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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 negatives 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 separate into two publicly traded companies, the composition of and markets for those companies, the anticipated costs and other impacts of the separation and the plan to achieve the separation through a tax-free spinoff; † 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 28, 2014. OUR INDUSTRIES AND QUARTERLY DEVELOPMENTS JDSU is a leading provider of network and service enablement solutions and optical products for telecommunications service providers, wireless operators, cable operators, network equipment manufacturers ("NEMs") and enterprises. JDSU is also an established leader in providing anti-counterfeiting technologies for currencies and other high-value documents and products. In addition, we leverage our core networking and optical technology expertise to deliver high-powered commercial lasers for manufacturing applications and expand into emerging markets, including 3D sensing solutions for consumer electronics. On September 10, 2014, the Company announced plans to separate into two publicly traded companies: an optical components and commercial lasers company consisting of JDSU's current Communications and Commercial Optical Products segment ("CCOP"), and a network and service enablement company consisting of JDSU's current Network Enablement ("NE"), Service Enablement ("SE") and Optical Security and Performance Products ("OSP") segments. The separation is expected to occur through a tax-free pro-rata spinoff of CCOP to JDSU shareholders, though the structure is subject to change based upon various tax and regulatory factors, and is expected to be completed by the calendar third quarter of 2015. 26 -------------------------------------------------------------------------------- Table of Contents In addition to the announcement to separate into two public companies, during the first quarter of fiscal 2015 the Company reorganized its Network Service and Enablement ("NSE") reportable segment into two separate reportable segments: Network Enablement and Service Enablement. Splitting NSE into two reportable segments provides greater clarity and transparency regarding the markets, financial performance and business models of the NE and SE businesses. NE is a hardware-centric and more mature business consisting primarily of NSE's traditional communications test instrument products. SE is a more software-centric business consisting primarily of (i) software solutions that are embedded within the network, and (ii) enterprise performance management solutions. Historical segment numbers have been recast to conform to this new reporting structure. To serve its markets, JDSU operates the following business segments: † Network Enablement † Service Enablement † Communications and Commercial Optical Products † Optical Security and Performance Products Network Enablement NE provides an integrated portfolio of network enablement instruments and software that access the network to help build out, activate, and certify, troubleshooting and maintenance tasks. These solutions support more profitable, higher-performing networks and help speed time-to-revenue. JDSU's network enablement products and services are largely organized between seven product groups that target specific network testing solutions: Cloud and Data Center, Ethernet, Fiber, Media Access and Content ("MAC"), Mobility, Services, and Waveready. NE solutions address lab and production environments, field deployment and service assurance for wireless and fixed communications networks, including storage networks. NE'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. NE is leveraging this installed base and knowledge of network management methods and procedures. NE 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. NE customers also include many of the NEMs served by our CCOP segment, including Alcatel-Lucent, Ciena, Cisco Systems, Fujitsu and Huawei. NE 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. Service Enablement SE solutions are embedded systems that provide network, service and application data. These solutions-including microprobes and software-monitor, collect and analyze network data to reveal the actual customer experience and identify opportunities for new revenue streams and network optimization. JDSU's service enablement products and services are largely organized between five product groups that target specific network intelligence, visibility and control solutions: Enterprise, Location Intelligence, Mobile Assurance and Analytics ("MAA"), Packet Portal, and RAN Solutions. SE solutions address lab and production environments, field deployment and service assurance for wireless and fixed communications networks. These solutions let carriers remotely monitor performance and quality of network, 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. SE customers include the same wireless and fixed services providers, NEMs, government organizations, large corporate customers, and storage-segment customers that are served by our NE segment. Communications and Commercial Optical Products CCOP is a leading provider of optical communications and commercial laser products and technologies and commercial laser components. JDSU optical communications offerings address the following markets: telecommunications ("Telecom"), datacom ("Datacom") and consumer and industrial ("Consumer and Industrial"). 