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JDS UNIPHASE CORP /CA/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements Statements contained in this Quarterly Report on Form 10-Q which are not historical facts are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. A forward-looking statement may contain words such as "anticipates," "believes," "can," "can impact," "could," "continue," "estimates," "expects," "intends," "may," "ongoing," "plans," "potential," "projects," "should," "will," "will continue to be," "would," or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements such as: † our expectations regarding demand for our products, including continued trends in end-user behavior and technological advancements that may drive such demand; † our belief that the Company is well positioned to benefit from certain industry trends and advancements, and our expectations of the role we will play in those advancements; † our plans for growth and innovation opportunities; † our plans to continue to operate as a Company comprised of a portfolio of businesses with a focus on optical and broadband innovation; † financial projections and expectations, including profitability of certain business units, plans to reduce costs and improve efficiencies, the effects of seasonality on certain business units, continued reliance on key customers for a significant portion of our revenue, future sources of revenue, competition and pricing pressures, the future impact of certain accounting pronouncements and our estimation of the potential impact and materiality of litigation; † our plans for continued development, use and protection of our intellectual property; † our strategies for achieving our current business objectives, including related risks and uncertainties; † our plans or expectations relating to investments, acquisitions, partnerships and other strategic opportunities; † our strategies for reducing our dependence on sole suppliers or otherwise mitigating the risk of supply chain interruptions; † our research and development plans; and † our expectations related to our products, including costs associated with the development of new products, product yields, quality and other issues. Management cautions that forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from those projected in such forward-looking statements. These forward-looking statements are only predictions and are subject to risks and uncertainties including those set forth in Part II, Item 1A "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q and in other documents we file with the Securities and Exchange Commission. Moreover, neither we assume nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. Forward-looking statements are made only as of the date of this Report and subsequent facts or circumstances may contradict, obviate, undermine or otherwise fail to support or substantiate such statements. We are under no duty to update any of the forward-looking statements after the date of this Form 10-Q to conform such statements to actual results or to changes in our expectations. In addition, Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended June 30, 2012. OUR INDUSTRIES AND QUARTERLY DEVELOPMENTS JDSU provides communications test and measurement solutions and optical products for telecommunications service providers, cable operators, and network equipment manufacturers. JDSU's diverse technology portfolio also fights counterfeiting and enables commercial lasers for a range of applications. To serve its markets, JDSU operates in the following business segments: CommTest, CCOP, and OSP. Communications Test and Measurement CommTest is a leading provider of instruments, software and services for the development and deployment of high-speed mobile and fixed communication networks. JDSU CommTest solutions lower operating expenses, reduce customer turnover, increase productivity across each critical phase of the network life cycle including research and development, production, deployment, and customer experience management ("CEM"), and speed time-to-revenue by accelerating the deployment of new services. JDSU enables the effective management of 29 -------------------------------------------------------------------------------- Table of Contents services, such as Voice over Internet Protocol (VoIP), 4G/LTE and Internet Protocol TV (IPTV), by providing visibility into the end-user experience and also by providing repair, calibration, instrument management, and other services to aid its customers in the rapid deployment and repair of networks and services. JDSU test solutions address lab and production (capacity expansion, 40G/100G), field deployment (network build and triple-play services), and service assurance (quality of experience) for Ethernet and IP services over cable, wireless, and fixed/telecom networks. JDSU also provides protocol test solutions for the development and field deployment of storage and storage-network technologies. JDSU CommTest is evolving into a world class network enablement leader, focusing investments on software and solutions offerings in high growth markets, while leveraging its instruments portfolio. These strategic investments will be placed globally to meet end customer demand. JDSU CommTest customers include the world's largest communications service providers, communications