VIAVI Solutions Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2019, ended December 29, 2018. Financial statements are unaudited; comparative periods ended December 30, 2017.
Business context and performance
VIAVI supplies network test, monitoring and assurance solutions and optical products. Its reporting segments are Network Enablement (NE), Service Enablement (SE), and Optical Security and Performance Products (OSP). Results include the acquired AvComm and Wireless Test and Measurement business (AW); its acquisition was completed in March 2018.
- Quarter revenue: $306.9 million, up 49.4% year over year. Product revenue was $272.8 million and service revenue $34.1 million.
- Quarter net income: $13.0 million, or $0.06 per diluted share, versus a $1.1 million net loss a year earlier. Continuing-operations income was $15.4 million; discontinued operations recorded a $2.4 million loss.
- First-half revenue: $575.4 million, up 45.2%. First-half net loss was $2.3 million, or $0.01 per diluted share, versus an $8.7 million loss.
- Margins: Quarter gross margin was 58.0%, versus 58.1%; first-half gross margin was 57.1%, versus 58.6%. Quarter operating income was $32.9 million (10.7% margin), compared with $6.9 million (3.4%); first-half operating income was $31.7 million, versus $13.6 million.
- Segment trends, quarter: NE revenue grew 60.2% to $195.5 million, including AW revenue and growth in lab instruments. OSP rose 72.6% to $83.2 million, supported by anti-counterfeiting and 3D-sensing demand. SE declined 19.9% to $28.2 million, mainly from mature assurance and data-center products.
Cash flow, debt and liquidity
- First-half operating cash flow was $69.1 million, compared with $34.9 million. Investing activities provided $89.9 million, including proceeds from investment sales and maturities; financing activities used $294.0 million, mainly for convertible-note repurchases and redemptions.
- At December 29, cash and cash equivalents were $465.6 million and short-term investments were $30.0 million. Including total restricted cash, the company reported combined cash, investments and restricted cash of $508.1 million, down from $793.6 million at June 30, 2018.
- Debt carrying value was $568.4 million; outstanding convertible-note principal totaled $685.0 million ($460.0 million of 1.00% notes due 2024 and $225.0 million of 1.75% notes due 2023). The 0.625% notes due 2033 were fully converted, repurchased or redeemed during the period. VIAVI reported compliance with debt covenants.
- Management said existing cash and investments should be sufficient for liquidity and capital needs over the next 12 months. The company had no material change in contractual commitments during the quarter.
Material changes and unusual items
- Revenue growth reflected AW, organic strength in 100Gb/400Gb lab instruments and fiber build-out, and increased OSP demand. North American cable spending weakened after customers largely completed DOCSIS 3.1 procurement.
- First-half acquired-intangible amortization rose to $38.1 million from $14.7 million. Restructuring charges were $15.1 million versus $4.0 million, largely for a workforce reduction affecting about 240 employees and integration of AW. The restructuring accrual was $11.8 million.
- VIAVI acquired RPC Photonics on October 30, 2018, expanding 3D-sensing offerings. Preliminary purchase consideration was $69.6 million, including $36.2 million fair value of contingent consideration; potential earn-out payments may reach $53.0 million.
- Adoption of ASC 606 changed revenue timing, particularly for certain software bundles. Comparative periods were recast; management reported no impact on cash flow from adoption.
- A $2.4 million charge to discontinued operations related to an Ontario tax assessment following denial of the company’s appeal.
Outlook, management commentary and risks
Management expects fiscal 2019 to benefit from improving 5G testing and deployment and fiber investment supporting 5G infrastructure. It expects year-over-year cable declines after the DOCSIS 3.1 procurement cycle. OSP anti-counterfeiting revenue is expected to moderate in the second half after strong first-half banknote redesign demand; 3D-sensing revenue is expected to decline seasonally after first-half strength. No specific consolidated revenue or earnings guidance was provided in the supplied filing text. Management estimated approximately $28 million of annualized gross savings from restructuring activities initiated over the prior 12 months.
Risks cited include macroeconomic and customer-demand uncertainty, pricing pressure and competition, customer concentration and industry consolidation, product mix and buying-pattern variability, foreign-exchange movements, and reliance on suppliers and international markets. The company also noted uncertainty in restructuring estimates and contingent earn-out valuations. Ordinary-course legal claims were described as uncertain; management did not expect them, individually or collectively, to materially affect results, but an unfavorable outcome could have a material impact. A U.K. pension-related liability was accrued at £5.9 million ($7.5 million), and the company continues a claim against the law firm involved.
Important facts for investors to verify
- How much of revenue growth and margin improvement is attributable to AW and other acquisitions versus ongoing organic demand.
- Whether 5G, fiber and 3D-sensing demand offsets expected cable, anti-counterfeiting and seasonal declines in the second half.
- Cash use and debt service after the $276.9 million of convertible-note repurchases and redemptions, and the carrying-value discount relative to principal debt.
- Progress and realized savings from restructuring, including the timing and cost of integrating AW and the $11.8 million restructuring accrual.
- Potential RPC earn-out payments and valuation changes, along with the outcome and financial exposure of tax, pension and other legal contingencies.