27 -------------------------------------------------------------------------------- Table of Contents JDSU optical communications products include a wide range of components, modules and subsystems to support and maintain customers in our two primary markets: Telecom, including carrier networks for access (local), metro (intracity), long-haul (city-to-city and worldwide) and submarine (undersea) networks, and Datacom for enterprise, cloud and data center applications, including storage-access networks ("SANs"), local-area networks ("LANs") and Ethernet wide-area networks ("WANs"). These products enable the transmission and transport of video, audio and text data over high-capacity fiber-optic cables. CCOP maintains 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. In the Consumer and Industrial markets, our optical communications products include our light source product which is integrated into 3D sensing platforms. 3D sensing systems use both CCOP's light source and OSP's 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 3D sensing include gaming platforms, home entertainment, mobile devices and personal computing. JDSU's portfolio of laser products includes components and subsystems used in a variety of OEM applications. OEMs use CCOP lasers-fiber, diode, direct-diode, diode-pumped solid-state and gas-that offer low- to high-power output with ultraviolet ("UV"), visible and infrared ("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. CCOP's optical communications products customers include Adva, Alcatel-Lucent, Ciena, Cisco Systems, Ericsson, Fujitsu, Huawei, Infinera, Microsoft, Nokia Networks, and Tellabs. CCOP's lasers customers include Amada, ASML, Beckman Coulter, Becton Dickinson, Disco, Electro Scientific Industries and KLA-Tencor. Optical Security and Performance Products OSP designs, manufactures, and sells products targeting anti-counterfeiting, consumer and industrial, government, healthcare and other markets. OSP's security offerings for the currency market include Optically Variable Pigment ("OVP®"), Optically Variable Magnetic Pigment ("OVMP®") and banknote thread substrates. OVP® enables a color-shifting effect used by banknote issuers and security printers worldwide for anti-counterfeiting applications on currency and other high-value documents and products. OVP® protects the currencies of more than 100 countries today. OSP also develops and delivers overt and covert anti-counterfeiting products that utilize its proprietary printing platform and are targeted primarily at the pharmaceutical and consumer-electronics markets. Leveraging its expertise in spectral management and its unique high-precision coating capabilities, OSP provides a range of products and technologies for the consumer-electronics market, including, for example, optical filters for 3D sensing devices designed for gaming and other platforms. OSP value-added solutions meet the stringent requirements of commercial and government customers in aerospace and defense. JDSU products are used in a variety of aerospace and defense applications, including optics for guidance systems, laser eye protection and night vision systems. These products, including coatings and optical filters, are optimized for each specific application. OSP serves customers such as 3M, Barco, Kingston, Lockheed Martin, Microsoft, 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. 28 -------------------------------------------------------------------------------- Table of Contents 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 September 27, September 28, Percentage 2014 2013 Change Change Segment net revenue: NE $ 132.8 $ 145.1 $ (12.3 ) (8.5 )% SE 48.2 26.8 21.4 79.9 CCOP 209.3 204.6 4.7 2.3 OSP 43.3 52.5 (9.2 ) (17.5 ) Net revenue $ 433.6 $ 429.0 $ 4.6 1.1 % Amortization of acquired technologies $ 10.0 $ 11.4 $ (1.4 ) (12.3 )% Percentage of net revenue 2.3 % 2.7 % Gross profit 199.3 185.2 14.1 7.6 % Gross margins 46.0 % 43.2 % Research and development 76.4 69.6 6.8 9.8 % Percentage of net revenue 17.6 % 16.2 % Selling, general and administrative 110.7 107.1 3.6 3.4 % Percentage of net revenue 25.5 % 25.0 % Amortization of other intangibles 5.1 2.7 2.4 88.9 % Percentage of net revenue 1.2 % 0.6 % Restructuring and related (benefits) charges 2.9 (0.8 ) 3.7 (462.5 )% Percentage of net revenue 0.7 % (0.2 )% Net Revenue Net revenue increased by $4.6 million, or 1.1%, during the three months ended September 27, 2014 compared to the same period a year ago. This increase was due to an increase in our SE and CCOP segments, partially offset by a decrease in our NE and OSP segments as discussed below. NE net revenue decreased by $12.3 million, or 8.5%, during the three months ended September 27, 2014 compared to the same period a year ago. This decrease was driven by $15.2 million of net revenue decreases primarily from our MAC and Ethernet product lines. These decreases were primarily due to a reduction in carrier spending in the current period which resulted in lower demand from key customers. This was partially offset by $2.9 million of net revenue increases primarily due to increased volume and higher demand from key customers of our Waveready product line. SE net revenue increased by $21.4 million, or 79.9%, during the three months ended September 27, 2014 compared to the same period a year ago as net revenue increased across our SE product lines. This increase was primarily due to incremental net revenue from our Enterprise product line which was acquired in third quarter of fiscal 2014, coupled with revenue growth in our Location Intelligence and RAN Solutions product lines driven by the recognition of previously deferred software and services revenue. 