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MICROSEMI CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q includes current beliefs, expectations and other forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed in Part II, Item 1A, "Risk Factors" and elsewhere in this Quarterly Report. This "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") and the accompanying condensed consolidated financial statements and notes thereto must be read in conjunction with the MD&A and the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended September 29, 2013, in their entirety. Unless the context otherwise requires, the "Company," "Microsemi," "we," "our," "ours" and "us" refer to Microsemi Corporation and its consolidated subsidiaries. OVERVIEW We are a leading designer, manufacturer and marketer of high-performance analog and mixed-signal semiconductor solutions differentiated by power, security, reliability and performance. We offer one of the industry's most comprehensive portfolios of semiconductor technology. Our products include high-performance and radiation-hardened analog mixed-signal integrated circuits, field programmable gate arrays ("FPGAs"), system on chip solutions ("SoCs") and application-specific integrated circuits ("ASICs"); power management products; timing and synchronization devices and precise time solutions, setting the world's standard for time; voice processing devices; radio frequency ("RF") solutions; discrete components; security technologies and scalable anti-tamper products; Power-over-Ethernet integrated circuits ("ICs") and midspans; as well as custom design capabilities and services. The principal end markets that we serve include Aerospace, Communications, Defense & Security, and Industrial. Today, Microsemi products are found in applications such as: communications infrastructure systems, both wireless and wired LAN systems, implantable pacemakers and defibrillators, missile systems, military and commercial satellites and aircrafts, oil field equipment and airport security systems. Mission and Vision Statements Mission: Strengthen and leverage the industry's most comprehensive product technology portfolio, differentiated by power, security, reliability and performance, to expand our leadership position in high-value, high-barrier-to-entry markets. Develop innovative leading-edge system solutions that provide our customers with an unparalleled competitive edge, and deliver best-in-class technical service and support. Vision: Leading-edge system solutions, solving the most difficult problems where performance matters, reliability is vital and security is non-negotiable. Our growth strategy is dependent on our ability to successfully develop new technologies and products, and is complemented by our ability to implement our selective acquisitions strategy. New technologies or products that we may develop may not lead to an incremental increase in revenues, and there is a risk that these new technologies or products will decrease the demand for our existing products and result in an offsetting reduction in revenues. There can be no assurance that the benefits of any acquisition will outweigh the attendant costs, and if they do not, our results of operations and stock price may be adversely affected. Summary of Financial Results Net sales, gross profit and gross margin were as follows (amounts in thousands): Quarter Ended Nine Months Ended June 29, June 30, June 29, June 30, 2014 2013 Variance $ Variance % 2014 2013 Variance $ Variance % Net sales $ 292,301 $ 242,630 $ 49,671 20.5 % $ 834,948 $ 725,561 $ 109,387 15.1 % Gross profit $ 153,590 $ 138,312 $ 15,278 11.0 % $ 440,537 $ 414,350 $ 26,187 6.3 % Gross margin 52.5 % 57.0 % (4.5 )% 52.8 % 57.1 % (4.3 )% We recorded an increase in net sales between the quarters ended June 29, 2014 ("Q3 2014") and June 30, 2013 ("Q3 2013"), and an increase in net sales between the nine months ended June 29, 2014 ("2014 YTD") and June 30, 2013 ("2013 YTD") with sales in each of our end markets benefiting from our acquisition of Symmetricom, Inc. (sometimes referred to herein as "Microsemi - FTD"). For 2014 YTD, we estimate that between 10% and 15% of net sales were derived from products 19-------------------------------------------------------------------------------- Table of Contents acquired in the Microsemi - FTD transaction. We did not conclude any acquisitions in fiscal year 2013. In 2014 YTD, we recorded $15.7 million in net sales, all amounts which have been collected, related to a government contract that was terminated by the government for convenience pursuant to the terms of the contract in the first quarter of 2014. As discussed further in "Results of Operations", we recorded net sales increases in our Communications, Defense & Security and Industrial end markets in Q3 2014 as compared to Q3 2013, offset by a decrease in our Aerospace end market. Comparing 2014 YTD to 2013 YTD, we recorded net sales increases in our Communications and Industrial end markets, offset by decreases in our Aerospace