Ciena Corporation — Q2 FY2015 Form 10-Q
Reporting period: Quarter and six months ended April 30, 2015. Unaudited results; dollar amounts are in U.S. dollars unless stated otherwise.
Business context and performance
Ciena sells communications networking equipment, software and services. Its four reported segments are Converged Packet Optical, Packet Networking, Optical Transport, and Software and Services. Q2 revenue grew primarily on demand for next-generation converged optical networking, while legacy stand-alone transport revenue continued to decline.
Key financial metrics
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Revenue | $621.6 million | $560.1 million | $1,150.8 million | $1,093.8 million |
| Gross profit / margin | $272.4 million / 43.8% | $237.7 million / 42.4% | $502.7 million / 43.7% | $463.5 million / 42.4% |
| Operating income | $42.4 million | $7.2 million | $46.6 million | $10.5 million |
| Net income (loss) | $20.7 million | $(10.2) million | $1.9 million | $(26.1) million |
| Diluted EPS | $0.17 | $(0.10) | $0.02 | $(0.25) |
| Operating cash flow | $37.8 million | Not stated here | $59.9 million | $(35.2) million |
Q2 revenue increased 11.0% year over year; six-month revenue increased 5.2%. Product revenue was $511.9 million and services revenue was $109.7 million in Q2. For the six-month period, product and services revenue were $934.2 million and $216.6 million, respectively.
Q2 segment revenue was $432.9 million for Converged Packet Optical, $53.3 million for Packet Networking, $16.5 million for Optical Transport, and $118.9 million for Software and Services. Versus Q2 FY2014, Converged Packet Optical grew 21.3% and Software and Services grew 11.1%; Packet Networking fell 19.9% and Optical Transport fell 44.4%.
At April 30, 2015, cash and cash equivalents were $586.3 million, short-term investments $145.1 million, and long-term investments $85.2 million, totaling $816.7 million in cash and investments. Current assets were $1.683 billion and current liabilities $575.5 million. Total debt carrying value was approximately $1.279 billion; the company also reported $1.067 billion of convertible-note principal and a $248.1 million Term Loan principal balance. The $200 million ABL facility had no borrowings outstanding; $60.4 million of letters of credit were supported by it.
Six-month investing cash outflow was $53.8 million, including $21.9 million for equipment and intellectual property and net purchases of available-for-sale securities. Financing cash outflow was $3.2 million. Cash and cash equivalents were essentially unchanged from October 31, 2014.
Material changes and notable items
- Service gross margin improved to 43.2% in Q2 from 34.8% a year earlier, which management attributed mainly to higher-margin software subscription services and lower maintenance repair costs. Product gross margin was broadly stable at 44.0%.
- Six-month operating expenses rose slightly to $456.1 million from $453.0 million. This included $8.1 million of restructuring expense for a global workforce reduction of about 125 employees, recorded in Q1.
- Inventory declined $40.1 million from October 31, 2014 to $214.6 million. The period included a $10.8 million excess-and-obsolete inventory provision, mainly tied to discontinued components and weaker demand for certain legacy products.
- The U.S. dollar’s strengthening reduced reported six-month revenue by an estimated $32.8 million, or 2.8%, versus the prior-year period. Ciena recorded $22.5 million of foreign-currency remeasurement losses in the first six months, net of hedging activity as described by management.
- In March 2015, 96.3% of the 4.0% convertible notes due 2015 were settled through stock issuance: approximately 8.9 million shares were issued and $6.9 million principal was repaid in cash. This increased the share count and reduced the notes’ current-maturity burden.
Outlook, risks and contingencies
- Management expected FY2015 operating expenses to increase slightly from FY2014 levels, supporting business growth, R&D and ERP-system investment. It did not provide specific revenue or earnings guidance in the supplied filing text.
- Management expects continued annual declines in Optical Transport revenue as customers migrate from stand-alone WDM and SONET/SDH platforms to converged architectures. It cited constrained capital spending by some large service-provider customers, intense competition, pricing pressure and quarterly revenue volatility as ongoing challenges.
- Ciena launched the Waveserver data-center interconnect platform in May 2015. Revenue is expected to be reported in Converged Packet Optical; the filing provides no quantified sales outlook for the product.
- The pending Cyan acquisition, announced May 3, 2015, was valued at approximately $400 million at signing, or $335 million net of estimated acquired cash. Consideration is principally Ciena stock, with a cash component; Ciena also expects to assume Cyan’s $50 million convertible notes. Closing was expected in Q4 FY2015, subject to shareholder, regulatory and other conditions. Ciena estimated about $30 million of merger-related expenses, most expected in Q3 and Q4.
- Five putative class actions filed in Delaware challenge the Cyan transaction and seek, among other relief, to block the merger or obtain damages. Ciena said it considers the suits without merit and intends to defend them. The filing also describes an older patent case that remains stayed and tax assessments in India; management did not expect ordinary-course legal matters or tax audits to have a material adverse effect, while noting possible India tax exposure of up to $2.7 million beyond amounts accrued.
- Other risks include customer concentration (AT&T represented 18.9% of Q2 revenue), reliance on limited-source suppliers and contract manufacturers, foreign-exchange exposure, inventory obsolescence, debt and potential dilution, and execution and integration risks for the Cyan acquisition. Management stated that available liquidity was expected to meet operating and other needs for at least 12 months.
Investor verification priorities
- Track whether Q2’s revenue and margin improvement persists, particularly the contribution from Converged Packet Optical and Software and Services versus continuing Optical Transport declines.
- Verify the Cyan merger’s closing conditions, litigation and regulatory status, total cash/debt consideration, and actual integration costs against the approximately $30 million estimate.
- Monitor customer concentration, especially AT&T spending, and the impact of service-provider capital spending and competitive pricing on orders and margins.
- Reconcile operating cash generation with working-capital movements, including receivables, deferred revenue, inventory provisions and collection days.
- Review debt maturities, interest expense, potential conversion-related dilution, and the capacity and conditions of the ABL facility.
- Assess foreign-exchange sensitivity, inventory exposure in legacy products, and progress on the Ottawa facilities transition and ERP investment.