CIENA Corporation
Investment Notes

Please see disclaimer at bottom of this document

January 23, 2006 Some Analysis
1. Some Selected Insider Holdings as of 1/17/06. These were taken from DEF14A. Using fully diluted shares , officers and directors own 2.6% of the company. According to filing, FMR Corp. owns 68,529,939 shares, has the right to acquire 522,824 shares and would have beneficial ownership of 69,052,763 shares, or 11.89% of company. FMR on the last filing owned 8.9% (see post on 10/12/05).

Name Title (if known) Shares owned Right to Acquire Beneficial Ownership
Chinnici, Joseph CFO 276,052 1,096,097 1,372,149
Bradley, Stephen DIR 40,000 310,500 350,500
Alexander, Stephen CTO 130,116 1,269,942 1,390,058
Nettles, Patrick COB 2,446,761 2,982,800 5,429,561
Smith, Gary CEO 38,073 2,952,737 2,990,810
Cash, Harvey 378,898 200,500 579,398
Davis, Don 10,000 120,000 130,000
O,Brien, Judith 29,349 215,466 244,815
Taylor, Gerald 2,000 208,532 210,532
All Officers and Directors as a Group (not a total of above) 3,381,185 12,492,212 15,873,397

2.    Shares Outstanding: Historically, Ciena has been  a dilution king.  I used to joke that they grew their shares on dilution farms in Iowa.  The truth hurts.

Year Shares O/S
1998 255,788
1999 267,042
2000 299,662
2001 311,815
2002 365,202
2003 446,696
2004 521,454
August 30, 2005 577,963,967
1/17/06 580,879,132

3.    Compensation Table: The following table is from DEF14A and includes compensation, Bonus, awards and other for 2005.

Name Full Compensation 2005 Full Compensation2004
Nettles (COB) $311,701 $612,012
Smith (PRES and CEO) 1,235,583 1,062,262
Alexander (CTO) 553,438 397,982
Chinnici (CFO) 607,538 454,103
Collier (SVP WWS) 754,531 594,245

4. Various option grants totaling 1,450,000 shares were issued to officers above. They expire 12/10/14 and are exercisable at $2.85 per share.

October 12, 2005 Some Analysis

1. Some Selected Insider Holdings as of 9/30/05. These were taken from DEF14A. Using fully diluted shares , officers and directors own 2.6% of the company. According to filing, FMR Corp. owns 50,797,910 shares, or 8.9% of company.

Name Title (if known) Shares owned
Chinnici, Joseph CFO 71,486
Bradley, Stephen DIR 40,000
Alexander, Stephen CTO 125,450
Nettles, Patrick COB 2,244,761
Smith, Gary CEO 18,075
Cash, Harvey 378,898
Davis, Don 10,000
Dillon, John 9,200
Fitt, Lawton 0
O,Brien, Judith 29,349
Taylor, Gerald 2,000
All Officers and Directors as a Group (not a total of above) 4,283,241

2.    Shares Outstanding: Ciena is a dilution king.  I used to joke that they grew their shares on dilution farms in Iowa.  The truth hurts.

Year Shares O/S
1998 255,788
1999 267,042
2000 299,662
2001 311,815
2002 365,202
2003 446,696
2004 521,454
August 30, 2005 577,963,967

3. Compensation Table: The following table is from DEF14A and includes compensation, Bonus, awards and other for 2004.

Name Full Compensation
Nettles (COB) $612,012
Smith (PRES and CEO) 1,062,262
Alexander (CTO) 397,982
Chinnici (CFO) 454,103
Collier (SVP WWS) 594,245
Jeffery 426,119

October 12, 2005                                               Analyst Day notes and thoughts

1. Yum, yum…. the lobster bisque was so dasm good. Truly was a great part of the day. Don’t get me wrong, the Caesar salad was fresh and tasty, the veggies cooked to perfection and the Filet Mignon was very nice. Lunch was certainly a fun and informational time. I sat with Joe Chinnici, CFO. I will write more about the discussions later. One comfort zone for me is my impression of management. I find them to be capable, energetic and focused. I will discuss later that perhaps the shareholder interests aren’t first on their mind. They certainly claim that shareholder value is important to them. I believe them when they say that. Yet, the truth of the matter is that the CEO, CFO and others have a greater interest in collecting their compensation packages over the growth of share price. The reason I see for this is that the officer’s do not own a great amount of shares. I will discuss that later in this note.

It really was a wonderful event. Ciena did a magnificent job. The energy of the organization is so evident. I don’t know if they will survive as a going concern, yet their enthusiasm seems real and competent.

2. This was a question I asked in the morning Q&A. “I appreciate and believe in your competence and I respect your ongoing vigor and focus of developing a strong organization, and continuing to do so even with the adverse industry conditions over the years. With that said, and with much respect, and Gary’s discussion on focus shareholder value. I totally believe in the goals of profitability and revenue generation. I also understand that their is a $3B Net Operating Loss (NOL) Carry-forward. This is equivalent to over $5.00 per share in earnings, where you do not have to pay Corporate Income Tax. These NOL’s begin to expire between the years of 2012 – 2019, using this fiscal year projections through year end October 2005. Have you considered for shareholder value, the possibility of merging your talents with an organization that can certainly utilize $3B of NOL’s by not paying Corporate Income Taxes, which is a great asset.” Joe Chinnici, CFO answered the question. He mentioned that they certainly have thought about it. He claims there is not a whole lot out there who could pay that much. He interestingly mentioned that someone to come along and take advantage of the entire $3B NOL , that would be “one heck of a purchase price.” I mentioned Microsoft, and he properly reminded me, that would be “one heck of a purchase price.” Joe mentioned that this scenario is certainly possible, but not probable. He did comment that it was a good question.

