VIAVI SOLUTIONS INC. Forward-Looking Statements Statements contained in this Quarterly report on Form 10-Q, which we also refer to as the Report, which are not historical facts are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. A forward-looking statement may contain words such as "anticipates," "believes," "can," "can impact," "could," "continue," "estimates," "expects," "intends," "may," "ongoing," "plans," "potential," "projects," "should," "will," "will continue to be," "would," or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements such as: •Our expectations regarding the impact of the COVID-19 pandemic on our business, financial condition and results of operations; •Our expectations regarding demand for our products, including industry trends and technological advancements that may drive such demand, the role we will play in those advancements and our ability to benefit from such advancements; •Our plans for growth and innovation opportunities; •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 theU.S. Securities and Exchange Commission . Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these 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 endedJune 27, 2020 . 32 -------------------------------------------------------------------------------- Table of Contents You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in "Risk Factors" and "Forward-Looking Statements." OUR INDUSTRIES AND QUARTERLY DEVELOPMENTSViavi Solutions Inc. (VIAVI also referred to as the Company, we, our and us), is a global provider of network test, monitoring and assurance solutions for communications service providers, enterprises, network equipment manufacturers, government and avionics. We help these customers harness the power of instruments, automation, intelligence and virtualization to Command the network. VIAVI is also a leader in light management solutions for 3D Sensing, anti-counterfeiting, consumer electronics, industrial, government, automotive, and defense applications. To serve our markets we operate the following business segments: •Network Enablement (NE); •Service Enablement (SE), and; •Optical Security and Performance Products (OSP). Network Enablement NE provides an integrated portfolio of testing solutions that access the network to perform build-out and maintenance tasks. These solutions include instruments, software and services to design, build, activate, certify, troubleshoot and optimize networks. They also support more profitable, higher-performing networks and facilitate time-to-revenue. Our solutions address lab and production environments, field deployment and service assurance for wireless and fixed communications networks, including storage networks. Our test instrument portfolio is one of the largest in the industry, with hundreds of thousands of units in active use by major network equipment manufacturers (NEMs), operators and services providers worldwide. Designed to be mobile, these products include instruments and software that access the network to perform installation and maintenance tasks. They help service provider technicians assess the performance of network elements and segments and verify the integrity of the information being transmitted across the network. These instruments are highly intelligent and have user interfaces that are designed to simplify operations and minimize the training required to operate them. Our NE solutions are also used by NEMs in the design and production of next-generation network equipment. Other Test & Measurement communications products also serve the public safety, government, and aerospace and defense markets. We also offer a range of product support and professional services designed to comprehensively address our customers' requirements. These services include repair, calibration, software support and technical assistance for our products. We offer product and technology training as well as consulting services. Our professional services, provided in conjunction with system integration projects, include project management, installation and implementation. NE customers include customer service providers (CSPs), NEMs, government organizations and large corporate customers, such as major telecom, mobility and cable operators, chip and infrastructure vendors, storage device manufacturers, storage network and switch vendors, and deployed private enterprise customers. Our customers include América Móvil, AT&T Inc., Lumen Technologies (formerlyCenturyLink Inc. ), Cisco Systems, Inc., Nokia Solutions and Networks, and Verizon Communications, Inc. Our NE products and associated services including acquired business are described below: Field Instruments: Primarily consisting of; (a) Access and Cable products; (b) Avionics products; (c) Fiber Instrument products; (d) Metro products; (e) RF Test products; and, (f) Radio Test products. Lab Instruments: Primarily consisting of; (a) Fiber Optic Production Lab Test; (b)Optical Transport products; (c) Storage Network Test products; and, (d) Wireless products. 