equipment manufacturers, government organizations, and large corporate customers. These include major telecom and cable operators such as AT&T, Bell Canada, Bharti Airtel Limited, British Telecom, China Mobile, China Telecom, Chunghwa Telecom, Comcast, CSL, Deutsche Telecom, France Telecom, Saudi Telecom Company, TalkTalk, Telefónica, Telmex, TimeWarner Cable, and Verizon. JDSU test and measurement customers also include many of the network-equipment manufacturers served by our CCOP segment, including Alcatel-Lucent, Ciena, Cisco Systems, Fujitsu, and Huawei. JDSU test and measurement customers also include chip and infrastructure vendors, storage-device manufacturers, storage-network and switch vendors, and deployed private enterprise customers. Storage-segment customers include Brocade, Cisco Systems, and EMC. Communications and Commercial Optical Products CCOP is a leading provider of products and technologies used in the optical communications and commercial laser markets. CCOP optical communications products include a wide range of components, modules, subsystems, and solutions for two market segments: telecommunications, including access (local), metro (intracity), long-haul (city-to-city and worldwide), and submarine (undersea) networks; and enterprise data communications, including storage access networks (SANs), local area networks (LANs), and Ethernet wide-area networks (WANs). The products enable the transmission and transport of video, audio, and text data over high-capacity, fiber-optic cables. Transmission products primarily consist of optical transceivers, optical transponders, and supporting components such as modulators and source lasers including vertical-cavity surface-emitting lasers (VCSELs). Transport products primarily consist of amplifiers, ROADMs, and Super Transport Blades, and supporting components such as 980 nanometer (nm) pumps, passive devices, and array waveguides (AWGs). Diode lasers from JDSU's CCOP segment combine with optical filters from the Company's OSP business segment to create a gesture recognition solution. Gesture recognition systems enable people to control technology with natural body gestures instead of using a remote, mouse or other device. Emerging gesture recognition systems simplify the way people interact with technology, and are first being used in applications for home entertainment and computing. CCOP commercial laser products serve a wide variety of original equipment manufacturer ("OEM") applications from low- to high-power output and with ultraviolet (UV), visible, and IR wavelengths. The broad portfolio addresses the needs of laser clients in applications such as micromachining, materials processing, bioinstrumentation, consumer electronics, graphics, and medical/dental. Core laser technologies include continuous-wave, q-switched, and mode-locked lasers addressing application needs from continuous-wave to megahertz repetition rates. Our commercial optical products include diode, direct-diode, diode-pumped solid-state (DPSS), and gas lasers. During the three months ended September 29, 2012, the CCOP business segment terminated the concentrated photovoltaic ("CPV") product line due to limited market opportunities. Customers for Optical Communications products include Adva, Alcatel-Lucent, Ciena, Cisco Systems, Ericsson, Fujitsu, Huawei, Infinera, Nokia Siemens Networks, and Tellabs. Customers for JDSU commercial lasers include Amada, ASML, Beckman Coulter, Becton Dickinson, Disco, Electro Scientific Industries, and KLA-Tencor. Optical Security and Performance Products OSP provides innovative optical security and performance products targeted to customers in the anti-counterfeiting, consumer electronics, government, healthcare and other markets. 30 -------------------------------------------------------------------------------- Table of Contents OSP's flagship security offering, Optically Variable Pigment ("OVP®"), enables a color-shifting effect used by issuers of banknotes and security printers worldwide for anti-counterfeiting applications on currency and other high value documents and products. OVP® is used to protect the currencies of more than 100 countries today. In addition to OVP®, OSP has a developed a range of other offerings targeted toward the currency market including Optically Variable Magnetic Pigment ("OVMP®"), and banknote thread substrates. Complementing its offerings to the currency market, OSP also develops and delivers overt and covert anti-counterfeiting products targeting the pharmaceuticals and consumer electronics markets. By leveraging its expertise in spectral management and its unique high precision coating capabilities, OSP plays a role in improving the performance attributes of a range of products serving the consumer electronics market. For example, OSP bandpass filters are currently used for gesture-recognition devices designed for the gaming market. Additionally, OSP manufactures components for phase and polarization control that enhance contrast for home theater projection systems. OSP also provides glasses and color filter wheels for 3D cinema applications. OSP provides value-added solutions to meet the stringent requirements of commercial and government customers in the aerospace and defense industries. For customers in the aerospace industry, JDSU precision optical filters are a critical component