Ciena has a $3b Net Operating Loss carry-forward. Hence they can make $3B (as long as they beat the phase-out period which begins 2012 and expires 2019) and never pay Corporate Income Taxes. There are a few kickers. One, Ciena sells less than $300M a year, how would they ever generate $3B in profits? $3B is equal to 5.14 per share. that is double their current share price. Ciena could sell the company to a larger company , one that could benefit by earning big $$$ and not paying corporate tax. i mentioned MSFT as a possibility. Of course MSFT would have to examine tax code and see if they qualify. I believe line of business has to be the same. yet, i think they could substantiate via delivery of their website, downloads, MSN, XBRL etc. We are currently investigating the feasibility of such an allowance.

Another reason this might never be explored, is management (other than Nettles (COB)), doesn’t own that many shares. Smith owns less than 100K shares, and Joe Chinnici CFO owns less than 300K shares. Perhaps their interests could be more in line as employees as opposed to shareholders. I am not dissing them. I am just stating that their compensation packages + options , could be more desirable, than a buyout and potential loss of a job. I think if insiders owned more stock, they would be more concerned with this. At this point i think their compensation packages are greater than their altruistic look at shareholder value. With that said, I will reiterate that I admire Ciena management a great deal.

Keep in mind, the past NOL of $3B has no relation to future cash flows. I believe that Ciena can turn the corner operationally. I would like them to make use of that huge asset. That alone is worth almost $2 per share ( $3B * 40% tax rate = $1.2B net). Add that to their tangible book value of i think $0.67, you have value at book, ignoring all goodwill and intangibles of $2.67 per share. That is a net number out the door. Do you know how much a company would pay for that?

What would Warren and Charlie do with this one?

3. Suzanne DuLong (CCO), discussed this was the first analyst day for Ciena since 2000. She mentioned that communications was in a significant network transition. She mentioned that Ciena is beginning to see signs of spending continuing in the area. She labeled Ciena as transmission specialists.

4. Gary Smith (President and CEO), mentioned that IP was the first global computer language. Ethernet being the first global access technology. He mentioned that every worldwide device has an address. This is called “convergence.” I found that to be an interesting comment. I always felt convergence was the merging of IP and PSTN, with voice, data and video. Gary brought out a new meaning. I kind of like it, and will hopefully have fun pondering that statement. He referred to voice, data and video as the “triple play and beyond.” Ciena’s goal will be to bundle these deployments. They intend to mine their current customers for future business. There will be a convergence from residential to enterprise. He mentioned that the typical customer today are the larger carriers. These carriers have limited capex budgets. It is Ciena’s job to help these carriers in a cost efficient and quality of service fashion.

He claims that Ciena’s core competence is being a “network specialist”. They are not looking to be end to end. I had asked Stephen Alexander (CTO), what does Ciena consider to be one of these areas that Ciena is not looking to deliver. He used routers as an example. Another example is ATM networks. If I remember correctly, Lucent is a primary supplier of ATM devices. If I also remember correctly, ATM is based on legacy networks, and not the future mesh IP networks. I believe that the router vendor Ciena refers to is Cisco. Stephen was very clear that storage solutions is certainly an area where Ciena is trying to deliver to.

Gary mentioned that Ciena business model is starting to work. He said he is comfortable with guidance previously given. He reiterated the following:

a. 5% revenue growth to Q4.

b. August was slow (month 1 of Q4). He mentioned that during August, Ciena was blaming vacations and summer slowness at the time and not a business slowdown. Gary is now certain that was the case, as September was strong, and October appears to be strong.

c. “very strong cash position.”

d. will achieve profitability via revenue growth.

e. expects a goodwill and intangible write down at year end. The write down will come from the CN1000 family. I will have to look at the Catena acquisition at some point and try to determine the write down. It is not that much of a concern for me, as our research and investment thesis is not based on intangible book value.

f. expects long term gross margins of 40%. Later in the day , Joe Chinnici mentioned that they would try and increase those even higher.

g. operating expenses to decline 8% sequentially, down to the low to mid $60M range.

h. long term goal of operating expenses to be 35% of Revenues.

i. looking to have R&D at 15% of revenues.

5. Steve Alexander (CTO). He discussed the Ciena solution as network specialists. I really don’t have much to write on this one. I will say that one thing during his presentation bothered me a great deal. I think me being bothered by the following is not a Ciena problem, but really a lack of sense of humor on my part.

” While certain statements in this presentation are forward-looking, others are not. All are made in reliance on the safe harbour provisions of the US Private Securities Litigation Reform Act of 1492.These statements include, without limitation, comments about sales’ ability to sell, sales operations’ ability to forecast with accuracy, or comments about pretty much anything else we choose to make. Although some of you may believe that the expectations reflected in these forward-looking statements are unreasonable and our corporate objectives will be met once pigs fly, we really do believe this stuff and we are here to tell you why. Because these statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by these forward-looking statements. In fact we reserve the right to talk about anything we want and go for coffee, as long as ~t s Starbucks and sales ~s pay ng. Factors that could cause differences between actual results and those implied by the forward-looking statements include, but are not limited to: material adverse changes in economic conditions in the markets; our inconsistent use of weird spellings such as colour and fibre; our desire to trundle along menacingly instead of to run screaming for the exits; our collective mood at any particular time; future regulatory actions and conditions in our operating areas; the relative motion of the Earth, moon and planets, fluctuations in foreign currency exchange rates and interest rates; technological innovations, including the cost of developing new products and the need to increase expenditures for IT support while reducing their quality of service; prolonged adverse or favourable weather conditions resulting in a material increase in overtime or an uncontrollable urge to go skiing, swimming, golfing, hiking, etc. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Have a nice day!”

