Jds Uniphase Cp (JDSU) - Description of business
JDS Uniphase Corporation (JDSU) is a worldwide leading provider of innovative broadband and optical products and solutions that enable dramatic improvements in the way we communicate, detect, present, and experience information. Our products are used in communications, commercial and consumer applications including broadband and optical networks, brand protection, biotechnology, semiconductor, aerospace and defense.
The storage and distribution of high-speed data, audio and video, such as high definition television (HDTV) and multi-player games, is transitioning from physical storage, compact discs (CDs), and digital video discs (DVDs) and related distribution methods to digital transmission over packet-based communications networks and storage on large-capacity servers and hard drives. These transitions require the support of higher capacity networks. Traffic generated over broadband access networks accounts for the majority of data traffic, and continues to grow. As greater bandwidth capability is delivered closer to the end user, we expect consumer demand for real-time, interactive visual and audio experiences to increase.
Many of the forces driving demand for high-bandwidth communications networks such as the emergence of Voice over Internet Protocol (VoIP), video over IP (IPTV), and on-line gaming are similarly transforming the consumer electronics industries. For example, cell phones increasingly offer integrated audio, image, and video capabilities, and digital music and video downloads over personal storage players are being rapidly adopted. We believe that the confluence of new digital consumer electronic technologies and the expanding availability of broadband networks will continue to drive significant bandwidth growth over optical networks. Given JDSUs leadership in the broadband test & measurement and optical networking markets, we believe that we are well positioned to continue to benefit from these industry trends.
Additionally, optical technologies are increasingly being applied to solve complex problems, for example, enabling the manufacture of smaller integrated circuits for use in todays compact consumer electronics. In the pharmaceutical sector, new drugs can be tested via induced fluorescence, and Deoxyribonucleic Acid (DNA) sequencing can be accomplished through the appropriate application of monochromatic light. Commercial and consumer products, ranging from medicines to electronics, can be protected against counterfeiting via secure labels with embedded optically variable micro flakes and other optical security devices. This technology is also used to inhibit counterfeiting of currencies and other valuable documents. These applications, in general, have been enabled through innovations in lasers, optically variable pigments, and other optical technologies. As a leader in optical innovation, we believe that JDSU can benefit as these trends and applications further evolve.
JDSU addresses three major markets: Optical Communications, Communications Test & Measurement, and Commercial and Consumer. To serve these markets, JDSU operates in three principal segments: Optical Communications, which accounted for approximately 39% of our net revenue in fiscal 2006; Communications Test & Measurement, which accounted for approximately 41% of our net revenue in fiscal 2006; and Advanced Optical Technologies, which accounted for approximately 14% of our net revenue in fiscal 2006. In addition, our Lasers business unit, included in All Other, accounted for approximately 6% of our net revenue in fiscal 2006.
In fiscal 2006, we changed our financial reporting structure with the formation of the Advanced Optical Technologies segment, which includes our Flex and Custom Optics businesses. Our Lasers business unit is being reported in the All Other category. Our Flex, Custom Optics and Laser businesses serve our Commercial and Consumer markets and were previously reported in our Consumer and Commercial segment. See Note 17. Operating Segments and Geographical Information of the Notes to Consolidated Financial Statements for details.
Our Optical Communications segment provides components, modules, and subsystems. They are used by communications equipment providers for telecommunications and data communications enabling the transmission, transport and receiving of video, audio, and text data encoded in optical signals over high-capacity fiber optic cables. JDSU offers a broad range of products, including tunable transmitters, receivers, amplifiers, multiplexers and demultiplexers, reconfigurable optical add/drop multiplexers (ROADMs), switches, optical performance monitors, couplers, splitters and circulators.
Our Communications Test & Measurement segment provides instruments, software, systems, and services that help communications equipment manufacturers and service providers accelerate the deployment of broadband networks and services from the core of the network to the home, including deployment over fiber to the curb, node or premise (FTTx) and digital networks. Our systems are designed to help network operators improve service quality, reduce customer turnover, and lower operating expenses. They enable the effective management of services such as VoIP and IPTV by providing visibility into the end-user experience. JDSU also provides repair, calibration, instrument management and other services to aid our customers in the rapid deployment and repair of networks and services. JDSUs Communications Test & Measurement solutions support a broad range of network architectures and protocol requirements, including optical core (long haul and metro), optical access (FTTx, passive optical network or PON), copper access (xDSL), cable access and cable head-end (MPEG, Coax), and enterprise networks (GE, FiberChannel). Services and protocols supported include VoIP, IPTV, metro Ethernet, ATM/Frame Relay, SONET/SDH, and many others.
Our Advanced Optical Technologies segment provides document authentication, brand protection and product differentiation solutions for a range of commercial and consumer applications. It also provides thin film coated optics for applications including computer monitors and flat panel displays, projection systems, photocopiers, facsimile machines, scanners, as well as optically variable micro flakes for security applications and decorative surface treatments.
Our lasers and high-performance photovoltaic converters offer solutions for semiconductor manufacturing, defense, aerospace, instrumentation, biotechnology, material processing, various sensor, and other applications. See Note 17. Operating Segments and Geographical Information of the Notes to Consolidated Financial Statements.
We were incorporated in California in May 1979 and reincorporated in Delaware in October 1993. JDSU is the product of several significant mergers and acquisitions, including, among others, the combination of Uniphase Corporation and JDS FITEL Inc. to form JDS Uniphase Corporation on June 30, 1999, and major subsequent acquisitions, including Optical Coating Laboratory, Inc. (OCLI) in February 2000, E-TEK Dynamics, Inc. (E-TEK) in June 2000, SDL, Inc. (SDL) in February 2001, Lightwave Electronics, Corp. (Lightwave) in May 2005, and Acterna, Inc. (Acterna) in August 2005.
We are subject to the information requirements of the Securities Exchange Act of 1934, or the Exchange Act. Therefore, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission (SEC). Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330, by sending an electronic message to the SEC at firstname.lastname@example.org or by sending a fax to the SEC at 1-202-777-1027. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically.
Our Internet address is www.jdsu.com. We post all SEC filings on our website at www.jdsu.com/investors as soon as reasonably practicable after they are electronically filed or furnished to the SEC. All such filings on our Investor Relations web site are available free of charge. The SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
Our Optical Communications and our Communications Test & Measurement markets are driven by major trends in the communications industry. Our Commercial and Consumer market is comprised of multiple applications across several market segments.
Optical Communications and Communications Test & Measurement Markets
In the communications industry, as content providers are developing new business models to expand their distribution capabilities, they are increasingly adopting on-line channels for the distribution of rich broadband content such as music, video programming, and movies. Telecommunications service providers are, in turn, planning to increase their revenues and profitability by expanding the capabilities of their IP packet-based networks to increase their network capacity and to deliver sophisticated levels of quality of service required to meet the service requirements of the content providers and the consumers.
Telecommunications, cable television, satellite, and wireless service providers are competing with each other to offer content providers and consumers with the ability to carry virtually any type of content via bundled services. Potential benefits for service providers include increased Average Revenue per User (ARPU) and reduced customer turnover, thus increasing profitability and long-term competitive advantage. As a result, many providers are developing new, consolidated network architectures intended to enable a triple-play (i.e. integrated voice, data and video services) offering from a single provider rather than three separate services from three separate providers over three separate networks.
Additionally, the proliferation of new and higher bandwidth services, including video-based content such as news, movies, and gaming, is generating strong growth in demand for network capacity and bandwidth rates, which in turn drives demand for many types of networking, access and transport systems.
Driven by this need to offer a broadening suite of digital services, network operators worldwide are migrating to IP networks, which offer an effective solution for delivering triple-play services while lowering capital operating costs.
Within the enterprise market, demand for broadband is driven by growing intra-company (LAN or local area network) and inter-company (WAN or wide area network) information networks needs. In addition, many companies are embracing new productivity-enhancing applications such as VoIP, which replaces traditional fixed circuit, point-to-point voice communications with packet-based network routed calls, and universal messaging systems that require greater bandwidth capability and data storage requirements.
Growing demand for network capacity and bandwidth is expected to result in greater adoption of optical communications products across the telecom sector, including long haul, metro (core and access), CATV, submarine, and fiber to the premises (FTTP or FTTx) and in the storage and enterprise sectors, including LAN, storage area networks (SAN) and WAN. We believe that deployment of fiber closer to the end user increases the availability of high-bandwidth services and will result in increased demand on the metro and long-haul infrastructures into which these services feed. We believe that JDSU, with its broad optical communications product portfolios, is poised to capitalize on these developments.
To remain competitive, telecommunications and cable service providers need to provision bandwidth more rapidly to keep up with the deployment of broadband triple-play services and the consequent increase in bandwidth demand. At the same time, service providers must continue to reduce operating costs associated with high-capacity DWDM networks. Migrating to Agile Optical Networks, which employ Reconfigurable Optical Add / Drop Multiplexers (ROADM), tunable transponders, and other Agile Optical products, can provide an effective solution. A service provider can add capacity, for instance, via remote management applications, eliminating the need to dispatch technicians to each impacted node.
We believe that increasing deployments of broadband access, the expansion of IP-based services, and the need to reduce deployment time and cost will result in increased demand for communications test & measurement instruments, systems, software, and services. Such communications test & measurement solutions support the rapid deployment of new services, increase customer satisfaction by helping technicians complete installation and repair work correctly the first time, and lower operating expenses by automating and improving network installation, maintenance, and management processes. We believe our broad portfolio of test and measurement solutions position us well to benefit from these developments.
We remain cautious, however, in attempting to forecast the future. Visibility remains limited, and we cannot provide any assurance as to the timing or scale of optical network deployments. In particular, we note that the service provider market is undergoing a phase of consolidation aimed at accelerating providers ability to provide triple-play or quadruple-play (includes wireless) services and to compete more effectively. This action is driving consolidation among network equipment manufacturers. In addition, the deployment of triple- or quadruple-play services increases the complexity of existing IP networks. While the trend is clear, the industry has embarked upon the initial phases of a long journey.
Commercial and Consumer Market
Brand Protection and Document Authentication
The prevalence of product counterfeiting is increasing, creating the potential for consumer health and safety risks, corporate liability issues, devaluation of brand image, weakening of brand loyalty, and lost revenues. Products that have been targets for counterfeiting have included pharmaceuticals, imaging supplies, apparel, automotive parts, consumer electronic products, and electronic media.
Multiple factors are contributing to the counterfeit market, including the broad adoption of the Internet to facilitate distribution, ready availability of low-cost, extremely high-quality printing equipment to reproduce product packaging, the elimination of international trade barriers, and an increasingly mobile global society.
In response, many corporate brand owners are accelerating the introduction of protective measures, developing overt and covert packaging strategies that provide consumers and/or inspection personnel with the ability to quickly determine product authenticity, for instance, by visually detecting a color-shifting effect on the package.
JDSU provides optical products for commercial and consumer security and brand authentication applications across various markets. Products from our Advanced Optical Technologies segment protect approximately 100 currencies worldwide and have been widely adopted by leading pharmaceutical and biotechnology companies on prescription drug packaging. Companies in other industry sectors also have implemented brand protection solutions using our color-shifting technology to prevent counterfeiting of their brands.
Global competition and an increasing range of product offerings are driving designers to look for innovative ways to differentiate their products. Products from our Advanced Optical Technology segment are used by our customers in decorative coatings to create striking or unusual visual effects.
Complex, high-performance optical coatings are needed in an increasing range of applications, including medical instruments, satellite solar covers, computer-driven projectors, large screen projection televisions, aerospace, and defense. JDSU is a leading manufacturer of optical thin film coatings and components used to manage light.