33 -------------------------------------------------------------------------------- Table of Contents Service Enablement SE provides embedded systems and enterprise performance management solutions that give global CSPs, enterprises and cloud operators visibility into network, service and application data. These solutions, which primarily consist of instruments, 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. Our portfolio of SE solutions addresses the same lab and production environments, field deployment and service assurance for operational and fixed communications networks, including storage networks, as our NE portfolio. Our solutions let carriers remotely monitor performance and quality of network, service and applications performance throughout the entire network. This provides our customers with enhanced network management, control, and optimization that allow network operators to initiate service to new customers faster, decrease the need for technicians to make on-site service calls, help to make necessary repairs faster and, as a result, lower costs while providing higher quality and more reliable services. Remote monitoring decreases operating expenses, while early detection helps increase uptime, preserve revenue, and helps operators better monetize their networks. SE customers include similar CSPs, NEMs, government organizations, large corporate customers, and storage-segment customers that are served by our NE segment. Our SE products and associated services are described below: Data Center: Consisting of our Network Performance Monitoring and Security tools. Assurance: Primarily consisting of our Growth Products (Location Intelligence and NITRO Mobile products) and Mature Products (Legacy Assurance and Legacy Wireline). Optical Security and Performance Products Our OSP segment leverages its core optical coating technologies and volume manufacturing capability to design, manufacture, and sell products targeting anti-counterfeiting, consumer and industrial, government, automotive industrial and other markets. Our anti-counterfeiting offerings for the currency market include, OVP (Optical Variable Pigment) and OVMP (Optical Variable Magnetic Pigment). OVP® enables a color-shifting effect used by banknote issuers and security printers worldwide for anti-counterfeiting applications on banknotes and other high-value documents. We also provide OVMP®, a technology that delivers depth and motion effects for authenticating banknotes. Our anti-counterfeiting technologies are deployed on the banknotes of more than 100 countries today. Leveraging our expertise in spectral management and our unique high-precision coating capabilities, OSP provides a range of products and technologies for the consumer and industrial market, including, for example, 3D Sensing optical filters and Engineered DiffusersTM. OSP value-added solutions meet the stringent requirements of commercial and government customers. Our 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,SICPA Holding SA Company (SICPA), STMicroelectronics N.V., Lockheed Martin Corporation and Seiko Epson Corporation. COVID-19 Pandemic Update The COVID-19 pandemic impacted theU.S. and virtually all of the countries and territories we operate in worldwide. The pandemic has prompted authorities worldwide to implement measures to contain the virus, which include and are not limited to, travel bans and restrictions, quarantines, shelter-in-place orders, temporary business closures, among others. The COVID-19 pandemic and these aforementioned measures, have had and continue to have, a substantial macroeconomic impact on businesses and economies worldwide. These conditions may continue and result in an adverse impact to our operations. 34 -------------------------------------------------------------------------------- Table of Contents Our priority during the COVID-19 pandemic has remained focused on protecting the health and safety of all those we serve, our employees, customers, suppliers, and communities - including implementing early and regular updates to our health and safety policies and procedures. We have shut down, slowed, or modified business operations and activities in certain geographies, including in some instances, limiting production to essential business services, all in conjunction with federal, state, and local health and safety regulations and shelter-in-place directives. We continue to follow the guidance of local and national governments, including monitoring the health of our employees who have returned to our offices, by limiting the gathering size of employee groups in indoor spaces per social distancing guidelines, and requiring those employees to wear masks and to undergo screenings prior to entering our offices. While distribution of the vaccines commenced in theUK andU.S. in late 2020, there have been logistical and operational challenges with the rollout, demand for the vaccine has far exceeded supply, and it will take some time for the global population to receive vaccines and for widespread immunity to develop. At the same time, new and potentially more contagious variants of the virus are developing in several countries and regions in which we operate. We will continue to take the health and safety measures described above to ensure the health and safety of our employees and those they come in contact with. The COVID-19 pandemic has not thus far had a substantial net impact on our liquidity position. We continue to generate operating cash flows to meet our short-term liquidity needs, and we expect to maintain access to the capital markets. To date, we have not observed any material or materially adverse indication of impairments under the authoritative guidance, to any of our assets or a significant change to the fair value of assets due to the COVID-19 pandemic. We have experienced and may continue to experience disruption of our facilities, suppliers and contract manufacturers, which has and may continue to negatively impact our sales and operating results. In addition, we have experienced and may continue to experience shipping and logistics challenges as many of our customers have also closed their facilities and are operating under similar