Lumentum(LITE) - 2024 Q1 - Quarterly Report

PART I Item 1. Financial Statements (Unaudited) This section presents Lumentum Holdings Inc.'s unaudited condensed consolidated financial statements, including statements of operations, comprehensive loss, balance sheets, stockholders' equity, and cash flows, along with detailed notes explaining significant accounting policies, recent pronouncements, business combinations, debt, equity, and segment information for the three months ended September 30, 2023, and comparative periods Condensed Consolidated Statements of Operations The company reported a significant net loss of $67.9 million for the three months ended September 30, 2023, a substantial decline from a near break-even net loss of $0.4 million in the prior year period, primarily driven by a sharp decrease in net revenue and gross profit | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | | Net revenue | $317.6 | $506.8 | | Cost of sales | $222.9 | $282.6 | | Amortization of acquired developed intangibles | $18.0 | $23.0 | | Gross profit | $76.7 | $201.2 | | Operating expenses | $157.5 | $187.7 | | Income (loss) from operations | $(80.8) | $13.5 | | Interest expense | $(9.7) | $(8.5) | | Other income, net | $21.2 | $13.8 | | Income (loss) before income taxes | $(69.3) | $18.8 | | Income tax provision (benefit) | $(1.4) | $19.2 | | Net loss | $(67.9) | $(0.4) | | Basic Net loss per share | $(1.02) | $(0.01) | | Diluted Net loss per share | $(1.02) | $(0.01) | - Net revenue decreased by $189.2 million (37.3%) and gross profit decreased by $124.5 million (61.9%) year-over-year[10] Condensed Consolidated Statements of Comprehensive Loss The company reported a comprehensive loss of $66.8 million for the three months ended September 30, 2023, significantly higher than the $1.0 million comprehensive loss in the prior year, primarily driven by the increased net loss | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :------------------------------------------ | :------------------------------------------ | :----------------------------------------- | | Net loss | $(67.9) | $(0.4) | | Other comprehensive income (loss), net of tax: | | | | Foreign currency translation adjustments | $(0.2) | — | | Net change in unrealized gain (loss) on available-for-sale securities | $1.3 | $(0.6) | | Other comprehensive income (loss), net of tax | $1.1 | $(0.6) | | Comprehensive loss, net of tax | $(66.8) | $(1.0) | Condensed Consolidated Balance Sheets As of September 30, 2023, total assets decreased slightly to $4,545.0 million from $4,632.1 million on July 1, 2023, mainly due to a decrease in short-term investments and accounts receivable, while total liabilities also decreased and stockholders' equity saw a reduction | Metric | Sep 30, 2023 (in millions) | Jul 1, 2023 (in millions) | | :-------------------------------- | :------------------------- | :------------------------ | | ASSETS | | | | Cash and cash equivalents | $861.6 | $859.0 | | Short-term investments | $1,082.7 | $1,154.6 | | Accounts receivable, net | $220.0 | $246.1 | | Inventories | $428.0 | $408.6 | | Total current assets | $2,691.7 | $2,777.9 | | Total assets | $4,545.0 | $4,632.1 | | LIABILITIES | | | | Total current liabilities | $593.7 | $633.8 | | Total liabilities | $3,234.2 | $3,276.3 | | STOCKHOLDERS' EQUITY | | | | Total stockholders' equity | $1,310.8 | $1,355.8 | - Total assets decreased by $87.1 million (1.9%) from July 1, 2023, to September 30, 2023[15] - Short-term investments decreased by $71.9 million (6.2%) and accounts receivable, net, decreased by $26.1 million (10.6%) QoQ[15] Condensed Consolidated Statements of Stockholders' Equity Total stockholders' equity decreased by $45.0 million from July 1, 2023, to September 30, 2023, primarily due to a net loss of $67.9 million, partially offset by stock-based compensation of $34.7 million | Metric | Balance as of July 1, 2023 (in millions) | Net Loss (in millions) | Other Comprehensive Income (in millions) | Stock-based Compensation (in millions) | Withholding Taxes (in millions) | Balance as of Sep 30, 2023 (in millions) | | :------------------------------------------ | :--------------------------------------- | :--------------------- | :--------------------------------------- | :------------------------------------- | :------------------------------ | :--------------------------------------- | | Common Stock | $0.1 | — | — | — | — | $0.1 | | Additional Paid-In Capital | $1,692.2 | — | — | $34.7 | $(12.9) | $1,714.0 | | Accumulated Deficit | $(340.6) | $(67.9) | — | — | — | $(408.5) | | Accumulated Other Comprehensive Income | $4.1 | — | $1.1 | — | — | $5.2 | | Total Stockholders' Equity | $1,355.8 | $(67.9) | $1.1 | $34.7 | $(12.9) | $1,310.8 | Condensed Consolidated Statements of Cash Flows For the three months ended September 30, 2023, cash and cash equivalents increased by $2.6 million, driven by cash provided by investing activities ($17.8 million), partially offset by cash used in operating activities ($2.3 million) and financing activities ($12.9 million), contrasting with the prior year period which saw a significant decrease in cash due to acquisitions | Activity | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :------------------------------------------ | :------------------------------------------ | :----------------------------------------- | | Net cash provided by (used in) operating activities | $(2.3) | $20.8 | | Net cash provided by (used in) investing activities | $17.8 | $(646.6) | | Net cash used in financing activities | $(12.9) | $(59.1) | | Increase (decrease) in cash and cash equivalents | $2.6 | $(684.9) | | Cash and cash equivalents at end of period | $861.6 | $605.3 | - Investing activities provided $17.8 million in cash, primarily from net proceeds of short-term investments, contrasting with $646.6 million used in the prior year due to acquisitions[20] Notes to Condensed Consolidated Financial Statements This section provides detailed disclosures on Lumentum's financial statements, covering business description, accounting policies, earnings per share, business combinations, cash and investments, fair value measurements, balance sheet details, goodwill and intangibles, debt, comprehensive income, restructuring, income taxes, equity, commitments, operating segments, revenue recognition, and a subsequent event regarding the Cloud Light acquisition Note 1. Description of Business and Summary of Significant Accounting Policies Lumentum is a leading provider of optical and photonic products for manufacturing, inspection, and life-science applications, reorganizing its operating segments in fiscal year 2024 into Cloud & Networking and Industrial Tech to better align with market trends and product mix, while acknowledging a volatile global macroeconomic environment impacting capital expenditures and supply chains - Lumentum is an industry-leading provider of optical and photonic products addressing a range of end