VIAVI SOLUTIONS INC. 10-Q

Item 2. 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; • The possible impact of the Russia-Ukraine conflict on our business; • 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 our capital markets and liquidity strategy, 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 July 3, 2021. 33 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 (CSPs), enterprises, network equipment manufacturers (NEMs), original equipment manufacturers (OEMs), 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 management solutions for 3D Sensing, anti-counterfeiting, consumer electronics, industrial, aerospace, automotive, and medical applications. To serve our markets we operate the following business segments: • Network Enablement (NE); • Service Enablement (SE), and; • Optical Security and Performance Products (OSP). Network Enablement Our NE segment 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, turn-up, certify, troubleshoot and optimize networks. They also support more profitable, higher-performing networks and help speed time-to-revenue. Our solutions address lab and production environments, field deployment and service assurance for wireless and wireline networks, including computing and 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 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, which 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. Within the NE product portfolio, our wireless products consist of flexible application software and multi-function hardware that our customers can easily use as standalone test and measurement solutions or combine with industry-standard computers, networks and third-party devices to create measurement, automation and embedded systems. Our Radio Access Network (RAN to Core) test and validation product addresses the various communications infrastructure market segments. 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. Our Avionics Communications (AvComm) products are a global leader in test and measurement instrumentation for communication and safety in the government, civil, aerospace and military markets. AvComm solutions encompass a full spectrum of instrumentation from turnkey systems, stand-alone instruments or modular components that provide customers with highly reliable, customized, innovative and cost-effective testing tools. 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, radio and avionics commercial companies, OEMs, and civil, state and federal agencies. Our customers include América Móvil, AT&T Inc., Lumen Technologies (formerly CenturyLink Inc.), Cisco Systems, Inc., Nokia, British Telecom Openreach, Deutsche Telekom AG and Verizon Communications, Inc. 34 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 assurance 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. 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 security offerings for the anti-counterfeiting market include OVP® and OVMP®. OVP® enables color-shifting effects and OVMP® enables depth and motion effects in addition to color-shifting effects. Both OVP® and OVMP® are formulated into inks used by banknote issuers and security printers worldwide for anti-counterfeiting applications on banknotes and other high-value documents. Our technologies are deployed on the banknotes of more than 100 countries today. Leveraging our unique high-precision coating and light shaping optics capabilities, OSP provides a range of products and technologies for the consumer, electronics, government, automotive and industrial markets, including, for example, optical filters and Engineered Diffusers TM for 3D sensing applications. Other OSP product lines include custom color solutions and spectral sensing. Custom color solutions include innovative special effects pigments that provide product enhancement for brands in the automotive and other industries. Spectral sensing solutions include handheld and process miniature near infrared spectrometers for pharmaceutical, agriculture, food, feed, and industrial applications. OSP serves customers such as SICPA Holding SA Company (SICPA), STMicroelectronics Holding N.V., Lockheed Martin Corporation and Seiko Epson Corporation. COVID-19 Pandemic Update The COVID-19 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, and temporary business closures among others. The ongoing COVID-19 pandemic, the emergence of new variants, and these aforementioned measures, continue to have an impact on businesses and economies worldwide. These conditions may continue and could result in an adverse impact to our operations. Worldwide distribution by central governments of the vaccines commenced in late 2020. There have been logistical and operational challenges with the rollout and global demand for the vaccine, particularly in developing nations, has exceeded supply. New and potentially more contagious variants of the virus have developed in several countries and regions in which we operate. 