restrictions. Additionally, NSE has experienced some impact to customer demand including for Field Instruments. Customer demand will be challenging to calibrate, due to the nature and timing of the COVID-19 pandemic. While COVID-19 has brought unprecedented challenges, we believe that we have a robust and adaptable supply chain. Our supply chain team has been working to meet our customer needs by executing on a risk mitigation plan, including multi-sourcing, pre-ordering components, transforming our logistics network, prioritizing critical customers, working with local government agencies to understand challenges, and partnering on solutions that limit disruptions to our operations while ensuring the safety of our employees, partners and suppliers. Nonetheless, surges in infection rate, new shutdowns, emergence of new and potentially more contagious variants of the virus and the slow pace of vaccine rollout may impact our suppliers and our ability to source materials in a timely manner. Capital markets and worldwide economies have also been significantly impacted by the COVID-19 pandemic, and onJune 8, 2020 , theNational Bureau of Economic Research announced that theU.S. was in a recession. Deterioration of macro-economic conditions could have a material adverse impact on our longer-term business as customers curtail and reduce overall spending. As the pandemic spread across the globe, there has been a tightening of the credit markets. We entered into a$300 million secured credit facility inMay 2020 to strengthen our liquidity position but have not drawn on this facility to date. Under a prolonged global recession, we could face future liquidity challenges and may not be able to obtain additional financing on favorable terms or at all. Despite the continued challenges that we are facing due to the COVID-19 pandemic, we remain confident that the actions that we are taking to manage such challenges, combined with our strong liquidity, position us well to navigate through the current economic environment and continue to execute on our long-term value creation strategy. 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. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted inthe United States of America , (U.S. GAAP), which require management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, net revenue and expenses, and the 35 -------------------------------------------------------------------------------- Table of Contents disclosure of contingent assets and liabilities. Our estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ from these estimates and such differences may be material. 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 of Financial Condition and Results of Operations in our Fiscal 2020 Annual Report on Form 10-K filed with theSecurities and Exchange Commission (SEC). There have been no material changes to our critical accounting policies and estimates. 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 Six Months Ended January 2, December 28, Percent January 2, December 28, Percent 2021 2019 Change Change 2021 2019 Change Change Segment net revenue: NE$ 180.9 $ 203.0 $ (22.1) (10.9) %$ 343.0 $ 401.9 $ (58.9) (14.7) % SE 25.8 31.2 (5.4) (17.3) % 47.2 52.1 (4.9) (9.4) % OSP 93.2 79.5 13.7 17.2 % 194.4 159.5 34.9 21.9 % Total net revenue$ 299.9 $ 313.7 $ (13.8) (4.4) %$ 584.6 $ 613.5 $ (28.9) (4.7) % Gross profit$ 180.1 $ 189.5 $ (9.4) (5.0) %$ 349.5 $ 363.9 $ (14.4) (4.0) % Gross margin 60.1 % 60.4 % 59.8 % 59.3 %
Research and development
(0.6) %$ 98.8 $ 101.8 $ (3.0) (2.9) % Percentage of net revenue 16.7 % 16.0 % 16.9 % 16.6 % Selling, general and administrative$ 79.5 $ 86.3 $ (6.8) (7.9) %$ 160.9 $ 179.5 $ (18.6) (10.4) % Percentage of net revenue 26.5 % 27.5 % 27.5 % 29.3 % Restructuring and related charges (benefits)$ 0.2 $ (0.9) $ 1.1 (122.2) %$ (0.4) $ (0.6) $ 0.2 (33.3) % Percentage of net revenue 0.1 % (0.3) % (0.1) % (0.1) % Interest and other income, net$ 1.1 $ 1.3 $ (0.2) (15.4) %$ 1.7 $ 4.0 $ (2.3) (57.5) % Percentage of net revenue 0.4 % 0.4 % 0.3 % 0.7 % Interest expense$ (9.0) $ (8.4) $ 0.6 7.1 %$ (18.0) $ (16.7) $ 1.3 7.8 % Percentage of net revenue 3.0 % 2.7 % 3.1 % 2.7 %
Provision for income taxes
26.3 %$ 21.1 $ 18.2 $ 2.9 15.9 % Percentage of net revenue 4.2 % 3.2 % 3.6 % 3.0 % Net Revenue 36
-------------------------------------------------------------------------------- Table of Contents Revenue from our service offerings exceeds 10% of our total consolidated net revenue and is presented separately in our Consolidated Statements of Operations. Service revenue primarily consists of maintenance and support, extended warranty, training, professional services and post-contract support in addition to other services such as calibration and repair services. When evaluating the performance of our segments, management focuses on total net revenue, gross profit and operating income and not the product or service categories. Consequently, the following discussion of business segment performance focuses on total net revenue, gross profit, and operating income consistent with our approach for managing the business. COVID-19 We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, the Company cannot reasonably estimate the ultimate impacts of COVID-19 on our financial condition, results of operations or cash flows in the future. However, if the COVID-19 pandemic is prolonged and there are continued delays in resumption of normal business operations and activities, we expect that it could have a material negative impact on our future revenue growth as well as our overall profitability. Three months endedJanuary 2, 2021 