LUMENTUM HOLDINGS INC.
You should read the following discussion in conjunction with the unaudited
condensed consolidated financial statements and the corresponding notes included
elsewhere in this Quarterly Report on Form 10-Q (this "Quarterly Report"). This
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements. The matters discussed in these
forward-looking statements are subject to risk, uncertainties and other factors
that could cause actual results to differ materially from those made, projected
or implied in the forward-looking statements. Please see "Risk Factors" and
"Forward-Looking Statements" for a discussion of the uncertainties, risks and
assumptions associated with these statements.
Forward-Looking Statements
This Quarterly Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). These
statements are based on our current expectations and involve risks,
uncertainties and assumptions that, if they never materialize or prove
incorrect, could cause our results to differ materially from those expressed or
implied by such forward-looking statements. These statements relate to, among
other things, our markets and industry, products and strategy, the impact of the
COVID-19 pandemic and related responses of business and governments to the
pandemic on our business and results of operations, sales, gross margins,
operating expenses, capital expenditures and requirements, liquidity, product
development and R&D efforts, manufacturing plans, litigation, effective tax
rates and tax reserves, our corporate and financial reporting structure, our
plans for growth and innovation, our plans to discontinue certain operations and
product lines, our expectations regarding US-China relations, market and
regulatory conditions, the successful integration of Oclaro's business
(including personnel), and our expected synergies and non-GAAP earnings
accretion from the acquisition of Oclaro, and are often identified by the use of
words such as, but not limited to, "anticipate," "believe," "can," "continue,"
"could," "estimate," "expect," "intend," "may," "might," "plan," "project,"
"seek," "should," "target," "will," "would," "contemplate," "believe,"
"predict," "potential" and similar expressions or variations intended to
identify forward-looking statements. These statements are based on the beliefs
and assumptions of our management, which are in turn based on information
currently available to management. Such forward-looking statements are subject
to risks, uncertainties and other important factors that could cause actual
results and the timing of certain events to differ materially from future
results expressed or implied by such forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in the section entitled "Risk Factors" included under Part II,
Item 1A of this Quarterly Report. Furthermore, such forward-looking statements
speak only as of the date of this report. Except as required by law, we
undertake no obligation to update any forward-looking statements to reflect
events or circumstances after the date of such statements.
40
--------------------------------------------------------------------------------Overview
We are an industry-leading provider of optical and photonic products defined by revenue and market share addressing a range of end-market applications includingOptical Communications , which we refer to as OpComms, and Lasers for manufacturing, inspection and life-science applications. We seek to use our core optical and photonic technology and our volume manufacturing capability to expand into attractive emerging markets that benefit from advantages that optical or photonics-based solutions provide, including 3D sensing for consumer electronics and diode light sources for a variety of consumer and industrial applications. We have two operating segments, OpComms and Lasers. The two operating segments were primarily determined based on how the Chief Operating Decision Maker ("CODM") views and evaluates our operations. Operating results are regularly reviewed by the CODM to make decisions about resources to be allocated to the segments and to assess their performance. Other factors, including market separation and customer specific applications, go-to-market channels, products and manufacturing, are considered in determining the formation of these operating segments. We believe the world is becoming more reliant on ever-increasing amounts of data flowing through optical networks and data centers, which demand new networks and data centers to be built to satisfy this insatiable demand for data. As higher levels of precision, new materials, factory and energy efficiency are being demanded by manufacturers, suppliers of manufacturing tools globally are turning more and more to laser based approaches, including the types of lasersLumentum supplies. Laser based 3D sensing is a rapidly developing market. The technology enables computer vision applications that enhance security, safety, and new functionality in the electronic devices that people rely on every day. We believe the global markets in whichLumentum participates have fundamentally robust, long-term trends that increase the need for our photonics products and technologies. OnDecember 10, 2018 , we completed the acquisition of Oclaro, a provider of optical components and modules for the long-haul, metro and data center markets. Refer to "Note 4. Business Combinations" in the notes to condensed consolidated financial statements for further discussion of the merger. Following the acquisition of Oclaro, during our fiscal 2019, we began making several strategic changes to our OpComms business to better position it for growth and profitability. These changes include attaining acquisition cost synergies related to redundant capabilities, the discontinuing of Telecom Lithium Niobate modulators and Datacom transceiver modules because of their muted growth and profitability trends. We expect actions related to these changes to be completed in fiscal 2021. We don't believe we are diminishing our profit potential in discontinuing