There is increased demand for high precision lasers for a variety of commercial markets, including semiconductors, materials processing and biotechnology as well as for use in imaging, aerospace and defense applications. Technology demands and trends in these markets are shaping the adoption of high-performance optical solutions. These trends include:
Wafer inspection and materials processing
Demand for electronic products with greater functionality, requiring high speed, precise micro machining, and materials processing
Advances in cytology (the study of cells used, for example, in the diagnosis of cancer), hematology (the study and science of blood), genome sequencing, and crime scene investigation
The development of innovative, non-invasive, effective measurement and analysis for bio-analysis
The need for remote sensing in environmental applications.
These trends are generating growing demand for commercial high-precision laser products. Market growth is further stimulated by the continuous reductions in size and power driven by adoption of solid state laser technology and the need for higher reliability in products. We believe that, as a leading provider of high-precision commercial lasers and other supporting technologies, we are poised to benefit from the development of these industry trends.
Power provided over copper cables is susceptible to RF and EMI interference. Photonic Power is immune to RF and EMI, is lighter, generates less heat, and is spark-free. JDSU is a pioneer in this emerging market with applications in aerospace, medical, defense, energy, and wireless communication.
Our principle operating segments are Optical Communications, Communications Test & Measurement and Advanced Optical Technologies. Our Lasers business, which includes our Photonic Power business unit, are reported in the All Other category.
Our Optical Communication segment provides the broadest portfolio of components, modules, and subsystems in the industry to support optical telecommunications networks, including submarine, long haul, metro, access, and cross-connect applications. We also serve the data communications market, including SAN, LAN, and Ethernet WAN applications.
We provide the industrys broadest portfolio of optical communications solutions required to build and maintain Agile Optical Networks. An Agile Optical Network (AON) is a dynamically reconfigurable DWDM network designed to accelerate triple-play service deployment and enable advanced wavelength applications at significantly reduced cost.
We believe the dynamically reconfigurable nature of the AON offers many unique competitive and cost advantages, enabling communications service providers to more efficiently use and scale network capacity, streamline service provisioning and modify network topology through simple point and click network management systems.
The breadth of our communications product offering with AON solutions is described below.
High Power Pump Lasers : We supply 980-nanometer and 14xx-nm (wavelength tailored) pump lasers that are utilized in erbium-doped fiber amplifiers (EDFAs) and Raman modules for amplification of optical signals. We also offer a line of high-power, high-brightness products targeted for industrial fiber laser and FTTx applications.
Modulators : Modulators are used to encode information being sent through the network. We supply a range of modulators, including monolithically integrated internal and high performance lithium niobate external modulators.
Wavelength Lockers : We supply wavelength lockers that are used to stabilize the wavelength of lasers in DWDM transmission systems.
Wavelength Division Multiplexing (WDM) Couplers, Filters, Isolators and Circulators : WDM couplers are used to split and combine signals of different wavelengths. We also supply isolators and circulators, including fixed and tunable filters, which are used to control the direction and flow of light in a network.
Switches and Attenuators : Optical switches are used to route and switch signals to different destinations within networks. Attenuators are used to adjust the power of the optical signal to be compatible with the optical receivers within a network system.
Submarine Applications : We offer the most comprehensive set of components for submarine applications. These include high power pump lasers and other active and passive components designed and manufactured to meet the stringent requirements of marine applications.
Modules and Subsystems
Agile Optical Switches: JDSUs Agile Optical Switch family provides the broadest portfolio of ROADM solutions to match the requirements of major market segments. These solutions are the building blocks of Agile Optical Networks and provide the flexibility to remotely reconfigure any or all wavelengths, reducing time-to-service, simplifying the network, and streamlining planning and management. This results in significant operating and capital expense reductions and faster time to revenue. In addition, our switching solutions enable the cost-effective creation and deployment of more complex network architectures.
Agile Transmission Modules : The JDSU Agile Transmission Modules family includes tunable transponders and tunable lasers. The deployment of next generation, IP-based voice, data and video services presents a new series of network management challenges for communications service providers, and we believe the flexibility enabled by JDSUs transponders is critical to their success. Our Agile Transmission Modules also support multiple modulation formats to allow multiple applications, from ultra long haul to metro networks, in a single platform.
Agile Optical Amplifiers : Our Agile Optical Amplifiers cover a wide range of functionality and are designed to boost optical signals, permitting an optical signal to travel a greater distance between electronic terminals and regenerators. Our amplifiers also respond dynamically to accommodate changes in the number of wavelengths or signal powers using advanced transient suppression techniques. As a result, they preserve gain, flatness, and output power over a wide range of input conditions to meet the needs of reconfigurable optical networks.
Transmitters: We manufacture transmitter modules that combine source lasers, modulators, wavelength lockers, and electronic drivers in one package to create and encode optical signals.
Transceivers and Transponders : For the data communications market we offer 1 Gb/s, 2 Gb/s and 3 Gb/s Fiber Channel, and 1 Gb/s and 10 Gb/s Ethernet transceivers. Form factors supported include GBIC SFP, X2 and XFP. In the telecom segment, we offer a broad range of solutions for Synchronous Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and WDM markets. Solutions offered include Small Form Factor pluggable (SFP) and 10 Gigabit Small Form Factor Pluggable (XFP) transceivers and 300 pin Small Form Factor (SFF) and LFF transponders. In addition to these fixed-wavelength telecom transponders, we offer tunable telecom transponders as part of our Agile Transmission module family.
Add-Drop Multiplexers : These modules allow systems to add and drop optical wavelengths without the need to convert to electrical signal. The modules include multiple components such as switches, wavelength multiplexers/demultiplexers, and attenuators.
Optical Channel Monitors : Optical Channel Monitors (OCM) allow optical network performance to be checked continuously in real-time. The OCM integrates all the functions needed to cost-effectively monitor wavelength, power, and optical signal to noise ratio (OSNR) performance.
WaveReady Products : These low-cost and easy-to-operate bit-rate and protocol independent modules, software, and shelves can be configured to deliver carrier class and enterprise optical transport solutions for LAN and SAN extension, Gigabit Ethernet, SONET, data, and video and to help triple play deployments. WaveReady solutions can be used with existing SONET-based networks to expand existing services such as DSL or add new services such as VoIP and provide a cost-effective solution to adding new fiber to a network. JDSUs unique portfolio of WaveReady Network Ready Subsystems allows providers to enable bandwidth aggregation and design hybrid dense or coarse WDM optical networks. The WaveReady family is easy to manage through Simple Network Management Protocol (SNMP) and TL1 compatible communication modules as well as JDSU Node Manager software.
Optical Layer Subsystems : We provide amplifier, transponder, switching and other circuit pack subsystems, which include optics and electronics on a circuit board and/or otherwise packaged with an interface for telecommunication systems. These products contain higher levels of hardware and firmware integration, including increasing levels of embedded software intelligence.
We compete against numerous public and private companies providing fiber optic components, modules, and subsystems, including independent merchant suppliers and business units within vertically integrated equipment manufacturers, some of whom are our customers. A partial list of our public company competitors includes Avanex, Bookham Technology, Finisar, Fujitsu, Furukawa Electric, Oplink Communications, and Sumitomo Electric. In addition to these established companies, we face significant and focused competition from other companies and from emerging start-ups. While each of our product families has multiple competitors, we believe that we have the broadest range of products and technologies available in the industry. Furthermore, we believe that the breadth and product leadership of our Agile Optical Network portfolio positions JDSU well as the industry continues to migrate from fixed to reconfigurable DWDM architectures and networks.
Communications Test & Measurement
JDSU offers one of the industrys most expansive set of communications-focused test and measurement solutions. This portfolio provides end-to-end test support across communications networks, including the core, metro, access, and home
networking environments. We are a leader in the test and measurement market and have an installed base of hundreds of thousands of test instruments and systems deployed in communications networks around the world. Our customers include the worlds largest communications service providers, communications equipment manufacturers, government organizations, and large corporate customers.
JDSUs test and measurement product portfolio includes:
Instruments Instruments are devices that perform various communications test and monitoring functions. Designed to be mobile devices, these products assist service provider technicians in assessing the performance of network elements and segments or verifying the integrity of the information being transmitted across the network. These instruments incorporate high levels of intelligence and have user interfaces that are designed to simplify operation and minimize necessary training. JDSUs test instruments also include those used by network equipment manufacturers (NEMs) in the design and manufacture of next-generation network equipment. Thorough testing by NEMs plays a critical role in producing the components and equipment that are the building blocks of network infrastructure.
Systems JDSUs systems are test and management devices that reside in our customers communication networks. Typically, these systems consist of hardware and software components. Using an integrated test and management system, our customers are able to analyze a variety of network elements, transmission technologies and protocols from a single console, simplifying the process of deploying, provisioning and managing network equipment and services. From a centralized location, technicians can access the test systems within the network and perform simultaneous test and monitoring functions on one or more elements, either manually or in an automated fashion. These capabilities allow network operators to initiate service to new customers faster, decrease the need for technicians to make on-site service calls and allow service providers to make necessary repairs faster and provide higher quality and more reliable services.
Software JDSU provides software products and custom software development services for our customers. Software products address applications for network capacity management, test operations support systems and workflow solutions. Software services are provided to customize software applications and to interface JDSU software to customer operations support systems.
Services JDSU offers a range of product support and professional services geared to comprehensively address our customers requirements. We provide repair, calibration, and software support services for our products as well as technical assistance on a global basis. In addition, we offer product and technology training services to our customers. Project management services are an integral part of the professional service offerings. These professional services are provided in conjunction with system integration projects that include installation and implementation. We provide product and process consulting to our customers.
We compete against various companies, including Agilent, Anritsu, Exfo, Spirent, and Sunrise. While each of our product families has multiple competitors, we believe that we have the broadest range of wireline products and solutions available in the communications test & measurement industry.
Advanced Optical Technologies
Our Advanced Optical Technologies segment represents JDSUs center of excellence for thin film coating. Optical thin film coatings are microscopic layers of materials such as silicon and magnesium fluoride that are applied to the surface of a substrate, including glass, plastic or metal, to alter the substrates optical properties. Thin film coatings work by controlling, enhancing or modifying the behavior of light to produce specific effects such as reflection, refraction, absorption, abrasion resistance, anti-glare, and electrical conductivity.
The aerospace, defense and medical/environmental instrumentation markets require sophisticated, custom, high-precision coated products and optical components that selectively absorb, transmit or reflect light to meet the specific performance requirements of advanced systems. We provide a wide array of precision optics and advanced optical technologies from the
ultraviolet to the far infrared portion of the light spectrum. Most products are custom optical filters that require one or more thin film coatings on a simple or irregular shape. Uses for these custom optics can be found in commercial applications, scientific products and telecommunication systems, among others. Our products include infrared filters, beam splitters, and optical sensors for aerospace applications, optical filters for medical instruments, and solar cell covers for satellites. Our products in the office automation market include photoreceptors and mirrors for photocopiers, document scanners, overhead projectors, facsimile machines, and printers.
Aerospace and Defense: We provide solar cell cover glass and thermal control mirror technology. One or more of our solar products can be found on U.S. manned spacecraft, on U.S. satellites, and on international satellites. In addition, we supply various types of filters used in military defense applications such as night vision goggles and electronic counter measures.
Consumer and Commercial Electronics: We manufacture and sell products for use in home and business display systems. These products include dichroic filters, mirrors, polarization compensators, heater panels and other coated optics, and assemblies.
Instrumentation: We provide multi-cavity and linear variable infrared filters on a variety of substrates for numerous applications, including gas monitoring and analysis, thermal imaging, smart munitions, fire detection, spectroscopy, and pollution monitoring. Our filters are additionally used in biomedical applications including microscopy, cytology semiconductor test systems, and test and measurement equipment. We also provide advanced optical technologies and filters that are used to create dramatic lighting effects and project rich, saturated color in intelligent lighting systems for concerts, discotheques, stages, studios, and architectural lighting.