29 -------------------------------------------------------------------------------- Table of Contents CCOP net revenue increased by $4.7 million, or 2.3%, during the three months ended September 27, 2014 compared to the same period a year ago. This increase was driven by $23.3 million of net revenue increases primarily from products addressing our Lasers and Telecom markets. These increases were primarily due to demand from a key customer for our second generation fiber laser product in the Lasers market and increased demand for our 40G and 100G modulators in the Telecom market. These increases were partially offset by $18.5 million of net revenue decreases from products addressing the Consumer and Industrial markets, primarily due to lower demand from a key customer for 3D sensing products in the current period. OSP net revenue decreased by $9.2 million, or 17.5%, during the three months ended September 27, 2014 compared to the same period a year ago. This decrease was driven by $13.1 million of net revenue decreases primarily from our Consumer and Industrial product line driven by the exit of lower margin legacy products in the fourth quarter of fiscal 2014 and lower demand from a key customer for 3D sensing products in the current period. This decrease was partially offset by $3.9 million of net revenue increases primarily from our Anti-Counterfeiting product line driven by cyclical demand for our currency products. 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 NE, SE 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, NE and SE markets, which affects revenue and gross margin; (c) fluctuations in customer buying patterns, which cause demand, revenue and profitability volatility; (d) the current trend of communication industry consolidation, which is expected to continue, that directly affects our CCOP, NE and SE customer bases and adds additional risk and uncertainty to our financial and business projections; and (e) the proposed spinoff may result in disruptions to, and negatively impact our relationships with, our customers and other business partners. In addition, we anticipate lower demand and revenue from our 3D sensing products in our CCOP and OSP segments through fiscal 2015 compared to fiscal 2014. 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 September 27, September 28, 2014 2013 Net revenue: Americas $ 193.9 44.7 % $ 199.2 46.4 % EMEA 105.0 24.2 104.0 24.3 Asia-Pacific 134.7 31.1 125.8 29.3 Total net revenue $ 433.6 100.0 % $ 429.0 100.0 % Net revenue was assigned to geographic regions based on customer shipment locations. Net revenue for Americas included net revenue from the United States of $143.9 million and $144.7 million, respectively, for the three months ended September 27, 2014 and September 28, 2013. Net revenue from customers outside the Americas represented 55.3% and 53.6%, respectively, of net revenue for the three months ended September 27, 2014 and September 28, 2013. We expect revenue from customers outside of North America to continue to be an important part of our overall net revenue and net revenue growth opportunities. Gross Margin Gross margin increased 2.8 percentage points during the three months ended September 27, 2014 from 43.2% in the same period a year ago to 46.0% in the current period. The increase was primarily due to a more favorable product mix within each our segments in current period, particularly in our SE segment driven by the addition of the higher-margin Enterprise product line which was acquired in the third quarter of fiscal 2014 This was partially offset by a change in segment mix as CCOP net revenue, which generates lower gross margin generally than our other three 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. We expect these factors to continue to result in variability of our gross margin. 30 -------------------------------------------------------------------------------- Table of Contents Research and Development ("R&D") As a percentage of net revenue, R&D expense increased by 1.4 percentage points during the three months ended September 27, 2014 compared to the same period a year ago as we continue to invest in our product portfolio to develop new technologies, products and services that offer our customers increased value and strengthen our position in our core markets. R&D expense increased by $6.8 million, or 9.8%, during the three months ended September 27, 2014 compared to the same period a year ago. This increase was primarily driven by a $7.6 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation associated with our ongoing investment in R&D and our strategic acquisitions in the second and third quarters of fiscal 2014. This was partially offset by an additional $1.2 million of R&D offsets from CCOP customer-funded development projects 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") As a percentage of net revenue, SG&A expense remained relatively flat during the three