and/or selling these product lines. We expect our Indium Phosphide photonic integrated circuits will continue to replace Lithium Niobate modulators over time and focusing on the development and sale of Datacom chips will enable to profitably participate in the growth in the Datacom and 5G wireless markets. Related to the strategic changes in our OpComms business, we entered into two strategic transactions to sell some of the discontinued product lines. In the second quarter of fiscal year 2020, we entered into an agreement with Advanced Fiber Resources (Zhuhai) Ltd. ("AFR"), a leading provider of passive optical components, to acquire the assets associated with certain Lithium Niobate product lines manufactured by our San Donato site for$17 million . The transaction was closed in the third quarter of fiscal year 2020. For further information regarding this transaction, refer to "Note 5. Assets and Liabilities Held For Sale" in the notes to condensed consolidated financial statements. OnApril 18, 2019 , we closed a transaction selling many of our Datacom transceiver module product lines toCambridge Industries Group ("CIG"). For further information regarding this transaction, refer to "Note 4. Business Combinations" in the notes to condensed consolidated financial statements. Impact of COVID-19 to our Business The outbreak of the COVID-19 has been declared a pandemic by theWorld Health Organization and continues to spread globally. The spread of COVID-19 has caused public health officials to recommend, and governments to enact, precautions to mitigate the spread of the virus, including travel restrictions and bans, extensive social distancing guidelines and issuing a "shelter-in-place" order in many regions of the world. The pandemic and these related responses have caused, and are expected to continue to cause a global slowdown of economic activity (including the decrease in demand for a broad variety of goods and services), disruptions in global supply chains and significant volatility and disruption of financial markets We have adopted several measures in response to the COVID-19 outbreak including complying with local, state or federal orders that require employees to work from home, instructing employees to work from home in certain jurisdictions, limiting the number of employees onsite which slowed our manufacturing operations in certain countries, enhanced use of personal protective equipment and restricting non-critical business travel by our employees. In the geographies we have operations, we have in general been deemed an essential business and been permitted to continue manufacturing and new product development operations in a more limited capacity during the pandemic. This stems from our critical role in global supply chains for the world's communications and health-care systems. Given the rapidly evolving situation, it is difficult to predict precisely when our ability to supply our products will improve or the magnitude and duration of the impact of the COVID-19 pandemic to our markets. The Company will continue to actively monitor the situation and may take further actions altering our business operations that we determine are in the best interests of our employees, customers, communities, business partners, suppliers, and stockholders, or as required by federal, state, or local authorities. It is not clear what the potential 41 -------------------------------------------------------------------------------- effects any such alterations or modifications may have on our business, including the effects on the Company's customers, employees, and prospects, or on our financial results for the remainder of fiscal year 2020. While the recent outbreak of the COVID-19 did not have a material adverse effect on our reported results for our third quarter, we are actively monitoring the impact of the coronavirus outbreak. Due to the severity of COVID-19 inthe United States and the timing of the most significant responses thereto in March, we believe the impact on our business in the fourth quarter and beyond will be greater than it was in the third quarter of 2020. The extent to which our operations will be impacted by the outbreak will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including new information which may emerge concerning the severity of the outbreak and actions by government authorities and private businesses to contain the outbreak or recover from its impact, among other things. Our primary strategic focus for several years has been technology and product leadership combined with close customer relationships in long-term healthy and growing markets. We believe this strategy is even more apt, and our long-term opportunity is not diminished with COVID-19. We believe there may be long-term opportunities, as the world's experience with COVID-19 could drive an increasingly digital and virtual world touching all aspects of life and work that increasingly emphasizes communications systems, cloud services, augmented and virtual reality, and enhanced security. Additionally, ever advancing electronic devices are needed to consume, produce, and communicate digital and virtual content. All these trends could drive the need for higher volumes of higher performing optical devices that we could supply. As such, we expect to continue to invest strongly in new products, technology, and customer programs. For more information on risks associated with the COVID-19 outbreak, see the section titled "Risk Factors" in Item 1A of Part II. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance withU.S. generally accepted accounting principles ("GAAP") as set forth in theFinancial Accounting Standards Board's Accounting Standards Codification ("ASC"), and we consider the various staff accounting bulletins and other applicable guidance issued by theUnited States Securities and Exchange Commission ("SEC"). GAAP, as set forth within the ASC, requires us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. Our management does not believe COVID-19 will have a significant impact on our critical accounting policies. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: • Inventory Valuation • Revenue Recognition • Income Taxes • Long-lived Asset Valuation • Business Combinations •Goodwill Except for the adoption of ASU 2016-02, Leases (Topic 842) and the resulting changes in our accounting policies and disclosures for lease accounting, there have been no significant changes to our significant accounting policies as of and for the three months endedMarch 28, 2020 , as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year endedJune 29, 2019 . Refer to "Note 1. Description of Business and Summary of Significant Accounting Policies" for the details of ASU 2016-02 (Topic 842) adoption. Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year endedJune 29, 2019 provides a more complete discussion of our critical accounting policies and estimates. Recently Issued Accounting Pronouncements Refer to "Note 2. Recently Issued Accounting Pronouncements" in the notes to condensed consolidated financial statements. 42 -------------------------------------------------------------------------------- Results of Operations The results of operations for the periods presented are not necessarily indicative of results to be expected for future periods. The following table summarizes selected unaudited condensed consolidated statements of operations items as a percentage of net revenue: Three Months Ended
Nine Months Ended
March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019
Segment net revenue:
OpComms 89.2 % 87.3 % 90.4 % 87.3 %
Lasers 10.8 12.7 9.6 12.7
Net revenue 100.0 100.0 100.0 100.0
Cost of sales 57.4 73.1 57.8 67.9
Amortization of acquired
developed technologies 3.5 6.5 3.0 2.9
Gross profit 39.2 20.4 39.3 29.2
Operating expenses:
Research and development 12.1 13.3 11.4 11.6
Selling, general and
administrative 15.2 12.8 13.8 13.0
Restructuring and related charges 0.7 4.9 0.4 2.6
Impairment charges 0.6 7.0 0.2 2.7
Total operating expenses 28.6 38.0 25.7 29.9
Income (loss) from operations 10.6 (17.6 ) 13.5 (0.7 )
Unrealized gain on derivative
liability - - - 0.8
Interest expense (3.9 ) (2.6 ) (3.5 ) (2.1 )
Other income (expense), net 5.4 1.2 2.1 1.0
Income (loss) before income taxes 12.1 (19.0 ) 12.2 (1.0 )
Provision for (benefit from)
income taxes 1.3 (1.9 ) 1.5 (0.1 )
Net income (loss) 10.8 % (17.1 )% 10.7 % (0.9 )%
43-------------------------------------------------------------------------------- Financial Data for the three and nine months endedMarch 28, 2020 andMarch 30, 2019 The following table summarizes selected unaudited condensed consolidated statements of operations items (in millions, except for percentages): Three Months Ended Nine Months Ended March 28, 2020 March 30, 2019 Change
Percentage Change March 28, 2020 March 30, 2019 Change Percentage Change Segment net revenue: OpComms$ 359.3 $ 377.9 $ (18.6 ) (4.9 )%$ 1,184.8 $ 1,013.4 $ 171.4 16.9 % Lasers 43.5 55.0 (11.5 ) (20.9 ) 125.7 147.3 (21.6 ) (14.7 ) Net revenue$ 402.8 $ 432.9 $ (30.1 ) (7.0 )%$ 1,310.5 $ 1,160.7 $ 149.8 12.9 % Gross profit$ 157.7 $ 88.3 $ 69.4 78.6 %$ 514.5 $ 339.1 $ 175.4 51.7 % Gross margin 39.2 % 20.4 % 39.3 % 29.2 % Research and development$ 48.7 $ 57.7 $ (9.0 ) (15.6 )%$ 149.6 $ 135.1 $ 14.5 10.7 % Percentage of net revenue 12.1 % 13.3 % 11.4 % 11.6 % Selling, general and administrative$ 61.3 $ 55.2 $ 6.1 11.1 %$ 180.4 $ 150.9 $ 29.5 19.5 % Percentage of net revenue 15.2 % 12.8 % 13.8 % 13.0 % Restructuring and related charges $ 2.7$ 21.1 $ (18.4 ) (87.2 )% $ 4.9 $ 30.2$ (25.3 ) (83.8 )% Percentage of net revenue 0.7 % 4.9 % 0.4 % 2.6 % Impairment charge $ 2.5$ 30.7 $ (28.2 ) (91.9 )% $ 2.5 $ 30.7$ (28.2 ) (91.9 )% Percentage of net revenue 0.6 % 7.0 % 0.2 % 2.6 % Net Revenue Net revenue decreased by$30.1 million , or 7.0%, during the three months endedMarch 28, 2020 compared to the three months endedMarch 30, 2019 . This decrease was primarily due to the decreased sales of Telecom and Datacom of$49.7 million and Lasers of$11.5 million , offset by increased sales of Consumer and Industrial of$31.1 million . OpComms net revenue decreased by$18.6 million , or 4.9%, during the three months endedMarch 28, 2020 compared to the three months endedMarch 30, 2019 . This decrease was primarily due to decreased sales of Telecom products partially offset by higher sales of 3D sensing products for mobile devices. Our Datacom sales slightly decreased, due to the sale of our Datacom transceiver module business, but such decrease was offset by significant increase in sales of Datacom chips. Lasers net revenue decreased by$11.5 million , or 20.9%, during the three months endedMarch 28, 2020 compared to the three months endedMarch 30, 2019 , primarily due to lower revenue from kilowatt class fiber lasers. Net revenue increased by$149.8 million , or 12.9%, during the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 . This increase was primarily due to the increased sales of Telecom and Datacom of$81.7 million and Consumer and Industrial of$89.7 million , offset by decreased sales of Lasers of$21.6 million . OpComms net revenue increased by$171.4 million , or 16.9%, during the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 . This increase was primarily due to increased sales in Telecom products, driven by the acquisition of Oclaro, as well as increased sales in 3D sensing products for mobile devices. 