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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 (except for Items 1, 1A, 6, 7, and 8) for the fiscal year ended June 30, 2012, and our Current Report on Form 8-K dated December 14, 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. Our diverse technology portfolio also fights counterfeiting and enables commercial lasers for a range of applications. To serve its markets, JDSU operates the following business segments: † Communications Test and Measurement ("CommTest") † Communications and Commercial Optical Products ("CCOP") † Optical Security and Performance Products ("OSP") 31 -------------------------------------------------------------------------------- Table of Contents Communications Test and Measurement CommTest provides an integrated portfolio of advanced field test and lab instruments, customer experience management ("CEM") tools and service-assurance solutions supported by monitoring software and optimization applications. This portfolio helps network operators and service providers effectively manage the continued growth of network traffic, devices and applications. As a result of this continued and rapid growth, operators and providers are looking for new ways to drive business agility and generate revenue with innovative services, while continuing to focus on reducing operating costs and improving performance. To this end, CommTest is focused on providing world-class network and service enablement solutions, focusing investments on software and solutions offerings in high-growth markets while leveraging its instruments portfolio. These strategic investments are being placed globally to meet end-customer demand. CommTest solutions address lab and production environments, field deployment and service assurance for Ethernet and IP services over wireless and fixed communications networks. CommTest also provides protocol test solutions for the development and field deployment of storage and storage-network technologies. CommTest's test instrument portfolio is one of the largest in the industry, with hundreds of thousands of units in active use by major network equipment manufacturers ("NEMs"), operators and services providers worldwide. CommTest is leveraging this installed base and knowledge of network management methods and procedures to develop advanced CEM and service-assurance solutions. Our CEM products let carriers remotely monitor performance and quality of service throughout the entire network. Remote monitoring decreases operating expenses, while early detection increases uptime, preserves revenue, and lets operators better monetize their networks. Service-assurance solutions address the entire scope of network monitoring from xDSL and Ethernet to mobile wireless, providing end-to-end visibility into customers' quality of experience through continuous monitoring and correlation of service and network performance. CommTest customers include wireless and fixed services providers, NEMs, government organizations and large corporate customers. These include major telecom, mobility 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, Telefónica, Telmex, TimeWarner Cable and Verizon. CommTest customers also include many of the NEMs 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. During the third quarter of fiscal 2013, we acquired Arieso, a leading provider of location-aware software solutions that allow mobile network operators improve the subscriber experience. Also, during the third quarter of fiscal 2013, Management approved a strategic plan to exit the low-speed wireline product line, which resulted in a $2.2 million charge for accelerated amortization of related intangibles of which $1.8 million and $0.4 million is included in Amortization of acquired technologies and Amortization of other intangibles in the Consolidated Statement of Operations, respectively. In addition, we incurred $11.3 million of inventory related charges primarily related to the write-off of inventory no longer being sold due to the low-speed wireline product line exit included in Cost of sales in the Consolidated Statement of Operations. Communications and Commercial Optical Products CCOP is a leading provider of optical communications and commercial laser products and technologies and commercial laser components. Serving telecommunications and enterprise data communications markets, CCOP products include components, modules, subsystems, and solutions for access (local), metro (intracity), long-haul (city-to-city and worldwide), and submarine (undersea) networks, as well as storage access networks ("SANs"), local area networks ("LANs") and Ethernet wide-area networks ("WANs"). These products enable the transmission and transport of video, audio and text data over high-capacity fiber-optic cables. CCOP maintains market-leading positions in the fastest-growing optical communications segments, including ROADMs and tunable XFPs and SFPs. CCOP's growing portfolio of pluggable transceivers supports LAN/SAN needs and the cloud for customers building proprietary data center networks. OEMs use CCOP lasers-fiber, diode, direct-diode, diode-pumped solid-state ("DPSS"), and gas-that offer low- to high-power output with ultraviolet ("UV"), visible and IR wavelengths. This broad product portfolio addresses the needs of laser clients in applications such as micromachining, materials processing, bio-instrumentation, 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. 