months ended September 27, 2014 compared to the same period a year ago, increasing by 0.5 percentage points. SG&A expense increased by $3.6 million, or 3.4 %, during the three months ended September 27, 2014 compared to the same period a year ago. This increase was primarily driven by a $3.9 million increase in labor and benefits expense primarily due to higher headcount and corresponding compensation related to our strategic acquisitions in the second and third quarters of fiscal 2014. This was partially offset by a $1.3 million reduction in SG&A travel expense related to our continuing efforts to reduce non-essential spending. We intend to continue to focus on reducing our SG&A expense as a percentage of net 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, expenses related to our proposed separation of the business into two public companies 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 $33 million excluding any one-time charge as a result of the restructuring activities initiated through the first quarter of fiscal 2015. We have reinvested and plan to reinvest a portion of our cost savings into R&D and new products that we believe will further differentiate us in the marketplace. Refer to "Note 11. Restructuring and Related Charges" for more information. Additionally, we expect to incur significant restructuring and related charges during the remainder of fiscal 2015 related to our proposed separation of the Company into two public companies and our continuing efforts to reduce ongoing costs of our businesses. During the three months ended September 27, 2014, we recorded $2.9 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: † During the first quarter of fiscal 2015, Management approved a plan in the CCOP segment to optimize operations and gain efficiencies by closing the Robbinsville, New Jersey site and consolidating roles and responsibilities across North America. As a result, a restructuring charge of $1.5 million was recorded for severance and employee benefits for approximately 30 employees primarily in manufacturing, R&D, and SG&A functions located in North America. Payments related to the remaining severance and benefits accrual are expected to be paid by the end of the third quarter of fiscal 2015. † We also incurred a restructuring charge of $0.3 million primarily for additional severance and employee benefits related to the NE Realignment Plan announced in the fourth quarter of fiscal 2014. 31 -------------------------------------------------------------------------------- Table of Contents During the three months ended September 28, 2013, we recorded benefits from restructuring activities of $0.8 million. These benefits relate to previously announced restructuring plans and are primarily the result of the following: † We incurred restructuring and related benefits from previously announced restructuring plans in the first quarter of fiscal 2014 relating to a reduction in the number of employees impacted by the OSP Operational Realignment Plan which reduced the total liability for this plan by approximately $0.9 million. Our restructuring and other lease exit cost obligations are net of sublease income or lease settlement estimates of approximately $5.8 million. Our ability to generate sublease income, as well as our ability to terminate lease obligations and recognize the anticipated related savings, is highly dependent upon the economic conditions, particularly commercial real estate market conditions in certain geographies, at the time we negotiate the lease termination and sublease arrangements with third parties as well as the performances by such third parties of their respective obligations. While the amount we have accrued represents the best estimate of the remaining obligations we expect to incur in connection with these plans, estimates are subject to change. Routine adjustments are required and may be required in the future as conditions and facts change through the implementation period. If adverse macroeconomic conditions continue, particularly as they pertain to the commercial real estate market, or if, for any reason, tenants under subleases fail to perform their obligations, we may be required to reduce estimated future sublease income and adjust the estimated amounts of future settlement agreements, and accordingly, increase estimated costs to exit certain facilities. Amounts related to the lease expense, net of anticipated sublease proceeds, will be paid over the respective lease terms through fiscal 2019. Interest and Other Income (Expense), Net Interest and other income (expense), net was $0.5 million during the three months ended September 27, 2014 as compared to $(0.6) million during the same period a year ago. This $1.1 million change was driven by a $0.6 million increase in interest income primarily due to higher invested balances and yields on our investment portfolios in the current period, coupled with an improved balance sheet hedging result in the current period as the foreign currency exchange loss was $0.3 million in the current period compared to a loss of $0.8 million in the prior period. Interest Expense Interest expense increased by $3.1 million, or 59.6%, during the three months ended September 27, 2014 compared to the same period a year ago. This was primarily due to a $4.2 million increase in accretion of unamortized debt discount and contractual