andDecember 28, 2019 Net revenue decreased by$13.8 million , or 4.4%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was due to revenue decrease from our NE and SE segments, partially offset by revenue increase in our OSP segment. Product revenues decreased by$19.8 million , or 7.0%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was primarily due to revenue declines from our NE and SE segments, partially offset by increased revenues from our OSP segment as discussed below. Service revenues increased by$6.0 million , or 18.9%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This increase was primarily due to increased revenues from our NE segment. NE net revenue decreased by$22.1 million , or 10.9%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was driven by the impact to our business from the COVID-19 lockdown impacting bothField Instruments and Lab & Production Equipment , including Cable, Access, Fiber, Wireless and AvComm products. SE net revenue decreased by$5.4 million , or 17.3%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease is primarily driven by decreased revenue from our Data Center and Growth Assurance products. OSP net revenue increased by$13.7 million , or 17.2%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This increase is driven by growth in revenue from our Anti-Counterfeiting and 3D Sensing products. Six Months EndedJanuary 2, 2021 andDecember 28, 2019 Net revenue decreased by$28.9 million , or 4.7%, during the six months endedJanuary 2, 2021 compared to the same period a year ago due to revenue decrease from our NE and SE segments, partially offset by our OSP segment. Product revenues decreased by$36.7 million , or 6.7% during the six months endedJanuary 2, 2021 compared to the same period a year ago due to revenue decrease from our NE and SE segments, partially offset by our OSP segment. Service revenues increased by$7.8 million , or 11.7%, during the six months endedJanuary 2, 2021 compared to the same period a year ago primarily due to increased support revenue from the NE and SE segments, partially offset by a decline in our OSP segment as discussed below. NE net revenue decreased by$58.9 million , or 14.7%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was driven by the impact to our business from the COVID-19 37 -------------------------------------------------------------------------------- Table of Contents lockdown impacting bothField Instruments and Lab & Production Equipment , including Cable, Access, Fiber, Wireless and AvComm products. SE net revenue decreased by$4.9 million , or 9.4%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This decrease is primarily driven by decreased revenue from our Data Center and Growth Assurance products. OSP net revenue increased by$34.9 million , or 21.9%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This increase is primarily driven by growth in revenue from our Anti-Counterfeiting and 3D Sensing 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, seasonality, profitability, and general financial performance, which could create period over period variability in our financial measures and present foreign exchange rate risks. Additionally, we have seen demand for our NE and SE products affected by macroeconomic uncertainty. We cannot predict when or to what extent these uncertainties will be resolved. Our revenues, profitability, and general financial performance may also be affected by: (a) pricing pressures due to, among other things, a highly concentrated customer base, increasing competition, particularly fromAsia -based competitors, and a general commoditization trend for certain products; (b) product mix variability in our 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 NE and SE customer bases and adds additional risk and uncertainty to our financial and business projections; (e) the impact of ongoing global trade policies, tariffs and sanctions; and (f) regulatory or economic developments and/or technology challenges that slow or change the rate of adoption of 5G, 3D Sensing and other emerging secular technologies and platforms. Revenue by Region We operate in three geographic regions:Americas ,Asia-Pacific andEurope Middle East andAfrica (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, which may differ from the location of their end customers. The following table presents net revenue by the three geographic regions we operate in and net revenue from countries that exceeded 10% of our total net revenue (in millions): Three Months Ended Six Months Ended January 2, 2021 December 28, 2019 January 2, 2021 December 28, 2019 Americas: United States $ 88.6 29.5 %$ 96.2 30.7 %$ 166.4 28.5 %$ 181.2 29.5 % Other Americas 19.8 6.7 % 20.6 6.6 % 37.4 6.4 % 41.3 6.8 % Total Americas$ 108.4 36.2 %$ 116.8 37.3 %$ 203.8 34.9 %$ 222.5 36.3 % Asia-Pacific: Greater China $ 73.2 24.4 %$ 80.5 25.7 %$ 152.3 26.1 %$ 152.4 24.8 % Other Asia-Pacific 23.2 7.7 % 32.5 10.3 % 52.3 8.9 % 67.8 11.1 % Total Asia-Pacific $ 96.4 32.1 %$ 113.0 36.0 %$ 204.6 35.0 %$ 220.2 35.9 % EMEA: Switzerland $ 19.9 6.6 %$ 13.5 4.3 %$ 37.8 6.5 %$ 25.7 4.2 % Other EMEA 75.2 25.1 % 70.4 22.4 % 138.4 23.6 % 145.1 23.6 % Total EMEA $ 95.1 31.7 %$ 83.9 26.7 %$ 176.2 30.1 %$ 170.8 27.8 % Total net revenue$ 299.9 100.0 %$ 313.7 100.0 %$ 584.6 100.0 %$ 613.5 100.0 % 38