I guess what bothered me about this statement is Steve’s sarcastic response to SEC requirements. I love sarcasm. What I dislike is abuse of accounting policies. As is discussed in much of our pre 2003 Ciena writings, we feel that Ciena often pushed the line on accounting policies. We felt that they were aggressive in use of pro-forma reporting, income elevation, under use of accruals and such. Here is a link where you can re-read some of our old discussions, which include a letter to Ciena and their audit committee. companies/ciena.html Like the rest of Ciena employees whom I have met, Steve seems competent, fair and honest. I guess him being in research, lends himself to creativity as portrayed above. As I write this, I kind of appreciate his humor, and reflect that I am more angered by Ciena’s policies past. Let me reiterate, that I am impressed with Stephen and rely on him in helping with Ciena and her future successful operational ventures.

6. Lunch with Joe Chinnici (CFO), was a pleasure. Joe seems to be a smart and honest guy. He is well spoken and seems to have an excellent sense of humor. He reminds me of actor Dennis Franz (Andy Sipowicz in NYPD Blue) in appearance. Joe discussed so much at lunch. Let’s see if I can ramble off some of his discussion.

a. Ciena has a definite presence in Broadwing Network.

b. Eventually Wi-Fi will become part of the optical infrastructure. Right now Wi-Fi is all over the place, and no real formation. He feels that will change in time. Much of this change will be geographically driven, as network topologies are different in different areas.

c. I asked if Ciena views Lucent today in a different manner than they did 5 years ago. It was obvious 5 years ago, that Ciena would question Lucent’s competence. They would often dis Lucent in their conference calls. Joe mentioned that in today’s environment, Lucent seems to have gotten their act together, and certainly appears to be a competent competitor.

d. Mentioned that gross profits are higher and currently attainable world wide, except for China. He mentioned that China herself is like a work-in-progress (my words, not his).

e. Interesting enough, CoreDirector failed in Hurricane Katrina. Not really a failure, but it did get knocked out, because it wasn’t made to be submerged. I mentioned to Joe, that my impression of CoreDirector was that it was a technological marvel, that hearing it failed, was like when I heard that my hero Mickey Mantle, was a heavy drinker and not such a nice person. Thankfully, I was able to switch my heroes to Bruce at that point :-). Actually, CoreDirector was not made to be submerged, and it is certainly not a design flaw.

f. Not much else at lunch, other than the awesome and chunky Lobster Bisque. So, freaking good, and I was able to wash it down this morning with my buddy David on my 5 mile run in the pouring rain. Actually, I most enjoyed analyst day several years ago with National Semi Conductor. They served cold cuts and soda’s, and frankly that was how I liked my hard earned invested dollars being spent. Oh well, I suffered on the bisque, filet, etc etc etc.

g. Mentioned that reverse split will not occur, until Ciena clearly “turns the corner.” I didn’t know how to interpret that comment.

8. Much discussion on CN4200. Ciena makes the following claims about the CN4200, ” The CN 4200 FlexSelect Advanced Services Platform is a new generation multiservice transport and Aggregation platform capable of supporting any transport protocol – including Time Division Multiplexing (TDM), Ethernet, storage or video—on any available port, even when on the same line card.” We heard discussions from analysts that they expect several wins in addition to Swisscom and BT. If I remember correctly, this product will replace the former ONI family products.

September 29, 2005

1. I have read several speculations that Ciena is a potential takeover target by Corning, or that they are about to win a major contract from Google ($100M). Also speculation that Ciena will align with ZTE in a fashion similar to the Lucent-Juniper relationship. One excellent analyst mentioned that he expects the Corning and Google rumors to be unlikely. The same analyst does expect the ZTE relationship to be real. It is only fair for me to mention that this same analyst has an under-perform on Ciena.

2. Speculation that Sycamore’s decision to hire investment bankers, might make US Government concerned with Sycamore as a vendor. This could be a plus for Ciena and her CoreDirector.

3. As of 9/20/05, Morningstar rates Ciena a “sell.” They cite integration risks of acquisitions. Their fair value estimate is $1.80 and would consider purchasing at $1.10. Their value is based on DCF.

4. I always like to watch debt levels and pricing of debt. If you search this site and even this document you will see several mentions of debt pricing often being an indicator of “smart money.” Ciena’s debt is a 3.75%, 02/01/08, convertible in 2005. The issuance was for $690M. I think that Ciena has bought back at a discount approximately $41.2M, making the debt now owed at $648.8M. The next call is 10/28/05 at 101.607. The notes are unsecured and the most recent price I have seen is 91.50. During October of 2001 these bonds traded at 58. Perhaps the increase is based on Ciena’s buybacks.

