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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 the expected impact of such plans on our financial performance; 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 29, 2013. OUR INDUSTRIES AND QUARTERLY DEVELOPMENTS JDSU provides network and service enablement solutions and optical products for telecommunications service providers, cable operators, network equipment manufacturers, and enterprises. Our diverse technology portfolio also fights counterfeiting and enables commercial lasers for a range of applications. In the first quarter of fiscal 2014, we changed the name of our Communication Test and Measurement segment to Network and Service Enablement ("NSE"). The name NSE more accurately reflects the value the Company brings to customers and the evolution of the Company's product portfolio, one that includes communications test instruments as well as microprobes, software and services that provide the necessary visibility throughout the network to improve service and application performance. To serve its markets, JDSU operates the following business segments: † Network and Service Enablement † Communications and Commercial Optical Products ("CCOP") † Optical Security and Performance Products ("OSP") 36 --------------------------------------------------------------------------------Network and Service Enablement NSE provides an integrated portfolio of network and service enablement solutions that provide end-to-end visibility and intelligence necessary for consistent, high-quality network, service and application performance. These solutions are made up of test instruments and customer experience assurance management solutions supported by microprobes, 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 network performance. To this end, NSE provides world-class network and service enablement solutions, focusing 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. JDSU's network enablement solutions include instruments and software to build, activate, certify, troubleshoot, monitor, and optimize networks that are differentiated through superior efficiency, higher profitability, reliable performance, and greater customer satisfaction. These products include instruments and software that access the network to perform installation and maintenance tasks. Our service enablement solutions collect and analyze complete network data to reveal the true customer experience and opportunities for new revenue streams with enhanced management, control, optimization and differentiation. NSE solutions address lab and production environments, field deployment and service assurance for wireless and fixed communications networks, including storage networks. NSE's solutions include one of the largest test instrument portfolios in the industry, with hundreds of thousands of units in active use by major NEMs, operators and services providers worldwide. NSE is leveraging this installed base and knowledge of network management methods and procedures to develop advanced customer experience solutions. These solutions let carriers remotely monitor performance and quality of service and applications performance throughout the entire network. Remote monitoring decreases operating expenses, while early detection increases uptime, preserves revenue, and lets operators better monetize their networks. NSE 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, Reliance Communications, Softbank, Telefónica, Telmex, TimeWarner Cable, Verizon and Vodafone. NSE customers also include many of the NEMs served by our CCOP segment, including Alcatel-Lucent, Ciena, Cisco Systems, Fujitsu and Huawei. NSE 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. On December 10, 2013, we acquired certain technology and other assets from Trendium, a provider of real-time intelligence solutions for customer experience assurance, asset optimization, and monetization of big data for 4G/Long term evolution ("LTE") mobile network operators. On January 6, 2014, we acquired Network Instruments, a leading developer of enterprise network and application-performance management solutions for global 2000 companies. Network Instruments extended JDSU's service enablement solutions to the enterprise, data center and cloud networking markets. We are currently evaluating the impact of recent strategic acquisitions on the reporting structure of our NSE segment. 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 SANs, LANs and WANs. These products enable the transmission and transport of video, audio and text data over high-capacity fiber-optic cables. CCOP maintains leading positions in the fastest-growing optical communications segments, including ROADMs and tunable XFPs and SFP+s. CCOP's growing portfolio of pluggable transceivers supports LAN/SAN needs and the cloud for customers building proprietary data center networks. 