interest expense related to the 0.625% Convertible Notes due 2033 (the "2033 Notes") which were issued on August 21, 2013. Due to the timing of the issuance of the 2033 Notes, the prior period reflects only a partial quarter of interest expense related to the 2033 Notes compared to a full quarter of expense in the current period. This was partially offset by the fact that the prior period reflected a one-time $1.3 million write-off of unamortized issuance costs upon the termination of our revolving credit facility. Provision for Income Tax We recorded an income tax expense of $6.1 million and $0.5 million for the three months ended September 27, 2014 and September 28, 2013, respectively. The income tax expense recorded for the three months ended September 27, 2014 and September 28, 2013, primarily relate to income tax in certain foreign and state jurisdictions based on our forecasted pre-tax income for the respective year. A tax benefit of $4.2 million was recorded in our income tax provision for the three months ended September 28, 2013 related to the income tax intraperiod tax allocation rules in relation to other comprehensive income. The income tax expense or benefit recorded for the respective periods presented differs from the expected income tax expense or benefit that would be calculated by applying the federal statutory rate to our income or loss before income taxes primarily due to the increases and decreases in valuation allowance for deferred tax assets attributable to our domestic and foreign losses from continuing operations and due to the income tax benefit recorded in continuing operations under the income tax intraperiod tax allocation rules. As of September 27, 2014 and June 28, 2014, our unrecognized tax benefits totaled $59.5 million and $60.3 million, respectively, and are included in deferred taxes and other non-current tax liabilities, net. We had $24.4 million accrued for the payment of interest and penalties at September 27, 2014. The unrecognized tax benefits that may be recognized during the next twelve months is approximately $23.2 million. 32 -------------------------------------------------------------------------------- Table of Contents Operating Segment Information (in millions): Three Months Ended September 27, September 28, Percentage 2014 2013 Change Change NE Net revenue $ 132.8 $ 145.1 $ (12.3 ) (8.5 )% Operating income 20.1 22.5 (2.4 ) (10.7 )% Operating margin 15.1 % 15.5 % SE Net revenue $ 48.2 $ 26.8 $ 21.4 79.9 % Operating income 0.8 (9.9 ) 10.7 (108.1 )% Operating margin 1.7 % (36.9 )% CCOP Net revenue $ 209.3 $ 204.6 4.7 2.3 % Operating income 25.1 27.2 (2.1 ) (7.7 )% Operating margin 12.0 % 13.3 % OSP Net revenue $ 43.3 $ 52.5 (9.2 ) (17.5 )% Operating income 15.9 19.1 (3.2 ) (16.8 )% Operating margin 36.7 % 36.4 % NE NE operating margin decreased 0.4 percentage points during the three months ended September 27, 2014 from 15.5% in the same period a year ago to 15.1% in the current period. The decrease in operating margin was primarily due to a decrease in net revenue as described above. This was partially offset by an improvement in gross margin driven by a more favorable product mix and supply chain efficiencies realized in the current period, coupled with a reduction in SG&A expense primarily due to our continuing efforts to reduce non-essential spending. SE SE operating margin increased 38.6 percentage points during the three months ended September 27, 2014 from (36.9)% in the same period a year ago to 1.7% in the current period. The increase in operating margin was primarily due to an increase in net revenue as described above, coupled with the addition of the higher-margin Enterprise product line which was acquired in the third quarter of fiscal 2014. This was partially offset by an increase in operating expenses driven by higher headcount associated with our strategic acquisitions during the second and third quarters of fiscal 2014 and our ongoing R&D investments. CCOP CCOP operating margin decreased 1.3 percentage points during the three months ended September 27, 2014 from 13.3% in the same period a year ago to 12.0% in the current period. The decrease in operating margin was primarily due an increase in operating expenses driven by higher headcount and spending associated with our ongoing R&D investments. This was partially offset by an improvement in gross margin primarily due to a more favorable product mix and improvements in yield, coupled with an increase in net revenue as noted above. OSP OSP operating margin remained relatively flat during the three months ended September 27, 2014, increasing by 0.3 percentage points from 36.4% in the same period a year ago to 36.7% in the current period. 