market applications for manufacturing, inspection, and life-science[22] - In fiscal Q1 2024, Lumentum changed its organizational structure, creating new operating segments: Cloud & Networking (Telecom and Datacom) and Industrial Tech (previous Lasers and Industrial & Consumer)[26] - The current global macroeconomic environment is volatile, impacted by inflation, dynamic supply chains, and a weaker macroeconomic environment affecting capital expenditures[27] Note 2. Recently Issued Accounting Pronouncements Lumentum early adopted ASU 2021-08 (Business Combinations) in fiscal 2023 with no material impact, and also adopted ASU 2020-06 (Accounting for Convertible Instruments) as of July 3, 2022, which simplified accounting for convertible instruments by treating them as a single liability and resulted in significant adjustments to liabilities and equity - Early adopted ASU 2021-08, Business Combinations (Topic 805)—Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, in fiscal 2023 with no material impact[34] - Adopted ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own Equity, as of July 3, 2022, simplifying accounting for convertible instruments as a single liability[35] | Metric | Balances pre-adoption of ASC 2020-06 (in millions) | Reclassify amounts from equity to debt (in millions) | Adjustment for interest accretion (in millions) | Tax effect (in millions) | Balances upon adoption of ASC 2020-06 (in millions) | | :------------------------- | :------------------------------------------------- | :----------------------------------------------- | :---------------------------------------------- | :----------------------- | :------------------------------------------------ | | Short Term Debt - 2024 Notes | $409.9 | — | — | — | $409.9 | | Long Term Debt - 2026 Notes | $831.4 | $312.9 | $(99.5) | — | $1,044.8 | | Long Term Debt - 2028 Notes | $634.7 | $229.3 | $(9.7) | — | $854.3 | | Additional Paid-In Capital | $2,003.6 | $(542.2) | — | $115.7 | $1,577.1 | | Accumulated Deficit | $129.1 | — | $(109.2) | $23.6 | $43.5 | | Deferred Tax Asset, Net | $12.9 | — | — | $92.1 | $105.0 | Note 3. Earnings Per Share Lumentum reported a basic and diluted net loss per share of $(1.02) for the three months ended September 30, 2023, compared to $(0.01) in the prior year, with potentially dilutive shares from convertible notes and stock-based plans excluded from diluted EPS calculations as the company incurred a net loss, making them anti-dilutive | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Oct 1, 2022 | | :------------------------------------------ | :------------------------------ | :----------------------------- | | Net loss - basic and diluted | $(67.9) | $(0.4) | | Weighted average common shares outstanding - basic and diluted | 66.7 | 68.1 | | Net loss per share: Basic | $(1.02) | $(0.01) | | Net loss per share: Diluted | $(1.02) | $(0.01) | - Anti-dilutive shares excluded from the calculation of diluted net loss per share for the three months ended September 30, 2023, included 31.2 million shares related to convertible notes, 4.6 million RSUs and PSUs, and 0.2 million ESPP shares[38] Note 4. Business Combinations Lumentum completed the acquisition of NeoPhotonics in August 2022 for $934.4 million, expanding its cloud and telecom network infrastructure capabilities, and also acquired IPG Photonics' telecom transmission product lines for $55.9 million in August 2022, further enhancing its Cloud & Networking segment - Completed the acquisition of NeoPhotonics Corporation on August 3, 2022, for a total purchase price consideration of $934.4 million, expanding opportunities in cloud and telecom network infrastructure[40][42] | NeoPhotonics Acquisition (in millions) | Fair Value | | :----------------------------------- | :--------- | | Total purchase price consideration | $934.4 | | Assets acquired | $811.0 | | Liabilities assumed | $191.9 | | Goodwill | $315.3 | - Acquired IPG Photonics' telecom transmission product lines on August 15, 2022, for $55.9 million, enhancing the Cloud & Networking segment with Digital Signal Processors (DSPs), ASICs, and optical transceivers[46][47] Note 5. Cash, Cash Equivalents and Short-term Investments As of September 30, 2023, Lumentum held $861.6 million in cash and cash equivalents and $1,082.7 million in short-term investments, recording $21.7 million in interest and investment income for the three months ended September 30, 2023, a significant increase from $4.8 million in the prior year, driven by higher interest rates | Category | Sep 30, 2023 (in millions) | Jul 1, 2023 (in millions) | | :------------------------- | :------------------------- | :------------------------ | | Cash and cash equivalents | $861.6 | $859.0 | | Short-term investments | $1,082.7 | $1,154.6 | - Interest and investment income increased to $21.7 million for the three months ended September 30, 2023, from $4.8 million in the prior year, due to an increase in interest rates on fixed income securities[54] Note 6. Fair Value Measurements Lumentum measures financial assets at fair value using a hierarchy (Level 1, 2, 3), with most cash equivalents and short-term investments classified as Level 1 or Level 2, while convertible notes are not recorded at fair value on a recurring basis but their estimated fair value is considered a Level 2 measurement - Fair value is determined based on a hierarchy: Level 1 (quoted prices in active markets), Level 2 (observable inputs for similar assets/liabilities), and Level 3 (unobservable inputs)[58][59] | Asset Category | Level 1 (in millions) | Level 2 (in millions) | Level 3 (in millions) | Total (in millions) | | :------------------------- | :-------------------- | :-------------------- | :-------------------- | :------------------ | | September 30, 2023 | | | | | | Cash equivalents | $700.5 | $4.8 | — | $705.1 | | Short-term investments | $279.9 | $807.6 | — | $1,087.5 | | Total assets | $980.4 | $807.6 | — | $1,788.0 | | Convertible Notes | Carrying Amount (Sep 30, 2023, in millions) | Estimated Fair Value (Sep 30, 2023, in millions) | | :---------------- | :------------------------------------------ | :----------------------------------------------- | | 2029 Notes | $598.8 | $553.2 | | 2028 Notes | $855.9 | $630.8 | | 2026 Notes | $1,046.2 | $885.1 | | 2024 Notes | $315.7 | $319.1 | | Total | $2,816.6 | $2,388.2 | Note 7. Balance Sheet Details Inventories increased to $428.0 million as of September 30, 2023, from $408.6 million on July 1, 2023, while property, plant, and equipment, net, increased to $511.6 million from $489.5 million, partly due to the purchase of land and buildings in Caswell, UK for $23.3 million, and other current liabilities decreased mainly due to lower income tax payable | Metric | Sep 30, 2023 (in millions) | Jul 1, 2023 (in millions) | | :-------------------------------- | :------------------------- | :------------------------ | | Inventories | $428.0 | $408.6 | | Property, plant