Ciena Corporation — Q3 FY2015 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended July 31, 2015. Ciena sells communications networking equipment, software and services through four segments: Converged Packet Optical, Packet Networking, Optical Transport, and Software and Services. Unless stated otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $602.9 million | $603.6 million | $1,753.7 million | $1,697.3 million |
| Gross profit / margin | $269.9 million / 44.8% | $264.0 million / 43.7% | $772.6 million / 44.1% | $727.5 million / 42.9% |
| Operating income / margin | $44.5 million / 7.4% | $37.0 million / 6.1% | $91.0 million / 5.2% | $47.5 million / 2.8% |
| Net income (loss) | $23.6 million | $16.2 million | $25.5 million | $(9.9) million |
| Diluted EPS | $0.19 | $0.15 | $0.22 | $(0.09) |
- Quarterly revenue was nearly flat year over year, while nine-month revenue increased 3.3%. Quarterly revenue fell 3.0% sequentially from Q2, which management attributed mainly to reduced spending by certain large service-provider customers, particularly in North America.
- For the quarter, Converged Packet Optical revenue rose 6.8% year over year to $408.0 million. Packet Networking fell 17.6% to $57.2 million; Optical Transport fell 43.6% to $17.5 million; Software and Services was down 0.6% to $120.3 million.
- Quarterly gross margin improved chiefly because of stronger services margins, including higher-margin software subscriptions and lower maintenance repair costs. Nine-month operating income improved despite restructuring charges, as revenue and gross margin increased.
- Operating cash flow was $177.5 million for the first nine months, versus $16.0 million in the comparable prior period. The 2015 period included $168.5 million of net income adjusted for non-cash charges and $9.0 million of cash from working capital changes.
- At July 31, cash and cash equivalents were $697.1 million; short- and long-term investments totaled $230.2 million. Combined cash and investments were $927.3 million, up $150.3 million from October 31, 2014. Total assets were $2.164 billion and stockholders’ equity was $177.9 million, versus a $69.6 million deficit at October 31, 2014.
- Balance-sheet debt was approximately $1.279 billion, comprising convertible notes and a term loan. The term loan had a $247.5 million principal balance and matures in 2019; convertible notes remained outstanding with maturities in 2017, 2018 and 2020. The $200 million ABL facility had no borrowings, with $54.3 million of letters of credit supported by it.
Material changes and significant items
- On March 15, 2015, the 4.0% convertible notes due 2015 matured. Approximately 96.3% of their principal was settled through issuance of about 8.9 million common shares; approximately $6.9 million was repaid in cash.
- Nine-month inventory declined $60.6 million to $194.0 million. Ciena recorded an $18.0 million excess-and-obsolete inventory provision, principally related to discontinued components and reduced demand forecasts for legacy platforms.
- A global workforce reduction of approximately 125 employees resulted in about $8.1 million of severance and related restructuring costs in the first quarter. Total nine-month restructuring costs were $8.3 million.
- Foreign exchange affected reported results: the stronger U.S. dollar reduced nine-month revenue by an estimated $37.9 million, or 2.1%, year over year. The company recorded $32.9 million of foreign currency remeasurement losses in interest and other income (loss), net, partly offset by hedge results.
Outlook, risks and contingencies
- Cyan acquisition after quarter-end: Ciena acquired Cyan on August 3, 2015, for approximately $33.6 million in cash and 10.6 million Ciena shares, plus assumed awards. By September 3, all $50 million of Cyan’s 8.0% convertible notes had been converted; Ciena issued approximately 4.6 million shares and paid $14.5 million cash. The acquisition was not reflected in Q3 operating results.
- Management expected approximately $25 million in total Cyan transaction and integration costs, including $7.9 million of non-cash share-based compensation, with a substantial majority expected in Q4 FY2015. It also expected purchase-accounting effects, including inventory fair-value step-up and intangible-asset amortization, to adversely affect Q4 gross margin and net income. Cyan’s inclusion was expected to increase Q4 revenue and operating expense. The filing provides no clear numerical revenue or earnings guidance for the full year.
- Management stated that existing cash, investments and other liquidity sources were expected to cover working capital, capital expenditures and other requirements for at least the next 12 months. It also identified constrained customer capital budgets, order timing, pricing pressure, customer concentration and quarterly revenue variability as significant business risks. AT&T represented 20.2% of Q3 revenue.
- Other key risks include competition, foreign-exchange movements, sole- or limited-source suppliers, inventory obsolescence, product execution, cybersecurity, debt obligations and Cyan integration. Management reported that substantially all of $1.5 billion in net deferred tax assets were offset by a valuation allowance.
- Five lawsuits challenging the Cyan merger had been consolidated in Delaware; defendants filed motions to dismiss, and Ciena stated it considered the case without merit. Ciena also became a defendant in a securities class action related to Cyan’s IPO. India tax authorities had issued assessments; Ciena accrued $1.1 million and disclosed possible exposure of up to $2.7 million without accruing that full amount. Management did not expect ordinary-course legal and tax matters to have a material effect, but outcomes remain uncertain.
- The filing reports effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether service-provider spending, especially in North America, stabilizes and whether Q3’s sequential revenue decline persists.
- Whether growth in Converged Packet Optical and Software and Services can offset continuing declines in Optical Transport and weakness in Packet Networking.
- The actual Q4 and subsequent-period impact of Cyan integration costs, purchase accounting, acquired revenue and the conversion-related share dilution.
- Future inventory provisions, gross-margin performance, foreign-exchange effects and cash conversion relative to reported operating cash flow.
- Debt maturities, interest costs, ABL availability and any developments in the Cyan-related litigation or India tax assessments.