35 Table of Contents Our priority during the COVID-19 pandemic has remained focused on protecting the health and safety of our employees, customers, suppliers, and communities, including implementing early and regular updates to our health and safety policies and procedures. We continue to follow COVID-19 pandemic protocols as required by local, state and federal guidelines. These COVID-19 pandemic protocols have not thus far had a substantial net impact on our liquidity position. We continue to generate operating cash flows to meet our short-term liquidity needs, and we expect to maintain access to the capital markets. To date, we have not observed any material or materially adverse indication of impairments under the authoritative guidance, to any of our assets or a significant change to the fair value of assets due to the COVID-19 pandemic. We have experienced and may continue to experience disruption of our facilities, suppliers and contract manufacturers, which has impacted 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 and delays. NSE has experienced some impact to customer demand. Customer demand will continue to be challenging to calibrate, due to the nature and timing of the COVID-19 pandemic. We will continue to take the measures described above to ensure the health and safety of our employees and those they come in contact with. We have a global supply chain footprint with our primary manufacturing located in China, France, Germany, United Kingdom and the United States. We have experienced increased freight and logistics costs due to supply chain shortages resulting in extended lead times with respect to our NE Field Instrument products. Our supply chain team has been working to meet our customer needs by executing on a risk mitigation plan, including multi-sourcing, pre-ordering components, transforming our logistics network, prioritizing critical customers, working with local government agencies to understand challenges, and partnering on solutions that limit disruptions to our operations while ensuring the safety of our employees, partners and suppliers. Nonetheless, surges in infection rate, new shutdowns or quarantines, emergence of new and potentially more contagious variants of the virus and staffing and labor supply challenges may impact our suppliers and our ability to source materials in a timely manner. Although COVID-19 has brought unprecedented challenges, we believe that we have a robust and adaptable supply chain. While our industry faced supply chain challenges resulting from the COVID-19 pandemic such as diminished manufacturing capacity and material shortages resulted in extended lead-times, increased logistics costs, and product volume impact, these factors did not materially impact our business in fiscal year 2021. In the first nine months of fiscal year 2022, we experienced higher than expected supply chain and commodity costs, including manufacturing, logistics and procurement, due to inflationary pressure. We expect these high costs to continue through the remainder of fiscal year 2022. As the pandemic spread across the globe in Spring 2020, there was a tightening of the credit markets. We entered into a $300 million secured credit facility in May 2020 to strengthen our liquidity position. In December 2021, we terminated this facility and entered into a $300 million asset-based secured credit facility. While capital markets and worldwide economies have stabilized and recovered since being acutely impacted by the COVID-19 pandemic, in the event of 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. We intend to comply with applicable governmental vaccine and/or quarantine mandates. Such mandates could, in some circumstances, result in skilled labor impacts including voluntary attrition or difficulty finding labor, or otherwise adversely affect our ability to operate our manufacturing facilities, obtain supplies, or deliver our products in a timely manner. Some laws and directives may also hinder our ability to move certain products across borders. Economic conditions can also influence order patterns. These factors could negatively impact our consolidated results of operations and cash flow 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. We expect 5G Wireless and Fiber to continue driving growth and profitability in fiscal 2022. 