44 -------------------------------------------------------------------------------- Lasers net revenue decreased by$21.6 million , or 14.7%, during the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 , primarily due to decreased sales of our kilowatt class fiber lasers. During the three and nine months endedMarch 28, 2020 , our net revenue was concentrated with two customers, who collectively accounted for 37% and 42% of our total net revenue, respectively. During the three and nine months endedMarch 30, 2019 , our net revenue was concentrated with three customers, who collectively accounted for 44% and 52% of our total net revenue, respectively. Although the magnitude of the impact of COVID-19 on our business operations remains uncertain and difficult to predict, and this remains a highly dynamic situation, we have experienced and will continue to experience in subsequent periods, disruptions to our and our customers' businesses that will adversely impact our business, financial condition and results of operations. Revenue by Region We operate in three geographic regions:Americas ,Asia-Pacific and EMEA. Net revenue is assigned to the geographic region and country where our product is initially shipped. For example, certain customers may request shipment of our product to a contract manufacturer in one country, however, the location of the end customers may differ. The following table presents net revenue by the three geographic regions we operate in and net revenue from countries within those regions that represented 10% or more of our total net revenue (in millions, except for percentages): Three Months Ended Nine Months Ended March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019 Amount % of Total Amount % of Total Amount % of Total Amount % of Total Americas: United States$ 38.6 9.6 %$ 29.7 6.9 %$ 118.9 9.1 %$ 72.3 6.3 % Mexico 33.2 8.2 53.5 12.3 88.3 6.7 164.8 14.2 Other Americas 1.4 0.3 0.9 0.2 3.2 0.3 2.7 0.2 Total Americas$ 73.2 18.1 %$ 84.1 19.4 %$ 210.4 16.1 %$ 239.8 20.7 % Asia-Pacific: Hong Kong$ 125.9 31.3 %$ 124.1 28.6 %$ 404.2 30.8 %$ 289.6 25.0 % South Korea 63.3 15.7 23.6 5.5 239.9 18.3 154.9 13.3 Japan 35.8 8.9 50.0 11.6 110.4 8.4 129.2 11.1 Other Asia-Pacific 77.2 19.2 98.4 22.7 248.8 19.0 234.4 20.2
Total
$ 1,003.3 76.5 %$ 808.1 69.6 % EMEA$ 27.4 6.8 %$ 52.7 12.2 %$ 96.8 7.4 %$ 112.8 9.7 % Total net revenue$ 402.8 $ 432.9 $ 1,310.5 $ 1,160.7 For the three and nine months endedMarch 28, 2020 , net revenue from customers outsidethe United States , based on customer shipping location, represented 90.4% and 90.9% of net revenue, respectively. For the three and nine months endedMarch 30, 2019 , net revenue from customers outsidethe United States , based on customer shipping location, represented 93.1% and 93.7% of net revenue, respectively. The increase in our net revenue fromthe United States during the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 is mainly due to the acquisition of Oclaro, which had a higher concentration of customers who manufacture inthe United States , as well as a change in shipment destination for some shipments to one of our large customers fromMexico tothe United States . During the nine months endedMarch 28, 2020 , our net revenue fromSouth Korea increased due to higher demand in 3D sensing products, while net revenue fromHong Kong increased as a result of higher sales of 3D sensing products and Datacom chips. Our net revenue is primarily denominated inU.S. dollars, including our net revenue from customers outsidethe United States as presented above. We expect revenue from customers outside ofthe United States to continue to be an important part of our overall net revenue and an increasing focus for net revenue growth opportunities. However, regulatory and enforcement actions bythe United States and other governmental agencies, as well as changes in tax and trade policies and tariffs, have impacted and may continue to impact net revenue from customers outsidethe United States . 45 -------------------------------------------------------------------------------- Gross Margin and Segment Gross Margin The following table summarizes segment gross margin for the three and nine months endedMarch 28, 2020 andMarch 30, 2019 (in millions, except for percentages): Three Months Ended Nine Months Ended Gross Profit Gross Margin Gross Profit Gross Margin March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019 OpComms$ 161.8 $ 143.5 45.0 % 38.0 %$ 550.1 $ 397.5 46.4 % 39.2 % Lasers 21.6 25.3 49.7 % 46.0 % 56.2 63.6 44.7 % 43.2 % Segment total$ 183.4 $ 168.8 45.5 % 39.0 %$ 606.3 $ 461.1 46.3 % 39.7 % Unallocated corporate items: Stock-based compensation (4.3 ) (3.2 ) (12.6 ) (11.7 ) Amortization of acquired intangibles (13.9 ) (28.1 ) (38.8 ) (33.3 ) Amortization of fair value adjustments (1.5 ) (14.5 ) (5.8 ) (15.8 ) Inventory and fixed asset write down due to product lines exit (2.3 ) (19.4 ) (6.0 ) (19.4 ) Integration related costs 0.3 (2.8 ) (3.1 ) (2.8 ) Other charges (1) (4.0 ) (12.5 ) (25.5 ) (39.0 ) Total$ 157.7 $ 88.3 39.2 % 20.4 %$ 514.5 $ 339.1 39.3 % 29.2 % (1) "Other charges" of unallocated corporate items for the three and nine months endedMarch 28, 2020 primarily include costs of transferring product lines to new production facilities, includingThailand of$0.4 million and$8.5 million , respectively. We also incurred excess and obsolete inventory charges driven by the decline in demand fromHuawei of$0.1 million and$12.8 million during the three and nine months endedMarch 28, 2020 . In addition, there were expenses of$1.6 million related to COVID-19 outbreak during the three and nine months endedMarch 28, 2020 , which include incremental costs for payroll expense such as overtime pay, facilities costs such as gloves, masks and temperature gauges, and under-utilized capacity at certain facilities, in which manufacturing output was impacted. These COVID-19 related costs are offset by benefits realized from government credits for employers' payroll tax. During the three and nine months endedMarch 30, 2019 , "other charges" of unallocated corporate items included costs of transferring product lines toThailand of$12.0 million and$38.7 million , respectively. The unallocated corporate items for the periods presented include the effects of amortization of acquired developed technologies and other intangibles, share-based compensation and certain other charges. We do not allocate these items to the gross margin for each segment because management does not include such information in measuring the performance of the operating segments. Gross Margin Gross margin for the three months endedMarch 28, 2020 increased to 39.2% from 20.4% for the three months endedMarch 30, 2019 . The increase was primarily driven by better gross margins within Datacom, due to the sale of our Datacom transceiver module business, which had lower margins, and increased revenue from our Datacom chip products, as well as increased revenue from 3D sensing products for mobile devices. In addition, for the three months endedMarch 28, 2020 , we had lower acquisition related costs such as amortization of acquired intangibles of$14.2 million and amortization of fair value adjustments of$13.0 million , as well as lower inventory and fixed asset write down charges due to product lines exit of$17.1 million . 