VIAVI Solutions Inc. — Q2 FY2018 Form 10-Q
Business context and period. VIAVI provides network test, monitoring and assurance solutions and optical products. This unaudited report covers the three and six months ended December 30, 2017; comparisons are with the periods ended December 31, 2016. Amounts are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Revenue | $201.8 | $206.5 | $397.0 | $417.3 |
| Gross profit / margin | $116.1 / 57.5% | $124.7 / 60.4% | $232.3 / 58.5% | $249.8 / 59.9% |
| Operating income | $3.7 | $6.7 | $13.7 | $16.8 |
| Net income (loss) | $(3.7) | $49.2 | $(8.5) | $127.2 |
| Diluted EPS | $(0.02) | $0.21 | $(0.04) | $0.54 |
| Operating cash flow | Not separately presented for quarter | Not separately presented for quarter | $34.9 | $36.7 |
- Q2 revenue declined 2.3%; six-month revenue declined 4.9%. Product revenue fell while service revenue increased.
- Q2 operating margin was 1.8%, versus 3.2% a year earlier. R&D spending declined, largely due to restructuring savings; restructuring charges were $2.5 in Q2 and $4.0 for the half-year.
- Prior-year net income included gains on Lumentum stock sales of $53.9 in Q2 and $135.4 for the six months. VIAVI had sold all its Lumentum shares by July 1, 2017, so there was no comparable gain in FY2018.
- Interest expense rose to $11.7 in Q2 and $24.2 for the half-year, mainly reflecting the 2024 convertible notes, partly offset by repurchases of 2033 notes. The six-month results also include a $3.8 loss on extinguishment of debt.
Liquidity, debt and cash flow
- At December 30, 2017, cash and cash equivalents were $753.1, short-term investments $452.3, and restricted cash $7.4. Combined cash, investments and restricted cash were $1,212.8, down $235.0 from July 1, 2017.
- Current assets were $1,479.7 and current liabilities $680.0. Current liabilities included $436.8 of debt classified as current because the 2033 notes had an expected remaining term of 0.6 years.
- Debt principal outstanding was $911.0: $451.0 of 2033 notes and $460.0 of 2024 notes. The balance-sheet carrying amount, net of discounts and issuance costs, was $799.0. The company reported compliance with debt covenants.
- For the six months, operating cash flow was $34.9; investing cash outflow was $85.0, including $56.2 for the Trilithic acquisition; and financing cash outflow was $213.3, including $175.0 for debt repurchases and $31.0 for share repurchases. Cash and cash equivalents decreased by $251.3.
- Management said existing cash and investments should meet liquidity and capital-spending needs for the next 12 months, while identifying working capital, markets, acquisitions, pension funding and financing terms as factors that could affect liquidity.
Material changes and management commentary
- Service Enablement revenue fell 20.9% in Q2 and 20.6% for the half-year, reflecting runoff of mature Assurance products and a planned narrowing of product lines. Network Enablement Q2 revenue grew 3.8%, supported by Trilithic and demand for cable field instruments, but the company cited weakness in Lab Instruments linked to a China slowdown.
- Optical Security and Performance Products revenue declined modestly. Management cited weaker anti-counterfeiting demand, partly offset by growth in 3D sensing and government products. The Santa Rosa operation was temporarily disrupted by October 2017 wildfires and resumed shortly thereafter.
- Trilithic was acquired in August 2017 for total consideration of $56.4, including a working-capital adjustment. It was integrated into Network Enablement.
- Management estimated approximately $49 million in annualized gross cost savings from restructuring activities initiated in the prior year, excluding one-time charges. It also said it expects mature Assurance revenue to continue declining in FY2018, OSP revenue to rebound in the second half, and 3D sensing to become more meaningful over the longer term. No numerical revenue or earnings guidance was provided.
- After quarter-end, VIAVI disclosed a $455 million cash agreement to acquire Cobham’s Test and Measurement business, subject to customary closing conditions and adjustments. It also repurchased $22.5 million principal of 2033 notes and approximately 1.1 million shares of common stock.
Risks, contingencies and unusual items
- The newly enacted U.S. Tax Cuts and Jobs Act contributed a $6.5 tax benefit. The company’s deemed-repatriation estimate was provisional; it had not completed its foreign earnings calculation. It had not yet determined a reasonable estimate of the deferred-tax remeasurement from the federal rate reduction.
- The company reported a $107.9 pension-plan funding deficit. A U.K. pension-related legal matter remained under appeal, with an accrual of GBP 5.7 million (about $7.7 million at quarter-end). Other ordinary-course claims could also have an adverse effect if resolved unfavorably.
- Management cited demand uncertainty, pricing pressure, customer concentration, competition, product mix, customer buying patterns, industry consolidation and foreign-exchange movements as risks to revenue and margins. It also disclosed wildfire and earthquake exposure at Northern California facilities.
- Revenue-recognition guidance scheduled for adoption in Q1 FY2019 may change timing for certain software arrangements bundled with support or services. The company planned full retrospective adoption and was still assessing the impact.
Important facts for investors to verify
- Whether the Cobham acquisition closes on the announced terms and how its $455 million cash consideration will be financed.
- The timing and refinancing or settlement plan for the $451 million principal of 2033 notes classified as current, and the status of subsequent debt repurchases.
- Whether management’s expected OSP rebound, 3D-sensing opportunity and estimated restructuring savings materialize, against continuing SE product runoff.
- The final accounting and tax effects of the Tax Cuts and Jobs Act, including the provisional foreign-earnings estimate.
- Developments in the U.K. pension litigation and the company’s pension funding obligations.