and equipment, net | $511.6 | $489.5 | | Operating lease right-of-use assets, net | $68.8 | $77.3 | | Other current liabilities | $31.3 | $47.8 | | Other non-current liabilities | $85.7 | $91.4 | - Purchased land and buildings in Caswell, United Kingdom, for $23.3 million in August 2023, contributing to the increase in property, plant, and equipment[68] - Other current liabilities decreased by $16.5 million, primarily due to a $17.3 million decrease in income tax payable[72] Note 8. Goodwill and Other Intangible Assets Goodwill remained at $695.1 million as of September 30, 2023, with $683.9 million assigned to Cloud & Networking and $11.2 million to Industrial Tech, following segment reorganization, while other intangible assets, net, decreased to $435.2 million from $459.2 million, with an estimated future amortization of $394.8 million | Segment | Goodwill (in millions) | | :---------------- | :--------------------- | | Cloud & Networking | $683.9 | | Industrial Tech | $11.2 | | Total | $695.1 | | Intangible Asset Category | Net Carrying Amounts (Sep 30, 2023, in millions) | Weighted Average Remaining Amortization Period (Years) | | :-------------------------------- | :----------------------------------------------- | :----------------------------------------------------- | | Acquired developed technologies | $232.0 | 4.0 | | Customer relationships | $162.8 | 3.5 | | In-process research and development | $40.4 | n/a | | Total intangible assets | $435.2 | | - Estimated future amortization for acquired developed technologies and customer relationships is $394.8 million[81] Note 9. Debt Lumentum's total convertible notes liability component was $2,816.6 million as of September 30, 2023, including 2029 Notes ($603.7M principal), 2028 Notes ($861.0M principal), 2026 Notes ($1,050.0M principal), and 2024 Notes ($323.1M principal), with the 2024 Notes classified as current liabilities due to their March 2024 maturity, and interest expense increased to $9.7 million for the quarter due to the issuance of 2029 Notes | Convertible Notes | Principal (in millions) | Net Carrying Amount (in millions) | Maturity Date | | :---------------- | :---------------------- | :-------------------------------- | :------------ | | 2029 Notes | $603.7 | $598.8 | Dec 15, 2029 | | 2028 Notes | $861.0 | $855.9 | June 15, 2028 | | 2026 Notes | $1,050.0 | $1,046.2 | Dec 15, 2026 | | 2024 Notes | $323.1 | $315.7 | March 15, 2024 | | Total | $2,837.8 | $2,816.6 | | - The 2024 Notes are classified as current liabilities as the debt will mature on March 15, 2024[117][120] | Interest Expense Component | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :--------------------------------------- | :------------------------------------------ | :----------------------------------------- | | Contractual interest expense | $4.8 | $2.7 | | Amortization of the debt discount and debt issuance costs | $4.9 | $5.7 | | Total interest expense | $9.7 | $8.4 | Note 10. Accumulated Other Comprehensive Income (Loss) Accumulated other comprehensive income, net of tax, increased to $5.2 million as of September 30, 2023, from $4.1 million on July 1, 2023, primarily due to a net change in unrealized gain on available-for-sale securities, partially offset by foreign currency translation adjustments | Component | Beginning Balance (Jul 1, 2023, in millions) | Other Comprehensive Gain (Loss), net (in millions) | Ending Balance (Sep 30, 2023, in millions) | | :------------------------------------------ | :----------------------------------------------- | :------------------------------------------------- | :--------------------------------------------- | | Foreign Currency Translation Adjustments | $10.4 | $(0.2) | $10.2 | | Defined Benefit Obligations | $(0.4) | — | $(0.4) | | Unrealized Gain (Loss) on Available-for-Sale Securities | $(5.9) | $1.3 | $(4.6) | | Total | $4.1 | $1.1 | $5.2 | Note 11. Restructuring and Related Charges Lumentum recorded $11.0 million in restructuring and related charges for the three months ended September 30, 2023, an increase from $9.3 million in the prior year, primarily due to company-wide cost reduction initiatives and integration efforts from the NeoPhotonics merger | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :------------------------- | :------------------------------------------ | :----------------------------------------- | | Balance as of beginning of period | $5.0 | — | | Charges | $11.0 | $9.3 | | Payments | $(6.7) | $(6.2) | | Balance as of end of period | $9.3 | $3.1 | - Restructuring charges in Q3 2023 were primarily due to company-wide cost reduction initiatives and integration efforts from the NeoPhotonics merger[124] Note 12. Income Taxes Lumentum recorded a tax benefit of $1.4 million for the three months ended September 30, 2023, a significant change from a $19.2 million tax provision in the prior year, primarily due to changes in prior year uncertain tax positions, partially offset by stock-based compensation tax expenses and foreign return to provision differences | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | | Income tax provision (benefit) | $(1.4) | $19.2 | - The tax benefit in Q3 2023 was primarily related to a discrete tax benefit from changes in prior year uncertain tax positions, partially offset by tax expenses related to stock-based compensation and foreign return to provision differences[128] - Unrecognized tax benefits totaled $59.5 million as of September 30, 2023, with an expected decrease of $1.9 million over the next 12 months due to the expiration of the statute of limitations[130] Note 13. Equity As of September 30, 2023, Lumentum had 4.6 million shares subject to RSUs and PSUs under the 2015 Plan, with 0.4 million shares available for grant, and total stock-based compensation expense decreased to $32.1 million for the quarter, down from $46.6 million in the prior year, partly due to lower acquisition-related stock-based compensation - As of September 30, 2023, 4.6 million shares were subject to restricted stock units (RSUs) and performance stock units (PSUs) under the 2015 Plan, with 0.4 million shares available for grant[132] | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | | Cost of sales | $6.0 | $5.5 | | Research and development | $10.3 | $9.6 | | Selling, general and administrative | $15.8 | $31.5 | | Total stock-based compensation | $32.1 | $46.6 | - Approximately $219.3 million of stock-based compensation cost related to RSU awards remains to be amortized over an estimated period of 2.3 years[143] Note 14. Commitments and Contingencies Lumentum's purchase obligations totaled $395.0 million as of September 30, 2023, primarily for inventory, and the company maintains product warranty reserves, which decreased to $5.5 million from $6.8 million, while being involved in various legal proceedings, including the Oclaro Merger Litigation, which received preliminary settlement approval in August 2023 - Purchase