and Defense & Security end markets. On July 24, 2014, we announced that we expect our consolidated net sales for the fourth quarter of fiscal year 2014 to be between $299 million and $305 million. Gross profit increased $15.3 million to $153.6 million (52.5% of net sales) for Q3 2014 from $138.3 million (57.0% of net sales) for Q3 2013 and increased $26.2 million to $440.5 million (52.8% of net sales) for 2014 YTD from $414.4 million (57.1% of net sales) for 2013 YTD. During Q3 2014, we recorded $7.9 million in inventory write-offs from restructuring activities, as discussed further in "Results of Operations". We also recorded acquisition-related inventory charges totaling $2.2 million for Q3 2014 and $16.7 million in 2014 YTD from our acquisition of Microsemi - FTD. As discussed further in "Results of Operations", during 2014 YTD, we recorded provisions for employee severance of $12.1 million, net provisions for contract termination costs of $8.2 million and provisions for other associated costs for restructuring of $6.7 million. For Q3 2014 and 2014 YTD, we recorded income tax provisions of $3.5 million and $6.7 million, respectively. For Q3 2013 and 2013 YTD, we recorded an income tax benefit of $0.0 million and an income tax provision of $6.3 million, respectively. The difference in our effective tax rates from the U.S. statutory rate of 35% primarily reflects the impact of the mix of domestic and international pre-tax income, valuation allowance and credits. Our tax provision for the nine months ended June 29, 2014 was the combined calculated tax expenses/benefits for various jurisdictions, as well as a benefit from the release of valuation allowance of approximately $2.7 million, that resulted from the preliminary allocation of consideration from of our acquisition of Microsemi - FTD. Uncertain macroeconomic conditions worldwide subject us to certain risks (see Part II, Item 1A, Risk Factors, "Negative or uncertain worldwide economic conditions may adversely affect our business, financial condition, cash flow and results of operations," "The concentration of the facilities that service the semiconductor industry, including facilities of current or potential vendors or customers, makes us more susceptible to events or disasters affecting the areas in which they are most concentrated," and "We may be unable to successfully implement our acquisitions strategy or integrate acquired companies and personnel with existing operations"). Markets Our products include discrete and integrated circuit, module, and subsystem solutions that enhance customer designs by improving performance, security, reliability and power consumption. The principal end markets we serve include: • Aerospace - Microsemi's high-performance solutions are used by the majority of commercial airliners manufactured today, including the latest advanced models such as the Boeing 787 Dreamliner, Airbus A350 and Airbus A380. Microsemi's high-reliability products are used in most satellites and in a wide range of commercial and military avionics systems. • Communications - Microsemi is a key supplier to top-tier companies focused on wired and wireless communications products. These products are deployed in applications ranging from the central office to the enterprise and the home, and to a broad array of wired and wireless networked devices. Microsemi boasts the largest and most complete timing product offering, as well as the industry's only end to end timing product portfolio. Microsemi also pioneered the concept and development of PoE technology and offers ICs and system solutions (midspans) based on this increasingly popular power transmission solution. • Defense & Security - Microsemi's solutions are used by all Tier 1 prime contractors in a variety of homeland and offshore security applications. Microsemi's defense and security solutions are also used in products such as unmanned aerial vehicles, next-generation body scanners, and radio and guidance systems. • Industrial - Microsemi delivers secure and highly reliable solutions for applications including industrial controls, machine-to-machine (M2M) communications, energy exploration and drilling, semiconductor capital equipment and alternative energy platforms. Microsemi is also a leading supplier of ultra-low power wireless solutions used in medical devices including implantable defibrillators and pacemakers, MRI machines, and portable medical equipment. 