Ciena Corporation — Q2 FY2016 Form 10-Q
Reporting period: Quarter and six months ended April 30, 2016. Amounts are in U.S. dollars; financial statements are unaudited.
Business context
Ciena provides communications-networking equipment, software and services. Its reporting segments are Networking Platforms, Software and Software-Related Services, and Global Services. Results include Cyan, acquired in August 2015, and the high-speed photonics assets of TeraXion, acquired February 1, 2016.
Financial results
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Revenue | $640.7m | $621.6m | $1,213.8m | $1,150.8m |
| Gross profit | $283.1m | $272.4m | $534.5m | $502.7m |
| Gross margin | 44.2% | 43.8% | 44.0% | 43.7% |
| Operating income | $28.2m | $42.4m | $39.5m | $46.6m |
| Net income | $14.0m | $20.7m | $2.5m | $1.9m |
| Diluted EPS | $0.10 | $0.17 | $0.02 | $0.02 |
Q2 revenue increased 3.1% year over year; six-month revenue rose 5.5%. Six-month product revenue increased 5.1%, while service revenue grew 7.2%. Networking Platforms revenue grew 4.9% in the six-month comparison, with Converged Packet Optical and Packet Networking gains partly offset by a 46.9% decline in Optical Transport. Software and Software-Related Services revenue rose 17.8%; Global Services rose 5.0%.
Operating expenses increased 10.8% in Q2 and 8.5% over six months year over year. Q2 operating income declined despite higher revenue, while six-month net income was slightly above the prior-year period. Q2 diluted EPS was lower year over year; weighted average basic shares increased to 138.0m from 113.6m, reflecting in part the prior-year convertible-note conversion and subsequent share activity.
Cash, debt and liquidity
- At April 30, 2016, cash and cash equivalents were $922.0m; short- and long-term investments totaled $320.4m. Combined cash, cash equivalents and marketable debt securities were $1,242.4m, up $221.3m from October 31, 2015.
- Six-month operating cash flow was $75.7m, compared with $59.9m a year earlier. Investing cash outflow was $179.9m, including $53.1m for equipment and intellectual property and $32.0m for the TeraXion acquisition. Financing cash inflow was $235.9m, including net proceeds from a new term loan.
- Balance-sheet debt comprised $5.0m current and $1,505.4m long-term debt, net. The company issued a $250m senior secured term loan due 2021, receiving approximately $246.1m net of fees and expenses. It expected to use the proceeds in part toward repayment of its 0.875% convertible notes due June 2017.
- The $250m asset-based revolving credit facility had no borrowings outstanding; $66.7m of letters of credit were supported by it. Management stated that available liquidity should meet operating, capital expenditure and other needs for at least the next 12 months.
Material changes, outlook and risks
- Management expected FY2016 revenue to be adversely affected by anticipated EMEA sales declines and the stronger U.S. dollar; it also expected operating expenses to increase versus FY2015 because of acquisitions, R&D, systems work and facility transitions. The filing provides no specific full-year revenue or earnings target.
- Six-month EMEA revenue fell 17.0% year over year amid constrained capital spending by some service-provider customers. Management also cited customer concentration, order timing, book-to-revenue variability, pricing pressure and foreign exchange as factors that could make results fluctuate.
- Gross margin faces pressure from market-based price erosion and inventory provisions. The company recorded a $20.1m six-month provision for excess and obsolete inventory, primarily due to lower forecast demand for certain Converged Packet Optical and Optical Transport products; the comparable prior-year provision was $10.8m.
- Foreign exchange reduced reported six-month revenue by an estimated $16.1m, or 1.3%, year over year. Currency movements also affected operating expenses and generated volatile gains and losses in interest and other income.
- Growth depends partly on customer adoption of Blue Planet and other software-defined networking and network-function-virtualization offerings. The software segment reported a six-month loss of $3.4m, versus $3.4m profit a year earlier, reflecting higher R&D and intangible amortization costs.
- Other execution and financial risks include competition, dependence on a small number of large customers and limited-source suppliers, inventory forecasting, contract manufacturers, acquisition integration, Ottawa and India facility transitions, and the planned ERP-system transition. The filing describes two Cyan-related lawsuits and other proceedings; Ciena said it did not expect ordinary-course matters to have a material financial effect, while the securities class action remained contested.
- Substantially all of the company’s $1.5bn net deferred tax assets were offset by a valuation allowance. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether EMEA demand, customer capital-spending plans and foreign-exchange movements evolve as management anticipated.
- Whether growth and profitability in Blue Planet and the Software and Software-Related Services segment improve enough to support the strategy.
- The persistence and earnings impact of inventory write-downs, particularly for Optical Transport and Converged Packet Optical products.
- Debt repayment plans and terms, including the intended use of 2021 Term Loan proceeds and the upcoming 2017 convertible-note maturity.
- Progress and costs of the Ottawa and India facility transitions and the ERP-system upgrade, as well as developments in the Cyan-related litigation.