Document Authentication and Brand Protection
Our security products use light interference technology, which allows inks or plastics to exhibit different colors and visual effects from different viewing angles. This technology is also used to inhibit counterfeiting of currencies and other valuable documents. We also supply products incorporating proprietary interference technologies to provide brand authentication and security solutions intended to deter counterfeiting. Applications include pharmaceuticals, imaging supplies, electronics, computer, and other consumer goods. We offer these products in a wide range of flexible solutions by incorporating them into labels and packaging.
Our line of decorative products utilize proprietary manufacturing processes and light interference technology to provide products with certain color characteristics that are attractive for applications in paints, cosmetics, and plastics. The products create a durable color shifting finish for automotive, consumer electronics, and other applications.
In these markets, we face competition from providers of special effect pigments, including BASF and Merck KGaA. We also face competition from Japanese coating companies such as Nidek, Toppan, and Tore as well as display component companies such as Viratec, Nitto Optical, Asahi, Nikon, and Fuji Photo-Optical. In our commercial and defense markets, we compete with optics companies such as Deposition Sciences and Barr Associates.
Our portfolio of laser products includes components and subsystems used in a wide variety of OEM applications. Our broad range of products, include high-reliability industrial diode lasers, fiber lasers, helium-neon (HeNe) gas lasers, air-cooled argon gas lasers, and continuous wave and pulsed diode-pumped solid-state lasers. The solid-state lasers include low- to high-power output, ultra violet (UV), visible and IR wavelength solid state solutions. This broad portfolio addresses the needs of our customers in markets and applications such as biotechnology, materials processing, semiconductor, graphics and imaging, remote sensing/ranging, and laser marking.
Diode-Pumped Solid-State Lasers: Our diode-pumped solid-state lasers with high output power, excellent beam quality, low noise, exceptional reliability, and extremely small packaging are used in biotechnology instrumentation, material processing,
graphics and imaging, semiconductor manufacturing, and laser induced fluorescence applications. We offer very low noise continuous wave green lasers, high repetition rate near infrared lasers, and high power pulsed and very high repetition rate UV lasers.
Industrial Diode Lasers: We have leveraged our telecom expertise into a family of industrial laser diode products, including components, plug and play modules and fiber-coupled devices. These diode lasers address a wide variety of applications, including laser pumping, thermal exposure, illumination, ophthalmology, image recording, printing, material processing, optical storage, and spectral analysis.
Argon Ion Lasers : We are a leading manufacturer of air-cooled argon ion lasers. Argon lasers are very stable and reliable over the entire range of operating currents and temperatures, making them well suited for complex, high-resolution OEM applications such as flow cytometry, DNA sequencing, graphics and imaging, and semiconductor inspection.
Helium-Neon Lasers: We offer helium-neon lasers in the red, green, yellow, and orange wavelengths. These products provide high output power with low noise, offering excellent beam pointing and amplitude stability, and instant start-up. These lasers are used in various applications, including bar code scanning, flow cytometry, metrology, photo processing, and alignment.
Fiber Lasers: Fiber lasers are compact in size, require simple wall-socket power, and are air-cooled, making them easy to integrate into a system. The nominal output wavelength of one micron is perfect for precision machining applications such as marking, bending and cutting, and selective soldering.
Photonic Power Solutions
JDSU is driving change in a broad range of market segments with photonic power, a revolutionary alternative to existing power delivery solutions. Delivering power over a fiber optic cable instead of copper wiring removes many of the barriers imposed by copper transport, isolating electronics from environmental factors across a broad array of applications. JDSUs innovative power delivery system can be used to drive sensors, gauges, actuators, low power communications devices, nanotechnology, micro-electromechanical (MEM) systems, and innumerable other electronic devices. The isolated nature of the power delivery makes it ideal for applications that require a spark-free environment or that are operating under high levels of RF, EMI, or voltage, or other harsh environmental conditions. Power is provided without contributing any adverse effects. This technology can be used in an ever-increasing number of applications, including medical, energy, defense, aerospace, wireless communications, and industrial sensors.
In our Lasers business, we compete with laser companies such as Coherent and the Spectra-Physics division of Newport. Our Photonic Power solutions feature a new, innovative technology for which there are not yet direct competitive offerings.
Our objective is to continue to be a leading supplier for all markets and industries we serve. Specifically, we plan to pursue the following product strategies:
The strategy of our Optical Communications segment is to help accelerate our customers profitability and time-to-revenue via enhanced vertically integrated optical platforms, such as higher-performance modules and circuit packs that leverage the broad optical components portfolio we sell directly to OEMs. Furthermore, we plan to help the service providers reduce their time to market and reduce operating expenses associated with the deployment of DWDM networks via the adoption of Agile Optical Networking solutions.
Within our Communications Test & Measurement segment, our strategy is to enhance our market position while continuing to improve profitability by providing communications test and management solutions that address the toughest business challenges of network operators and communications equipment manufacturers. Our focus is to enable network operators to accelerate deployment of new services, improve quality and reduce customer churn, and lower network operating expenses.
Our Advanced Optical Technologies segment aims to uniquely differentiate and effectively protect valuable brands via a secure, flexible, and aesthetically innovative optical platform. We also strive to supply the highest quality, best in class optical components, and assemblies with innovative coating processes that help our customers effectively differentiate their products.
Our Lasers business unit strives to enable our customers next generation laser applications, such as laser-based solutions in bio-medical, graphical, remote sensing and material processing markets, by exploiting laser product transitions from gas to solid state. Furthermore, we plan to accelerate new customer applications enabled by our high-performance Photonic Power photovoltaic converters.
In support of these product strategies, we are pursuing a corporate strategy that we believe will best position us for future opportunities in all the markets we serve. The key elements of our corporate strategy include:
Enabling our customers innovation in broadband and optical markets. We are committed to working closely with our customers from initial product design through to manufacturing and delivery. We strive to engage with our customers at the early stages of development to provide them with their entire component, module or subsystem needs. Our sales, customer support, product marketing, and development efforts are organized to maximize effectiveness in our customer interactions. Based on current and anticipated demand, we will continue to invest organically and inorganically in new technologies and products that offer our customers increased efficiency, higher performance, improved functionality, and/or higher levels of integration.
Shaping our product portfolio based on profitability and revenue growth. In fiscal 2006, we deliberately exited product lines with approximately $80 million of annualized revenue that were unable to contribute to our longer term profitability objectives. Acquisition targets are carefully selected to support our objective to expand our addressable market in potentially higher growth, higher profitability areas. Similarly, decisions to invest in organic product development will continue to be driven by profitability and revenue growth objectives.
Diversifying our customer base and product portfolio. Our acquisition strategy over the last several years has focused on our desire to diversify our business in terms of product offering and customer base. The acquisition of Acterna, for example, doubled our addressable market in the optical communications market and expanded our customer list beyond network equipment manufacturers to include carriers and cable companies. In our lasers business, the acquisition of Lightwave significantly strengthened our portfolio of solid-state lasers and improved our competitiveness as the industry transitions away from gas lasers.
Reducing legacy operating complexity and manufacturing costs to enable increased efficiency and quality improvement. Between 2001 and 2006, we consolidated 41 manufacturing locations. We remain committed to streamlining our manufacturing operations and reducing costs by using contract manufacturers where appropriate for our less complex, high volume products, and by situating our factories in lower-cost locations capable of consistently meeting our customers quality and performance requirements.
Although we expect to be successful in implementing our strategy, there are many internal and external factors that could impact our ability to meet any or all of our objectives. Some of these factors are discussed under Risk Factors.
As part of our strategy, we are committed to the ongoing evaluation of strategic opportunities and, where appropriate, the acquisition of additional products, technologies or businesses that are complementary to, or broaden the markets for our products. During fiscal 2006, we believe we strengthened our business model by expanding our addressable market, customer base, and expertise, diversifying our product portfolio, and fortifying our core businesses through acquisition as well as through organic initiatives.
In May 2006, we completed the acquisition of Test-Um Inc. (Test-Um), an industry-leading provider of home networking test instruments for the FTTx and digital cable markets. By acquiring Test-Um, we expanded our channels for the sale of our broad portfolio of test instruments for broadband access networks, including the recently introduced SmartClass line of instruments. We plan to leverage Test-Ums network of several hundred distribution partners, making our access test instruments
available to the service installation and electrical contractors served by Test-Um today. In addition, the acquisition creates new market opportunities for Test-Ums products, which will be made available through JDSUs direct sales and service organization serving the largest telecommunications and cable service providers worldwide.
In November 2005, we completed the acquisition of Agility Communications, Inc. (Agility), a leading provider of widely tunable laser solutions for optical networks. The acquisition is expected to solidify our leadership position in the rapidly growing market for tunable lasers and transponders; offer an optimal path to high volume, high yield, tunable, pluggable solutions when combined with JDSUs manufacturing scalability; establish JDSU as the broadest end-to-end agile optical network portfolio provider in the marketplace.
In August 2005, we completed the acquisition of privately held Acterna, Inc. (Acterna), a leading worldwide provider of broadband and optical test and measurement solutions for telecommunications and cable service providers and network equipment manufacturers. With this acquisition, we have become a leading provider of broadband test and measurement systems serving an expanded customer base that includes the largest 100 telecommunications and cable services providers and system manufacturers worldwide. The combined portfolio of products and services are expected to enhance the deployment of IP-based data, voice, and video services over optical long haul, metro, fiber-to-the-home, DSL, and cable networks. Starting the first quarter of fiscal 2006, the addition of Acternas Test & Measurement business comprised a new reportable segment of our business.
In May 2005, we acquired Photonic Power Systems, Inc., (PPS). PPS pioneered the delivery of electrical power over fiber. The acquisition of PPS supports our goal of technology innovation and could allow JDSU to enter a number of new markets, including medical, wireless communications, electrical power, industrial sensors, and aerospace applications.
In May 2005, we acquired Lightwave Electronics Corporation (Lightwave), a leading provider of solid-state lasers for commercial markets including materials processing, semiconductor fabrication, and biotech. The acquisition of Lightwave expanded JDSUs product line of the higher-growth solid-state laser market broadening our customer base and reinforcing our commitment to the OEM laser business. Examples of solid-state laser applications include PC board via-hole drilling, wafer singulation for solar cells and light emitting diode (LEDs), wafer inspection and alignment, memory repair, and ultraviolet flow cytometry and confocal microscopy.
Please refer to Note 3. Mergers and Acquisitions of Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K for further discussion of the acquisitions completed during fiscal 2006.
Restructuring Programs & Divestitures
Since April 2001, we have significantly consolidated and rationalized the manufacturing of our products based on core competencies, cost efficiency, and alternative manufacturers, where appropriate. Among other things, we continue to strengthen our partnerships with contract manufacturers primarily for our telecommunications, data communications, and laser products. We also are centralizing in-house manufacturing to our lower-cost facility in Shenzhen, China.
In November 2004, we announced a strategic decision to sell our Singapore and Bintan, Indonesia, manufacturing operations to Fabrinet Co. Ltd. (Fabrinet), one of our contract manufacturers. The agreement provides us with long-term sourcing guarantees for the datacom transceivers.
In April 2005, we announced restructuring programs designed to further reduce the number of manufacturing facilities, in addition to the divestiture or exit from selected businesses and product lines that were not strategic and/or were not capable of meeting our desired profitability goals. This restructuring program included the reduction of headcount at our Santa Rosa facility, the sale of our Fuzhou, China, and Mountain Lakes, New Jersey, businesses, the transfer of our manufacturing operations in Ewing, New Jersey, and Rochester, Minnesota, to a contract manufacturer, and the sale of our CATV product line to a third party.
