VIAVI SOLUTIONS INC. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and capital resources during the period ended July 2, 2022. Unless otherwise noted, all references herein for the years 2022, 2021, and 2020 represent the fiscal years ended July 2, 2022, July 3, 2021, and June 27, 2020, respectively. We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. Factors that could cause or contribute to these differences include those discussed below and in this Annual Report on Form 10-K, particularly in “Risk Factors” and “Forward-Looking Statements.” This discussion should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included in this Annual Report that have been prepared in accordance with accounting principles generally accepted in the United States of America. Our actual results could differ materially from those discussed in the forward-looking statements. OVERVIEW We are 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. VIAVI is also a leader in light management solutions for the anti-counterfeiting, consumer electronics, industrial, government, and automotive markets. To serve our markets, we operate in the following business segments: • Network Enablement (NE); • Service Enablement (SE); and • Optical Security and Performance Products (OSP). During fiscal 2022, we experienced global supply chain disruptions, increased raw material costs, higher shipping-related charges, and inflationary pressures. Nevertheless, our ability to secure critical components, build inventory and meet customer demands has helped enable us to grow revenue and market share. We saw strong revenue growth in our NE business segment driven by fiber and wireless, as North American service providers upgraded and expanded their networks with fiber optic, and wireless demand increased in fiscal 2022. Our SE business segment also experienced an increase in revenue year over year as we saw strong growth in assurance solutions and data center products, in part due to increased market demand for 5G and growth in network traffic. Revenue from our OSP business segment did decrease, primarily driven by a decrease in demand for our consumer electronics and industrial products. However, any prolonged disruption of manufacturing of our products, commerce and related activity caused by the pandemic or significant decrease in demand for our products could materially and adversely affect our results of business, operations, and financial conditions. It may also have the effect of heightening many of the other risks such as those relating to our quarterly revenue and operating results as well as on our liquidity and on our ability to satisfy our indebtedness obligations, including the compliance with the covenants that apply to our indebtedness. Our financial results and long-term growth model will continue to be driven by revenue growth, non-GAAP operating profit, non-GAAP diluted earnings per share (EPS) and cash flow from operations. We believe these key operating metrics are useful to investors because management uses these metrics to assess the growth of our business and the effectiveness of our marketing and operational strategies. 31 T a b le of Contents We continue to make strategic investments to support our three-year strategic plan highlighted during our September 2019 Analyst Day Event such as: • Continued to invest in R&D to revamp product portfolio and enable the business to leverage secular trends in 5G, Fiber and 3D Sensing. • Enhanced the sales team to continue expanding Total Addressable Market (TAM), gain market share and execute successfully against our competitors. • Successfully completed four acquisitions, consistent with our acquisition strategy. Looking Ahead to 2023 As we look forward to the year ahead, our focus remains on executing against our strategic priorities to drive revenue and earnings growth, capture market share and continue to optimize our capital structure. Our emphasis is to continue to execute successfully despite supply chain shortages. Our ability to secure critical components, build inventory and meet customer demands has been a great differentiator and enabled us to grow revenue and market share. We plan to improve profitably driven by operating leverage in the business model as we grow both organically and inorganically. FINANCIAL HIGHLIGHTS Our fiscal 2022 results included the following notable items: • Net revenues of $1.3 billion, up $93.5 million or 7.8% year-over-year • GAAP operating margin of 14.3%, up 240 bps year-over-year • Non-GAAP operating margin of 22.2%, up 110 bps year-over-year • GAAP Diluted EPS of $0.07, down $0.22 or 75.9% year-over-year • Non-GAAP Diluted EPS of $0.95, up $0.12 or 14.5% year-over-year In fiscal 2022, VIAVI achieved new highs despite the COVID-19 related supply chain issues and inflationary pressures. Net revenue of $1.3 billion, up $93.5 million or 7.8%, was led by our NSE segment, which reached a record revenue of $949.1 million, up 13.3% year-over-year. VIAVI's fiscal 2022 GAAP operating margin of 14.3% was up 