46 -------------------------------------------------------------------------------- Gross margin for the nine months endedMarch 28, 2020 increased to 39.3% from 29.2% for the nine months endedMarch 30, 2019 . The increase was primarily driven by better gross margins within Telecom, due to the acquisition of Oclaro, better gross margins within Datacom, due to the sale of our Datacom transceiver module business and increased revenue of our Datacom chip products, which have higher margins, and increased revenue of 3D sensing products for mobile devices. In addition, for the nine months endedMarch 28, 2020 , we had lower amortization of fair value adjustments related to the Oclaro acquisition of$10.0 million , as well as lower inventory and fixed asset write down charges due to product lines exit of$13.4 million . We sell products in certain markets that are consolidating, undergoing product, architectural and business model transitions, have high customer concentrations, are highly competitive, 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. Although the magnitude of the impact of COVID-19 on our business operations remains uncertain and difficult to predict, and this remains a highly dynamic situation, we have experienced and will continue to experience in subsequent periods, disruptions to our and our customers' businesses that will adversely impact our business, financial condition and results of operations. Segment Gross Margin OpComms OpComms gross margin for the three months endedMarch 28, 2020 increased to 45.0% from 38.0% for the three months endedMarch 30, 2019 . The increase was primarily driven by better gross margins within Datacom, due to the sale of our Datacom transceiver module business, which had lower than average gross margins, and increased revenue from our higher margin Datacom chip products, which have higher than average gross margins, and increased revenue of 3D sensing products for mobile devices. OpComms gross margin for the nine months endedMarch 28, 2020 increased to 46.4% from 39.2% for the nine months endedMarch 30, 2019 . The increase was primarily driven by better gross margins within Telecom, due to the acquisition of Oclaro, better gross margins within Datacom, due to the sale of our lower margin Datacom transceiver module business and increased revenue of our higher margin Datacom chip products, and increased revenue of 3D sensing products for mobile devices. Lasers Lasers gross margin for the three months endedMarch 28, 2020 increased to 49.7% from 46.0% for the three months endedMarch 30, 2019 . This increase was primarily driven by the streamlining of our manufacturing supply chain related to our kilowatt class fiber products. Lasers gross margin for the nine months endedMarch 28, 2020 increased to 44.7% from 43.2% for the nine months endedMarch 30, 2019 . This increase was primarily driven by the streamlining of our manufacturing supply chain related to our kilowatt class fiber products. Research and Development ("R&D") R&D expense decreased by$9.0 million , or 15.6%, for the three months endedMarch 28, 2020 compared to the three months endedMarch 30, 2019 . The decrease in R&D expense was primarily due to the decrease in payroll related expense of$1.9 million and the decrease in R&D materials of$2.3 million , as a result of the sale of our Datacom transceiver module business. In addition, we had$1.8 million increase in non-recurring engineering credits from customers. R&D expense increased by$14.5 million , or 10.7%, for the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 . The increase in R&D expense was primarily due to the increase of$9.1 million in investments in key product lines and R&D materials. In addition, payroll related expense increased by$8.5 million mainly due to the acquisition of Oclaro, partially offset by the sale of our Datacom transceiver module business. These increases were offset by$2.4 million higher non-recurring engineering credits from customers. We believe that continuing our investments in R&D is critical to attaining our strategic objectives. Despite the uncertainty related to COVID-19 and the global economic outlook, we currently plan to continue to invest in R&D and new products that we believe will further differentiate us in the marketplace and expect our investment in R&D to increase in absolute dollars in future quarters. Selling, General and Administrative ("SG&A") SG&A expense increased by$6.1 million , or 11.1%, during the three months endedMarch 28, 2020 compared to the three months endedMarch 30, 2019 . The increase in SG&A expense was primarily due to the increase in payroll related expense of$2.8 million , stock-based compensation of$2.4 million , integration related costs of$3.7 million , offset by lower discretionary travel and trade shows of$2.0 million , primarily due to COVID-19 restrictions. SG&A expense increased by$29.5 million , or 19.5%, during the nine months endedMarch 28, 2020 compared to the nine months endedMarch 30, 2019 . The increase in SG&A expense was primarily due to the increase in amortization of intangibles of$14.2 million and integration related costs of$9.8 million as a result of Oclaro acquisition, as well as the increase in payroll related expense of$13.8 million , offset by lower discretionary travel and trade shows, primarily due to COVID-19 restrictions in the three months endedMarch 28, 2020 . 