Viavi Solutions Inc. — Q2 FY2017 Form 10-Q
Reporting period: Three and six months ended December 31, 2016; unaudited. Comparisons are to the periods ended January 2, 2016. Fiscal 2017 has 52 weeks versus 53 weeks in fiscal 2016. Viavi reports Network Enablement (NE), Service Enablement (SE), and Optical Security and Performance Products (OSP); Lumentum was separated in August 2015 and is presented as discontinued operations in the prior-year comparison.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2016 | Prior comparable period | Six months ended Dec. 31, 2016 | Prior comparable period |
|---|---|---|---|---|
| Revenue | $206.5 million | $232.1 million | $417.3 million | $461.8 million |
| Gross profit and margin | $124.7 million; 60.4% | $141.8 million; 61.1% | $249.8 million; 59.9% | $282.3 million; 61.1% |
| Operating income | $6.7 million | $9.2 million | $16.8 million | $6.3 million |
| Net income (loss) | $49.2 million | $4.0 million | $127.2 million | $(65.1) million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $28.9 million | $(1.3) million |
- Quarterly revenue fell 11.0%; six-month revenue fell 9.6%. Quarterly GAAP operating margin was approximately 3.2%, versus 4.0% a year earlier.
- Net income included gains on Lumentum share sales of $53.9 million for the quarter and $135.4 million for the six months. The gains substantially increased reported net income and were not operating income.
- At December 31, 2016, cash and cash equivalents were $505.7 million, short-term investments $498.0 million, and restricted cash $11.2 million, totaling $1,014.9 million. Current assets were $1,274.9 million and current liabilities $245.0 million.
- Long-term debt carrying value was $598.3 million, representing $650.0 million principal of 0.625% convertible notes due 2033. No short-term debt was reported; Viavi said it was compliant with debt covenants.
- Six-month investing cash flow was $46.1 million and financing cash flow was $(36.1) million. Capital expenditures were $20.1 million; share repurchases used $39.7 million.
Material changes and operating drivers
- Quarterly NE revenue decreased 14.2% to $117.0 million, primarily reflecting weaker North American communications-service-provider demand for field instruments. Six-month NE revenue declined 7.2%.
- SE revenue rose 10.0% to $40.6 million in the quarter, helped by acceptance of Assurance solutions and deferred-revenue recognition, but fell 9.2% for the six months. Management cited declines in mature support-contract renewals and nonrecurring prior Data Center deals.
- OSP revenue declined 16.8% to $48.9 million in the quarter and 14.9% for the six months, primarily due to lower cyclical bank-note volumes in anti-counterfeiting products. Consumer and industrial growth partly offset the decline.
- Quarterly gross margin decreased 0.7 percentage points. Management attributed pressure mainly to NE revenue and product mix; six-month margin pressure also reflected lower-margin SE pass-through hardware revenue.
- Research and development and selling, general and administrative expenses declined year over year, mainly due to restructuring, lower headcount, site consolidations, and lower separation-related costs.
Outlook, risks, contingencies, and unusual items
- Management provided no specific revenue or earnings guidance in the filing. It said existing cash balances and investments should be sufficient for liquidity and capital spending needs over the next 12 months.
- In January 2017, management approved a global workforce-reduction and restructuring plan expected to affect up to approximately 10% of employees. Viavi estimated charges of up to $30 million, including up to $24 million in cash costs, with most charges expected in Q3 FY2017 and completion by the end of Q2 FY2018.
- Management identified uncertain demand, macroeconomic conditions, foreign exchange movements, pricing pressure, competition, customer concentration, product mix, customer buying patterns, and communications-industry consolidation as risks to revenue and margins. It expects continued declines in mature SE Assurance products and said the new workforce plan may further reduce SE revenue.
- Viavi had a material weakness in controls over the interim income tax provision; management concluded disclosure controls were not effective at December 31, 2016. Remediation controls had been implemented but not operated long enough to establish full remediation; completion was anticipated during fiscal 2017.
- A UK pension deed-of-trust dispute remained under appeal. Viavi had accrued GBP 5.7 million after an adverse court decision and was also pursuing a claim against the law firm involved. The filing notes ordinary-course claims could have a material impact if resolved unfavorably, although management did not then expect a material adverse effect overall.
- Defined-benefit pension plans were underfunded by approximately $100.0 million at December 31, 2016; the company also reported a $1.2 million non-pension post-retirement liability. Unrecognized tax benefits were $42.3 million, with $2.3 million accrued for interest and penalties.
Most important facts for investors to verify
- How much reported earnings depended on the Lumentum stock-sale gains, and how remaining Lumentum shares are valued or disposed of.
- Whether revenue declines in NE and OSP persist, and whether SE growth products can offset mature Assurance and Data Center weakness.
- The execution, cash cost, timing, and expected savings of the workforce-reduction plan.
- Progress in remediating the interim income-tax control weakness and any effects on future tax estimates or disclosures.
- Developments in the UK pension litigation, pension funding requirements, and the company’s ability to meet debt and liquidity needs.