Ciena Corporation (CIENA) — Q3 FY2018 Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2018. Comparisons are with the corresponding 2017 periods unless stated otherwise. Amounts are in U.S. dollars.
Business context
Ciena provides networking hardware, software and services for communications and other network operators. Its reporting segments are Networking Platforms, Software and Software-Related Services, and Global Services. Growth in the quarter was led by Converged Packet Optical products, including Waveserver, with stronger sales to Web-scale customers; results also reflected increased sales in APAC and EMEA.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $818.8 million | $728.7 million | $2,194.9 million | $2,057.2 million |
| Gross profit / margin | $351.5 million / 42.9% | $328.1 million / 45.0% | $916.6 million / 41.8% | $920.1 million / 44.7% |
| Operating income / margin | $85.3 million / 10.4% | $82.0 million / 11.3% | $134.1 million / 6.1% | $158.9 million / 7.7% |
| Net income (loss) | $50.8 million | $60.0 million | $(408.7) million | $101.9 million |
| Diluted EPS | $0.34 | $0.39 | $(2.84) | $0.69 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $161.2 million | $96.3 million |
- Revenue: Q3 rose 12.4%; nine-month revenue rose 6.7%. Nine-month Networking Platforms revenue increased 6.7%, Software and Software-Related Services increased 11.8%, and Global Services increased 4.3%.
- Profitability: Q3 gross profit increased, but gross margin fell 2.1 percentage points as cost of goods sold grew faster than revenue. Management cited aggressive pricing, early-stage network deployments and product/service mix. Nine-month gross profit declined slightly despite revenue growth.
- Tax and earnings: The nine-month net loss primarily reflects a provisional $503.7 million tax provision related mainly to the Tax Act: $431.3 million for remeasurement of U.S. deferred tax assets and $45.6 million for the transition tax. These estimates could change. Excluding this unusual tax charge, reported results would differ materially; the filing does not provide a non-GAAP adjusted net income figure here.
- Cash flow and liquidity: Nine-month operating cash flow was $161.2 million, including a $491.9 million non-cash deferred tax provision; working capital used approximately $96.0 million, chiefly from higher receivables. Cash, cash equivalents and investments totaled $984.6 million at July 31, up $15.2 million from October 31, 2017.
- Debt: Balance-sheet current and long-term debt totaled approximately $940.2 million, including $353.7 million current and $586.5 million long-term. No ABL revolver borrowings were outstanding; $62.9 million of letters of credit used the facility. The $250 million ABL facility matures in December 2020.
Material changes and notable items
- Q3 revenue growth was concentrated in Networking Platforms (+14.4%); Software and Software-Related Services revenue decreased 2.5% for the quarter, including a 22.2% decline in Software Platforms.
- AT&T revenue was $87.4 million in Q3, down from $120.9 million; a Web-scale provider contributed $86.4 million and was not a 10%-or-more customer in the comparable quarter. Verizon revenue increased to $97.1 million from $82.9 million. Customer concentration remains significant.
- Inventory was $227.9 million, down from $267.1 million at October 31, 2017. The company recorded a $19.9 million nine-month provision for excess and obsolete inventory, primarily due to lower forecast demand for certain Networking Platforms products.
- Ciena acquired Packet Design on July 2 for approximately $41.1 million cash, including $1.3 million of Q3 acquisition and integration costs. The acquisition adds Layer 3 network optimization and analytics capabilities to its software strategy.
- The company recorded $16.7 million in nine-month restructuring costs, including a global workforce reduction of about 230 employees and excess-facility commitments.
- Ciena repurchased 3.0 million shares for $74.8 million through July 31 under its $300 million authorization. Through August 31, cumulative repurchases reached 3.5 million shares, with $212.8 million of authorization remaining.
Outlook, risks and contingencies
- The filing gives no specific consolidated revenue, earnings or margin guidance. Management expects continued gross-margin fluctuations or reductions during FY2018 as it pursues market share, with aggressive pricing and early deployment mix potentially producing low or negative margins on particular orders.
- Management said cash, investments, operating cash flow and available liquidity should meet working-capital, capital expenditure and other needs for at least the next 12 months. The $350 million aggregate principal amount of 3.75% convertible notes matures October 15, 2018; the filing describes cash settlement of principal and a cash-and-shares approach for any conversion amount above principal, subject to stated limits.
- Ciena expects quarterly operating-expense benefits of approximately CAD$2.95 million (about $2.3 million) from Canadian government grants through March 2022, subject to eligible costs and investment, employment and project milestones. Amounts may be recouped if conditions are not met.
- Risks include reliance on a small number of customers and their spending plans, component supply and trade disruptions, pricing pressure, foreign-exchange exposure, inventory forecasting, and execution of software and distribution strategies. Three Web-scale providers were among Q3’s top customers.
- Ciena is cooperating with the SEC and DOJ on an investigation of alleged improper payments involving a customer employee in an ASEAN country. No provision was recorded; the ultimate outcome is uncertain and could involve fines, penalties or other remedies. The company also continues to defend a securities class action arising from Cyan’s IPO and says it believes the case lacks merit.
- Other notable exposures include provisional Tax Act accounting, a $724.1 million net deferred tax asset subject to realization assessment, and a possible approximately $23.0 million withholding-tax liability if certain foreign earnings are repatriated.
Important facts for investors to verify
- How the October 2018 convertible-note maturity and any conversion premium are ultimately settled, and the resulting cash and share impact.
- Whether revenue growth broadens beyond a small group of large customers, and whether AT&T spending and Web-scale demand remain stable.
- Whether gross margins stabilize as deployment mix changes, and whether inventory provisions or warranty costs rise further.
- Final Tax Act accounting, deferred-tax-asset recoverability and any additional tax charges or liabilities.
- Developments in the SEC/DOJ investigation, Cyan-related litigation, and the conditions and benefits attached to the Canadian grant.