In September 2005, and in further support of our cost reduction program and profitability objectives, we sold our front surface mirror product line.
In November 2005, we took steps to further commit to the consolidation of our manufacturing operations and the transfer of such operations to other of our facilities and to the facilities of our contract manufacturing partners. Specifically, we closed our Rochester, Minnesota, facility and announced the transition of products manufactured at our Ottawa site to contract manufacturers and an additional phase of consolidation at our Santa Rosa facility.
In February 2006, we entered into an agreement with Fabrinet to transfer the manufacturing operations in Ottawa, Canada to company facilities in Shenzhen, China, and St. Etienne, France. In addition, certain manufacturing operations were transferred to Fabrinet facilities in Thailand. Non-manufacturing activities at the Ottawa site were unaffected by this agreement.
We have consolidated manufacturing, research and development, sales and administrative facilities through building and site closures. As of June 30, 2006, 52 sites and buildings in North America, Europe and Asia-Pacific have been closed. The process involves consolidating product lines, standardizing on global product designs, and transferring manufacturing to fewer locations. The 52 sites closed were as follows:
North America: Allentown, Pennsylvania; Asheville, North Carolina; Calabasas, California; Camarillo, California; Columbus, Ohio; Eatontown, New Jersey; Freehold, New Jersey; Gloucester, Massachusetts; Horsham, Pennsylvania; Manteca, California; Melbourne, Florida (two sites); Mountain Lakes, New Jersey; Nashua, New Hampshire; Ottawa, Canada (three sites); Piscataway, New Jersey; Raleigh, North Carolina; Richardson, Texas; Rochester, Minnesota; Rochester, New York; San Jose, California (five sites); Santa Barbara, California; Santa Clara, California; Santa Rosa, California; Scarborough, Canada; Toronto, Canada; Valencia, California; Victoria, Canada; Westlake, California. South America: Cotia, Brazil Europe: Arnhem, Netherlands; Bracknell, United Kingdom; Eindhoven, Netherlands; Helsinki, Finland; Hillend, United Kingdom; Leobersdorf, Austria; Oxford, United Kingdom; Plymouth, United Kingdom; Torquay, United Kingdom; Waghaeusel-Kirrlach, Germany; Witham, United Kingdom. Asia-Pacific: Bintan, Indonesia; Fuzhou, China; Shunde, China; Sydney, Australia; Taipei, Taiwan.
We continue to centralize many administrative functions such as information technology, human resources, and finance to take advantage of common processes and controls, and economies of scale.
Our results of operations and financial condition were significantly affected by charges related to our restructuring activities, the write-downs of inventories, and the impairment of our investments and long-lived assets during fiscal 2006, 2005, and 2004. We may not be successful in our manufacturing strategy, and there are many risks to be addressed as described in the Risk Factors section.
Please refer to Managements Discussion and Analysis of Financial Condition and Results of Operations under Item 7 and Notes to the Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K for further discussion on these charges.
Sales and Marketing
We market our products primarily to service and cable providers, network equipment manufacturers, OEMs, distributors and strategic partners in North America, Europe and Asia-Pacific. Our sales organizations communicate directly with customers engineering, manufacturing and purchasing personnel in determining the design, performance, and cost specifications for customer product requirements.
Our customers for optical communications solutions include Agilent, Alcatel, Ciena, Cisco Systems, Ericsson, Fujitsu, Hewlett-Packard, Huawei, IBM, Lucent, Nortel, Siemens, and Bell South.
Our customers for communications test & measurement solutions include all major telecom and cable operators such as AT&T, Verizon, Deutsche Telekom, British Telecom, France Telecom, China Telecom, Telmex, Comcast, TimeWarner, and many others. Our Test & Measurement customers also include many of the network equipment manufacturers served by our optical communications group.
Customers for our advanced optical technologies and our laser markets include Agilent, Applied Biosystems, BAE System, Eastman Kodak, Hitachi, ITT, Mitsubishi, Northrup Grumman, SICPA, Sony, and Toshiba.
We believe that a high level of customer support is necessary to develop and maintain long-term relationships with our customers. Each relationship begins at the design-in phase and is maintained as customer needs change. We provide direct service and support to our customers through our offices in North America, Asia, and Europe. We have aligned our sales organization in the communications business to offer customers a single point of contact for all of their product requirements and created centers of excellence to streamline customer interactions with product line managers. We are also continuing to consolidate administrative functions to provide improved customer service and reduce our cost.
Research and Development
During fiscal 2006, 2005, and 2004, we incurred research and development expenses of $155.5 million, $93.7 million, and $99.5 million, respectively. Our total number of employees engaged in research and development has increased to 975 as of June 30, 2006, compared to 532 as of June 30, 2005, and 647 at June 30, 2004. The increase in fiscal 2006 was mainly related to the acquisition of Acterna.
We devote substantial resources to research and development to develop new and enhanced products to serve our markets. Once the design of a product is complete, our engineering efforts shift to enhancing both the performance of that product and our ability to manufacture it in volume and at lower cost.
For the optical communications market, we are increasing our focus on the most promising markets while maintaining our capability to provide products throughout the network. We are increasing our emphasis on the next generation Agile Optical components and modules, such as ROADMs and tunable devices needed for long-haul, metro, access, local area network, storage area network, and enterprise markets. We are also responding to our customers requests for higher levels of integration, including the integration of optics, electronics and software in our modules, subsystems, and circuit packs.
In our communications test & measurement market, we are increasing our focus on the most promising market, the broadband triple-play segment, while maintaining our capability to serve all major network architecture and protocols needs.
In our advanced optical technologies and laser markets, our research and development efforts concentrate on developing more innovative solutions such as economical and commercially suitable light interference micro flakes, color separation filters, and various components for optical systems, and components, modules and assemblies to serve the display and instrumentation markets.
The following table sets forth our major manufacturing locations and the primary products manufactured at each location as of June 30, 2006. Manufacturing facilities and products manufactured by our contract-manufacturing partners (located in California, Texas, Ottawa, China, Indonesia, Singapore, Malaysia, and Thailand) are not included in the table below:
NORTH AMERICA: United States: Allentown, PA Tunable laser packaging Commerce, CA Packaging labels for both security and non-security applications Germantown, MD Test & Measurement products Indianapolis, IN Test & Measurement products Coral Springs, FL
Color and image enhancement products
San Jose, CA High power pump lasers, source lasers, waveguides submarine products, CoC testing, and solid state lasers Santa Rosa, CA Optical display and projection products, light interference pigments for security and decorative applications, gas and solid state lasers, laser subsystems, and thin film filters Bloomfield, CT Lithium niobate modulators, wavelength lockers, and electronic drivers for telecommunications REST OF WORLD: China: Beijing Light interference pigments for security applications Shenzhen Variety of standard optical components and modules, transceivers and transponders, photodetectors, receiver products, erbium doped fiber amplifiers (EDFA), optical amplifiers, and source lasers France: St. Etienne Test & Measurement products Germany: Eningen Test & Measurement products
Sources and Availability of Raw Materials
Our intention is to establish at least two sources of supply for materials whenever possible, although we do have some sole source supply arrangements. The loss or interruption of such arrangements could have an impact on our ability to deliver certain products on a timely basis.
Patents and Proprietary Rights
Intellectual property rights that apply to our various products include patents, trade secrets, and trademarks. We do not intend to broadly license our intellectual property rights unless we can obtain adequate consideration or enter into acceptable patent cross-license agreements. As of June 30, 2006, we held over 1,200 U.S. patents and several hundred foreign patents.
Backlog consists of purchase orders for products for which we have assigned shipment dates within the following 12 months. As of June 30, 2006, our backlog was approximately $331.8 million as compared to $142.4 million at June 30, 2005. Because of possible changes in product delivery schedules and cancellation of product orders and because our sales will often reflect orders shipped in the same quarter in which they are received, our backlog at any particular date is not necessarily indicative of actual revenue or the level of orders for any succeeding period.
We had 7,099 employees as of June 30, 2006, as compared to 5,022 and 6,041 as of June 30, 2005 and 2004, respectively. Our workforce as of June 30, 2006 included 4,255 employees in manufacturing, 975 employees in research and development, 711 employees in general and administrative functions (including information technology, finance, and human resources), and 1,158 employees in sales and marketing.
We have never experienced a work stoppage, slowdown or strike. Notwithstanding the reductions in force that have taken place, we consider our employee relations generally to be good.
Similar to other technology companies, particularly those in Silicon Valley, we rely upon our ability to use stock options and other forms of stock-based compensation as key components of our executive and employee compensation structure. Historically, these components have been critical to our ability to retain important personnel and offer competitive compensation packages. Without these components, we would be required to significantly increase cash compensation levels (or develop alternative compensation structures) to retain our key employees, particularly as and when an industry recovery returns. Recent accounting rules relating to the expensing of stock-based compensation may result in us substantially reducing, or even eliminating, all or portions of our equity compensation programs which may negatively impact our ability to attract and retain key employees.
ITEM 1A. RISK FACTORS
We have a history of net losses, and our future profitability is not assured.
We incurred net losses of $151.2 million, $261.3 million, and $115.5 million in our fiscal years ended June 30, 2006, 2005 and 2004, respectively. Although we have made progress both in reducing costs associated with our legacy business, as well as in significantly improving our operating results (principally through the acquisition of Acterna in the first quarter of fiscal 2006), a confluence of factors may reduce the impact of these improvements, and may also undermine our ability to grow revenues or to achieve future profitability. These factors include, among others:
uncertain future telecom carrier and cable operator capital and R&D spending levels, which particularly affects our Optical Communications and Communications Test & Measurement segments;
fluctuations in demand for, and sales of, our products;
adverse changes to our product mix, both fundamentally (resulting from new product transitions, the declining profitability of certain legacy products and the termination of certain formerly higher margin products, among other things) and due to quarterly demand fluctuations;
adverse charges associated with underutilization of our manufacturing capacities;
intense pricing pressure across our product lines (due to competitive forces, increasingly from Asia, and to a highly concentrated customer base for many of our product lines), which continues to offset many of the cost improvements we are realizing quarter over quarter;
availability and cost of components for our products;
increasing commoditization of previously differentiated products, principally in the optical communications markets, and the concomitant negative effect on average selling prices and profit margins, particularly in our Optical Communications segment;
continuing execution challenges, particularly in our optical communications and commercial laser product portfolio, which limit revenue opportunities and harm profitability, market opportunities and customer relations;
restructuring charges, employee severance expenses and other costs associated with asset divestitures, facility consolidations, product transfers, product terminations and other actions associated with our continuing restructuring activities;
revenue declines associated with terminated or divested product lines;
continuing redundant costs related to transitioning of manufacturing to low cost locations;
continuing high levels of selling, general and administrative, (SG&A) expenses; and
seasonal fluctuations in revenue from our Communications Test & Measurement products.
Taken together, these factors limit our ability to predict future profitability levels. While some of these factors may diminish over time as we improve our cost structure and focus on enhancing our product mix, several factors, such as continuous pricing pressure, increasing Asia-based competition, increasing commoditization of previously-differentiated products, a highly concentrated customer base for many of our product lines and seasonal Communications Test & Measurement revenue fluctuations, are likely to remain endemic to our businesses. If we fail to achieve profitability expectations, the price of our debt and equity securities, as well as our business and financial condition, may be adversely impacted.
If information networks do not continue to expand as expected, or if industry consolidation continues, our business will be adversely impacted.
