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Ciena Corp. (CIEN - Analyst Report) reported mixed second-quarter 2014 results. The telecom equipment maker reported earnings of 6 cents per share (excluding share-based compensation and other one-time items) as against a loss of 7 cents reported in the year-ago quarter. Earnings managed to beat the Zacks Consensus Estimate of 3 cents.

Shares were up 18.4% ($3.49) following the second quarter earnings release.

Revenues

Revenues jumped 10.3% year over year to $560.1 million, which lagged the Zacks Consensus Estimate of $562.0 million. Revenues also beat the mid-point of management’s guided range of $540.0 to $570.0 million. Orders were up 7.0% on a year-over-year basis.

Product revenues (82.3% of revenues) rose 11.5% from the year-ago quarter to $460.8 million. Services revenues (17.7% of revenues) climbed 5.0% year over year to $99.2 million.

Converged Packet Optical revenues surged 63.7% year over year to $356.8 million. Packet Networking increased 11.9% from the year-ago quarter to $66.5 million. Optical Transport revenues increased 5.3% year over year to $29.6 million. Software and services revenues increased 19.1% from the year-ago quarter to $107.1 million.

United States contributed 58.0% of the revenues, while international customers contributed 42.0% in the last quarter. One customer represented 21.5% of the revenues. AT&T (T - Analyst Report) and Verizon (VZ - Analyst Report) were two of Ciena’s top carrier customers.

Operating Results

Gross margin (Including share-based compensation) expanded 60 basis points (bps) on a year-over-year basis to 42.9% due to favorable customer and product mix.

Operating expense, as a percentage of revenues (including share-based compensation), declined 250 bps from the year-ago quarter to 43.6%. The year-over-year decline was primarily driven by lower research & development (down 140 bps), selling & marketing (down 20 bps) and general & administrative expenses (down 40 bps).

As a result of lower operating expenses, Ciena reported operating income (including share-based compensation) of $23.0 million compared with $8.8 million reported in the year-ago quarter.

Ciena reported net income of $7.4 million or 6 cents per share versus a loss of $7.6 million or 7 cents in the year-ago quarter.

Balance Sheet

At the end of the second quarter of 2014, cash and cash equivalents (including short-term and long-term investments) were $430.2 million compared with $440.1 million in the previous quarter. Cash flow from operations was $2.0 million in the quarter compared with outflow of $37.2 million in the prior quarter.

Guidance

Ciena forecasts revenues in the range of $585.0 to $615.0 million for the third quarter of fiscal 2014. The Zacks Consensus Estimate is currently pegged at $592.0 million, slightly lower than the mid-point of the company’s guidance range.

Adjusted gross margin (excluding one-time operating items) is projected to be at the lower to mid 40% range. Ciena expects adjusted operating expense of approximately $210.0 million for the third quarter.

Management expects order flow to increase from the second quarter and remain strong during 2014. Ciena continues to expect average operating expense of $205.0 million for fiscal 2014. The company expects to achieve the lower end of its operating margin target range of 7.0% to 10.0% for the fiscal year.

In the second half of 2014, the company is likely to introduce a new application software and an entirely new product platform targeting opportunities that will expand its addressable market in a way that makes strategic sense for both Ciena and its customers.

Our Take

Ciena provided a cautious second-quarter margin guidance, which may remain an overhang on the stock in the near term. Higher operating expenses continue to remain a concern.

Although Ciena expects to improve its operating leverage, we believe any decline in top-line growth particularly due to stiff competition from Cisco (CSCO - Analyst Report) and Alcatel-Lucent S.A will negatively impact profitability, going forward.

Nevertheless, we believe increasing spending on optical upgrades and higher number of orders from international customers will boost top-line growth in fiscal 2014. Moreover, the company’s Tier 1 contract wins and strong backlog are expected to boost near-term results.

Additionally, the diversification of customer base will be a major growth driver going forward. Further, the partnership with Ericsson is a significant positive that will drive international revenues in the long run.

Currently, Ciena has a Zacks Rank #3 (Hold).

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