Lumentum Holdings Inc. — Q1 FY2021 Form 10-Q
Business and period: Lumentum supplies optical and photonic products through Optical Communications (OpComms) and Commercial Lasers (Lasers), serving communications, consumer and industrial, manufacturing, inspection, and life-science markets. The quarter was the 13 weeks ended September 26, 2020; comparisons are with the 13 weeks ended September 28, 2019. Amounts below are U.S. dollars.
Financial highlights
| Metric | Q1 FY2021 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $452.4 million | $449.9 million | Up 0.6% |
| Gross profit / margin | $205.7 million / 45.5% | $167.7 million / 37.3% | Margin up 8.2 percentage points |
| Operating income / margin | $99.0 million / 21.9% | $59.8 million / 13.3% | Higher |
| Net income | $67.1 million | $47.6 million | Up |
| Diluted EPS | $0.86 | $0.61 | Up |
| Operating cash flow | $104.7 million | $87.5 million | Up |
OpComms revenue rose 3.0% to $428.5 million, while Lasers revenue fell 29.3% to $23.9 million, mainly on lower kilowatt-class fiber laser sales. Management attributed stronger gross margin largely to a more favorable Datacom mix, including higher-margin chip sales and the exit of the lower-margin Datacom transceiver module business. Reported gross profit also reflects acquired-intangible amortization and other unallocated items.
Research and development was $50.4 million (up 1.0%); selling, general and administrative expense was $56.3 million (down 0.7%). There were no restructuring charges in the quarter, compared with $1.3 million in the prior-year period. Interest expense increased to $16.0 million from $11.4 million, principally reflecting amortization of debt discount and issuance costs on the 2026 convertible notes. The tax provision was $16.5 million versus $5.8 million; the filing cites higher projected foreign taxes and higher year-to-date pretax income.
Balance sheet, debt and cash flow
- Cash and cash equivalents were $269.5 million, down from $298.0 million at June 27, 2020. Short-term investments were $1,341.2 million, bringing cash, cash equivalents and short-term investments to $1,610.7 million.
- Current assets were $2,166.7 million and current liabilities $293.4 million. Accounts receivable increased to $263.6 million from $233.5 million; inventory increased to $212.6 million from $188.9 million.
- Convertible notes had a $1,134.7 million carrying value at quarter-end, against $1.5 billion aggregate principal: $450 million due 2024 and $1.05 billion due 2026. They are unsecured and have no financial covenants. The notes’ estimated fair value was $1,738.9 million. The term loan facility had been repaid in fiscal 2020.
- Operating cash flow of $104.7 million was offset by $114.0 million used in investing activities and $19.2 million used in financing activities, resulting in a $28.5 million decrease in cash and cash equivalents. Investing cash outflows included $88.2 million net purchases of short-term investments and $26.3 million of capital expenditures; financing outflows principally included $19.1 million of restricted-stock tax payments.
- Management stated that cash and expected operating cash flows should cover liquidity and capital spending needs for at least the next 12 months. Purchase obligations totaled $257.9 million, generally expected to be fulfilled within one year.
Outlook, commentary and key risks
- No numerical revenue or earnings guidance is provided in the filing. Management said it expects to continue investing strongly in R&D and new products, and expects R&D spending to increase in absolute dollars in future quarters.
- COVID-19 had not materially adversely affected reported first-quarter results, according to management, but restrictions, workforce limits, supply-chain and logistics disruption, and uncertain customer demand could affect future operations and results. The company said the duration and scale of the impact were not predictable.
- Trade and export restrictions are a material uncertainty. Lumentum said the August 2020 U.S. rules further restricted sales to Huawei, anticipated applying for an export license, and believed Huawei sales beyond Q2 FY2021 would continue to decline. The company recorded excess and obsolete inventory charges related to U.S. trade restrictions and lower Huawei demand.
- Customer concentration is significant: one customer accounted for 35% of quarterly revenue. Three customers collectively represented 38% of gross receivables. Management also highlighted dependence on limited suppliers and contract manufacturers, competitive and pricing pressures, product-mix variability, and foreign-exchange exposure.
- The 2024 notes could become convertible at holders’ option if the specified stock-price test is met in Q2 FY2021; approximately $375 million of carrying value could then be reclassified to current liabilities. Conversion or fundamental-change provisions may require cash settlement or result in dilution, depending on the circumstances and settlement choice.
- A remaining Oclaro merger-related putative class action names Lumentum as a defendant. The court granted in part and denied in part a motion to dismiss on October 8, 2020; the matter remained pending. The filing says management believes ordinary-course claims are not expected to have a material adverse effect, but outcomes are uncertain.
- After quarter-end, on October 29, 2020, Lumentum closed an acquisition of intellectual property and other photonics technology assets for $10.0 million.
Most important facts for investors to verify
- Whether the improved gross margin is sustainable and how Datacom chip demand and the lower-margin product exit affect future mix.
- Whether the 35% customer concentration, Huawei restrictions, and related inventory exposure change materially.
- Whether COVID-19, supplier capacity, manufacturing transfers, and logistics affect production, deliveries, or customer demand.
- The 2024 notes’ conversion status and potential current-liability reclassification, alongside future cash, debt-service, and dilution exposure.
- Developments in the pending merger litigation, tax audits and unrecognized tax benefits, and the integration or returns associated with the post-quarter $10 million technology-asset acquisition.