Our future success as a manufacturer of optical components, modules and subsystems, and communications test and measurement products ultimately depends on the continued growth of the communications industry and, in particular, the continued expansion of global information networks. As part of that growth, we are relying on increasing demand for high-content voice, video, text and other data delivered over high-speed connections (i.e., high bandwidth communications). As network usage and bandwidth demand increase, so does the need for advanced networks to provide the required bandwidth and for advanced instruments and equipment to facilitate the installation, maintenance and operation of these networks. Without network and bandwidth growth, the need for our products, and hence our future growth as a manufacturer of these products, is jeopardized. Currently, while increasing demand for network services and for broadband access, in particular, is apparent, growth is limited by several factors including, among others, an uncertain regulatory environment, reluctance from content providers to supply video and audio content over the communications infrastructure, and uncertainty regarding long-term sustainable business models as multiple industries (cable, traditional telecommunications, wireless, satellite, etc.) offer non-complementary and competing content delivery solutions. More broadly, current consolidation trends among communications service providers and network equipment manufacturers could cause temporary or permanent delays in network expansion. Ultimately, should long-term expectations for network growth and bandwidth demand not be realized or not support sustainable business models, our customers and our business would be significantly harmed.
We believe that we will continue to rely upon a limited number of customers for a significant portion of our revenues for each period for the foreseeable future and any failure by us to capture a significant share of these customers could materially harm our business. Dependence on a limited number of customers exposes us to the risk that order reductions from any one customer can have a material adverse effect on periodic revenue. We believe that the telecommunications industry has entered a period of consolidation. To the extent that our customer base consolidates, we will have increased dependence on fewer customers who may be able to exert increased pressure on our prices and contractual terms in general. Customer consolidation activity could also create the potential for pauses in customer demand for our products as a consequence of their new decision frameworks and periods of operational streamlining.
Our Communications Test & Measurement Segment is particularly vulnerable to seasonal variations in our business.
The majority of the products in our Communications Test & Measurement segment are subject to significant seasonal fluctuations in demand. Reasons for this seasonal variation include, among other things, the customary capital equipment and research and development buying patterns of the telecommunications carriers and cable service providers, which are the most significant customers for these products. As a consequence, we expect seasonal demand fluctuations to cause significant, periodic variations in our financial results for this reportable segment. Moreover, our overall financial results will be adversely impacted by these seasonal fluctuations to the extent that financial results from our other reportable segments do not offset the declines in our Communications Test & Measurement segment.
Without stability and growth in our non-communications businesses our margins and profitability may be adversely impacted.
The Advanced Optical Technologies segment and Lasers business unit represents a material, although varying, portion of our total net revenue. Gross margins associated with products in these segments often exceed those from products in the Optical Communications segment. While we believe that actions we have taken in the last several quarters (including, among other things, divestitures and end of life programs associated with certain optics and display products within this segment) have significantly reduced the financial risk, revenue declines associated with Advanced Optical Technologies have had, and may in the future continue to have, a disproportionate impact on total company profitability measures in any quarter. Accordingly, our strategy emphasizes the growth opportunities in all of our reported segments, as we seek to expand our markets and customer base, improve the profitability of our product portfolio and improve time to revenue. Therefore, we are engaged in exploring new investments, strategic partnerships and product opportunities in Advanced Optical Technologies and lasers business. Contractions in these markets or our failure to execute programs related to such investments, partnerships and opportunities may significantly harm our business.
Our Custom Optics business has experienced significant recent setbacks and is subject to major transition and risk.
In recent periods, our Custom Optics revenues have declined substantially from historic levels, due to, among other things, product line terminations, market seasonality, increased competition, pricing pressures and uncertain demand levels. In response, we have elected to phase out or divest certain products, outsource the manufacture of one product and consolidate the manufacturing resources related to the remainder of the business. We may incur additional costs or experience additional adverse financial and operational impacts related to declines in our Custom Optics business.
Actions to improve our cost structure are costly and risky and the timing and extent of expected benefits is uncertain.
In response to our profitability concerns we are working vigorously to reduce our cost structure. We have taken, and expect to continue to take, significant actions (including site closures, product transfers, asset divestitures and product terminations) in furtherance of this goal. In this regard, over the past several quarters we have initiated several major cost reduction initiatives. These initiatives include the transfer of manufacturing of certain of our products to contract manufacturing partners and our Shenzhen, China, facilities, site consolidations and divestitures, product line and operations divestitures, end of life programs and significant headcount reductions. We expect to continue to take additional, similar actions for the foreseeable future opportunistically. We cannot be certain that these programs will be successful or completed as and when anticipated. These programs are costly, and we have incurred, and will continue to incur, expenses to complete them. In addition, these programs are risky, as they are time-consuming and disruptive to our operations, employees, customers and suppliers, with no guarantee that the expected results (particularly cost savings and profitability expectations) will be achieved as and when projected or that the costs to complete these programs will not increase above expected levels. Cost savings achieved through these programs may not be timely or sufficient enough to offset continuing pricing declines.
If we incur more restructuring-related charges than currently anticipated, our consolidated financial condition and results of operations may be adversely impacted.
In April 2001, we initiated the Global Realignment Program, or GRP, under which we began restructuring our business in response to the economic downturn. In fiscal year 2006, we recorded total related restructuring charges of $35.0 million. These charges along with other charges, have adversely affected, and will continue to adversely affect, our results of operations and cash flows for the periods in which such charges have been, or will be, incurred. In the future, we may incur additional charges or write-offs in connection with restructuring initiatives.
If our contract manufacturers fail to perform their obligations, our business will be adversely impacted.
We are increasing our use of contract manufacturers as a cost effective alternative to internal manufacturing of lower complexity, higher volume products. Among other things, we recently transferred, or have agreed to transfer, several of our facilities, assets and manufacturing operations to our contract manufacturer, Fabrinet Co. Ltd., and have also agreed to transfer the manufacture of certain other products to an additional contract manufacturer. As a result, our reliance on these and other contract manufacturers as primary manufacturing resources is growing significantly. Consequently, we are increasingly exposed to the general risks associated with the businesses, operations and financial condition of our contract manufacturers, including, among other things, the risks of bankruptcy, insolvency, management changes, adverse change of control, natural disasters, and local political or economic volatility or instability. Thus, if our contract manufacturers do not fulfill their obligations to us on a timely basis for any reason, or if we do not properly manage these relationships and the transition of assets, operations and product manufacturing to these contract manufacturers, our business and customer relationships will be adversely impacted. In addition, by undertaking these activities, we run the risk that the reputation and competitiveness of our products and services may deteriorate as a result of the reduction of our control over quality and delivery schedules. We also may experience supply interruptions, cost escalations and competitive disadvantages if our contract manufacturers fail to develop, implement or maintain manufacturing methods appropriate for our products and customers. In this regard, we have experienced, and continue to periodically experience, difficulties (such as delays, interruptions and quality problems) associated with products we have transferred to contract manufacturers. If we are forced to transfer manufacturing from one contract manufacturer to another there would likely be additional cost and delay involved. These may continue, resulting in, among other things, lost revenue opportunities, customer dissatisfaction and additional costs.
We have continuing concerns regarding the manufacture, quality and distribution of our products. These concerns are heightened as new product offerings and overall demand increase.
Our success depends upon our ability to deliver high quality products on time and at acceptable cost to our customers. As a technology company, we constantly encounter quality, volume and cost concerns. Currently, a combination of factors is exacerbating our concerns, including:
our continuing cost reduction programs, which include site consolidations, asset divestitures, product transfers (internally and to contract manufacturers) and employee reductions, require the re-establishment and re-qualification by our customers of complex manufacturing lines, as well as modifications to systems, planning and operational infrastructure. During this process, we have experienced, and continue to experience additional costs, delays in re-establishing volume production levels, supply chain interruptions, planning difficulties, inventory issues, factory absorption concerns, and systems integration problems;
increases in demand for certain of our products, in the midst of our cost reduction programs, are straining our execution abilities as well as those of our suppliers, as we are experiencing periodic and varying capacity, workforce and materials constraints, enhanced by the impact of our ongoing product and operational transfers; and
recently, we have commenced a series of new product programs and introductions, particularly in our circuit pack, communications modules, optical switches and communications test and management products, which due to the untested and untried nature of the relevant products and of their manufacture with their increased complexity, expose us to yield and product risk internally and with our materials suppliers.
These factors have caused considerable strain on our execution capabilities and customer relations. Currently, we are (a) having periodic difficulty responding to customer delivery expectations for some of our products, (b) experiencing yield and quality problems, particularly with some of our new products and higher volume products, and (c) expending additional funds and other resources to respond to these execution challenges. We are currently losing revenue opportunities due to these concerns. We are also, in the short-term, diverting resources from new product research and development and other functions to assist with resolving these matters. If we do not improve our performance in all of these areas, our operating results will be harmed, the commercial viability of new products may be challenged and our customers may choose to reduce their purchases of our products and purchase additional products from our competitors.
Variability of manufacturing yields may affect our gross margins.
We manufacture products using highly complex processes that require technologically advanced equipment and continuous modification to improve yields and performance. Manufacturing yields depend on a number of factors, including the volume of production due to customer demand and the nature and extent of changes in specifications required by customers for which we perform design-in work. Difficulties in the manufacturing process, the effects from a shift in product mix, changes in product specifications and the introduction of new product lines can reduce yields or disrupt production and thereby increase our manufacturing costs. We may experience difficulties in achieving planned yields, which may adversely affect our gross margins. An increase in the rejection rate of products during the quality control process can also result in lower yields and margins. If we are unable to continue to improve yields in the future, particularly during the production of new products or introduction of new process technologies, we may be unable to meet our customers requirements and our results of operations could be materially and adversely affected.
If our customers do not qualify our manufacturing lines for volume shipments, our operating results could be adversely impacted.
Customers will not purchase certain of our products, other than limited numbers of evaluation units, prior to qualification of the manufacturing lines for the products. This concern is particularly relevant to us as we continue programs to reduce costs through targeted, customer-driven, restructuring events, which involve the relocation of certain of our manufacturing internally and to external manufacturers. Each new and relocated manufacturing line must undergo rigorous qualification testing with our customers. The qualification process can be lengthy and is expensive, with no guarantee that any particular product qualification process will lead to profitable product sales. The qualification process determines whether the manufacturing line achieves the customers quality, performance and reliability standards. Our expectations as to the time periods required to qualify a product line and ship products in volumes to customers may be erroneous. Delays in qualification can cause a long-term supply program to be cancelled. These delays will also impair the expected timing, and may impair the expected amount, of sales of the affected products. Nevertheless, we may, in fact, experience delays in obtaining qualification of our manufacturing lines and, as a consequence, our operating results and customer relationships would be harmed.
We could incur significant costs to correct defective products.
Our products are rigorously tested for quality both by our customers and by us. Nevertheless, our products do, and may continue to, fail to meet customer expectations from time-to-time. Also, not all defects are immediately detectible. Customers testing procedures are limited to evaluating our products under likely and foreseeable failure scenarios. For various reasons (including, among others, the occurrence of performance problems that are unforeseeable in testing or that are detected only when products are fully deployed and operated under peak stress conditions), our products may fail to perform as expected long after customer acceptance. Failures could result from faulty design or problems in manufacturing. In either case, we could incur significant costs to repair and/or replace defective products under warranty, particularly when such failures occur in installed systems. We have experienced such failures in the past and remain exposed to such failures, as our products are widely deployed throughout the world in multiple demanding environments and applications. In some cases, product redesigns or additional capital equipment may be required to correct a defect. We have in the past increased our warranty reserves and have incurred significant expenses relating to certain communications products. Any significant product failure could result in lost future sales of the affected product and other products, as well as severe customer relations problems, litigation and damage to our reputation.
If we cannot develop new product offerings or if our new product offerings fail in the market, our business will be adversely impacted.
