Lumentum Holdings Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, the three months ended September 29, 2018. Comparisons are with the three months ended September 30, 2017, unless otherwise noted. Amounts are in millions of U.S. dollars except per-share data.
Business context
Lumentum supplies optical communications and photonic products, and commercial lasers. Its Optical Communications segment serves telecom, datacom, and consumer and industrial markets, including 3D sensing. The company reported strong growth in 3D sensing, telecom, and lasers, while datacom sales declined. The proposed acquisition of Oclaro had not closed by the reporting date.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 | Change or context |
|---|---|---|---|
| Revenue | $354.1 | $243.2 | Up 45.6% |
| Gross profit / margin | $126.0 / 35.6% | $68.5 / 28.2% | Margin increased 7.4 percentage points |
| Operating expenses | $68.9 | $65.8 | Up $3.1 |
| Operating income / margin | $57.1 / 16.1% | $2.7 / 1.2% | Material improvement |
| Net income | $47.4 | $7.1 | |
| Basic / diluted EPS | $0.73 / $0.72 | $0.11 / $0.04 | Prior-year diluted EPS used a different conversion method |
| Cash from operations | $57.2 | $9.7 | |
| Cash and cash equivalents | $459.4 | $397.3 at June 30, 2018 | Quarter-end balance |
| Short-term investments | $274.9 | $314.2 at June 30, 2018 | Cash plus short-term investments: $734.3 |
| Convertible notes | $450.0 face value | $338.5 carrying value at quarter-end; 0.25% notes due 2024 |
- Revenue mix: OpComms revenue was $310.1, up 49.2%; Lasers revenue was $44.0, up 24.6%. Consumer and industrial revenue rose to $133.0 from $52.3, primarily from 3D sensing. Datacom revenue fell to $34.2 from $45.2.
- Margins: OpComms gross margin increased to 40.3% from 34.7%; Lasers gross margin increased to 40.2% from 30.0%. Management attributed the consolidated margin improvement mainly to higher 3D sensing and laser sales and lower datacom sales. Thailand facility setup and product-transfer costs of $12.7 reduced reported gross profit.
- Operating expenses and other items: R&D was $34.6, down 4.7%; SG&A was $33.0, up 24.1%, including Oclaro transaction costs and higher compensation. Restructuring charges were $1.3, versus $2.9. The quarter included a $2.1 unrealized loss on the preferred-stock derivative, versus a $4.2 gain in the prior-year quarter. Income tax expense was $5.2, compared with a $3.6 tax benefit.
- Cash flow and working capital: Investing activities provided $9.5, including net proceeds of $39.8 from short-term investment sales and maturities, offset partly by $29.6 of capital expenditures. Financing activities used $4.6. Operating cash flow included a $41.9 increase in accounts receivable, partly offset by a $15.3 decrease in inventory.
- Balance sheet: Current assets were $1,181.1 and current liabilities $213.9. Total liabilities were $625.7. The company also reported $35.8 of redeemable convertible preferred stock; this is distinct from the convertible notes.
Material changes and management outlook
- Management said it expects cash and operating cash flows to meet liquidity and capital-spending needs for at least the next 12 months. It also expects R&D investment to increase in absolute dollars in future quarters. The filing provides no numerical revenue or earnings guidance.
- The Oclaro merger remained subject to Chinese antitrust approval. As of October 26, 2018, expected consideration was approximately $1.6 billion, anticipated to be funded with about $600 million in Lumentum stock, $500 million in new debt, and the remainder from combined-company cash. A senior secured term loan commitment was up to $550 million; no funds had been borrowed as of September 29. The company recorded $0.4 in ticking fees and capitalized $0.9 in debt-issuance costs. Specified regulatory failure circumstances could trigger an $80 million termination fee.
- On October 15, 2018, the company gave notice of intent to redeem all Series A preferred shares. Management expected the holder to convert by November 14, 2018. The filing describes the preferred stock’s $35.8 redemption value and accrued dividends; the anticipated conversion or redemption was subsequent to quarter-end.
- Revenue was concentrated: three customers represented 30.5%, 15.0%, and 13.0% of quarterly revenue. Two contract manufacturers accounted for 51.5% and 25.1% of net inventory purchases. Management highlighted risks from customer concentration, demand variability, competition and pricing, manufacturing transfers and supplier dependence, tariffs and trade policy, and merger execution and financing.
- One Oclaro stockholder lawsuit, the Karri putative class action, remained pending and sought, among other relief, to block the merger. The other identified merger-related suits had been dismissed. Management stated that ordinary-course claims were not expected to have a material adverse effect, while noting litigation outcomes are uncertain.
Most important facts for investors to verify
- Whether the Oclaro merger received Chinese antitrust approval, closed on the expected timetable, and was financed on the anticipated terms.
- Whether the 3D sensing growth and customer demand proved sustainable, given the high customer concentration and potential order volatility.
- Whether reported margin improvement persisted after Thailand transfer and setup costs, and whether those costs or manufacturing yields changed.
- How operating cash flow developed after the quarter, especially accounts receivable collection, capital spending, and liquidity needs for the merger.
- Whether Series A preferred shares converted or were redeemed, and the resulting cash use, dilution, and derivative-related earnings volatility.
- Whether trade restrictions, supplier concentration, pending litigation, or tax developments materially affected results or the merger.