33 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Our cash investments are made in accordance with an investment policy approved by the Audit Committee of our Board of Directors. In general, our investment policy requires that securities purchased be rated A-1/P-1, A/A2 or better. In November, 2012, the policy was amended to allow an allocation to securities rated A-2/P-2, BBB/Baa2 or better, with such allocation not to exceed 10% of any investment portfolio. Securities that are downgraded subsequent to purchase are evaluated and may be sold or held at Management's discretion. No security may have an effective maturity that exceeds 37 months, and the average duration of our holdings may not exceed 18 months. At any time, no more than 5.0% 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 September 27, 2014 and virtually all debt securities held were of investment grade (at least BBB-/Baa3). As of September 27, 2014, U.S. entities owned approximately 82.4% of our cash and cash equivalents, short-term investments and restricted cash. As of September 27, 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 three months ended September 27, 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 September 27, 2014 our combined balance of cash and cash equivalents, short-term investments and restricted cash remained relatively flat, decreasing by $0.4 million to $880.9 million from $881.3 million as of June 28, 2014. During the three months ended September 27, 2014, cash provided by operating activities was $40.8 million, primarily resulting from $56.4 million of net income adjusted for both non-cash charges (e.g., depreciation, amortization and stock-based compensation) and changes in our deferred tax balances which are non-cash in nature, partially offset by changes in operating assets and liabilities of $15.6 million. Changes in our operating assets and liabilities related primarily to a decrease in accrued payroll and related expenses of $16.3 million due to timing of salary and higher variable incentive payments and a decrease in accrued expenses and other current and non-current liabilities of $12.0 million, partially offset by an increase in accounts payable of $17.9 million due to lower payment activity in the current quarter. During the three months ended September 28, 2013, cash provided by operating activities was $29.5 million, resulting from our net income adjusted for non-cash items such as depreciation, amortization and stock-based compensation of $52.9 million and changes in operating assets and liabilities that used $23.7 million. Changes in operating assets and liabilities related primarily to a decrease in accrued payroll and related expenses of $22.8 million due to timing of salary payments, an increase in accounts receivable of $18.6 million due to an increase in sales and a decrease in accrued expenses and other current and non-current liabilities of $6.6 million, partially offset by an increase in accounts payable of $29.5 million due to lower payment activity. During the three months ended September 27, 2014, cash used in investing activities was $12.0 million, primarily resulting from $151.7 million of purchases of available-for-sale investments and $26.5 million of cash used for capital expenditures, partially offset by $164.7 million of maturities and sales of available-for-sale investments in the current period. During the three months ended September 28, 2013 cash used for investing activities was $410.9 million, primarily related to the investment of proceeds from the 2033 Notes for purchases of available-for-sale investments of $470.5 million, partially offset by proceeds from maturities of available-for-sale investments of $46.8 million and sales of available-for-sale investments of $25.7 million. During the three months ended September 27, 2014, cash used in financing activities was $9.4 million, primarily resulting from a $9.8 million holdback payment related to the acquisition of Network Instruments and $4.7 million of cash used to repurchase our common stock, partially offset by $5.4 million of proceeds from the exercise of stock options and the issuance of common stock under our employee stock purchase plan in the current period. 34 -------------------------------------------------------------------------------- Table of Contents During the three months ended September 28, 2013, cash used for financing activities $547.8 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. 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 and credit market which impact the liquidity and valuation of our investment portfolios; † volatility in foreign exchange market which impacts our financial results; † 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 first quarter of fiscal 2015, 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 28, 2014, 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 15. Commitments and Contingencies." Employee Stock-based Benefit Plans Our stock-based benefit plans are a broad-based, long-term retention program that is intended to attract and retain employees and align stockholder and employee interests. Refer to "Note 13. 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 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. As of September 27, 2014, our pension plans were under funded by $102.4 million since the projected benefit obligation exceeded the fair value of its plan assets. Similarly, we had a liability of $1.1 million related to our non-pension post-retirement benefit plan. Pension plan assets are managed by external third parties and we monitor the performance of our investment managers. As of September 27, 2014, the fair value of plan assets had increased approximately 2.7% since June 28, 2014, 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 $9.7 million based upon June 28, 2014 data. 35 -------------------------------------------------------------------------------- Table of Contents 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 14. Employee Defined Benefit Plans" for more details. |