32 -------------------------------------------------------------------------------- Table of Contents Gesture-recognition systems use both CCOP laser diodes and optical filters from the Company's OSP business segment. These systems simplify the way people interact with technology by enabling the use of natural body gestures, like the wave of a hand, instead of using a device like a mouse or remote control. Emerging markets for gesture recognition include gaming, home entertainment and personal computing. CCOP's optical communications products customers include Adva, Alcatel-Lucent, Ciena, Cisco Systems, Ericsson, Fujitsu, Huawei, Infinera, Nokia Siemens Networks, and Tellabs. CCOP's lasers customers include Amada, ASML, Beckman Coulter, Becton Dickinson, Disco, Electro Scientific Industries, and KLA-Tencor. During the first quarter of fiscal 2013, Management approved a plan to exit the concentrated photovoltaic ("CPV") product line. As a result the Company incurred a $2.6 million charge during the period for accelerated amortization of related intangibles which is included in Amortization of acquired technologies in the Consolidated Statement of Operations. Optical Security and Performance Products OSP designs, manufactures, and sells products targeting anti-counterfeiting, consumer electronics, government, healthcare, and other markets. OSP's security offerings for the currency market include Optically Variable Pigment ("OVP®"), Optically Variable Magnetic Pigment ("OVMP®") and banknote thread substrates. OVP® enables a color-shifting effect used by banknote issuers and security printers worldwide for anti-counterfeiting applications on currency and other high-value documents and products. OVP® protects the currencies of more than 100 countries today. OSP also develops and delivers overt and covert anti-counterfeiting products targeting the pharmaceuticals and consumer-electronics markets. Leveraging its expertise in spectral management and its unique high-precision coating capabilities, OSP improves the performance of a range of products in the consumer-electronics market. For example, gesture-recognition devices designed for the gaming market use OSP bandpass filters. OSP also manufactures components for phase and polarization control that enhance contrast in home-theater projection systems. OSP also provides glasses and color filter wheels for 3D cinema applications. OSP value-added solutions meet the stringent requirements of commercial and government customers in aerospace and defense. In the aerospace industry, JDSU precision optical filters are a critical component in satellite and spacecraft power- and temperature-control systems. OSP also supplies anti-reflection coatings, beamsplitters, optical filters, laser optics, solar reflectors, and mirrors for a variety of defense and security applications including guidance systems, high-energy laser systems, battlefield eye protection, infrared night-vision systems, and secure optical communications. OSP serves customers such as 3M, Barco, Kingston, Lockheed Martin, Northrup Grumman, Pan Pacific, Seiko Epson, and SICPA. During the second quarter of fiscal 2013, JDSU completed the sale of the Hologram Business, which primarily addressed the transaction card market. JDSU 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 quarterly JDSU 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 Current Report on Form 8-K filed with the SEC on December 14, 2012. 33 -------------------------------------------------------------------------------- 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 Statements of Operations items (in millions, except for percentages): Three Months Ended Nine Months Ended March 30, March 31, Percentage March 30, March 31, Percentage 2013 2012 Change Change 2013 2012 Change Change Segment net revenue: CommTest $ 174.2 $ 177.8 $ (3.6 ) $ 539.1 $ 558.6 $ (19.5 ) CCOP 179.2 173.1 6.1 559.9 516.6 43.3 OSP 51.9 52.4 (0.5 ) 156.6 153.2 3.4 Net revenue $ 405.3 $ 403.3 $ 2.0 0.5 % $ 1,255.6 $ 1,228.4 $ 27.2 2.2 % Gross profit $ 155.3 $ 167.8 $ (12.5 ) (7.4 )% $ 516.9 $ 523.9 $ (7.0 ) (1.3 )% Gross margins 38.3 % 41.6 % 41.2 % 42.6 % Research and development 65.8 62.0 3.8 6.1 % 190.9 180.2 10.7 5.9 % Percentage of net revenue 16.2 % 15.4 % 15.2 % 14.7 % Selling, general and administrative 107.3 104.5 2.8 2.7 % 317.4 320.1 (2.7 ) (0.8 )% Percentage of net revenue 26.5 % 25.9 % 25.3 % 26.1 % Amortization of acquired technologies 17.0 14.1 2.9 20.6% 48.7 43.8 4.9 11.2 % Percentage of net revenue 4.2 % 3.5 % 3.9 % 3.6 % Amortization of other intangibles 3.1 5.7 (2.6 ) (45.6 )% 8.8 16.2 (7.4 ) (45.7 )% Percentage of net revenue 0.8 % 1.4 % 0.7 % 1.3 % Restructuring and related charges 0.4 2.0 (1.6 ) (80.0 )% 6.1 7.5 (1.4 ) (18.7 )% Percentage of net revenue 0.1 % 0.5 % 0.5 % 0.6 % Loss from discontinued operations, net of tax - (1.2 ) 1.2 (100.0 )% (1.0 ) (5.9 ) 4.9 (83.1 )% Percentage of net revenue - % 0.3 % 0.1 % 0.5 % Net Revenue Net revenue increased by $2.0 million, or 0.5%, during the three months ended March 30, 2013 compared to the same period a year ago. This increase was primarily