The following is a debt rating history:

Rating Source Date Rating
Moody’s 02/05/01 Ba3
Standard & Poor’s 02/05/01 B+
Dominion Bond 02/09/01 NR
Fitch Ratings 02/09/01 NR
Standard & Poor’s 08/26/02 B
Moody’s 10/16/02 B1
Moody’s 04/05/04 B2

February 23, 2005

1. There were two, 10% or greater customers. These 2 customers represented 32% of quarterly revenues. Verizon is probably one of the customers. Ciena claimed in CC that both customers were US customers. Mentioned that one of the customers is a long haul customer, and different than the one from 4Q04. 2nd 10% customer is buying various products across all business units. Domestic sales were 83% of total revenues.

2. On the face, inventories and accounts receivable look reasonable to sales. No great increases in either, which could show containment. Accounts Receivable increased 13% YOY, whereas Sales increased 43%. Inventories actually decreased around 6% YOY. Accounts Receivable DSO’s were 50, same as 4Q04, according to CC.

3. Weighted average shares outstanding grew from 472,935,000 in 1Q04 to 571,573,000 in 1Q05. This is an increase of almost $100M shares, or a quarter billion in market cap. Share count is inline with prior guidance on 8/25/04.

4. Nothing incredibly telling in Statement of Cash Flows. Will have to wait for 10Q. Cash burn was $56M.

5. I have read that annual breakeven is $620M. That is certainly a large number to achieve profitability. I have seen breakeven’s as low as $540M, but that is with 40% gross margins.

6. Sequential revenue growth of 16%, YOY of 43%.

7. Cash and short term investments are $1.23B

8. Business unit revenue breakdown 1Q05

Business Unit Revenue Percent of Total
Broadband Access (BBG) $15,281 16.1%
Data Networking (DNG) $16,579 17.5%
Global Network Services (GNS) $12,448 13.1%
Transport and Switching (TSG) $50,440 53.3%
Total $94,748 100.0%

9. “we are seeing early signs of what could be a thaw in demand for core networking applications..”

10. Gross margin down because of product mix. CC mentioned Long Haul (LH) as the culprit. LH will continue to sell through in 2Q05, but GM of 40% should be reached (according to CC). Confident of gross margin improvement in 2005.

11. Headcount increased by 17 to 1,668.

12. Customers are starting to purchase across product lines.

13. Storage solutions appear to be gaining traction. This was not said per se, just an observation of mine.

14. Ciena starting to see advantages in wins from mesh networks.

15. Claimed in CC that a partner relationship they have been working on for some time will give additional leverage in Ethernet technology, particularly in Europe.

16. Guidance

a. Revenue to increase 5 – 7% in 2Q05.

b. Long Haul will continue in transport footprint, causing gross margins to be flat to down in 2Q05 from Q1.

c. operating expenses in Q2 to be flat to slightly up.

d. other income and expense will be expense of $1.1M

e. share count to be approx 573M in Q2.

f. cash use from operations to be similar to Q1.

17. Question and Answers in CC (the ones that interested me in my research)

a. confusion on Gross Margin. Ciena claims that visibility is not present, and can fluctuate a great deal.

b. Interest expense was paid out during quarter.

c. R&D still being invested strongly. Investing R&D in the core of the network.

August 25, 2004

Conference Call notes for 3Q04

1. There were two, 10% or greater customers. These 2 customers represented 27% of quarterly revenues. Both customers were U.S. customers. One customer was Long Haul, whereas the other was a mixture of Long Haul, Data Networking and Broadband Access. In 2Q04, only 1 customer was responsible for 32.2% of the total revenue.

2. Core Networking, which includes CoreDirector, contributed about 27% of revenue in 3Q04.

3. Revenue from Metro and Enterprise Group contributed about 29% of revenue in 3Q04.

4. Data Networking Group contributed about 9% of revenue in 3Q04.

5. Revenue from Broadband Access Group contributed about 20% of revenue in 3Q04.

6. Revenue from Support Related Services contributed about 15% of revenue in 3Q04.

7. Gross Margin improved significantly from prior quarter, but was still below previous guidance. The factors that caused this weakness was a delayed CoreDirector deployment and less than expected Broadband Access revenues. This was balanced by lower than expected Long-Haul Transport sales.

8. Working to preserve strength of Balance Sheet.

9. Expects operating expenses to be in the area of $65 to 70M run rate as they exit 4Q04.

10. Gross Margins will be lumpy quarter to quarter. Overall goal is to have Gross Margins in excess of 40%. They expect to achieve this via product mix, product cost reductions and strong margin contributions from service business.

11. Interestingly, CIENA contends that, ” Press and analyst’s speculation at this time is that DSL port deployments exceeded take-up rates and the market is expected to find a balance over the next several quarters. But to be clear, we do not believe competitors are gaining traction here nor are we seeing a wholesale change in architecture. And DSL, we believe, continues to represent a growth application for us.” This was said immediately after this comment, ”

12. DSL will remain a key carrier service offering. Catena acquisition will fuel this. The CNX-100 will fuel this, according to CIENA. This is a DLC overlay, and CIENA mentioned that this is a low risk cost for carriers looking to DSL enable legacy DLC’s.

13. Claims to have secured a partnership with a major player in the storage arena. Channels and partnerships will become an increasingly important part of CIENA’s strategy.

14. The DN 7000 series will expand beyond the initial application of both SBC and Verizon. It is now being deployed for multiple applications at both carriers. It supports data services, such as DSL. It also offers safe migration paths to IP and MPLS for legacy services, such as ATM and frame relay.

15. The CN 1000 platform secured 3 new customers.


1. Gross Margin is anticipated to be slightly greater in 4Q04.

2. Overall operating expenses expected to decrease slightly.

3. Operating expense run rate expected to be $65 to $70M at end of 4th quarter.

4. expected share count of 570M shares.