36 Table of Contents Recent Global Events Due to the ongoing conflict between Russia and Ukraine, the US, EU and UK have broadened restrictions on exports to Russia, thereby blocking shipments of technology, telecommunications and consumer electronics products to Russia. This caused us to suspend transactions in the region effective February 2022 and has negatively impacted our business in the region. While sales in the region are not material to our total consolidated revenues or net income and we are 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 at this time. However, these estimates may change, as new events occur and additional information becomes available. Actual results may differ materially from these estimates assumptions or conditions due to risks and uncertainties, including the ongoing situation in Ukraine as well as the potential for additional trade actions or retaliatory cyber-attacks aimed at infrastructure or supply chains, the impact on our future operations and results in the region remains uncertain. 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 2021 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. 37 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 Nine Months Ended April 2, 2022 April 3, 2021 Change Percent Change April 2, 2022 April 3, 2021 Change Percent Change Segment net revenue: NE $ 204.3 $ 190.9 $ 13.4 7.0 % $ 623.6 $ 533.9 $ 89.7 16.8 % SE 26.5 20.3 6.2 30.5 % 79.3 67.5 11.8 17.5 % OSP 84.7 92.2 (7.5) (8.1) % 254.2 286.6 (32.4) (11.3) % Total net revenue $ 315.5 $ 303.4 $ 12.1 4.0 % $ 957.1 $ 888.0 $ 69.1 7.8 % Amortization of acquired technologies $ 7.4 $ 8.3 $ (0.9) (10.8) % $ 22.7 $ 24.9 $ (2.2) (8.8) % Percentage of net revenue 2.3 % 2.7 % 2.4 % 2.8 % Gross profit $ 186.9 $ 182.0 $ 4.9 2.7 % $ 572.4 $ 531.5 $ 40.9 7.7 % Gross margin 59.2 % 60.0 % 59.8 % 59.9 % Research and development $ 54.9 $ 52.1 $ 2.8 5.4 % $ 159.0 $ 150.9 $ 8.1 5.4 % Percentage of net revenue 17.4 % 17.2 % 16.6 % 17.0 % Selling, general and administrative $ 89.0 $ 86.1 $ 2.9 3.4 % $ 269.0 $ 247.0 $ 22.0 8.9 % Percentage of net revenue 28.2 % 28.4 % 28.1 % 27.8 % Amortization of other intangibles $ 2.2 $ 8.3 $ (6.1) (73.5) % $ 7.5 $ 24.9 $ (17.4) (69.9) % Percentage of net revenue 0.7 % 2.7 % 0.8 % 2.8 % Restructuring and related charges (benefits) $ — $ (0.4) $ 0.4 (100.0) % $ (0.1) $ (0.8) $ 0.7 (87.5) % Percentage of net revenue — % 0.1 % — % 0.1 % Loss on convertible note exchange $ (6.4) $ — $ (6.4) 100.0 % $ (98.7) $ — $ (98.7) 100.0 % Percentage of net revenue 2.0 % — % 10.3 % — % Interest income and other income (loss), net $ 0.6 $ (0.9) $ 1.5 (166.7) % $ 3.1 $ 0.8 $ 2.3 287.5 % Percentage of net revenue 0.2 % 0.3 % 0.3 % 0.1 % Interest expense $ (6.4) $ (3.6) $ (2.8) (77.8) % $ (17.1) $ (10.8) $ (6.3) (58.3) % Percentage of net revenue 2.0 % 1.2 % 1.8 % 1.2 % Provision for income taxes $ 9.4 $ 14.2 $ (4.8) (33.8) % $ 25.3 $ 35.3 $ (10.0) (28.3) % Percentage of net revenue 3.0 % 4.7 % 2.6 % 4.0 % 38 Table of Contents 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, 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 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 new, and potentially more virulent variants continue to emerge, 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 April 2, 2022 and April 3, 2021 Net revenue increased by $12.1 million, or 4.0%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was due to revenue increase from our NE and SE segments, partially offset by revenue decrease in our OSP segment. Product revenues increased by $9.2 million, or 3.5%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was due to revenue increase from our NE and SE segments, partially offset by revenue decrease in our OSP segment. Service revenues increased by $2.9 million, or 7.9%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was due to revenue increase from our NE and OSP segments, partially offset by revenue decrease in our SE segment. NE net revenue increased by $13.4 million, or 7.0%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was primarily driven by increased revenue volume from our Field Instruments and Lab and Production Equipment, including Fiber products. SE net revenue increased by $6.2 million, or 30.5%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was primarily driven by increased revenue from our Growth Assurance and Data Center products. OSP net revenue decreased by $7.5 million, or 8.1%, during the three months ended April 2, 2022 compared to the same period a year ago. This decrease was primarily driven by decreased revenue from our Anti-Counterfeiting Product lines. 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. 