due to an increase in volume and demand in our CCOP segment in the current period, partially offset by a decline in net revenue in our CommTest and OSP segments, as described below. CommTest net revenue decreased by $3.6 million, or 2.0%, during the three months ended March 30, 2013, compared to the same period a year ago. This decrease was driven by $12.3 million of net revenue decreases primarily from our Broadband and Networking and Media Access and Content product lines. These decreases were primarily due to (i) the wind-down of legacy wireline products, (ii) declines in average selling prices ("ASP") as a result of increased competition within the Media Access Content product line and (iii) procurement delays at a key customer. This was partially offset by $8.7 million of net revenue increases primarily from our Mobility product line driven by new products from the acquisitions of Dyaptive and GenComm. 34 -------------------------------------------------------------------------------- Table of Contents CCOP net revenue increased by $6.1 million, or 3.5%, during the three months ended March 30, 2013, compared to the same period a year ago. This increase was driven by $22.2 million of net revenue increases primarily from our Pluggables, Solid State Lasers and Modulators product lines. These increases were primarily due to higher demand in the current period for new products that were released in the prior fiscal year and new customers in the current period. This was partially offset by $16.1 million of net revenue decreases primarily from our Fiber Lasers, Tunables and Amplifiers product lines. These decreases were primarily due to lower demand from key customers for these product lines and the timing of customer transition to newer products within our Fiber Lasers product line. OSP net revenue decreased by $0.5 million, or 1.0%, during the three months ended March 30, 2013, compared to the same period a year ago. This decrease was driven by $3.3 million of net revenue decreases from our Consumer and Industrial product line primarily due to lower demand for display products, lower cyclical sales in window film products and reductions in 3D products in the current period. This was partially offset by $2.8 million of net revenue increases primarily from our Anti-Counterfeiting product line driven by higher demand for currency products. Net revenue increased by $27.2 million, or 2.2%, during the nine months ended March 30, 2013 compared to the same period a year ago. This increase was primarily due to (i) an incremental increase in volume and demand in our CCOP segment in the current period, and (ii) the fact that the prior period reflected a reduction in CCOP net revenue of approximately $15 million due to the regional flooding in Thailand which temporarily suspended operations at one of our primary contract manufacturers, Fabrinet. This was partially offset by a decline in CommTest net revenue, as described below. CommTest net revenue decreased by $19.5 million, or 3.5%, during the nine months ended March 30, 2013, compared to the same period a year ago. This decrease was driven by $44.9 million of net revenue decreases primarily from our Media Access and Content and Services product lines. These decreases were primarily due to the wind-down of legacy wireline products and procurement delays at a key customer. This was partially offset by $25.4 million of net revenue increases primarily from our Mobility product line driven by by new products from the acquisitions of Dyaptive and GenComm. CCOP net revenue increased $43.3 million, or 8.4%, during the nine months ended March 30, 2013, compared to the same period a year ago. This increase was driven by $68.1 million of net revenue increases primarily from our Pluggables, Modulators, Tunables and Solid State Lasers product lines. These increases were primarily due to (i) higher demand in the current period for new products that were released in the prior fiscal year, (ii) new customers in the current period and (iii) the recovery from the adverse impact of the regional flooding in Thailand in the prior period as described above. This was partially offset by $24.8 million of net revenue decreases primarily from our ROADMs, Gas Lasers and Amplifiers product lines driven by lower demand from key customers. OSP net revenue increased by $3.4 million, or 2.2%, during the nine months ended March 30, 2013, compared to the same period a year ago. This increase was driven by $11.5 million of net revenue increases primarily from our Anti-Counterfeiting product line driven by higher demand for currency products. This was partially offset by $8.1 million of net revenue decreases from our Consumer and Industrial product line driven by lower demand for commercial infrared products, lower cyclical sales in 3D and window film products and lower demand for gesture products in the current period. 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 be resolved. 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 competition, particularly from Asia-based competitors, and a general commoditization trend for certain products; (b) high product mix variability, particularly in our CCOP and CommTest markets, which affects revenue and gross profit; (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 contract 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 limit our ability to predict longer-term revenue, profitability and general financial performance. 