240bps over fiscal 2021 due to leverage on revenue growth. Non-GAAP operating margin of 22.2% expanded 110 basis points largely due to revenue growth and a lower intangible amortization. GAAP Diluted EPS of $0.07 decreased 75.9%, or $0.22, from fiscal 2021 largely due to the loss incurred in connection with the repurchase of certain 1.00% and 1.75% Senior Convertible Notes (the Original Senior Convertible Notes). Non-GAAP Diluted EPS of $0.95 increased 14.5% or $0.12 from $0.83 in fiscal 2021 as a result of the operating performance and an improved tax rate. In fiscal 2022, we generated $178.1 million in operating cash flow and deployed $72.5 million or 5.6% of revenues towards capital expenditures. We completed a $400.0 million high-yield 2029 notes offering at an attractive rate of 3.75% interest which allowed us to retire about 40% of the Original Senior Convertible Notes during Q1, and subsequent redemption transactions the remainder of the year allowed for additional retirements of approximately 17% of the Original Senior Convertible Notes. At the end of fiscal 2022, 43% of the original principal value of the Original Senior Convertible Notes remain outstanding. Also during fiscal 2022 we repurchased 14.8 million shares of our common stock for $235.5 million. 32 T a b le of Contents A reconciliation of Non-GAAP financial measures to GAAP financial measures is provided below (in millions, except EPS amounts): Years Ended July 2, 2022 July 3, 2021 Operating Income Operating Margin Operating Income Operating Margin GAAP measures $ 185.0 14.3 % $ 142.2 11.9 % Stock-based compensation 52.3 4.1 % 48.3 3.9 % Change in fair value of contingent liability 0.3 — % (5.3) (0.4) % Other charges unrelated to core operating performance (1) 9.6 0.7 % 3.4 0.3 % Amortization of intangibles 39.7 3.1 % 66.5 5.5 % Restructuring and related benefits (0.1) — % (1.6) (0.1) % Total related to Cost of Revenue and Operating Expenses 101.8 7.9 % 111.3 9.2 % Non-GAAP measures $ 286.8 22.2 % $ 253.5 21.1 % Years Ended July 2, 2022 July 3, 2021 Net income Diluted EPS Net Income Diluted EPS GAAP measures $ 15.5 $ 0.07 $ 67.5 $ 0.29 Items reconciling GAAP net income and EPS to non-GAAP net income and EPS: Stock-based compensation 52.3 0.22 48.3 0.21 Change in fair value of contingent liability 0.3 — (5.3) (0.02) Other charges unrelated to core operating performance (1) 9.6 0.04 3.4 0.01 Amortization of intangibles 39.7 0.17 66.5 0.28 Restructuring and related benefits (0.1) — (1.6) (0.01) Non-cash interest expense and other expense 102.2 0.43 0.2 — Benefit from income taxes 5.8 0.02 16.2 0.07 Total related to net income and EPS 209.8 0.88 127.7 0.54 Non-GAAP measures $ 225.3 $ 0.95 $ 195.2 $ 0.83 Shares used in per share calculation for Non-GAAP EPS 238.2 236.3 (1) Other items include charges unrelated to core operating performance primarily consisting of acquisition and integration related charges, transformational initiatives such as site consolidations, and reorganization, loss on sale of investments and loss on disposal of long-lived assets. 33 T a b le of Contents Use of Non-GAAP (Adjusted) Financial Measures The Company provides non-GAAP operating margin, non-GAAP net income and non-GAAP net income per share financial measures as supplemental information regarding the Company’s operational performance. The Company uses the measures disclosed in this Report to evaluate the Company’s historical and prospective financial performance, as well as its performance relative to its competitors. Specifically, management uses these items to further its own understanding of the Company’s core operating performance, which the Company believes represent its performance in the ordinary, ongoing and customary course of its operations. Accordingly, management excludes from core operating performance items such as those relating to certain purchase price accounting adjustments, amortization of acquisition-related intangibles and inventory step-up, stock-based compensation, restructuring, separation costs, changes in fair value of contingent consideration liabilities and certain investing expenses and non-cash activities that management believes are not reflective of such ordinary, ongoing and core operating activities. Non-GAAP financial measures are not in accordance with, preferable to, or an alternative for, generally accepted accounting principles in the United States. The Company believes providing this additional information allows investors to see Company results through the eyes of management and that providing non-GAAP financial measures in conjunction with GAAP measures provides valuable supplemental information regarding the Company’s overall performance. The Company further believes that providing this information allows investors to better understand the Company’s financial performance and, importantly, to evaluate the efficacy of the methodology and information used by management to evaluate and measure such performance. The non-GAAP adjustments described in this Report are excluded by the Company