Item 1. Financial Statements
Item 1. Financial Statements (Unaudited)
VIAVI SOLUTIONS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(unaudited)
Three Months Ended
October 3, 2020
September 28, 2019
Revenues:
Product revenue
$
247.9
$
264.8
Service revenue
36.8
35.0
Total net revenue
284.7
299.8
Cost of revenues:
Product cost of revenue
93.6
104.3
Service cost of revenue
13.5
12.7
Amortization of acquired technologies
8.2
8.4
Total cost of revenues
115.3
125.4
Gross profit
169.4
174.4
Operating expenses:
Research and development
48.8
51.5
Selling, general and administrative
81.4
93.2
Amortization of other intangibles
8.5
8.7
Restructuring and related (benefits) charges
( 0.6
)
0.3
Total operating expenses
138.1
153.7
Income from operations
31.3
20.7
Interest income and other income, net
0.6
2.7
Interest expense
( 9.0
)
( 8.3
)
Income before taxes
22.9
15.1
Provision for income taxes
8.6
8.3
Net income
$
14.3
$
6.8
Net income per share:
Basic
$
0.06
$
0.03
Diluted
$
0.06
$
0.03
Shares used in per-share calculations:
Basic
228.8
229.4
Diluted
231.8
236.4
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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VIAVI SOLUTIONS INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(unaudited)
Three Months Ended
October 3, 2020
September 28, 2019
Net income
$
14.3
$
6.8
Other comprehensive income (loss):
Net change in cumulative translation adjustment, net of tax
27.6
( 27.4
)
Amortization of actuarial income (losses)
0.8
0.7
Net change in accumulated other comprehensive income (loss)
28.4
( 26.7
)
Comprehensive income (loss)
$
42.7
$
( 19.9
)
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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VIAVI SOLUTIONS INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except share and par value data)
(unaudited)
October 3, 2020
June 27, 2020
ASSETS
Current assets:
Cash and cash equivalents
$
590.8
$
539.0
Short-term investments
1.5
1.5
Restricted cash
3.2
3.5
Accounts receivable, net
220.1
235.5
Inventories, net
87.3
83.3
Prepayments and other current assets
58.7
50.8
Total current assets
961.6
913.6
Property, plant and equipment, net
175.4
172.5
Goodwill, net
387.9
381.4
Intangibles, net
134.4
148.1
Deferred income taxes
110.2
105.4
Other non-current assets
54.9
55.3
Total assets
$
1,824.4
$
1,776.3
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$
45.2
$
53.0
Accrued payroll and related expenses
51.2
51.4
Deferred revenue
60.1
54.6
Accrued expenses
21.4
22.6
Current portion of long-term debt
—
2.8
Other current liabilities
49.6
48.4
Total current liabilities
227.5
232.8
Long-term debt
606.6
600.9
Other non-current liabilities
236.5
231.2
Commitments and contingencies (Note 18)
Stockholders’ equity:
Common stock, $0.001 par value; 1 billion shares authorized; 229 million shares at October 3, 2020 and 229 million shares at June 27, 2020, issued and outstanding
0.2
0.2
Additional paid-in capital
70,280.7
70,274.3
Accumulated deficit
( 69,389.6
)
( 69,397.2
)
Accumulated other comprehensive loss
( 137.5
)
( 165.9
)
Total stockholders’ equity
753.8
711.4
Total liabilities and stockholders’ equity
$
1,824.4
$
1,776.3
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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VIAVI SOLUTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(unaudited)
Three Months Ended
October 3, 2020
September 28, 2019
OPERATING ACTIVITIES:
Net income
$
14.3
$
6.8
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation expense
8.8
9.8
Amortization of acquired technologies and other intangibles
16.7
17.1
Stock-based compensation
12.5
10.3
Amortization of debt issuance costs and accretion of debt discount
5.9
5.5
Net change in fair value of contingent liabilities
—
1.7
Other
0.6
0.6
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable
19.7
0.5
Inventories
( 3.4
)
( 3.4
)
Other current and non-currents assets
( 3.2
)
( 1.7
)
Accounts payable
( 8.5
)
( 1.6
)
Income taxes payable
2.5
2.0
Deferred revenue, current and non-current
4.0
( 4.1
)
Deferred taxes, net
( 1.0
)
( 1.3
)
Accrued payroll and related expenses
( 1.4
)
3.8
Accrued expenses and other current and non-current liabilities
( 3.6
)
( 14.7
)
Net cash provided by operating activities
$
63.9
$
31.3
INVESTING ACTIVITIES:
Capital expenditures
$
( 8.0
)
$
( 7.1
)
Proceeds from the sale of assets
0.5
1.2
Net cash used in investing activities
$
( 7.5
)
$
( 5.9
)
FINANCING ACTIVITIES:
Payment of debt issuance costs
$
( 0.1
)
$
—
Repurchase and retirement of common stock
( 6.7
)
( 1.5
)
Withholding tax payment on vesting of restricted stock awards
( 9.3
)
( 7.6
)
Payment of financing obligations
( 0.4
)
( 1.0
)
Proceeds from employee stock purchase plan
3.5
2.3
Payment of debt
( 2.8
)
—
Net cash used in financing activities
$
( 15.8
)
$
( 7.8
)
Effect of exchange rates on cash, cash equivalents and restricted cash
$
11.2
$
( 14.4
)
Net increase (decrease) in cash, cash equivalents and restricted cash
51.8
3.2
Cash, cash equivalents and restricted cash at the beginning of the period (1)
547.4
530.4
Cash, cash equivalents and restricted cash at the end of the period (2)
$
599.2
$
533.6
(1) These amounts include both current and non-current balances of restricted cash totaling $ 8.4 million and $ 8.9 million as of June 27, 2020 and June 29, 2019 , respectively.
(2) These amounts include both current and non-current balances of restricted cash totaling $ 8.4 million and $ 8.3 million as of October 3, 2020 and September 28, 2019 , respectively.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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VIAVI SOLUTIONS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in millions)
(unaudited)
Three Months Ended October 3, 2020
Common Stock
Shares
Amount
Additional Paid-In Capital
Accumulated Deficit
Accumulated Other Comprehensive Loss
Total
Balance at June 27, 2020
228.3
$
0.2
$
70,274.3
$
( 69,397.2
)
$
( 165.9
)
$
711.4
Net income
—
—
—
14.3
—
14.3
Other comprehensive income
—
—
—
—
28.4
28.4
Shares issued under employee stock plans, net of tax
1.6
—
( 6.1
)
—
—
( 6.1
)
Stock-based compensation
—
—
12.5
—
—
12.5
Repurchase of common stock
( 0.6
)
—
—
( 6.7
)
—
( 6.7
)
Balance at October 3, 2020
229.3
$
0.2
$
70,280.7
$
( 69,389.6
)
$
( 137.5
)
$
753.8
Three Months Ended September 28, 2019
Common Stock
Shares
Amount
Additional Paid-In Capital
Accumulated Deficit
Accumulated Other Comprehensive Loss
Total
Balance at June 29, 2019
228.8
$
0.2
$
70,244.7
$
( 69,384.5
)
$
( 134.6
)
$
725.8
Cumulative adjustment for adoption of ASC 842
—
—
—
3.0
—
3.0
Net income
—
—
—
6.8
—
6.8
Other comprehensive loss
—
—
—
—
( 26.7
)
( 26.7
)
Shares issued under employee stock plans, net of tax
1.7
—
( 9.7
)
—
—
( 9.7
)
Stock-based compensation
—
—
10.4
—
—
10.4
Repurchase of common stock
( 0.1
)
—
—
( 1.5
)
—
( 1.5
)
Balance at September 28, 2019
230.4
$
0.2
$
70,245.4
$
( 69,376.2
)
$
( 161.3
)
$
708.1
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The financial information for Viavi Solutions Inc. (“VIAVI” also referred to as “the Company”) for the three months ended October 3, 2020 and September 28, 2019 is unaudited, and includes all normal and recurring adjustments Company management considers necessary for a fair statement of the financial information set forth herein. The accompanying consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America ( U.S. GAAP ) for interim financial information and rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, such information does not include all of the information and footnotes required by U.S. GAAP for annual consolidated financial statements. For further information, please refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K, for the year ended June 27, 2020 .
There have been no material changes to the Company’s accounting policies during the three months ended October 3, 2020 , as compared to the significant accounting policies presented in “ Note 1. Basis of Presentation ” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report for the year ended June 27, 2020 on Form 10-K, filed with the SEC on August 24, 2020 .
The balance sheet as of June 27, 2020 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The results for the three months ended October 3, 2020 and September 28, 2019 may not be indicative of results for the fiscal year ending July 3, 2021 or any future periods.
Fiscal Years
The Company utilizes a 52 - 53 week fiscal year ending on the Saturday closest to June 30th. The Company’s fiscal 2021 is a 53 -week year ending on July 3, 2021 . The Company’s fiscal 2020 was a 52 -week year ending on June 27, 2020 . The Company’s first quarter of fiscal year 2021 was a 14-week quarter compared to the standard 13-week quarters.
Principles of Consolidation
The consolidated financial statements include the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.