39 Table of Contents 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) chip component shortages, supply chain and shipping logistic constraints; (f) the impact of ongoing global trade policies, tariffs and sanctions; and (g) regulatory or economic developments and/or technology challenges that slow or change the rate of adoption of 5G, 3D Sensing and other emerging secular technologies and platforms. Revenue by Region We operate in three geographic regions: Americas, Asia-Pacific 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 Nine Months Ended April 2, 2022 April 3, 2021 April 2, 2022 April 3, 2021 Americas: United States $ 87.4 27.7 % $ 77.4 25.5 % $ 280.9 29.4 % $ 243.8 27.5 % Other Americas 21.4 6.8 % 24.4 8.1 % 75.1 7.8 % 61.8 7.0 % Total Americas $ 108.8 34.5 % $ 101.8 33.6 % $ 356.0 37.2 % $ 305.6 34.5 % Asia-Pacific: Greater China $ 65.8 20.9 % $ 71.9 23.7 % $ 194.9 20.4 % $ 224.1 25.2 % Other Asia-Pacific 48.7 15.4 % 30.3 10.0 % 136.9 14.3 % 82.7 9.3 % Total Asia-Pacific $ 114.5 36.3 % $ 102.2 33.7 % $ 331.8 34.7 % $ 306.8 34.5 % EMEA: Switzerland $ 18.8 6.0 % $ 18.1 6.0 % $ 43.7 4.6 % $ 56.0 6.3 % Other EMEA 73.4 23.2 % 81.3 26.7 % 225.6 23.5 % 219.6 24.7 % Total EMEA $ 92.2 29.2 % $ 99.4 32.7 % $ 269.3 28.1 % $ 275.6 31.0 % Total net revenue $ 315.5 100.0 % $ 303.4 100.0 % $ 957.1 100.0 % $ 888.0 100.0 % Net revenue from customers outside the Americas during the three and nine months ended April 2, 2022 represented 65.5% and 62.8% of net revenue, respectively. Net revenue from customers outside the Americas during the three and nine months ended April 3, 2021 represented 66.4% and 65.5% of net revenue, respectively. We expect revenue from customers outside of the 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 decreased by 0.8 percentage points during the three months ended April 2, 2022 from 60.0% in the same period a year ago to 59.2% in the current period. This decrease was primarily driven by gross margin reduction in our NE and OSP segment as discussed below in the Operating Segment Information section. This decrease was partially offset by higher revenue volume and favorable product mix within our SE segments. 40 Table of Contents Gross margin decreased by 0.1 percentage points during the nine months ended April 2, 2022 from 59.9% in the same period a year ago to 59.8% in the current period. This decrease was primarily driven by gross margin reduction in our OSP segment as discussed below in the Operating Segment Information section. This decrease was partially offset by higher revenue volume and favorable product mix within our NE and SE segments. 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. Amortization of Acquired Technologies and Intangibles Amortization of acquired technologies and intangibles decreased $7.0M or 42.2% during the three months ended April 2, 2022 compared to the same period a year ago. This decrease is primarily due to the runoff of intangible assets becoming fully amortized in fiscal 2021. Amortization of acquired technologies and intangibles decreased $19.6M or 39.4% during the nine months ended April 2, 2022 compared to the same period a year ago. This decrease is primarily due to the runoff of intangible assets becoming fully amortized in fiscal 2021. Research and Development R&D expense increased by $2.8 million, or 5.4%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was driven by targeted investments to support increased demand for our key product lines. As a percentage of net revenue, R&D expense increased by 0.2 percentage points during the three months ended April 2, 2022 compared to the same period a year ago. R&D expense increased by $8.1 million, or 5.4%, during the nine months ended April 2, 2022 compared to the same period a year ago. This increase was driven by targeted investments to support increased demand for our key product lines. As a percentage of net revenue, R&D expense decreased by 0.4 percentage points during the nine months ended April 2, 2022 compared to the same period a year ago. We believe that continuing our investments in R&D is critical to attaining our strategic objectives. We plan to continue to invest in R&D and new products that will further differentiate us in the marketplace. Selling, General and Administrative SG&A expense increased by $2.9 million, or 3.4%, during the three months ended April 2, 2022 compared to the same period a year ago. This increase was primarily due to targeted investments in people, processes and technology. As a percentage of net revenue, SG&A decreased 0.2 percentage points during the three months ended April 2, 2022 compared to the same period a year ago. SG&A expense increased by $22.0 million, or 8.9%, during the nine months ended April 2, 2022 compared to the same period a year ago. This increase was primarily due to targeted investments in people, processes and technology. As a percentage of net revenue, SG&A increased 0.3 percentage points during the nine months ended April 2, 2022 compared to the same period a year ago. 