COMS results: nothing extraordinary

COMS reported earnings that were basically in-line with expectations. Guidance for next quarter is also in-line. The strongest growth came from VoIP (recently won Edward Jones) that grew 30% sequentially, and COMS said it won most of the business from AV and CSCO. VoIP is hot, but winning this Edward Jones deal took COMS 2 years, 2 years! is a very long sales cycle and pricing on this stuff can move down very dramatically within that time frame. VoIP is even going to be driving revenue growth for these companies but profitability seems shaky. COMS just like CSCO will sell networking equipment (switches and routers) to make VoIP happen and other than this enterprises aren't upgrading their networks so atleast we get some good out of this transition. Layer 2 switches are under intense pricing pressure and anything that can make enterprises upgrade the core Layer 3 switches will help with margins.

COMS said Americas business is solid not robust, what does that really mean? Beats me. COMS said linearity was actually good which is a positive in my opinion. Do not extrapolate that too far since COMS said that last quarter also and we had 3 networking vendors: ETS, EXTR and FDRY blow up right after. I don't things are that bad this time around but take it with a grain of salt. Overall I think it bodes well for CSCO since SMB and Enterprise businesses in the Americas are continuing to spend, how Europe pans out is anyone's guess.

JDS follows EXTR in option vesting

To be fair, I have to disclose that JDSU has also accelerated option vesting on approximately 33.85M shares or 22% of outstanding unvested options. All this is in anticipation of option expensing later in the year but the only way these tricks will work is if the stock moves higher from here. As with any dilutive transaction shareholders should not accept these management/employee enrichment schemes laying down.

FD: Author has no position in JDSU

Extreme compensation scheme

EXTR accelerated option vesting for some 4.5M shares, which is 21% of outstanding options. What is amazing is that this accelerated dilution is to avoid "expense in fiscal years 2006, 2007 and 2008." This amounts to about $11.43M of "free money" paid-for by all of the current shareholders. And get this, "the Compensation Committee believes that this action is in the best interests of Extreme Networks' stockholders". I do not how that creates any thing for current shareholders. If you bought the stock at anything above $7 (that's the price of options that are being accelerated vesting) then you are down 40% and these employees/management gets to erase that lose. Maybe I am naive but seems like its more about employee-interest than shareholder interest. Its not like these employees are new, these folks have been there years and the stock price reflects their efforts (sorry to sound so blunt).

This might be a way to raise employee morale, and yes a lot of other companies have done this in the past but it is still dilutive for current shareholders, and if I was one of them I would be furious after this. The only positive I see from this is that it might indicate that management believes stock will move up from here to get these options in the money. But you never know, they might get bought out.

FD: Author has no position in EXTR

Citrix enters traffic management market

CTXS is going to spend over $300M to buy one of the leaders in WAN optimization space, NetScaler. This is the same market that Juniper spent roughly $500M to enter with two acquisitions in April. CSCO which already addressed this market bought FineGround about a week or so ago for $70M to enhance its optimization products. FFIV the kingpin in this market has seen its shares steadily decline ever since the spree of acquisitions began. Other public players in the market include RDWR, and to lesser extent FDRY and NT.

NetScaler had been rumored to be the first choice for JNPR. NetScaler got a hefty valuation of approximately 15x revenues, which seems expensive on any reliable growth projections, hence CTXS stock was down almost 10% on the news. As I have explained earlier, this L4-L7 (layer 4 to layer 7 of the OSI model) market is one of the fastest in the enterprise networking with Dell'Oro expecting revenue CAGR of 19% from 2004 to 2009.

I beleive that a non-enterprise networking company like CTXS spent this much money to enter this market because the centralized application access market that CTXS addresses is being taken over by web-based applications. To continue its growth trajectory CTXS had to enter this market or risk long term survivability. NetScaler will also provide CTXS load balancing capabilities to enhance its server farms efficiency. The startegy makes sense but the risk of entering new market and competing in a hotly contested market, not to mention the dilution that you get with paying a hefty premium made CTXS shareholder little wary today. CTXS might have a winner in its hand if the channel integration and product integration is successful.

Why CIEN can't get it right

CIEN reported earnings this morning and results were better than expected by sell-siders. Guidance was actually in line but gross margins are expected to increase next quarter. The issue with CIEN is that it has spent millions on buying numerous companies in past year or two to get it self out of the optical business and all that money hasn't really delivered. CIEN bought companies for storage infrastructure, for Enterprise market for addressing the access market but none of these have really lived up to expectations. Case in point is Catena that after being bought over a year ago is still delivering the $25M/qtr goal expected at the time of acquisition. CIEN still gets over 60% of its revenues from Optical equipment, which doesn't carry the 40%+ gross margin management expects to achieve sometime in future, they won't put a date on this goal..nice to have a moving target I suppose. CIEN also gets 12% of revenues from services which also carry very dismal gross margins. With all that money spent in buying companies which has led to growing operating expenses this company can not get a handle on cash burn. There is no imminent threat to liquidity but it points to the real issue with CIEN, the issue of unprofitable revenue growth coupled with bloated infrastructure. Company expects to be profitable at $150M/qtr revenue run-rate at 40%+ gross margins. Call me a pessimist, but that goal is good 50% away from recently quarter's revenue run rate and we all know optical business has great tendency to be very lumpy. And the gross margin goal of 40%+, well that is a long shot away also. I would like to see more cost reductions at CIEN, especially in R&D and G&A and revenue growth from acquired companies that sell non-optical products with higher gorss margins. But I am not holding my breath for this to happen any time soon, my model says they can't get to $150M run rate for over a year and 40% gross margin won't make them profitable unless they cut expenses. With the recent run in the stock ahead of earnings I wouldnt' be surprised to see people leave this train on its own.

Note: the 40%+ gross margin expectations could be easier to achieve if the recently signed agreement with Broadwing for $35M in cash lets CIEN account for those payments as product revenues with essentially 100% gross margin. Let me know if you want clarification on this "Fuzzy math".