Use of Estimates
The preparation of the Company’s consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements, the reported amount of net revenues and expenses and the disclosure of commitments and contingencies during the reporting periods. The Company bases estimates on historical experience and assumptions about future periods that are believed to be reasonable based on available information. The Company’s reported financial positions or results of operations may be materially different under changed conditions or when using different estimates and assumptions, particularly with respect to significant accounting policies. If estimates or assumptions differ from actual results, subsequent periods are adjusted to reflect readily available current information.
A novel strain of coronavirus (COVID-19) was first identified in Wuhan, China by the Chinese government in December 2019, and subsequently declared an international pandemic by the World Health Organization (WHO) in March 2020. The worldwide spread of the COVID-19 virus has resulted in a global slowdown of economic activity which is likely to decrease demand for a broad variety of goods and services, including from our customers, while also continuing to disrupt sales channels and marketing activities for an unknown period of time until the disease is contained. While, the Company expects this to have a negative impact to our sales and our results of operations, the Company is not aware of any specific event or circumstances that would require an update to the estimates or judgments or a revision of the carrying value of assets or liabilities as of the date of issuance of this Quarterly Report on Form 10-Q. These estimates may change, as new events occur and additional information becomes available. Actual results may differ materially from these estimates assumptions or conditions.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 2. Recently Issued Accounting Pronouncements
Recent Accounting Pronouncements Adopted
In June 2016, the FASB issued guidance that changes the accounting for recognizing impairments of financial assets. Under the new guidance, credit losses for certain types of financial assets will be estimated based on expected losses. In the first quarter of fiscal 2021 the Company adopted the accounting standard using the modified retrospective approach. The adoption of the new standard did not have a material impact on the Company’s Consolidated Financial Statements.
Recent Accounting Pronouncements Not Yet Adopted
In August 2018, the FASB issued guidance to amend the disclosure requirements related to defined benefit pension and other post-retirement plans. Some of the changes include adding a disclosure requirement for significant gains and losses related to changes in the benefit obligation for the period and removing the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year. This guidance is effective for the Company in the first quarter of fiscal 2022 and early adoption is permitted. The Company is evaluating the impact of adopting this new accounting guidance on its Consolidated Financial Statements.
In December 2019, the FASB issued guidance which simplifies the accounting for income taxes, eliminates certain exceptions within ASC 740, Income Taxes , and clarifies certain aspects of the current guidance to promote consistency among reporting entities. The guidance is effective for the Company in the first quarter of fiscal year 2022 and early adoption is permitted. The Company is evaluating the effects that the adoption of this guidance will have on its consolidated financial statements.
In August 2020, the FASB issued guidance which simplifies the accounting for financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. The guidance allows for either full retrospective adoption or modified retrospective adoption. The guidance is effective for the Company in the first quarter of fiscal year 2023 and early adoption is permitted. The Company is evaluating the impact of adoption of this guidance will have on its Consolidated Financial Statements.
Note 3. Earnings Per Share
The following table sets forth the computation of basic and diluted net income per share ( in millions, except per share data ):
Three Months Ended
October 3, 2020
September 28, 2019
Numerator:
Net income
$
14.3
$
6.8
Denominator:
Weighted-average shares outstanding:
Basic
228.8
229.4
Shares issuable assuming conversion of convertible notes (1)
—
2.8
Effect of dilutive securities from stock-based benefit plans
3.0
4.2
Diluted
231.8
236.4
Net income per share:
Basic
$
0.06
$
0.03
Diluted
$
0.06
$
0.03
(1)
Represents the number of shares that would be issued if the Company’s Senior Convertible Notes had been converted. The par amount of the Company’s convertible notes is payable in cash equal to the principal amount of the notes plus any accrued and unpaid interest and the “in-the money” conversion benefit feature above the conversion price is payable in cash, shares of the Company’s common stock or a combination of both, at the Company’s election.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table sets forth the weighted-average potentially dilutive securities excluded from the computation of the diluted net income per share because their effect would have been anti-dilutive ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
(2) (3)
Restricted stock units
1.0
0.1
(2)
The Company’s 1.00 % Senior Convertible Notes due 2024 are not included in the table above. The par amount of convertible notes is payable in cash equal to the principal amount of the notes plus any accrued and unpaid interest and then the “in-the-money” conversion benefit feature at the conversion price above $ 13.22 per share payable in cash, shares of the Company’s common stock or a combination of both at the Company’s election. The Company’s average stock price for the period presented did not exceed the conversion price of $ 13.22 . Refer to “ Note 11. Debt ” for more details.
(3)
The Company’s 1.75 % Senior Convertible Notes due 2023 are not included in the table above. The par amount of convertible notes is payable in cash equal to the principal amount of the notes plus any accrued and unpaid interest and then the “in-the money” conversion benefit feature at the conversion price above $ 13.94 per share payable in cash, shares of the Company’s common stock or a combination of both at the Company’s election. The Company’s average stock price for the period presented did not exceed the conversion price of $ 13.94 . Refer to “ Note 11. Debt ” for more details.
Note 4. Accumulated Other Comprehensive Loss
The Company’s accumulated other comprehensive loss consists of the accumulated net unrealized gains or losses on available-for-sale investments, foreign currency translation adjustments and change in unrealized components of defined benefit obligations.
For the three months ended October 3, 2020 , the changes in accumulated other comprehensive loss, net of tax, by component were as follows ( in millions ):
Unrealized losses on available-for sale investments
Foreign
currency translation adjustments
Change in unrealized components of defined benefit obligations (1)
Total
Beginning balance as of June 27, 2020
$
( 5.1
)
$
( 129.6
)
$
( 31.2
)
$
( 165.9
)
Other comprehensive income before reclassification
—
27.6
—
27.6
Amounts reclassified to accumulated other comprehensive loss
—
—
0.8
0.8
Net current-period other comprehensive income
—
27.6
0.8
28.4
Ending balance as of October 3, 2020
$
( 5.1
)
$
( 102.0
)
$
( 30.4
)
$
( 137.5
)
(1) The amount reclassified out of accumulated other comprehensive loss represents the amortization of actuarial losses included as a component of cost of revenues, research and development (“R&D”) and selling, general and administrative (“SG&A”) in the Consolidated Statement of Operations for the three months ended October 3, 2020 . There was no tax impact for the three months ended October 3, 2020 . Refer to “ Note 17. Employee Pension and Other Benefit Plans ” for more details on the computation of net periodic cost for pension plans.
Note 5. Acquisitions
During the twelve months ended June 27, 2020 , the Company completed a business acquisition for total consideration of approximately $ 10.7 million , of which $ 5.2 million cash was paid at close and $ 5.5 million in payments to be made based on the occurrence of future events. The fair value of earn-out liabilities is discussed further in “ Note 8. Fair Value Measurements ”.
In connection with this acquisition, the Company recorded approximately $ 6.2 million of developed technology and customer relationships and $ 1.4 million of deferred tax liability resulting from the acquisitions. The acquired developed technology and customer relationship assets are being amortized over their estimated useful lives of six years .
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 6. Balance Sheet and Other Details
Contract Balances
Unbilled Receivables: The Company records a receivable when an unconditional right to consideration exists and transfer of control has occurred, such that only the passage of time is required before payment of consideration is due. Timing of revenue recognition may differ from the timing of customer invoicing. Payment terms vary based on product or service offerings and payment is generally required within 30 to 90 days from date of invoicing. Certain performance obligations may require payment before delivery of the service to the customer .
Contract Assets: A Contract Asset is recognized when a conditional right to consideration exists and transfer of control has occurred. Contract Assets include fixed fee professional services, where the transfer of services has occurred in advance of the Company's right to invoice. Contract Assets, included in accounts receivable, net, on the Consolidated Balance Sheets, are not material to the Consolidated Financial Statements. The prior year’s Consolidated Balance Sheets and Statements of Cash Flows have been updated to conform to the current period’s presentation. Contract asset balances will fluctuate based upon the timing of transfer of services, billings and customers’ acceptance of contractual milestones.
Gross receivables include both billed and Unbilled Receivables/Contract Assets. As of October 3, 2020 and June 27, 2020 , the Company had total unbilled receivables (Unbilled Receivables/Contract Assets) of $ 5.1 million and $ 3.8 million , respectively.
Deferred Revenue: Deferred revenue consists of contract liabilities primarily related to support, solution deployment services, software maintenance, product, professional services, and training when the Company has a right to invoice or payments have been received and transfer of control has not occurred. Revenue is recognized on these items when the revenue recognition criteria are met, generally resulting in ratable recognition over the contract term. Contract liabilities are included in deferred revenue and non-current liabilities on the Consolidated Balance Sheets.
The Company also has short-term and long-term deferred revenues related to undelivered hardware and professional services, consisting of installations and consulting engagements, which are recognized as the Company's performance obligations under the contract are completed and accepted by the customer.
