Ciena: Done taking our lumps

The telecommunications market is in the midst of a severe contraction, with potential customers for equipment makers like Ciena either going out of business, suspending their spending plans or otherwise altering their strategies in bids to remain above water. And this was before the Sept. 11 attacks on the United States, which has since left the entire technology industry in uncertainty.

But Ciena Chairman Patrick Nettles believes the company can navigate such industrywide problems as well as handle the competition from larger rivals such as Cisco Systems and Nortel Networks. Ciena has taken its lumps with the rest of the industry as the carriers cut back equipment spending. Yet Ciena and other smaller outfits were some of the last to warn investors of lower revenue, suggesting attributes that may have helped more agile companies in this climate.

Nettles says that cost looms large in carriers' minds these days, and that Ciena will continue to concentrate on producing networking devices that lower overall costs for carriers--a strategy that other equipment makers will surely heed as well. He also believes that the harsher climate squeezes the old-line companies harder by hastening the extinction of their older products, which they depended on to give them steadier revenue.

Analyst Paul Sagawa at Sanford C. Bernstein believes that older products might actually save the venerable companies since carriers only spend on what is mandatory in leaner times and limit purchases to replacement parts that maintain older networks rather than on newer equipment.

Ciena's main product lines are optical data switches and bandwidth dense wave division multiplexing (DWDM) equipment for long-haul networks, which transmit data between cities, and metropolitan networks, which handle data within urban areas. In recent years, the company has had a lot of success with an optical switch called the CoreDirector.

Nettles served as chief executive of Ciena beginning in 1994 and became board chairman in October 2000. He stepped down from the CEO spot last May to assume the title of executive chairman and to focus on long-term strategy for the company.

Nettles sat down with CNET News.com to give an update on his company and an outlook on the beleaguered communications-equipment industry.

Q: A lot of people think there will be consolidation within the telecom-equipment sector. What's Ciena's thinking on that?
A: In general, we will look to this as an opportunity where we may actually have a good alternative to offer to some of the players out there. The problem, of course, is that there are a lot of look-alike companies. There are 30 or 40 companies that all are making products that are difficult--for me, anyway--to tell apart in the 30-second test. There are probably two or three or four homes for 30 or 40 companies, and unfortunately the rest will have a real challenge.

How should we measure company and technology progress in the current market?
It's sort of an old story that we've been telling for a while, but I want to point out that while (capital expenditure) reductions have been the big issue that everybody talks about, probably a more significant issue in some respects is the shift of spending from legacy gear to new-generation gear. And that shift is between two segments generally not separated by a lot of the market research folks, so it's been hard to track in any credible way. But if you look at that shift, it gives us a market opportunity that is quite significant--at least in terms of stability, if not growth. The challenge right now for all of us is that the impact of Sept. 11 is frankly unknown, and is something that we all have to take some time to digest.

What advantages do relatively newer equipment makers like Ciena have over older equipment makers like Lucent and Nortel?
We set out to develop products, which are targeted at the new generation of requirements for networks that are dominantly data-centric in their architecture. The products offered from legacy suppliers to date have been primarily gear that was designed for voice, and the result is a mis-fit for those legacy products which are reflected in floor space, operational cost and, in general, scalability.

What are the disadvantages that the newer companies would have when they face these giants?
Most of the new companies are running into a serious problem of not getting to scale soon enough. They don't have a lot of customers, so losing one customer can be a devastating hit. In this kind of climate the customer is thinking less about "do you have the hottest technology or the best box?" and a lot more about "are you going to be here three years, five years, 10 years down the road when we need continued help and support for these products?" Ciena is uniquely positioned as building enough scale to get past that credibility gap, but a lot of other companies are fighting that, particularly the private companies. There are a number of private companies vying (to make) the next hot box, but they aren't getting customer traction because the customers simply aren't going to take that kind of risk right now.