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 April 2, 2022 the Company did not have a restructuring accrual compared to an accrual of $0.5 million as of July 3, 2021. For the three months ended April 2, 2022, there were no restructuring charges or benefits recorded. During the nine months ended April 2, 2022, the Company recorded restructuring benefits of $0.1 million. During the three and nine months ended April 3, 2021, the Company recorded restructuring and related benefits of $0.4 million and $0.8 million, respectively. Refer to “Note 13. Restructuring and Related Charges” for more information. 41 Table of Contents Loss on convertible note exchange During the three months ended April 2, 2022, the Company entered into separate privately-negotiated agreements with certain holders of its 1.75% Senior Convertible Notes due 2023 and 1.00% Senior Convertible Notes due 2024. The Company paid $64.7 million in cash in exchange for $23.2 million principal amount of the 2023 Notes and $26.8 million principal amount of the 2024 Notes. The Company recorded a loss of $6.4 million in connection with the transactions. During the nine months ended April 2, 2022, the Company entered into separate privately-negotiated agreements with certain holders of its 1.75% Senior Convertible Notes due 2023 and 1.00% Senior Convertible Notes due 2024. The Company paid an aggregate of 10.6 million shares of its common stock, par value $0.001 per share, and $320.2 million in cash in exchange for $137.6 million principal amount of the 2023 Notes and $233.0 million principal amount of the 2024 Notes. The Company recorded a loss of $98.7 million in connection with the settlement transactions. Interest income and other income (loss), net Interest income and other income (loss), net, was $0.6 million during the three months ended April 2, 2022 compared to $(0.9) million during the same period a year ago. This $1.5 million increase was primarily driven by a favorable foreign exchange impact as the balance sheet hedging program provided a more favorable offset to the remeasurement of underlying foreign exchange exposures during the current period. Interest income and other income, net, was $3.1 million during the nine months ended April 2, 2022 compared to $0.8 million during the same period a year ago. This $2.3 million increase was primarily driven by a favorable foreign exchange impact as the balance sheet hedging program provided a more favorable offset to the remeasurement of underlying foreign exchange exposures during the current period. Interest Expense Interest expense increased by $2.8 million or 77.8% during the three months ended April 2, 2022 compared to the same period a year ago. This increase was primarily due to higher debt levels, the higher interest rate on Senior Notes due 2029 and amortization of issuance costs as a result of the issuance of Senior Notes due 2029 in September 2021. Interest expense increased by $6.3 million or 58.3% during the nine months ended April 2, 2022 compared to the same period a year ago. This increase was primarily due to higher debt levels, the higher interest rate on Senior Notes due 2029 and amortization of issuance costs as a result of the issuance of Senior Notes due 2029 in September 2021. Provision for Income Taxes We recorded an income tax provision of $9.4 million and $25.3 million for the three and nine months ended April 2, 2022, respectively. We recorded an income tax provision of $14.2 million and $35.3 million for the three and nine months ended April 3, 2021, respectively. The income tax provision for the three and nine months ended April 2, 2022 and April 3, 2021 primarily relates to income tax in certain foreign and state jurisdictions based on our forecasted pre-tax income or loss. The income tax provision for the nine months ended April 2, 2022 includes a $8.1 million tax benefit recognized upon the statute of limitations on a transfer pricing reserve in a non-US jurisdiction. 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 to the changes in valuation allowance for deferred tax assets attributable to our domestic and foreign income from continuing operations. As of April 2, 2022, and July 3, 2021, our unrecognized tax benefits totaled $50.2 million and $55.5 million, respectively, are included in deferred taxes and other non-current tax liabilities, net. We had $1.6 million accrued for the payment of interest and penalties as of April 2, 2022. 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. 