37 -------------------------------------------------------------------------------- Original equipment manufacturers ("OEMs") use CCOP lasers-fiber, diode, direct-diode, diode-pumped solid-state, and gas-that offer low- to high-power output with 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. Photonic power products transport energy over optical fiber, enabling electromagnetic- and radio-interference-free power and data transmission for remote sensors such as high-voltage line current monitors. Gesture recognition systems use both CCOP's gesture recognition light source and OSP's gesture recognition optical filters. 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 platforms, home entertainment, mobile devices and personal computing. CCOP's optical communications products customers include Adva, Alcatel-Lucent, Ciena, Cisco Systems, Ericsson, Fujitsu, Huawei, Infinera, Nokia Solutions and Networks, and Tellabs. CCOP's lasers customers include Amada, ASML, Beckman Coulter, Becton Dickinson, Disco, Electro Scientific Industries, and KLA-Tencor. On January 27, 2014, we acquired Time-Bandwidth Products, a provider of high powered and ultrafast lasers for the industrial and scientific markets. Manufacturers use high-power, ultrafast lasers to create micro parts for consumer electronics and to process semiconductor chips. Use of ultrafast lasers for micromachining applications is being driven primarily by increasing use of consumer electronics and connected devices globally. 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. 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 gaming platforms use OSP optical filters. 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. During the fourth quarter of fiscal 2013, we made a decision to cease production of certain legacy custom optic products at the end of their lifecycle, including anti-reflection products, solar cell covers, and front-surface mirrors for display and office automation applications as well as certain infrared and box coater solutions. We expect to complete our phase out of these legacy products by the end of the fourth quarter of fiscal 2014. OSP serves customers such as 3M, Barco, Kingston, Lockheed Martin, Northrup Grumman, Pan Pacific, Seiko Epson, and SICPA. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS Refer to "Note 2. Recently Issued Accounting Pronouncements" regarding the effect of certain recent accounting pronouncements on our consolidated financial statements. 38 --------------------------------------------------------------------------------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 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). 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 29, March 30, Percentage March 29, March 30, Percentage 2014 2013 Change Change 2014 2013 Change Change Segment net revenue: NSE $ 172.3 $ 174.2 $ (1.9 ) (1.1 )% $ 539.2 $ 539.1 $ 0.1 0.0 % CCOP 194.6 179.2 15.4 8.6 597.2 559.9 37.3 6.7 OSP 51.1 51.9 (0.8 ) (1.5 ) 158.2 156.6 1.6 1.0 Net revenue $ 418.0 $ 405.3 $ 12.7 3.1 % $ 1,294.6 $ 1,255.6 $ 39.0 3.1 % Gross profit $ 184.7 $ 155.3 $ 29.4 18.9 % $ 574.8 $ 516.9 $ 57.9 11.2 % Gross margin 44.2 % 38.3 % 44.4 % 41.2 % Amortization of acquired technologies 11.0 17.0 (6.0 ) (35.3 )% 32.3 48.7 (16.4 ) (33.7 )% Percentage of net revenue 2.6 % 4.2 % 2.5 % 3.9 % Research and development 74.1 65.8 8.3 12.6% 216.0 190.9 25.1 13.1 % Percentage of net revenue 17.7 % 16.2 % 16.7 % 15.2 % Selling, general and administrative 113.4 107.3 6.1 5.7 % 329.5 317.4 12.1 3.8 % Percentage of net revenue 27.1 % 26.5 % 25.5 % 25.3 % Amortization of other intangibles 5.2 3.1 2.1 67.7 % 10.7 8.8 1.9 21.6 % Percentage of net revenue 1.2 % 0.8 % 0.8 % 0.7 % Restructuring and related charges 3.6 0.4 3.2 800.0 % 3.8 6.1 (2.3 ) (37.7 )% Percentage of net revenue 0.9 % 0.1 % 0.3 % 0.5 % Loss from discontinued operations, net of tax - - - - % - (1.0 ) 1.0 (100.0 )% Percentage of net revenue - % - % - % 0.1 % Net Revenue Net revenue increased by $12.7 million, or 3.1%, during the three months ended March 29, 2014 compared to the same period a year ago. This increase was primarily due to an increase in our CCOP segment, as discussed below. 