We are a technology-dependent company. Our success or failure depends, in large part, upon our ability to continuously and successfully introduce and market new products and technologies meeting or exceeding our customers expectations in a timely manner. Accordingly, we intend to continue to develop new product lines and improve the business for existing ones. However, we have considerably reduced our research and development spending from historic levels and some of our competitors now spend considerably higher percentages of their revenues on research and development than we do. If we fail to develop and sustain a robust, commercially viable product pipeline, our business will be adversely impacted. We are also experiencing market timing concerns for some of our product offerings, particularly relative to our Communications Test and Measurement segment.
In recent periods, we have increased our focus on new products, particularly in our circuit pack, communications modules, optical switches and test and measurement businesses. However, several of the key relevant products are untried and untested and have not yet demonstrated long-term commercial viability. Occasionally, problems occur causing us to cancel or adjust new
product programs. Current challenges, which we are particularly experiencing across our new Optical Communications product efforts, include establishing sustainable pricing and cost models, predictable and acceptable quality and yields, and adequate and reliable supply chains, as well as demonstrating our (and our suppliers) ability to scale and provide adequate facilities, personnel and other resources. If we fail to successfully develop and commercialize some or all of these new products, our business could be adversely impacted.
Signs of market stability are not necessarily indicative of long-term growth.
Both our direct communications equipment manufacturer customer base and their customer base, the service providers, have been significantly reduced due to industry consolidations and the reduction of the competitive local exchange carriers. These consolidations have the potential to directly impact our communications test business, which includes all of the major telecommunications service providers in our customer base, as well as our optical communications products. Notwithstanding signs of market stability, visibility into our markets, particularly the telecommunications market, remains limited and average selling prices continue to decline, creating uncertainty and variability in our revenue and profitability targets and projections. Because our visibility remains limited, we remain cautious and cannot predict the timing or magnitude of growth for our industries or our business at this time.
The communications equipment industry has extremely long product development cycles requiring us to incur product development costs without assurances of an acceptable investment return.
The telecommunications industry is a capital-intensive industry similar, in many respects, to any other infrastructure development industry. Large volumes of equipment and support structures are installed over vast areas, with considerable expenditures of funds and other resources, with long investment return period expectations. Moreover, reliability requirements are intense. Consequently, there is significant resistance to network redesigns and upgrades. Redesigns and upgrades of installed systems are undertaken only as required in response to user demand and competitive pressures and generally only after the applicable carrier has received sufficient return on its major investment. At the component supplier level this creates considerable, typically multi-year, gaps between the commencement of new product development and volume purchases. Accordingly, we and our competitors often incur significant research and development and sales and marketing costs for products that, at the earliest, will be purchased by our customers long after much of the cost is incurred and, in some cases, may never be purchased due to changes in industry or customer requirements in the interim.
Our business and financial condition could be harmed by our long-term growth strategy.
We have made, and expect in the future to make, significant investments to enable our future growth through, among other things, internal expansion programs, product development, acquisitions and other strategic initiatives. We may continue to grow our business through business combinations or other acquisitions of businesses, products or technologies. We continually evaluate and explore strategic opportunities as they arise, including business combinations, strategic partnerships, capital investments and the purchase, licensing or sale of assets. Acquisitions typically entail many risks (see Risks in acquisitions). If we fail to manage or anticipate our future growth effectively, particularly during periods of industry uncertainty, our business will be adversely impacted. Through our cost reductions measures we are balancing the need to consolidate our operations with the need to preserve our ability to grow and scale our operations as our markets stabilize and recover. If we fail to achieve this balance, our business will be adversely impacted to the extent our resources and operations are insufficient to support growth.
One of our products is dependent upon a single customer for a majority of sales.
We have a strategic alliance with SICPA, our principal customer for our light interference pigments which are used to, among other things, provide security features in currency. Under a license and supply agreement, we rely exclusively on SICPA to market and sell this product worldwide. The agreement requires SICPA to purchase minimum quantities of these pigments over the term of the agreement. If SICPA fails to purchase these quantities, as and when required by the agreement, for any reason, our business and operating results (including, among other things, our revenue and gross margin) will be harmed, at least in the short-term. In the long-term, we may be unable to find a substitute marketing and sales partner or develop these capabilities ourselves.
We depend on a limited number of vendors.
We depend on a limited number of contract manufacturers, subcontractors, and suppliers for raw materials, packages and standard components. Many of our important products rely on single-source suppliers for critical materials. These products include several of our advanced components, modules and subsystem products across our business. We generally purchase these single or limited source products through standard purchase orders or one-year supply agreements, and we have no long-term guaranteed supply agreements with such suppliers. In addition, many of our important suppliers are small companies facing financial stability, quality, yield, scale or delivery concerns. Some of these companies may be acquired, undergo material reorganizations or become insolvent. Others are larger companies with limited dependency upon our business, resulting in unfavorable pricing, quantity or delivery terms. The recent signs of market stability in our business have exacerbated these concerns as we increase our purchasing to meet our customers demands. While we are currently undertaking programs to ensure the long-term strength of our supply chain, we are experiencing and expect to continue to experience, strain on our supply chain and periodic supplier problems. Our business and results of operations could be adversely affected by a stoppage or delay of supply, substitution of more expensive or less reliable products, receipt of defective parts or contaminated materials, an increase in the price of such supplies, or our inability to obtain reduced pricing from our suppliers in response to competitive pressures. In addition, these problems have affected, and will continue to affect, our ability to meet customer expectations. If we do not identify and implement long-term solutions to our supply chain concerns, our customer relationships and business will be materially impacted.
We generally use a rolling twelve and fifteen month forecast based on anticipated product orders, customer forecasts, product order history, warranty and service demand, and backlog to determine our material requirements. Lead times for the parts and components that we order vary significantly and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If actual orders do not match our forecasts, we may have excess or shortfalls of some materials and components as well as excess inventory purchase commitments. We could experience reduced or delayed product shipments or incur additional inventory write-downs and cancellation charges or penalties, which would increase costs and could have a material adverse impact on our results of operations.
Any failure to remain competitive would harm our operating results.
The markets in which we sell our products are highly competitive and characterized by rapidly changing and converging technologies, as well as continuous pricing pressure. We face intense competition from established domestic and international competitors and the threat of future competition from new and emerging companies in all aspects of our business. Much of our current competition comes from large, diversified Asian corporations, and emerging optical companies based in China. These competitors have considerable expertise, and often very low cost structures. The competitive threat is exacerbated by the overall trend towards increased commoditization of traditionally highly differentiated products, particularly in our Optical Communications segment. Increased pricing pressures have resulted in lower average selling prices for our Optical Communications products and continued operating losses for fiscal 2006. We expect Asian, and particularly Chinese, competition to increase across our portfolio. To remain competitive in both the current and future business climates, we believe we must maintain a substantial commitment to innovation and product differentiation, as well as significantly improve our cost structure. Our efforts to remain competitive may be unsuccessful.
Risks in acquisitions.
Our growth is dependent upon market growth, our ability to enhance our existing products and the introduction of new products on a timely basis. We have and will continue to address the need to develop new products through acquisitions of other companies and technologies. Acquisitions involve numerous risks, including the following:
difficulties in integrating the operations, technologies, products and personnel of the acquired companies;
inadequate internal control procedures and disclosure controls to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002;
diversion of managements attention from normal daily operations of the business;
potential difficulties in completing projects associated with in-process research and development;
difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;
insufficient net revenue to offset increased expenses associated with acquisitions; and
potential loss of key employees of the acquired companies.
Acquisitions may also cause us to:
issue common stock that would dilute our current shareholders percentage ownership;
assume liabilities, some of which may be unknown at the time of such acquisitions;
record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;
incur amortization expenses related to certain intangible assets;
incur large and immediate write-offs of in-process research and development costs; or
become subject to litigation.
Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful or will not adversely affect our business, operating results, or financial condition. We are currently devoting significant resources to the integration of our recent acquisition of Acterna, which among other things, requires significant investment in IT systems and infrastructure. Failure to manage and successfully integrate acquisitions could harm our business and operating results in a material way. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that all pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products.
Expenses relating to acquired in-process research and development costs are charged in the period in which an acquisition is completed. These charges may occur in future acquisitions resulting in variability in our quarterly earnings.
If we fail to attract and retain key personnel, our business could be adversely impacted.
Our future depends, in part, on our ability to attract and retain key personnel. We may not be able to hire and retain such personnel at compensation levels consistent with our existing compensation and salary structure. Our future also depends on the continued contributions of our executive management team and other key management and technical personnel, each of whom would be difficult to replace. The loss of service from these or other executive officers or key personnel or the inability to continue to attract qualified personnel could have a material adverse effect on our business. Retention of key talent is an increasing concern as we continue to implement cost improvement programs, including product transfers and site reductions, and as we continue to address our profitability concerns.
Similar to other technology companies, particularly those located in Silicon Valley, we rely upon our ability to use stock options and other forms of stock-based compensation as key components of our executive and employee compensation structure. Historically, these components have been critical to our ability to retain important personnel and offer competitive compensation packages. Without these components, we would be required to significantly increase cash compensation levels (or develop alternative compensation structures) in order to retain our key employees, particularly as and when an industry recovery returns.
Recent requirements mandating the expensing of stock-based compensation awards may cause us to substantially reduce, or even eliminate, all or portions of our stock-based compensation programs which may negatively impact our ability to attract and retain key employees.
If we fail to attract and retain key finance personnel, our ability to maintain internal control over financial reporting may be impaired.
We have filled most of the vacancies within our finance organization. In the past two quarters, we have strengthened the technical capabilities of finance management staff through the hiring of our Corporate Controller, Technical Accounting Director, Assistant Corporate Controller, and Manufacturing Controller. We will continue to recruit key finance personnel to support the operations of our Communications Test & Measurement segment, which was established through our acquisition of Acterna, which has previously been a privately held company with internal control procedures and disclosure controls and procedures that were not designed or maintained for public company reporting. If we are unable to attract and retain our key finance personnel we may not be able to sustain our internal controls over financial reporting.
Finance personnel in new positions may require additional quarterly reporting cycles to be fully trained and familiar with historically complex transactions and the challenges of integrating Acterna and other strategic acquisitions. Should we continue to experience turnover or are unable to recruit financial personnel needed in the corporate accounting and finance functions, or should the demands increase on our current resources due to an increase in the number of complex, non-routine transactions, our internal control over financial reporting could be adversely impacted. This could result in material weaknesses in our internal controls over financial reporting.
Certain of our non-communications related products are subject to governmental and industry regulations, certifications and approvals.
The commercialization of certain of the products we design, manufacture and distribute through our Advanced Optical Technologies segment and Lasers business unit may be more costly due to required government approval and industry acceptance processes. Development of applications for our light interference pigment products may require significant testing that could delay our sales. For example, certain uses in cosmetics may be regulated by the Food and Drug Administration, which has extensive and lengthy approval processes. Durability testing by the automobile industry of our pigments used with automotive paints can take up to three years. If we change a product for any reason, including technological changes or changes in the manufacturing process, prior approvals or certifications may be invalid and we may need to go through the approval process again. If we are unable to obtain these or other government or industry certifications in a timely manner, or at all, our operating results could be adversely affected.
We face risks related to our international operations and revenue.
Our customers are located throughout the world. In addition, we have significant offshore operations, including product development, manufacturing, sales and customer support operations. Our operations outside North America include product development and manufacturing facilities in Europe and Asia and service, sales and support offices worldwide.
Our international presence exposes us to certain risks, including the following:
Our ability to comply with customs, import/export and other trade compliance regulations of the countries in which we do business, together with any unexpected changes in such regulations;
difficulties in establishing and enforcing our intellectual property rights;
tariffs and other trade barriers;
political, legal and economic instability in foreign markets, particularly in those markets in which we maintain manufacturing and product development facilities;
difficulties in staffing and management;
language and cultural barriers;
seasonal reductions in business activities in the countries where our international customers are located;
integration of foreign operations;
longer payment cycles;
greater difficulty in accounts receivable collection;
difficulties in management of foreign distributors;
currency fluctuations; and
potential adverse tax consequences.