42 Table of Contents Operating Segment Information Information related to our operating segments were as follows, (in millions): Three Months Ended Nine Months Ended April 2, 2022 April 3, 2021 Change Percentage Change April 2, 2022 April 3, 2021 Change Percentage Change Network Enablement Net revenue $ 204.3 $ 190.9 $ 13.4 7.0 % $ 623.6 $ 533.9 $ 89.7 16.8 % Gross profit 130.3 123.1 7.2 5.8 % 401.0 339.9 61.1 18.0 % Gross margin 63.8 % 64.5 % 64.3 % 63.7 % Service Enablement Net revenue $ 26.5 $ 20.3 $ 6.2 30.5 % $ 79.3 $ 67.5 $ 11.8 17.5 % Gross profit 18.3 12.4 5.9 47.6 % 54.4 44.3 10.1 22.8 % Gross margin 69.1 % 61.1 % 68.6 % 65.6 % Network and Service Enablement Net revenue $ 230.8 $ 211.2 $ 19.6 9.3 % $ 702.9 $ 601.4 $ 101.5 16.9 % Operating income 34.4 20.9 13.5 64.6 % 110.7 56.4 54.3 96.3 % Operating margin 14.9 % 9.9 % 15.7 % 9.4 % Optical Security and Performance Net revenue $ 84.7 $ 92.2 $ (7.5) (8.1) % $ 254.2 $ 286.6 $ (32.4) (11.3) % Gross profit 47.0 55.9 (8.9) (15.9) % 143.8 175.3 (31.5) (18.0) % Gross margin 55.5 % 60.6 % 56.6 % 61.2 % Operating income 33.3 40.5 (7.2) (17.8) % 104.6 132.4 (27.8) (21.0) % Operating margin 39.3 % 43.9 % 41.1 % 46.2 % Network Enablement During the three months ended April 2, 2022, NE gross margin decreased by 0.7 percentage points from 64.5% in the same period a year ago to 63.8% in the current period, reflecting an unfavorable product mix. During the nine months ended April 2, 2022, NE gross margin increased by 0.6 percentage points from 63.7% in the same period a year ago to 64.3% in the current period, reflecting higher revenue volumes and favorable product mix. Service Enablement During the three months ended April 2, 2022, SE gross margin increased by 8.0 percentage points from 61.1% in the same period a year ago to 69.1% in the current period. This increase was primarily due to higher revenue and favorable product mix. During the nine months ended April 2, 2022, SE gross margin increased by 3.0 percentage points from 65.6% in the same period a year ago to 68.6% in the current period. This increase was primarily due to higher revenue and favorable product mix. Network and Service Enablement (NSE) During the three months ended April 2, 2022, NSE operating margin increased by 5.0 percentage points from 9.9% in the same period a year ago to 14.9% in the current period. This increase in operating margin was primarily driven by higher revenue volume. During the nine months ended April 2, 2022, NSE operating margin increased by 6.3 percentage points from 9.4% in the same period a year ago to 15.7% in the current period. This increase in operating margin was primarily driven by higher revenue volume. 43 Table of Contents Optical Security and Performance Products During the three months ended April 2, 2022, OSP gross margin decreased by 5.1 percentage points from 60.6% in the same period a year ago to 55.5% in the current period. This decrease was primarily due to lower revenue, corresponding reduced manufacturing absorption and unfavorable product mix. During the nine months ended April 2, 2022, OSP gross margin decreased by 4.6 percentage points from 61.2% in the same period a year ago to 56.6% in the current period. This decrease was primarily due to lower revenue, corresponding reduced manufacturing absorption and unfavorable product mix. OSP operating margin decreased by 4.6 percentage points during the three months ended April 2, 2022 from 43.9% in the same period a year ago to 39.3% in the current period. The decrease in operating margin was primarily due to the aforementioned reduction in gross margin. OSP operating margin decreased by 5.1 percentage points during the nine months ended April 2, 2022 from 46.2% in the same period a year ago to 41.1% in the current period. The decrease in operating margin was primarily due to the aforementioned reduction in gross margin. Liquidity and Capital Resources As of April 2, 2022 and July 3, 2021, 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 $596.0 million and $703.7 million, respectively. Our cash investments are made in accordance with an investment policy approved by the Audit Committee of our Board of Directors and has not changed from that disclosed in our Form 10-K for the fiscal year ended July 3, 2021. As of April 2, 2022, U.S. entities owned approximately 36.4% of our cash and cash equivalents, short-term investments and short-term restricted cash. As of April 2, 2022, 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 April 2, 2022, 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 December 30, 2021, 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 senior secured asset-based revolving credit facility in a maximum aggregate amount of $300 million, which matures on December 30, 2026. The Credit Agreement also provides that, under certain circumstances, the Company may increase the aggregate amount of revolving commitments thereunder by an aggregate amount of up to $100 million so long as certain conditions are met. 