The following tables summarize the activity related to deferred revenue ( in millions ):
October 3, 2020
Three Months Ended
Deferred revenue:
Balance at beginning of period
$
74.6
Revenue deferrals for new contracts (1)
29.8
Revenue recognized during the period
( 24.3
)
Balance at end of period
$
80.1
Short-term deferred revenue
$
60.1
Long-term deferred revenue
$
20.0
Remaining Performance Obligations: Remaining performance obligations represent the aggregate amount of the transaction price allocated to performance obligations that are not delivered or incomplete, as of October 3, 2020 . Remaining performance obligations include deferred revenue plus unbilled amounts not yet recorded. The aggregate amount of the transaction price allocated to remaining performance obligations does not include amounts owed under cancelable contracts where there is no substantive termination penalty.
Remaining performance obligation estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidation, adjustments for revenue that has not materialized, and adjustments for currency.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The value of the transaction price allocated to remaining performance obligations as of October 3, 2020 , was $ 205.5 million . The Company expects to recognize approximately 88 % of remaining performance obligations as revenue within the next 12 months , and the remainder thereafter.
Disaggregation of revenue
The Company's revenue is presented on a disaggregated basis on the Consolidated Statements of Operations and in “ Note 19. Operating Segments and Geographic Information ”. This information includes revenue from reportable segments and a break-out of products and services for which the nature and timing of the revenue as characterized above is generally at a point in time and over time, respectively.
Accounts receivable allowance
The following table presents the activities and balances for allowance for doubtful accounts ( in millions ):
June 27, 2020
Charged to Costs and Expenses
Deductions (1)
October 3, 2020
Allowance for doubtful accounts
$
3.0
$
0.1
$
( 0.4
)
$
2.7
(1) Represents the effect of currency translation adjustments and write-offs of uncollectible accounts, net of recoveries.
Inventories, net
The following table presents the components of inventories, net ( in millions ):
October 3, 2020
June 27, 2020
Finished goods
$
30.8
$
30.0
Work in process
13.6
22.5
Raw materials
42.9
30.8
Inventories, net
$
87.3
$
83.3
Prepayments and other current assets
The following table presents the components of prepayments and other current assets ( in millions ):
October 3, 2020
June 27, 2020
Prepayments
$
11.8
$
10.9
Asset held for sale
2.5
2.5
Advances to contract manufacturers
7.0
7.3
Refundable income taxes
12.3
10.8
Transaction tax receivables
9.7
10.6
Other current assets
15.4
8.7
Prepayments and other current assets
$
58.7
$
50.8
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other current liabilities
The following table presents the components of other current liabilities ( in millions ):
October 3, 2020
June 27, 2020
Customer prepayments
$
0.4
$
0.5
Restructuring accrual
4.0
6.5
Income tax payable
13.1
10.7
Warranty accrual
4.6
4.6
Transaction tax payable
4.2
3.2
Operating lease liabilities (Note 12)
12.0
11.7
Foreign exchange forward contracts liability
1.5
1.5
Other
9.8
9.7
Other current liabilities
$
49.6
$
48.4
Other non-current liabilities
The following table presents components of other non-current liabilities ( in millions ):
October 3, 2020
June 27, 2020
Pension and post-employment benefits
$
106.2
$
102.7
Financing obligation
16.2
16.2
Deferred tax liability
23.6
23.9
Long-term deferred revenue
20.0
20.0
Fair value of contingent consideration (1)
8.9
9.4
Operating lease liabilities (Note 12)
26.3
28.1
Uncertain tax position
11.9
11.6
Other
23.4
19.3
Other non-current liabilities
$
236.5
$
231.2
(1) See “ Note 8. Fair Value Measurements ” of the Notes to our Consolidated Financial Statements for more detail.
Note 7. Investments and Forward Contracts
Available-For-Sale Investments
The following table presents the Company’s available-for-sale securities as of October 3, 2020 ( in millions ):
Amortized Cost/
Carrying Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available-for-sale debt securities:
Asset-backed securities
$
0.9
$
—
$
( 0.4
)
$
0.5
Total available-for-sale debt securities
$
0.9
$
—
$
( 0.4
)
$
0.5
The Company generally classifies debt securities as available-for-sale and as cash equivalents, short-term investments, or other non-current assets based on the stated maturities; however, certain securities with stated maturities of longer than twelve months which are highly liquid and available to support current operations are also classified as short-term investments. As of October 3, 2020 , the total estimated fair value of $ 0.5 million was classified as other non-current assets.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In addition to the amounts presented above, the Company’s short-term investments classified as trading securities related to the deferred compensation plan as of October 3, 2020 , were $ 1.5 million , of which $ 0.4 million was invested in debt securities, $ 0.2 million was invested in money market instruments and funds and $ 0.9 million was invested in equity securities. Trading securities are reported at fair value, with the unrealized gains or losses resulting from changes in fair value recognized in the Company’s Consolidated Statements of Operations as a component of interest and other income, net.
During the three months ended October 3, 2020 and September 28, 2019 , the Company recorded no other-than-temporary impairment charges in each respective period.
The following table presents contractual maturities of the Company’s debt securities classified as available-for-sale as of October 3, 2020 , ( in millions ):
Amortized Cost/
Carrying Cost
Estimated
Fair Value
Amounts maturing in more than 5 years
$
0.9
$
0.5
Total debt available-for-sale securities
$
0.9
$
0.5
The following table presents the Company’s available-for-sale securities as of June 27, 2020 , ( in millions ):
Amortized Cost/
Carrying Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available-for-sale securities:
Asset-backed securities
$
0.9
$
—
$
( 0.4
)
$
0.5
Total available-for-sale securities
$
0.9
$
—
$
( 0.4
)
$
0.5
As of June 27, 2020 , the estimated fair value of $ 0.5 million was classified as other non-current assets.
In addition to the amounts presented above, as of June 27, 2020 , the Company’s short-term investments classified as trading securities, related to the deferred compensation plan, were $ 1.4 million , of which $ 0.3 million was invested in debt securities, $ 0.2 million was invested in money market instruments and funds and $ 0.9 million was invested in equity securities. Trading securities are reported at fair value, with the unrealized gains or losses resulting from changes in fair value recognized in the Company’s Consolidated Statements of Operations as a component of interest and other income, net.
Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. There is an established hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the most observable inputs be used when available. Observable inputs are, inputs which market participants would use in valuing an asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs which reflect the assumptions market participants would use in valuing an asset or liability.
The Company’s cash and investment instruments are classified within Level 1 or Level 2 of the fair value hierarchy based on quoted prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.
•
Level 1: includes financial instruments for which quoted market prices for identical instruments are available in active markets. Level 1 assets of the Company include money market funds, U.S. Treasury securities and marketable equity securities as they are traded with sufficient volume and frequency of transactions.
•
Level 2: includes financial instruments for which the valuations are based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities. Level 2 instruments of the Company generally include certain U.S. and foreign government and agency securities, commercial paper, corporate and
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
municipal bonds and notes, asset-backed securities, certificates of deposit, and foreign currency forward contracts. To estimate their fair value, the Company utilizes pricing models based on market data. The significant inputs for the valuation model usually include benchmark yields, reported trades, broker and dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data, and industry and economic events.
•
Level 3: includes financial instruments for which fair value is derived from valuation-based inputs, that are unobservable and significant to the overall fair value measurement. As of October 3, 2020 and June 27, 2020 , the Company did not hold any Level 3 investment securities. The fair value of the Company’s contingent liabilities was determined using Level 3 inputs, as discussed further in “ Note 8. Fair Value Measurements ”.
Non-Designated Foreign Currency Forward Contracts
The Company has foreign subsidiaries that operate and sell the Company’s products in various markets around the world. As a result, the Company is exposed to foreign exchange risks. The Company utilizes foreign exchange forward contracts to manage foreign currency risk associated with foreign currency denominated monetary assets and liabilities, primarily certain short-term intercompany receivables and payables, and to reduce the volatility of earnings and cash flows related to foreign-currency transactions. The Company does not use these foreign currency forward contracts for trading purposes.
As of October 3, 2020 , the Company had forward contracts that were effectively closed but not settled with the counterparties by quarter end. Therefore, the fair value of these contracts of $ 8.0 million and $ 1.5 million is reflected as prepayments and other current assets and other current liabilities, respectively. As of June 27, 2020 , the fair value of these contracts of $ 2.2 million and $ 1.5 million is reflected as prepayments and other current assets and other current liabilities, respectively.
The forward contracts outstanding and not effectively closed, with a term of less than 120 days, were transacted near quarter end; therefore, the fair value of the contracts is not significant. As of October 3, 2020 and June 27, 2020 , the notional amounts of the forward contracts the Company held to purchase foreign currencies were $ 129.3 million and $ 146.4 million , respectively, and the notional amounts of forward contracts the Company held to sell foreign currencies were $ 19.8 million and $ 22.0 million , respectively.
The change in the fair value of foreign currency forward contracts is recorded as gain or loss in the Company’s Consolidated Statements of Operations as a component of interest and other income, net. The cash flows related to the settlement of foreign currency forward contracts are classified as operating activities. The foreign exchange forward contracts incurred a gain of $ 6.5 million and a loss of $ 2.6 million for the three months ended October 3, 2020 and September 28, 2019 , respectively.
Note 8. Fair Value Measurements
3Z Telecom, Inc. Acquisition
On May 31, 2019 (“3Z Close Date”), the Company acquired all of the equity of 3Z Telecom, Inc. (“3Z”) for approximately $ 23.2 million in cash and contingent consideration (“earn-out”) liability of up to $ 7.0 million in cash based on the achievement of certain net revenue targets over approximately a two year period, subsequent to the 3Z Close Date. The acquisition of 3Z expands the Company’s Field Instrument offerings.