Net revenue from customers outside the Americas accounted for 39%, 34% and 36% of our total net revenue for fiscal year 2006, 2005 and 2004, respectively. We expect that net revenue from customers outside North America will continue to account for a significant portion of our total net revenue. Lower sales levels that typically occur during the summer months in Europe and some other overseas markets may materially and adversely affect our business. In addition, the revenues we derive from many of our customers depend on international sales and consequently further expose us to the risks associated with such international sales.
The international dimensions of our operations and sales subject us to a myriad of domestic and foreign trade regulatory requirements. As part of our ongoing integration program, we are evaluating our current trade compliance practices and implementing improvements where necessary. Among other things, we are auditing our product export classification and customs procedures and are installing trade information and compliance systems using our global enterprise software platforms. We do not currently expect the costs of such evaluation or the implementation of any resulting improvements to have a material adverse effect on our operating results or business. However, our evaluation and related implementation are not yet complete and, accordingly, the costs could be greater than expected, and such costs and the legal consequences of any failure to comply with applicable regulations could affect our business and operating results.
Changes in our effective tax rate or adverse outcomes resulting from tax audits may have an adverse impact our results.
As an international corporation, we are subject to taxation in the various jurisdictions in which we conduct business. Significant judgment is required in the determination of our worldwide provision for income taxes and this determination requires the interpretation and application of complex and sometimes uncertain tax laws and regulations. Our effective tax rate may be adversely impacted by changes in the mix of earnings between countries which have different statutory tax rates, in the valuation of our deferred tax assets, and by changes in tax rules and regulations. We are subject to income tax audits in the respective jurisdictions in which we conduct business and we regularly assess the likelihood of adverse outcomes resulting from these tax audits to ascertain the adequacy of our provision for income taxes. There can be no assurance that the outcomes of these tax audits will not have an adverse impact on our results and financial condition.
We are increasing operations in China, which exposes us to risks inherent in doing business in China.
As a result of our efforts to reduce costs, we have increased our manufacturing operations in China. Looking ahead we expect to expand our research and development activities in China. Our China-based activities are subject to greater political, legal and economic risks than those faced by our other operations. See We face risks related to our international operations and revenue. These concerns will increase as we expand our activities in China to include product research and development, which may expose our critical technology to foreign misappropriation. In particular, the political, legal and economic climate in China (both at national and regional levels) is extremely fluid and unpredictable. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, such as those relating to taxation, import and export tariffs, environmental regulations, land use rights, intellectual property and other matters, which laws and regulations remain highly underdeveloped and subject to change, with little or no prior notice, for political or other reasons. Moreover, the enforceability of applicable existing Chinese laws and regulations is uncertain. These concerns are heightened for foreign businesses, such as ours, operating in China. In addition, we may not obtain the requisite legal permits to continue to operate in China and costs or operational limitations may be imposed in connection with obtaining and complying with such permits. Our business could be materially harmed by any changes to the political, legal or economic climate in China or the inability to enforce applicable Chinese laws and regulations.
Currently, we operate manufacturing facilities located in Shenzhen and Beijing, China. As part of our efforts to reduce costs, we continue to increase the scope and extent of our manufacturing operations in our Shenzhen facilities. Accordingly, we expect that our ability to operate successfully in China will become increasingly important to our overall success. As we continue to consolidate our manufacturing operations, we will incur additional costs to transfer product lines to our facilities located in China, including costs of qualification testing with our customers, which could have a material adverse impact on our operating results and financial condition. See also If our customers do not qualify our manufacturing lines for volume shipments, our operating results could be adversely impacted.
As a result of a government order to ration power for industrial use, operations in our Shenzhen facilities may be subject to possible interruptions or shutdowns. Our ability to complete manufacturing commitments on a timely basis may be adversely affected. If we are required to make significant investments in generating capacity to sustain uninterrupted operations at our Shenzhen facilities, we may not realize the reductions in costs anticipated from our expansion in China. In addition, future outbreaks of avian influenza, or other communicable diseases, could result in quarantines or closures of our Beijing and Shenzhen facilities, thereby disrupting our operations and expansion in China.
We intend to export the majority of the products manufactured at our facilities in China. Accordingly, upon application to and approval by the relevant governmental authorities, we will not be subject to certain Chinese taxes and are exempt from customs duty assessment on imported components or materials when the finished products are exported from China. We are, however, required to pay income taxes in China, subject to certain tax relief. As the Chinese trade regulations are in a state of flux, we may become subject to other forms of taxation and duty assessments in China or may be required to pay for export license fees in the future. In the event that we become subject to any increased taxes or new forms of taxation imposed by authorities in China, our results of operations could be materially and adversely affected.
Managing our inventory is complex and may include write-downs of excess or obsolete inventory.
Managing our inventory of components and finished products is a complex task. A number of factors, including the need to maintain a significant inventory of certain components that are in short supply or that must be purchased in bulk to obtain favorable pricing or require long lead times, may result in our maintaining large amounts of inventory. In addition, we base many of our operating decisions, and enter into purchase commitments, on the basis of anticipated revenue trends which are highly unpredictable. Inventory which is not used or expected to be used as and when planned may become excess or obsolete. Any excess or obsolete inventory could also result in sales price reductions and/or inventory write-downs, which historically have adversely affected our business and results of operations, and we expect to continue.
Our business and operations would be adversely impacted in the event of a failure of our information technology infrastructure.
We rely upon the capacity, reliability and security of our information technology hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. We are constantly updating our information technology infrastructure. For example, we have entered into an agreement with Oracle to provide and maintain our global ERP infrastructure on an outsourced basis. Any failure to manage, expand and update our information technology infrastructure or any failure in the operation of this infrastructure could harm our business.
Our recent acquisitions of Acterna and Agility create additional burden and risk, in the short term, as we expend resources to install the appropriate information technology systems and other processes to address our expanded operations. The integration of Acterna is of particular concern to our information technology infrastructure due to Acternas size and complexity. Converting Acternas business processes, data and applications to our standards continues to be a complex and time-consuming task. During this transition period, we are exposed to the risks associated with incompatible and complex reporting systems.
Despite our implementation of security measures, our systems are vulnerable to damages from computer viruses, natural disasters, unauthorized access and other similar disruptions. Any system failure, accident or security breach could result in disruptions to our operations. To the extent that any disruptions or security breach results in a loss or damage to our data, or in inappropriate disclosure of confidential information, it could harm our business. In addition, we may be required to incur significant costs to protect against damage caused by these disruptions or security breaches in the future.
If we fail to remediate our current system of internal controls to an effective level, we may not be able to accurately report our financial results or prevent fraud. As a result, our business could be harmed and current and potential investors could lose confidence in our financial reporting, which could have a negative effect on the trading price of our debt and equity securities.
Effective internal controls are necessary for us to provide reliable financial reports and to effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our brand, operating results and the market value of our debt and equity securities could be harmed. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. Specifically, our Annual Report on Form 10-K for fiscal 2006 identified certain material weakness in our internal controls processes identified by our independent registered public accounting firm in connection with performing an audit of our financial statements related to Acterna, a privately held company which we acquired in August 2005.
We have devoted significant resources to remediate and improve our internal controls. We have also been monitoring the effectiveness of these remediated measures. We cannot be certain that these measures will ensure adequate controls over our financial processes and reporting in the future. We intend to continue implementing changes to our processes to improve internal controls over financial reporting. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.
Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our debt and equity securities. Further, the impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers, which could harm our business. The additions of Acterna and Agility have significantly increased the burden on our systems and infrastructure, and impose additional risk to the ongoing effectiveness of our internal controls, disclosure controls, and procedures. As privately-held companies, both Acterna and Agility lacked the systems, reporting infrastructure, and internal control procedures typical of a publicly-held company of similar size and complexity. The integration of Acterna is of particular concern to our internal controls, disclosure controls, and procedures due to Acternas size and complexity. Consequently, we expect to expend significant resources and effort in this regard and are not certain that our efforts will be successful.
If we fail to timely file with the trustee of our Zero Coupon Senior Convertible Notes or our 1% Senior Convertible Notes certain information, documents and reports required to be filed by us with the SEC, such notes could become due and payable immediately. As a result, our liquidity position could be adversely impacted or we may not have enough cash to pay the note holders, which would harm our business and the trading price of our debt and equity securities.
Recently, we have had difficulty filing certain of our reports with the SEC in the accelerated timeframe required by the SEC. Under the terms of both of the indentures governing our senior convertible notes, we must comply with certain covenants, agreements and conditions, including filing with the trustee certain information, documents and reports required to be filed by us with the SEC. Certain failures to comply with the filing of such reports with the trustee would constitute a default. Upon such a default, the trustee or holders of 25% of the outstanding principal of either series of notes have the option to send us a notice of default, demanding that such default be cured within 60 days. If we receive such a notice of default, we will be required to cure such default within 60 days or obtain a waiver from holders of a majority of the outstanding principal balance of each series of notes. If we cannot cure such default within 60 days or obtain a waiver, the notes could be accelerated. This could severely impact our liquidity position or, under certain circumstances, we may not have enough cash to pay the note holders, which would harm our business and the trading price of debt and equity securities.
If we have insufficient proprietary rights or if we fail to protect those we have, our business would be materially harmed.
We may not obtain the intellectual property rights we require.
Others, including academic institutions, our competitors and other large technology-based companies, hold numerous patents in the industries in which we operate. Some of these patents may purport to cover our products. In response, we may seek to acquire license rights to these or other patents or other intellectual property to the extent necessary to ensure we possess sufficient intellectual property rights for the conduct of our business. Unless we are able to obtain such licenses on commercially reasonable terms, patents or other intellectual property held by others could inhibit our development of new products, impede the sale of some of our current products, or substantially increase the cost to provide these products to our customers. In the past, licenses generally have been available to us where third-party technology was necessary or useful for the development or production of our products. In the future licenses to third-party technology may not be available on commercially reasonable terms, if at all. Generally, a license, if granted, includes payments by us of up-front fees, ongoing royalties or a combination of both. Such royalties or other
terms could have a significant adverse impact on our operating results. We are a licensee of a number of third-party technologies and intellectual property rights and are required to pay royalties to these third-party licensors on certain software used by us as well as on some of our telecommunications products and laser subsystems.
Our products may be subject to claims that they infringe the intellectual property rights of others.
The industry in which we operate experiences periodic claims of patent infringement or other intellectual property rights. We have received in the past and, from time to time, may in the future receive notices from third parties claiming that our products infringe upon third-party proprietary rights. One consequence of the recent economic downturn is that many companies have turned to their intellectual property portfolios as an alternative revenue source. This is particularly true of companies which no longer compete with us. Many of these companies have larger, more established intellectual property portfolios than ours. At any one time we generally have various pending claims from third parties that our products or operations infringe or misappropriate their intellectual property rights or that one or more of our patents are invalid. We will continue to respond to these claims in the course of our business operations. In the past, the settlement and disposition of these disputes has not had a material adverse impact on our business or financial condition, however this may not be the case in the future. Further, the litigation or settlement of these matters, regardless of the merit of the claims, could result in significant expense to us and divert the efforts of our technical and management personnel, whether or not we are successful. If we are unsuccessful, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses to the technology that is the subject of the litigation. We may not be successful in such development, or such licenses may not be available on terms acceptable to us, if at all. Without such a license, we could be enjoined from future sales of the infringing product or products, which could adversely affect our revenues and operating results.
The use of open source software in our products, as well as those of our suppliers, manufacturers and customers, may expose us to additional risks and harm our intellectual property position .