5. Net Loss expected to be between 6 to 8 cents per share.

6. Total cash used in 4Q04 expected to be $90M. Of that, $65 to $70M is expected to be from ongoing operating activities.

Selected Answers to Questions

1. R&D spending expected to be used in the core of the network. Continuing to make enhancements in CoreDirector. Mentioned that they just came out with a new transport platform. Based on all of this, Ciena is committed to this space. R&D dollars do need to be spent in nurturing the new access and data platforms.
2. Claims to be in the middle of a very large RFP for British Telecom. (our notes….This is something for investors to watch).
3. Verizon and SBC are in the early stages of DSL deployment. CIENA was primarily addressing the CNX 5 when making that comment. Keep in mind that Susan Kalla from FBR mentioned that she thought the 2 companies were near completion of their DSL upgrade. It will be interesting to read her comments in the future on this.
4. Claims that GIGBE deployment is “on track”.

Just some Notes

1. Short fall for 3Q04 appears to be do to Long Haul delays, CoreDirector (CD) push-outs and weakness in Catena Line Cards for domestic DSL deployments. We have read that the Long Haul delay was from MCI.

2. Headcount increased by 41 employees during the quarter. This increase is net of the closing of the San Jose facility (340) and the increase from the Catena and Internet Photonics acquisition (380).

3. DSO increased to 59 days, from 49 days.

4. There is an industry concern that CIENA is having difficulty integrating its broadened portfolio.

5. Inventory turns were 3.9 X, this was 7.7 X in 2Q04. This is difficult to judge from quarter to quarter. The reduced turns may have been caused by the CoreDirector and LH push-outs.

6. Interestingly, we have seen at least one sell side analyst confirm that both, “DSL subscribers and DSLAM user ports, slowed considerably in Q2 as inventories piled up at US carriers.”

7. We have read that 10% customers may have been Verizon, MCI or US Government. Catena may have been 20% of revenue.

8. At this point, we are modeling F2005 revenues at $290M. This is substantially below current consensus estimates. Historically, we generally use a low estimate. Our modeling has not been extensive for CIENA, as we are hoping this is a turnaround candidate. We used the same modeling in 2000 and 2001. At that time we were selling CIENA short. Interesting to see how we projected revenue growth that was less than consensus. We did this task to determine our investment risk of our short. Notice how we considered revenues of $1.3B for F2005 :-).

9. Net cash per share is $1.16 per share.

10. It has been mentioned by industry sources that CoreDirector is losing market share to both Lucent and Sycamore Networks.

Notes to Current Analysis Report

1. CIENA recently released 3Q04 results with revenues of $75.589M, and a loss $141.5M. Revenue grew 1.2% from 2Q04, and 10.40% YOY. CIENA mentioned that 35% of revenues came from DSL, FTTX, storage extension and triple play services.
2. Labels perspective on Optical infrastructure as “Negative”. Based on 3Q04 financials. Claims that 35% of revenues being generated from non optical infrastructure is concerning. Mentions that loss of $141.5M is a “significant portion of CIENA’s remaining resources”.
3. Claims that CIENA’s acquired portfolio strategy remains unproven. Mentions that CIENA needs to explain how it will reduce core optical R&D, and at same time maintain a strategic focus.
4. Claims that customers might align with other vendors, as concerns for future financial instability risks are increasing. This could bode well for competitors and alternative suppliers.
5. Mentions improved gross margins and that acquisition related charges contributed significantly to the $141.5M loss.
6. Claims that CIENA stated a $65-70M run rate by year end. Wants to see proof that costs will be under control.
7. Claims that current customers, primarily mentioning service providers with a base of installed CIENA equipment, will be assessing CIENA’s viability over the next few quarters.
8. Mentioned a concern of additional negative factors which could cause stress on CIENA’s credit ratings. Incidentally, CIENA’s current debt rating is B2/B, which is a highly speculative rating. CIENA’s bonds currently seem to be priced at the $86 level, which produces a YTM of just under 8.60%. The bonds are callable and come due February 2008.
9. Definitely mentioned a few positives, such as GIGbe, gross margin levels, momentum of product development, such as CNX-100 Modular Broadband Loop Carrier , a 10 gig ADM for the Online Metro, and the CN2600 Multiservice Edge Aggregator. They named a few others as well.
10. They mentioned two key items, which we have been discussing as well. One mention was the level of confidence that has eroded with management. Remember, management had a historical track record of meeting or exceeding guidance in the late 90’s and early 2000’s. They coined the phrase of “steak and not sizzle”, whereas now, we are seeing much sizzle, and absolutely no steak. The other issue was CIENA’s comment that the DSL market in North America is slowing. Current Analysis claims that statement seems to be contradicting what is really happening in the market.

February 21, 2003 05:00 PM

Does Ciena Have Competition ?

We have heard discussion from investors that there is a belief that the CIENA solution for Optical switching is clearly the best around and that the solution is so great that there are no formidable competitors. Our response is that is purely a fantasy. CIENA , of course remains a technological leader, yet they certainly have formidable competition. Four competitors ( in no particular order) are Nortel, Lucent, Corvis and Sycamore Networks.