35 -------------------------------------------------------------------------------- Table of Contents We operate primarily in three geographic regions: Americas, EMEA and Asia-Pacific. The following table presents net revenue by geographic regions (in millions): Three Months Ended Nine Months Ended March 30, March 31, March 30, March 31, 2013 2012 2013 2012 Net revenue: Americas $ 194.1 47.9 % $ 187.1 46.4 % $ 618.0 49.2 % $ 601.1 48.9 % EMEA 95.1 23.5 101.1 25.1 294.4 23.5 302.0 24.6 Asia-Pacific 116.1 28.6 115.1 28.5 343.2 27.3 325.3 26.5 Total net revenue $ 405.3 100.0 % $ 403.3 100.0 % $ 1,255.6 100.0 % $ 1,228.4 100.0 % Net revenue is assigned to geographic regions based on customer shipment locations. Net revenue from customers in the Americas during the three months ended March 30, 2013 and March 31, 2012 included net revenue from the United States of $144.1 million and $148.9 million, respectively. Net revenue from customers in the Americas during the nine months ended March 30, 2013 and March 31, 2012 included net revenue from the United States of $469.0 million and $477.7 million, respectively. Net revenue from customers outside the Americas during the three months ended March 30, 2013 and March 31, 2012 represented 52.1% and 53.6% of net revenue, respectively. Net revenue from customers outside the Americas during the nine months ended March 30, 2013 and March 31, 2012, represented 50.8% and 51.1% of net revenue, respectively. We expect revenue from customers outside of North America to continue to be an important part of our overall net revenue and an increasing focus for net revenue growth opportunities. Gross Margin Gross margin during the three months ended March 30, 2013, decreased 3.3 percentage points to 38.3% from 41.6% compared to the same period a year ago. The decrease in gross margin was primarily due to inventory charges and accelerated amortization of acquired developed technology related to the strategic exit of the low-speed wireline product line and declines in ASP as a result of increased competition within the Media Access Content product line of CommTest. This was partially offset by an improvement in CCOP gross margin primarily due to higher revenue with a more favorable product mix and an improvement in yield in the current period. Gross margin during the nine months ended March 30, 2013, decreased 1.4 percentage points to 41.2% from 42.6% compared to the same period a year ago. The decrease in gross margin was primarily due to (i) charges related to the strategic exit from the low-speed wireline product line in the current period as referenced above, (ii) CCOP net revenue, which yields lower gross margin generally than our other two segments, representing a higher percentage of consolidated net revenue in the current period compared to the same period a year ago, and (iii) an increase in amortization expense of acquired developed technology primarily due to recent acquisitions. This was partially offset by improvements in CommTest gross margin in the current period primarily due to (i) savings obtained through targeted restructuring activities to consolidate and rationalize business functions, (ii) savings associated with the recent outsourcing of our repair operations and ongoing efforts to outsource manufacturing and reduce the number of contract manufacturing partners, and (iii) a more favorable product mix as net revenue generated from higher margin products, particularly from our Mobility product line, increased compared to the 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/or 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 increased $3.8 million, or 6.1%, during the three months ended March 30, 2013 compared to the same period a year ago. This increase was primarily driven by a $5.3 million increase in labor and benefits expense primarily due to higher headcount associated with our continued investment in product development and a $0.6 million increase in stock-based compensation in the current period. This was partially offset by a $1.8 million decrease in supplies expenses primarily due to a reduction in materials usage by CCOP in the current period. R&D expense increased $10.7 million, or 5.9%, during the nine months ended March 30, 2013 compared to the same period a year ago. This increase was driven by a $9.2 million increase in labor and benefits expense primarily due to higher headcount as 36 -------------------------------------------------------------------------------- Table of Contents referenced above and higher variable incentive compensation and a $1.2 million increase in stock-based compensation in the current period. This was partially offset by a $1.4 million decrease in facilities expense primarily due to the exit from certain sites in connection with restructuring activities in our CommTest segment in the current period. We believe that continuing our investments in R&D is critical to attaining our strategic objectives. We plan to continue to invest in R&D and new products that will further differentiate us in the marketplace and expect our investment in dollar terms to increase in future quarters. Selling, General