39 -------------------------------------------------------------------------------- NSE net revenue decreased by $1.9 million, or 1.1%, during the three months ended March 29, 2014 compared to the same period a year ago. This decrease was driven by $11.0 million of net revenue decreases primarily from our Network Visibility and Control and Services product lines. These decreases were primarily due to the fact that the prior period reflected net revenue from a significant one-time project in our Network Visibility and Control product line, coupled with lower current period demand in our Services product line for hardware services. This was partially offset by $9.1 million of net revenue increases primarily from our Mobility, Cloud and Data Center and Fiber product lines. These increases were primarily due to increased demand from key customers in our Mobility and Fiber product lines and new products in our Cloud and Data Center product line from the acquisition of Network Instruments in the current period. CCOP net revenue increased by $15.4 million, or 8.6%, during the three months ended March 29, 2014 compared to the same period a year ago. This increase was driven by $31.6 million of net revenue increases primarily from our Gesture Recognition Light Source, Circuit Packs and Pluggable product lines. These increases were primarily due to (i) higher demand for our Gesture Recognition Light Source product line related to our customer's next generation gaming console, (ii) higher demand from key customers in our Circuit Packs product line and (iii) higher demand for new products from key customers in our Pluggables product line. These increases were partially offset by $16.2 million of net revenue decreases primarily due to lower deployments by customers of our ROADMs product line and lower demand from key customers in our Passive Components product line. OSP net revenue decreased by $0.8 million, or 1.5%, during the three months ended March 29, 2014 compared to the same period a year ago. This decrease was driven by $6.1 million of net revenue decreases primarily from our Anti-Counterfeiting product line driven by lower cyclical demand for our currency products. This decrease was partially offset by $5.3 million of net revenue increases primarily from our Consumer and Industrial product line driven by last-time buys of products impacted by our plan to exit certain legacy product offerings by the end of the fourth quarter of fiscal 2014 and higher demand for our Gesture Recognition Filters. Net revenue increased by $39.0 million, or 3.1%, during the nine months ended March 29, 2014 compared to the same period a year ago. This increase was primarily due to an increase in our CCOP segment, as discussed below. NSE net revenue remained relatively flat during the nine months ended March 29, 2014 compared to the same period a year ago, increasing by $0.1 million. This increase was driven by $29.8 million of net revenue increases primarily from our Media Access and Content and Fiber product lines. These increases were primarily due to higher demand from a key customer of our Media Access and Content product line and increased spending for the deployment of LTE networks by key customers of our Fiber product line. This was partially offset by $29.7 million of net revenue decreases primarily from our Network Visibility and Control and Ethernet product lines. These decreases were primarily due to the fact that the prior period reflected net revenue from a significant one-time project in our Network Visibility and Control product line and reduced current period spending from key customers in our Ethernet product line. CCOP net revenue increased by $37.3 million, or 6.7%, during the nine months ended March 29, 2014 compared to the same period a year ago. This increase was driven by $102.4 million of net revenue increases primarily from our Gesture Recognition Light Source, Circuit Packs and Pluggable product lines. These increases were primarily due to (i) higher demand for our Gesture Recognition Light Source product line related to our customer's next generation gaming console, (ii) higher demand from key customers in our Circuit Packs product line and (iii) higher demand for new products from key customers in our Pluggables product line. This was partially offset by $65.1 million of net revenue decreases primarily from our ROADMs, Passive Components and Tunables product lines. These decreases were primarily due to lower deployments by customers of our ROADMs product line and lower demand from key customers in our Passive Components and Tunables product lines. OSP net revenue increased by $1.6 million, or 1.0%, during the nine months ended March 29, 2014 compared to the same period a year ago. This increase was driven by $11.5 million of net revenue increases primarily from our Consumer and Industrial product line driven by last-time buys of products impacted by our restructuring plan to exit certain legacy product offerings by the end of the fourth quarter of fiscal 2014 and higher demand for our Gesture Recognition Filters. This was partially offset by $9.9 million of net revenue decreases primarily from our Anti-Counterfeiting product line driven by lower cyclical demand 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 uncertain demand in our NSE 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 NSE markets, which affects revenue and gross margin; (c) fluctuations in customer buying patterns, which cause demand, revenue and profitability volatility; and (d) the current trend of communication industry consolidation, which is expected to continue, that directly affects our CCOP and NSE customer bases and adds additional risk and uncertainty to our financial and business projections. 