One example of possible competition is Sycamore’s SN 16000 optical switch. It has 1024 port grooming, which I believe surpasses CIENA’s CoreDirector. The SN 16000 now offers the standards-based BLSR support that CIENA’s CoreDirector still lacks. We think that the combination of Sycamore’s SN 16000SC (metro) and SN 16000 would be possible competition for CIENA. Supposedly, the Sycamore solution is cheaper than the CIENA solution. Some recent Sycamore network contracts have been with, NTT and Vodafone for optical switching .
CIENA still does not use L band. We previously wrote about L-Band on January 2, 2003 . This is what we previously wrote :

” There has been discussion that as traffic demand growth continue, that L-band support will become more valuable. Corvis uses L-band to support greater and future scalability. L- band support gives the carrier the ability to increase capacity with a wide array of different fiber types. Hence, carriers are not limited to one type of fiber. There are several tier 1 providers that do not offer L-band support (CIENA for one). Of course, these companies would argue that L-band is not necessary .”

CIENA is an established Tier 1 vendor. They were first to market with CoreDirector and other companies are now playing catch up. CoreDirector has the sales force and the experience, along with a time proven solution. Yet, CIENA is susceptible to competition. We focused our discussion above on Sycamore Networks. We used them as an example, and did not intend to exclude other competitors, whom we will add are probably more severe competition to CIENA than Sycamore. The following are a few blurbs on other CIENA competitors.

A. Fujitsu – strong in the metro SONET market. They have a full transport product portfolio from Ultra Long Haul, Long Haul, Metro and access.

B. Lucent – Please see our extensive work on Lucent companies/lucentnotes.html .
Lucent has recent wins in China, Korea and Indonesia.

C. Marconi

D. Nortel – competitors in the Metro and Long Haul DWDM systems. A recent contract win for Nortel was Cox Communications.

E. Corvis – can we call Corvis an ” emerging competitor ” ? Corvis had only $ 7 million in revenues last quarter and a projected $ 20 – 22 mil for F2003. Corvis currently has a very limited customer base. Corvis has been a company that has been mentioned in RFP’s for AT&T and GIG_BE. Corvis does support L-Band technology. This is what we previously wrote about Corvis and how it could compete with the likes of a CIENA.

Here is some information on one of the Corvis products, CorWave ON . CorWave ON offers greater scalability to carriers, 2.84 Tbps of capacity. Proponents of the Corvis solution like that this product offers more efficient bandwidth management due to its future scalability when bandwidth is needed. The competitors of Corvis are claiming that the increased scalability is not necessary, since carriers are not growing into the capacity which CorWave ON provides. The competitors feel that Corvis is offering a product that is not currently necessary, which is both early and more expensive than its competitors products (such as Nortel Long Haul Optera 4000 ). This will be an interesting product to watch, as bandwidth continues to grow at the same time the recession looms. A few companies to watch in this sector, who are being mentioned as promising are Adva Optical Networking , Fujitsu ( a tier 1 provider) , Lucent (who surprisingly is still labeled as a 2nd tier provider) and a 3rd tier provider who is emerging, called Turin Networks .

There has been discussion that as traffic demand growth continue, that L-band support will become more valuable. Corvis uses L-band to support greater and future scalability. L- band support gives the carrier the ability to increase capacity with a wide array of different fiber types. Hence, carriers are not limited to one type of fiber. There are several tier 1 providers that do not offer L-band support (CIENA for one). Of course, these companies would argue that L-band is not necessary .

Corvis claims to offer the advantage of quick provisioning. This was demonstrated with the Broadwing and Williams deployments. This enables carriers to deploy additional capacity in a little amount of time. We are still eager to see more customers appear for Corvis. We would like to see another tier 1 Service Provider hire Corvis for their broadband deployment needs. Corvis still has not announced a new tier 1 customer. As the new year starts, we of course, would love to see Corvis named as a tier 1 provider by a new customer. Our greatest hopes would be that Corvis would be internationally recognized and proven as a preferred provider of Optical Networking and Switching systems. ”

Some Observations from earnings report Q1’o3

A. Revenue breakdown as a percentage of revenues

Long Haul                   15 %
Switching                     41 %
Metro Switching           9 %
Metro                            22 %
Services                        13 %

B. Long Haul transport has shown improvement. We do not know if this is company or industry specific. Of course, if industry specific, that could potentially help other companies we follow, such as Lucent and Corvis. It appears that carriers may be in maintenance mode only for long haul, such as spending on small line cards. Of course, two RFP’s that have been discussed in the sector have been AT&T and GIG-BE. We wrote about these two potential deployments previously. You can read about them here (please see entries on November 4 and 13th , 2002) .

We also wrote about GIG-BE here (see December 20, 2002 entry ). The following is what was written by us on December 20, 2002 in relation to GIG-BE.

“We wrote previously about GIGBE ( Global Information Grid Bandwidth Expansion) companies/corvisnotes.html look at our writings on November 13, 2002. We have come across more information in regards to GIGBE and the telecom space. Project of about $ 875 M to be awarded in 2003. This will be a 2 year project. Sources believe that US based companies will have an advantage over international companies, such as Nortel and Alcatel. Larger companies such as Lucent and Cisco will have an incumbent advantage because of their large established businesses. Yet, we are still hearing Corvis being mentioned in the Long Haul Optical. GIGBE will focus on upgrading the Defense Information Systems Agency (DISA) communications network. The focus will be on upgrading the existing network to Next Generation Optical Networks, Ethernet technologies and increasing the security of the network. We have read that the RFP will be broken up into 3 components. We have read an estimate of the entire $ 875 M RFP to be sectioned evenly among Optical ( which includes Fiber, Metro and Long Haul Optical), Ethernet and systems integration. We have read a discussion that a further RFP will be awarded for additional connectivity, security and switching equipment. We were previously reading a lot of speculation that Corvis was in the running for much of the Long Haul portion. We have seen less discussion of Corvis lately in this realm. This does not at all mean that Corvis is not in the running. We merely have been reading a number of reports without a Corvis mention. This actually should not be considered uncommon as they are one of the smaller players, and could theoretically surprise many of the incumbents if they were part of the RFP awards. ”

C. We have seen Fiscal 2003 revenue estimates in the $300 million range , going up towards $ 400 million in Fiscal 2004.

D. CoreDirector revenues were $ 28 million or 40 % of total revenues. CoreDirector accounted for $28.2 million during the previous quarter (Q4’02).