and Administrative ("SG&A") SG&A expense increased $2.8 million, or 2.7%, during the three months ended March 30, 2013 compared to the same period a year ago. This increase was primarily driven by (i) a $3.3 million increase in labor and benefits expense primarily due to higher headcount coupled with higher internal commissions and variable incentive compensation, (ii) $1.6 million of transaction costs related to the acquisition of Arieso and (iii) a $1.2 million increase in stock-based compensation in the current period. This was partially offset by a $2.6 million decrease in various other expenses such as facilities and bad debt expense in the current period. SG&A expense decreased $2.7 million, or 0.8%, during the nine months ended March 30, 2013 compared to the same period a year ago. This decrease was primarily driven by (i) the absence in the current period of a $7.9 million legal expense in the prior period associated with a litigation settlement, (ii) a $4.1 million decrease in various other expenses such as external legal expense and external commissions in the current period and (iii) a $2.0 million decrease in facilities expense in the current period. This was partially offset by (i) a $7.6 million increase in labor and benefits expense primarily due to higher headcount coupled with higher internal commissions and variable incentive compensation, (ii) a $2.0 million increase in stock-based compensation and (iii) $1.6 million of transaction costs related to the acquisition of Arieso in the current period. We intend to continue to focus on reducing our SG&A expense 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 litigation expenses, which could increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter. Restructuring and Related Charges We continue to seek to 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 the market conditions. We estimate annualized cost savings of approximately $26.5 million excluding any one-time charge 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 and nine months ended March 30, 2013, we incurred restructuring and related charges of $0.4 million and $6.1 million, respectively. During the three and nine months ended March 31, 2012, we incurred restructuring and related charges of $2.0 million and $7.5 million, respectively. During the third quarter of fiscal 2013, we incurred restructuring and related charges of $0.4 million. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † Management approved the CCOP Outsourcing Plan to transition certain functions related to the CCOP segment to an offshore contract manufacturer to align with our continuous efforts to improve supply chain optimization. As a result, a restructuring charge of $0.9 million was recorded for severance and employee benefits for 46 employees primarily in manufacturing, research and development and selling, general and administrative functions. As of March 30, 2013, 4 employees have been terminated. The employees being affected are located in the United States. Payments related to remaining severance and benefits accrual are expected to be paid by the end of the first quarter of fiscal 2015; and † This change was offset by a benefit of $0.5 million for severance and benefits, primarily related to the CommTest Operation and Repair Outsourcing Restructuring Plan announced in the fourth quarter of fiscal 2012, CommTest Manufacturing Support Consolidation Plan announced in the third quarter of fiscal 2012. 37 -------------------------------------------------------------------------------- Table of Contents During the third quarter of fiscal 2012, we incurred restructuring and related charges of $2.0 million. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † Management approved the CommTest Manufacturing Support Consolidation plan for the CommTest Segment that resulted in a charge of $2.7 million towards severance and employee benefits, offset by a benefit of $0.7 million to adjust the accrual for previously restructured lease related obligations and a benefit of $0.2 million for severance and employee benefits due to decreased obligation of remaining payments. This plan continues Management's efforts to consolidate our manufacturing support operations, by reducing the number of contract manufacturer locations worldwide and moving them to lower cost regions such as Mexico and China. This action affected 77 employees in manufacturing, research and development and selling, general and administrative functions. Payments related to severance and benefits accrual are expected to be paid by the end of the first quarter of fiscal 2014. During the nine months ended March 30, 2013, we recorded $6.1 million in restructuring and related charges. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † $3.2 million for severance and benefits related to the CCOP Outsourcing Plan announced in the current quarter, the CommTest Wireless Business Plan announced in the second quarter of fiscal 2013, and the CCOP CPV plan announced during the first quarter of fiscal 2013 and $1.6 million of additional severance and employee benefits arising primarily to adjust the accrual for the CommTest Operation and Repair Outsourcing Restructuring and the CommTest Manufacturing Support Consolidation plans announced in the fourth and third quarters of fiscal 2012, respectively; † $0.8 million for transfer costs and lease construction costs in CommTest which were the result of the repair outsourcing initiative announced by Management during the fourth quarter of fiscal 2012; and † $0.5 million for the exit of two leased sites in CommTest for the plan announced during the fourth quarter of fiscal 2012. During the nine months ended March 31, 2012, we recorded $7.5 million in restructuring and related charges. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † $5.1 million for severance and benefits, net of adjustments, primarily related to the CommTest Manufacturing Support Consolidation Plan announced in the current quarter, the CommTest Solutions Business Restructuring Plan announced in the second quarter of fiscal 2012, the CCOP segment restructuring plan announced in the first quarter of fiscal 2012, and the continued implementation of the CommTest Germany Restructuring Plan; † $1.5 million for manufacturing transfer costs in the CommTest and the previous AOT segment which were the result of the transfer of certain production processes into existing sites in the United States, or to contract manufacturers; and † $0.9 million for lease exit costs consisting of a $1.7 million charge from exiting three of the facilities under the CommTest Market Rebalancing Plan announced in the third quarter of fiscal 2011 and the facility under the CommTest Germantown Tower Plan announced in the second quarter of fiscal 2012, offset by a benefit of $0.8 million arising primarily to adjust the accrual for previously restructured lease related obligations. Our restructuring and other lease exit cost obligations are net of sublease income or lease settlement estimates of approximately $3.6 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 Interest and other income (expense), net decreased by $1.1 million during the three months ended March 30, 2013 compared to the same period a year ago, primarily due to foreign exchange loss and loss realized, in accordance with the authoritative guidance, in connection with repurchase of $50.0 million aggregate principal amount of our 1% Senior Convertible Notes at par in the current period. 38 -------------------------------------------------------------------------------- Table of Contents Interest and other income (expense), net decreased by $5.9 million during the nine months ended March 30, 2013, compared to the same period a year ago, primarily due to loss realized, in accordance with the authoritative guidance, in connection with repurchase of $150.0 million aggregate principal amount of our 1% Senior Convertible Notes at prices at or below par in the current period. Interest Expense Interest expense decreased by $2.7 million during the three months ended March 30, 2013 compared to the same period a year ago. Interest expense decreased by $4.7 million during the nine months ended March 30, 2013, compared to the same period a year ago. The decreases in interest expense for both the three and nine month periods, were primarily due to repurchases of $164.0 million of the aggregate principal amount of our 1% Senior Convertible Notes subsequent to the three months ended March 31, 2012. Provision for Income Tax We recorded an income tax expense of $1.6 million and $9.1 million for the three and nine months ended March 30, 2013, respectively. We recorded an income tax expense of $3.1 million and $9.5 million for the three and nine months ended March 31, 2012, respectively. The income tax expense recorded for the three and nine months ended March 30, 2013 and March 31, 2012, respectively, primarily relates to income tax in certain foreign and state jurisdictions based on our forecasted pre-tax income for the year in those locations. The income tax expense recorded differs from the expected 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 in valuation allowance for deferred tax assets attributable to our domestic and foreign losses from continuing operations. As of March 30, 2013 and June 30, 2012, our unrecognized tax benefits totaled $61.1 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 March 30, 2013. Discontinued Operations During the second quarter of fiscal 2013, we completed the sale of the Hologram Business within the previous AOT reportable segment to OpSec Security Inc. and received gross proceeds of $11.5 million in cash, subject to an earn-out clause. Based on an assessment to be performed following the one-year period subsequent to the closing date (the "earn-out period"), the buyer may be required to pay up to a maximum additional amount of $4.0 million contingent on the Hologram Business exceeding a pre-determined revenue target during the earn-out period. No amount related to the earn-out clause will be recognized unless it is realized or realizable, in accordance with authoritative guidance. If any amount related to the earn-out clause meets the recognition criteria it will be included as a component of discontinued operations in the Consolidated Statements of Operations. We recorded a gain of $0.6 million in connection with the sale during the nine months ended March 30, 2013. Net revenue of the Hologram Business for the nine months ended March 30, 2013 was $5.2 million. Net revenue of the Hologram Business for the three and nine months ended March 31, 2012 was $5.9 million and $14.4 million, respectively. Net loss for the nine months ended March 30, 2013 was $1.0 million. Net loss for the three and nine months ended March 31, 2012 was $1.2 million and $5.9 million, respectively. There was no tax effect associated with the discontinued operation for any periods presented. 