-------------------------------------------------------------------------------- Table of Contents Net revenue from customers outside theAmericas during the three and six months endedJanuary 2, 2021 represented 63.8% and 65.1% of net revenue, respectively. Net revenue from customers outside theAmericas during the three and six months endedDecember 28, 2019 represented 62.8% and 63.7% of net revenue, respectively. We expect revenue from customers outside ofUnited States to continue to be an important part of our overall net revenue and an increasing focus for net revenue growth opportunities. Gross Margin Gross margin decreased by 0.3 percentage points during the three months endedJanuary 2, 2021 from 60.4% in the same period a year ago to 60.1% in the current period. This decrease was primarily driven by lower revenue volume and unfavorable product mix within our NE segment, offset by increased factory utilization due to revenue growth and favorable product mix in our OSP and SE segments. Gross margin increased by 0.5 percentage points during the six months endedJanuary 2, 2021 from 59.3% in the same period a year ago to 59.8% in the current period. This increase was primarily driven by improved factory utilization due to higher revenue volume and favorable product mix within our OSP segment and gross margin improvement in our SE segment. This increase was partially offset by gross margin reduction in our NE segment as discussed below in the Operating Segment Information section. 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 toAsia-Pacific -based competition), are price sensitive and/or are affected by customer seasonal and mix variant buying patterns. We expect these factors to continue to result in variability of our gross margin. Research and Development R&D expense decreased by$0.3 million , or 0.6%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was driven by variable expense reductions and cost efficiencies realized during the period. As a percentage of net revenue, R&D expense increased, by 0.7 percentage points during the three months endedJanuary 2, 2021 compared to the same period a year ago. R&D expense decreased by$3.0 million , or 2.9%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was primarily driven by variable expense reductions and cost efficiencies during the reporting period. As a percentage of net revenue R&D expense increased by 0.3 percentage points during the six months endedJanuary 2, 2021 compared to the same period a year ago. 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. Selling, General and Administrative SG&A expense decreased by$6.8 million , or 7.9%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was primarily due to lower spend on sales commissions and travel and entertainment expenses in the current period, partially offset by the change in the fair value of contingent consideration. As a percentage of net revenue, SG&A decreased 1.0 percentage point during the three months endedJanuary 2, 2021 compared to the same period a year ago. SG&A expense decreased by$18.6 million , or 10.4%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This decrease was primarily due to lower spend on sales commissions and travel and entertainment expenses in the current period, partially offset by the change in the fair value of contingent consideration. As a percentage of net revenue, SG&A decreased 1.8 percentage points during the six months endedJanuary 2, 2021 compared to the same period a year ago. We intend to continue to focus on reducing our SG&A expense as a percentage of net revenue. However, we may experience in the future, increased expenses related to a return to travel, industry trade shows, and other business related expenses as the macroeconomic environment returns to normalcy and pre-pandemic conditions. Further, certain impacts unrelated to our core operating performance, such as mergers and acquisitions-related expenses, litigation expenses and changes in the fair value measurement of our contingent consideration liabilities, could increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter. 39 -------------------------------------------------------------------------------- Table of Contents From time to time we have initiated strategic restructuring events primarily intended to reduce costs, consolidate our operations, integrate various acquisitions, rationalize the manufacturing of our products and align our businesses to address market conditions. As ofJanuary 2, 2021 andJune 27, 2020 , the Company's total restructuring accrual was$3.6 million and$6.5 million , respectively. During the three and six months endedJanuary 2, 2021 , the Company recorded restructuring and related charges (benefits) of$0.2 million and$(0.4) million , respectively. During the three and six months endedDecember 28, 2019 , the Company recorded restructuring and related benefits of$(0.9) million and$(0.6) million , respectively. Refer to "Note 13. Restructuring and Related Charges" for more information. Interest and Other Income, Net Interest Expense Interest expense increased by$0.6 million , or 7.1%, during the three months endedJanuary 2, 2021 compared to the same period a year ago. This increase was primarily due to the commitment fee on unutilized portion of the revolving credit facility, the amortization of issuance costs related to the revolving credit facility as well as an increase in debt discount accretion on the 2023 Notes and 2024 Notes during the current period. Interest expense increased by$1.3 million , or 7.8%, during the six months endedJanuary 2, 2021 compared to the same period a year ago. This increase was primarily due to the commitment fee on unutilized portion of the revolving credit facility, the amortization of issuance costs related to the revolving credit facility as well as an increase in debt discount accretion on the 2023 Notes and 2024 Notes during the current period. Interest and other