E. We have read several rumors that CIENA will be hired by British Telecom for CoreDirector. These rumors have been whirling around the net and mentioned in several sell side analyst reports. We have read that CoreDirector is being mentioned as possible deployment in France Telecom and Deutsche Telecom . CIENA apparently has indicated that a number of RFP’s have been postponed or delayed.

F. We read that Sprint’s selection of Alcatel’s 1696 Metro DWDM ( announced on February 11, 2003) was a decision that was made prior to the closing of CIENA’s ONI acquisition.

February 19, 2002

CIENA Corporation
Conference Call for CIENA / ONI Systems Merger
February 19, 2002
Conference Call Notes

Gary Smith of CIENA discussed :

1. success is not contingent on revenue synergies. Smith feels significant operating costs and manufacturing efficiencies will exist.

2. ONI brings over 20 relationships to the table.

3. Gary Smith called CIENA an ” Optical Powerhouse ” – “can deliver a robust end to end, network solution. This synergy is specifically geared to worldwide incumbent carriers.

4. Expects deal to close in 2nd or 3rd calendar quarter 2002.

5. Expects deal to be non dilutive in F2002. Company will have approx $1.3 billion , net of debt (both ONI and Ciena’s debt included).

Hugh Martin Discusses the merger

1. brings two leaders of the industry together.
2. discussed large incumbent carriers. Claims that carriers love technology, and thinks ONI products are best of breed. Vendors are looking for a smaller number of vendors, and vendors looking for an end to end solution. This combination offers the full package. Share a common vision of nextgen solutions. Expects ONLINE family will replace CIENA Lightworks product. ONI can act as front end for CoreDirector and MetroDirector family. Full interoperability.
3. hopes to be heavily involved in the integration process, especially from a deployment end. Will resign as soon as no longer needed.

Questions and Answers

1. How will near term revenue stream be protected for near term revenue stream , since it is 12 % of sales (according to questioner).
CIENA’s Smith said that the synergy is that ONI is the “clear leader ” in the metro space.

2. CIENA did not really elaborate on revenue synergies. Hugh Martin discussed the K2 SONET platform. ONI will bring their technology to help the K2 become an integral part of the network .

3. Rick Shafer (CIBC) asked about ONI’s metro optical switch and the K2. Hugh Martin discussed that overlap was not only with K2 , but also with CoreDirector.

4. It was indicated by ONI and confirmed with CIENA that only one greater than 10 % customer overlaps. ONI brings 20 new customers to the table.

5. Analyst asked for CIENA’s roadmap for Ethernet storage. CIENA mentioned it’s a great focus, but will not reveal plans, especially those for service offerings.

6. Asked about the overlapping customer (Qwest). Smith doesn’t want to talk about specific customers. There is an overlap of 10 customers. ONI has 30 customers and CIENA has over 60. Even with the overlap , there are complementary factors, CIENA in the Long Haul and Switching , whereas ONI in the Metro. Smith discussed integration of sales space. Smith feels this adds another ” wonderful sales channel “

7. Still thinks there is a big market for Nextgen SONET.

July 18, 2000

The following are some thoughts on CIENA

1. Gross Margins have been on a decline since 1997. Gross Margins have shown an increase to 43 % in the 2nd quarter ended April 30, 2000. I will wait for the next quarter ( August 17, 2000) to see if I will use this increase as a positive trend. Even if gross margin rises to 43 %, our CIENA valuation will not change. I am trying to determine if this interim gross profit increase is due to the rise in inventory (see discussion below).

Year G/P %

1997 60 %
1998 50 %
1999 38 %

Furthermore, for F2000 Ciena had a sequential Revenue Growth rate of 7.7 % for Q1 and 22 % for Q2. Inventories in these same periods, increased 4 % in Q1 and 30 % in Q2.

Text books describe various warning signals to research; at times when there is more of a story than just the bottom line. I am not stating that CIENA has a warning signal, I am merely painting a picture for discussion and further clarification.

The 2 warning signs that should be researched are

1. Why have Gross Margins shown a constant decrease ?

2. Why are inventories rising at a sequentially higher rate than Sales ?

Peter Lynch in “One Up On Wall Street “on page 215 writes…

“…an inventory buildup is usually a bad sign. When inventories grow faster than sales, it’s a red flag.”
Upon further reading of the 1999 10 K (most recent audited financial statement), I found the following discussion regarding Gross Margins :

“The decrease in gross profit from fiscal 1998 to fiscal 1999 and from fiscal 1997 to fiscal 1998 was largely attributable to lower selling prices.”

“CIENA’s gross margins may be affected by a number of factors, including continued competitive market pricing, lower manufacturing volumes and efficiencies and fluctuations in component costs. During fiscal 2000, CIENA expects to face continued pressure on gross margins, primarily as a result of substantial price discounting by competitors seeking to acquire market share. CIENA intends to counter this pressure with the addition of new products and continued product cost reduction and production efficiency programs. See “Risk Factors”.”