39 -------------------------------------------------------------------------------- Table of Contents Operating Segment Information (in millions) Three Months Ended Nine Months Ended March 30, March 31, Percentage March 30, March 31, Percentage 2013 2012 Change Change 2013 2012 Change Change CommTest Net revenue $ 174.2 $ 177.8 $ (3.6 ) (2.0 )% $ 539.1 $ 558.6 $ (19.5 ) (3.5 )% Operating income 13.0 20.1 (7.1 ) (35.3 )% 65.1 72.2 (7.1 ) (9.8 )% Operating margin 7.5 % 11.3 % 12.1 % 12.9 % CCOP Net revenue 179.2 173.1 6.1 3.5 % 559.9 516.6 43.3 8.4 % Operating income 19.2 14.1 5.1 36.2 % 64.2 56.3 7.9 14.0 % Operating margin 10.7 % 8.1 % 11.5 % 10.9 % OSP Net revenue 51.9 52.4 (0.5 ) (1.0 )% 156.6 153.2 3.4 2.2 % Operating income 18.6 18.5 0.1 0.5 % 56.0 53.0 3.0 5.7 % Operating margin 35.8 % 35.3 % 35.8 % 34.6 % CommTest CommTest operating margin decreased 3.8 percentage points during the three months ended March 30, 2013 to 7.5% from 11.3% compared to the same period a year ago. The decrease was primarily driven by a decline in gross margin and a 2.0% decrease in net revenue in the current period as referenced above. CommTest operating margin decreased 0.8 percentage points during the nine months ended March 30, 2013 to 12.1% from 12.9% compared to the same period a year ago. The decrease was primarily driven by a 3.5% decrease in net revenue as referenced above, partially offset by an improvement in gross margin primarily due to cost savings and a more favorable product mix as referenced above. CCOP CCOP operating margin increased 2.6 percentage points during the three months ended March 30, 2013 to 10.7% from 8.1% compared to the same period a year ago. The increase in operating margin was primarily driven by an improvement in gross margin due to a more favorable product mix and an improvement in yield in the current period. This was partially offset by an increase in R&D expense primarily due to higher headcount and a reduction in R&D expense offsets from joint product development projects in the current period. CCOP operating margin increased 0.6 percentage points during the nine months ended March 30, 2013 to 11.5% from 10.9% compared to the same period a year ago. The increase in operating margin was primarily driven by an 8.4% increase in net revenue as referenced above and by an improvement in gross margin due to a more favorable product mix and an improvement in yield in the current period. This was partially offset by an increase in R&D and SG&A expense primarily due to higher headcount and variable incentive compensation in the current period. OSP OSP operating margin increased 0.5 percentage points during the three months ended March 30, 2013 to 35.8% from 35.3% compared to the same period a year ago. The increase in operating margin was primarily driven by an improvement in gross margin due to a more favorable product mix and lower inventory excess and obsolescence charges in the current period. OSP operating margin increased 1.2 percentage points during the nine months ended March 30, 2013 to 35.8% from 34.6% compared to the same period a year ago. The increase in operating margin was primarily driven by a decrease in SG&A expense due to a one-time benefit from a litigation settlement related to an insurance claim and by a 2.2% increase in revenue as referenced above in the current period. This was partially offset by an increase in R&D expense in the current period. 40 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Our cash investments 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. In November, 2012, the policy was amended to allow an allocation to securities rated A-2/P-2, BBB/Baa2 or better, with such allocation not to exceed 10% of any investment portfolio. 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. or sovereign governments or 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 March 30, 2013 and virtually all debt securities held were of investment grade (at least BBB-/Baa3). As of March 30, 2013, approximately 80.1% of our cash and cash equivalents, short-term investments and restricted cash were held in the U.S. As of March 30, 2013, the majority of our cash investments 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 nine months ended March 30, 2013, 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. As of March 30, 2013, we had a combined balance of cash and cash equivalents, short-term investments and restricted cash of $638.8 million, a decrease of $113.9 million from June 30, 2012. Cash and cash equivalents decreased by $143.4 million in the nine months ended March 30, 2013, primarily due to $125.3 million used for financing activities, $83.2 million used for the acquisitions of business, $46.7 million used for the purchase of property, plant and equipment and net cash outflows of $32.9 million used for the purchase of available-for-sale investments, offset by cash generated by operating activities of $130.7 million