from its GAAP financial measures. The non-GAAP adjustments are outlined below. Cost of revenues, costs of research and development and costs of selling, general and administrative : The Company’s GAAP presentation operating expenses may include (i) additional depreciation and amortization from changes in estimated useful life and the write-down of certain property, equipment and intangibles that have been identified for disposal but remained in use until the date of disposal, (ii) workforce related charges such as severance, retention bonuses and employee relocation costs related to formal restructuring plans, (iii) costs for facilities not required for ongoing operations, and costs related to the relocation of certain equipment from these facilities and/or contract manufacturer facilities, (iv) stock-based compensation, (v) changes in fair value of contingent consideration liabilities and (vi) other charges unrelated to our core operating performance comprising mainly of acquisition related transaction costs, amortization of acquisition related inventory step-up, integration costs related to acquired entities, litigation and other costs and contingencies unrelated to current and future operations, including transformational initiatives such as the implementation of simplified automated processes, site consolidations, and reorganizations. The Company excludes these items in calculating non-GAAP operating margin, non-GAAP net income and non-GAAP net income per share. The Company believes excluding these items enables investors to evaluate more clearly and consistently the Company’s core operational performance. Amortization of intangibles : The Company includes amortization expense related to intangibles in its GAAP presentation of cost of revenues and operating expense. The Company excludes these significant non-cash items in calculating non-GAAP operating margin, non-GAAP net income and non-GAAP net income per share. Non-cash interest expense and other expense : The Company incurred a loss of $101.8M for fiscal 2022 in connection with the repurchase of certain 1.00% and 1.75% Senior Convertible Notes. The Company eliminates this in calculating non-GAAP net income and non-GAAP net income per share, because it believes that in so doing, it can provide investors a clearer and more consistent view of the Company’s core operating performance. Income tax expense or benefit: The Company excludes certain non-cash tax expense or benefit items, such as the utilization of net operating losses where valuation allowances were released, intra-period tax allocation benefit and the tax effect for amortization of non-tax deductible intangible assets, in calculating non-GAAP net income and non-GAAP net income per share. 34 T a b le of Contents RESULTS OF OPERATIONS This section of this Annual Report on Form 10-K generally discusses the results of operations for the fiscal year ended July 2, 2022 and July 3, 2021 and year to-year comparisons between such fiscal years. Discussions of the year to-year comparisons between the fiscal year ended July 3, 2021 and June 27, 2020, that are not included in this Annual Report on Form 10-K, can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended July 3, 2021 . 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 as a percentage of net revenue: Years Ended July 2, 2022 July 3, 2021 June 27, 2020 Segment net revenue: Network Enablement 65.4 % 62.3 % 65.7 % Service Enablement 8.0 7.6 9.0 Optical Security and Performance 26.6 30.1 25.3 Net revenue 100.0 100.0 100.0 Cost of revenues 37.9 37.6 38.6 Amortization of acquired technologies 2.3 2.8 2.9 Gross profit 59.8 59.6 58.5 Operating expenses: Research and development 16.5 16.9 17.0 Selling, general and administrative 28.3 28.2 27.7 Amortization of other intangibles 0.7 2.8 3.1 Restructuring and related (benefits) charges — (0.1) 0.3 Total operating expenses 45.5 47.8 48.1 Income from operations 14.3 11.8 10.4 Loss on convertible note settlement (7.9) — — Interest and other (loss) income, net 0.4 0.3 0.9 Interest expense (1.8) (1.2) (1.2) Income before income taxes 5.0 10.9 10.1 Provision for income taxes 3.8 5.3 5.8 Net income 1.2 % 5.6 % 4.3 % 35 T a b le of Contents Financial Data for Fiscal 2022, 2021 and 2020 The following table summarizes selected Consolidated Statement of Operations items ( in millions, except for percentages ): 2022 2021 Change Percent Change 2021 2020 Change Percent Change Segment net revenue: NE $845.8 $746.6 $99.2 13.3% $746.6 $746.7 $(0.1) —% SE 103.3 91.3 12.0 13.1% 91.3 102.7 (11.4) (11.1)% OSP 343.3 361.0 (17.7) (4.9)% 361.0 286.9 74.1 25.8% Net revenue $1,292.4 $1,198.9 $93.5 7.8% $1,198.9 $1,136.3 $62.6 5.5% Amortization of acquired technologies $30.0 $33.2 $(3.2) (9.6)% $33.2 $32.7 $0.5 1.5% Percentage of net revenue 2.3 % 2.8% 2.8% 2.9% Gross profit $773.5 $714.4 $59.1 8.3% $714.4 $665.3 $49.1 7.4% Gross margin 59.8% 59.6% 59.6% 58.5% Amortization of intangibles $9.7 $33.3 $(23.6) (70.9)% $33.3 $35.1 $(1.8) (5.1)% Percentage of net revenue 0.7% 2.8% 2.8% 3.1% Research