RPC Photonics, Inc. Acquisition
On October 30, 2018 (“RPC Close Date”), the Company acquired all of the equity interest of RPC Photonics, Inc. (“RPC”) for approximately $ 33.4 million in cash and an additional earn-out of up to $ 53.0 million in cash based on the achievement of certain gross profit targets over approximately a four years period, subsequent to the RPC Close Date. The achievement or distributions of earn-out payments are not limited in any one period. The acquisition of RPC expands the Company’s 3D Sensing offerings.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fair Value Measurements
The Company’s assets and liabilities measured at fair value for the periods presented are as follows ( in millions ):
October 3, 2020
June 27, 2020
Total
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Assets:
Debt available-for-sale securities:
Asset-backed securities
$
0.5
$
—
$
0.5
$
—
$
0.5
$
—
$
0.5
$
—
Total debt available-for-sale securities
0.5
—
0.5
—
0.5
—
0.5
—
Money market funds
347.7
347.7
—
—
334.6
334.6
—
—
Trading securities
1.5
1.5
—
—
1.4
1.4
—
—
Foreign currency forward contracts (1)
8.0
—
8.0
—
2.2
—
2.2
—
Total assets (2)
$
357.7
$
349.2
$
8.5
$
—
$
338.7
$
336.0
$
2.7
$
—
Liability:
Foreign currency forward contracts (3)
$
1.5
$
—
$
1.5
$
—
$
1.5
$
—
$
1.5
$
—
Contingent consideration (4)
9.9
—
—
9.9
9.9
—
—
9.9
Total liabilities
$
11.4
$
—
$
1.5
$
9.9
$
11.4
$
—
$
1.5
$
9.9
(1) $ 8.0 million and $ 2.2 million in prepayments and other current assets on the Company’s Consolidated Balance Sheets as of October 3, 2020 and June 27, 2020 , respectively.
(2) Includes as of October 3, 2020 , $ 340.2 million in cash and cash equivalents, $ 1.5 million in short-term investments, $ 3.2 million in restricted cash, $ 8.0 million in prepayments and other current assets and $ 4.8 million in other non-current assets on the Company’s Consolidated Balance Sheets. Includes as of June 27, 2020 , $ 327.2 million in cash and cash equivalents, $ 1.4 million in short-term investments, $ 3.4 million in restricted cash, $ 2.2 million in prepayments and other current assets, and $ 4.5 million in other non-current assets on the Company’s Consolidated Balance Sheets.
(3) Includes $ 1.5 million and $ 1.5 million in other current liabilities on the Company’s Consolidated Balance Sheets as of October 3, 2020 and June 27, 2020 , respectively.
(4) Includes $ 8.9 million and $ 9.4 million in other non-current liabilities and $ 1.0 million and $ 0.5 million in other current liabilities as of October 3, 2020 and June 27, 2020 , respectively.
The Company’s Level 3 liabilities as of October 3, 2020 , consist of contingent purchase consideration. The Company has aggregate contingent liabilities related to its business and asset acquisitions completed during fiscal 2020 and 2019 . As of October 3, 2020 and June 27, 2020 and, the aggregate fair value of contingent consideration was $ 9.9 million , respectively. The fair value of earn-out liabilities were determined using a Monte Carlo Simulation that includes significant unobservable inputs such as the risk-adjusted discount rate, gross profit volatility, and projected financial forecast of acquired business over the earn-out period. The fair value of contingent consideration liabilities is remeasured at each reporting period at the estimated fair value based on the inputs on the date of remeasurement, with the change in fair value recognized in the Selling, General and Administrative expense of the Consolidated Statements of Operations.
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table provides a reconciliation of changes in fair value of the Company’s Level 3 liabilities for the three months ended October 3, 2020 ( in millions ):
Three Months Ended
October 3, 2020
Balance as of June 27, 2020
$
9.9
Fair value adjustment of contingent consideration liabilities
—
Balance as of October 3, 2020
$
9.9
No payments were made in connection with the Company’s contingent earn-out liabilities during the three months ended October 3, 2020 and September 28, 2019 .
Note 9. Goodwill
The following table presents changes in goodwill allocated to the Company’s reportable segments (in millions) :
Network Enablement
Service Enablement
Optical Security
and Performance
Products
Total
Balance as of June 27, 2020
$
334.9
$
4.3
$
42.2
$
381.4
Currency translation adjustments
6.5
—
—
6.5
Balance as of October 3, 2020
$
341.4
$
4.3
$
42.2
$
387.9
The Company tests goodwill for impairment at the reporting unit level annually during the fourth quarter of each fiscal year, or more frequently if events or circumstances indicate that the asset may be impaired. In the fourth quarter of fiscal 2020 , the Company reviewed goodwill under the qualitative assessment of the authoritative guidance and concluded that it was more likely than not that the fair value of each reporting unit exceeded its carrying amount and that no indication of impairment existed.
There were no events or changes in circumstances which triggered an impairment review during the three months ended October 3, 2020 .
Note 10. Acquired Developed Technology and Other Intangibles
The following tables present details of the Company’s acquired developed technology, customer relationships and other intangibles ( in millions ):
As of October 3, 2020
Gross Carrying Amount
Accumulated Amortization
Net
Acquired developed technology
$
441.9
$
( 352.8
)
$
89.1
Customer relationships
197.3
( 163.0
)
34.3
Other (1)
36.6
( 25.6
)
11.0
Total intangibles
$
675.8
$
( 541.4
)
$
134.4
As of June 27, 2020
Gross Carrying Amount
Accumulated Amortization
Net
Acquired developed technology
$
437.1
$
( 341.6
)
$
95.5
Customer relationships
194.7
( 154.1
)
40.6
Other (1)
35.7
( 23.7
)
12.0
Total intangibles
$
667.5
$
( 519.4
)
$
148.1
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(1)
Other intangibles consist of customer backlog, non-competition agreements, patents, proprietary know-how and trade secrets, trademarks and trade names.
The following table presents the amortization recorded relating to acquired developed technology, customer relationships and other intangibles ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Cost of revenues
$
8.2
$
8.4
Operating expenses
8.5
8.7
Total amortization of intangible assets
$
16.7
$
17.1
Based on the carrying amount of acquired developed technology, customer relationships and other intangibles as of October 3, 2020 , and assuming no future impairment of the underlying assets, the estimated future amortization is as follows ( in millions ):
Fiscal Years
Remainder of 2021
$
48.4
2022
38.6
2023
24.7
2024
10.2
2025
5.6
Thereafter
6.9
Total amortization
$
134.4
The acquired developed technology, customer relationships and other intangibles balance are adjusted quarterly to record the effect of currency translation adjustments.
Note 11. Debt
As of October 3, 2020 and June 27, 2020 , the Company’s long-term debt on the Consolidated Balance Sheets represented the carrying amount of the liability component of the Senior Convertible Notes, net of unamortized debt discounts and issuance costs.
The following table presents the carrying amounts of the liability and equity components of our debt ( in millions ):
October 3, 2020
June 27, 2020
Principal amount of 1.00% Senior Convertible Notes
$
460.0
$
460.0
Principal amount of 1.75% Senior Convertible Notes
225.0
225.0
Unamortized discount of liability component
( 73.7
)
( 79.1
)
Unamortized debt issuance cost
( 4.7
)
( 5.0
)
Carrying amount of liability component
$
606.6
$
600.9
Carrying amount of equity component (1)
$
136.8
$
136.8
(1)
Included in additional paid-in-capital on the Consolidated Balance Sheets.
The Company was in compliance with all debt covenants as of October 3, 2020 and June 27, 2020 .
17
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Revolving Credit Facility
On May 5, 2020 , we entered into a credit agreement (the Credit Agreement) with Wells 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 on March 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 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 of October 3, 2020 and June 27, 2020 , we had no amounts outstanding under the Credit Agreement.
1.75 % Senior Convertible Notes (“2023 Notes”)
On May 29, 2018 , the Company issued $ 225.0 million aggregate principal amount of 1.75 % Senior Convertible Notes due 2023 in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The Company issued $ 155.5 million aggregate principal of the 2023 Notes to certain holders of the 2033 Notes in exchange for $ 151.5 million principal of the 2033 Notes (the “Exchange Transaction”) and issued and sold $ 69.5 million aggregate principal amount of the 2023 Notes in a private placement to accredited institutional buyers (the “Private Placement”). The carrying value of the liability component at issuance was calculated as the present value of its cash flows using a discount rate of 5.3 % based on the 5 -year swap rate plus credit spread as of the issuance date. As of October 3, 2020 , the expected remaining term of the 2023 Notes is 2.7 years.
The proceeds from the 2023 Notes Private Placement amounted to $ 67.3 million after issuance costs. The 2023 Notes are an unsecured obligation of the Company and bear interest at an annual rate of 1.75 % payable in cash semi-annually in arrears on June 1st and December 1st of each year, beginning December 1, 2018. The 2023 Notes mature on June 1, 2023 unless earlier converted, redeemed or repurchased.