income, net, was$1.1 million during the three months endedJanuary 2, 2021 compared to$1.3 million the same period a year ago. This$0.2 million decrease was primarily driven by a$1.3 million decrease in interest income due to lower yields on money market funds in which we invest excess cash during the current period coupled with cash repatriation from a jurisdiction with relatively high interest rates to a jurisdiction with low interest rates prior to the current period. This decrease in interest income was offset by a$1.1 million favorable foreign exchange impact as the balance sheet hedging program provided a more favorable offset to the remeasurement of underlying foreign exchange exposures during the current period. Interest and other income, net, was$1.7 million during the six months endedJanuary 2, 2021 compared to$4.0 million the same period a year ago. This$2.3 million decrease was primarily driven by$2.6 million decrease in interest income due to lower yields on money market funds in which we invest excess cash during the current period coupled with cash repatriation from a jurisdiction with relatively high interest rates to a jurisdiction with low interest rates prior to the current period. Provision for Income Taxes We recorded an income tax expense of$12.5 million and$21.1 million for the three and six months endedJanuary 2, 2021 , respectively. We recorded an income tax expense of$9.9 million and$18.2 million for the three and six months endedDecember 28, 2019 , respectively. The income tax expense for the three months and six endedJanuary 2, 2021 andDecember 28, 2019 primarily relates to income tax in certain foreign and state jurisdictions based on our forecasted pre-tax income or loss for the respective fiscal year. The income tax provision recorded differs from the expected tax provision that would be calculated by applying the federal statutory rate to our income from continuing operations before taxes primarily due the changes in valuation allowance for deferred tax assets attributable to our domestic and foreign income from continuing operations. As ofJanuary 2, 2021 , andJune 27, 2020 , our unrecognized tax benefits totaled$48.4 million and$48.4 million , respectively, and are included in deferred taxes and other non-current tax liabilities, net. We had$3.9 million accrued for the payment of interest and penalties as ofJanuary 2, 2021 . The timing and resolution of income tax examinations is uncertain, and the amounts ultimately paid, if any, upon resolution of issues raised by the taxing authorities may differ from the amounts accrued for each year. Although we do not expect that our balance of gross unrecognized tax benefits will change materially in the next 12 months, given the uncertainty in the development of ongoing income tax examinations, we are unable to estimate the full range of possible adjustments to this balance. 40 -------------------------------------------------------------------------------- Table of Contents Operating Segment Information Information related to our operating segments were as follows, (in millions): Three Months Ended Six Months Ended January 2, December 28, January 2, December 28, 2021 2019 Change Percentage Change 2021 2019 Change Percentage Change Network Enablement Net revenue$ 180.9 $ 203.0 $ (22.1) (10.9) %$ 343.0 $ 401.9 $ (58.9) (14.7) % Gross profit 113.3 134.8 (21.5) (15.9) % 216.8 262.8 (46.0) (17.5) % Gross margin 62.6 % 66.4 % 63.2 % 65.4 % Service Enablement Net revenue$ 25.8 $ 31.2 $ (5.4) (17.3) %$ 47.2 $ 52.1 $ (4.9) (9.4) % Gross profit 17.6 20.8 (3.2) (15.4) % 31.9 33.4 (1.5) (4.5) % Gross margin 68.2 % 66.7 % 67.6 % 64.1 % Network and Service Enablement Net revenue$ 206.7 $ 234.2 $ (27.5) (11.7) %$ 390.2 $ 454.0 $ (63.8) (14.1) % Operating income 22.2 37.5 (15.3) (40.8) % 35.5 59.8 (24.3) (40.6) % Operating margin 10.7 % 16.0 % 9.1 % 13.2 % Optical Security and Performance Net revenue$ 93.2 $ 79.5 $ 13.7 17.2 %$ 194.4 $ 159.5 $ 34.9 21.9 % Gross profit 58.4 43.6 14.8 33.9 % 119.4 86.9 32.5 37.4 % Gross margin 62.7 % 54.8 % 61.4 % 54.5 % Operating income 44.6 30.4 14.2 46.7 % 91.9 60.8 31.1 51.2 % Operating margin 47.9 % 38.2 % 47.3 % 38.1 % Network Enablement During the three months endedJanuary 2, 2021 , NE gross margin decreased by 3.8 percentage points from 66.4% in the same period a year ago to 62.6% in the current period, reflecting lower revenue volumes due to the impact of COVID-19 and unfavorable product mix. During the six months endedJanuary 2, 2021 , NE gross margin decreased by 2.2 percentage points from 65.4% in the same period a year ago to 63.2% in the current period. This decrease in the current period reflects lower revenue volumes due to the impact of COVID-19 and unfavorable product mix. Service Enablement During the three months endedJanuary 2, 2021 , SE gross margin increased by 1.5 percentage points from 66.7% in the same period a year ago to 68.2% in the current period. This increase was primarily due to favorable product mix in our Assurance growth products. During the six months endedJanuary 2, 2021 , SE gross margin increased by 3.5 percentage points from 64.1% in the same period a year ago to 67.6% in the current period. This increase was primarily due to favorable product mix in our Assurance growth products. Network and Service Enablement (NSE) During the three months endedJanuary 2, 2021 , NSE operating margin decreased by 5.3 percentage points from 16.0% in the same period a year ago to 10.7% in the current period. This decrease in operating margin was primarily driven by lower revenue volume and gross profit margin in the NE segment, offset by a reduction in operating expenses reflecting disciplined expense management, ongoing efficiency programs and lower variable expenses such as commissions, events travel and entertainment due to the pandemic. 