASDAQ:CSCO) upped its own R&D by just 3.4%. And Nortel (NYSE:NT)? Couldn't tell you. At this point, Nortel's restated financials are such a mess, I doubt even it knows how much it spent on what or when.

Now flip things around, and read a bit of first bad news, then good news, about telecom equipment makers:

• Franco Phones Falter
• JDSU's Ugly Pair o' Twos
• Telecom Making a Comeback?
• Rare Day of Joy for Ciena Faithful

Fool contributor Rich Smith has no position in any of the companies mentioned above.