20-------------------------------------------------------------------------------- Table of Contents Recent Product Introductions Microsemi marketed a number of new products that were announced during the recent quarter, including: • full military temperature support for the company's SmartFusion2™ SoC FPGA and IGLOO2™ FPGA product portfolio for defense and aerospace markets; • WhiteboxSSL™, a cryptography key management plugin and drop-in replacement for OpenSSL which enables significantly stronger protection against memory attacks such as the one experienced in the highly-publicized Heartbleed attack; • the industry's only commercially-available low noise chip scale atomic clock (LN CSAC), which enhances the low size, weight, and power (SWaP) of Microsemi's existing CSAC by adding low phase noise performance; • a new silicon carbide (SiC) MOSFET product family with new 1200 volt (V) solutions, designed for high-power industrial applications where efficiency is critical such as solutions for solar inverters, electric vehicles, welding and medical devices; and • a new line of monolithic microwave integrated circuit (MMIC) devices comprised of 16 products spanning DC-40GHz and includes wideband amplifier, low noise amplifier and switch products designed for the defense, communications, instrumentation and aerospace markets. RESULTS OF OPERATIONS Net sales increased $49.7 million or 20.5% to $292.3 million in Q3 2014 from $242.6 million in Q3 2013 and increased $109.4 million or 15.1% to $834.9 million for 2014 YTD from $725.6 million for 2013 YTD, with sales in each of our end markets benefiting from our acquisition of Microsemi - FTD. For 2014 YTD, we estimate that between 10% to 15% of net sales were derived from products acquired with Microsemi - FTD. In 2014 YTD, we recorded $15.7 million in net sales, all amounts which have been collected, related to a government contract that was terminated by the government for convenience pursuant to the terms of the contract in the first quarter of 2014. Estimated sales by end markets are based on our understanding of end market uses of our products. An estimated breakout of net sales by end markets is approximately as follows (amounts in thousands): Quarter Ended Nine Months Ended June 29, June 30, June 29, June 30, 2014 2013 2014 2013 Aerospace $ 43,399 $ 45,075 $ 125,807 $ 137,484 Communications 100,181 67,769 297,068 208,890 Defense & Security 79,947 76,302 221,959 231,369 Industrial 68,774 53,484 190,114 147,818 Total $ 292,301 $ 242,630 $ 834,948 $ 725,561 Net sales in the Aerospace end market decreased $1.7 million to $43.4 million in Q3 2014 from $45.1 million in Q3 2013 and decreased $11.7 million to $125.8 million for 2014 YTD from $137.5 million for 2013 YTD. While we believe we are benefiting from significant content growth on newer aircrafts such as the Boeing 787, Airbus A350 and A380, net sales were impacted by irregular order rates and a softening satellite market. Going forward, we expect that our differentiated highly-reliable and secure FPGA technology will contribute to growth in this end market and we noted increasing orders for satellite product, which due to long cycle times, will mostly be shipped in the December quarter and beyond. We are optimistic about the long term fundamentals of our Aerospace end market. In the near term, we expect that sales in this end market will remain stable based on our current backlog and shipments made to date, although the mix of satellite products is expected to soften in the upcoming quarter due to extended cycle times. Net sales in the Communications end market increased $32.4 million to $100.2 million in Q3 2014 from $67.8 million in Q3 2013 and increased $88.2 million to $297.1 million for 2014 YTD from $208.9 million for 2013 YTD. This end market benefited from contributions from our acquisition of Microsemi - FTD, increased contributions of voice circuit, timing and synchronization products, higher sales of LTE and gateway applications and amounts recognized from the termination of a contract by the government in the first quarter of 2014. We expect long term growth in this end market, driven by continued strength from our timing and synchronization products, gateway and enterprise communications applications. With the integration of Microsemi - FTD's products, we believe we have the broadest portfolio of timing products which allows us to better anticipate and serve our customers' needs while improving our market share. 21-------------------------------------------------------------------------------- Table of Contents Net sales in the Defense & Security end market increased $3.6 million to $79.9 million in Q3 2014 from $76.3 million in Q3 2013 and decreased $9.4 million to $222.0 million for 2014 YTD from $231.4 million for 2013 YTD. While sales increased sequentially, this end market was impacted by rescheduling of orders and industry weakness surrounding the government shutdown during the first quarter of 2014. For the next quarter, we note a stronger environment with an improving defense budget, growing foreign military sales and normalization of channel inventories. While we believe that net sales in this end market will grow, we recognize that this market is still impacted by the lingering effects of sequestration. Net sales in the Industrial end market increased $15.3 million to $68.8 million in Q3 2014 from $53.5 million in Q3 2013 and increased $42.3 million to $190.1 million for 2014 YTD from $147.8 million for 2013 YTD. This end market benefited from increased shipments of ultra-low power radios in medical applications, as well as broad based strength for our power