40 -------------------------------------------------------------------------------- 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 region (in millions): Three Months Ended Nine Months Ended March 29, March 30, March 29, March 30, Net revenue: 2014 2013 2014 2013 Americas $ 196.5 47.0 % $ 194.1 47.9 % $ 609.5 47.1 % $ 618.0 49.2 % EMEA 102.3 24.5 95.1 23.5 311.1 24.0 294.4 23.5 Asia-Pacific 119.2 28.5 116.1 28.6 374.0 28.9 343.2 27.3 Total net revenue $ 418.0 100.0 % $ 405.3 100.0 % $ 1,294.6 100.0 % $ 1,255.6 100.0 % 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 29, 2014 and March 30, 2013 included net revenue from the United States of $152.0 million and $144.1 million, respectively. Net revenue from customers in the Americas during the nine months ended March 29, 2014 and March 30, 2013 included net revenue from the United States of $454.6 million and $469.0 million, respectively. Net revenue from customers outside the Americas during the three months ended March 29, 2014 and March 30, 2013 represented 53.0% and 52.1% of net revenue, respectively. Net revenue from customers outside the Americas during the nine months ended March 29, 2014 and March 30, 2013, represented 52.9% and 50.8% 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 increased 5.9 percentage points during the three months ended March 29, 2014 from 38.3% in the same period a year ago to 44.2% in the current period. The increase was primarily due to (i) the fact that the prior period reflected inventory charges and accelerated amortization of acquired developed technology related to the strategic exit of NSE's low-speed wireline product line, (ii) improvement in NSE gross margin driven by a reduction in manufacturing variances and improved cost efficiencies realized in the current period through the consolidation of our contract manufacturing partners during the second half of fiscal 2013 and (iii) a reduction in amortization of developed technology in the current period driven by certain significant intangible assets becoming fully amortized in the first quarter of fiscal 2014. This increase was partially offset by a change in segment mix as CCOP net revenue, which generates lower gross margin generally than our other two segments, represented a higher percentage of consolidated net revenue in the current period. Gross margin increased 3.2 percentage points during the nine months ended March 29, 2014 from 41.2% in the same period a year ago to 44.4% in the current period. The increase was primarily due to (i) a reduction in amortization of developed technology in the current period due to certain significant intangible assets becoming fully amortized in the first quarter of fiscal 2014, (ii) the absence of charges in the current period related to the strategic exit from NSE's low-speed wireline product line that were reflected in the prior period as referenced above and (iii) improvement in NSE gross margin driven by a reduction in manufacturing variances and improved cost efficiencies realized in the current period through the consolidation of our contract manufacturing partners during the second half of fiscal 2013. This increase was partially offset by a change in segment mix as CCOP net revenue, which generates lower gross margin generally than our other two segments, represented a higher percentage of consolidated net revenue in the current period. 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. Further, we are continuing significant organic investments in research and development (as discussed under "Research and Development" below) and have made a number of strategic acquisitions to add new products and capabilities to our portfolio, with a goal of driving towards higher gross margin solutions. We expect these factors to continue to result in variability of our gross margin. 41 --------------------------------------------------------------------------------Research and Development ("R&D") R&D expense increased by $8.3 million, or 12.6%, during the three months ended March 29, 2014 compared to the same period a year ago. This increase was primarily driven by a $6.8 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation associated with our ongoing investment in R&D and strategic acquisitions, coupled with a $1.6 million increase in materials spending primarily in our CCOP segment. R&D expense increased by $25.1 million, or 13.1%, during the nine months ended March 29, 2014 compared to the same period a year ago. This increase was primarily driven by a $20.4 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation associated with our ongoing investment in R&D and strategic acquisitions. Additionally, R&D offsets from CCOP customer-funded development projects were $2.9 million higher in