Based on quoted market prices as of October 3, 2020 and June 27, 2020 , the fair value of the 2023 Notes was approximately $ 250.9 million and $ 251.4 million , respectively. The 2023 Notes are classified within Level 2 as they are not actively traded in markets.
1.00 % Senior Convertible Notes (“2024 Notes”)
On March 3, 2017 , the Company issued $ 400.0 million aggregate principal amount of 1.00 % Senior Convertible Notes due 2024 in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. On March 22, 2017 , the Company issued an additional $ 60.0 million upon exercise of the over-allotment option of the initial purchasers. The total proceeds from the 2024 Notes amounted to $ 451.1 million after issuance costs. The 2024 Notes are an unsecured obligation of the Company and bear interest at an annual rate of 1.00 % payable in cash semi-annually in arrears on March 1 and September 1 of each year. The 2024 Notes mature on March 1, 2024 unless earlier converted or repurchased. The carrying value of the liability component at issuance was calculated as the present value of its cash flows using a discount rate of 4.8 % based on the 7 -year swap rate plus credit spread as of the issuance date. As of October 3, 2020 , the expected remaining term of the 2024 Notes is 3.4 years.
Based on quoted market prices as of October 3, 2020 and June 27, 2020 , the fair value of the 2024 Notes was approximately $ 524.8 million and $ 523.3 million , respectively. The 2024 Notes are classified within Level 2 as they are not actively traded in markets.
18
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Interest Expense
The following table presents the interest expense for contractual interest, amortization of debt issuance costs and accretion of debt discount ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Interest expense-contractual interest
$
2.1
$
2.1
Amortization of debt issuance cost
0.5
0.3
Accretion of debt discount
5.4
5.1
Note 12. Leases
The Company is a lessee in several operating leases, primarily real estate facilities for office space. The Company determines if an arrangement is a lease or contains a lease at inception. Operating lease liabilities are recognized based on the present value of the remaining lease payments, discounted using the discount rate for the lease at the commencement date. As the rate implicit in the lease is not readily determinable for our operating leases, the Company uses an incremental borrowing rate based on information available at the commencement date to determine the present value of future lease payments. The lease term is the non-cancelable period of the lease and includes options to extend or terminate the lease when it is reasonably certain that an option will be exercised. Operating ROU assets are recognized at commencement based on the amount of the initial measurement of the lease liability. Operating ROU assets also include any lease payments made prior to lease commencement and exclude lease incentives. Lease expense is recognized on a straight-line basis over the lease term.
Operating ROU assets are included in other non-current assets and lease liabilities are included in other current liabilities and other non-current liabilities in the Company’s consolidated balance sheets. Lease and non-lease components for all leases are accounted for separately. The Company does not recognize ROU assets and lease liabilities for leases with a lease term of twelve months or less.
The Company's lease arrangements are composed of operating leases with various expiration dates through March 31, 2030 . The Company's leases do not contain any material residual value guarantees.
For the three months ended October 3, 2020 and September 28, 2019 , the total operating lease costs were $ 3.4 million and $ 3.3 million , respectively. Total variable lease costs were immaterial during the three months ended October 3, 2020 and September 28, 2019 . The total operating costs were included in cost of revenues, research and development, and selling, general and administrative in the Company’s Consolidated Statements of Operations.
As of October 3, 2020 , the weighted-average remaining lease term was 5.1 years, and the weighted-average discount rate was 4.7 % .
For the three months ended October 3, 2020 and September 28, 2019 , cash paid for amounts included in the measurement of operating lease liabilities were $ 4.4 million and $ 3.4 million , respectively; and operating ROU assets obtained in exchange of new operating lease liabilities were $ 1.6 million and $ 1.9 million , respectively.
The balance sheet information related to our operating leases is as follows ( in millions ):
October 3, 2020
Other non-current assets
$
40.2
Total operating ROU assets
$
40.2
Other current liabilities
$
12.0
Other non-current liabilities
26.3
Total operating lease liabilities
$
38.3
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Future minimum operating lease payments as of October 3, 2020 are as follows ( in millions ):
Operating Leases
Remainder of 2021
$
9.1
2022
11.0
2023
6.6
2024
4.8
2025
3.9
Thereafter
7.7
Total lease payments
$
43.1
Less: Interest
( 4.8
)
Present value of lease liabilities
$
38.3
Future minimum operating lease payments as of June 27, 2020 , were as follows ( in millions ):
Operating Leases
Fiscal 2021
$
12.8
Fiscal 2022
10.2
Fiscal 2023
6.0
Fiscal 2024
4.6
Fiscal 2025
3.6
Thereafter
7.5
Total lease payments
$
44.7
Less: Interest
( 4.9
)
Present value of lease liabilities
$
39.8
Note 13. Restructuring and Related Charges
The Company has initiated restructuring events primarily intended to reduce its costs, consolidate its operations, integrate various acquisitions, streamline product manufacturing and align its business to address market conditions. The Company’s restructuring charges primarily include severance and benefit costs to eliminate a specific number of positions, facilities and equipment costs to vacate facilities and consolidate operations, and lease termination costs. The timing of associated cash payments is dependent upon the type of restructuring charge and can extend over multiple periods.
As of October 3, 2020 and June 27, 2020 , the Company’s total restructuring accrual was $ 4.0 million and $ 6.5 million , respectively. During the three months ended October 3, 2020 , the Company recorded restructuring and related benefits charges of $ 0.6 million . During the three months ended September 28, 2019 , the Company recorded restructuring and related charges of $ 0.3 million .
20
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Summary of Restructuring Plans
The following table presents the adjustments to the accrued restructuring expenses related to all of the Company’s restructuring plans described below for the three months ended October 3, 2020 (in millions) :
Balance June 27, 2020
Three Months Ended October 3, 2020 Benefits
Cash
Settlements
Non-cash Settlements
and Other Adjustments (2)
Balance October 3, 2020
Fiscal 2019 Plan
NSE, including AW (1)
$
6.5
$
( 0.6
)
$
( 2.0
)
$
0.1
$
4.0
Total (3)
$
6.5
$
( 0.6
)
$
( 2.0
)
$
0.1
$
4.0
(1)
Plan type includes workforce reduction cost.
(2)
Other adjustments represents the effect of currency translation adjustments.
(3)
$ 4.0 million and $ 6.5 million in other current liabilities on the Consolidated Balance Sheets as of October 3, 2020 and June 27, 2020 , respectively.
Fiscal 2019 Plans
NSE, including AW Restructuring Plan
During the first quarter of fiscal 2019, Management approved restructuring and workforce reduction plans within its Network Service and Enablement (“ NSE ”) business, including actions related to the recently acquired AW business. These actions further drive the Company’s strategy for organizational alignment and consolidation as part of its continued commitment to a more cost effective and agile organization and to improve overall profitability in the Company’s NSE business. Included in these restructuring plans are specific actions to consolidate and integrate the newly acquired AW business within the NSE business segment. The plan was re-approved in the third quarter of fiscal 2019 and the fourth quarter of fiscal 2020 to include additional headcount and to further drive operational improvement.
During the first quarter of fiscal 2021 restructuring benefits of $ 0.6 million was recorded in the three months ended October 3, 2020 for adjustments to severance and employee benefits. Payments related to the severance and benefits accrual are expected to be paid by the end of the fourth quarter of fiscal 2021.
Note 14. Income Taxes
The Company recorded an income tax provision of $ 8.6 million and $ 8.3 million for the three months ended October 3, 2020 and September 28, 2019 , respectively.
The income tax provision for the three months ended October 3, 2020 and September 28, 2019 primarily relates to income tax in certain foreign and state jurisdictions based on the Company’s 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 the Company’s income from continuing operations before taxes primarily due to the changes in valuation allowance for deferred tax assets attributable to the Company’s domestic and foreign income (loss) from continuing operations.
As of October 3, 2020 , and June 27, 2020 , the Company’s unrecognized tax benefits totaled $ 48.3 million and $ 48.4 million , respectively, and are included in deferred taxes and other non-current tax liabilities, net. The Company had $ 3.6 million accrued for the payment of interest and penalties at October 3, 2020 . 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 the Company does 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, the Company is unable to estimate the full range of possible adjustments to this balance.
21
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 15. Stockholders' Equity
Repurchase of Common Stock
In September 2019, the Board of Directors authorized a stock repurchase program of up to $ 200 million of the Company’s common stock through open market or private transactions before September 30, 2021 . The new stock repurchase program replaces the previous $ 200 million stock repurchase program that was set to expire on September 30, 2019 . Under the new repurchase program, the Company may repurchase its common stock from time to time at the discretion of the Company’s management.
During the three months ended October 3, 2020 , the Company repurchased 565 thousand shares of its common stock for $ 6.7 million . As of October 3, 2020 , the Company had remaining authorization of $ 148.8 million for future share repurchases. The number of shares to be repurchased and the timing of such repurchases will be based on several factors, including business and financial market conditions.