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 the assets of the Company and those of its subsidiaries that are borrowers and guarantors under the Credit Agreement. Amounts outstanding under the Credit Agreement accrue interest as follows: (i) if the amounts outstanding are denominated in US Dollars, at a per annum rate equal to either, at the Company’s election, Term SOFR plus a margin of 1.35% to 1.85% per annum, or a specified base rate plus a margin of 0.25% to 0.75%, in each case, depending on the average excess availability under the facility, (ii) if the amounts outstanding are denominated in Sterling, at a per annum rate equal to SONIA plus a margin of 1.2825% to 1.7825%, depending on the average excess availability under the facility, (iii) if the amounts outstanding are denominated in Euros, at a per annum rate equal to the Euro Interbank Offered Rate plus a margin of 1.25% to 1.75%, depending on the average excess availability under the facility, or (iv) if the amounts outstanding are denominated in Canadian Dollars, at a per annum rate equal to either, at the Company’s election, the Canadian Dollar Offered Rate plus a margin of 1.25% to 1.75%, or a specified base rate plus a margin of 0.25% to 0.75%, in each case, depending on the average excess availability under the facility. 44 Table of Contents The covenants of the Credit Agreement include customary restrictive covenants that, among other things, restrict the Company’s ability to incur additional indebtedness, grant liens and make certain acquisitions, investments, asset dispositions and restricted payments. In addition, the Credit Agreement contains certain financial covenants that require the Company to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 if excess availability under the facility is less than the greater of 10% of the lesser of maximum revolver amount and borrowing base and $20 million. As of April 2, 2022, we had no amounts outstanding under the Credit Agreement. In connection with the entry into the Credit Agreement described above, the Company terminated its existing $300 million revolving credit agreement, dated May 5, 2020. Nine Months Ended April 2, 2022 As of April 2, 2022, our combined balance of cash and cash equivalents and restricted cash decreased by $106.9 million to $601.5 million from $708.4 million as of July 3, 2021. During the nine months ended April 2, 2022, Cash provided by operating activities was $104.5 million, consisting of net loss of $1.0 million adjusted for non-cash charges (e.g., loss on convertible note settlement, depreciation, amortization, stock-based compensation and other non-cash items) which totaled $192.1 million, including changes in deferred tax balances, and changes in operating assets and liabilities that used $86.6 million. Changes in our operating assets and liabilities related primarily to a decrease in income taxes payable of $27.5 million, an increase in inventory of $26.5 million, an increase in accounts receivable of $19.2 million, a decrease in accrued payroll and related expenses of $16.9 million, a decrease in accounts payable of $4.9 million and an increase in other current and non-current assets of $2.5 million. These were partially offset by an increase in deferred revenue of $9.8 million and an increase in accrued expenses and other current and non-current liabilities of $1.1 million. During the nine months ended April 2, 2022, Cash used in investing activities was $51.2 million, primarily related to $53.4 million of cash used for capital expenditures and $1.2 million of cash used for acquisitions, offset by $3.4 million proceeds from sales of assets. During the nine months ended April 2, 2022, Cash used in financing activities was $151.3 million, primarily resulting from $324.3 million paid in connection with the Convertible Note Exchange transactions, $207.0 million cash paid to repurchase common stock under our share repurchase program, $12.5 million in withholding tax payments on the vesting of restricted stock awards, $10.2 million debt issuance costs paid in the period and $5.1 million in other payments, primarily acquisition related. These were partially offset by $400.0 million gross proceeds from issuance of the 3.75% Notes due 2029, and $7.8 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 risks and uncertainties that could positively or negatively impact our liquidity position, which are detailed in Item 1A “Risk Factors.” Contractual Obligations There were no material changes to our existing contractual commitments during the third quarter of fiscal 2022. 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. 45 Table of Contents 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 April 2, 2022, our pension plans were under-funded by $92 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 April 2, 2022, the fair value of plan assets had decreased approximately 4.8% since July 3, 2021, 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 July 3, 2021. 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 July 3, 2021.