Certain of the software and/or firmware that we use and distribute (as well as that of our suppliers, manufacturers and customers) may be, be derived from, or contain, so-called open source software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available under licenses which impose obligations in the event the software or derivative works thereof are distributed or re-distributed. These obligations may require us to make source code for the derivative works available to the public, and/or license such derivative works under a particular type of license, rather than the forms of license customarily used to protect our own software products. While we believe we have complied with our obligations under the various applicable licenses for open source software, in the event that a court rules that these licenses are unenforceable, or in the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work. Additionally, open source licenses are subject to occasional revision. In the event future iterations of open source software are made available under a revised license, such license revisions may adversely affect our ability to use such future iterations.
Our intellectual property rights may not be adequately protected.
Our future depends in part upon our intellectual property, including trade secrets, know-how and continuing technological innovation. We currently hold numerous U.S. patents on products or processes and corresponding foreign patents and have applications for some patents currently pending. The steps taken by us to protect our intellectual property may not adequately prevent misappropriation or ensure that others will not develop competitive technologies or products. Other companies may be investigating or developing other technologies that are similar to our own. It is possible that patents may not be issued from any application pending or filed by us and, if patents do issue, the claims allowed may not be sufficiently broad to deter or prohibit others from marketing similar products. Any patents issued to us may be challenged, invalidated or circumvented. Further, the rights under our patents may not provide a competitive advantage to us. In addition, the laws of some territories in which our products are or may be developed, manufactured or sold, including Europe, Asia-Pacific or Latin America, may not protect our products and intellectual property rights to the same extent as the laws of the United States.
We face certain litigation risks that could harm our business.
We have had numerous lawsuits filed against us asserting various claims, including securities and ERISA class actions and stockholder derivative actions. The results of complex legal proceedings are difficult to predict. Moreover, many of the complaints filed against us do not specify the amount of damages that plaintiffs seek, and we therefore are unable to estimate the possible
range of damages that might be incurred should these lawsuits be resolved against us. While we are unable to estimate the potential damages arising from such lawsuits, certain of them assert types of claims that, if resolved against us, could give rise to substantial damages. Thus, an unfavorable outcome or settlement of one or more of these lawsuits could have a material adverse effect on our financial position, liquidity and results of operations. Even if these lawsuits are not resolved against us, the uncertainty and expense associated with unresolved lawsuits could seriously harm our business, financial condition and reputation. Litigation can be costly, time-consuming and disruptive to normal business operations. The costs of defending these lawsuits, particularly the securities class actions and stockholder derivative actions, have been significant, will continue to be costly and may not be covered by our insurance policies. The defense of these lawsuits could also result in continued diversion of our managements time and attention away from business operations, which could harm our business.
Recently enacted and proposed regulatory changes will cause us to incur increased costs.
We continue to evaluate our internal control systems in order to allow our management to report on, and our independent registered public accounting firm to attest to, our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002. As a result, we continue to incur substantial expenses. In addition, we continue to make acquisitions and we cannot assure that we will be able to properly integrate the internal controls processes of, or effectively implement internal controls processes for, the acquired assets or companies. See also If we fail to remediate our current system of internal controls to an effective level, we may not be able to accurately report our financial results or prevent fraud. As a result, our business could be harmed and current and potential investors could lose confidence in our financial reporting, which could have a negative effect on the trading price of our debt and equity securities.
If we fail to manage our exposure to worldwide financial and securities markets successfully, our operating results and financial statements could be materially impacted.
We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and prices of marketable equity and fixed-income securities. We do not use derivative financial instruments for speculative or trading purposes. The primary objective of most of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, a majority of our marketable investments are investment grade, liquid, short-term fixed-income securities and money market instruments denominated in U.S. dollars. A substantial portion of our net revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, some of these activities are conducted in other currencies, primarily Canadian, European and Asian currencies. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we may enter into foreign currency forward contracts or other hedging instruments. The contracts and other hedging instruments are intended to reduce, but not eliminate, the impact of foreign currency exchange rate movements. Unhedged currency exposures may fluctuate in value and produce significant earnings and cash flow volatility.
As of June 30, 2006, we held investments in other public and private companies and had limited funds invested in private venture funds. Such investments represented approximately $10.8 million on our consolidated balance sheet at June 30, 2006. In addition to our investments in public companies, we have in the past made, and expect to continue to make, investments in privately held companies as well as venture capital investments for strategic and commercial purposes. In recent quarters some of the private companies in which we held investments have ceased doing business and have either liquidated or are in bankruptcy proceedings. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to further write down the value of our investments, which could materially harm our results of operations or financial condition.
We may be subject to environmental liabilities which could increase our expenses and harm our operating results.
We are subject to various federal, state and foreign laws and regulations governing the environment, including those governing pollution and protection of human health and the environment and, recently, those restricting the presence of certain substances in electronic products and holding producers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate. Laws governing the environmental effects of electronic products have been passed in several European Union member countries, and similar laws are now pending in various jurisdictions within the United States. The European Union has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment, or RoHS, and the Waste Electrical and Electronic Equipment, or WEEE, directives. The RoHS directive prohibits the use of certain substances, including lead, mercury, cadmium and chromium, in covered products placed on the market after July 1, 2006. The WEEE directive obligates
parties that place electrical and electronic equipment onto the market in the European Union to clearly mark the equipment, register with and report to European Union regulators regarding distribution of the equipment, and provide a mechanism to recall and properly dispose of the equipment. Each European Union member country has enacted, or is expected to soon enact, legislation clarifying what is and what is not covered by the WEEE directive in that country. However, there is still some uncertainty in certain European Union countries as to which party involved in the manufacture, distribution and sale of electronic equipment will be ultimately held responsible. If we are deemed to be a manufacturer of covered products, we may be required to register as a producer in certain European Union countries, and incur financial responsibility with respect to products sold within the European Union, including products of other manufacturers that have been replaced by our products. We may also incur substantial costs to change our manufacturing processes, redesign or reformulate, and obtain substitute components for, our products that are deemed covered products under the RoHS directive. We may also incur significant inventory write-downs if certain components held in inventory become unusable because they are not RoHS-compliant. If we fail to timely provide RoHS-compliant products, we will not be able to offer our products within European Union, and we may be subject to civil or criminal liabilities.
Similar legislation has been and may be enacted in other locations where we manufacture or sell our products. We will need to ensure that we comply with such laws and regulations as they are enacted, as well as all environmental laws and regulations, and as appropriate or required, that our component suppliers also timely comply with such laws and regulations. If we fail to timely comply with such laws, we could face sanctions for such noncompliance, and our customers further may refuse to purchase our products, which would have a materially adverse effect on our business, financial condition and results of operations.
With respect to compliance with environmental laws and regulations in general, we have incurred and in the future could incur substantial costs for the cleanup of contaminated properties, either those we own or operate or to which we have sent wastes in the past, or to comply with such environmental laws and regulations; further, we could be subject to disruptions to our operations and logistics as a result of such clean-up or compliance obligations. In addition, if we were found to be in violation of these laws, we could be subject to governmental fines and liability for damages resulting from such violations. If we have to make significant capital expenditures to comply with environmental laws, or if we are subject to significant expenditures in connection with a violation of these laws, our financial condition or operating results could be adversely impacted.
We are exposed to risks related to our indemnification of third parties.
From time to time, in the normal course of business, we indemnify third parties with whom we enter into contractual relationships. These contracts primarily relate to divestiture agreements, under which we may provide customary indemnifications to purchasers of our businesses or assets, certain real estate leases, under which we may be required to indemnify property owners, and certain agreements with our officers, directors and employees. We have agreed, under certain conditions, to hold these third parties harmless against specified losses, such as those arising from a breach of representations or covenants, third party claims that our products when used for their intended purposes infringe the intellectual property rights of others, environmental and other liabilities, claims arising from our use of our leased premises our or directors, officers and employees service with us. If such third parties become involved in legal disputes in which they contend that we allegedly have indemnification obligations, we may be subject to potential liability. It is not possible to determine the maximum potential amount of liability under any indemnification obligations, whether or not asserted, due to our limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in each particular claim. Historically, payments made by us under these obligations have not been material.
We sold $475 million of senior convertible notes in 2003 and $425 million of senior convertible notes in 2006, which may cause our reported earnings per share to be more volatile because of the conversion contingency features of these notes.
We issued $475 million of indebtedness in October 2003 and $425 million of indebtedness in May and June, 2006 in the form of senior convertible notes. The issuance of these notes substantially increased our principal payment obligations and we may not have enough cash to repay the notes when due. The degree to which we are leveraged could materially and adversely affect our ability to successfully obtain financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. In addition, the holders of those notes are entitled to convert those notes into shares of our common stock or a combination of cash and shares of common stock under certain circumstances which would cause dilution to our existing stockholders and lower our reported per share earnings.
Our rights plan and our ability to issue additional preferred stock could harm the rights of our common stockholders.
In February 2003, we amended and restated our Stockholder Rights Agreement and currently each share of our outstanding common stock is associated with one right. Each right entitles stockholders to purchase 1/100,000 share of our Series B Preferred Stock at an exercise price of $21.00.
The rights only become exercisable in certain limited circumstances following the tenth day after a person or group announces acquisition of or tender offers for 15% or more of our common stock. For a limited period of time following the announcement of any such acquisition or offer, the rights are redeemable by us at a price of $0.01 per right. If the rights are not redeemed, each right will then entitle the holder to purchase common stock having the value of twice the then-current exercise price. For a limited period of time after the exercisability of the rights, each right, at the discretion of our Board of Directors, may be exchanged for either 1/100,000 share of Series B Preferred Stock or one share of common stock per right. The rights expire on June 22, 2013.
Our Board of Directors has the authority to issue up to 499,999 shares of undesignated preferred stock and to determine the powers, preferences and rights and the qualifications, limitations or restrictions granted to or imposed upon any wholly unissued shares of undesignated preferred stock and to fix the number of shares constituting any series and the designation of such series, without the consent of our stockholders. The preferred stock could be issued with voting, liquidation, dividend and other rights superior to those of the holders of common stock.
The issuance of Series B Preferred Stock or any preferred stock subsequently issued by our Board of Directors, under some circumstances, could have the effect of delaying, deferring or preventing a change in control.
Some provisions contained in the rights plan, and in the equivalent rights plan that our subsidiary, JDS Uniphase Canada Ltd., has adopted with respect to our exchangeable shares, may have the effect of discouraging a third party from making an acquisition proposal for us and may thereby inhibit a change in control. For example, such provisions may deter tender offers for shares of common stock or exchangeable shares, which offers may be attractive to stockholders, or deter purchases of large blocks of common stock or exchangeable shares, thereby limiting the opportunity for stockholders to receive a premium for their shares of common stock or exchangeable shares over the then-prevailing market prices.
Some anti-takeover provisions contained in our charter and under Delaware laws could hinder a takeover attempt.
We are subject to the provisions of Section 203 of the Delaware General Corporation Law prohibiting, under some circumstances, publicly-held Delaware corporations from engaging in business combinations with some stockholders for a specified period of time without the approval of the holders of substantially all of our outstanding voting stock. Such provisions could delay or impede the removal of incumbent directors and could make more difficult a merger, tender offer or proxy contest involving us, even if such events could be beneficial, in the short-term, to the interests of the stockholders. In addition, such provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock. Our certificate of incorporation and bylaws contain provisions relating to the limitations of liability and indemnification of our directors and officers, dividing our board of directors into three classes of directors serving three-year terms and providing that our stockholders can take action only at a duly called annual or special meeting of stockholders. These provisions also may have the effect of deterring hostile takeovers or delaying changes in control or management of us.
ITEM 1B. UNRESOLVED STAFF COMMENTS