and development $213.2 $203.0 $10.2 5.0% $203.0 $193.6 $9.4 4.9% Percentage of net revenue 16.5% 16.9% 16.9% 17.0% Selling, general and administrative $365.7 $337.5 $28.2 8.4% $337.5 $315.0 $22.5 7.1% Percentage of net revenue 28.3% 28.2% 28.2% 27.7% Restructuring and related (benefits) charges $(0.1) $(1.6) $1.5 (93.8)% $(1.6) $3.5 $(5.1) (145.7)% Percentage of net revenue —% (0.1)% (0.1)% 0.3% Loss on convertible note exchange $(101.8) $— $(101.8) 100.0% $— $— $— —% Percentage of net revenue (7.9)% —% —% —% Interest and other income, net $5.2 $3.3 $1.9 57.6% $3.3 $9.6 $(6.3) (65.6)% Percentage of net revenue 0.4% 0.3% 0.3% 0.8% Interest expense $(23.3) $(14.7) $(8.6) 58.5% $(14.7) $(13.4) $(1.3) 9.7% Percentage of net revenue (1.8)% (1.2)% (1.2)% (1.2)% Provision for income taxes $49.6 $63.3 $(13.7) (21.6)% $63.3 $65.3 $(2.0) (3.1)% Percentage of net revenue 3.8% 5.3% 5.3% 5.8% Foreign Currency Impact on Results of Operations While the majority of our net revenue and operating expenses are denominated in U.S. dollar, a portion of our international operations are denominated in currencies other than the U.S. dollar. Changes in foreign exchange rates may significantly affect revenue and expenses. While we use foreign currency hedging contracts to mitigate some foreign currency exchange risk, these activities are limited in the protection that they provide us and can themselves result in losses. We have presented below “constant dollar” comparisons of our net sales and operating expenses which exclude the impact of currency exchange rate fluctuations. Constant dollar net revenue and operating expenses are non-GAAP financial measures, which is information derived from consolidated financial information but not presented in our financial statements prepared in accordance with U.S. GAAP. Our management believes these non-GAAP measures, when considered in conjunction with the corresponding U.S. GAAP measures, may facilitate a better understanding of changes in net revenue and operating expenses. 36 T a b le of Contents Fiscal 2022 and 2021 If currency exchange rates had been constant in fiscal 2022 and 2021, our consolidated net revenue in “constant dollars” would have increased by approximately $10.8 million, or 0.8% of net revenue, which primarily impacted our NE and SE segments. The impact of foreign currency fluctuations on net revenue was not indicative of the impact on net income due to the offsetting foreign currency impact on operating costs and expenses. If currency exchange rates had been constant in fiscal 2022 and 2021, our consolidated operating expenses in “constant dollars” would have increased by approximately $4.8 million, or 0.4% of net revenue. The Results of Operations are presented in accordance with U.S. GAAP and not using constant dollars. Refer to Item 7A “Qualitative and Quantitative Disclosures about Market Risk” of this Annual Report on Form 10-K for further details on foreign currency instruments and our related risk management strategies. 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. Fiscal 2022 and 2021 Net revenue increased $93.5 million, or 7.8%, during fiscal 2022 when compared to fiscal 2021. This increase was driven by strength in our NE and SE segments, partially offset by a decrease in our OSP segment. Product revenues increased $84.1 million, or 8.0%, during fiscal 2022 when compared to fiscal 2021. During the period we realized strength from our NE and SE segments, which was offset by a decline in our OSP segment. Service revenues increased $9.4 million, or 6.4%, during fiscal 2022 when compared to fiscal 2021. This increase was primarily due to increased support revenue from our NE segments, offset by declines in our SE and OSP segments. NE net revenue increased $99.2 million, or 13.3% during fiscal 2022 when compared to fiscal 2021, reflecting continued strength in our Wireless and Optical Lab & Production products. SE net revenue increased $12.0 million, or 13.1%, during fiscal 2022 when compared to fiscal 2021. This was primarily driven by increased volume in our Data Center and Growth Assurance products. OSP net revenue decreased $17.7 million, or 4.9%, during fiscal 2022 when compared to fiscal 2021. This was primarily driven by a decrease in revenues from our 3D Sensing products. Going forward, we expect to continue to encounter a number of industry and market risks and uncertainties that may limit our visibility, and consequently, our ability to predict future revenue, profitability and general financial performance, and that could create quarter over quarter variability in our financial measures. For example, while the majority of our net revenue and expenses are denominated in U.S. dollars, a portion of our international operations are denominated in foreign currencies. The strengthening of the U.S. dollar relative to foreign currencies could negatively impact reported revenue. Additionally, we have seen demand for our NE, SE, and OSP products affected by macroeconomic uncertainty. We cannot predict when or to what extent these uncertainties will be resolved. 