the same period a year ago, which contributed to the increase 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 by $6.1 million, or 5.7%, during the three months ended March 29, 2014 compared to the same period a year ago. This increase was primarily driven by a $5.2 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation related to our strategic acquisitions. This was partially offset by a $1.1 million decrease in acquisition-related costs and a $0.5 million reduction in other SG&A expenses primarily driven by lower external costs due to the insourcing of certain information technology ("IT") applications in the fourth quarter of fiscal 2013. SG&A expense increased by $12.1 million, or 3.8%, during the nine months ended March 29, 2014 compared to the same period a year ago. This increase was primarily driven by a $15.8 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation related to our strategic acquisitions. This was partially offset by a $4.1 million decrease in external costs due to the insourcing of certain IT applications in the fourth quarter of fiscal 2013 and a $1.2 million decrease in acquisition-related costs. 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 reduce costs through targeted restructuring efforts intended to consolidate our operations, rationalize the manufacturing of our products and align our businesses in response to market conditions. We estimate annualized cost savings of approximately $23.2 million, excluding any one-time charges as a result of the restructuring activities initiated in the past year. Refer to "Note 11. Restructuring and Related Charges" for more detail. During the three and nine months ended March 29, 2014, we incurred restructuring and related charges of $3.6 million and $3.8 million, respectively. 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 third quarter of fiscal 2014, we incurred restructuring and related charges of $3.6 million. The charges are a combination of new and previously announced restructuring plans and are primarily the result of the following: † During the third quarter of fiscal 2014, Management approved a plan in the NSE segment to realign its services, support and product resources in response to market conditions in the mobile assurance market and to increase focus on software products and next generation solutions through acquisitions and R&D. As a result, a restructuring charge of $3.3 million was recorded for severance and employee benefits for 63 employees primarily in SG&A and manufacturing functions located in North America, Latin America, Asia and Europe. As of March 29, 2014, 34 employees have been terminated. Payments related to the remaining severance and benefits accrual are expected to be paid by the end of the second quarter of fiscal 2015. 42 -------------------------------------------------------------------------------- † We recorded a $0.7 million charge to adjust the lease liability accrual for the Germantown location related to the NSE Lease Restructuring Plan approved in the fourth quarter of fiscal 2013. † We recorded a $0.4 million benefit to adjust the accrual balance for the NSE Operation and Repair Outsourcing Restructuring Plan approved in the fourth quarter of fiscal 2012. During the third quarter of fiscal 2013, we incurred restructuring and related charges of $0.4 million. These charges 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, R&D and SG&A 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. † This change was offset by a benefit of $0.5 million for severance and benefits, primarily related to the NSE Operation and Repair Outsourcing Restructuring Plan announced in the fourth quarter of fiscal 2012 and the NSE Manufacturing Support Consolidation Plan announced in the third quarter of fiscal 2012. During the nine months ended March 29, 2014, we recorded $3.8 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: † $4.8 million for severance and benefits for the Central Finance and IT Plan announced in the second quarter of fiscal 2014 and for the NSE Product Strategy Restructuring Plan announced in the current quarter. These charges were slightly offset by a benefit of $0.7 million relating to a reduction in the number of employees impacted by the OSP Operational Realignment Plan approved during the fourth quarter of fiscal 2013. † $0.8 million benefit to adjust the lease liability accrual for the Germantown location related to the NSE Lease Restructuring Plan approved in the fourth quarter of fiscal 2013. During the nine months ended March 30, 2013, we recorded $6.1 million in restructuring and related charges. The charges 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 NSE 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 NSE Operation and Repair Outsourcing Restructuring and the NSE 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 NSE which were the result of the repair outsourcing initiative announced by Management during the fourth quarter of fiscal 2012. † $0.5 million for the exit of two leased sites in NSE for the plan announced during the fourth quarter of fiscal 2012. Our restructuring and other lease exit cost obligations are net of sublease income or lease settlement estimates of approximately $5.0 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. 