Note 16. Stock-Based Compensation
Overview
The impact on the Company’s results of operations of recording stock-based compensation by function for the three months ended October 3, 2020 and September 28, 2019 , as follows ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Cost of revenues
$
1.2
$
1.0
Research and development
2.2
1.7
Selling, general and administrative
9.1
7.6
Total stock-based compensation expense
$
12.5
$
10.3
Approximately $ 1.2 million and $ 1.0 million of stock-based compensation expense was capitalized to inventory as of October 3, 2020 and September 28, 2019 , respectively.
Full Value Awards
Full Value Awards refer to restricted stock units that are granted without an exercise price and are converted to shares immediately upon vesting. Performance-based awards are performance-based with market conditions, performance conditions, time-based or a combination, and are expected to vest over one to four years . When converted into shares upon vesting, shares equivalent in value to the minimum withholding taxes liability on the vested shares are withheld by the Company for the payment of such taxes.
During the three months ended October 3, 2020 and September 28, 2019 , the Company granted 2.5 million and 2.9 million time-based awards, respectively. The fair value of the time-based Full Value Awards is based on the closing market price of the Company’s common stock on the date of award. These time-based awards granted to eligible employees generally vest in annual or quarterly installments over a period of three years , are subject to the employees’ continuing service to the Company and do not have an expiration date.
During the three months ended October 3, 2020 and September 28, 2019 , the Company granted 0.6 million and 0.5 million , performance-based awards, respectively. These performance-based shares represent the target amount of grants, and the actual number of shares awarded upon vesting may vary depending upon the achievement of the relevant performance conditions. The shares attained over target upon vesting are reflected as awards granted during the period. Accordingly, during the three months ended October 3, 2020 and September 28, 2019 , the Company granted an additional 0.1 million and 0.1 million shares due to performance-based shares attained over target. The aggregate grant-date fair value of performance-based awards granted during the three months ended October 3, 2020 and September 28, 2019 were estimated to be $ 8.9 million and $ 6.2 million , respectively. The majority of performance-based awards vest in equal annual installments over three years based on the attainment of certain performance
22
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
measures and the employee’s continued service through the vest date. The performance-based awards with market conditions were valued using a Monte Carlo simulation.
As of October 3, 2020 , $ 75.5 million of unrecognized stock-based compensation cost related to Full Value Awards remains to be amortized.
Note 17. Employee Pension and Other Benefit Plans
The Company sponsors significant qualified and non-qualified pension plans for certain past and present employees in the United Kingdom (“U.K.”) and Germany. The Company also is responsible for the non-pension post-retirement benefit obligation assumed from a past acquisition.
Most of the plans have been closed to new participants and no additional service costs are being accrued, except for certain plans in Germany assumed in connection with an acquisition in fiscal 2010. Benefits are generally based upon years of service and compensation or stated amounts for each year of service.
As of October 3, 2020 , the U.K. plan was partially funded while the other plans were unfunded. The Company’s policy for funded plans is to make contributions equal to or greater than the requirements prescribed by law or regulation. For unfunded plans, the Company pays the post-retirement benefits when due. During the three months ended October 3, 2020 , the Company contributed $ 1.0 million to the U.K. plan and $ 0.8 million to the other plans. The funded plan assets consist primarily of managed investments.
The following table presents the components of net periodic cost for the pension and benefits plans ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Service cost
$
0.1
$
0.1
Interest cost
0.3
0.4
Expected return on plan assets
( 0.4
)
( 0.4
)
Amortization of net actuarial losses
0.8
0.7
Net periodic benefit cost
$
0.8
$
0.8
Both the calculation of the projected benefit obligation and net periodic cost are based upon actuarial valuations. These valuations use participant-specific information such as salary, age, years of service, and assumptions about interest rates, compensation increases and other factors. At a minimum, the Company evaluates these assumptions annually and makes changes as necessary.
The Company expects to incur cash outlays of approximately $ 10.0 million related to its defined benefit pension plans during fiscal 2021 to make current benefit payments and fund future obligations. As of October 3, 2020 , approximately $ 1.8 million had been incurred. These payments have been estimated based on the same assumptions used to measure the Company’s projected benefit obligation at June 27, 2020 .
Note 18. Commitments and Contingencies
Legal Proceedings
In June 2016, the Company received a court decision regarding the validity of an amendment to a pension deed of trust related to one of its foreign subsidiaries which the Company contends contained an error requiring the Company to increase the pension plan’s benefit. The Company had subsequently further amended the deed to rectify the error. The court ruled that the amendment increasing the pension plan benefit was valid until the subsequent amendment. The Company estimated the liability to range from (amounts represented as £ denote GBP) £ 5.7 million to £ 8.4 million . The Company determined the likelihood of loss to be probable and accrued £ 5.7 million as of July 2, 2016 in accordance with authoritative guidance on contingencies. The accrual is included in pension and post-employment benefits, which is a component of other non-current liabilities in the Company’s Consolidated Balance Sheets.
23
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company pursued an appeal of the court decision. In March 2018, the appellate court affirmed the decision of the lower court. The Company is pursuing a deed of rectification claim and continues to pursue a claim against the U.K. law firm responsible for the error. As of October 3, 2020 , the related accrued pension liability was £ 6.5 million or $ 8.4 million .
The Company is subject to a variety of claims and suits that arise from time to time in the ordinary course of our business. While management currently believes that resolving claims against the Company, individually or in aggregate, will not have a material adverse impact on its financial position, results of operations or statement of cash flows, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future. Were an unfavorable final outcome to occur, there exists the possibility of a material adverse impact on the Company’s financial position, results of operations or cash flows for the period in which the effect becomes reasonably estimable.
Guarantees
The Company follows authoritative guidance which requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. In addition, disclosures about the guarantees that an entity has issued, including a tabular reconciliation of the changes of the entity’s product warranty liabilities, are required.
The Company from time to time enters into certain types of contracts that contingently require the Company to indemnify parties against third-party claims. These contracts primarily relate to: (i) divestiture agreements, under which the Company may provide customary indemnifications to purchasers of the Company’s businesses or assets; (ii) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises; and (iii) certain agreements with the Company’s officers, directors and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship.
The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on the Consolidated Balance Sheets as of October 3, 2020 and June 27, 2020 .
Outstanding Letters of Credit and Performance Bonds
As of October 3, 2020 , the Company had standby letters of credit of $ 7.5 million and performance bonds of $ 0.9 million collateralized by restricted cash.
Product Warranties
The Company provides reserves for the estimated costs of product warranties at the time revenue is recognized. In general, the Company offers its customers warranties up to three years and has accrued a reserve for the estimated costs of product warranties at the time revenue is recognized. It estimates the costs of its warranty obligations based on its historical experience of known product failure rates, use of materials to repair or replace defective products and service delivery costs incurred in correcting product failures. From time to time, specific warranty accruals may be made if unforeseen technical problems arise. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
24
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents the changes in the Company’s warranty reserve during the three months ended October 3, 2020 and September 28, 2019 , ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Balance as of beginning of period
$
9.4
$
8.7
Provision for warranty
0.4
0.4
Utilization of reserve
( 0.2
)
( 1.0
)
Adjustments to pre-existing warranties (includes changes in estimates)
—
0.7
Balance as of end of period
$
9.6
$
8.8
Note 19. Operating Segments and Geographic Information
The Company evaluates its reportable segments in accordance with the authoritative guidance on segment reporting. The Company’s Chief Executive Officer is the Company’s Chief Operating Decision Maker (“CODM”). The Company's reportable segments reflect the way the Company's (CODM) reviews and assesses performance of the business.
The Company’s reportable segments are:
(i) Network Enablement:
NE provides 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. The Company also offers a range of product support and professional services such as repair, calibration, software support and technical assistance for our products.
(ii) Service Enablement:
SE solutions are embedded systems that yield network, service and application performance data. These solutions—including instruments, microprobes and software—monitor, collect and analyze network data to reveal the actual customer experience and to identify opportunities for new revenue streams and network optimization.
(iii) Optical Security and Performance Products:
OSP provides innovative, precision, high performance optical products for anti-counterfeiting, government, industrial, automotive and consumer electronic markets, including 3D Sensing applications.
The CODM manages the Company in two broad business categories: NSE and OSP. The CODM evaluates segment performance of the NSE business based on the combined segment gross and operating margins. Operating expenses associated with the NSE business are not allocated to the individual segments within NSE, as they are managed centrally at the business unit level. The CODM evaluates segment performance of the OSP business based on segment operating margin. The Company allocates corporate-level operating expenses to its segment results, except for certain non-core operating and non-operating activities as discussed below.
The Company does not allocate stock-based compensation, acquisition-related charges, amortization of intangibles, restructuring and related (benefits) charges, impairment of goodwill, changes in fair value of contingent consideration liabilities, non-operating income and expenses, or other charges unrelated to core operating performance to its segments because management does not include this information in its measurement of the performance of the operating segments. These items are presented as “Other Items” in the table below. Additionally, the Company does not specifically identify and allocate all assets by operating segment.
