Business context and reporting period
Viavi Solutions Inc. filed this unaudited Form 10-Q for its fiscal third quarter ended April 1, 2017. The quarter covers three months; year-to-date figures cover nine months. Viavi provides network testing, monitoring and assurance solutions and optical security and performance products. Comparisons are with the quarter and nine months ended April 2, 2016; fiscal 2017 year-to-date includes one fewer week. Lumentum results are presented as discontinued operations following its 2015 separation.
Financial performance and position
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Revenue | $196.0 million | $220.4 million | $613.3 million | $682.2 million |
| Gross profit / margin | $117.0 million / 59.7% | $131.3 million / 59.6% | $366.8 million / 59.8% | $413.6 million / 60.6% |
| Operating income (loss) | $(15.2) million | $7.2 million | $1.6 million | $13.5 million |
| Net income (loss) | $26.0 million | $33.8 million | $153.2 million | $(31.3) million |
| Diluted EPS | $0.11 | $0.14 | $0.65 | $(0.13) |
Q3 revenue fell 11.1% year over year. Network Enablement (NE) revenue declined 16.0%, Service Enablement (SE) declined 18.5%, and Optical Security and Performance Products (OSP) increased 2.9%. Q3 operating loss included $18.4 million of restructuring and related charges. Net income was supported by a $51.2 million gain on Lumentum stock sales; the nine-month gain was $186.6 million. Thus, reported net income substantially reflects investment-sale gains rather than operating performance.
Operating cash flow for the first nine months was $46.2 million, compared with $35.0 million a year earlier. Investing cash flow was $74.9 million and financing cash flow was $369.0 million, including $451.1 million net proceeds from convertible notes and $91.6 million of share repurchases. Cash and cash equivalents were $964.2 million at April 1, 2017. Cash, short-term investments and restricted cash totaled $1,454.6 million, up $474.8 million from July 2, 2016. Current assets were $1,697.5 million and current liabilities $247.0 million.
Long-term debt carried on the balance sheet was $958.1 million; principal outstanding was $1.11 billion, comprising $650 million of 0.625% convertible notes due 2033 and $460 million of 1.00% convertible notes due 2024. The company reported compliance with debt covenants and no short-term debt. Management said existing cash and investments should meet liquidity and capital spending needs for the next 12 months.
Material changes versus the prior comparable period
- Revenue declined across NE and SE, while Q3 OSP revenue increased; year-to-date revenue declined in all three segments.
- Q3 gross margin was nearly unchanged, but nine-month gross margin fell 0.8 percentage points. Lower NE/SE revenue and mix affected margins.
- Operating expenses declined year to date, including R&D down 15.8% and SG&A down 12.6%, but restructuring charges rose to $20.2 million from $1.7 million.
- Year-to-date net income improved from a loss to profit, chiefly because Lumentum share-sale gains rose to $186.6 million from $39.8 million.
- Cash and cash equivalents increased substantially, primarily alongside issuance of the 2024 convertible notes. Common shares outstanding declined, reflecting repurchases.
Outlook, commentary, risks and unusual items
No specific revenue or earnings guidance is provided in the filing. Management estimated approximately $51 million in annualized gross cost savings from restructuring activities initiated in the prior year, excluding one-time charges. The fiscal 2017 plan narrows SE operations and reduces costs; approximately 300 employees were affected, with related payments expected by the second quarter of fiscal 2018. Management also cautioned that the workforce reduction may reduce near-term NSE R&D investment and that mature SE Assurance revenue is expected to continue declining.
Management cited weaker North American communications-service-provider demand, delayed enterprise spending and deal push-outs, declining mature-product support renewals, and cyclical banknote demand. Other identified risks include competition and pricing pressure, customer and product-mix concentration, industry consolidation, foreign-exchange movements, investment-market liquidity, and uncertainty in forecasting demand and margins. The company has significant pension obligations: plans were underfunded by $101.3 million, plus a $1.2 million non-pension post-retirement liability.
A UK pension deed dispute remained under appeal; Viavi had accrued GBP 5.7 million after a court ruling found an amendment increasing plan benefits valid until a later amendment. The company is also pursuing a claim against the law firm involved. Ordinary-course claims could have an adverse effect if outcomes are unfavorable. Disclosure controls were deemed ineffective at quarter-end due to a previously identified material weakness in controls over the interim income tax provision; remediation was underway, with full remediation anticipated by fiscal Q4 2017. Subsequent to quarter-end, Viavi sold 0.2 million Lumentum shares for $10.1 million gross proceeds and an $8.4 million realized gain.
Important facts for investors to verify
- How much earnings and cash generation are sustainable excluding Lumentum investment-sale gains, restructuring costs and other non-core items.
- Whether NE and SE demand stabilizes, mature SE declines moderate, and management’s estimated cost savings are achieved without impairing product development.
- The terms, conversion exposure, dilution potential and future cash obligations of both convertible note issues.
- Progress and completion of remediation of the income-tax control weakness, and any further tax or valuation-allowance effects.
- Developments in the UK pension litigation, pension funding requirements, and the company’s ability to maintain liquidity amid operating and market risks.