Ciena Corporation — Q2 FY2020 Form 10-Q
Reporting period: Quarter and six months ended May 2, 2020; comparisons are to the periods ended May 4, 2019. Amounts below are in U.S. dollars unless noted.
Business context and period results
Ciena sells networking hardware, software and services to communications service providers, cable and multiservice operators, Web-scale providers, governments and other customers. Its reportable segments are Networking Platforms, Platform Software and Services, Blue Planet Automation Software and Services, and Global Services.
COVID-19 disrupted supply, customer fulfillment and logistics, and in-person sales activity. At the same time, Ciena reported higher-than-typical orders from a concentrated group of existing large customers. Management cautioned that some orders may reflect temporary purchasing behavior and that demand sustainability was uncertain.
Key financial metrics
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $894.1 million | $865.0 million | $1,727.0 million | $1,643.5 million |
| Gross profit / margin | $413.3 million / 46.2% | $374.7 million / 43.3% | $783.9 million / 45.4% | $698.0 million / 42.5% |
| Operating income / margin | $127.5 million / 14.3% | $80.3 million / 9.3% | $205.4 million / 11.9% | $128.3 million / 7.8% |
| Net income | $91.7 million | $52.7 million | $154.0 million | $86.4 million |
| Diluted EPS | $0.59 | $0.33 | $0.99 | $0.55 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $130.9 million | $90.0 million |
Q2 revenue grew 3.4% year over year; six-month revenue grew 5.1%. Q2 product revenue rose 4.1%, while services revenue was essentially flat. For the six months, product revenue increased 5.5% and services revenue 3.3%.
Q2 gross-margin improvement reflected favorable customer and product mix, which management characterized as significantly benefiting from short-term COVID-related factors, plus improved service margins and product cost reductions. Pricing pressure partly offset product-margin gains. Six-month gross margin also improved on product mix, cost reductions and higher-margin maintenance services.
Financial position, cash flow and debt
- At May 2, 2020, cash and cash equivalents were $887.7 million and short-term investments were $100.7 million, totaling $988.5 million. This compared with $1,024.0 million in cash and investments at November 2, 2019.
- Long-term debt had a net carrying value of $679.4 million, with $6.9 million current debt; total term-loan carrying value was approximately $686.3 million. Ciena refinanced its $693 million term loan in January 2020 into a new loan maturing September 2025. The six-month statements include a $0.6 million debt extinguishment and modification loss.
- The $300 million asset-backed revolving credit facility had no borrowings outstanding; $80.8 million of letters of credit were supported by it. Management said available liquidity was expected to cover working capital, capital expenditures and other needs for at least the next 12 months.
- Six-month operating cash flow was $130.9 million, versus $90.0 million a year earlier. Investing cash flow was an outflow of $58.5 million, including $45.5 million of equipment and intellectual-property purchases and $28.3 million for the Centina acquisition. Financing cash flow was an outflow of $83.9 million, including $74.5 million of share repurchases and $18.2 million for employee tax-withholding repurchases.
- Current assets were $2,340.2 million and current liabilities $713.0 million. Total liabilities were $1,616.2 million and stockholders’ equity $2,240.6 million.
Material changes versus comparable periods
- Q2 Networking Platforms revenue increased 3.1%, led by Converged Packet Optical; Packet Networking declined 12.3%. Platform Software and Services rose 27.7%, Blue Planet rose 20.4%, and Global Services declined 3.9%, including a 17.1% decrease in installation and deployment.
- For the six months, Networking Platforms revenue rose 4.6%, Platform Software and Services 26.1%, and Blue Planet 11.1%; Global Services was nearly flat. Americas and EMEA revenue increased, while APAC revenue declined 13.5% for the six-month period.
- Operating expenses rose 1.5% for the six months, slower than revenue growth. Net income increased 78% for the six months, supported by higher gross profit and operating income; the effective tax rate was lower, primarily due to reduced BEAT and related regulatory changes.
- Cash and investments declined $35.5 million from fiscal year-end, primarily reflecting capital spending, the Centina acquisition and repurchases. The company suspended its stock repurchase program effective March 17, 2020; $275.4 million remained authorized at May 2.
Outlook, risks and notable items
- The filing provides no numerical revenue, earnings or margin guidance. Management said the duration and severity of COVID-19 effects and the sustainability of elevated orders were uncertain. Its liquidity assessment covers at least the next 12 months.
- Remaining performance obligations were $1.078 billion at May 2, 2020; Ciena expected approximately 83% to be recognized as revenue within 12 months. These obligations consist of non-cancelable orders awaiting transfer of control.
- COVID-related risks include supplier capacity and component shortages, fulfillment and transportation delays, restricted customer access and sales trials, possible delayed or canceled customer orders, and collection risk. Management also warned that concentration among large customers and changing customer spending could amplify adverse market conditions.
- Management said Q2 order growth came from a concentrated set of incumbent customers and might be temporary. Favorable quarterly margins likewise included customer/product mix effects that may not persist. Ciena also cited pricing pressure, foreign-exchange exposure, inventory forecasting, and dependence on third-party manufacturers.
- Ciena made its fifth-generation WaveLogic coherent modem commercially available in Q2, with shipments beginning on certain platforms. It expected new mobile xHaul routing platforms in the second half of calendar 2020 and continued developing Blue Planet automation capabilities for 5G.
- Other items include $12.6 million of six-month inventory-obsolescence provision, primarily related to lower forecast demand for certain Networking Platforms products; a global workforce reduction of 86 employees; and adoption of lease accounting that added operating right-of-use assets and lease liabilities to the balance sheet. Ciena said ordinary-course litigation and tax matters were not expected to have a material effect. A Canadian research grant may be subject to recoupment if specified investment, employment or project milestones are not met.
Important facts for investors to verify
- Whether COVID-related supply disruptions, customer fulfillment constraints and restrictions on sales activity persist, and whether elevated orders reverse or continue.
- Whether Q2’s favorable customer/product mix and gross margins are repeatable, especially given the decline in Packet Networking and installation services.
- Customer concentration and spending trends: AT&T accounted for $105.6 million of Q2 revenue; AT&T and Verizon together accounted for $393.3 million in the six-month period.
- Cash conversion and working-capital movements, including the $151.7 million cash use in accounts payable, accruals and other obligations, and the $54.8 million use in prepaid expenses and other.
- Debt, lease obligations and liquidity assumptions, including the status of the suspended repurchase program and the company’s ability to maintain supply and customer delivery.