obligations amounted to $395.0 million as of September 30, 2023, representing legally binding commitments primarily for inventory[149] | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :------------------------- | :------------------------------------------ | :----------------------------------------- | | Balance as of beginning of period | $6.8 | $10.0 | | Provision for warranty | $0.2 | $1.5 | | Utilization of reserve | $(1.5) | $(2.1) | | Balance as of end of period | $5.5 | $10.1 | - The Oclaro Merger Litigation, a class action, received preliminary approval for a class-wide settlement in August 2023, with defendants intending to vigorously defend if the settlement does not proceed[158] Note 15. Operating Segments and Geographic Information Lumentum reorganized its reportable segments to Cloud & Networking and Industrial Tech in fiscal Q1 2024, with net revenue decreasing by 37.3% YoY to $317.6 million, Cloud & Networking revenue down 36.2% and Industrial Tech down 40.1%, and total segment profit decreasing by 77.0% YoY to $39.2 million, while Asia-Pacific remains the largest revenue region (68.9%) - Lumentum reorganized its operating segments to Cloud & Networking and Industrial Tech in fiscal Q1 2024, evaluating performance based on segment revenue and segment profit[161][162] | Segment | Net Revenue (Sep 30, 2023, in millions) | Net Revenue (Oct 1, 2022, in millions) | Change (in millions) | Percentage Change | | :---------------- | :-------------------------------------- | :------------------------------------- | :------------------- | :---------------- | | Cloud & Networking | $229.7 | $360.1 | $(130.4) | (36.2)% | | Industrial Tech | $87.9 | $146.7 | $(58.8) | (40.1)% | | Total Net Revenue | $317.6 | $506.8 | $(189.2) | (37.3)% | | Region | Net Revenue (Sep 30, 2023, in millions) | % of Total (Sep 30, 2023) | Net Revenue (Oct 1, 2022, in millions) | % of Total (Oct 1, 2022) | | :---------------- | :-------------------------------------- | :------------------------ | :------------------------------------- | :------------------------ | | Americas | $66.0 | 20.8% | $122.0 | 24.1% | | Asia-Pacific | $219.0 | 68.9% | $336.5 | 66.4% | | EMEA | $32.6 | 10.3% | $48.3 | 9.5% | | Total | $317.6 | 100.0% | $506.8 | 100.0% | Note 16. Revenue Recognition Lumentum disaggregates revenue by segment and geography, with Cloud & Networking accounting for 72.3% of net revenue and Industrial Tech for 27.7% for the three months ended September 30, 2023, while accounts receivable decreased by 10.6% and deferred revenue decreased by 23.8% QoQ | Segment | Amount (Sep 30, 2023, in millions) | % of Total (Sep 30, 2023) | Amount (Oct 1, 2022, in millions) | % of Total (Oct 1, 2022) | | :---------------- | :----------------------------------- | :------------------------ | :---------------------------------- | :------------------------ | | Cloud & Networking | $229.7 | 72.3% | $360.1 | 71.1% | | Industrial Tech | $87.9 | 27.7% | $146.7 | 28.9% | | Net revenue | $317.6 | 100.0% | $506.8 | 100.0% | | Contract Balance | Sep 30, 2023 (in millions) | Jul 1, 2023 (in millions) | Change (in millions) | Percentage Change | | :-------------------------------- | :------------------------- | :------------------------ | :------------------- | :---------------- | | Accounts receivable, net | $220.0 | $246.1 | $(26.1) | (10.6)% | | Deferred revenue and customer deposits | $1.6 | $2.1 | $(0.5) | (23.8)% | Note 17. Subsequent Event On November 7, 2023, Lumentum completed the acquisition of Cloud Light Technology Limited for approximately $750.0 million, with $706.6 million paid in cash, aiming to strengthen Lumentum's position in cloud and networking markets, particularly for AI/ML data center infrastructure - Completed the acquisition of Cloud Light Technology Limited on November 7, 2023, for approximately $750.0 million, with $706.6 million paid in cash[177] - The acquisition is expected to position Lumentum to serve the growing needs of cloud and networking customers, particularly those focused on optimizing data center infrastructure for AI/ML[177] - Incurred $3.7 million of transaction costs related to the Cloud Light acquisition during the three months ended September 30, 2023[178] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on Lumentum's financial condition and results of operations for the three months ended September 30, 2023, covering an overview of the business, recent mergers and acquisitions, supply chain challenges, critical accounting policies, and a detailed analysis of revenue, gross margin, segment profit, operating expenses, interest, and taxes, concluding with a discussion of liquidity and cash flows Forward-Looking Statements This section contains forward-looking statements regarding Lumentum's markets, products, strategy, and financial performance, which are subject to risks and uncertainties that could cause actual results to differ materially - This Quarterly Report contains forward-looking statements regarding Lumentum's markets, industry, products, strategy, and financial results, which are subject to risks, uncertainties, and other important factors[182] Overview Lumentum is a leading provider of optical and photonic products, benefiting from long-term trends in data growth, precision manufacturing, and 3D sensing, reorganizing its segments to Cloud & Networking and Industrial Tech in fiscal Q1 2024 to better align with market and customer trends, and now evaluates segment performance based on segment profit - Lumentum is an industry-leading provider of optical and photonic products for manufacturing, inspection, and life-science applications[183] - The company's markets are driven by robust, long-term trends including increasing data flow in optical networks and data centers, demand for precision manufacturing, and growth in 3D sensing and LiDAR applications[184] - In fiscal Q1 2024, Lumentum reorganized its operating segments to Cloud & Networking and Industrial Tech, and now evaluates segment performance based on segment profit, which includes directly managed operating expenses[186][187] Merger and Acquisition Lumentum completed the acquisition of Cloud Light Technology Limited on November 7, 2023, for approximately $750.0 million, aiming to strengthen its position in cloud and networking for AI/ML data center infrastructure, and continuously evaluates strategic opportunities to expand markets and diversify its product portfolio - Completed the acquisition of Cloud Light Technology Limited on November 7, 2023, for approximately $750.0 million, with $706.6 million paid in cash[193] - The Cloud Light acquisition is expected to position Lumentum to serve the growing needs of cloud and networking customers, particularly those focused on optimizing their data center infrastructure for AI/ML[193] - Lumentum continuously evaluates strategic opportunities to acquire additional businesses, products, or technologies that are complementary or broaden its