VIAVI Solutions Inc. — Q1 Fiscal 2017 Form 10-Q
Reporting period: The unaudited quarter ended October 1, 2016; comparisons are to the three months ended October 3, 2015. The company reported that the current quarter included one fewer week of activity. Unless noted otherwise, amounts are in millions of U.S. dollars.
Business context and results
Viavi provides network test, monitoring and assurance solutions and optical security and performance products. Its reportable businesses are Network Enablement (NE), Service Enablement (SE) and Optical Security and Performance Products (OSP). Lumentum, separated in August 2015, is presented as discontinued operations in the prior-period comparison.
| Metric | Q1 FY2017 | Prior comparable quarter |
|---|---|---|
| Revenue | $210.8 | $229.7 |
| Gross profit / margin | $125.1 / 59.3% | $140.5 / 61.2% |
| Operating income (loss) | $10.1 | $(2.9) |
| Net income (loss) | $78.0 | $(69.1) |
| Diluted earnings (loss) per share | $0.33 | $(0.29) |
| Cash provided by (used in) operations | $10.3 | $(0.3) |
Revenue fell 8.2%. Product revenue was $188.3, down 5.9%, and service revenue was $22.5, down 23.7%. Net income included an $81.5 gain on the sale of Lumentum shares; the company sold 3.9 million shares and held 3.4 million shares valued at $141.1 at quarter-end. Thus, reported net income substantially reflects this investment gain, while operating income was $10.1.
Segment performance and changes
- NE: Revenue rose 0.9% to $118.6; gross margin improved to 65.3% from 64.4%. Lab instrument growth was partly offset by weaker Access and Cable and Metro demand.
- SE: Revenue declined 24.0% to $36.4; gross margin fell to 58.5% from 69.7%. The company cited lower mature-product support renewals, nonrecurring prior-period data-center deals, and less favorable mix.
- OSP: Revenue fell 13.1% to $55.8, mainly due to lower currency-product demand and bank-note volumes. Operating margin was 41.9%, compared with 41.0%.
Consolidated gross margin declined 1.9 percentage points. Research and development expense fell 18.5% to $36.1, and selling, general and administrative expense fell 20.5% to $75.4, reflecting restructuring, lower headcount and reduced separation-related and stock-compensation costs.
Cash, debt and liquidity
At October 1, 2016, cash and cash equivalents were $474.3, short-term investments were $558.8 and restricted cash was $11.1. Total current assets were $1,298.7 versus current liabilities of $243.0. Long-term debt had a carrying value of $590.8; principal on the unsecured 0.625% convertible notes due 2033 was $650.0. The company reported compliance with debt covenants and no short-term debt.
Operating cash flow was $10.3. Investing cash flow was $1.6 and financing cash flow was $(22.4), including $25.5 of share repurchases. Cash and cash equivalents decreased $8.6 during the quarter, while cash, investments (including marketable equity securities) and restricted cash combined increased $64.4 to $1,044.2. Management stated existing cash and investments should meet liquidity and capital spending needs for the next 12 months.
Outlook, risks and unusual items
- No specific numerical revenue or earnings guidance is provided. Management cited limited visibility and possible quarter-to-quarter variability, and expects continued revenue declines in mature SE Assurance products.
- Risks include macroeconomic uncertainty affecting demand, pricing pressure and competition, customer concentration, product-mix volatility, industry consolidation, foreign exchange movements and customer purchasing patterns.
- Cost reductions initiated in the prior year are expected to produce approximately $18.0 of annualized gross savings, excluding one-time charges. Management also expects to continue investing in R&D and new products.
- The company repurchased approximately 3.4 million shares for $25.5 during the quarter. Its authorization was increased to $150 million and expires December 31, 2017; $120.0 remained available at quarter-end. Subsequent to quarter-end, it repurchased approximately 1.3 million shares at an average $7.35 per share.
- A UK court decision concerning a pension trust deed resulted in an $8.4 accrual; Viavi appealed. The company also disclosed ordinary-course legal matters and stated that an unfavorable outcome could have a material effect, although management did not currently expect a material adverse impact.
- Disclosure controls were deemed ineffective at quarter-end because of a material weakness in controls over the interim income tax provision. Remediation controls had been implemented and tested for design, but had not operated long enough to establish full remediation; completion was anticipated during fiscal 2017.
- Pension plans were underfunded by $107.5 at quarter-end. Unrecognized tax benefits were $41.8, with $1.0 potentially recognizable over the next 12 months.
Important facts for investors to verify
- How much of reported earnings reflects recurring operations versus the $81.5 Lumentum share-sale gain.
- Whether SE revenue, support renewals and gross margins stabilize, and whether mature Assurance declines continue.
- Whether cost savings can offset lower revenue and margin pressure without impairing product development or growth.
- Progress and effectiveness of remediation for the income-tax control material weakness.
- Outcome of the UK pension deed appeal, pension funding requirements and the company’s substantial convertible-note obligations.
- Cash conversion and working-capital trends, including the effects of customer prepayments and collections timing.