47 -------------------------------------------------------------------------------- From time to time, we expect to incur non-core expenses, such as mergers and acquisition-related expenses and litigation expenses, which will likely increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter. Restructuring and Related Charges We have initiated various strategic restructuring events primarily intended to reduce costs, consolidate our operations, rationalize the manufacturing of our products and align our business in response to market conditions and as a result of our acquisition of Oclaro in the second quarter of fiscal 2019. During the three and nine months endedMarch 28, 2020 , we recorded$2.7 million and$4.9 million , respectively, in restructuring and related charges in our condensed consolidated statements of operations. The charges were mainly attributable to severance charges associated with the decision to move certain manufacturing activities fromSan Jose, California to our facility inThailand . During the three and nine months endedMarch 30, 2019 , we recorded$21.1 million and$30.2 million , respectively, in restructuring and related charges in our condensed consolidated statements of operations, primarily attributable to severance and employee related benefits associated with the wind down of operations for Lithium Niobate modulators and Datacom modules resulting in$18.0 million of severance charges and$1.6 million of lease restructuring charges. During the three and nine months endedMarch 30, 2019 , we also recorded restructuring charges primarily associated with acquisition related synergies. In addition, the nine month period charges included severance and employee related benefits associated with Oclaro's executive severance and retention agreements. These retention agreements provided, under certain circumstances, for payments and benefits upon an involuntary termination of employment. Any changes in the estimates of executing our restructuring activities will be reflected in our future results of operations. Impairment charges In the third quarter of fiscal 2019, we announced our plan to discontinue the development of future Datacom transceiver modules which impacted theMilpitas and Shenzhen Datacom module teams. While we expect strong growth in Datacom volumes in the future, gross margins at the transceiver market level are lower due to extreme competition. Following the Oclaro acquisition, we have a differentiated leadership position across a range of photonic chips on which the Datacom, wireless, and access markets critically rely. During the three and nine months endedMarch 28, 2020 andMarch 30, 2019 , we recorded$2.5 million ,$2.5 million ,$30.7 million , and$30.7 million , respectively, in long-lived asset impairment charges in connection with the above plan. Interest Expense For the three months endedMarch 28, 2020 andMarch 30, 2019 , we recorded interest expense of$15.6 million and$11.3 million , respectively. The increase in interest expense during the three months endedMarch 28, 2020 as compared to the three months endedMarch 30, 2019 was mainly driven by the increase in amortization of the debt discount and contractual interest expense of$10.8 million due to the issuance of our 0.50% Convertible Notes due in 2026 (the "2026 Notes"), offset by the decrease in contractual interest expense on our term loan facility of$6.2 million , which was fully repaid in the second quarter of fiscal 2020. For the nine months endedMarch 28, 2020 andMarch 30, 2019 , we recorded interest expense of$45.3 million and$24.9 million , respectively. The increase in interest expense during the nine months endedMarch 28, 2020 as compared to the nine months endedMarch 30, 2019 was mainly driven by amortization of the debt discount and contractual interest expense incurred from our 2026 Notes, as well as the loss on early extinguishment of debt of$8.0 million , which represents the write-off of the issuance costs in conjunction with payback of our term loan facility in the second quarter of fiscal 2020. Other Income (Expense), Net The components of other income (expense), net are as follows (in millions): Three Months Ended
Nine Months Ended
March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019
Foreign exchange gains
(losses), net $ 0.7 $ (1.0 ) $ (0.3 ) $ (1.0 )
Interest income 5.2 3.9 12.6 10.0
Other income (expense), net 15.8 2.3 15.6 2.7
Total other income
(expense), net $ 21.7 $ 5.2 $ 27.9 $ 11.7
48-------------------------------------------------------------------------------- For the three and nine months endedMarch 28, 2020 , other income, net increased by$16.5 million and$16.2 million , respectively, as compared to the three and nine months endedMarch 30, 2019 , mainly driven by a gain on the sale of Lithium Niobate modulators business of$13.8 million . The transaction was completed in the third quarter of fiscal year 2020. Unrealized Gain on Derivative Liability We recorded$8.8 million of unrealized gain on Series A Preferred Stock derivative liability for the nine months endedMarch 30, 2019 . OnNovember 2, 2018 , all 35,805 shares of our Series A Preferred Stock were converted to common stock with the outstanding balance of the embedded derivative liability reclassified to additional paid in capital. There will be no further adjustments to "unrealized gain (loss) on derivative liability" due to this conversion. For further discussion of our derivative liability, see "Note 11. Non-Controlling Interest Redeemable Convertible Preferred Stock and Derivative Liability" in the notes to condensed consolidated financial statements. Provision for (Benefit from) Income Taxes (in millions) Three Months Ended Nine Months Ended March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019 Provision for (benefit from) income taxes$ 5.2 $ (8.2 )