41 -------------------------------------------------------------------------------- Table of Contents During the six months endedJanuary 2, 2021 , NSE operating margin decreased by 4.1 percentage points from 13.2% in the same period a year ago to 9.1% in the current period. This decrease in operating margin was primarily driven by lower revenue volume and gross profit margin in the NE segment, offset by a reduction in operating expenses reflecting disciplined expense management, ongoing efficiency programs and lower variable expenses such as commissions, events travel and entertainment due to the pandemic. Optical Security and Performance Products During the three months endedJanuary 2, 2021 OSP gross margin increased by 7.9 percentage points from 54.8% in the same period a year ago to 62.7% in the current period. This increase was primarily due to increased factory utilization due to higher revenue volumes. During the six months endedJanuary 2, 2021 , OSP gross margin increased by 6.9 percentage points from 54.5% in the same period a year ago to 61.4% in the current period primarily due to favorable product mix driven by higher revenue in Anti-Counterfeiting and 3D Sensing products. OSP operating margin increased by 9.7 percentage points during the three months endedJanuary 2, 2021 from 38.2% in the same period a year ago to 47.9% in the current period. The increase in operating margin was primarily due to higher gross margins as discussed above. OSP operating margin increased by 9.2 percentage points during the six months endedJanuary 2, 2021 from 38.1% in the same period a year ago to 47.3% in the current period. The increase in operating margin was primarily due to higher gross margins as discussed above. Liquidity and Capital Resources As ofJanuary 2, 2021 andJune 27, 2020 , we had assets classified as cash and cash equivalents, as well as short-term investments and short-term restricted cash, in an aggregate amount of$648.8 million and$544.0 million , respectively. Our cash investments are made in accordance with an investment policy approved by the Audit Committee of our Board of Directors and has not changed from that disclosed in our Form 10-K. As ofJanuary 2, 2021 ,U.S. entities owned approximately 47.0% of our cash and cash equivalents, short-term investments and short-term restricted cash. The recent COVID-19 pandemic has caused disruption in global capital markets and over time may impact our ability to obtain credit and/or negotiate acceptable financing terms. As ofJanuary 2, 2021 , 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 endedJanuary 2, 2021 , 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 theU.S. may exceed theFederal 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. OnMay 5, 2020 , we entered into a credit agreement (the Credit Agreement) withWells Fargo Bank, National Association (Wells Fargo) as administrative agent, and other lender related parties. The Credit Agreement provides for a$300 million senior secured revolving credit facility, which matures onMarch 1, 2023 . The Credit Agreement also provides that, under certain circumstances, we may incur term loans or increase the aggregate principal amount of revolving commitments by an aggregate amount of up to$200 million plus additional amounts so long as our secured net leverage ratio, determined on a pro forma basis does not exceed 1.50:1.00. The proceeds from the credit facility established under the Credit Agreement will be used for working capital and other general corporate purposes. The obligations under the Credit Agreement are secured by substantially all of our assets. Amounts outstanding under the Credit Agreement accrue interest at a rate equal to either, at our election, LIBOR plus a margin of 1.75% to 2.50% per annum, or a specified base rate plus a margin of 0.75% to 1.50%, in each case, depending on our consolidated secured leverage ratio. We are required to pay a commitment fee on the unutilized portion of the facility which ranges between 0.30% and 0.40% per annum depending on our consolidated secured leverage ratio. As ofJanuary 2, 2021 , we had no amounts outstanding under the Credit Agreement. 42 -------------------------------------------------------------------------------- Table of Contents Six Months EndedJanuary 2, 2021 As ofJanuary 2, 2021 , our combined balance of cash and cash equivalents and restricted cash increased by$105.3 million to$652.7 million from$547.4 million as ofJune 27, 2020 . During the six months endedJanuary 2, 2021 , Cash provided by operating activities was$132.6 million , consisting of net income of$36.2 million adjusted for non-cash charges (e.g., depreciation, amortization and stock-based compensation) which totaled$82.6 million , including changes in deferred tax balances, and changes in operating assets and liabilities that provided$13.8 million . Changes in our operating assets and liabilities related primarily to an increase of accrued payroll and related expenses of$16.0 million , an increase in deferred revenue of$4.1 million , an increase in income taxes payable of$10.4 million , and a decrease in other current and non-current assets of$3.9 million . These were partially offset by a decrease in accrued expenses and other current and non-current liabilities of$8.5 million , an increase in accounts receivable of$6.4 million , an increase in inventory of$3.3 million , and a decrease in accounts payable of$2.4 million . During the six months endedJanuary 2, 2021 , Cash used in investing activities was$18.0 million , primarily related to$18.5 million of cash used for capital expenditures and$0.6 million of cash used for acquisitions, offset by$1.1 million proceeds from sales of assets. During the six months endedJanuary 2, 2021 , Cash used in financing activities was$35.6 million , primarily resulting from$23.8 million cash paid to repurchase common stock under our share repurchase program,$11.8 million in withholding tax payments on the vesting of restricted stock awards,$2.8 million cash paid to settle assumed debt from an acquisition in fiscal year 2020, and$0.6 million payments on financing obligations. These were partially offset by$3.5 million in proceeds from the issuance of common stock under our employee stock purchase plan. Six Months EndedDecember 28, 2019 As ofDecember 28, 2019 , our combined balance of cash and cash equivalents and restricted cash increased by$29.8 million to$560.2 from$530.4 million as ofJune 29, 2019 . During the six months endedDecember 28, 2019 , Cash provided by operating activities was$69.3 million , consisting of net income of$34.8 million adjusted for non-cash charges (e.g., depreciation, amortization and stock-based compensation) which totaled$81.9 million , including changes in deferred tax balance, and changes in operating assets and liabilities that used$47.4 million . Changes in our operating assets and liabilities related primarily to an increase in accounts receivable of$13.5 million mainly driven by revenue growth, a decrease in accounts payable of$14.2 million primarily driven by timing of purchases and related payments, a decrease in accrued expenses and other current and non-current liabilities of$37.3 million , and an increase in other current and non-current assets of$2.5 million . These changes were partially offset by an increase in accrued payroll and related expenses of$8.2 million , an increase in income taxes payable of$5.8 million , a decrease in inventories of$3.2 million due to higher shipment volume at the end of the quarter, and an increase in deferred revenue of$2.9 million . During the six months endedDecember 28, 2019 , Cash used in investing activities was$10.7 million , primarily related to$13.3 million of cash used for capital expenditures, offset by$3.1 million proceeds from sales of assets. During the six months endedDecember 28, 2019 , Cash used in financing activities was$25.3 million , primarily due to$15.1 million in withholding tax payments on vesting of restricted stock awards,$10.7 million in cash paid to repurchase common stock under our share repurchase program, and$1.8 million in payment of financing obligations, offset by$2.3 million in proceeds from the issuance of common stock under our employee stock purchase plan. 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; •impact of the COVID-19 pandemic on our financial condition; •changes in accounts receivable, inventory or other operating assets and liabilities which affect our working capital; 43 -------------------------------------------------------------------------------- Table of Contents •increase in capital expenditure to support the revenue growth opportunity of our business; •changes in customer payment terms and patterns, which typically results in customers delaying payments or negotiating 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 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, which may include open market purchases of our 2023 Notes and/or 2024 Notes prior to their maturity or of our common stock; and •potential funding of pension liabilities either voluntarily or as required by law or regulation. Contractual Obligations There were no material changes to our existing contractual commitments during the second quarter of fiscal 2021. 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, other than the guarantees discussed in "Note 18. Commitments and Contingencies." Employee Equity Incentive Plan 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 16. Stock-Based Compensation" for more details. Pension and Other Post-Retirement Benefits We sponsor significant pension plans for certain past and present employees in theUnited Kingdom (U.K. ) andGermany . We are also responsible for the non-pension post-retirement benefit obligation (PBO) assumed from a past acquisition. All of these plans have been closed to new participants and no additional service costs are being accrued, except for certain plans inGermany assumed in connection with an acquisition in fiscal 2010. TheU.K. plan is partially funded, and the otherGermany plans, which were initially established as "pay-as-you-go" plans, are unfunded. As ofJanuary 2, 2021 , our pension plans were under funded by$117.6 million since the PBO exceeded the fair value of plan assets. Similarly, we had a liability of$0.4 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 ofJanuary 2, 2021 , the fair value of plan assets had increased approximately 8.5% sinceJune 27, 2020 , our most recent fiscal year end. A key actuarial assumption in calculating the net periodic cost and the PBO is the discount rate. Changes in the discount rate impact the interest cost component of the net periodic benefit cost calculation and PBO due to the fact that the PBO is calculated on a net present value basis. 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$9.2 million based upon data as ofJune 27, 2020 . 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 17. Employee Pension and Other Benefit Plans" for more details. 44
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