markets[195] Supply Chain Constraints and Inventory Management Lumentum's business has been negatively impacted by global supply chain issues, including semiconductor component shortages, which led to increased procurement costs and customer inventory build-up, resulting in reduced customer orders and is expected to continue impacting the business through the end of calendar year 2023 - Lumentum's business and customers have been negatively impacted by worldwide logistics and supply chain issues, including semiconductor component shortages[196] - Due to global supply chain constraints, Lumentum incurred incremental supply and procurement costs to fulfill customer demands[196] - Customer orders have declined as customers manage down accumulated inventory, a trend expected to continue through the end of calendar year 2023[197] Critical Accounting Policies and Estimates Lumentum's financial statements rely on critical accounting policies and estimates, including inventory valuation, revenue recognition, income taxes, business combinations, and goodwill/intangible asset impairment, with no significant changes to these policies occurring during the three months ended September 30, 2023 - Critical accounting policies and estimates include Inventory Valuation, Revenue Recognition, Income Taxes, Business Combinations, and Goodwill and Intangible Assets - Impairment Assessment[199] - There have been no significant changes to these critical accounting policies during the three months ended September 30, 2023[199] Recently Issued Accounting Pronouncements This section refers to Note 2 for details on recently issued accounting pronouncements, which includes the adoption of ASU 2020-06 simplifying convertible instrument accounting - Refer to Note 2. Recently Issued Accounting Pronouncements in the notes to condensed consolidated financial statements for details[200] Results of Operations Lumentum's net revenue decreased by 37.3% year-over-year to $317.6 million for the three months ended September 30, 2023, with gross margin significantly declining to 24.1% from 39.7% in the prior year, and the company reported an operating loss of $80.8 million, a substantial decrease from an operating income of $13.5 million in the prior year | Metric | September 30, 2023 | October 1, 2022 | | :------------------------------------------ | :----------------- | :-------------- | | Net revenue | 100.0% | 100.0% | | Cost of sales | 70.2% | 55.8% | | Amortization of acquired developed intangibles | 5.7% | 4.5% | | Gross profit | 24.1% | 39.7% | | Research and development | 23.1% | 14.3% | | Selling, general and administrative | 23.0% | 20.9% | | Restructuring and related charges | 3.5% | 1.8% | | Total operating expenses | 49.6% | 37.0% | | Income (loss) from operations | (25.4)% | 2.7% | | Interest expense | (3.0)% | (1.7)% | | Other income, net | 6.7% | 2.7% | | Income (loss) before income taxes | (21.8)% | 3.7% | | Income tax provision (benefit) | (0.4)% | 3.8% | | Net loss | (21.4)% | (0.1)% | Net Revenue Net revenue decreased by $189.2 million (37.3%) year-over-year to $317.6 million, driven by reductions in both Cloud & Networking (36.2%) and Industrial Tech (40.1%) segments, primarily attributed to customer inventory management and build-up, as well as increased market competition in Industrial Tech | Segment | Net Revenue (Sep 30, 2023, in millions) | Net Revenue (Oct 1, 2022, in millions) | Change (in millions) | Percentage Change | | :---------------- | :-------------------------------------- | :------------------------------------- | :------------------- | :---------------- | | Cloud & Networking | $229.7 | $360.1 | $(130.4) | (36.2)% | | Industrial Tech | $87.9 | $146.7 | $(58.8) | (40.1)% | | Total Net Revenue | $317.6 | $506.8 | $(189.2) | (37.3)% | - The decrease in Cloud & Networking net revenue is primarily due to reduction in demand associated with inventory management and build-up at customers[204] - The decrease in Industrial Tech net revenue is primarily due to higher market competition and reduction in demand associated with customer inventory management[204] Revenue by Region Asia-Pacific remained the largest revenue region, accounting for 68.9% of total net revenue, despite a decrease from $336.5 million to $219.0 million year-over-year, while Americas' revenue also declined significantly from $122.0 million to $66.0 million | Region | Net Revenue (Sep 30, 2023, in millions) | % of Total (Sep 30, 2023) | Net Revenue (Oct 1, 2022, in millions) | % of Total (Oct 1, 2022) | | :---------------- | :-------------------------------------- | :------------------------ | :------------------------------------- | :------------------------ | | Americas | $66.0 | 20.8% | $122.0 | 24.1% | | Asia-Pacific | $219.0 | 68.9% | $336.5 | 66.4% | | EMEA | $32.6 | 10.3% | $48.3 | 9.5% | | Total | $317.6 | 100.0% | $506.8 | 100.0% | - Net revenue from customers outside the United States represented 87.1% of total net revenue for the three months ended September 30, 2023[208] Gross Margin Gross margin decreased significantly to 24.1% for the three months ended September 30, 2023, from 39.7% in the prior year, primarily due to lower revenue, a less profitable product mix (especially lower sales of higher-margin imaging and sensing products), an $11.3 million increase in inventory excess and obsolescence charges, and factory underutilization - Gross margin decreased to 24.1% for the three months ended September 30, 2023, from 39.7% for the three months ended October 1, 2022[210] - The decrease was driven by lower revenue, a less profitable product mix (lower sales of higher margin imaging and sensing products), an $11.3 million increase in inventory excess and obsolescence charges, and factory underutilization[210] Segment Profit Total segment profit decreased by $131.3 million (77.0%) year-over-year to $39.2 million, with Cloud & Networking segment profit decreasing by 76.5% due to lower revenue and factory underutilization, while Industrial Tech segment profit decreased by 77.8% due to a less profitable product mix and increased inventory charges | Segment | Segment Profit (Sep 30, 2023, in millions) | Segment Profit (Oct 1, 2022, in millions) | Change (in millions) | Percentage Change | | :---------------- | :----------------------------------------- | :---------------------------------------- | :------------------- | :---------------- | | Cloud & Networking | $23.9 | $101.7 | $(77.8) | (76.5)% | | Industrial Tech | $15.3 | $68.8 | $(53.5) | (77.8)% | | Total Segment Profit | $39.2 | $170.5 | $(131.3) | (77.0)% | - Cloud & Networking segment profit decreased primarily due to lower revenue and negative impact from factory underutilization[213] - Industrial Tech segment profit decreased primarily due to a less profitable mix of products, including lower sales of higher margin imaging and sensing products, and increased inventory excess and obsolescence charges[213] Research and Development ("R&D") R&D