43 --------------------------------------------------------------------------------Interest and Other Income (Expense), Net Interest and other income (expense), net was $0.6 million during the three months ended March 29, 2014 as compared to $(0.9) million during the same period a year ago. This $1.5 million change was primarily due to a currency exchange loss of $2.0 million in the prior period compared to a currency exchange loss of $0.3 million in the current period driven by improved balance sheet hedging, and the fact that the prior period reflected a $0.7 million realized loss in connection with the repurchase of $50.0 million aggregate principal amount of the 1% Senior Convertible Notes due 2026 (the "2026 Notes") which were fully repurchased and redeemed in fiscal 2013. This was partially offset by a decrease in other income of $0.9 million primarily due to the receipt of a deposit in the prior period. Interest and other income (expense), net was $0.4 million during the nine months ended March 29, 2014 as compared to $(3.7) million during the same period a year ago. This $4.1 million change was primarily driven by the fact that the prior period reflected a $4.1 million realized loss in connection with the repurchase of $150.0 million aggregate principal amount of the 2026 Notes which were fully repurchased and redeemed in fiscal 2013 and a $0.5 million reduction in other expense primarily due to the absence of commitment fees due under the revolving credit facility which the Company terminated in the first quarter of fiscal 2014. This was partially offset by a decrease in other income of $1.1 million primarily due to the receipt of a deposit in the prior period. Interest Expense Interest expense increased by $3.5 million, or 83.3%, during the three months ended March 29, 2014 compared to the same period a year ago. The increase was primarily due to accretion of the debt discount on our 0.625% Senior Convertible Notes due 2033 ("the 2033 Notes") in the current period as compared to the accretion on our 2026 Notes in the same period a year ago. The increase was primarily driven by the fact that the unamortized debt discount of our 2033 Notes in the current period was significantly higher than that of our 2026 Notes in the prior period. During the three months ended March 29, 2014 and March 30, 2013 we accreted debt discount of $6.0 million and $2.8 million, respectively. Interest expense increased by $5.9 million, or 38.3%, during the nine months ended March 29, 2014 compared to the same period a year ago. The increase was primarily due to an increase in accretion of the debt discount as referenced above, coupled with a $1.3 million write-off of unamortized issuance costs related to the termination of the revolving credit facility in the first quarter of fiscal 2014. During the nine months ended March 29, 2014 and March 30, 2013, we accreted debt discount of $14.6 million and $10.6 million, respectively. Provision for Income Tax We recorded an income tax benefit of $17.2 million and $13.7 million for the three and nine months ended March 29, 2014, respectively. 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. The income tax benefit recorded for the three and nine months ended March 29, 2014, primarily relates to income tax in certain foreign and state jurisdictions based on our forecasted pre-tax income for the year in those locations offset by the recognition of $21.7 million of uncertain tax benefits related to deferred tax assets due to the expiration of the statute of limitations in a non-US jurisdiction. A tax benefit of $5.1 million was recorded for the nine months ended March 29, 2014, related to the income tax intraperiod tax allocation rules in relation to other comprehensive income. In accordance with authoritative guidance, the year to date benefit may reverse during the year. The income tax expense recorded for the three and nine months ended March 30, 2013, primarily relates to income tax in certain foreign and state jurisdictions based on the Company's forecasted pre-tax income for the year in those locations. The income tax benefit and 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, the income tax benefit recorded in continuing operations under the income tax intraperiod tax allocation rules, and the recognition of the unrecognized tax benefits. As of March 29, 2014 and June 29, 2013, our unrecognized tax benefits totaled $58.4 million and $80.7 million, respectively, and are included in deferred taxes and other non-current tax liabilities, net. We had $23.6 million accrued for the payment of interest and penalties at March 29, 2014. The unrecognized tax benefits that may be recognized during the next twelve months are approximately $21.4 million. 