products in the plasma and semiconductor capital equipment markets. In the near term, we believe that net sales in this end market will grow against the backdrop of an improving macroeconomic recovery. We expect growth contributions from our chip scale atomic clocks that serve energy exploration applications, ultra-low power RF products, several emerging market opportunities, and our current backlog. Net sales by geographic area based on a customer's ship-to location were as follows (amounts in thousands): Quarter Ended Nine Months Ended June 29, June 30, June 29, June 30, 2014 2013 2014 2013 United States $ 155,475 $ 124,411 $ 439,477 $ 379,625 Europe 42,461 34,445 121,021 106,609 Asia 85,767 75,900 251,012 221,616 Other 8,598 7,874 23,438 17,711 Total $ 292,301 $ 242,630 $ 834,948 $ 725,561 Gross profit increased $15.3 million to $153.6 million (52.5% of net sales) for Q3 2014 from $138.3 million (57.0% of net sales) for Q3 2013 and increased $26.2 million to $440.5 million (52.8% of net sales) for 2014 YTD from $414.4 million (57.1% of net sales) for 2013 YTD. We periodically evaluate the profitability of our various offerings. Should the actual or expected profitability fall below an acceptable threshold, we may decide to stop offering a product, in part to reallocate manufacturing, operations, engineering, sales and support resources to products we expect to generate greater returns. During Q3 2014, our evaluation led us to selectively exit product offerings that we believe will continue to lag our overall profitability goals. This resulted in inventory charges of $7.9 million. We believe that for many of these products, market dynamics dictate that price is the primary differentiator rather than our value-added core competencies of power, reliability, security and performance. We also recorded acquisition-related inventory charges totaling $2.2 million for Q3 2014 and $16.7 million in 2014 YTD from our acquisition of Microsemi - FTD. Selling, general and administrative ("SG&A") expenses increased $12.3 million to $61.1 million for Q3 2014 from $48.8 million in Q3 2013 and increased $29.0 million to $181.5 million for 2014 YTD from $152.5 million for 2013 YTD. The increase was due to the effects of our acquisition of Microsemi - FTD, including acquisition-related costs of $0.3 million in Q3 2014 and $2.4 million in 2014 YTD, higher stock-based compensation expense and higher selling expense related to our increase in net sales. Research and development expense increased $5.9 million to $48.0 million for Q3 2014 from $42.2 million for Q3 2013 and increased $14.1 million to $141.5 million for 2014 YTD from $127.3 million for 2013 YTD, primarily due to the effects of our acquisition of Microsemi - FTD. The principal focus of our research and development activities has been to improve processes and to develop new products that support the growth of our businesses. The spending on research and development was principally to develop new higher-margin application-specific products, including, among others, our 65nm process development for next generation programmable products, higher power PoE solutions, the continued roadmap development of our industry-leading timing & synchronization products, our silicon germanium ("SiGe") RF power amplifier solutions for wireless LAN applications, and the ongoing development of gallium nitride ("GaN") and silicon carbide ("SiC") power management and RF solutions. Amortization of intangible assets increased $2.4 million to $23.4 million for Q3 2014 from $21.0 million for Q3 2013 and increased $5.8 million to $69.7 million for 2014 YTD from $63.9 million for 2013 YTD. The increase was primarily due to the amortization of acquired intangibles related to our acquisition of Microsemi - FTD, offset by intangible assets that reached their amortizable lives. These amounts include amortization related to acquired completed technology of $33.2 million for 2014 YTD and $29.3 million for 2013 YTD. Restructuring charges amounted to $14.7 million for Q3 2014 compared to $1.0 million for Q3 2013 and $27.1 million for 2014 YTD compared to $8.1 million for 2013 YTD. The variances related to the timing and announcement of restructuring 22-------------------------------------------------------------------------------- Table of Contents activities, with the year-to-date increase primarily related to severance and facility shutdown costs and actions following our acquisition of Microsemi - FTD. The following table reflects the related restructuring activities and the accrued liabilities at the dates below (amounts in thousands): Contract Employee Severance Termination Costs Other Associated Costs Total Balance at September 29, 2013 $ 1,826 $ 6,936 $ - $ 8,762 Assumed from acquisition 799 1,885 - 2,684 Provisions 12,142 10,874 6,688 29,704 Reversal of prior provision - (2,631 ) - (2,631 ) Cash expenditures (11,812 ) (5,343 ) (2,025 ) (19,180 ) Other non-cash settlement - (578 ) (4,607 ) (5,185 ) Balance at June 29, 2014 $ 2,955 $ 11,143 $ 56 $ 14,154 We recorded