Lumentum Holdings Inc. — Q2 FY2020 Form 10-Q
Reporting period: Quarter and six months ended December 28, 2019. Amounts are in U.S. dollars; financial statements are unaudited. Comparisons are with the periods ended December 29, 2018. The prior-year quarter included Oclaro only from its December 10, 2018 acquisition date, so year-over-year comparisons are affected by the acquisition.
Financial performance
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $457.8 million | $373.7 million | $907.7 million | $727.8 million |
| Gross profit / margin | $189.1 million / 41.3% | $124.8 million / 33.4% | $356.8 million / 39.3% | $250.8 million / 34.5% |
| Operating income | $74.8 million | $11.5 million | $134.6 million | $68.6 million |
| Net income | $49.1 million | $16.3 million | $96.7 million | $63.7 million |
| Diluted EPS | $0.63 | $0.08 | $1.24 | $0.82 |
Q2 revenue rose 22.5%; six-month revenue rose 24.7%. Q2 operating margin was 16.3%, versus 3.1% a year earlier. Revenue growth was mainly attributed to Oclaro-related Telecom sales and higher Consumer and Industrial sales, including 3D sensing. Lasers revenue was nearly flat in Q2 and fell 10.9% for the six-month period, primarily due to lower kilowatt-class fiber laser sales.
For the six months, research and development expense increased 30.4% to $100.9 million, while selling, general and administrative expense increased 24.5% to $119.1 million. Restructuring charges declined to $2.2 million from $9.1 million.
Cash flow, balance sheet and debt
- Operating cash flow: $249.8 million for the six months, compared with $159.6 million. Net income was $96.7 million; working-capital movements included a $54.0 million increase in receivables and a $44.3 million decrease in inventories.
- Investing cash flow: $57.8 million provided, including net proceeds of $105.7 million from short-term investment sales and purchases, partly offset by $47.4 million of capital expenditures.
- Financing cash flow: $344.8 million provided, mainly reflecting $1,042.9 million of net proceeds from the 2026 notes, offset by repayment of $497.5 million of term-loan principal and $200.0 million of share repurchases.
- Liquidity: Cash and cash equivalents were $1,085.0 million, up from $432.6 million at June 29, 2019; short-term investments were $230.6 million. Current assets were $1,883.0 million and current liabilities $304.2 million.
- Debt: The company issued $1.05 billion of 0.50% convertible notes due 2026 and repaid its term loan in full. It also had $450 million principal amount of 0.25% convertible notes due 2024. Total convertible-note principal was $1.5 billion; reported carrying value was approximately $1.092 billion. The notes are unsecured and have conversion and fundamental-change repurchase provisions.
Management stated that cash and expected operating cash flows should be sufficient for liquidity and capital-spending needs for at least the next 12 months. The filing reports no material off-balance-sheet arrangements.
Material changes, outlook and risks
- Gross-margin improvement reflected better Telecom margins, the exit from the Datacom transceiver-module business, and improved 3D sensing margins. The six-month comparison also reflects the Oclaro acquisition. Acquired-intangible amortization rose substantially and reduced reported gross profit.
- The $1.05 billion 2026-note issuance funded repayment of the term loan and, in part, the concurrent $200 million repurchase of 2.9 million shares at an average $69.68 per share. Repayment of the term loan resulted in an $8.0 million early-extinguishment charge; interest expense increased to $29.7 million for the six months from $13.6 million.
- Management expects R&D spending to increase in absolute dollars in future quarters. It expected Telecom product-line transitions, including Lithium Niobate modulators, to finish in FY2021; Datacom transceiver-module sales were expected to wind down to zero during FY2020. The company is investing in Datacom chips and expects those sales to grow over time. No specific revenue or earnings guidance is provided.
- Key exposures include customer concentration (two customers represented 41% of Q2 revenue and 44% for the six months), geographic concentration (Asia-Pacific accounted for 76.6% of Q2 revenue), and dependence on a limited number of suppliers and contract manufacturers. Huawei-related demand declines contributed to excess and obsolete inventory charges of $6.0 million in Q2 and $12.7 million for the six months; export restrictions could further constrain sales and increase inventory risk.
- The filing identifies trade restrictions and tariffs, intense competition and pricing pressure, manufacturing and supply-chain disruption, integration and product-transition execution, foreign-exchange movements, and customer demand variability as risks. It also notes the emerging coronavirus outbreak as a potential source of disruption to Asian operations, suppliers, customers and distribution.
- One Oclaro merger-related class-action lawsuit naming Lumentum remained pending; a motion to dismiss was fully briefed. Management said it intended to defend the case vigorously and reported no material claims or proceedings assessed as probable or reasonably possible at quarter-end.
Important facts for investors to verify
- How much of reported revenue and margin growth reflects Oclaro consolidation versus organic demand, and whether improved OpComms margins are sustainable.
- Revenue outlook and customer demand for 3D sensing, Telecom, Datacom chips and commercial lasers, including the effect of Huawei restrictions and customer concentration.
- Progress and costs associated with Oclaro integration, facility transfers, and planned exits from Lithium Niobate and Datacom transceiver modules.
- Cash conversion and working-capital trends, alongside the $1.5 billion principal amount of convertible notes, their conversion terms, and potential dilution or cash settlement requirements.
- Developments in the pending merger litigation, tax audits and unrecognized tax benefits, and supply-chain, trade-policy and coronavirus-related disruption risks.