Lumentum Holdings Inc. — Q2 FY2019 Form 10-Q
Reporting period: The 13 weeks ended December 29, 2018; six-month comparisons are for the six months ended that date. Fiscal 2019 ends June 29, 2019. Figures are in U.S. dollars unless noted.
Business context and reporting period
Lumentum supplies optical and photonic products through its Optical Communications (OpComms) and Commercial Lasers segments. It completed its acquisition of Oclaro on December 10, 2018, for total consideration of approximately $1.425 billion. The quarter includes Oclaro’s results only from the acquisition date; Oclaro contributed $29.6 million of revenue. The purchase price allocation, including acquired intangibles, tax matters, and contingencies, remained preliminary.
Key financial metrics
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $373.7 million | $404.6 million | $727.8 million | $647.8 million |
| Gross profit / margin | $124.8 million / 33.4% | $171.1 million / 42.3% | $250.8 million / 34.5% | $239.6 million / 37.0% |
| Operating income | $11.5 million | $90.8 million | $68.6 million | $93.5 million |
| Net income | $16.3 million | $204.8 million | $63.7 million | $211.9 million |
| Basic / diluted EPS attributable to common stockholders | $0.24 / $0.08 | $3.21 / $3.05 | $0.96 / $0.82 | $3.34 / $3.10 |
| Cash provided by operating activities | Not presented for the quarter | Not presented for the quarter | $159.6 million | $114.8 million |
Q2 OpComms revenue was $325.4 million, down 9.6%; Lasers revenue was $48.3 million, up 8.5%. For the six-month period, OpComms revenue rose 11.9% and Lasers revenue rose 15.7%.
At December 29, cash and cash equivalents were $371.3 million and short-term investments were $312.8 million, totaling $684.1 million in cash and investments. Current assets were $1.357 billion and current liabilities were $325.5 million. Debt included a $500 million secured term loan (carrying value $490.8 million) and $450 million principal amount of 0.25% convertible notes due 2024 (carrying value $342.9 million). The term loan matures December 2025; its stated rate was 4.89% and effective rate 5.16% at quarter-end.
Material changes versus comparable periods
- Quarterly revenue declined 7.6%, principally as consumer and industrial sales fell, including a $96.0 million decrease in 3D-sensing mobile-device products. Telecom sales increased $62.3 million, largely from ROADMs; Oclaro added $29.6 million of revenue.
- Six-month revenue increased 12.3%, driven primarily by a $94.8 million increase in Telecom sales, plus Oclaro revenue. Consumer and industrial and Datacom sales were lower.
- Quarterly gross margin fell to 33.4% from 42.3%, reflecting lower 3D-sensing sales and Thailand facility start-up and product-transfer costs. Six-month margin fell to 34.5% from 37.0%, primarily due to Thailand costs. The filing reports $14.5 million of such costs for the quarter and $27.2 million for the six-month period.
- Q2 net income comparison is heavily affected by the prior-year $109.3 million income-tax benefit, primarily from releasing U.S. federal and certain state valuation allowances. The current quarter recorded $1.4 million of tax expense. Current-period earnings also include a $10.9 million gain on the Series A preferred-stock derivative; the preferred stock converted in November, so the company said it does not expect further gains or losses from that derivative.
- SG&A increased 75.6% in Q2 to $62.7 million, including Oclaro-related accelerated equity awards and a transaction success fee. Restructuring charges rose to $7.8 million from $0.8 million.
Cash flow, outlook, risks, and unusual items
- For the six months, operating cash flow was $159.6 million; investing cash outflow was $672.4 million, including $619.8 million paid for Oclaro net of cash acquired; financing cash inflow was $487.0 million, mainly from the term loan. Cash declined $26.0 million from June 30, 2018.
- Management said cash and expected operating cash flows should meet liquidity and capital-spending needs for at least the next 12 months. It expects R&D spending to increase in absolute dollars in future quarters. The filing provides no numerical revenue or earnings guidance.
- Oclaro-related expenses included $20.9 million of restructuring and stock-based compensation charges, including $5.7 million of cash severance and $15.2 million related to accelerated equity awards. The acquired inventory fair-value step-up was $60.3 million and is being expensed as inventory is sold.
- Key risks include customer concentration and order volatility: three customers represented 26.1%, 15.0%, and 13.8% of quarterly revenue. One contract manufacturer represented 48.7% of quarterly net inventory purchases. Other cited risks include 3D-sensing demand, pricing competition, manufacturing transitions and supply dependence, tariffs and trade restrictions, and integrating Oclaro.
- The company disclosed one remaining Oclaro merger-related putative class action, which it intends to defend vigorously. It also noted potential uncertainty around recovery of Oclaro-related Malaysia GST refunds and ongoing domestic and foreign tax audits; management did not expect tax-audit resolutions within 12 months to have a significant impact.
- The term loan carries collateral and restrictive covenants; Lumentum reported compliance with all covenants at quarter-end. Management reported effective disclosure controls, while noting that integration and evaluation of Oclaro’s internal controls were ongoing.
Important facts for investors to verify
- Whether 3D-sensing demand, especially from major customers, recovers and how customer concentration affects quarterly sales.
- Oclaro integration progress, realized synergies, final purchase-price allocation, and any additional acquisition or integration costs.
- How quickly Thailand start-up and product-transfer costs subside and whether gross margins improve as product mix changes.
- Cash generation, debt service, term-loan covenant compliance, and the effect of the secured borrowing on financial flexibility.
- Developments in the remaining merger litigation, Malaysia GST refund appeal, and tax audits or tax-law changes.