Ciena Corporation (CIENA) — Q3 FY2011 Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2011. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context
Ciena supplies communications networking equipment, software and services. Results reflect the March 2010 acquisition of Nortel’s Metro Ethernet Networks business (MEN). The nine-month 2010 comparison includes MEN only from its acquisition date, making year-over-year comparisons less like-for-like.
Financial performance
| Metric | Q3 FY2011 | Q3 FY2010 | Nine months FY2011 | Nine months FY2010 |
|---|---|---|---|---|
| Revenue | $435.3 | $389.7 | $1,286.5 | $819.0 |
| Gross profit / margin | $184.9 / 42.5% | $144.0 / 37.0% | $519.2 / 40.4% | $329.1 / 40.2% |
| Operating expenses | $202.3 | $243.6 | $666.1 | $569.8 |
| Operating loss | $(17.4) | $(99.6) | $(146.9) | $(240.6) |
| Net loss / diluted loss per share | $(31.5) / $(0.33) | $(109.9) / $(1.18) | $(173.2) / $(1.82) | $(253.2) / $(2.73) |
- Q3 revenue rose 11.7% year over year. Product revenue was $350.0 million and services revenue $85.3 million. Packet-Optical Transport contributed $266.6 million; Packet-Optical Switching $40.7 million; Carrier Ethernet Service Delivery $40.5 million; and Software and Services $87.6 million.
- Q3 gross margin improved year over year and sequentially, with management citing product mix, including higher Packet-Optical Switching and Carrier Ethernet sales. Service gross margin fell to 38.8% from 42.9% a year earlier, partly due to service mix and geography.
- Nine-month revenue increased 57.1%, substantially reflecting MEN and the partial-period comparison. Packet-Optical Transport drove much of the increase; Carrier Ethernet Service Delivery revenue declined 33.6% year over year.
- Operating loss and net loss narrowed in both comparison periods. Sequentially, Q3 operating loss improved from $55.6 million in Q2 FY2011 and net loss from $62.7 million.
Cash flow, liquidity and debt
- Cash used in operating activities was $132.5 million for the first nine months, versus $203.2 million a year earlier. Investing activities used $83.4 million; financing provided $13.2 million. Cash and cash equivalents declined $202.7 million from the beginning of the fiscal year.
- At July 31, cash and cash equivalents were $486.3 million and long-term U.S. Treasury investments were $50.2 million, for $536.6 million in combined cash and investments. Working capital was approximately $862.0 million.
- Convertible notes had a carrying value of $1.442 billion, with principal maturities ranging from 2013 to 2018. Stockholders’ equity was $28.6 million. Management said current cash, equivalents and investments should cover operating, capital and other liquidity needs for at least 12 months.
- Contractual obligations totaled $1.941 billion, including $1.441 billion of convertible-note principal, $185.8 million of note interest, $106.6 million of operating leases and $207.5 million of purchase obligations. Some purchase orders are cancellable or adjustable; $61.1 million of commitments were secured by standby letters of credit.
Changes, outlook and notable items
- Q3 operating expenses fell 16.9% year over year, reflecting lower acquisition/integration costs, intangible amortization and restructuring costs, and the substantial end of Nortel transition services. The quarter also included a $4.3 million benefit from an Ontario grant.
- Management expected another $8–12 million of MEN integration costs and $1–2 million of restructuring charges during the remainder of FY2011. No specific revenue or earnings guidance was provided.
- The conditional Ontario grant may provide up to CAD$25 million through FY2015, subject to investment, employment and project milestones and possible recoupment. Ciena recorded a CAD$4.1 million benefit in the nine-month period.
- MEN-related acquisition accounting continued to affect margins: acquired inventory fair-value step-up charges included $14.3 million in cost of goods sold in the first nine months of FY2011. A $6.9 million non-cash warranty-liability reduction also lowered warranty provisions.
- Management cited cautious customer spending, longer sales and collection cycles, intense competition and pricing pressure, particularly in Packet-Optical Transport and international markets. It also noted foreign-exchange exposure; unfavorable currency movements reduced nine-month R&D results by approximately $10.6 million, net of hedging.
- Risks include customer and supplier concentration, reliance on contract manufacturers and limited-source components, inventory obsolescence, execution of new product transitions, acquisition integration, foreign currency exposure, and approximately $1.4 billion of convertible debt. Nearly all $1.4 billion of net deferred tax assets were offset by a valuation allowance.
- Legal matters include a July 2011 patent-infringement complaint concerning ROADM technology and the stayed Graywire patent case. Ciena said it intended to defend both. Mexican tax assessments carried $1.6 million of accruals, with up to $5.8 million of additional possible losses not accrued because management did not consider them probable.
Investor verification priorities
- Track operating cash use, working-capital needs, receivables collection and the trend in cash and investments.
- Assess debt service and maturity planning against the $1.442 billion carrying value of convertible notes and the company’s limited reported equity.
- Separate organic growth from MEN acquisition effects, and monitor segment mix, gross margins and customer concentration.
- Confirm whether projected integration and restructuring costs, grant conditions and expected cost savings develop as management described.
- Review the status and potential financial exposure of the ROADM and Graywire litigation and Mexican tax assessments.
- Reconcile filing figures where disclosures differ: the statements report nine-month revenue of $1,286.515 million, while certain MD&A tables show $1,286.215 million or $1,286.515 million; the segment disclosure also gives Software and Services revenue as $254.591 million in one table and $254.291 million in another.