expense remained relatively consistent year-over-year, increasing slightly by $0.8 million (1.1%) to $73.5 million, as Lumentum plans to continue investing in R&D to differentiate products despite macroeconomic challenges | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | Change (in millions) | Percentage Change | | :------------------------- | :------------------------------------------ | :----------------------------------------- | :------------------- | :---------------- | | Research and development | $73.5 | $72.7 | $0.8 | 1.1% | - Lumentum plans to continue investing in R&D and new products to further differentiate itself in the marketplace, despite a challenging macroeconomic environment[215] Selling, General and Administrative ("SG&A") SG&A expense decreased by $32.7 million (30.9%) year-over-year to $73.0 million, primarily driven by $15.7 million lower stock-based compensation and $12.5 million lower acquisition-related costs, largely due to the NeoPhotonics merger in the prior year | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | Change (in millions) | Percentage Change | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | :------------------- | :---------------- | | Selling, general and administrative | $73.0 | $105.7 | $(32.7) | (30.9)% | - The decrease in SG&A expense was primarily driven by $15.7 million of lower stock-based compensation and $12.5 million of lower acquisition-related costs, mainly due to the NeoPhotonics merger in the prior year[216] Restructuring and Related Charges Restructuring and related charges increased to $11.0 million for the three months ended September 30, 2023, from $9.3 million in the prior year, mainly due to company-wide cost reduction initiatives and integration efforts from the NeoPhotonics merger | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | Change (in millions) | Percentage Change | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | :------------------- | :---------------- | | Restructuring and related charges | $11.0 | $9.3 | $1.7 | 18.3% | - Charges in Q3 2023 were primarily due to company-wide cost reduction initiatives and integration efforts from the NeoPhotonics merger[219] Interest Expense Interest expense increased to $9.7 million for the three months ended September 30, 2023, from $8.5 million in the prior year, primarily due to the issuance of the 2029 Notes in June 2023 | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :---------------- | :------------------------------------------ | :----------------------------------------- | | Interest expense | $9.7 | $8.5 | - The increase in interest expense is due to the issuance of the 2029 Notes in June 2023[221] Other Income, Net Other income, net, increased by $7.4 million year-over-year to $21.2 million, driven by a $16.9 million increase in interest and investment income due to higher interest rates, partially offset by a $9.5 million decrease in foreign exchange gains | Component | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | Change (in millions) | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | :------------------- | | Foreign exchange gains (losses), net | $(0.5) | $9.0 | $(9.5) | | Interest and investment income | $21.7 | $4.8 | $16.9 | | Total other income, net | $21.2 | $13.8 | $7.4 | - The increase in other income, net, was primarily due to a $16.9 million increase in interest and investment income, driven by higher interest rates on fixed income securities[222] Provision (Benefit) for Income Taxes Lumentum recorded a tax benefit of $1.4 million for the three months ended September 30, 2023, compared to a tax provision of $19.2 million in the prior year, primarily due to a discrete tax benefit from changes in prior year uncertain tax positions | Metric | Three Months Ended Sep 30, 2023 (in millions) | Three Months Ended Oct 1, 2022 (in millions) | | :-------------------------------- | :------------------------------------------ | :----------------------------------------- | | Income tax provision (benefit) | $(1.4) | $19.2 | - The tax benefit in Q3 2023 includes a discrete tax benefit of $1.8 million primarily related to changes in prior year uncertain tax positions[223] Financial Condition Lumentum's financial condition as of September 30, 2023, shows strong liquidity with $861.6 million in cash and cash equivalents and $1,082.7 million in short-term investments, with contractual obligations totaling $3,404.7 million, including significant convertible note principal and interest payments, and cash flows for the quarter were slightly positive, driven by investing activities Liquidity and Capital Resources As of September 30, 2023, Lumentum had $861.6 million in cash and cash equivalents and $1,082.7 million in short-term investments, primarily held in the United States, and the company believes its current liquidity and operating cash flows will be sufficient for at least the next 12 months, but acknowledges potential needs for additional capital for growth and acquisitions | Metric | Sep 30, 2023 (in millions) | Jul 1, 2023 (in millions) | | :------------------------- | :------------------------- | :------------------------ | | Cash and cash equivalents | $861.6 | $859.0 | | Short-term investments | $1,082.7 | $1,154.6 | - Lumentum intends to indefinitely reinvest funds held outside the United States, except for certain locations, to avoid potential material repatriation taxes[229] - The company believes that its cash and cash equivalents and cash flows from operating activities will be sufficient to meet liquidity and capital spending requirements for at least the next 12 months[230] Contractual Obligations As of September 30, 2023, Lumentum's total contractual obligations amounted to $3,404.7 million, with $720.5 million due within one year, including significant principal and interest payments on convertible notes, as well as purchase obligations and operating lease liabilities | Obligation | Total (in millions) | Less than 1 year (in millions) | More than 1 year (in millions) | | :-------------------------------- | :------------------ | :----------------------------- | :----------------------------- | | Asset retirement obligations | $7.5 | — | $7.5 | | Operating lease liabilities | $62.8 | $15.3 | $47.5 | | Pension plan contributions | $2.2 | $2.2 | — | | Purchase obligations | $395.0 | $360.6 | $34.4 | | Convertible notes - principal | $2,837.8 | $323.1 | $2,514.7 | | Convertible notes - interest | $99.4 | $19.3 | $80.1 | | Total | $3,404.7 | $720.5 | $2,684.2 | Indebtedness Lumentum's convertible notes include 2029 Notes ($603.7M principal), 2028 Notes ($861.0M principal), 2026 Notes ($1,050.0M principal), and 2024 Notes ($323.1M principal), with the 2024 Notes classified as current liabilities due to their March 2024 maturity, and the other notes are non-current but could become current if specific stock price conversion thresholds are met - The 2024 Notes ($323.1 million principal) are