37 T a b le of Contents Revenue by Region We operate in three geographic regions, including 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) : Years Ended July 2, 2022 July 3, 2021 June 27, 2020 Americas: United States $ 388.9 30.1 % $ 330.0 27.5 % $ 341.6 30.1 % Other Americas 96.8 7.5 % 85.6 7.2 % 73.2 6.4 % Total Americas $ 485.7 37.6 % $ 415.6 34.7 % $ 414.8 36.5 % Asia-Pacific: Greater China $ 256.4 19.8 % $ 277.0 23.1 % $ 245.7 21.6 % Other Asia-Pacific 205.3 15.9 % 133.5 11.1 % 122.5 10.8 % Total Asia-Pacific $ 461.7 35.7 % $ 410.5 34.2 % $ 368.2 32.4 % EMEA: Switzerland $ 62.7 4.9 % $ 76.6 6.4 % $ 64.6 5.7 % Other EMEA 282.3 21.8 % 296.2 24.7 % 288.7 25.4 % Total EMEA $ 345.0 26.7 % $ 372.8 31.1 % $ 353.3 31.1 % Total net revenue $ 1,292.4 100.0 % $ 1,198.9 100.0 % $ 1,136.3 100.0 % Net revenue from customers outside the Americas for fiscal 2022, represented 62.4% of net revenue, a decrease of 2.9% year-over-year. This decrease is primarily due to lower revenues from EMEA and strong NSE North America revenues. 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 in fiscal 2022 improved by 0.2% to 59.8% from 59.6% in fiscal 2021. This increase was primarily driven by higher revenue volume and favorable product mix. 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 increased $10.2 million, or 5.0%, during fiscal 2022 compared to fiscal 2021. This increase was primarily driven by targeted investments to support increased demand in our growth products. As a percentage of net revenue, R&D slightly decreased during fiscal 2022 when compared to fiscal 2021. 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 $28.2 million, or 8.4%, in fiscal 2022 compared to fiscal 2021. This increase was driven by higher sales commissions, increased travel and variable pay. As a percentage of net revenue, SG&A increased slightly to 28.3% in fiscal 2022 when compared to 2021. 38 T a b le of Contents We intend to continue to focus on reducing our SG&A expense as a percentage of net revenue. However, we have in the recent past experienced, and may continue to experience in the future, certain charges unrelated to our core operating performance, such as acquisitions and integration related expenses and litigation expenses, which could increase our SG&A expenses and potentially impact our profitability expectations in any particular quarter. Amortization of Acquired Technologies and Intangibles Amortization of acquired technologies and intangibles for fiscal 2022 decreased $26.8 million, or 40.3%, to $39.7 million from $66.5 million in fiscal 2021. This decrease is primarily due to intangible assets becoming fully amortized. Acquired In-Process Research and Development In accordance with authoritative guidance, we recognize acquired in-process and development (IPR&D) at fair value as of the acquisition date, and subsequently account for it as an indefinite-lived intangible asset until completion or abandonment of the associated R&D efforts. We periodically review the stage of completion and likelihood of success of each IPR&D project. The nature of the efforts required to develop IPR&D projects into commercially viable products principally relates to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the products can be produced to meet their design specifications, including functions, features and technical performance requirements. Restructuring and Related Charges From time to time we have initiated strategic restructuring events primarily intended to reduce costs, consolidate our operations, rationalize the manufacturing of our products and align our businesses in response to market conditions. During fiscal 2022, we recorded a net restructuring benefit of $0.1 million and made final remaining payments of $0.4 million, after which the plan was closed. We estimate annualized gross cost savings of approximately $16.8 million excluding any one-time charges as a result of the recent restructuring activities. Refer to “Note 13. Restructuring and Related Charges” under Item 8 of this Annual Report on Form 10-K for more information. Loss on Convertible Note Exchange During fiscal 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 $347.3 million in cash in exchange for $156.9 million principal amount of the 2023 Notes and $236.1 million principal amount of the 2024 Notes. The Company recorded a loss of $101.8 million in connection with the settlement transactions. Interest and Other Income, Net Interest and other income, net was $5.2 million in fiscal 2022 as compared to $3.3 million in fiscal 2021. This $1.9 million increase was primarily driven by $1.4 million favorable foreign exchange impact as the balance sheet hedging program provided a more favorable offset to the remeasurement of underlying foreign exchange exposures for fiscal 2022 and an increase of $0.5 million in interest income due to rising interest rates during fiscal 2022. Interest Expense Interest expense increased $8.6 million, or 58.5%, during fiscal 2022 compared