Lumentum Holdings Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2020, the 13 weeks ended September 28, 2019. Comparative period: three months ended September 29, 2018. Financial statements are unaudited. Lumentum supplies optical communications and photonics products and commercial lasers. Results include Oclaro from its December 2018 acquisition, so year-over-year comparisons are not fully like-for-like.
Key financial results
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Revenue | $449.9 million | $354.1 million | +27.1% |
| Gross profit / margin | $167.7 million / 37.3% | $126.0 million / 35.6% | Margin +1.7 points |
| Operating income / margin | $59.8 million / 13.3% | $57.1 million / 16.1% | Income +4.7% |
| Net income | $47.6 million | $47.4 million | +0.4% |
| Diluted EPS | $0.61 | $0.72 | -15.3% |
| Cash from operations | $87.5 million | $57.2 million | +$30.3 million |
- Revenue growth reflected the Oclaro acquisition, increased Consumer and Industrial sales, and organic Telecom and Datacom growth. OpComms revenue rose 34.2% to $416.1 million; Lasers revenue fell 23.2% to $33.8 million, primarily on lower kilowatt-class fiber and solid-state laser sales.
- Gross margin improved, principally from higher sales of higher-margin 3D sensing products. Operating expenses rose substantially: R&D increased 44.2% to $49.9 million and SG&A increased 71.8% to $56.7 million, including acquisition-related costs and acquired-intangible amortization.
- EPS declined despite slightly higher net income, with weighted-average diluted shares increasing to 77.6 million from 63.9 million. Interest expense rose to $11.4 million from $5.1 million, mainly due to the Oclaro-related term loan.
- Cash and cash equivalents were $539.0 million at quarter-end, up from $432.6 million at June 29, 2019. Short-term investments were $291.9 million, bringing cash, cash equivalents and short-term investments to $830.9 million.
- Operating cash flow was $87.5 million; capital expenditures were $21.7 million. Investing activities provided $21.7 million, principally from net sales of short-term investments. Financing activities used $2.8 million.
- Current assets were $1.423 billion and current liabilities $316.8 million. Debt principal comprised a $497.5 million term loan and $450.0 million convertible notes due 2024. The term loan’s net carrying value was $489.3 million; the notes’ net carrying value was $356.5 million. The company reported compliance with loan covenants.
Material changes and unusual items
- Three customers accounted for 58% of revenue, versus 59% in the prior-year quarter; three customers represented 49% of gross receivables at quarter-end. Asia-Pacific contributed 77.9% of revenue. Hong Kong revenue increased with 3D sensing shipments for a large mobile-device customer.
- Unallocated gross-profit items included $12.5 million of acquired-intangible amortization, $3.4 million of integration costs, $2.2 million of inventory fair-value amortization, and $6.7 million of excess and obsolete charges attributed to lower Huawei demand. Product-line transfer costs to Thailand were also included in other charges.
- Lumentum adopted the new lease accounting standard on June 30, 2019. At adoption, it recorded $91.5 million of operating lease assets and $81.5 million of operating lease liabilities; adoption affected balance-sheet presentation.
- On October 30, 2019, after quarter-end, Lumentum voluntarily prepaid $150.0 million of term-loan principal. It expected to record an approximately $2.5 million debt-extinguishment loss in Q2 FY2020.
Outlook, management commentary and risks
- Management said it expects R&D spending to increase in absolute dollars in future quarters. It expects the transition from overlapping Oclaro product lines and exits from certain Telecom products to be completed in fiscal 2021; it did not expect significant revenue declines from the exiting Telecom lines until then.
- The company planned to wind down Lithium Niobate modulator operations during fiscal 2020, with customer transition to other products; it expects Indium Phosphide photonic integrated circuits to replace these modulators over time. Datacom transceiver-module sales were expected to ramp down to zero during fiscal 2020 following the business sale.
- Management stated that cash and operating cash flows should meet liquidity and capital-spending needs for at least the next 12 months. No numeric revenue or earnings guidance is provided in the supplied filing text.
- Key risks include customer concentration and order volatility; export restrictions and trade tensions, particularly involving Huawei; competitive pricing and product commoditization; manufacturing transitions and reliance on limited suppliers; integration and execution risks following Oclaro; and fluctuations in product mix and gross margin.
- One Oclaro merger-related putative class action, the Karri lawsuit, remained pending; Lumentum was named in an amended complaint and defendants’ motion to dismiss was pending. Management said no material claims or proceedings were probable or reasonably possible at quarter-end.
Most important facts for investors to verify
- How much of revenue growth and margin improvement is sustainable organic growth versus Oclaro acquisition contribution and 3D sensing mix?
- Whether the decline in Lasers revenue and Huawei-related excess and obsolete charges persist or affect future margins and inventory.
- Progress on Telecom, Lithium Niobate and Datacom product exits, customer transitions, and Thailand manufacturing transfers.
- Customer concentration, including the large customer associated with Hong Kong 3D sensing shipments, and the effects of export-control or trade-policy changes.
- Debt repayment and interest costs following the $150 million post-quarter term-loan prepayment, and the expected $2.5 million extinguishment loss.
- Developments in the pending Karri litigation, tax audits and the $18.8 million of unrecognized tax benefits.