presented in current liabilities as they mature on March 15, 2024[235] - The 2029, 2028, and 2026 Notes are non-current but could be reclassified to current liabilities if the stock price exceeds 130% of their respective conversion prices for 20 trading days in a fiscal quarter[232][233][234] Share Buyback Program Lumentum has a share buyback program authorizing up to $1.2 billion through May 2025, with $569.6 million remaining as of September 30, 2023, and no shares were repurchased during the three months ended September 30, 2023, but 0.3 million shares were repurchased for $25.7 million in the prior year period - Lumentum has a share buyback program authorizing up to $1.2 billion to purchase common stock through May 2025, with $569.6 million remaining as of September 30, 2023[236] - No shares were repurchased during the three months ended September 30, 2023. In the prior year period, 0.3 million shares were repurchased for $25.7 million[236] Unrecognized Tax Benefits Unrecognized tax benefits for uncertain tax positions totaled $59.5 million as of September 30, 2023, and the company cannot reliably estimate the timing of future payments related to these positions - Unrecognized tax benefits for uncertain tax positions totaled $59.5 million as of September 30, 2023[238] - The company is unable to reliably estimate the timing of future payments related to uncertain tax positions[238] Cash Flows Cash and cash equivalents increased by $2.6 million in Q3 2023, with operating activities using $2.3 million cash, investing activities providing $17.8 million (net proceeds from short-term investments), and financing activities using $12.9 million (tax payments for stock settlement) - Cash and cash equivalents increased by $2.6 million, from $859.0 million to $861.6 million, during the three months ended September 30, 2023[239] - Operating activities used $2.3 million cash, reflecting a net loss offset by non-cash items and changes in operating assets and liabilities[240] - Investing activities provided $17.8 million cash, primarily from net proceeds from sales or maturities of short-term investments, partially offset by capital expenditures[242] - Financing activities used $12.9 million cash, attributable to tax payments related to net share settlement of restricted stock units[244] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section outlines Lumentum's exposure to various market risks, including foreign exchange risk due to international operations, equity price risk from convertible notes, interest rate fluctuation risk on its investment portfolio, and bank liquidity risk from cash holdings in financial institutions Foreign Exchange Risk Lumentum is exposed to foreign exchange risk due to international operations and expenses denominated in various foreign currencies, recording a net foreign exchange loss of $0.5 million in Q3 2023, a shift from a $9.0 million gain in Q3 2022, reflecting currency volatility - Lumentum recorded a net foreign exchange loss of $0.5 million for the three months ended September 30, 2023, compared to a net foreign exchange gain of $9.0 million in the prior year period[245] - Foreign currency exchange risks are related to expenses denominated principally in Chinese Yuan, Canadian Dollar, Thai Baht, Japanese Yen, UK Pound, Swiss Franc, Euro, and Brazilian Real[246] Equity Price Risk Lumentum is exposed to equity price risk from the conversion options embedded in its convertible notes (2029, 2028, 2026, and 2024 Notes), where fluctuations in the company's stock price affect the potential value of shares distributed upon conversion - Lumentum is exposed to equity price risk related to the conversion options embedded in its convertible notes (2029, 2028, 2026, and 2024 Notes)[247][248] - The potential value of the shares to be distributed to the holders of convertible notes changes when the market price of Lumentum's stock fluctuates[248] Interest Rate Fluctuation Risk Lumentum's investment portfolio of $1,944.3 million (cash, cash equivalents, short-term investments) is subject to interest rate fluctuations, where a hypothetical 1% change in interest rates would impact the fair value of the portfolio by approximately $6.8 million - As of September 30, 2023, Lumentum had cash, cash equivalents, and short-term investments totaling $1,944.3 million[249] - A hypothetical increase or decrease in interest rates of 1% (100 basis points) would result in a decrease or an increase in the fair value of the investment portfolio of approximately $6.8 million[250] Bank Liquidity Risk Lumentum holds $156.3 million in unrestricted cash in operating accounts with domestic and international financial institutions, exposing it to bank liquidity risk, where failures of these institutions could impact liquidity, investment portfolio value, and supply chain operations - As of September 30, 2023, Lumentum had approximately $156.3 million of unrestricted cash in operating accounts held with domestic and international financial institutions[251] - Cash balances could be lost or become inaccessible if underlying financial institutions fail or are unable to meet liquidity requirements, potentially impacting operations, investment portfolio value, and supply chain[251] Item 4. Controls and Procedures This section details Lumentum's evaluation of its disclosure controls and procedures, confirming their effectiveness as of September 30, 2023, and states that there were no material changes in internal control over financial reporting during the quarter, while acknowledging the inherent limitations of any control system Evaluation of Disclosure Controls and Procedures Management, including the CEO and CFO, concluded that Lumentum's disclosure controls and procedures were effective as of September 30, 2023, providing reasonable assurance that required information is recorded, processed, summarized, and reported timely - Management concluded that Lumentum's disclosure controls and procedures were effective as of September 30, 2023[253] Changes in Internal Control over Financial Reporting There were no changes in Lumentum's internal control over financial reporting during the quarter ended September 30, 2023, that materially affected, or are reasonably likely to materially affect, its internal control over financial reporting - No changes in internal control over financial reporting occurred during the quarter ended September 30, 2023, that materially affected or are reasonably likely to materially affect it[254] Inherent Limitations on Effectiveness of Controls Management acknowledges that disclosure controls and internal control over financial reporting can only provide reasonable, not absolute, assurance due to inherent limitations such as resource constraints and the need to balance benefits against costs - Management recognizes that disclosure controls and internal control over financial reporting can provide only reasonable, not absolute, assurance due