to fiscal 2021. This increase was primarily due to higher debt levels, higher interest rate on Senior Notes due 2029 and higher amortization of issuance costs as a result of the issuance of Senior Notes due 2029. Provision for Income Tax We recorded an income tax provision of $49.6 million for fiscal 2022. The expected tax provision derived by applying the federal statutory rate to our income before income taxes for fiscal 2022 differed from the income tax expense recorded primarily due to valuation allowances in addition to the foreign tax impact of the internal intellectual property restructuring transaction and withholding taxes offset by a tax benefit recognized upon the statute of limitations on a transfer pricing reserve in a non-US jurisdiction. 39 T a b le of Contents On July 2, 2022, the Company completed a planned internal transaction moving certain of VIAVI’s intellectual properties out of a foreign jurisdiction where tax rates are scheduled to increase to the U.S. entity established in fiscal 2021 to own and manage VIAVI’s other intellectual properties. The Company recorded foreign tax expense of $13.2 million related to this transaction. Based on a jurisdiction-by-jurisdiction review of anticipated future income and due to the continued economic uncertainty in the industry, management has determined that in many of our jurisdictions, it is more likely than not that our net deferred tax assets will not be realized in those jurisdictions. During fiscal 2022, the valuation allowance for deferred tax assets increased by $11.9 million which was primarily due to the increase in capitalization of federal research expenditures in the U.S. The decrease in income tax provision of $13.7 million or 21.6% during fiscal 2022 was due primarily to an $8.1 million tax benefit recognized upon the statute of limitations on a transfer pricing reserve in a non-US jurisdiction coupled with the decrease in the impact of the aforementioned fiscal 2022 transaction of $13.2 million as compared to the fiscal 2021 charge of $19.1 million related to internal transactions restructuring certain of our intellectual properties. We are routinely subject to various federal, state and foreign audits by taxing authorities. We believe that adequate amounts have been provided for any adjustments that may result from these examinations. Operating Segment Information ( in millions ): 2022 2021 Change Percentage Change 2021 2020 Change Percentage Change NE Net revenue $845.8 $746.6 $99.2 13.3% $746.6 $746.7 $(0.1) —% Gross profit 543.6 474.2 69.4 14.6% 474.2 482.4 (8.2) (1.7)% Gross margin 64.3% 63.5% 63.5% 64.6% SE Net revenue $103.3 $91.3 $12.0 13.1% $91.3 $102.7 $(11.4) (11.1)% Gross profit 71.5 59.9 11.6 19.4% 59.9 68.8 (8.9) (12.9)% Gross margin 69.2% 65.6% 65.6% 67.0% NSE Net revenue $949.1 $837.9 $111.2 13.3% $837.9 $849.4 $(11.5) (1.4)% Operating income 147.8 92.2 55.6 60.3% 92.2 108.8 (16.6) (15.3)% Operating margin 15.6% 11.0% 11.0% 12.8% OSP Net revenue $343.3 $361.0 $(17.7) (4.9)% $361.0 $286.9 $74.1 25.8% Gross profit 193.6 218.1 (24.5) (11.2)% 218.1 153.0 65.1 42.5% Gross margin 56.4% 60.4% 60.4% 53.3% Operating income 139.0 161.3 (22.3) (13.8)% 161.3 102.1 59.2 58.0% Operating margin 40.5% 44.7% 44.7% 35.6% Network Enablement NE gross margin increased by 0.8% during fiscal 2022 to 64.3% from 63.5% in fiscal 2021. This increase is due to leverage on growth and a more favorable product mix. Service Enablement SE gross margin increased by 3.6% during fiscal 2022 to 69.2% from 65.6% in fiscal 2021. This increase is due to a more favorable product mix. 40 T a b le of Contents Network and Service Enablement NSE operating margin increased by 4.6% during fiscal 2022 to 15.6% from 11.0% in fiscal 2021. The increase in operating margin was primarily driven by gross margin expansion offset by higher sales commissions. Optical Security and Performance Products OSP gross margin decreased by 4.0% during fiscal 2022 to 56.4% from 60.4% in fiscal 2021. This decrease was primarily due to higher input costs and startup costs in our new Arizona facility. OSP operating margin decreased by 4.2% during fiscal 2022 to 40.5% from 44.7% in fiscal 2021. The decrease in operating margin was primarily due to the lower gross margin. Liquidity and Capital Resources We believe our existing liquidity and sources of liquidity, namely operating cash flows, credit facility capacity, and access to capital markets, will continue to be adequate to meet our liquidity needs, including but not limited to, contractual obligations, working capital and capital expenditure requirements, financing strategic initiatives, fund debt maturities, and execute purchases under our share repurchase program over the next twelve months and beyond. 