We recorded a tax provision (benefit) of$5.2 million and$(8.2) million for the three months endedMarch 28, 2020 andMarch 30, 2019 , respectively, and$19.6 million and$(1.6) million for the nine months endedMarch 28, 2020 andMarch 30, 2019 , respectively. We recognized a discrete tax benefit of$4.1 million during the three months endedMarch 28, 2020 from the release of uncertain tax positions related to the fiscal 2016 U.S. federal income tax return as a result of the expiration of statute of limitations during the quarter. Our estimated effective tax rate for fiscal 2020 differs from the 21%U.S. statutory rate primarily due to the income tax benefit of the earnings of our foreign subsidiaries being taxed at rates that differ from theU.S. statutory rate as well as theU.S. federal R&D and foreign tax credits, partially offset by the income tax expense from non-deductible stock-based compensation and the tax effect of Global Intangible Low-Taxed Income ("GILTI"), Base Erosion and Anti-Abuse Tax ("BEAT") and subpart F inclusion. Contractual Obligations The following table summarizes our contractual obligations as ofMarch 28, 2020 , and the effect such obligations are expected to have on our liquidity and cash flow over the next five years (in millions): Payments due by period Less than 1 More than 5 Total year 1 - 3 years 3 - 5 years years Contractual Obligations Asset retirement obligations$ 4.9 $ - $ 1.0 $ 1.8$ 2.1 Finance lease liabilities, including imputed interest 4.0 3.9 0.1 - - Operating lease liabilities, including imputed interest (1) 80.6 13.5 24.0 16.5 26.6 Pension plan contributions (2) 0.5 0.5 - - - Purchase obligations (3) 257.2 255.3 1.9 - - Convertible notes - principal (4) 1,500.0 - - 450.0 1,050.0 Convertible notes - interest (4) 41.3 5.9 12.7 12.2 10.5 Total$ 1,888.5 $ 279.1 $ 39.7 $ 480.5 $ 1,089.2 (1) The amounts of operating lease liabilities in the table above do not include any sublease income amounts nor do they include payments for short-term leases or variable lease payments. As ofMarch 28, 2020 , we expect to receive sublease income of approximately$5.9 million over the next three years. (2) The amount in the preceding table represents planned contributions to our defined benefit plans. Although additional future contributions will be required, the amount and timing of these contributions will be affected by actuarial assumptions, the actual rate of returns on plan assets, the level of market interest rates, legislative changes, and the amount of voluntary contributions to the plan. Any contributions for the following fiscal year and later will depend on the value of the plan assets in the future and thus are uncertain. As such, we have not included any amounts beyond one year in the table above. (3) Purchase obligations represent legally-binding commitments to purchase inventory and other commitments made in the normal course of business to meet operational requirements. Refer to "Note 17. Commitments and Contingencies" in the notes to condensed consolidated financial statements. 49 -------------------------------------------------------------------------------- (4) Includes principal and interest on our 0.25% Convertible Notes due in 2024 (the "2024 Notes" and together with the 2026 Notes, the "Notes") throughMarch 2024 , and principal and interest on our 2026 Notes throughDecember 2026 . We have the right to redeem the 2024 Notes and the 2026 Notes in whole or in part at any time on or afterMarch 15, 2024 and on or afterDecember 15, 2026 , respectively. Refer to "Note 12. Debt" in the notes to condensed consolidated financial statements. As ofMarch 28, 2020 , our other non-current liabilities also include$18.1 million of unrecognized tax benefit for uncertain tax positions. We are unable to reliably estimate the timing of future payments related to uncertain tax positions and therefore have excluded them from the preceding table. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, as such term is defined in rules promulgated by theSEC , that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. Financial Condition Liquidity and Capital Resources As ofMarch 28, 2020 andJune 29, 2019 , our cash and cash equivalents of$688.3 million and$432.6 million , respectively, were largely held inthe United States . The total amount of cash outsidethe United States as ofMarch 28, 2020 was$84.7 million , which was primarily held by entities incorporated inJapan , theUnited Kingdom , theBritish Virgin Islands ,Hong Kong , andThailand . Although the cash currently held inthe United States as well as the cash generated inthe United States from future operations is expected to cover our normal operating requirements, a substantial amount of additional cash could be required for other purposes, such as capital expenditures to support our business and growth, including costs associated with increasing internal manufacturing capabilities, particularly in ourThailand facility, strategic transactions and partnerships, and future acquisitions. Our intent is to indefinitely reinvest funds held outsidethe United States , except for the funds held in theCayman Islands ,Japan andHong Kong , and our current plans do not demonstrate a need to repatriate them to fund our domestic operations. However, if in the future, we encounter a significant need for liquidity domestically or at a particular location that we cannot fulfill through borrowings, equity offerings, or other internal or external sources, or the cost to bring back the money is insignificant from a tax perspective, we may determine that cash repatriations are necessary or desirable. Repatriation could result in additional material taxes. These factors may cause us to have an overall tax rate higher than other companies or higher than our tax rates have been in the past. If conditions warrant, we may seek to obtain additional financing through debt or equity sources. To the extent we issue additional shares, our existing stockholders may be diluted. However, any such financing may not be available on terms favorable to us, or may not be available at all. As ofMarch 28, 2020 , our condensed consolidated balance of cash, cash equivalents, and restricted cash increased by$256.2 million , to$688.8 million from$432.6 million as ofJune 29, 2019 . The increase in cash, cash