provisions for employee severance of $12.1 million for 2014 YTD, which covered approximately 300 individuals in engineering, manufacturing, administration and sales. Employee severance is expected to be paid within the next twelve months. We recorded provisions for contract termination costs of $10.9 million for 2014 YTD, of which $7.9 million was recorded for the fair value at the cease-use date of operating lease liabilities for space we have exited and $3.0 million was recorded for lease termination costs. Facilities consisted of manufacturing sites, as well as sales, engineering and administrative space. We recorded a $2.6 million reversal of prior provision related to a lease termination agreement executed during Q3 2014 for a manufacturing facility in Scottsdale, Arizona. We recorded provisions for this facility when it ceased production activities during the quarter ended April 3, 2011. We recorded provisions for other associated costs for restructuring of $6.7 million for 2014 YTD. Facility and equipment impairments accounted for $3.1 million, costs incurred to close facilities and relocate operations accounted for $2.1 million and $1.5 million related to the sale of a property that was previously used primarily as a manufacturing facility. For Q3 2014 and 2014 YTD, we recorded income tax provisions of $3.5 million and $6.7 million, respectively. For Q3 2013 and 2013 YTD, we recorded an income tax benefit of $0.0 million and an income tax provision of $6.3 million, respectively. The difference in our effective tax rates from the U.S. statutory rate of 35% primarily reflects the impact of the mix of domestic and international pre-tax income, valuation allowance and credits. Our tax provision for the nine months ended June 29, 2014 was the combined calculated tax expenses/benefits for various jurisdictions, as well as a benefit for the release of valuation allowance of approximately $2.7 million, that resulted from the preliminary allocation of consideration from our acquisition of Microsemi - FTD. CAPITAL RESOURCES AND LIQUIDITY We had $183.3 million and $256.4 million in cash and cash equivalents at June 29, 2014 and September 29, 2013, respectively. During 2014 YTD and 2013 YTD, we financed our operations with cash generated from operations. A significant portion of our cash and cash equivalents are domiciled in the United States and we believe that we have the ability to raise cash in the United States through existing and new credit facilities or by settling loans with our foreign subsidiaries. We believe that through our cash flows from operations, together with our existing cash and cash equivalents, we will be able to meet our operating and capital requirements for at least the next twelve months. Our various foreign subsidiaries hold cash and cash equivalents, and as we intend to reinvest certain foreign earnings indefinitely, these balances held outside the United States may not be readily available to meet our domestic cash requirements. We require a substantial amount of cash in the United States for operating requirements, purchases of property and equipment, debt service, and potentially for future acquisitions. If we are unable to meet our domestic cash requirements using domestic cash flows from operations, domestic cash and cash equivalents, or by settling loans with our foreign subsidiaries, it may be necessary for us to consider repatriation of earnings that we have designated as permanently reinvested. Any repatriation of earnings may require us to record additional income tax expense and remit additional taxes, which could have a material effect on our results of operations, cash flows and financial condition. 23-------------------------------------------------------------------------------- Table of Contents Net cash provided by operating activities increased $34.5 million to $147.1 million for 2014 YTD from $112.6 million for 2013 YTD. A summary of net cash provided by operating activities for 2014 YTD and 2013 YTD is as follows (amounts in thousands): Nine Months Ended June 29, June 30, 2014 2013 Net income (loss) $ (9,673 ) $ 29,588 Depreciation and amortization 93,935 85,425 Provision for doubtful accounts 17 (213 ) Amortization of deferred financing cost 591 755 Loss on disposition or impairment of assets 7,693 - Deferred income taxes 3,330 1,962 Stock-based compensation 32,781 25,409 Net change in working capital accounts 20,752 (30,126 ) Net change in other long term assets and liabilities (2,318 ) (183 ) Net cash provided by operating activities $ 147,108 $ 112,617 Accounts receivable increased $22.1 million to $184.2 million at June 29, 2014 from $162.1 million at September 29, 2013. Inventories increased $34.7 million to $196.7 million at June 29, 2014 from $162.0 million at September 29, 2013. Current liabilities increased $29.9 million to $163.2 million at June 29, 2014 from $133.2 million at September 29, 2013. These increases were due primarily to our acquisition of Microsemi - FTD. Net cash used in investing activities was $276.2 million