Business context and reporting period
JDS Uniphase Corporation (now Viavi Solutions Inc.) filed this unaudited Form 10-Q for fiscal first quarter 2015, the three months ended September 27, 2014. The comparable quarter ended September 28, 2013. The company supplies network and service enablement solutions, optical products and commercial lasers, and optical security products.
During the quarter, the company split its former Network Service and Enablement segment into Network Enablement (NE) and Service Enablement (SE); prior-period segment figures were recast. On September 10, 2014, it announced plans to spin off CCOP as a separate public company, targeting completion by the third calendar quarter of 2015.
Financial performance and position
| Metric | Q1 FY2015 | Prior-year quarter |
|---|---|---|
| Revenue | $433.6 million | $429.0 million |
| Gross profit / margin | $199.3 million / 46.0% | $185.2 million / 43.2% |
| Operating income | $4.2 million | $6.6 million |
| Net income (loss) | $(9.7) million | $0.3 million |
| Diluted earnings (loss) per share | $(0.04) | $0.00 |
| Cash from operating activities | $40.8 million | $29.5 million |
Revenue rose 1.1%. Gross margin improved 2.8 percentage points, which management attributed mainly to favorable product mix, including the higher-margin Enterprise product line in SE. Operating expenses increased to $195.1 million from $178.6 million, including higher R&D and intangible amortization, and $2.9 million of restructuring charges versus a $0.8 million benefit a year earlier. Interest expense rose to $8.3 million from $5.2 million, primarily reflecting a full quarter of expense on the 2033 convertible notes. A $6.1 million tax provision contributed to the quarterly net loss despite a pretax loss.
Segment revenue and operating income were: NE $132.8 million and $20.1 million; SE $48.2 million and $0.8 million; CCOP $209.3 million and $25.1 million; OSP $43.3 million and $15.9 million. SE revenue increased 79.9%, partly from the acquired Enterprise product line and recognition of previously deferred software and services revenue. NE revenue fell 8.5%, and OSP revenue fell 17.5%; CCOP revenue increased 2.3%.
At September 27, 2014, cash and cash equivalents were $311.1 million, short-term investments $537.7 million and restricted cash $32.1 million, totaling $880.9 million. Current assets were $1,411.8 million and current liabilities $409.6 million. Long-term debt had a $542.5 million carrying value against $650.0 million principal for 0.625% convertible notes due 2033; the company reported compliance with debt covenants and no short-term debt. Operating cash flow was $40.8 million, investing cash outflow $12.0 million and financing cash outflow $9.4 million. Capital expenditures were $26.5 million.
Changes, outlook, risks and unusual items
- Revenue mix shifted: strong SE growth and modest CCOP growth were offset by weaker NE and OSP. CCOP growth included increased laser and 40G/100G modulator demand, partly offset by lower 3D-sensing demand; OSP was affected by lower 3D-sensing demand and the exit of lower-margin legacy products.
- Management expected lower 3D-sensing demand and revenue in CCOP and OSP through fiscal 2015. It also cited uncertain demand, pricing pressure, competition (particularly from Asia-based competitors), customer concentration, product-mix swings and industry consolidation as sources of variability. Management said R&D investment was expected to increase in coming quarters.
- The company estimated approximately $33 million in annualized savings from restructuring initiated through Q1 FY2015, excluding one-time charges. It expected significant additional restructuring and separation-related charges during the rest of fiscal 2015.
- Management believed existing cash and investments would cover liquidity and capital-spending needs for the next 12 months. The company reported an underfunded pension position of $102.4 million and expected approximately $5.1 million of fiscal 2015 pension cash outlays.
- The proposed CCOP spin-off was subject to board, tax, registration and regulatory conditions, might be delayed or abandoned, and could cause added costs, management distraction or customer and employee disruption. If the spin-off did not qualify as tax-free, the company and shareholders could face substantial tax liabilities.
- Ordinary-course legal claims were disclosed; management did not then expect them to have a material adverse effect, but noted outcomes were uncertain. Unrecognized tax benefits were $59.5 million, with $24.4 million accrued for interest and penalties; about $23.2 million of benefits might be recognized within 12 months.
- Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Progress, timing, costs and tax treatment of the proposed CCOP separation, including whether the targeted completion date remains achievable.
- Whether SE growth is sustainable beyond acquisition contributions and previously deferred revenue recognition, and whether NE and OSP demand stabilizes.
- Drivers of the gross-margin improvement and the effect of product mix, pricing pressure and lower 3D-sensing demand on future margins.
- Expected restructuring and separation charges, and whether projected savings are realized without impairing growth investments.
- Cash conversion, investment liquidity and credit exposure; the convertible notes’ cash obligations and conversion terms; and pension funding needs.
- Potential tax, legal, warranty and lease-exit exposures, including changes to unrecognized tax benefits and restructuring estimates.