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 credit markets which would impact our ability to obtain additional financing on favorable terms or at all; • Volatility in foreign exchange market which impacts our financial results; • Possible investments or acquisitions of complementary businesses, products or technologies; • While the principal payment obligations of our 1.00% Senior Convertible Notes due 2024, our 1.75% Senior Convertible Notes due 2023, and our 3.75% Senior Notes due 2029 (together the “Notes”) are substantial and there are covenants that restrict our debt level and credit facility capacity, we may be able to incur substantially more debt; • Issuance or repurchase of debt or equity securities, which may include open market purchases of our 2023 Notes, 2024 Notes and/or 2029 Notes prior to their maturity or of our common stock; • Potential funding of pension liabilities either voluntarily or as required by law or regulation; • Compliance with covenants and other terms and conditions related to our financing arrangements; and • The risks and uncertainties detailed in Item 1A “Risk Factors” section of our Annual Report on Form 10-K. 41 T a b le of Contents Cash and Cash Equivalents and Short Term Investments Our cash and cash equivalents consist mainly of investments in institutional money market funds, short-term deposits held at major global financial institutions, and similar short duration instruments. Our strategy is focused on the preservation of capital and supporting our liquidity requirements that meet high credit quality standards, as specified in our investment policy approved by the Audit Committee of our Board of Directors. Our investments in debt securities and marketable equity securities are primarily classified as available for sale or trading assets and are recorded at fair value. The cost of securities sold is based on the specific identification method. Unrealized gains and losses on available-for-sale investments are recorded as other comprehensive (loss) income and are reported as a separate component of stockholders’ equity. As of July 2, 2022, U.S. subsidiaries owned approximately 40.3% of our cash and cash equivalents, short-term investments and restricted cash. As of July 2, 2022, the majority of our cash investments have maturities of 90 days or less and are of high credit quality. Nonetheless we could realize investment losses under adverse market conditions. During the twelve months ended July 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. Senior Secured Asset-Based Revolving Credit Facility 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 $300.0 million, which matures on December 30, 2026. The Credit Agreement also provides that, under certain circumstances, we may increase the aggregate amount of revolving commitments thereunder by an aggregate amount of up to $100.0 million so long as certain conditions are met. As of July 2, 2022, we had no borrowings under this facility and our available borrowing capacity was approximately $206.4 million. Refer to “Note 11. Debt” under Item 8 of this Annual Report on Form 10-K for more information. Revolving Credit Facility On May 5, 2020, we entered into a credit agreement with Wells Fargo as administrative agent, and other lender related parties. We borrowed $150.0 million and repaid $150.0 million under this credit agreement during the first quarter of fiscal 2022. In connection with the entry into the senior secured asset-based revolving credit facility noted above, we terminated this facility. Refer to “Note 11. Debt” under Item 8 of this Annual Report on Form 10-K for more information. Cash Flows Year Ended July 2, 2022 As of July 2, 2022, our combined balance of cash and cash equivalents and restricted cash decreased by $135.6 million to $572.8 million from a balance of $708.4 million as of July 3, 2021. Cash provided by operating activities was $178.1 million, consisted of net income of $15.5 million adjusted for non-cash or non-operating charges (e.g., depreciation, amortization of intangibles, stock-based compensation, amortization of debt issuance cost, loss on convertible note settlement and discount and net change in fair value of contingent liabilities), including changes in deferred tax balances which totaled $226.1 million, offset by changes in operating assets and liabilities that used $63.5 million. Changes in our operating assets and liabilities related primarily to an increase in deferred revenue of $13.2 million, an increase in accrued payroll and related expenses of $3.0 million and an increase in accrued expenses and other current and non-current liabilities of $1.4 million. This was partially offset by cash outflows from an increase in inventories of $27.7 million, a decrease in income taxes payable of $18.2 million, an increase in accounts receivable of $18.3 million, an increase in other current and non-current assets of $11.3 million and a decrease in accounts payable of $5.6 million driven by timing of purchases and related payments. 