in satellite and spacecraft power and temperature control systems. OSP also supplies antireflection coatings, beamsplitters, optical filters, laser optics, solar reflectors, and mirrors for a variety of applications including guidance systems, high-energy laser systems, battlefield eye protection, infrared night vision systems and secure optical communications for defense and security systems. Additionally, OSP supplies optical performance products for a variety of additional applications in the automotive, biomedical, entertainment and office automation markets. The OSP segment serves customers such as 3M, Barco, Kingston, Lockheed Martin, Northrup Grumman, Pan Pacific, Seiko Epson, and SICPA. On September 18, 2012, the Company entered into a definitive agreement to sell the Hologram Business and closed the sale on October 12, 2012. The Hologram Business primarily addressed the transaction card market. The Company has presented its current and historical Consolidated Statements of Operations and segment financials to reflect the sale of this business. The historical results of this business are reflected as discontinued operations in accordance with the authoritative guidance under US GAAP and are not included in JDSU's quarterly results from continuing operations for all periods presented. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS See "Note 2. Recently Issued Accounting Pronouncements" regarding the effect of certain recent accounting pronouncements on our consolidated financial statements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES For a description of the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our consolidated financial statements, refer to Item 7 on Management Discussion and Analysis in our Fiscal 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). 31 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The results of operations for the current period are not necessarily indicative of results to be expected for future periods. The following table summarizes selected Consolidated Statement of Operations items (in millions, except for percentages): Three Months Ended September 29, October 1, Percentage 2012 2011 Change Change Segment Net Revenue: CommTest $ 169.5 $ 184.9 $ (15.4 ) (8.3 )% CCOP 194.9 180.3 14.6 8.1 OSP 56.5 50.6 5.9 11.7 Net revenue $ 420.9 $ 415.8 $ 5.1 1.2 % Gross profit $ 172.6 $ 181.6 $ (9.0 ) (5.0 )% Gross margins 41.0 % 43.7 % Research and development 61.6 59.3 2.3 3.9 % Percentage of net revenue 14.6 % 14.3 % Selling, general and administrative 104.7 110.3 (5.6 ) (5.1 )% Percentage of net revenue 24.9 % 26.5 % Amortization of acquired technologies 17.1 14.3 2.8 19.6 % Percentage of net revenue 4.1 % 3.4 % Restructuring and related charges 2.7 1.5 1.2 80.0 % Percentage of net revenue 0.6 % 0.4 % Loss from discontinued operations, net of tax (1.8 ) (2.2 ) 0.4 (18.2 )% Percentage of net revenue 0.4 % 0.5 % Net Revenue Net revenue in the three months ended September 29, 2012 increased $5.1 million, or 1.2%, to $420.9 million from $415.8 million for the same period a year ago. The increase was primarily due to an increased demand for products in CCOP and OSP, partially offset by a decline in CommTest revenue. Net revenue increased $14.6 million, or 8.1%, in CCOP during the three months ended September 29, 2012 compared to same period a year ago. This growth was primarily driven by increased demand and volume in our optical communications product lines, in particular our Circuit Packs, Tunables, Pluggables, Modulators, and High Power Lasers ("HPL") product lines. This increase was partially offset by ASP erosion and a decline in net revenue from certain legacy products. Net revenue increased $5.9 million, or 11.7%, in OSP during the three months ended September 29, 2012 compared to same period a year ago. This growth was primarily driven by higher demand in currency products, partially offset by a decline in defense products. Net revenue decreased $15.4 million, or 8.3%, in CommTest during the three months ended September 29, 2012 compared to same period a year ago. The decrease was primarily due to uncertainty in the macro-economic environment which reduced service providers' spending, particularly in Europe and North America, broadly across our CommTest product portfolio. Additionally, net revenue decreased due to less favorable fluctuations in foreign exchange rates and due to the wind down of legacy product portfolios. This decrease was partially offset by slight growth within the instruments product portfolio and the customer experience management ("CEM") product portfolio in the Asia-Pacific region. 