and net proceeds from the sale of the Hologram Business of $11.2 million. During the nine months ended March 30, 2013, cash provided by operating activities was $130.7 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $131.1 million and changes in operating assets and liabilities that used $0.4 million. Changes in operating assets and liabilities related primarily to a decrease in accrued payroll and related expenses of $24.3 million due to timing of bonus and salary payments and lower bonus accrual and a decrease in accrued expenses and other current and non-current liabilities of $15.1 million, offset by a decrease in inventory of $19.8 million and an decrease in accounts receivable of $17.2 million driven by our collection efforts. During the nine months ended March 31, 2012, cash provided by operating activities was $81.8 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $141.6 million, and changes in operating assets and liabilities that used $59.8 million related primarily to a decrease in accrued payroll and related expenses of $36.9 million which was primarily due to timing of bonus and salary payments and lower bonus and commission accruals, an increase in inventories of $22.9 million primarily as part of a supply-chain strategy to enhance lead time for customer shipments, a decrease in accounts payable of $19.0 million and an increase in other current and non-current assets of $6.5 million, offset by a decrease in accounts receivable of $28.6 million primarily due to a decrease in net revenue. During the nine months ended March 30, 2013, cash used for investing activities was $150.5 million, primarily related to cash used for the acquisitions of GenComm and Arieso of $83.2 million, cash used for the purchase of property, plant and equipment of $46.7 million and net cash outflows used for the purchase of available-for-sale investments of $32.9 million, offset by net proceeds from sale of the Hologram Business of $11.2 million. Since we continue to invest in new technology, laboratory equipment, and manufacturing capacity to support revenue growth opportunities, investments were made during the nine months ended March 30, 2013 to increase manufacturing capacity in Asia and the U.S., to set up and improve facilities, and to upgrade information technology systems. During the nine months ended March 31, 2012, cash used for investing activities was $73.4 million, primarily related to cash used for the purchase of property, plant and equipment of $56.9 million, cash used for the acquisitions of QuantaSol and Dyaptive of $12.5 million, and net cash outflows used for the purchase of available-for-sale investments of $8.2 million, offset by proceeds from the sale of assets of $2.1 million primarily from the Eningen transaction. Since we continue to invest in new technology, laboratory equipment, 41 -------------------------------------------------------------------------------- Table of Contents and manufacturing capacity to support revenue growth opportunities across all three segments, investments were made during the nine months ended March 31, 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 nine months ended March 30, 2013, cash used for financing activities was $125.3 million, primarily related to the repurchase of our 1% Senior Convertible Notes in the amount of $145.8 million, offset by proceeds from the exercise of stock options and the issuance of common stock under our employee stock purchase plan of $21.3 million. During the nine months ended March 31, 2012, cash provided by financing activities was $13.1 million, related to proceeds from the exercise of stock options and the issuance of common stock under our employee stock purchase plan of $17.5 million and proceeds from financing obligation of $6.9 million related to the Eningen transaction, offset by payments made on financing obligations and issuance cost for revolving credit facility of $9.7 million and $1.6 million, respectively. 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 $161.0 million outstanding under the 1% Senior Convertible Notes, which is expected to be paid no later than the end of the fourth quarter of fiscal 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. Contractual Obligations During the third quarter of fiscal 2013, there were no material changes to the contractual obligations previously disclosed in our Current Report on Form 8-K for dated December 14, 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. and Germany. On November 30, 2012, we terminated the defined benefit pension plan in South Korea. We are also 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 in connection with an acquisition during fiscal 2010. The U.K. plan is 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 42 -------------------------------------------------------------------------------- Table of Contents 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 March 30, 2013, our pension plans were under funded by $89.9 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 professionally managed and we monitor the performance of our investment managers. As of March 30, 2013, the value of plan assets had increased approximately 14.8% 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 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. |