for 2014 YTD compared to $31.1 million for 2013 YTD. Net cash used in investing activities for 2014 YTD was $28.9 million in purchases of property and equipment and net cash consideration of $287.7 million for the acquisition of Microsemi FTD, offset by $40.3 million for the proceeds from the sales of short term investments. Net cash used in investing activities for 2013 YTD consisted of $31.1 million in purchases of property and equipment. Net cash provided by financing activities was $56.0 million for 2014 YTD compared to $(64.9) million for 2013 YTD. Net cash provided by financing activities in 2014 YTD consisted of borrowings under our Credit Agreement of $289.5 million offset by principal repayments of $150.0 million on our credit facility, debt extinguishment of $89.5 million recorded in conjunction with Amendment No. 5 to our Credit Agreement and $1.5 million in credit facility issuance costs. In addition, for 2014 YTD, we recorded $10.6 million in net proceeds from stock awards offset by a $3.0 million payment to terminate a capital lease. Net cash used in financing activities in 2013 YTD primarily consisted of borrowings under our Credit Agreement of $277.5 million offset by principal repayments of $77.0 million, debt extinguishment of $277.5 million and $0.6 million in credit facility issuance costs. In addition, for 2013 YTD, we recorded $12.7 million in net proceeds from stock awards. The debt extinguishments referenced above did not change the net principal balance outstanding. Credit Agreement We are a party to a senior secured credit facility with Royal Bank of Canada ("RBC") which consists of a term loan facility and a $50.0 million revolving credit facility. As of June 29, 2014, we had $726.0 million in term loan borrowings and no revolving borrowings. Subsequent to June 29, 2014, we completed optional principal prepayments on the incremental term loan totaling $28.0 million resulting in an aggregate term loan balance of $698.0 million. During the quarter ended March 30, 2014, we entered into Amendment No. 5 to our Amended and Restated Credit Agreement dated as of October 13, 2011 (as amended, the "Credit Agreement") with RBC as administrative agent and collateral agent, the other agents party thereto and the lenders referred to therein. The amendment provided for (i) new pricing term for certain of our term loans, (ii) certain modifications to the excess cash flow prepayment and restricted payment provisions, and (iii) an increase in the amount of incremental credit facilities that Microsemi can request to an aggregate amount not to exceed $300.0 million plus certain amounts based on the Company's leverage ratio. In connection with the amendment, RBC replaced Morgan Stanley Senior Funding, Inc. ("MSSF") as administrative agent and Morgan Stanley & Co. LLC as collateral agent under the Credit Agreement. We accounted for the amendment as a debt modification with respect to amounts that remained in the syndicate and a debt extinguishment with respect to the $89.5 million that exited the syndicate. Accordingly, during the quarter ended March 30, 2014, we recorded debt extinguishment expense of $0.7 million. The amendment did not impact the net principal balance outstanding as amounts that exited the syndicate were replaced. 24-------------------------------------------------------------------------------- Table of Contents During the quarter ended December 29, 2013, we entered into a commitment letter with MSSF pursuant to which MSSF committed to provide a $150.0 million incremental term loan under our term loan facility, which MSSF subsequently syndicated during the quarter. The incremental term loan was made available to (i) finance the acquisition of Symmetricom, (ii) repay any existing indebtedness of Symmetricom following the consummation of the merger, and (iii) pay fees and expenses related to the merger. The covenants under the incremental term loan are consistent with those in our existing Credit Agreement. As described above, RBC is the current administrative and collateral agent. The fair value of our term loans were approximately $722.8 million at June 29, 2014 and $674.3 million at September 29, 2013. We classify this valuation as a Level 2 fair value measurement. Under our Credit Agreement, we may borrow under a "Base Rate" which approximates the prime rate plus an applicable margin or "Eurodollar Rate" which approximates LIBOR plus an applicable margin. Eurodollar Rate loans are also subject to a Eurodollar Floor. At June 29, 2014, the principal amounts outstanding were Eurodollar Rate loans and interest rate information as of June 29, 2014 were as follows (amounts in thousands): Principal Eurodollar Outstanding Base Rate Base Rate Margin Rate Margin Eurodollar Floor Applicable Rate Revolving and swingline loans $ - 3.25 % 3.25 % 4.25 % - % - % Term loan $ 646,375 3.25 % 1.50 % 2.50 % 0.75 % 3.25 % Incremental term loan $ 79,651 3.25 % 1.75 % 2.75 % 0.75 % 3.50 % Our term loan facility matures in February 2020 and as of June 29, 2014, there are no