32 -------------------------------------------------------------------------------- Table of Contents Going forward, we expect to continue to encounter a number of industry and market risks and uncertainties that may limit our visibility, and consequently, our ability to predict future revenue, profitability and general financial performance, and that could create quarter over quarter variability in our financial measures. For example, continued economic issues in Europe have led to uncertainty of demand in our CommTest and optical communications product portfolios and we cannot predict when or to what extent this uncertainty will last. Our revenues, profitability, and general financial performance may also be affected by: (a) strong pricing pressures, particularly within our optical communications markets, due to, among other things, a highly concentrated customer base, increasing Asia-based competition, and a general commoditization trend for certain products; (b) high product mix variability, particularly in our CCOP markets, which causes revenue and gross profit variability; (c) continuing service provider seasonality, which causes demand, revenue and profitability volatility at each level of the communications industry; (d) the current trend of communication industry consolidations, which is expected to continue, that directly affects our CCOP and CommTest customer bases and adds additional risk and uncertainty to our financial and business predictability; and (e) activities related to our program of assembly manufacturing transitions in our CommTest segment that present additional supply chain and product delivery disruption risks, yield and quality concerns and risk of increased cost. These risks, while expected to diminish over the next several quarters, limit our ability to predict longer term revenue, profitability and general financial performance. We operate primarily in three geographic regions: Americas, Europe Middle East and Africa ("EMEA") and Asia-Pacific. The following table presents net revenue by geographic regions (in millions): Three Months Ended September 29, October 1, 2012 2011 Net revenue: Americas $ 209.8 49.8 % $ 207.7 50.0 % EMEA 97.0 23.0 100.9 24.2 Asia-Pacific 114.1 27.2 107.2 25.8 Total net revenue $ 420.9 100.0 % $ 415.8 100.0 % Net revenue was assigned to geographic regions based on customer shipment locations. Net revenue for Americas included net revenue from the United States of $163.9 million and $169.5 million, respectively, for the three months ended September 29, 2012 and October 1, 2011. Net revenue from customers outside the Americas represented 50.2% and 50.0%, respectively, of net revenue for the three months ended September 29, 2012 and October 1, 2011. We expect revenue from customers outside of North America to continue to be an important part of our overall net revenue and net revenue growth opportunities. Gross Margin Gross margin in the three months ended September 29, 2012 decreased 2.7 percentage points to 41.0% from 43.7% compared to the same period a year ago. Gross margin declined primarily due to a less favorable product mix as higher margin product lines in CommTest represented a smaller proportion of consolidated net revenue compared to the same period a year ago as net revenue from CommTest declined by $15.4 million. In addition, during the three months ended September 29, 2012 CCOP incurred a $0.8 million charge related to the write-off of inventory and a $2.6 million charge for accelerated amortization of acquired technologies related to the plan to terminate the CPV product line. The decrease was partially offset by a favorable $1.9 million out-of-period adjustment recorded during the three months ended September 29, 2012 and an increase in gross margin in OSP compared to same period a year ago. As discussed in more detail under "Net Revenue" above, we sell products in certain markets that are consolidating, undergoing product, architectural and business model transitions, have high customer concentrations, are highly competitive (increasingly due to Asia-Pacific based competition), are price sensitive and are affected by customer seasonal and mix variant buying patterns. We expect these factors to continue to result in variability of our gross margin. Research and Development ("R&D") R&D expense for the three months ended September 29, 2012 increased $2.3 million, or 3.9%, to $61.6 million from $59.3 million compared to the same period a year ago. As a percentage of revenue, R&D expense increased to 14.6% compared to 14.3% in the same period a year ago. The increase in R&D expense was primarily due to increased investments in new network enablement product platforms for the next generations of communication networks, partially offset by lower variable incentive pay due to a decrease in operating income. 33 -------------------------------------------------------------------------------- Table of Contents We believe that investment in R&D is critical to achieve our strategic objectives and we plan to continue to invest in R&D and new products to further differentiate us in the marketplace. In addition, we have devoted and will continue to devote significant engineering resources to assist with production, quality and delivery challenges which can impact our new product development activities. Selling, General and Administrative ("SG&A") SG&A expense for the three months ended September 29, 2012 decreased $5.6 million, or 5.1%, to $104.7 million from $110.3 million compared to the same period a year ago. As a percentage of revenue, SG&A expense decreased to 24.9% compared to 26.5% in the same period a year ago. The decrease in SG&A expense was primarily due to $7.4 million in charges recorded during the three months ended October 1, 2011 related to a litigation settlement and a reduction in variable incentive pay due to a decrease in operating income. These reductions were partially offset by various increases in SG&A charges, such as costs associated with mergers and acquisition activity and stock-based compensation. We intend to continue to focus on