I was also reviewing the most recent 10 Q , and I found this blurb..

ended April 30, 1999 and 2000, respectively. The approximate $0.3 million or
9.2% decrease in interest income and other income (expense), net was
attributable to lower invested cash balances.>>

Ciena made .18 per share for the first 6 months of the fiscal year. They include interest income of .04 per share in that number. Operating earnings are actually .14 per share. Ciena (IMHO) most certainly should sell at multiples greater than typical companies earnings ratios , but, it just seems odd that such a high multiple is paid for declining interest income. Why should a company be rewarded with a p/e of 100++, when a material part of the earnings is from non-reoccurring interest income.

Also, I found it interesting the discussion of stock options. I think Stock option expense and the new accounting reporting requirements will put a further drain on earnings growth. It may also eat up cash, especially if the price of Ciena stays high, as the company might have to buy the shares on the market to satisfy the exercising optionees. The company may avoid buying stock on the open market, and issue new shares instead. If Ciena were to issue more shares , there would be a dilutive effect to earnings and to shareholders. Remember, if a company issues more shares and net income stays the same, then eps will drop.

One more thing, the elimination of “pooling accounting”, this also will drain future earnings growth, since goodwill will now have to be amortized via an expense. This will be a further drain on earnings per share only if the company makes acquisitions.

I estimate Ciena’s 5 year growth rate to be 25 % .

Value Line issued a Ciena report dated July 7, 2000. Value Line forecasts earnings to grow at a 27.50 % rate. Using those growth rates , I come up with the following valuation model for Ciena.

Year eps Intrinsic Value

2000 .60 22.20
2001 1.10 40.71
2002 1.40 51.90
2003 1.79 66.17
2004 2.28 84.37

This scenario also generates a PEG Ratio (P/E / Growth Rate) in year 2001 of 5.93 using a price of 179.50. Generally, I like to invest in companies with a PEG ratio of less than 1.0.

Other fundamentals are :

Price to sales 32.05 X
Price to free cash flow 1197 X
Current Ratio has declined to 4.13 from 4.65

ACE Consensus Estimates from July 9,2000 predict profit for year 2000 to be .58 (.02 below above scenario) and 2001 to be 1.08 (also .02 above scenario above). Incidentally, Ciena lost money in 1999.
If we expand the projected growth rate to 50 % ( the highest growth rate documented by an analyst covering Ciena, (see First Union report , June 13, 2000). Using 50 % growth rate, I come up with the following values based on growth.

Year eps Intrinsic Value

2000 .69 43.63
2001 1.09 68.92
2002 1.64 103.38
2003 2.45 155.08
2004 3.68 232.61
I just don’t find the current price worthy of the growth rate. One possible flaw in my analysis is if the 5 year growth rate exceeds 50 %.

I have also noticed the following

* R & D as % of Sales is decreasing

* decreasing cash positions

* increasing accounts receivable
Value Line made the following statements in their July 7, 2000 report :
“Ciena’s timely shares are too risky for most investors and have POOR long term appreciation potential.”

A few other of my observations :
1. Non recurring losses, totaling .27 and .10 have been used by Ciena for 1998 and 1999.
2. Common Shares Outstanding are growing from 103 million in 1998 to projected 146 million in 2001.
3. Revenues per share have decreased since 1996.

1996 4.16
1997 3.77
1998 4.92
1999 3.46
1999 had the least revenue per share in 4 years.
4. Cash flow per share have decreased since 1996
1996 1.19
1997 1.24
1998 1.07
1999 .43

Is Cash Flow decreasing because Ciena is paying off everyone options that are being exercised. Remember, when options are exercised by employees, the cost does not hit the income statement or eps, yet for tax purposes the expense is a deductible expense.

Projected year 2000 Revenues are 800 million, yet, they carry a market cap well over 23 billion dollars.

IMHO, Ciena is not worth its current valuation. My analysis could be wrong and that is why diversification is used in portfolios. I believe that Ciena is in a “bubble sector”. I do not argue the excellence of the company and the future and importance of its existence. I merely find the company to have a current value of well under the current share price of 178 5/8.



If you are a client of ours, and if you have questions regarding CIENA, please call our office. If you are not a client of Redfield, Blonsky & Co. LLC Investment Management Division and are reading these notes, we urge you to do your own research. We will not be responsible for any person making an investment decision based on these notes. these notes are a “by-product” of our research. We are not responsible for the accuracy of these notes. We are not responsible for errors that may occur in these notes. Please do not rely on us to monitor or update this or any other report we may issue. In theory, we could come across some type of data or idea, which causes us to eliminate our long position of CIENA from our portfolios. We will not notify readers revisions to these notes. We are not responsible to keep readers of these notes updated for changes or material errors or for any reason whatsoever. We manage portfolios for clients, and those clients are our greatest concern as it relates to investing. Certain clients of Redfield, Blonsky & Co LLC may not have eBay in their portfolios. There could be various reasons for this. Again, if you would like to discuss CIENA, please contact Ronald R. Redfield, CPA, PFS (partner in charge of investment management division).

Information herein is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Opinions, estimates, and projections constitute our judgment and are subject to change without notice. This publication is provided to you for information purposes only and is not intended as an offer or solicitation. Redfield, Blonsky & Co. LLC and Ronald R Redfield, CPA, PFS, may hold a position or act as an advisor on any investments mentioned in a report or discussion.