scheduled principal repayments until the maturity date. The Credit Agreement stipulates an annual principal payment of a percentage of Excess Cash Flow ("ECF"). The first ECF application date will be measured as of the end of fiscal year 2015 and the ECF percentage will be 50% if the Consolidated Leverage Ratio (as defined in the Credit Agreement) as of the last day of the fiscal year is equal to or greater than 3.00 to 1.00 and 0% otherwise. We currently pay an undrawn commitment fee of 0.375% on the unused portion of the revolving facility. If any letters of credit are issued, then we expect to pay a fronting fee equal to 0.25% per annum of the aggregate face amount of each letter of credit and a participation fee on all outstanding letters of credit at a per annum rate equal to the margin then in effect with respect to Eurodollar Rate-based loans on the face amount of such letter of credit. Our Credit Agreement includes financial covenants requiring a maximum leverage ratio and minimum fixed charge coverage ratio that are applicable only when revolving loans or swingline loans are outstanding at the end of a fiscal quarter and also contains other customary affirmative and negative covenants and events of default. We were in compliance with our covenants as of June 29, 2014. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States that require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the unaudited condensed consolidated financial statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Information, with respect to our critical accounting policies, that we believe could have the most significant effect on our reported results and require subjective or complex judgments is contained in Note 1 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 29, 2013. We have made no significant changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the year ended September 29, 2013. RECENTLY ISSUED ACCOUNTING STANDARDS In December 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2011-11, the objective of which is to provide additional disclosures on the effect or potential effect of rights of setoff associated with an entity's recognized assets and recognized liabilities within the scope of the update. The guidance in the update primarily impacts financial instruments and derivatives subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU did not impact our consolidated financial position, results of operations or cash flows. 25-------------------------------------------------------------------------------- Table of Contents In February 2013, the FASB issued ASU 2013-04, the objective of which is to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. The guidance in the update requires that these arrangements be recorded as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. ASU 2013-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We are currently assessing the impact of this ASU on our consolidated financial position and results of operations. In July 2013, the FASB issued ASU 2013-11 which requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward, with certain exceptions. ASU 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We are currently assessing the impact of this ASU but adoption will only have the potential of affecting the presentation of unrecognized tax benefits and will not impact our consolidated financial position, results of operations or cash flows. In April 2014, the FASB issued ASU No. 2014-08 which changes the threshold for reporting discontinued operations and adds additional disclosures. The guidance in this ASU updates the definition of discontinued operations to include the disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. ASU 2014-08 is effective prospectively for all disposals of components of an entity that occur with annual periods beginning on or after December 15, 2014, and interim periods therein. We are currently assessing the impact of this ASU on our consolidated financial position and results of operations. In May 2014, the FASB issued ASU 2014-09 which provides guidance on how an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and on accounting for costs to obtain or fulfill a contract with a customer. The ASU also requires expanded disclosure regarding the nature, amount, timing and uncertainty of revenue that is recognized. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, with early application not permitted. We are currently assessing the adoption and impact of this ASU on our consolidated financial position and results of operations. In June 2014, the FASB issued ASU 2014-12 which provides guidance on how to account for shared-based payment awards where the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. The ASU requires that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. ASU 2014-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015, and early adoption is permitted. We are currently assessing the impact of this ASU on our consolidated financial position and results of operations. |