reducing our SG&A expenses as a percentage of revenue. However, we have in the recent past experienced, and may continue to experience in the future, certain non-core expenses, such as mergers and acquisitions related expenses and legal expenses in connection with litigation, which could increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter. We are also increasing SG&A expenses in the near term to upgrade business infrastructure and systems. Restructuring and Related Charges We continue to take advantage of opportunities to further reduce costs through targeted restructuring efforts intended to consolidate and rationalize business functions and related locations based on core competencies and cost efficiencies, to align the business in response to market conditions. We estimate annualized cost savings of approximately $20.6 million excluding any one-time charges as a result of the restructuring activities initiated in the past year. See "Note 11. Restructuring and Related Charges" for more detail. During the three months ended September 29, 2012, we incurred restructuring expenses of $2.7 million. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † During the first quarter of fiscal 2013, management approved a plan to terminate the CPV product line within CCOP based on limited opportunities for market growth. As a result, a restructuring charge of $0.6 million was recorded towards severance and employee benefits for 13 employees in manufacturing, research and development and selling, general and administrative functions. As of September 29, 2012, no employees have been terminated. The employees being affected are located in North America, Europe and Asia. Payments related to remaining severance and benefits accrual are expected to be paid by the end of the second quarter of fiscal 2013. † We also incurred restructuring and related charges from previously announced restructuring plans in the first quarter of fiscal 2013 relating to the following: (i) $0.5 million for transfer costs in CommTest which was the result of the repair outsourcing initiative approved by management during the fourth quarter of fiscal 2012 (ii) $0.5 million for the exit of two leased sites in CommTest for the plan approved during the fourth quarter of fiscal 2012 and (iii) $1.1 million of additional severance and employee benefits arising primarily to adjust the accrual for restructuring plans announced in the fourth quarter of fiscal 2012 in CommTest. During the first quarter of fiscal 2012, we recorded $1.5 million in restructuring and related charges. The charges are a combination of new and continuations of the previously announced restructuring plan and are primarily a result of the following: † We re-organized CCOP by integrating the business functions and responsibilities into a single management structure to drive efficiency and segment profitability in light of then-current economic conditions. As a result, a restructuring charge of $1.1 million was recorded towards severance and employee benefits for 40 employees in research and development and selling, general and administrative functions. The affected employees were located in North America and Asia. Payments related to severance and benefits were paid by October 2011. † We also incurred restructuring and related charges from previously announced restructuring plans, in the first quarter of fiscal 2012, relating to: (i) $0.3 million of severance and employee benefits from continued implementation of the EMEA early retirement program; (ii) $0.9 million for manufacturing transfer costs in CommTest and OSP which were the result of the transfer of certain production processes into existing sites in the U.S. or to contract manufacturers; and (iii) a $0.8 million benefit, net arising primarily to adjust the accrual for restructuring plans announced in the third and fourth quarters of fiscal 2011 in CommTest that did not materialize due to management's decision to re-locate employees and realize co-location efficiencies and accrue for exit of one of the facilities. 34 -------------------------------------------------------------------------------- Table of Contents Our restructuring and other lease exit cost obligations are net of sublease income or lease settlement estimates of approximately $4.0 million. Our ability to generate sublease income, as well as our ability to terminate lease obligations and recognize the anticipated related savings, is highly dependent upon the economic conditions, particularly commercial real estate market conditions in certain geographies, at the time we negotiate the lease termination and sublease arrangements with third parties as well as the performances by such third parties of their respective obligations. While the amount we have accrued represents the best estimate of the remaining obligations we expect to incur in connection with these plans, estimates are subject to change. Routine adjustments are required and may be required in the future as conditions and facts change through the implementation period. If adverse macroeconomic conditions continue, particularly as they pertain to the commercial real estate market, or if, for any reason, tenants under subleases fail to perform their obligations, we may be required to reduce estimated future sublease income and adjust the estimated amounts of future settlement