25
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following tables presents information on the Company’s reportable segments for the three months ended October 3, 2020 and September 28, 2019 ( in millions ):
Three Months Ended October 3, 2020
Network and Service Enablement
Network Enablement
Service Enablement
Network and Service Enablement
Optical Security and Performance Products
Other Items
Consolidated GAAP Measures
Product revenue
$
139.2
$
7.7
$
146.9
$
101.0
$
—
$
247.9
Service revenue
22.9
13.7
36.6
0.2
—
36.8
Net revenue
$
162.1
$
21.4
$
183.5
$
101.2
$
—
$
284.7
Gross profit
$
103.5
$
14.3
$
117.8
$
61.0
$
( 9.4
)
$
169.4
Gross margin
63.8
%
66.8
%
64.2
%
60.3
%
59.5
%
Operating income
$
13.3
$
47.3
$
( 29.3
)
$
31.3
Operating margin
7.2
%
46.7
%
11.0
%
Three Months Ended September 28, 2019
Network and Service Enablement
Network Enablement
Service Enablement
Network and Service Enablement
Optical Security and Performance Products
Other Items
Consolidated GAAP Measures
Product revenue
$
177.3
$
7.7
$
185.0
$
79.8
$
—
$
264.8
Service revenue
21.6
13.2
34.8
0.2
—
35.0
Net revenue
$
198.9
$
20.9
$
219.8
$
80.0
$
—
$
299.8
Gross profit
$
128.0
$
12.6
$
140.6
$
43.3
$
( 9.5
)
$
174.4
Gross margin
64.4
%
60.3
%
64.0
%
54.1
%
58.2
%
Operating income
$
22.3
$
30.4
$
( 32.0
)
$
20.7
Operating margin
10.1
%
38.0
%
6.9
%
Three Months Ended
October 3, 2020
September 28, 2019
Corporate reconciling items impacting gross profit:
Total segment gross profit
$
178.8
$
183.9
Stock-based compensation
( 1.2
)
( 1.0
)
Amortization of intangibles
( 8.2
)
( 8.4
)
Other charges unrelated to core operating performance (1)
—
( 0.1
)
GAAP gross profit
$
169.4
$
174.4
Corporate reconciling items impacting operating income:
Total segment operating income
$
60.6
$
52.7
Stock-based compensation
( 12.5
)
( 10.3
)
Amortization of intangibles
( 16.7
)
( 17.1
)
Change in fair value of contingent liability
—
( 1.7
)
Other charges unrelated to core operating performance (1)
( 0.7
)
( 2.6
)
Restructuring and related (benefits) charges
0.6
( 0.3
)
GAAP operating income from continuing operations
$
31.3
$
20.7
26
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VIAVI SOLUTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(1)
During the three months ended October 3, 2020 and September 28, 2019 , other charges unrelated to core operating performance primarily consisted of certain acquisiti on and integration related changes, transformational initiatives such as, site consolidations, and reorganization, loss on sale of investments and loss on disposal of long-lived assets.
The Company operates primarily in three geographic regions: Americas, Asia-Pacific, and Europe, Middle East and Africa (“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 tables present net revenue by the three geographic regions we operate in and net revenue from countries that exceeded 10% of our total net revenue for the three months ended October 3, 2020 and September 28, 2019 (in millions):
Three Months Ended
October 3, 2020
September 28, 2019
Product Revenue
Service Revenue
Total
Product Revenue
Service Revenue
Total
Americas:
United States
$
63.7
$
14.1
$
77.8
$
71.4
$
13.6
$
85.0
Other Americas
14.3
3.3
17.6
16.6
4.1
20.7
Total Americas
$
78.0
$
17.4
$
95.4
$
88.0
$
17.7
$
105.7
Asia-Pacific:
Greater China
$
77.3
$
1.7
$
79.0
$
70.5
$
1.4
$
71.9
Other Asia-Pacific
25.4
3.8
29.2
31.3
4.0
35.3
Total Asia-Pacific
$
102.7
$
5.5
$
108.2
$
101.8
$
5.4
$
107.2
EMEA:
Switzerland
$
17.9
$
0.1
$
18.0
$
12.2
$
—
$
12.2
Other EMEA
49.3
13.8
63.1
62.8
11.9
74.7
Total EMEA
$
67.2
$
13.9
$
81.1
$
75.0
$
11.9
$
86.9
Total net revenue
$
247.9
$
36.8
$
284.7
$
264.8
$
35.0
$
299.8
27
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 the U.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 ended June 27, 2020 .
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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 DEVELOPMENTS
Viavi 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 operated 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 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 (formerly CenturyLink 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; (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.
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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 (a) Growth Products (Location Intelligence and Nitro Mobile products) and (b) 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 and OVMP. 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 Diffusers TM .
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 has confirmed cases in the U.S. and most 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.
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
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Table of Contents
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.
The COVID-19 pandemic has not 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 enabled by our strong credit ratings. 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.
Capital markets and worldwide economies have also been significantly impacted by the COVID-19 pandemic, and on June 8, 2020, the National Bureau of Economic Research announced that the U.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 in May 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 in the 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 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 the Securities and Exchange Commission (SEC). There have been no material changes to our critical accounting policies and estimates.
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Table of Contents
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
October 3, 2020
September 28, 2019
Change
Percent Change
Segment net revenue:
NE
$
162.1
$
198.9
$
(36.8
)
(18.5
)%
SE
21.4
20.9
0.5
2.4
%
OSP
101.2
80.0
21.2
26.5
%
Total net revenue
$
284.7
$
299.8
$
(15.1
)
(5.0
)%
Gross profit
$
169.4
$
174.4
$
(5.0
)
(2.9
)%
Gross margin
59.5
%
58.2
%
Research and development
$
48.8
$
51.5
$
(2.7
)
(5.2
)%
Percentage of net revenue
17.1
%
17.2
%
Selling, general and administrative
$
81.4
$
93.2
$
(11.8
)
(12.7
)%
Percentage of net revenue
28.6
%
31.1
%
Restructuring and related (benefits) charges
$
(0.6
)
$
0.3
$
(0.9
)
(300.0
)%
Percentage of net revenue
(0.2
)%
0.1
%
Interest and other income, net
$
0.6
$
2.7
$
(2.1
)
(77.8
)%
Percentage of net revenue
0.2
%
0.9
%
Interest expense
$
(9.0
)
$
(8.3
)
$
0.7
8.4
%
Percentage of net revenue
3.2
%
2.8
%
Provision for income taxes
$
8.6
$
8.3
$
0.3
3.6
%
Percentage of net revenue
3.0
%
2.8
%
Net Revenue
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
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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 ended October 3, 2020 and September 28, 2019
Net revenue decrease d by $15.1 million , or 5.0% , during the three months ended October 3, 2020 compared to the same period a year ago. This decrease was due to revenue decrease from our NE segment, partially offset by revenue increase in our OSP and SE segments as discussed below.
Product revenues decrease d by $16.9 million , or 6.4% , during the three months ended October 3, 2020 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 increase d by $1.8 million , or 5.1% , during the three months ended October 3, 2020 compared to the same period a year ago. This increase was primarily due to increased revenues from our NE and SE segments.
NE net revenue decrease d by $36.8 million , or 18.5% , during the three months ended October 3, 2020 compared to the same period a year ago. This decrease was driven by the impact to our business from the COVID-19 lockdown primarily in our Field Instruments, such as Cable, Access and AvComm products.
SE net revenue increase d by $0.5 million , or 2.4% , during the three months ended October 3, 2020 compared to the same period a year ago. This increase is primarily driven by increased revenue from our Growth Assurance products.
OSP net revenue increase d by $ 21.2 million , or 26.5% , during the three months ended October 3, 2020 compared to the same period a year ago. This increase is primarily driven by growth in revenue across all product lines which include our Anti-Counterfeiting, 3D Sensing, and Aerospace & Defense 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 from Asia-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.
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Revenue by Region
We operate in three geographic regions: Americas, Asia-Pacific and Europe Middle East and Africa (“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
October 3, 2020
September 28, 2019
Americas:
United States
$
77.8
27.3
%
$
85.0
28.4
%
Other Americas
17.6
6.2
%
20.7
6.9
%
Total Americas
$
95.4
33.5
%
$
105.7
35.3
%
Asia-Pacific:
Greater China
$
79.1
27.8
%
$
71.9
24.0
%
Other Asia-Pacific
29.1
10.2
%
35.3
11.8
%
Total Asia-Pacific
$
108.2
38.0
%
$
107.2
35.8
%
EMEA:
Switzerland
$
17.9
6.3
%
$
12.2
4.0
%
Other EMEA
63.2
22.2
%
74.7
24.9
%
Total EMEA
$
81.1
28.5
%
$
86.9
28.9
%
Total net revenue
$
284.7
100.0
%
$
299.8
100.0
%
Net revenue from customers outside the Americas during the three months ended October 3, 2020 and September 28, 2019 represented 66.5% and 64.7% of net revenue, respectively.
We expect revenue from customers outside of United 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 increase d by 1.3 percentage points during the three months ended October 3, 2020 from 58.2% in the same period a year ago to 59.5% in the current period. This increase was primarily driven by favorable product mix within our OSP segment.
As discussed in more detail under “ Net Revenue ” above, we sell products in certain markets that are consolidating, undergoing product, architectural and business model transitions, have high customer concentrations, are highly competitive (increasingly due to Asia-Pacific-based competition), are price sensitive and/or are affected by customer seasonal and mix variant buying patterns. We expect these factors to continue to result in variability of our gross margin.