42 T a b le of Contents Cash used in investing activities was $71.0 million, primarily related to $72.5 million of cash used for capital expenditures and $8.3 million cash used for acquisitions. This was partially offset by $9.8 million proceeds from sales of assets. Cash used in financing activities was $210.4 million, primarily resulting from $351.6 million paid connection with the repurchase of certain Original Senior Convertible Notes, $235.9 million of cash used to repurchase common stock under our share repurchase program, $14.1 million in withholding tax payment on vesting of restricted stock awards, $10.5 million debt issuance costs paid in the period and $6.1 million in other payments. These were partially offset by $400 million gross proceeds from issuance of the 3.75% Notes due in 2029 and $7.8 million in proceeds from the issuance of common stock under our employee stock purchase plan. Material Contractual and Material Cash Obligations The following summarizes our contractual obligations at July 2, 2022, and the effect such obligations are expected to have on our liquidity and cash flow over the next five years ( in millions ): Payments due by period Total Less than 1 year 1 - 3 years 3 - 5 years More than 5 years Asset retirement obligations—expected cash payments $ 4.2 $ 0.5 $ 1.1 $ 0.9 $ 1.7 Debt: 2029 3.75% Senior Notes 400.0 — — — 400.0 2023 1.75% Senior Convertible Notes 68.1 68.1 — — — 2024 1.00% Senior Convertible Notes 223.9 — 223.9 — — Estimated interest payments 120.8 19.1 33.0 31.2 37.5 Purchase obligations (1) 188.9 177.7 10.3 0.9 — Operating lease obligations (2) 51.2 10.2 17.6 10.6 12.8 Non-cancelable leaseback obligations (1) 29.0 3.0 6.1 6.3 13.6 Royalty payment 2.8 1.7 0.8 0.3 — Pension and post-retirement benefit payments (3) 66.2 8.0 10.9 10.9 36.4 Total $ 1,155.1 $ 288.3 $ 303.7 $ 61.1 $ 502.0 (1) Refer to “Note 18. Commitments and Contingencies” for more information. (2) Refer to “Note 12. Leases” for more information. (3) Refer to “Note 17. Employee Pension and Other Benefit Plans” for more information. Purchase obligations represent legally-binding commitments to purchase inventory and other commitments made in the normal course of business to meet operational requirements. Of the $188.9 million of purchase obligations as of July 2, 2022, $76.2 million are related to inventory and the other $112.7 million are non-inventory items. As of July 2, 2022, our other non-current liabilities primarily relate to asset retirement obligations, pension and financing obligations which are presented in various lines in the preceding table. Share Repurchase Program During fiscal 2022 we repurchased 14.8 million shares of our common stock outstanding for $235.5 million pursuant to our 2019 and 2021 Share Repurchase Plans. As of July 2, 2022, the 2019 plan had $67.3 million of the authorized amount remaining; the 2021 plan had no authorized amount remaining. Refer to “Note 15. Stockholders Equity” under Item 8 of this Annual Report on Form 10-K for more information. 43 T a b le of Contents Employee Defined Benefit Plans and Other Post-retirement Benefits We sponsor significant qualified and non-qualified pension plans for certain past and present employees in the U.K. and Germany. We also are responsible for the non-pension post-retirement benefit obligation assumed from a past acquisition. Most 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 during fiscal 2010. The U.K. plan is partially funded and the other plans, which were initially established as “pay-as-you-go” plans, are unfunded. As of July 2, 2022, our pension plans were underfunded by $66.2 million since the Pension Benefit Obligation (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. We anticipate future annual outlays related to the German plans will approximate estimated future benefit payments. These future benefit payments have been estimated based on the same actuarial assumptions used to measure our projected benefit obligation and currently are forecasted to range between $5.1 million and $8.0 million per annum. In addition, we expect to contribute approximately $1.2 million to the U.K. plan during fiscal 2023. During fiscal 2022, we (amounts represented as £ and $ denote GBP and USD, respectively) contributed £1.0 million or approximately $1.3 million, while in fiscal 2021, we contributed £1.5 million or approximately $2.0 million to its U.K. pension plan. These contributions allowed us to comply with regulatory funding requirements. Recently Issued Accounting Pronouncements Refer to “Note 2. Recently Issued Accounting Pronouncements” under Item 8 of this Annual Report on Form 10-K, regarding the effect of certain recent accounting pronouncements on our Consolidated Financial Statements. Critical Accounting 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. Refer to “Note 1. Basis of Presentation” under Item 8 of this Annual Report on Form 10-K, for a discussion of the estimates used in preparation our Consolidated Financial Statements. For our Pension accounting, significant judgment is required i n actuarial assumption used when establishing the discount rate for the net periodic cost and the projected benefit obligation (PBO) calculations. 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 $5.0 million based upon data as of July 2, 2022. 44 T a b le of Contents