agreements, and accordingly, increase estimated costs to exit certain facilities. Amounts related to the lease expense, net of anticipated sublease proceeds, will be paid over the respective lease terms through fiscal 2019. Interest and Other Income (Expense), Net During the three months ended September 29, 2012 interest and other income (expense), net increased $0.4 million to $0.5 million from $0.1 million compared to the same period a year ago. Interest Expense During the three months ended September 29, 2012 interest expense decreased $0.5 million to $6.1 million from $6.6 million compared to the same period a year ago. The decrease in interest expense was primarily due to the repurchase of $14.0 million and $50.0 million aggregate principal amount of the 1% Senior Convertible Notes during the three months ended June 30, 2012 and September 29, 2012, respectively. Provision for Income Tax We recorded an income tax expense of $3.4 million for each of the three month periods ended September 29, 2012 and October 1, 2011, respectively. The income tax expense recorded for the three months ended September 29, 2012 and October 1, 2011 primarily relate to income tax in certain foreign and state jurisdictions based on the Company's forecasted pre-tax income for the respective year. The income tax expense or benefit recorded for the respective periods presented differs from the expected income tax expense or benefit that would be calculated by applying the federal statutory rate to our income or loss before income taxes primarily due to the increases and decreases in valuation allowance for deferred tax assets attributable to our domestic and foreign losses from continuing operations. As of September 29, 2012 and June 30, 2012, our unrecognized tax benefits totaled $63.0 million and $61.3 million, respectively, and are included in deferred taxes and other non-current tax liabilities, net. We had $24.3 million accrued for the payment of interest and penalties at September 29, 2012. Discontinued Operations On September 18, 2012, we entered into a definitive agreement to sell the Hologram Business within the previous AOT reportable segment to OpSec Security Inc. for $11.5 million in cash, subject to an earnout clause, requiring the buyer to pay up to a maximum additional amount of $4.0 million if the revenue generated by the business exceeds a pre-determined target amount during the one-year period immediately following the closing. The transaction was closed on October 12, 2012. Net revenue for the Hologram Business three months ended September 29, 2012, and October 1, 2011, was $4.9 million and $5.0 million, respectively. Net loss for the three months ended September 29, 2012, and October 1, 2011, was $1.8 million and $2.2 million, respectively. There was no tax effect associated with the discontinued operation. 35 -------------------------------------------------------------------------------- Table of Contents Operating Segment Information (in millions) Three Months Ended September 29, October 1, Percentage 2012 2011 Change Change Communications Test and Measurement Net revenue $ 169.5 $ 184.9 $ (15.4 ) (8.3 )% Operating income 16.8 24.1 (7.3 ) (30.3 )% Operating margin 9.9 % 13.0 % Communications and Commercial Optical Products Net revenue $ 194.9 $ 180.3 14.6 8.1 % Operating income 23.8 25.6 (1.8 ) (7.0 )% Operating margin 12.2 % 14.2 % Optical Security and Performance Products Net revenue $ 56.5 $ 50.6 5.9 11.7 % Operating income 21.2 17.6 3.6 20.5 % Operating margin 37.5 % 34.8 % The decrease in operating margin for CommTest during the three months ended September 29, 2012 compared to the same period a year ago was due to the decrease in net revenue, partially offset by reductions in SG&A and R&D expense as a result of lower variable incentive pay due to a decrease in operating income in the current period and savings obtained through targeted restructuring activities to consolidate and rationalize business functions to achieve cost efficiencies. The decrease in operating margin for CCOP during the three months ended September 29, 2012 compared to the same period a year ago was due to a decrease in gross margin as a result of charges related to the termination of the CPV product line, increased pricing pressure and due to an increase in R&D spending to develop new product platforms. These decreases were partially offset by an increase in net revenue. The increase in operating margin for OSP during the three months ended September 29, 2012 compared to the same period a year ago was due to an increase in net revenue from currency products and a slight increase in gross margin, while operating expenses remained flat. Liquidity and Capital Resources Our investments of surplus cash are made in accordance with an investment policy approved by the Audit Committee of our Board of Directors. In general, our investment policy requires that securities purchased be rated A-1/P-1, A/A2 or better. Securities that are downgraded subsequent to purchase are evaluated and may be sold or held at management's discretion. No security may have an effective maturity that exceeds 37 months, and the average duration of our holdings may not exceed 18 months. At any time, no more than 5% of the investment portfolio may be concentrated in a single issuer other than the U.S. government or U.S. agencies. Our investments in