Research and Development
R&D expense decrease d by $2.7 million , or 5.2% , during the three months ended October 3, 2020 compared to the same period a year ago. This decrease was primarily driven by variable expense reductions and cost efficiencies during the period. As a percentage of net revenue, R&D remained relatively flat , declining 0.1 percentage points during the three months ended October 3, 2020 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
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SG&A expense decrease d by $11.8 million or 12.7% , during the three months ended October 3, 2020 compared to the same period a year ago. This decrease was primarily due to decreased spend on sales commissions, travel and entertainment expenses in the current period. As a percentage of net revenue, SG&A decrease d 2.5 percentage points during the three months ended October 3, 2020 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, certain charges unrelated to our core operating performance, such as mergers and acquisitions-related expenses, litigation expenses and charges from changes in the fair value measurement of our contingent consideration liabilities, which could increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter.
Restructuring and Related Charges
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 of October 3, 2020 , our total restructuring accrual was $4.0 million . During the three months ended October 3, 2020 , we recorded restructuring and benefits charges of $0.6 million . During the three months ended September 28, 2019 , the Company recorded restructuring and related charges of $0.3 million . Refer to “ Note 13. Restructuring and Related Charges ” for more information.
Interest and Other Income, Net
Interest and other income, net, was $0.6 million during the three months ended October 3, 2020 compared to $2.7 million the same period a year ago. This $2.1 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 and a $1.1 million unfavorable foreign exchange impact as the balance sheet hedging program provided less favorable offset to the remeasurement of underlying foreign exchange exposures during the current period.
Interest Expense
Interest expense increase d by $0.7 million , or 8.4% , during the three months ended October 3, 2020 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 of the 2023 Notes and 2024 Notes during the current period.
Provision for Income Taxes
We recorded an income tax provision of $8.6 million and $8.3 million for the three months ended October 3, 2020 and September 28, 2019 , respectively.
The income tax provision for the three months ended October 3, 2020 and September 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 (loss) from continuing operations.
As of October 3, 2020 , and June 27, 2020 , our unrecognized tax benefits totaled $48.3 million and $48.4 million , respectively, and are included in deferred taxes and other non-current tax liabilities, net. We had $3.6 million accrued for the payment of interest and penalties at October 3, 2020 . 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.
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Operating Segment Information
Information related to our operating segments were as follows, ( in millions ):
Three Months Ended
October 3, 2020
September 28, 2019
Change
Percentage Change
Network Enablement
Net revenue
$
162.1
$
198.9
$
(36.8
)
(18.5
)%
Gross profit
103.5
128.0
(24.5
)
(19.1
)%
Gross margin
63.8
%
64.4
%
Service Enablement
Net revenue
$
21.4
$
20.9
$
0.5
2.4
%
Gross profit
14.3
12.6
1.7
13.5
%
Gross margin
66.8
%
60.3
%
Network and Service Enablement
Net revenue
$
183.5
$
219.8
$
(36.3
)
(16.5
)%
Operating income
13.3
22.3
(9.0
)
(40.4
)%
Operating margin
7.2
%
10.1
%
Optical Security and Performance
Net revenue
$
101.2
$
80.0
$
21.2
26.5
%
Gross profit
61.0
43.3
17.7
40.9
%
Gross margin
60.3
%
54.1
%
Operating income
47.3
30.4
16.9
55.6
%
Operating margin
46.7
%
38.0
%
Network Enablement
During the three months ended October 3, 2020 , NE gross margin decrease d by 0.6 percentage points from 64.4% in the same period a year ago to 63.8% in the current period reflecting lower revenue volumes due to the impact of COVID-19.
Service Enablement
During the three months ended October 3, 2020 , SE gross margin increase d by 6.5 percentage points from 60.3% in the same period a year ago to 66.8% 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 ended October 3, 2020 , NSE operating margin decrease d by 2.9 percentage points from 10.1% in the same period a year ago to 7.2% in the current period. This decrease in operating margin was primarily driven by lower revenue volume and gross profit margin in NE segment and offset by a reduction in operating expenses reflecting disciplined expense management and 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 ended October 3, 2020 OSP gross margin increase d by 6.2 percentage points from 54.1% in the same period a year ago to 60.3% in the current period. This increase was primarily due to higher volume and better manufacturing cost absorption.
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OSP operating margin increase d by 8.7 percentage points during the three months ended October 3, 2020 from 38.0% in the same period a year ago to 46.7% in the current period. The increase in operating margin was primarily due to higher gross margins as discussed above.
Liquidity and Capital Resources
As of October 3, 2020 and June 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 $595.5 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 10-K. As of October 3, 2020 , U.S. entities owned approximately 50.9% 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 of October 3, 2020 , the majority of our cash investments have maturities of 90 days or less and are of high credit quality. Although we intend to hold these investments to maturity, in the event that we are required to sell any of these securities under adverse market conditions, losses could be recognized on such sales. During the three months ended October 3, 2020 , we have not realized material investment losses but can provide no assurance that the value or the liquidity of our investments will not be impacted by adverse conditions in the financial markets. In addition, we maintain cash balances in operating accounts that are with third party financial institutions. These balances in the U.S. may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. While we monitor the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail.
On May 5, 2020 , we entered into a credit agreement (the “Credit Agreement”) with Wells 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 on March 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 of October 3, 2020 , we had no amounts outstanding under the Credit Agreement.
Three Months Ended October 3, 2020
As of October 3, 2020 , our combined balance of cash and cash equivalents and restricted cash increased by $51.8 million to $599.2 million from $547.4 million as of June 27, 2020 .
During the three months ended October 3, 2020 , Cash provided by operating activities was $63.9 million , consisting of net income of $14.3 million adjusted for non-cash charges (e.g., depreciation, amortization and stock-based compensation) which totaled $ 43.5 million , including changes in deferred tax balances, and changes in operating assets and liabilities that provided $6.1 million . Changes in our operating assets and liabilities related primarily to a decrease in accounts receivable of $19.7 million driven by strong collections in the quarter, an increase in deferred revenue of $4.0 million , an increase in income taxed payable of $2.5 million . These were partially offset by a decrease in accounts payable of $8.5 million due to the timing of payment in the quarter, an increase in other current and non-current assets of $3.2 million , an increase in inventory of $3.4 million , a decrease in accrued expenses and other current and non-current liabilities of $3.6 million , and a decrease in accrued payroll and related expenses of $1.4 million .
During the three months ended October 3, 2020 , Cash used in investing activities was $7.5 million , primarily related to $8.0 million of cash used for capital expenditures, offset by $0.5 million proceeds from sales of assets.
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During the three months ended October 3, 2020 , Cash used in financing activities was $15.8 million , primarily resulting from $9.3 million in withholding tax payments on the vesting of restricted stock awards, $6.7 million in cash paid to repurchase common stock under our share repurchase program, $2.8 million cash paid to settle assumed debt from an acquisition in fiscal year 2020 and $0.4 million payments on financing obligations; offset by $3.5 million in proceeds from the issuance of common stock under our employee stock purchase plan.
Three Months Ended September 28, 2019
As of September 28, 2019 , our combined balance of cash and cash equivalents and restricted cash decreased by $3.2 million to $533.6 from $530.4 million as of June 29, 2019 .
During the three months ended September 28, 2019 , Cash provided by operating activities was $31.3 million , consisting of net income of $6.8 million adjusted for non-cash charges (e.g., depreciation, amortization and stock-based compensation) which totaled $43.7 million , including changes in deferred tax balance, and changes in operating assets and liabilities that used $19.2 million . Changes in our operating assets and liabilities related primarily to an increase in inventories of $3.4 million , a decrease in deferred revenue of $4.1 million , an increase in other current and non-current assets of $1.7 million , a decrease in accounts payable of $1.6 million , and a decrease in accrued expenses and other current and non-current liabilities of $14.7 million . These changes were partially offset by an increase in accrued payroll and related expenses of $3.8 million , an increase in income taxes payable of $2.0 million , and a decrease in accounts receivable of $0.5 million
During the three months ended September 28, 2019 , Cash used in investing activities was $5.9 million , primarily related to $7.1 million of cash used for capital expenditures, offset by $1.2 million proceeds from sales of assets.
During the three months ended September 28, 2019 , Cash used in financing activities was $7.8 million , primarily due to $7.6 million in withholding tax payments on vesting of restricted stock awards, $1.5 million in cash paid to repurchase common stock under our share repurchase program, and $1.0 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;
•
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 first quarter of fiscal 2021 .
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as such term is defined in rules promulgated by the SEC, 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 the United Kingdom (“U.K.”) and Germany. 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 in Germany assumed in connection with an acquisition in fiscal 2010. The U.K. plan is partially funded, and the other Germany plans, which were initially established as “pay-as-you-go” plans, are unfunded. As of October 3, 2020 , our pension plans were under funded by $113.2 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 of October 3, 2020 , the fair value of plan assets had decreased approximately 2.4% since June 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 of June 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.
Item 3. Quantitative and Qualitative Disclosure About Market Risks
The Company’s market risk has not changed materially from the foreign exchange and interest rate risks disclosed in Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended June 27, 2020 .
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.