44 -------------------------------------------------------------------------------- Discontinued Operations During the second quarter of fiscal 2013, we closed the sale of the Hologram Business, previously within the OSP reportable segment, and received gross proceeds of $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. In the fourth quarter of fiscal 2014, we submitted an arbitration demand to resolve a dispute regarding the amount we are owed from the buyer under the earnout clause. Net revenue of the Hologram Business for the nine months ended March 30, 2013 was $5.2 million. Net loss for the nine months ended March 30, 2013 was $1.0 million. There was no tax effect associated with the discontinued operation for any periods presented. Operating Segment Information (in millions) Three Months Ended Nine Months Ended March 29, March 30, Percentage March 29, March 30, Percentage 2014 2013 Change Change 2014 2013 Change Change NSE Net revenue $ 172.3 $ 174.2 $ (1.9 ) (1.1 )% $ 539.2 $ 539.1 $ 0.1 - % Operating income 9.9 13.0 (3.1 ) (23.8 )% 51.2 65.1 (13.9 ) (21.4 )% Operating margin 5.7 % 7.5 % 9.5 % 12.1 % CCOP Net revenue 194.6 179.2 15.4 8.6 % 597.2 559.9 37.3 6.7 % Operating income 22.4 19.2 3.2 16.7 % 73.5 64.2 9.3 14.5 % Operating margin 11.5 % 10.7 % 12.3 % 11.5 % OSP Net revenue 51.1 51.9 (0.8 ) (1.5 )% 158.2 156.6 1.6 1.0 % Operating income 18.2 18.6 (0.4 ) (2.2 )% 57.8 56.0 1.8 3.2 % Operating margin 35.6 % 35.8 % 36.5 % 35.8 % NSE NSE operating margin decreased 1.8 percentage points during the three months ended March 29, 2014 from 7.5% in the same period a year ago to 5.7% in the current period. The decrease in operating margin was primarily due to an increase in operating expenses driven by higher headcount primarily related to strategic acquisitions in fiscal 2014 and ongoing R&D investments primarily in our Media Access and Content product line. This was partially offset by an improvement in gross margin driven by a reduction in manufacturing variances and improved cost efficiencies realized in the current period from the consolidation of our contract manufacturing partners during the second half of fiscal 2013. NSE operating margin decreased 2.6 percentage points during nine months ended March 29, 2014 from 12.1% in the same period a year ago to 9.5% in the current period. The decrease in operating margin was primarily due to an increase in operating expenses driven by higher headcount primarily related to strategic acquisitions in fiscal 2014 and ongoing R&D investments primarily in our Media Access and Content product line. This was partially offset by an improvement in gross margin driven by a reduction in manufacturing variances and improved cost efficiencies realized in the current period from the consolidation of our contract manufacturing partners during the second half of fiscal 2013. CCOP CCOP operating margin increased 0.8 percentage points during the three months ended March 29, 2014 from 10.7% in the same period a year ago to 11.5% in the current period. The increase in operating margin was primarily due to an overall increase in CCOP net revenue as referenced above and an improvement in gross margin driven by a favorable product mix and improvements in yields. This was partially offset by an increase in R&D expense primarily due to higher headcount associated with our ongoing R&D investments in the current period. 45 -------------------------------------------------------------------------------- CCOP operating margin increased 0.8 percentage points during nine months ended March 29, 2014 from 11.5% in the same period a year ago to 12.3% in the current period. The increase in operating margin was primarily due to improvement in gross margin driven by improvement in yields and an overall increase in CCOP net revenue as referenced above. This was partially offset by an increase in R&D expense primarily due to higher headcount associated with our ongoing R&D investments and higher R&D offsets in the same period a year ago as referenced above. OSP OSP operating margin remained relatively flat during the three months ended March 29, 2014, decreasing by 0.2 percentage points. The decrease in operating margin was primarily due to an unfavorable product mix, partially offset by a reduction in SG&A expense driven by lower labor and benefits expenses. OSP operating margin increased 0.7 percentage points during nine months ended March 29, 2014 from 35.8% in the same period a year ago to 36.5% in the current period. The increase in operating margin was primarily due to improvement in gross margin driven by a reduction in SG&A expense due to lower labor and benefits expenses. 