debt securities and marketable equity securities are primarily classified as available-for-sale investments or trading assets and are recorded at fair value. The cost of securities sold is based on the specific identification method. Unrealized gains and losses on available-for-sale investments are reported as a separate component of stockholders' equity. We did not hold any investments in auction rate securities, mortgage backed securities, collateralized debt obligations, or variable rate demand notes at September 29, 2012 and virtually all debt securities held were of investment grade (at least BBB-/Baa3). As of September 29, 2012, approximately 82.0% of our cash and cash equivalents, short-term investments, and restricted cash were held in the U.S. As of September 29, 2012, the majority of our investments of surplus cash have maturities of 90 days or less and are of high credit quality. Although we intend to hold these investments to maturity, in the event that we are required to sell any of these securities under adverse market conditions, losses could be recognized on such sales. During the three months ended September 29, 2012, we have not realized material investment losses but can provide no assurance that the value or the liquidity of our other investments will not be impacted by adverse conditions in the financial markets. In addition, we maintain cash balances in operating accounts that are with third party financial institutions. These balances in the U.S. may exceed the Federal Deposit Insurance Corporation ("FDIC") insurance limits. While we monitor the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail. 36 -------------------------------------------------------------------------------- Table of Contents As of September 29, 2012, we had a combined balance of cash and cash equivalents, short-term investments and restricted cash of $730.3 million, a decrease of $22.4 million from June 30, 2012. Cash and cash equivalents decreased by $68.5 million in the three months ended September 29, 2012, primarily due to net cash outflows of $45.2 million used for the purchase of available-for-sale investments, $41.1 million used for financing activities, $17.8 million used for the purchases of property, plant and equipment and $9.1 million used for the acquisition of GenComm, offset by cash generated by operating activities of $43.1 million. During the three months ended September 29, 2012, cash provided by operating activities was $43.1 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $45.8 million, and changes in operating assets and liabilities that used $2.7 million primarily related to a decrease in accrued payroll and related expenses of $14.0 million due to timing of variable incentive pay and salary payments, an increase in other current and non-current assets of $13.7 million, offset by a decrease in accounts receivable of $34.8 million primarily due to collection efforts and decreases in net revenue. During the three months ended October 1, 2011, cash provided by operating activities was $22.9 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $49.8 million, and changes in operating assets and liabilities that used $26.9 million related primarily to a decrease in accrued payroll and related expenses of $23.3 million, an increase in inventories of $18.5 million, a decrease in accounts payable of $15.2 million and a decrease in deferred revenue of $13.1 million, offset by a decrease in accounts receivable of $45.6 million primarily driven by seasonality of our collection activities. During the three months ended September 29, 2012 cash used for investing activities was $72.5 million, primarily related to net cash outflows used for the purchase of available-for-sale investments of $45.2 million, cash used for the purchase of property, plant and equipment of $17.8 million and cash used for the acquisition of GenComm of $9.1 million. Since we continue to invest in new technology, laboratory equipment, and manufacturing capacity to support revenue growth opportunities, investments were made during the three months ended September 29, 2012 to increase manufacturing capacity in Asia and the U.S., to set up and improve facilities, and to upgrade information technology systems. During the three months ended October 1, 2011, cash used for investing activities was $48.2 million, primarily related to net cash outflows used for the purchase of available-for-sale investments of $23.2 million, cash used for the purchase of property, plant and equipment of $21.2 million, and cash used for the acquisition of QuantaSol of $3.7 million. During the three months ended September 29, 2012, cash used for financing activities was $41.1 million, primarily related to the repurchase of our 1% Senior Convertible Notes in the amount of $47.8 million, offset by proceeds from the exercise of stock options and the issuance of common stock under our employee stock purchase plan of $6.9 million. During the three months ended October 1, 2011, cash used for financing activities was $0.1 million related to payments made on financing obligations of $6.5 million, offset by proceeds from the exercise of stock options and the issuance of common stock under our employee stock purchase plan of $6.4 million. We believe that our existing cash balances, investments and availability under our revolving credit facility