to inherent limitations and resource constraints[255] PART II - OTHER INFORMATION Item 1. Legal Proceedings Lumentum is subject to various legal proceedings and claims in the ordinary course of business, and while management believes these will not have a material adverse impact on financial position, an unfavorable outcome could have a material adverse effect, with specific details referenced in Note 14 - Lumentum is subject to a variety of claims and suits that arise from time to time in the ordinary course of business[258] - Management believes that resolving claims against the company, individually or in the aggregate, will not have a material adverse impact on financial position, results of operations, or cash flows, but acknowledges inherent uncertainties[258] Oclaro Merger Litigation The Karri Lawsuit, a class action challenging the 2018 Oclaro merger, received preliminary approval for a class-wide settlement in August 2023, and defendants intend to vigorously defend the lawsuit if the settlement does not proceed - The Karri Lawsuit, a class action challenging the 2018 Oclaro merger, received preliminary approval for a class-wide settlement on August 17, 2023[158] - Defendants intend to continue to defend the Karri Lawsuit vigorously if the settlement does not go forward for any reason[158] Item 1A. Risk Factors This section details the significant risks and uncertainties that could adversely affect Lumentum's business, financial condition, results of operations, and stock price, spanning macroeconomic conditions, supply chain dependencies, intense competition, international operations, strategic transactions, human capital management, legal and regulatory compliance, and factors specific to the company's common stock Risk Factor Summary Investing in Lumentum's common stock involves a high degree of risk, including those related to unfavorable economic conditions, reliance on limited suppliers and customers, supply chain constraints, intense competition, international operations, strategic transactions, human capital, legal/regulatory compliance, and stock price volatility - Investing in Lumentum's common stock involves a high degree of risk, including those related to unfavorable economic and market conditions, reliance on limited suppliers and customers, and challenges relating to supply chain constraints[260][261][262] - Key risks also include changes in technology and intense competition, the ability to sell to significant customers (e.g., U.S.-China trade restrictions), international operations, strategic transactions, human capital, legal/regulatory compliance, and volatility of common stock trading price[262][263][265] Risks Related to Our Business Lumentum's business faces risks from volatile macroeconomic conditions, including inflation and geopolitical instability, which can decrease demand and increase costs, while dependence on a limited number of suppliers and customers, along with intense competition and rapid technological change, further impacts revenue and profitability, and supply chain constraints and customer inventory adjustments continue to pose challenges - Operating results may be adversely affected by unfavorable changes in macroeconomics and market conditions and the uncertain geopolitical environment, leading to decreased demand and increased costs[266][267] - Dependence on a limited number of suppliers for raw materials, packages, and components poses risks of supply failures, delays, quality issues, and increased costs[268] - Intense competition and rapidly changing technology require continuous innovation and cost control; failure to do so may result in decreased revenues and profitability[277][278] - Reliance on a limited number of customers, many without contractual purchase commitments, makes revenue forecasting difficult and exposes the company to risks from order cancellations, delays, and inventory adjustments[279][280] - Restrictions on selling products to significant customers, particularly in China (e.g., Huawei), due to export controls and trade tensions, negatively impact revenue and may lead to excess and obsolete inventory charges[281][282][284] - International operations expose the company to economic, business, regulatory, social, and political conditions in foreign countries, including currency fluctuations, trade protection laws, and geopolitical unrest[286][287] Risks Related to Human Capital Lumentum's success depends on its ability to recruit and retain key personnel, especially engineers and sales staff, in a highly competitive talent market, and changes in immigration laws could also negatively impact the ability to hire and retain foreign national employees - Future success depends on the ability to recruit and retain executive, engineering, manufacturing, sales, marketing, and support personnel in a highly competitive market[347] - Changes in immigration laws, regulations, and procedures may adversely affect the ability to hire or retain foreign national workers, increasing operating expenses and negatively impacting product delivery[348] Risks Related to Legal, Regulatory and Compliance Lumentum faces risks from export control laws, requiring government authorization for product exports, and potential legal and regulatory consequences for non-compliance, and the company is also subject to evolving social and environmental responsibility regulations (ESG), privacy and data protection laws (GDPR, CCPA), and conflict mineral disclosure requirements, which can increase costs and impact reputation - Exports of certain products are subject to U.S. government export controls, requiring pre-shipment authorization, and failure to obtain licenses could limit sales and negatively impact business[350][351] - Increased focus on environmental, social, and governance (ESG) matters and evolving regulations (e.g., climate change, conflict minerals) may increase compliance costs, impact customer relationships, and affect reputation[355][359][361] - Subject to global privacy and data protection laws (e.g., GDPR, CCPA, CPRA), which are frequently modified and require ongoing compliance efforts, potentially leading to increased costs and penalties for non-compliance[363][364][366] Risks Related to Our Common Stock Lumentum's stock price is volatile due to various factors, including economic conditions, market speculation, and operating performance, and servicing existing and future indebtedness, particularly convertible notes, requires significant cash flow and may limit operating flexibility, while potential conversion of convertible notes could dilute existing stockholders' ownership, and the company does not expect to pay dividends in the foreseeable future - Lumentum's common stock price may be volatile and decline regardless of operating performance due to general economic and market conditions, fluctuations in operating results, and external factors[367][368] - Servicing existing and future indebtedness, inc