equivalents, and restricted cash was mainly due to cash provided by operating activities of$401.6 million and cash provided by financing activities of$332.5 million , offset by cash used in investing activities of$477.9 million during the nine months endedMarch 28, 2020 . As ofMarch 30, 2019 , our consolidated balance of cash and cash equivalents, including cash classified within assets held-for-sale, decreased by$39.0 million , to$358.3 million from$397.3 million as ofJune 30, 2018 . The decrease in cash and cash equivalents was mainly due to cash used in investing activities of$725.3 million , principally related to cash used to acquire Oclaro; partially offset by cash provided by financing activities of$484.1 million , primarily related to$490.8 million in proceeds from a term loan, net of debt issuance costs, used to fund the Oclaro acquisition, and cash provided by operating activities of$202.4 million during the nine months endedMarch 30, 2019 . Operating Cash Flow Cash provided by operating activities was$401.6 million during the nine months endedMarch 28, 2020 . Our net income was$140.1 million for the nine months endedMarch 28, 2020 . Cash provided by operating activities was generated primarily from$232.8 million of non-cash items (such as depreciation, stock-based compensation, amortization of intangibles, amortization 50 -------------------------------------------------------------------------------- of debt discount and debt issuance costs on our term loans and convertible notes, and other non-cash charges), and$28.7 million of changes in our operating assets and liabilities. Changes in our operating assets and liabilities related primarily to a decrease in inventories of$48.3 million offset by an increase in accounts receivable of$23.8 million . Cash provided by operating activities was$202.4 million during the nine months endedMarch 30, 2019 . Our net loss was$10.6 million for the nine months endedMarch 30, 2019 . Cash provided by operating activities was generated primarily from$210.0 million of non-cash items (such as depreciation, stock-based compensation, unrealized (gain) loss on derivative liability, amortization of intangibles, amortization of discount on the 2024 Notes, amortization of the debt issuance costs on the term loan, amortization of fair value adjustment in connection with the acquisition of Oclaro, net amortization of discounts and premium on investments, and impairment charges and others), and$3.0 million of changes in our operating assets and liabilities. Investing Cash Flow Cash used in investing activities of$477.9 million during the nine months endedMarch 28, 2020 was primarily attributable to purchases of short-term investments, net of sales and maturities of$427.9 million , capital expenditures of$64.9 million , and payment for asset acquisition of$4.0 million , offset by proceeds from sale of product lines of$18.9 million . Cash used in investing activities of$725.3 million during the nine months endedMarch 30, 2019 , was primarily attributable to$619.8 million in cash payments to acquire all outstanding shares of common stock of Oclaro, net of cash received through the acquisition of Oclaro. In addition we had capital expenditures of$80.5 million , payment for asset acquisition of$1.3 million , and purchase of short-term investments, net of sales of$23.7 million . Financing Cash Flow Cash provided by financing activities of$332.5 million during the nine months endedMarch 28, 2020 resulted primarily from the proceeds of the issuance of the 2026 Notes of$1,042.4 million , net of issuance costs, offset by the repurchase of shares of our common stock of$200.0 million and repayment of our term loan facility of$497.5 million . Cash provided by financing activities of$484.1 million during the nine months endedMarch 30, 2019 , primarily resulted from$490.8 million of proceeds from a term loan, net of debt issuance costs, used to partially finance the Oclaro acquisition,$4.7 million from the issuance of common stock under the employee stock plan; partially offset by the repayment of capital lease obligations of$6.1 million , tax payments related to restricted stock of$2.4 million , a payment of an acquisition related holdback of$1.0 million , and dividend payments on our Series A Preferred Stock of$0.7 million . Liquidity and Capital Resources Requirements We believe that our cash and cash equivalents as ofMarch 28, 2020 and cash flows from our operating activities will be sufficient to meet our liquidity and capital spending requirements for at least the next 12 months. However, if market conditions are favorable, we may evaluate alternatives to opportunistically pursue additional financing. 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, including the impact of COVID-19; • fluctuations in demand for our products as a result of changes in regulations, tariffs or other trade barriers, and trade relations in general;
• changes in accounts receivable, inventory or other operating assets and
liabilities, which affect our working capital;
• increase in capital expenditures to support our business and growth;
• the tendency of customers to delay payments or to negotiate favorable
payment terms to manage their own liquidity positions;
• timing of payments to our suppliers;
• factoring or sale of accounts receivable;
• volatility in fixed income and credit, which impact the liquidity and
valuation of our investment portfolios;
• volatility in foreign exchange markets, which impacts our financial results;
51
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• possible investments or acquisitions of complementary businesses,
products or technologies, or other strategic transactions or
partnerships;
• issuance of debt or equity securities, or other financing transactions,
including bank debt;
• potential funding of pension liabilities either voluntarily or as
required by law or regulation; and
• the settlement of any conversion or redemption of the 2024 Notes and the
2026 Notes in cash.
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