will be sufficient to meet our liquidity and capital spending requirements, including the repayment of the principal balance of $261.0 million outstanding under the 1% Senior Convertible Notes, which is expected to be paid no later than May 2013 based on the put and call provisions of the 1% Senior Convertible Notes. However, there are a number of factors that could positively or negatively impact our liquidity position, including: † global economic conditions which affect demand for our products and services and impact the financial stability of our suppliers and customers; † changes in accounts receivable, inventory or other operating assets and liabilities which affect our working capital; † increase in capital expenditure to support the revenue growth opportunity of our business; † the tendency of customers to delay payments or to negotiate favorable payment term to manage their own liquidity positions; † timing of payments to our suppliers; † factoring or sale of accounts receivable; † volatility in fixed income, credit, and foreign exchange markets which impact the liquidity and valuation of our investment portfolios; † possible investments or acquisitions of complementary businesses, products or technologies; † issuance or repurchase of debt or equity securities; † potential funding of pension liabilities either voluntarily or as required by law or regulation, and † compliance with covenants and other terms and conditions related to our financing arrangements. 37 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations During the first quarter of fiscal 2013, there were no material changes to the contractual obligations previously disclosed in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, except for those occurring in the ordinary course of our business. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, other than the guarantees discussed in "Note 16. Commitments and Contingencies." Employee Stock-based Benefit Plans Our stock-based benefit plans are a broad-based, long-term retention program that is intended to attract and retain employees and align stockholder and employee interests. See "Note 13. Stock-Based Compensation" for more detail. Pension and Other Post-retirement Benefits We sponsor pension plans for certain past and present employees in the U.K., Germany and South Korea. JDSU also is responsible for the non-pension post-retirement benefit obligation of a previously acquired subsidiary. Most of these plans have been closed to new participants and no additional service costs are being accrued, except for the plans assumed during fiscal 2010 and the first quarter of fiscal 2013 in connection with acquisitions. The U.K. plan and South Korea plan are partially funded; and the German plans, which were established as "pay-as-you-go" plans, are unfunded. The authoritative guidance requires the recognition of the funded status of the pension plans and non-pension post-retirement benefit plans (retirement-related benefit plans) as an asset or a liability in the Consolidated Balance Sheet. The authoritative guidance also requires the recognition of changes in that funded status in the year in which they occur through the gains and (losses) not affecting retained earnings, net of tax, and the recognition of previously unrecognized gains/(losses), prior service costs/(credits) and transition assets as a component of Accumulated gains and (losses) not affecting retained earnings. The funded status of a retirement plan is the difference between the projected benefit obligation and the fair value of its plan assets. The projected benefit obligation is the actuarial present value of all benefits attributed by the plan's benefit formula to employee service. At September 29, 2012, our pension plans were under funded by $91.9 million since the projected benefit obligation exceeded the fair value of its plan assets. Similarly, we had a liability of $1.1 million related to our non-pension post-retirement benefit plan. Pension plan assets are managed professionally and we monitor the performance of our investment managers. As of September 29, 2012, the value of plan assets had increased approximately 2.5% since June 30, 2012, our most recent fiscal year end. A key actuarial assumption is the discount rate. Changes in the discount rate impact the interest cost component of the net periodic benefit cost calculation and, due to the fact that the projected benefit obligation ("PBO") is calculated on a net present value basis, changes in the discount rate will also impact the current PBO. Decreases in the discount rate will generally increase pre-tax cost, recognized expense and the PBO. Increases in the discount rate tend to have the opposite effect. We estimate a 50 basis point decrease or increase in the discount rate would cause a corresponding increase or decrease, respectively, in the PBO of approximately $7.0 million based upon June 30,2012 data. In estimating the expected return on plan assets, we consider historical returns on plan assets, adjusted for forward-looking considerations, inflation assumptions and the impact of the active management of the plan's invested assets. While it is not possible to accurately predict future rate movements, we believe our current assumptions are appropriate. Please refer to "Note 14. Employee Defined Benefit Plans" for further discussion. |