One asset that could be in the old-line companies' favor is that in times of cut budgets, carriers only decide to do spending that is mandatory, as in, only buy spare parts for their older Lucent and Nortel boxes. This means that carriers are less likely over the next few quarters to try out new solutions from the upstart companies. Do you agree?
I think there is a tendency not to be aggressive in trying new things. We've spent the last several years building our base of customers. We now have over 50 customers that we are doing business with--in aggregate that we've announced--and I think that base gives us a position that is considerably more favorable than many of the private companies or some companies that have just gone public (recently). It's absolutely true that the carriers will only do what they have to in this kind of environment. If we had been six or 12 months late compared to our current timing, I think we would have a very tough time. Another problem...for the big traditional players is that if you look at analyst reports for the makeup of their business, they've got a lot of moving parts all moving in the wrong direction. I'm quite sympathetic to the management dilemma that's going on there.

You mean some companies are just too big?
They have a product suite that has been (made) obsolete almost overnight. In some respects...what we saw in the last six to nine months was an acceleration of the demise of legacy products because of the pressure on capital expenditures. So instead of having a graceful end of life for those products, they had a precipitous end of life.

Has Ciena's business or technology strategy changed over the past few months in terms of the next big thing that's going to come from the company?
In general, if you look back at the history of technology, dislocating change occurs once in a relatively long time and then what follows after that are substantive incremental improvements. Maybe it's capacity if you think of disk drives, maybe it's CPU speed in terms of computers. Maybe it's channel count in terms of WDM systems. So there's a series of things that are continuations of what's under way in our product line, and those are the things we're focused on. It's a very tough time to launch new products. It's a very good time to augment the feature set of existing products, and that's where we're spending a lot of our time in the short term. Longer term, we will continue to grow the switching capacity of CoreDirector, and will continue to push closer toward the edge of the network with higher-bandwidth technology.

So you're working on augmenting, improving and upgrading the products that are already used by your customers?
We don't see a major new dislocating technology opportunity right around the corner. Some people have speculated that all-optical switching, for example, would be another dislocating technology. Everybody working on that at this point has come to the conclusion that it's a tougher problem and the economic prove-in is tougher than originally expected.

Is the focus on equipment for metropolitan networks due to the so-called glut in the long haul?
We don't necessarily agree that there's a glut. I think that's a bit of a misnomer. There is a lot of fiber, no doubt about it, but unless that fiber has equipment attached to it, it's not a bandwidth glut. Traffic (is) growing. It's hard to get good data, but the best indications we can find are somewhere between 80 percent and 120 percent annual growth in traffic. That's a huge rate, so more equipment has to be put in. In some cases that's going to be...in existing systems, (and) in (other) cases it's going to be new routes that overlay the existing routes as network expansion reaches its natural limit.

So long-haul network routes are not a good market opportunity for companies such as Ciena right now?
No, I think if you ask the long-haul people they would agree they are curtailing but not terminating their investment. In the metro space, on the other hand, a lot less has been done to expand the bandwidth of that part of the network. So there's a lot of fiber that's been put in the ground by folks like Metromedia, but not a lot of that has been put into service, and so there's a significant opportunity there.

Do you think the metro will catch up to the long-haul in terms of fiber laid down?
Whether the market size matches the long haul anytime soon is hard to tell. The big imponderable there is the behavior of the Bell operating companies and equivalents. (There's an) opportunity to do a significant amount of high-bandwidth facility builds, but (there's) not an urgency of doing that. The CLECs (competitive local exchange carriers) don't appear to be effective in creating meaningful competition in most markets, so it's not clear what the timing of all that will be. But there is fiber, there are companies that have significant needs. It's a hard situation to predict, particularly in the aftermath of the events of Sept. 11.

Looking back just a few years ago, Ciena has had some serious troubles, whether it was trying to get the (failed) Tellabs merger off the ground or scrambling for customers after the lost AT&T contract, which certainly set the company back. You could arguably say that Ciena has come back from those missteps. With that perspective, there are a lot companies experiencing similar misfortunes. Do you have any advice for the chairmen and CEOs of those companies?
The circumstances today don't match what we at Ciena went through in 1998, because this is an industry situation. It's extremely hard for any young company to promote themselves as a significant player in this space right now. The customers have gotten very conservative, so it's tough without significant scale and credibility. The alternative for many of these suppliers is to seek to be acquired. Unfortunately, the companies that normally do the acquiring are in big trouble and probably not focused on acquisitions in the least. I know one or two companies have already closed--I expect to see a lot more of those, unfortunately.