Ciena Corporation — Q3 Fiscal 2019 Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2019. Ciena sells networking hardware, software and related services. Financial amounts below are in millions unless noted.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $960.6 | $818.8 | $2,604.1 | $2,194.9 |
| Gross profit | $424.4 | $351.5 | $1,122.4 | $916.6 |
| Gross margin | 44.2% | 42.9% | 43.1% | 41.8% |
| Operating income | $125.3 | $85.3 | $253.6 | $134.1 |
| Net income (loss) | $86.7 | $50.8 | $173.1 | $(408.7) |
| Diluted EPS | $0.55 | $0.34 | $1.10 | $(2.84) |
Q3 revenue rose 17.3% year over year; nine-month revenue rose 18.6%, and operating income increased approximately 89%. The prior-year nine-month net loss largely reflects a $503.7 million tax provision associated with the Tax Cuts and Jobs Act, including deferred-tax remeasurement and transition-tax charges. Operating margins, calculated from reported figures, were 13.0% versus 10.4% for Q3 and 9.7% versus 6.1% for the nine-month periods.
Cash, liquidity and debt: Nine-month operating cash flow was $173.1, versus $161.2 in the prior-year period. Working capital used $207.6 of cash, including a $115.4 inventory increase. Cash, cash equivalents and investments totaled $842.9 at July 31, down $110.5 from October 31, 2018. The term loan had a $688.9 net carrying value ($694.8 principal); the $250 million asset-backed revolver had no borrowings outstanding, with $75.0 of letters of credit supported by it. Management said available liquidity should meet operating and other requirements for at least 12 months.
Nine-month investing activities provided $35.8, including securities transactions; capital spending was $49.1. Financing activities used $229.9, including $111.3 to settle the convertible-note conversion liability and $110.5 of program stock repurchases. Ciena repurchased an additional $17.3 of shares after quarter-end through September 6, with $370.8 remaining under the authorization.
Material changes and operating trends
- Growth was led by Networking Platforms, up 17.5% in Q3 and 19.7% for nine months. Converged Packet Optical drove the increase; Packet Networking declined in Q3. Blue Planet Automation revenue grew 141.2% in Q3 and 136.4% for nine months, while Platform Software and Services was nearly flat in Q3 and down 2.7% for nine months.
- Global Services revenue increased 16.5% in Q3 and 14.2% for nine months. Product margins improved, supported by cost reductions and manufacturing efficiencies; service margins declined, in part due to lower-margin Blue Planet services and early-stage international deployments.
- North America, EMEA and CALA grew in the nine-month period; APAC revenue fell 7.5%, primarily due to lower spending in India and Australia. The stronger U.S. dollar reduced reported nine-month revenue by approximately $37.4 million, according to management.
- Inventory rose to $356.8 from $262.8 at October 31, 2018. Ciena recorded $18.8 of excess-and-obsolete inventory provision in the first nine months, primarily related to lower forecast demand for certain Networking Platforms products.
- Customer concentration remains significant. In Q3, a Web-scale provider and Verizon each accounted for at least 10% of revenue; for the nine-month period, AT&T, Verizon and a Web-scale provider each exceeded that threshold.
Outlook, risks and unusual items
- Ciena reported remaining performance obligations of $1.15 billion at July 31 and expected approximately 83% to be recognized within the next 12 months. The filing does not provide specific numerical revenue or earnings guidance.
- Management cited strong network-operator demand, favorable industry and competitive dynamics, and execution of its strategy, but cautioned that the strong revenue and profit growth rates achieved in the first nine months are not expected to be sustainable long term. It also expects Web-scale customer growth to moderate from fiscal 2019 levels to date.
- ASC 606 was adopted in fiscal 2019 using the modified retrospective method; 2018 comparatives were not restated. Adoption increased reported nine-month 2019 revenue by $27.5 and net income by $4.8 versus figures without the new standard. This limits direct comparability.
- Key risks include spending changes or loss of large customers, pricing pressure, demand and inventory forecasting, supplier and contract-manufacturer disruptions, foreign exchange, and trade restrictions. A new 15% U.S. tariff effective September 1, 2019 applied to certain China-origin imports, including some Ciena products; management said further trade actions remained uncertain. Restrictions affecting Huawei could also disrupt suppliers that serve Huawei.
- Restructuring charges were $11.7 for nine months, including a workforce reduction of approximately 225 employees and costs for vacated facilities. The DOJ closed its investigation into a previously disclosed payment matter in December 2018; the SEC notified Ciena in September 2019 that it had concluded its investigation and did not intend to recommend enforcement action. A Cyan-related securities class action settlement was approved August 8, 2019, with no material liability attributed to Ciena.
Important facts for investors to verify
- How much of reported growth reflects durable customer demand versus project timing, customer mix and the ASC 606 accounting change.
- Whether inventory converts to sales as planned, given its increase and the recorded obsolescence provision.
- Customer spending trends and concentration, particularly among large service providers and Web-scale customers.
- The effect of tariffs, supplier exposure and potential supply-chain interruptions on costs, margins and delivery schedules.
- Debt service, cash deployment through repurchases, and the progress and expected conversion of the $1.15 billion remaining performance obligations.