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 5.0% or $5.0 million, whichever is greater, of each of our investment portfolios 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 recorded as other comprehensive income (loss) and 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 29, 2014 and virtually all debt securities held were of investment grade (at least BBB-/Baa3). As of March 29, 2014, U.S. entities owned approximately 83.9% of our cash and cash equivalents, short-term investments and restricted cash. As of March 29, 2014, 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 29, 2014, we have not realized material investment losses but can provide no assurance that the value or the liquidity of our 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 29, 2014, we had a combined balance of cash and cash equivalents, short-term investments and restricted cash of $926.2 million, an increase of $410.3 million from June 29, 2013 primarily due to our issuance of the 2033 Notes and $126.4 million of cash provided by operating activities, partially offset by a $100.0 million share repurchase in the first quarter of fiscal 2014. Cash and cash equivalents increased by $33.5 million in the nine months ended March 29, 2014 due to $557.2 million of cash provided by financing activities and $126.4 million of cash provided by operating activities, partially offset by $651.8 million of cash used in investing activities. During the nine months ended March 29, 2014, cash provided by operating activities was $126.4 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $173.7 million, and changes in operating assets and liabilities that used $47.3 million. Changes in operating assets and liabilities related primarily to a decrease in accrued payroll and related expenses of $33.0 million due to timing of salary and variable incentive payments, a decrease in accrued expenses and other current and non-current liabilities of $23.2 million, a decrease in income taxes payable of $22.2 million, partially offset by an increase in accounts payable of $23.2 million due to lower payment activity in the current quarter and increase in deferred revenue current and non-current of $9.4 million. 46 -------------------------------------------------------------------------------- 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 29, 2014, cash used in investing activities was $651.8 million, primarily due to $885.1 million of purchases of available-for-sale securities largely driven by the investment of proceeds from the 2033 Notes, $219.3 million of cash used for the acquisitions of Trendium, Network Instruments and Time Bandwidth Products, and $68.1 million of purchases of property, plant and equipment. These were partially offset by proceeds from maturities of available-for-sale investments of $327.7 million and sales of available-for-sale investments of $186.8 million in the current period. 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 29, 2014, cash provided by financing activities was $557.2 million, primarily related to the $650.0 million proceeds from the 2033 Notes partially offset by the repurchase of 7.4 million shares of our outstanding common stock for $100.0 million in the current period. 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. We believe that our existing cash balances and investments will be sufficient to meet our liquidity and capital spending requirements over the next twelve months. 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 2014, 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 29, 2013, 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." 47 --------------------------------------------------------------------------------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. Refer to "Note 14. Stock-Based Compensation" for more information. Pension and Other Post-retirement Benefits We sponsor significant pension plans for certain past and present employees primarily in the U.K., Germany and Switzerland. 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 acquisitions during fiscal 2010 and the third quarter of fiscal 2014. The U.K. plan and Switzerland 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. As of March 29, 2014, our pension plans were under funded by $100.8 million since the projected benefit obligation exceeded the fair value of its plan assets. Similarly, we had a liability of $0.9 million related to our non-pension post-retirement benefit plan. Pension plan assets are managed by external third parties and we monitor the performance of our investment managers. As of March 29, 2014, the fair value of plan assets had increased approximately 5.0% since June 29, 2013, 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 $7.7 million based upon June 29, 2013 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. Refer to "Note 15. Employee Defined Benefit Plans" for more details. |